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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




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FORM 10-K

(Mark
One)

x ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF


THE SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended December 31,
2002

OR

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934


Commission file number: 1-6388



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(RJ REYNOLDS LOGO)

(Exact name of registrant as specified in its
charter)


|                                                                   |  |                                        
|------------------------------------------------------------------ |  | ---------------------------------------
|Delaware                                                           |  | 56-0950247                             
|(State or other jurisdiction of incorporation or
    organization) |  | (I.R.S. Employer Identification Number)

401 North Main Street

Winston-Salem, NC 27102-2866


(Address of principal executive offices) (Zip
Code)


(336) 741-5500

(Registrants telephone number, including
area code)




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Securities registered pursuant to
Section 12(b) of the Act:

|                                       |  |                   |          |                     |  |                                      |  |  |          | 
|-------------------------------------- |  | ----------------- | -------- | ------------------- |  | ------------------------------------ |  |  | -------- | 
|                                       |  | Name of each      |          |                     |  | Name of each                        
|                                       |  | exchange on which |          |                     |  | exchange on which                   
|Title of each class                    |  | registered        |          | Title of each class |  | registered                          
|                                       |  |                   |          |                     |  |                                     
|Common stock, par value $.01 per share |  |                   | New York |                     |  | 8 3/4 Notes due August 15, 2005      |  |  | New York | 
|7 5/8 Notes due September 15, 2003     |  |                   | New York |                     |  | 8 3/4 Notes due July 15, 2007        |  |  | New York | 
|8 3/4 Senior Notes due April 15, 2004  |  |                   | New York |                     |  | 9 1/4 Debentures due August 15, 2013 |  |  | New York | 

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

Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past 90 days. YES x NO
o

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.
x

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the Act).

 YES x NO
o

The aggregate market value of common stock held
by non-affiliates of R.J. Reynolds Tobacco Holdings, Inc. on
June 28, 2002 was approximately $4.8 billion, based on the
closing price of $53.75. Certain directors of R.J. Reynolds
Tobacco Holdings, Inc. are considered affiliates for purposes of
this calculation but should not necessarily be deemed affiliates
for any other purpose.

Indicate the number of shares outstanding of each
of the registrants classes of common stock, as of the
latest practicable date: February 4, 2003: 84,849,600
shares of common stock, par value $.01 per share.

Documents Incorporated by Reference:

Portions of the Definitive Proxy Statement of
R.J. Reynolds Tobacco Holdings, Inc. to be filed with the
Securities and Exchange Commission pursuant to
Regulation 14A of the Securities Exchange Act of 1934 on or
prior to March 19, 2003 are incorporated by reference into
Part III of this report.



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INDEX

|               |  |                                                                                           |     |  |     | 
|-------------- |  | ----------------------------------------------------------------------------------------- | --- |  | --- | 
|Part I         |  |                                                                                           |     |  |     | 
|Item 1.        |  | Business                                                                                  |     |  | 3   | 
|Item 2.        |  | Properties                                                                                |     |  | 31  | 
|Item 3.        |  | Legal Proceedings                                                                         |     |  | 31  | 
|Item 4.        |  | Submission of Matters to a Vote of Security
    Holders                                   |     |  | 31  | 
|               |  | Executive Officers and Certain Significant
    Employees of the Registrant                |     |  | 31  | 
|              
|Part II        |  |                                                                                           |     |  |     | 
|Item 5.        |  | Market for Registrants Common Equity and
    Related Stockholder Matters                 |     |  | 34  | 
|Item 6.        |  | Selected Financial Data                                                                   |     |  | 35  | 
|Item 7.        |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations |     |  | 36  | 
|Item 7a.       |  | Quantitative and Qualitative Disclosures about
    Market Risk                            |     |  | 57  | 
|Item 8.        |  | Financial Statements and Supplementary Data                                               |     |  | 58  | 
|Item 9.        |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure  |     |  | 113 | 
|              
|Part III       |  |                                                                                           |     |  |     | 
|Item 10.       |  | Directors and Executive Officers of the Registrant                                        |     |  | 113 | 
|Item 11.       |  | Executive Compensation                                                                    |     |  | 113 | 
|Item 12.       |  | Security Ownership of Certain Beneficial Owners
    and Management                        |     |  | 113 | 
|Item 13.       |  | Certain Relationships and Related Transactions                                            |     |  | 113 | 
|Item 14.       |  | Controls and Procedures                                                                   |     |  | 113 | 
|              
|Part IV        |  |                                                                                           |     |  |     | 
|Item 15.       |  | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                      |     |  | 113 | 
|              
|Signatures     |  |                                                                                           | 122 | 
|              
|Certifications |  |                                                                                           | 123 | 

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PART I

Item 1. Business

R.J. Reynolds Tobacco Holdings, Inc. was
incorporated as a holding company in 1970, and is listed on the
NYSE as RJR. RJRs wholly owned subsidiaries include its
operating subsidiaries, R. J. Reynolds Tobacco Company, referred
to as RJR Tobacco, and Santa Fe Natural Tobacco Company, Inc.,
referred to as Santa Fe. RJR also wholly owns RJR Acquisition
Corp.

RJRs Internet website address is
www.RJRHoldings.com. RJRs annual report on
Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and all amendments to those reports are
available free of charge through its website, as soon as
reasonably practicable after such material is electronically
filed with, or furnished to, the SEC. RJRs Internet
website and the information contained therein or connected
thereto are not intended to be incorporated into this Annual
Report on Form 10-K.

RJR has one reportable operating segment, RJR
Tobacco, which is the second largest cigarette manufacturer in
the United States. RJR Tobaccos largest selling cigarette
brands, CAMEL, WINSTON, SALEM and DORAL, were four of the top
ten best-selling brands of cigarettes in the United States in
2002. Those brands, and its other brands, including VANTAGE,
MORE and NOW, are manufactured in a variety of styles and
marketed in the United States to meet a range of adult smoker
preferences.

During 1999, RJR and Nabisco Group Holdings
Corp., referred to as NGH, completed a series of transactions to
reorganize their businesses and capital structures. In May 1999,
RJR and RJR Tobacco sold the international tobacco business to
Japan Tobacco Inc. A portion of the proceeds from the sale of
the international tobacco business was used by RJR to repurchase
$4 billion of its debt. Additionally, RJR transferred $1.6
billion in cash proceeds, together with its 80.5% interest in
Nabisco Holdings Corp., referred to as Nabisco, to NGH through a
merger transaction. In June 1999, NGH distributed all of the
outstanding shares of RJR common stock to NGH common
stockholders of record as of May 27, 1999. Shares of RJR
began trading separately on June 15, 1999.

On December 11, 2000, RJR acquired its
former parent, NGH, a non-operating public shell company with no
material assets or liabilities other than $11.8 billion in cash.
RJR Acquisition Corp. paid $30 for each outstanding share of
NGH, or $9.8 billion in the aggregate, and was merged into NGH,
with NGH being the surviving corporation. After the merger, NGH
changed its name to RJR Acquisition Corp. Net cash proceeds to
RJR Acquisition Corp. were $1.5 billion, after transaction costs
and payments to NGH stockholders.

On January 16, 2002, RJR acquired, with
cash, 100% of the voting stock of privately held Santa Fe at a
cost of $354 million. Fiesta Acquisition Corp., a wholly owned
subsidiary of RJR, merged with and into Santa Fe, and Santa Fe,
being the surviving corporation, became a wholly owned operating
subsidiary of RJR. Santa Fe manufactures and markets cigarettes
and other tobacco products, under the NATURAL AMERICAN SPIRIT
brand, primarily in the United States. Although Santa Fe is an
operating segment of RJR, its financial condition and results of
operations do not meet the materiality criteria to be
reportable. As a result, information related to Santa Fe is not
generally disclosed separately in this document.

On July 16, 2002, RJR, through its wholly
owned subsidiary R. J. Reynolds Tobacco C.V., acquired a 50%
interest in R.J. Reynolds-Gallaher International Sarl, a joint
venture created with Gallaher Group Plc, to manufacture and
market a limited portfolio of American-blend cigarette brands.
The joint venture, headquartered in Switzerland, will initially
market its products in France, Spain, the Canary Islands and
Italy. RJRs financial contribution over the next five
years is expected to be $75 million to $100 million. As part of
the transaction, RJR Tobacco is licensing REYNOLDS, a new
American-blend brand in a unique Slide Box pack, to the joint
venture. This investment is accounted for using the equity
method.

RJR believes that the acquisition of NGH and
Santa Fe, and the joint venture with Gallaher Group Plc present
meaningful opportunities for RJR to build shareholder value. The
acquisition of NGH provided $1.5 billion of net cash proceeds to
RJR, which has funded RJRs share repurchase programs and
the acquisition of Santa Fe. Santa Fes approach to
building brand equity is consistent with RJR Tobaccos
strategy for its key brands, and the acquisition is expected to
enhance RJRs consolidated earnings. The joint venture
provides

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RJR an opportunity to compete in the growing
international American-blend market, and RJR believes the joint
venture will be accretive to RJRs earnings in three to
four years.


Industry Overview

U.S. cigarette shipments decreased at a compound
annual rate of 1.6% from 1987 through 1997. After declining 4.6%
in 1998 and 9% in 1999, shipments remained relatively stable in
2000, declined 3.2% in 2001 and declined 3.7%, to 391.4 billion
units in 2002. From December 1999 to December 2002, wholesale
cigarette prices of the major manufacturers increased $0.64 per
pack overall. The average wholesale list price of a pack of RJR
Tobaccos full-price brands was $2.45, $2.64 and $2.76 in
2000, 2001 and 2002, respectively.

Competition

Profitability of the U.S. cigarette industry and
RJR was adversely impacted during 2002, particularly in the
second half, by unprecedented increases in state excise taxes,
competitive promotional spending and deep-discount brand growth.
The premium, or full, price-tier was negatively impacted by
widening price gaps between those brands and the deep-discount
brands. For further discussion see  Business
Trends and Initiatives and  Governmental
Activity in Managements Discussion and
Analysis of Financial Condition and Results of Operations
in Item 7.

RJRs operating subsidiaries primarily
conduct business in the highly competitive U.S. market with
several large participants. Based on data collected by
Information Resources Inc./Capstone, during 2002, 2001 and 2000,
Philip Morris Incorporated had an overall retail share of the
U.S. market of 49.35%, 50.45%, and 50.37%, respectively. During
these same years, RJR Tobacco had an overall share of 22.93%,
23.42% and 23.58%, respectively, and the remaining participants
held lesser shares.

Competition is primarily based on a brands
products, positioning, consumer loyalty, retail display,
promotion, price and advertising. Substantial marketing support,
merchandising display and competitive pricing and other
financial incentives generally are required to maintain or
improve a brands market position or to introduce a new
brand.

Increased selling prices and higher cigarette
taxes have resulted in the growth of deep-discount brands and
competitive discounting. Deep-discount brands are
brands manufactured by manufacturers that are not original
participants in the Master Settlement Agreement, and
accordingly, do not have cost structures burdened with
MSA-related payments to the same extent as the original
participating manufacturers. The growth in market share of the
deep-discount brands has had, and will continue to have, an
adverse impact on the market share of the remaining industry
participants. For further information regarding the adverse
impact of price increases on RJR Tobaccos sales volume see
Managements Discussion and Analysis of Financial
Condition and Results of Operations  Results of
Operations in Item 7.

Established cigarette brands historically have
had a competitive advantage in the United States because
significant cigarette marketing restrictions made gaining
consumer awareness and trials of new brands difficult. RJR
Tobacco has repositioned or introduced brands designed to appeal
to adult smokers of competing brands in the United States, but
there can be no assurance that such efforts will be successful.
See  Marketing for further discussion of
RJR Tobaccos marketing efforts.

Strategy

RJR is focused on strengthening its core
businesses to enhance long-term shareholder value. RJRs
companies marketplace strategies are to:



| |   |                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Strengthen brand equity by offering adult smokers
    products, packaging and programs that reinforce brand loyalty
    and encourage adult smokers to switch to their brands; and
|
| |  | Defend their brands by maintaining a competitive
    price.                                                                                                                       

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Marketing

RJRs operating subsidiaries are committed
to building strong brands. On a combined basis,
RJR Tobaccos four key brands represent over 80% of
its volume and share of market. RJR Tobaccos marketing
programs are designed to strengthen each brands image,
build brand awareness and loyalty and attract adult smokers of
competing brands, primarily in an effort to grow share of market
on RJR Tobaccos four key brands. While the key
brands retail share of market on a combined basis was
relatively stable from 1999 through 2001, it declined .48 share
points in 2002. RJR Tobacco utilizes a two-fold approach to
market its key brands: build strong brand equity while
maintaining a competitive price. RJR Tobaccos competitive
pricing includes discounting programs, such as retail buydowns,
free product promotions and consumer coupons. Retail buydowns
refer to payments made to the retailer to reduce the price that
consumers pay at retail. Free product promotions include offers
such as Buy 2 packs, Get 1 pack free. Consumer
coupons are distributed in a variety of methods including in, or
on, the cigarette pack and direct mail.

In addition, RJR Tobacco provides trade
incentives through trade terms, wholesale partner programs and
retail display allowances. Trade discounts are provided to
wholesalers based on compliance with certain terms. The
wholesale partner programs provide incentives to RJR
Tobaccos direct buying customers based on performance
levels. Retail display allowances are paid to the retailer based
on compliance with RJR Tobaccos display terms.

The cost of these programs, with the exception of
free product promotions, are recorded as a reduction of net
sales in compliance with Emerging Issues Task Force Issue
No. 01-9. The cost of free product promotions is recorded
in cost of goods sold. To protect its key brands, RJR Tobacco
significantly increased promotional spending in the second half
of 2002, in response to heightened competitive spending. For
further information about pricing, net of discounting and new
programs and products, see Managements Discussion
and Analysis of Financial Condition and Results of
Operations  Results of Operations in
Item 7.

During 2002, CAMELs filtered styles
continued to grow based on the strength of the brands
equity, driven by its Pleasure to Burn positioning.
CAMELs share increased during the fourth quarter compared
to both the third quarter of 2002 and the fourth quarter of
2001, and CAMEL was one of the few full-price brands in the
industry to increase share in 2002. Initiatives launched in 2002
and prior years to actively market CAMELs three distinct
product families  the Classic, Turkish and
Exotic Blends  contributed to the brands
strong performance in 2002 and will be further leveraged in 2003
to support CAMELs continued growth.

Base WINSTONs 2002 share declined compared
with 2001; however, its share has remained relatively stable
since March of 2002, despite intense competitive price
pressures. In 2003, the brand is strengthening its brand equity
with a new Leave the Bull Behind marketing campaign.
WINSTON is the only leading national brand that offers adult
smokers additive-free, naturally smooth tobacco blends, and the
new campaign highlights that distinction.

SALEMs share declined in 2002, reflecting
reduced levels of in-market support, while the brand developed
new ideas to enhance its positioning. In the second quarter of
2003, the brand will launch a new Stir the Senses
campaign, distinctive packaging and expand the availability of
the Slide Box styles into additional markets. The Stir the
Senses campaign and new packaging communicate that SALEM offers
adult smokers a range of choices in menthol styles. The brand
has two distinct product lines: SALEM Green Label, with a
lighter menthol taste, and SALEM Black Label, with a richer
menthol-and-tobacco taste.

DORAL continues to hold the highest retail share
of the nations savings brand market. The brands 2002
average share of market was slightly below that of 2001, but
DORALs market share grew over the course of the year,
reversing its prior-year trend. DORALs renewed strength in
2002 reflects the impact of a comprehensive brand upgrade, which
featured new tobacco blends on key styles, contemporary new
packaging and imaginative Splendidly Blended
advertising, and increased promotional spending.

Additional RJR Tobacco full-price and
savings products are offered to meet the diverse preferences of
adult smokers. Other full-price brands include VANTAGE, MORE and
NOW. In the savings category, MONARCH, BEST VALUE and various
private-label brands are available for cost-conscious adult
smokers.

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In 2003, RJR Tobacco will begin a phased
expansion of ECLIPSE, a cigarette that primarily heats rather
than burns tobacco, into a select number of retail chain
outlets. Based on learning garnered from the ECLIPSE test market
in Dallas/Fort Worth since April 2000, where the brand built a
small  but loyal  franchise of adult
smokers, RJR Tobacco believes the brand has business
potential if it is selectively distributed and supported by
cost-efficient communications targeted to specific prospective
adult smokers. This move further underscores
RJR Tobaccos commitment to finding ways to develop
and market consumer-acceptable cigarettes that may present less
smoking-related health risk. RJR Tobacco has concluded that
ECLIPSE may present less risk for certain, but not all, smoking
related diseases, when compared with tobacco-burning cigarettes.
This conclusion is based on the weight of evidence from several
scientific studies conducted internally by RJR Tobacco and
externally by several universities, funded by RJR Tobacco,
and reviewed by an outside expert scientific panel.

RJR Tobacco continues to use advertisements
in magazines read primarily by adults, direct mailings to
age-verified adult smokers and other means to market its brands
and enhance their appeal among adult smokers. RJR Tobacco
continues to advertise and promote at retail cigarette locations
and in other adult venues where permitted. As a result of the
MSA and other federal, state and local legislative and
regulatory restrictions, RJR Tobacco does not utilize
television, radio or billboard advertising or certain other
marketing and promotional tools for cigarettes. See note 1 to
the consolidated financial statements and
Managements Discussion and Analysis of Financial
Condition and Results of Operations  Results of
Operations for further information.

During the year, Santa Fes NATURAL AMERICAN
SPIRIT brand grew share and volume, demonstrating the power of
the brands high-equity, premium positioning.

Anti-smoking groups have attempted to restrict
cigarette sales, cigarette advertising and the testing and
introduction of new cigarette products. The MSA, signed in late
1998, contains provisions restricting the marketing of
cigarettes. See  Litigation Affecting the
Cigarette Industry for further discussion of the MSA.

Manufacturing and
Distribution

RJR Tobacco owns both of its cigarette
manufacturing facilities, which are located in the
Winston-Salem, North Carolina area: Tobaccoville, a
two-million-square-foot facility constructed in 1985; and the
Whitaker Park complex, which includes a
one-and-one-half-million-square-foot plant,
RJR Tobaccos Central Distribution Center and a pilot
plant for trial manufacturing of new products. RJR Tobacco
has a combined production capacity of approximately 150 billion
cigarettes per year, and believes its cigarette manufacturing
facilities are technologically advanced.

RJR Tobacco sells its cigarettes primarily
to distributors, wholesalers and certain large retail stores,
which buy on a spot basis. RJR Tobacco distributes its
cigarettes primarily to public warehouses located throughout the
United States that serve as local distribution centers for its
customers. No significant backlog of orders existed at
December 31, 2002 or 2001.

Sales made by RJR Tobacco to McLane Company,
Inc. and its affiliate, Wal-Mart Stores, Inc., comprised 20% of
RJRs consolidated revenue in both 2002 and 2001 and 19% in
2000. No other customer accounted for 10% or more of RJRs
revenue during those years. RJR has a good relationship with
McLane Company and its affiliate, Wal-Mart Stores, Inc.
RJR Tobaccos sales to McLane are not governed by any
supply contract; however, McLane and RJR Tobacco are
parties to an arrangement, whereby RJR Tobacco observes the
vendors inventory to manage the supply and level of the
vendors inventory. McLane and RJR Tobacco also are
parties to certain contracts in which consideration is based on
the vendors compliance with specified performance levels
and incentive terms.

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Raw Materials

In its production of cigarettes, RJR Tobacco uses
burley and flue-cured leaf tobaccos, as well as Oriental
tobaccos grown primarily in Turkey and Greece. RJR Tobacco
believes there is a sufficient supply in the worldwide tobacco
market to satisfy its current and anticipated production
requirements.

Tobacco leaf supplies are obtained in auctions or
through short-term contracts, which are frequently renegotiated.
RJR Tobacco believes the relationship with its suppliers is
good. During 2002, RJR Tobacco contracted directly with tobacco
growers to purchase the majority of its U.S. flue-cured and
burley leaf. The cost of tobacco purchased by contract from
growers has not differed materially from that historically
purchased through the auction process.

RJR Tobacco has developed a simple, practical way
to reduce tobacco-specific nitrosamines, or TSNAs, by
approximately 90% in flue-cured tobacco. Since some scientists
believe that TSNAs are among the most potent carcinogenic
compounds found in cigarette smoke and unburned tobacco
products, RJR Tobacco is converting to the use of low-TSNA
flue-cured tobacco in its cigarette blends. RJR Tobacco
believes, however, that there is no scientific basis at this
time to conclude that reducing nitrosamines, or any other single
class of compounds, will reduce the risks associated with
smoking.

Tobacco leaf is an agricultural product subject
in the United States to government production controls and price
supports that can substantially affect market prices. The
tobacco leaf price support program is subject to congressional
review and may be changed at any time. In December 1994,
Congress enacted the Uruguay Round Agreements Act to replace a
domestic content requirement with a tariff rate quota system
that bases tariffs on import volumes. The tariff rate quotas
have been established by the United States with overseas tobacco
producers and became effective on September 13, 1995.

Research and Development

RJR Tobaccos research and development
activities are located in its technologically advanced Bowman
Gray Technical Center in its Whitaker Park complex. Scientists
and engineers continue to create more efficient methods of
preparing tobacco blends and new products, as well as develop
product enhancements and packaging that differentiate CAMEL,
WINSTON, SALEM, DORAL and other RJR Tobacco brands from
competitive brands. A major focus for research and development
activity is the development of products that may present less
risk associated with smoking. RJR Tobaccos research and
development expense for the years ended December 31, 2002,
2001 and 2000 was $63 million, $64 million and $58 million,
respectively.

Intellectual Property

RJRs operating subsidiaries own numerous
trademarks, including the brand names of their cigarettes and
the distinctive elements of their packaging and displays.
RJRs operating subsidiaries material trademarks are
registered with the U.S. Patent and Trademark Office. Rights in
these trademarks in the United States will last as long as
RJRs subsidiaries continue to use the trademarks. The
operating subsidiaries consider the blends and recipes used to
make each of their brands distinctive to be trade secrets. These
trade secrets are not patented.

RJR Tobacco sold most of its trademarks and
patents outside the United States in connection with the sale of
the international tobacco business to Japan Tobacco Inc. The
sale agreement granted Japan Tobacco the right to use certain of
RJR Tobaccos trade secrets outside the United States, but
details of the ingredients or formulae for flavors and the
blends of tobacco may not be provided to any sub-licensees or
sub-contractors. The agreement also prohibits Japan Tobacco and
its licensees and sub-licensees from the sale or distribution of
tobacco products of any description employing the purchased
trademarks and other intellectual property rights in the United
States.

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Legislation and Other Matters Affecting the
Cigarette Industry

The tobacco industry is subject to a wide range
of laws and regulations regarding the marketing, sale, taxation
and use of tobacco products imposed by local, state, federal and
foreign governments. Various state governments have adopted or
are considering, among other things, legislation and regulations
increasing their excise taxes on cigarettes; restricting
displays and advertising of tobacco products; establishing fire
safety standards for cigarettes; raising the minimum age to
possess or purchase tobacco products; requiring the disclosure
of ingredients used in the manufacture of tobacco products;
imposing restrictions on smoking in public and private areas and
restricting the sale of tobacco products directly to consumers
or other unlicensed recipients, including over the Internet. In
addition, in 2003, the U.S. Congress may consider legislation
regarding further increases in the federal excise tax,
regulation of cigarette manufacturing and sale by the U.S. Food
and Drug Administration, amendments to the Federal Cigarette
Labeling and Advertising Act to require additional warnings,
reduction or elimination of the tax deductibility of advertising
expenses, implementation of a national standard for
fire-safe cigarettes, regulation of the retail sale
of cigarettes over the Internet and changes to the tobacco
price-support program. Together with manufacturers price
increases in recent years and substantial increases in state and
federal excise taxes on cigarettes, these developments have had
and will likely continue to have an adverse effect on cigarette
sales. For further discussion of the regulatory and legislative
environment applicable to the cigarette business, see
Managements Discussion and Analysis of Financial
Condition and Results of
Operations  Governmental Activity in
Item 7.

Litigation Affecting the Cigarette
Industry

Overview

Introduction.Various legal actions, proceedings and
claims, including litigation claiming that lung cancer and other
diseases, as well as addiction, have resulted from the use of,
or exposure to, RJRs operating subsidiaries
products, are pending or may be instituted against RJR Tobacco
or its affiliates, including RJR, or indemnitees. During the
fourth quarter of 2002, 67 new cases were served against RJR
Tobacco or its affiliates, including RJR, or indemnitees, and 38
cases were dismissed or otherwise resolved without trial in
their favor. On December 31, 2002, there were 1,650 active
cases pending, including approximately 1,184 individual smoker
cases pending in West Virginia state court as a consolidated
action, as compared with 1,639 on December 31, 2001, and
1,664 on December 31, 2000. As of February 4, 2003,
1,541 active tobacco-related cases were pending against RJR
Tobacco and/or its affiliates or indemnitees: 1,530 in the
United States; eight in Puerto Rico; two in Israel; and one in
Canada. The U.S. case number does not include the 2,791 Broin
II cases, which involve individual flight attendants
alleging injuries as a result of exposure to environmental
tobacco smoke, referred to as ETS or secondhand smoke, in
aircraft cabins, pending as of February 4, 2003, and
discussed below.

The U.S. cases, exclusive of the Broin IIcases, are pending in 36 states and the District of
Columbia: 1,086 in West Virginia (nearly 100 cases were
dismissed in the West Virginia consolidated action between
December 31, 2002 and February 4, 2003); 98 in
Florida; 56 in California; 47 in New York; 41 in Mississippi; 27
in Nevada; 25 in Louisiana; 24 in Maryland; 15 in Alabama; 13 in
Iowa; 12 in Missouri; 8 in each of Illinois, Massachusetts and
New Jersey; 6 in each of the District of Columbia, Georgia and
Texas; 5 in each of Arizona and Tennessee; 4 in each of
Minnesota, Ohio and Pennsylvania; 3 in each of Connecticut and
New Hampshire; 2 in each of Kansas, South Carolina and South
Dakota; and 1 in each of Arkansas, Kentucky, Maine, Michigan,
North Carolina, North Dakota, New Mexico, Oregon, Utah and
Wisconsin. Of the 1,530 active U.S. cases, 138 are pending in
federal court, 1,390 in state court and 2 in tribal court.

The following table lists the categories of the
U.S. tobacco-related cases currently pending against RJR Tobacco
or its affiliates, including RJR, or indemnitees; the number of
cases relating to each case type pending as of February 4,
2003; the changes in the number of cases by case type since
October 14, 2002, the cut-off date used to calculate the number
of cases pending against RJR Tobacco or its affiliates or
indemnitees

8



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##### 



in RJRs Quarterly Report on Form 10-Q
for the quarter ended September 30, 2002; and a
cross-reference to the discussion of each case type.


|                                                          |  |             |       |             |  |           |           |  |  |  |    | 
|--------------------------------------------------------- |  | ----------- | ----- | ----------- |  | --------- | --------- |  |  |  | -- | 
|                                                          |  | Number of   |       | Change in   |  |          
|                                                          |  | Cases as    |       | Number of   |  |          
|                                                          |  | of          |       | Cases since |  |          
|                                                          |  | February 4, |       | October 14, |  | Page     
|Case Type                                                 |  | 2003        |       | 2002        |  | Reference
|                                                          |  |             |       |             |  |          
|Individual Smoking and Health                             |  |             | 1,377 |             |  |           | -91       |  |  |  | 15 | 
|Flight Attendant  ETS (Broin
    II)                     |  |             | 2,791 |             |  |           | -10       |  |  |  | 16 | 
|Class Action                                              |  |             | 49    |             |  |           | +15       |  |  |  | 17 | 
|Governmental Health-Care Cost Recovery                    |  |             | 33    |             |  |           | +1        |  |  |  | 19 | 
|Other Health-Care Cost Recovery and Aggregated
    Claims |  |             | 8     |             |  |           | -2        |  |  |  | 22 | 
|Master Settlement Agreement-Enforcement and
    Validity  |  |             | 7     |             |  |           | -1        |  |  |  | 23 | 
|Asbestos Contribution                                     |  |             | 5     |             |  |           | -3        |  |  |  | 23 | 
|Antitrust                                                 |  |             | 39    |             |  |           | +2        |  |  |  | 24 | 
|Other Litigation                                          |  |             | 12    |             |  |           | No Change |  |  |  | 25 | 

In July 2000, a jury in the Florida state court
case Engle v. R. J. Reynolds Tobacco Co.rendered a
punitive damages verdict in favor of the Florida
class of plaintiffs of approximately $145 billion, with
approximately $36.3 billion being assigned to RJR Tobacco. RJR
Tobacco and other defendants have appealed this verdict. Oral
argument occurred before Floridas Third District Court of
Appeal on November 6, 2002. An opinion from this
intermediate appellate court is expected in 2003. RJR Tobacco
believes it has numerous bases for a successful appeal, although
it cannot predict the outcome of the appellate process. See
 Class-Action Suits below for a further
description of the Englecase.

In November 1998, the major U.S. cigarette
manufacturers, including RJR Tobacco, entered into the MSA with
46 U.S. states and certain U.S. territories and possessions.
These cigarette manufacturers previously settled four other
cases scheduled to come to trial, brought on behalf of
Mississippi, Florida, Texas and Minnesota, by separate
agreements with each state. The MSA and the other state
settlement agreements settled all health-care cost recovery
actions brought by, or on behalf of, the settling jurisdictions,
released the major U.S. cigarette manufacturers from various
additional present and potential future claims, imposed a stream
of future payment obligations on RJR Tobacco and the other major
U.S. cigarette manufacturers and placed significant restrictions
on their ability to market and sell cigarettes in the future.
The cash payments made by RJR Tobacco under the MSA and the
other state settlement agreements were $2.5 billion,
$2.4 billion and $2.2 billion in 2002, 2001 and 2000,
respectively. RJR Tobacco estimates these payments will be
$1.9 billion in 2003 and will exceed $2 billion per
year thereafter. However, these payments will be subject to
adjustments for, among other things, the volume of cigarettes
sold by RJR Tobacco, RJR Tobaccos market share and
inflation. See  Governmental
Health  Care Cost Recovery
Cases  MSA and Other State Settlement
Agreements below for a detailed discussion of the MSA and
the other state settlement agreements, including RJR
Tobaccos monetary obligations under these agreements.

Accounting for Tobacco-Related Litigation
Contingencies.In accordance with
applicable accounting principles, RJR and RJR Tobacco will
record any loss related to tobacco litigation at such time as an
unfavorable outcome becomes probable and the amount can be
reasonably estimated. For the reasons set forth below,
RJRs management continues to conclude that the loss of any
particular smoking and health tobacco litigation claim against
RJR Tobacco or its affiliates, when viewed on an individual
basis, is not probable. Therefore, no liability for pending
tobacco-related litigation currently is recorded in RJRs
consolidated financial statements.

Neither RJR Tobacco nor its affiliates, including
RJR, have paid any damages as the result of a final judgment
entered after a fully litigated smoking and health tobacco
litigation claim, and a very high percentage of the
tobacco-related litigation claims brought against them continue
to be dismissed at or before trial. Generally, RJR Tobacco and
its affiliates, including RJR, have not settled, and currently
do not intend to settle, any smoking and health tobacco
litigation claims. It is the policy of RJR Tobacco and its
affiliates, including RJR, to vigorously defend all
tobacco-related litigation claims. RJR Tobacco and its
affiliates,

9



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##### 



including RJR, believe that they have a number of
valid defenses to the tobacco-related litigation claims against
them, and that their consistently successful defense of
tobacco-related litigation in the past will continue in the
future.


The only smoking and health tobacco litigation
claims settled by RJR Tobacco involved (1) the MSA, the
related settlements with the states of Mississippi, Florida,
Texas and Minnesota, and the funding of a $5.2 billion
trust fund contemplated by the MSA to benefit tobacco growers,
and (2) the original Broinflight attendant case
discussed below under  Class-Action
Suits. Despite valid legal defenses, the decision to
settle these matters resulted from unique circumstances that do
not apply to the other tobacco litigation cases pending against
RJR Tobacco and its affiliates, including RJR.

The circumstances surrounding the MSA, the
state-specific settlements and the funding of a trust fund to
benefit the tobacco growers, are readily distinguishable from
the current categories of cases involving RJR Tobacco. The
claims underlying the MSA and the state-specific settlements
were brought on behalf of the states to recover funds paid for
health care and medical and other assistance to state citizens
suffering from diseases and conditions allegedly related to
tobacco use. The MSA and the state-specific settlements settled
all the health-care cost recovery actions brought by, or on
behalf of, the settling jurisdictions and contain releases of
various additional present and future claims. In accordance with
the MSA, various tobacco companies agreed to fund a $5.2 billion
trust fund to be used to address the possible adverse economic
impact of the MSA on tobacco growers. A discussion of the MSA
and the other state settlement agreements, and a table depicting
the related payment schedule under these agreements, is set
forth below under  Governmental Health-Care
Cost Recovery Cases  MSA and Other State Settlement
Agreements.

The states were a unique set of plaintiffs and
are not involved in any of the smoking and health cases
remaining against RJR or RJR Tobacco. Additionally, few smoker
class-action complaints have been certified or, if certified,
have survived on appeal. Seventeen federal courts that have
considered the issue, including two courts of appeals, and most
state courts have rejected class certification in smoking and
health cases. Most of the health-care cost recovery actions
similar in theory to the state cases involving other plaintiffs,
such as unions, hospitals, Indian tribes, and local and foreign
governments, have been dismissed, have been won by RJR Tobacco
at trial or have not involved punitive damages. Finally, in the
Department of Justice case brought against various industry
members, including RJR Tobacco, the U. S. District Court for the
District of Columbia granted the non-Liggett defendants
motion to dismiss plaintiffs Medical Care Recovery Act and
Medicare Secondary Payer claims, whereby the federal government
made arguments similar to the states and sought to recover
federal funds expended in providing health care to smokers who
have developed diseases and injuries alleged to be
smoking-related. The only remaining claims in this case involve
alleged violations of the federal RICO statute.

Similarly, the original Broincase,
discussed below under  Class-Action
Suits, was settled in the middle of trial during
discussions with the federal government concerning the possible
settlement of the claims underlying the MSA and the
state-specific settlements, among other things. The Broincase was settled at that time in an attempt to remove this
case as a political distraction during the industrys
settlement discussions with the federal government and a belief
that further Broinlitigation would be resolved by a
settlement at the federal level.

Following is a description of the material
pending tobacco-related litigation to which RJR Tobacco and its
affiliates, including RJR, are subject. Even though RJRs
management continues to conclude that the loss of any particular
smoking and health tobacco litigation claim against RJR Tobacco
or its affiliates, when viewed on an individual basis, is not
probable, the possibility of material losses related to tobacco
litigation is more than remote. However, RJRs management
is unable to predict the outcome of such litigation or to
reasonably estimate the amount or range of any possible loss.
Moreover, notwithstanding the quality of defenses available to
it and its affiliates in tobacco-related litigation matters, it
is possible that RJRs results of operations, cash flows or
financial condition could be materially adversely affected by
the ultimate outcome of certain pending or future litigation
matters.

Theories of Recovery.The plaintiffs seek recovery on a
variety of legal theories, including negligence, strict
liability in tort, design defect, special duty, voluntary
undertaking, breach of warranty, failure to warn,

10



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##### 



fraud, misrepresentation, unfair trade practices,
conspiracy, unjust enrichment, medical monitoring, public
nuisance and violations of state and federal antitrust and RICO
laws. In certain of these cases, plaintiffs claim that cigarette
smoking exacerbated injuries caused by exposure to asbestos.


Plaintiffs seek various forms of relief,
including compensatory and punitive damages, treble/multiple
damages and statutory damages and penalties, creation of medical
monitoring and smoking cessation funds, disgorgement of profits,
and injunctive and other equitable relief. Although pleaded
damages often are not determinable from a complaint, and the law
governing the pleading and calculation of damages varies from
state to state and jurisdiction to jurisdiction, compensatory
and punitive damages have been specifically pleaded in a number
of cases, sometimes in amounts ranging into the hundreds of
millions and even billions of dollars.

Defenses.The
defenses raised by RJR Tobacco and/or its affiliates, including
RJR, include, where applicable, preemption by the Federal
Cigarette Labeling and Advertising Act of some or all claims
arising after 1969, the lack of any defect in the product,
assumption of the risk, contributory or comparative fault, lack
of proximate cause, remoteness, lack of standing and statutes of
limitations or repose. RJR has asserted additional defenses,
including jurisdictional defenses, in many of the cases in which
it is named.

Scheduled Trials.Trial schedules are subject to change,
and many cases are dismissed before trial. However, it is likely
that there will be an increased number of tobacco cases against
RJR Tobacco and/or its affiliates, including RJR, some involving
claims for amounts ranging possibly into the hundreds of
millions and even billions of dollars, coming to trial during
2003. The following table lists the trial schedule, as of
February 4, 2003, for RJR Tobacco or its affiliates,
through the end of 2003.

|                  |  |                                               |  |                                  |              |                                       |  |                                                        |  | 
|----------------- |  | --------------------------------------------- |  | -------------------------------- | ------------ | ------------------------------------- |  | ------------------------------------------------------ |  | 
|Trial Date        |  | Case Name                                     |  | Case Type                        |              | Jurisdiction                         
|                  |  |                                               |  |                                  |              |                                      
|February 3, 2003  |  | Allen v. R. J. Reynolds Tobacco Co.           |  |                                  | Individual   |                                       |  | U.S. District Court,Southern District(Miami, FL)      
|February 24, 2003 |  | Harvey v. ABB Lummus Global, Inc.             |  |                                  | Individual   |                                       |  | Superior Court,San Francisco County(San Francisco, CA)
|April 14, 2003    |  | Brown v. Philip Morris, Inc.                  |  | Flight Attendant  ETS(Broin II) |              | Circuit Court,Dade County(Miami, FL) 
|April 21, 2003    |  | Krigbaum v. American Tobacco Co.              |  |                                  | Individual   |                                       |  | Superior Court,Santa Clara County(San Jose, CA)       
|April 28, 2003    |  | Williams v. Philip Morris, Inc.               |  | Flight Attendant  ETS(Broin II) |              | Circuit Court,Dade County (Miami, FL)
|May 5, 2003       |  | DeLuca v. Liggett & Myers, Inc.               |  |                                  | Individual   |                                       |  | U.S. District Court,Northern District(Chicago, IL)    
|May 12, 2003      |  | Welch v. Brown & Williamson Tobacco
    Corp. |  |                                  | Individual   |                                       |  | Superior Court, Jackson County(Independence, MO)      
|May 30, 2003      |  | Brown v. American Tobacco Co., Inc.           |  |                                  | Class Action |                                       |  | Superior Court,San Diego County(San Diego, CA)        

11



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##### 



|                   |  |                                                                     |  |                                  |            |                                       |  |                                                       |  | 
|------------------ |  | ------------------------------------------------------------------- |  | -------------------------------- | ---------- | ------------------------------------- |  | ----------------------------------------------------- |  | 
|Trial Date         |  | Case Name                                                           |  | Case Type                        |            | Jurisdiction                         
|                   |  |                                                                     |  |                                  |            |                                      
|June 2003          |  | Levine v. R. J. Reynolds Tobacco Co.                                |  |                                  | Individual |                                       |  | Circuit Court,Palm Beach County(West Palm Beach, FL) 
|June 6, 2003       |  | In Re Tobacco
    Litigation  Individual Personal Injury
    Cases |  |                                  | Individual |                                       |  | West Virginia Mass Litigation Panel(Charleston, WV)  
|June 16, 2003      |  | Sheppard v. R. J. Reynolds Tobacco
    Co.                          |  |                                  | Individual |                                       |  | U.S. District Court,Southern District(Miami, FL)     
|June 23, 2003      |  | Baker v. Philip Morris, Inc.                                        |  | Flight Attendant  ETS(Broin II) |            | Circuit Court,Dade County (Miami, FL)
|June 23, 2003      |  | Burkes v. Philip Morris, Inc.                                       |  | Flight Attendant  ETS(Broin II) |            | Circuit Court,Dade County (Miami, FL)
|June 23, 2003      |  | Leopard v. R. J. Reynolds Tobacco
    Co.                           |  |                                  | Individual |                                       |  | U.S. District Court,Eastern District(Little Rock, AR)
|June 30, 2003      |  | Brumfield v. Philip Morris, Inc.                                    |  |                                  | Individual |                                       |  | U.S. District Court,Northern District(Oakland, CA)   
|July 14, 2003      |  | Leon v. Philip Morris, Inc.                                         |  | Flight Attendant  ETS(Broin II) |            | Circuit CourtDade County (Miami, FL) 
|August 4, 2003     |  | Frost v. Philip Morris, Inc.                                        |  | Flight Attendant  ETS(Broin II) |            | Circuit Court,Dade County (Miami, FL)
|August 4, 2003     |  | Thompson v. Brown & Williamson Tobacco
    Corp.                    |  |                                  | Individual |                                       |  | Circuit Court, Jackson County(Independence, MO)      
|August 18, 2003    |  | Mittan v. Philip Morris, Inc.                                       |  | Flight Attendant  ETS(Broin II) |            | Circuit Court,Dade County (Miami, FL)
|September 2, 2003  |  | Sargeant v. R. J. Reynolds Tobacco
    Co.                          |  |                                  | Individual |                                       |  | Circuit Court,Brevard County(Cocoa, FL)              
|September 8, 2003  |  | Smith v. Philip Morris Cos., Inc.                                   |  |                                  | Antitrust  |                                       |  | District Court,Seward County(Liberal, KS)            
|September 19, 2003 |  | Coy v. Philip Morris, Inc.                                          |  |                                  | Individual |                                       |  | U.S. District Court,Southern District(Miami, FL)     
|October 6, 2003    |  | Roach v. Brown & Williamson Tobacco
    Corp.                       |  |                                  | Individual |                                       |  | Circuit Court, Jackson County(Independence, MO)      

12



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##### 



|                 |  |                                           |  |           |              |              |  |                                                       |  | 
|---------------- |  | ----------------------------------------- |  | --------- | ------------ | ------------ |  | ----------------------------------------------------- |  | 
|Trial Date       |  | Case Name                                 |  | Case Type |              | Jurisdiction
|                 |  |                                           |  |           |              |             
|October 6, 2003  |  | Turner v. R. J. Reynolds Tobacco Co.      |  |           | Class Action |              |  | Circuit Court,Madison County(Edwardsville, IL)       
|October 6, 2003  |  | Coleman v. R. J. Reynolds Tobacco
    Co. |  |           | Individual   |              |  | U.S. District Court,Eastern District(St. Louis, MO)  
|October 6, 2003  |  | Davis v. R. J. Reynolds Tobacco Co.       |  |           | Individual   |              |  | U.S. District Court,Southern District(Des Moines, IA)
|November 3, 2003 |  | Hall v. R. J. Reynolds Tobacco Co.        |  |           | Individual   |              |  | Circuit Court,Hillsborough County(Tampa, FL)         
|November 3, 2003 |  | Stitt vs. Philip Morris Cos., Inc.        |  |           | Individual   |              |  | U.S. District Court,Western District(Pittsburgh, PA) 

Trial Results.Since
January 1, 1999, 27 smoking and health and health-care cost
recovery cases in which RJR Tobacco was a defendant have been
tried. Verdicts in favor of RJR Tobacco and, in some cases, RJR
Tobacco and other defendants, were returned in 16 of the 27
cases. Of the 16 RJR Tobacco wins, four were tried in Florida,
two were tried in each of California, Mississippi and New York,
and one was tried in each of Louisiana, New Jersey, Ohio, South
Carolina, Tennessee and West Virginia. Most recently, in
Conley v. R. J. Reynolds Tobacco Co., a California
federal court judge granted RJR Tobaccos and Philip Morris
Inc.s motion for directed verdict on December 31,
2002. On February 6, 2003, however, plaintiffs filed an
appeal to the California Court of Appeals. On February 7,
2003, state court juries in California and Florida,
respectively, found in favor of RJR Tobacco and other cigarette
manufacturers in Lucier v. Phillip Morris, Inc.(an
individual smoker case) and Seal v. Philip Morris, Inc.(a Broin IIcase). Plaintiffs in the California,
Florida, Mississippi and West Virginia cases have filed appeals
or post-trial motions challenging the verdicts.

Three of the cases resulted in a mistrial. Most
recently, in May 2002, a mistrial was declared in a Broin IIcase brought by a flight attendant, Queipo,and the
case subsequently was dismissed.

The following chart reflects the verdicts and
post-trial developments in the eight cases that have been tried
since January 1999 in which juries have returned verdicts in
favor of plaintiffs and against RJR Tobacco. In addition, RJR
Tobacco has been fined a total of $34.8 million in two other
lawsuits filed by the Attorney General of California, discussed
below under  MSA  Enforcement and
Validity and  Other Litigation and
Developments. RJR Tobacco is appealing both cases.

|                                                                                  |  |                                         |  |              |  |                                                |  |                                                                                                                                                                                                                      |  |                                                                                                                                          
|--------------------------------------------------------------------------------- |  | --------------------------------------- |  | ------------ |  | ---------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|Date of Verdict                                                                   |  | Case Name                               |  | Case Type    |  | Jurisdiction                                   |  | Verdict                                                                                                                                                                                                              |  | Post-Trial Status                                                                                                                        
|                                                                                  |  |                                         |  |              |  |                                                |  |                                                                                                                                                                                                                      |  |                                                                                                                                          
|July 7, 1999  Phase I
    April 7, 2000  Phase II
    July 14, 2000  Phase III |  | Engle v. R. J. Reynolds
    Tobacco Co. |  | Class Action |  | Circuit Court,
    Dade County
    (Miami, FL) |  | $12.7 million compensatory damages against all
    defendants, including RJR Tobacco; $145 billion punitive damages
    against all defendants, of which approximately $36.3 billion was
    assigned to RJR Tobacco |  | Final judgment on appeal to the Third District
    Court of Appeal of Florida; oral argument heard November 6,
    2002; decision pending

13



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|                  |  |                                                                         |  |                                         |  |                                                                  |  |                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|----------------- |  | ----------------------------------------------------------------------- |  | --------------------------------------- |  | ---------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Date of Verdict   |  | Case Name                                                               |  | Case Type                               |  | Jurisdiction                                                     |  | Verdict                                                                                                                                                                                                      |  | Post-Trial Status                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                  |  |                                                                         |  |                                         |  |                                                                  |  |                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|March 20, 2000    |  | Whiteley v. Raybestos-
    Manhattan, Inc.                              |  | Individual                              |  | Superior Court,
    San Francisco County
    (San Francisco, CA) |  | $1.72 million compensatory damages against RJR
    Tobacco and another tobacco defendant; $20 million punitive
    damages, of which $10 million was assigned to RJR Tobacco                                 |  | Final judgment on appeal to the California Court
    of Appeal; briefing complete; oral argument has not been
    scheduled                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|October 12, 2000  |  | Jones v. Brown &
    Williamson Tobacco
    Corp.                       |  | Individual                              |  | Circuit Court, Hillsborough County (Tampa, FL)                   |  | $200,000 compensatory damages against RJR Tobacco                                                                                                                                                            |  | RJR Tobacco granted new trial on
    December 28, 2000; new trial decision affirmed by Second
    District Court of Appeal of Florida on August 30, 2002;
    plaintiffs opening brief filed with the Supreme Court of
    Florida on November 26, 2002. On December 9, 2002, the
    Supreme Court of Florida issued an order to show cause as to why
    Jones notice of appeal should not be treated as a notice
    to invoke discretionary jurisdiction. Jones filed his response
    to the order to show cause, and RJR Tobacco filed its reply to
    appellants response to the show cause order.
|June 4, 2001      |  | Blue Cross and Blue
    Shield of New Jersey v.
    Philip Morris, Inc. |  | Health-Care Cost Recovery               |  | U.S. District Court, Eastern District (Brooklyn,
    NY)         |  | $17.8 million compensatory damages against all
    defendants, of which $6.6 million was assigned to RJR Tobacco.
    Judge subsequently ordered plaintiffs attorneys entitled
    to $37.8 million in fees |  | Final judgment on appeal to the U.S. Court of
    Appeals for the Second Circuit; briefing complete; oral argument
    occurred on February 13, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|December 12, 2001 |  | Kenyon v. R. J. Reynolds
    Tobacco Co.                                |  | Individual                              |  | Circuit Court,
    Hillsborough County
    (Tampa, FL)           |  | $165,000 compensatory damages against RJR Tobacco                                                                                                                                                            |  | Final judgment on appeal to the Second District
    Court of Appeal of Florida; briefing complete; oral argument has
    been scheduled for April 23, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|February 22, 2002 |  | Burton v.
    R. J. Reynolds
    Tobacco Co.                            |  | Individual                              |  | U.S. District Court
    (Kansas City, KS)                        |  | $198,000 compensatory damages and $15 million
    punitive damages against RJR Tobacco                                                                                                                       |  | Final judgment on appeal to the U.S. Court of
    Appeals for the Tenth Circuit; RJR Tobaccos opening brief
    was filed February 12, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|June 18, 2002     |  | French v. Philip Morris, Inc.                                           |  | Flight
    Attendant-
    ETS(Broin II) |  | Circuit Court,
    Dade County
    (Miami, FL)                   |  | $5.5 million compensatory damages against all
    defendants, including RJR Tobacco                                                                                                                          |  | Judge reduced damages award to $500,000, of which
    $123,500 was assigned to RJR Tobacco; final judgment on appeal
    to the Third District Court of Appeal of Florida; opening brief
    due March 21, 2003                                                                                                                                                                                                                                                                                                                                                                                              

14



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##### 



|                   |  |                                                 |  |            |  |                                                 |  |                                                   |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|------------------ |  | ----------------------------------------------- |  | ---------- |  | ----------------------------------------------- |  | ------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Date of Verdict    |  | Case Name                                       |  | Case Type  |  | Jurisdiction                                    |  | Verdict                                           |  | Post-Trial Status                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                   |  |                                                 |  |            |  |                                                 |  |                                                   |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|September 25, 2002 |  | Figueroa-Cruz v.
    R. J. Reynolds Tobacco Co. |  | Individual |  | U.S. District Court
    (San Juan, Puerto Rico) |  | $500,000 compensatory damages against RJR Tobacco |  | Trial judge granted RJR Tobaccos motion for
    judgment as a matter of law on October 9, 2002, and entered
    judgment in RJR Tobaccos favor; plaintiffs appealed to
    U.S. Court of Appeals for the First Circuit; no briefing
    schedule has been set. On January 28, 2003, RJR Tobacco
    filed a response to appellants docketing statement, a
    motion to amend the caption of the case, and a motion to dismiss
    appellants appeal for failure to prosecute.

Additionally, since January 1, 1999,
verdicts have been returned in 16 tobacco-related cases in which
neither RJR Tobacco nor its affiliates, including RJR, were
defendants. Verdicts were returned in favor of defendants in 10
cases  three in Tennessee, and one in each of
Connecticut, Florida, Missouri, Ohio, Pennsylvania, Rhode Island
and Texas. Most recently, a Philadelphia state court jury
returned a verdict in favor of Philip Morris on January 27,
2003. Plaintiffs appeal is pending in the Ohio case.
Verdicts in favor of plaintiffs were returned in six cases,
three of which were tried in California, two in Oregon and one
in Florida. Defendants appeals or post-trial motions are
pending in these cases.

Finally, the California Supreme Court heard oral
argument in the Naegele v. Raybestos-Manhattan, Inc.and
Myers v. Philip Morris, Inc.cases on May 7, 2002.
The court assessed the retroactive effect of Californias
amended Civil Code Section 1714.45, which repealed a
California statute that limited plaintiffs ability to sue
manufacturers of tobacco products from 1988 through 1998. On
August 5, 2002, the court ruled that the immunity repeal
could not be applied retroactively and the immunity remains for
the ten-year period the statute was in effect. In addition, the
court found that the immunity applied to fraud claims but not to
claims of adulteration. RJR Tobacco believes that these
decisions should have a favorable impact on cases currently on
appeal (e.g., Whiteley v. Raybestos-Manhattan,
Inc.) and cases at the trial court.

Individual Smoking and Health Cases

As of February 4, 2003, approximately 1,377
individual cases were pending in the United States against RJR
Tobacco. This category of cases includes smoking and health
cases alleging personal injury brought by or on behalf of
individual plaintiffs (but does not include the Broin IIcases discussed below). A total of 1,364 of the pending
cases are brought by or on behalf of individual smokers or their
survivors. Thirteen of the cases are brought by or on behalf of
individuals or their survivors alleging personal injury as a
result of exposure to ETS.

In 2002, three individual cases were tried in
which RJR Tobacco was a party. On February 22, 2002, in
Burton v. R. J. Reynolds Tobacco Co., a federal district
court jury in Kansas found in favor of RJR Tobacco and Brown
& Williamson on product defect and conspiracy claims, but
found for the plaintiff on failure to warn, failure to test and
fraudulent concealment claims. The jury apportioned
99 percent of the fault to RJR Tobacco and
1 percent to Brown & Williamson. It awarded the
plaintiff $198,400 in compensatory damages, and determined that
the plaintiff was entitled to punitive damages against RJR
Tobacco but not Brown & Williamson. On June 21, 2002,
the trial court awarded the plaintiff $15 million in punitive
damages. RJR Tobacco appealed to the United States Court of
Appeals for the Tenth Circuit, and filed its opening appellate
brief on February 12, 2003.

In Figueroa-Cruz v. R. J. Reynolds Tobacco
Co.,a federal district court jury in San Juan, Puerto Rico,
found in favor of one of two plaintiffs on September 25,
2002. On October 9, 2002, however, the trial judge granted
RJR Tobaccos motion for judgment on the pleadings.
Plaintiffs are appealing the ruling to the U.S. Court of
Appeals for the First Circuit.

15



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##### 



Most recently, RJR Tobacco has prevailed in two
individual smoker lawsuits in California. In Conley v. R. J.
Reynolds Tobacco Co., a California federal court judge
granted RJR Tobaccos and Philip Morris, Inc.s motion
for directed verdict on December 31, 2002. Plaintiffs
appealed to the California Court of Appeals on February 6,
2003. And, in Lucier v. Philip Morris, Inc.,a California
state court jury found in favor of RJR Tobacco and Philip
Morris, Inc. on February 7, 2003.

Broin II Cases

As of February 4, 2003, approximately 2,791
lawsuits brought by individual flight attendants for personal
injury as a result of illness allegedly caused by exposure to
secondhand or environmental tobacco smoke in airplane cabins,
referred to as the Broin IIcases, were pending in
Florida. In these lawsuits, filed pursuant to the terms of the
settlement of the Broin v. Philip Morris, Inc.class
action, discussed below under  Class-Action
Suits, each individual flight attendant will be required
to prove that he or she has a disease and that the
individuals exposure to secondhand smoke in airplane
cabins caused the disease. Under the terms of the settlement of
the original Broincase, punitive damages are not
available in the Broin IIcases.

On October 5, 2000, Judge Robert Kaye
entered an order applicable to all Broin IIcases that
the terms of the Broinsettlement agreement do not
require the individual Broin IIplaintiffs to prove the
elements of strict liability, breach of warranty or negligence.
Under this order, there is a rebuttable presumption in
plaintiffs favor on those elements, and plaintiffs bear
the burden of proving that their alleged adverse health effects
actually were caused by exposure to environmental tobacco smoke.
Although defendants still may prevail on causation and other
theories, RJR Tobacco does not believe that the order is correct
under Florida law or that it accurately reflects the intent of
the Broinsettlement agreement. RJR Tobacco, along with
the other defendants, initially appealed this order in Jett
v. Philip Morris, Inc.In October 2001, the intermediate
appellate court dismissed the appeal as premature without
addressing the Kaye order. Defendants asked the court to
reconsider its ruling, but the court refused to do so.
Defendants asked the Florida Supreme Court to review the order,
but the court declined to accept jurisdiction on June 24,
2002.

On April 5, 2001, in the first Broin IIflight attendant case to go to trial, Fontana v. Philip
Morris, Inc., a Florida state court jury returned a verdict
in favor of the defendants, including RJR Tobacco. On
April 16, 2001, plaintiff filed motions for a mistrial,
judgment notwithstanding the verdict or for a new trial. On
October 1, 2001, the trial judge denied plaintiffs
post-trial motions. Plaintiff appealed to the Florida Third
District Court of Appeal. Defendants cross-appealed on
November 8, 2001, raising objections to the Judge Kaye
order described above. On December 30, 2002, the plaintiff
voluntarily dismissed her appeal of the final judgment, thereby
rendering defendants cross-appeal moot.

Jury selection began in state court in Florida on
May 20, 2002 in Queipo v. Philip Morris, Inc. The
court declared a mistrial shortly after the plaintiff began
presenting evidence. The plaintiff voluntarily dismissed the
action on June 3, 2002.

In French v. Philip Morris, Inc.,a
Florida state court jury found in favor of the plaintiff on
June 18, 2002, and awarded $5.5 million in compensatory
damages. On September 13, 2002, the trial judge reduced the
damages award to $500,000, but denied the defendants
remaining post-trial motions. Defendants appeal of the
trial courts final judgment is pending in the Third
District Court of Appeal of Florida. Their initial brief is due
on March 21, 2003.

In Janoff v. Philip Morris, Inc.,a
Florida state court jury found in favor of the defendants,
including RJR Tobacco, on September 5, 2002. On
September 12, 2002, plaintiff filed a motion for a new
trial, which the judge granted on January 8, 2003.
Defendants appealed the ruling to the Third District Court of
Appeal of Florida on February 3, 2003.

In Tucker v. Philip Morris, Inc., a
Florida state court jury found in favor of the defendants,
including RJR Tobacco, on October 4, 2002.
Plaintiffs post-verdict motions were denied on
January 28, 2003.

Most recently, a Florida state court jury found
in favor of RJR Tobacco and other cigarette manufacturers
on February 7, 2003, in Seal v. Philip Morris, Inc.

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Class-Action Suits

As of February 4, 2003, approximately 49
class-action cases were pending in the United States against
RJR Tobacco, and in some cases, RJR. In May 1996, in
Castano v. American Tobacco Co.,the Fifth Circuit Court
of Appeals overturned the certification of a nationwide class of
persons whose claims related to alleged addiction to tobacco
products. Since this ruling by the Fifth Circuit, most
class-action suits have sought certification of statewide,
rather than nationwide, classes. Class-action suits based on
claims similar to those asserted in Castanoare pending
against RJR Tobacco, and in some cases RJR, in state or federal
courts in Alabama, California, the District of Columbia,
Florida, Illinois, Louisiana, Missouri, Nevada, New York, Ohio,
Oregon, Tennessee, Texas, Utah and West Virginia. Twenty-five
virtually identical class-action complaints have been filed by
one attorney in Nevada since July 2002.

Class-action suits have been filed in a number of
states against individual cigarette manufacturers and their
parent corporations, alleging that the use of the terms
lights and ultralights constitutes
unfair and deceptive trade practices. In December 2000, a state
court in Pennsylvania refused to certify one such class action,
Oliver v. RJR Tobacco Co. That case was later voluntarily
dismissed.Three such suits are pending against RJR
Tobacco and RJR in Florida, Illinois and Missouri. A class has
been certified in the Illinois case, Turner v. R. J. Reynolds
Tobacco Co., discussed below. A class certification decision
is pending in the Missouri case, Collora v. R. J. Reynolds
Tobacco Co., while the Florida case is in the class
certification discovery phase.

Other types of class-action suits also are
pending in additional jurisdictions. Most of these suits assert
claims on behalf of classes of individuals who claim to be
addicted, injured or at greater risk of injury by the use of
tobacco or exposure to environmental tobacco smoke, or the legal
survivors of such persons. A number of unions and other
third-party payers have filed health-care cost recovery actions
in the form of class actions. These cases are discussed
separately below. Class certification motions are pending in
several state and federal courts.

Few smoker class-action complaints have been
certified or, if certified, have survived on appeal. Seventeen
federal courts that have considered the issue, including two
courts of appeals, and most state courts have rejected class
certification in smoking and health cases. Only one federal
district court has certified a smoker class action 
In re Simon (II) Litigation which is
pending in the U.S. District Court for the Eastern District of
New York before Judge Weinstein. In Simon (II), on
September 19, 2002, Judge Weinstein certified a nationwide
mandatory, non-opt-out punitive damages class. Defendants sought
reconsideration of the certification ruling, although it was
denied by Judge Weinstein on October 25, 2002. On
February 14, 2003, the U.S. Court of Appeals for the Second
Circuit granted the defendants petition to review the
class certification decision. Most recently, on
February 10, 2003, in Sims v. Philip Morris, Inc.,the U.S. District Court for the District of Columbia
denied certification of a proposed class of smokers who
purchased cigarettes while underage.

Classes have been certified in several state
court class-action cases in which RJR Tobacco is a defendant. On
November 5, 1998, in Scott v. American Tobacco Co.,
a Louisiana state appeals court affirmed the certification of a
medical monitoring and/or smoking cessation class of Louisiana
residents who were smokers on or before May 24, 1996. On
February 26, 1999, the Louisiana Supreme Court denied the
defendants petition for writ of certiorari and/or review.
Jury selection began on June 18, 2001. An initial jury was
selected by July 16, 2001. However, the defendants,
including RJR Tobacco, raised multiple challenges to the jury
selection process. At various times, the Louisiana Court of
Appeals and/or the Louisiana Supreme Court removed a number of
jurors and alternate jurors that the trial court had allowed to
be seated. The jury selection process was finally completed on
September 23, 2002, and opening statements occurred on
January 21, 2003. The trial is now in progress.

Trial began in July 1998 in Florida state court
in Engle v. R. J. Reynolds Tobacco Co., in which a class
consisting of Florida residents, or their survivors, alleges
diseases or medical conditions caused by their alleged
addiction to cigarettes. On July 7, 1999, the
jury found against RJR Tobacco and the other cigarette
manufacturer defendants in the initial phase, which included
common issues related to certain elements of liability, general
causation and a potential award of, or entitlement to, punitive
damages.

17



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The second phase of the trial, which consisted of
the claims of three of the named class representatives, began on
November 1, 1999. On April 7, 2000, the jury returned
a verdict against all defendants. They awarded plaintiff Mary
Farnan $2.85 million, the estate of plaintiff Angie Della
Vecchia $4.023 million and plaintiff Frank Amodeo $5.831
million. The jury also found, however, that Frank Amodeo knew or
should have known of his claim prior to May 5, 1990. RJR Tobacco
believes that the legal effect of that finding should be to bar
his claim based on the applicable statute of limitations.

The trial court also ordered the jury in the
second phase of the trial to determine punitive damages, if any,
on a class-wide basis. On July 14, 2000, the jury returned
a punitive damages verdict in favor of the Florida
class of approximately $145 billion against all the
defendants, with approximately $36.3 billion being assigned to
RJR Tobacco.

On July 24, 2000, the defendants, including
RJR Tobacco, filed numerous post-verdict motions, including
motions for a new trial and to reduce the amount of the punitive
damages verdict. On November 6, 2000, the trial judge
denied the post-trial motions and entered judgment. On
November 7, 2000, RJR Tobacco posted an appeal bond in the
amount of $100 million, pursuant to a Florida statute enacted on
May 9, 2000, and intended to apply to the Engle
case, and initiated the appeals process. The opening appellate
brief of certain defendants, including RJR Tobacco, was filed on
November 26, 2001. The plaintiff class filed its responsive
brief on June 7, 2002; defendants reply brief was
filed on September 26, 2002. Oral argument before
Floridas Third District Court of Appeal took place on
November 6, 2002. A decision is expected in 2003. Although
RJR Tobacco believes it has numerous bases for a successful
appeal, it cannot predict the outcome of the appellate process.

On May 7, 2001, three of the non-RJR Tobacco
defendants entered into agreements with the Engleclass
to deposit an additional $1.86 billion into separate escrow
accounts to ensure that the stay of execution in effect pursuant
to the Florida bond statute will remain in effect as to these
three defendants throughout the appellate process, regardless of
the results of a challenge, if any, to the Florida bond statute.
Approximately $700 million of the total amount deposited by
these three defendants is non-refundable and will go to the
trial court to be distributed, regardless of the result of the
appeal. RJR Tobacco has not entered into a similar agreement
with the Engleclass. Although RJR Tobacco cannot predict
the outcome of any possible challenges to the Florida bond
statute, RJR Tobacco remains confident of the applicability and
validity of the statute in the Englecase. In addition,
12 other states, Georgia, Indiana, Kentucky, Louisiana,
Michigan, Nevada, North Carolina, Ohio, Oklahoma, South
Carolina, Virginia and West Virginia, have enacted legislation
similar to the Florida bond statute. The Mississippi Supreme
Court also has placed limits on appeal bonds by court rule.

RJR Tobacco has been named as a defendant in 11
individual cases filed by members of the Engleclass. One
such case (in which RJR Tobacco was dismissed prior to trial),
Lukacs v. Philip Morris, Inc., was tried against Philip
Morris and Brown & Williamson, and resulted in a verdict for
the plaintiffs on June 11, 2002. The Florida state court jury
awarded the plaintiffs a total of $37.5 million in compensatory
damages. The plaintiffs have agreed to stay execution on the
judgment pending the result of the Engleappeal.

On November 30, 2000, in Daniels v.
Philip Morris Cos., Inc.,a San Diego Superior Court judge
reversed a prior ruling and, based on a California unfair
business practices statute, certified a class consisting of all
persons who, as California resident minors, smoked one or more
cigarettes in California between April 2, 1994 and
December 1, 1999. Trial was scheduled for October 18,
2002, but the court granted defendants motions for summary
judgment on preemption and First Amendment grounds on
September 12, 2002, and dismissed the action. At a hearing
on October 21, 2002, the judge made final his original
ruling. The plaintiffs are currently appealing the dismissal to
the California Court of Appeal, Fourth Appellate District,
Division One.

On April 11, 2001, in Brown v. American
Tobacco Co., Inc.,the same judge in San Diego granted in
part plaintiffs motion for class certification. The class
is composed of adult residents of California who smoked at least
one of defendants cigarettes from 1993 through 2000, and
who were exposed to defendants marketing and advertising
activities in California. Certification was granted as to
plaintiffs claims that defendants violated §17200 of
the California Business and Professions Code. The court,
however, refused to certify the class under the California Legal
Remedies Act. Class certification on plaintiffs common law
claims was

18



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denied on April 10, 2000. Defendants
petitioned the California Supreme Court to review the trial
courts class certification ruling, but the Supreme Court
denied the petition on January 16, 2002. The defendants,
including RJR Tobacco, filed their motion for summary judgment
on January 31, 2003. Trial is scheduled to begin on
May 30, 2003.


On November 14, 2001, in Turner v. R. J.
Reynolds Tobacco Co., an Illinois state court judge
certified a class defined as [a]ll persons who purchased
defendants Doral Lights, Winston Lights, Salem Lights and
Camel Lights, in Illinois, for personal consumption, between the
first date that defendants sold Doral Lights, Winston Lights,
Salem Lights and Camel Lights through the date the court
certifies this suit as a class
action . . . . Trial is scheduled to
begin on October 6, 2003. This case currently includes both
RJR and RJR Tobacco as defendants. Similar class-action cases in
the same jurisdiction have been certified against Philip Morris
and Brown & Williamson.

RJR Tobacco and other cigarette manufacturer
defendants settled one class-action suit, Broin v. Phillip
Morris, Inc., in October 1997. This case had been brought in
Florida state court on behalf of all flight attendants of U.S.
airlines alleged to be suffering from diseases or ailments
caused by exposure to secondhand smoke in airplane cabins. The
settlement agreement required the participating tobacco
companies to pay a total of $300 million in three annual $100
million installments, allocated among the companies by market
share, to fund research on the early detection and cure of
diseases associated with tobacco smoke. It also required those
companies to pay a total of $49 million for plaintiffs
counsels fees and expenses. RJR Tobaccos
portion of these payments was approximately $86 million. The
settlement agreement bars class members from bringing aggregate
claims or obtaining punitive or exemplary damages and also bars
individual claims to the extent that they are based on fraud,
misrepresentation, conspiracy to commit fraud or
misrepresentation, RICO, suppression, concealment or any other
alleged intentional or willful conduct. The defendants agreed
that, in any individual case brought by a class member, the
defendant will bear the burden of proof with respect to whether
ETS can cause certain specifically enumerated diseases
(general causation). With respect to all other
issues relating to liability, including whether an individual
plaintiffs disease was caused by his or her exposure to
ETS in aircraft cabins (specific causation), the
individual plaintiff will have the burden of proof.
Floridas Third District Court of Appeal denied various
challenges to this settlement on March 24, 1999, and
subsequently denied motions to reconsider. On September 7,
1999, the Florida Supreme Court dismissed all proceedings, and
the settlement and judgment became final. The Broin IIcases, discussed above, arose out of the settlement of this
case.

Governmental Health-Care Cost Recovery
Cases

MSA and Other State Settlement Agreements.In June 1994, the Mississippi attorney
general brought an action, Moore v. American Tobacco Co.,
against various industry members, including RJR Tobacco. This
case was brought on behalf of the state to recover state funds
paid for health care and medical and other assistance to state
citizens suffering from diseases and conditions allegedly
related to tobacco use. Most other states, through their
attorneys general or other state agencies, sued RJR Tobacco and
other U.S. cigarette manufacturers based on similar theories.
The cigarette manufacturer defendants, including RJR Tobacco,
settled the first four of these cases scheduled to come to
trial, those of Mississippi, Florida, Texas and Minnesota, by
separate agreements between each state and those manufacturers
in each case.

On November 23, 1998, the major U.S.
cigarette manufacturers, including RJR Tobacco, entered into the
MSA with attorneys general representing the remaining 46 states,
the District of Columbia, Puerto Rico, Guam, the Virgin Islands,
American Samoa and the Northern Marianas. The MSA became
effective on November 12, 1999, and settled all the
health-care cost recovery actions brought by, or on behalf of,
the settling jurisdictions and contained releases of various
additional present and future claims.

In the settling jurisdictions, the MSA released
RJR Tobacco, its indemnitees and RJR from: (1) all claims
of the settling states and their respective political
subdivisions and other recipients of state health-care funds,
relating to past conduct arising out of the use, sale,
distribution, manufacture, development, advertising, marketing
or health effects of, the exposure to, or research, statements
or warnings about, tobacco products

19



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and (2) all monetary claims relating to
future conduct arising out of the use of, or exposure to,
tobacco products that have been manufactured in the ordinary
course of business.


The cash payments made by RJR Tobacco under
the MSA and other existing settlement agreements were
$2.5 billion, $2.4 billion and $2.2 billion under
these agreements in 2002, 2001 and 2000, respectively.
RJR Tobacco records its allocation of ongoing settlement
charges in cost of products sold as products are shipped. Set
forth below is a table depicting the unadjusted tobacco industry
settlement payment schedule under the MSA and the other
settlement agreements and related information.

Unadjusted Tobacco Industry Settlement Payment
Schedule

|                                              |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |         |       |       |  |         |       |       |  |         |       |       |  |         |       |       |  |         |       |       | 
|--------------------------------------------- | ---------------------------------------- | --------------------- | ----- | ----- | ----- | ---- | ----- | ----- | ------ | ---- | ----- | ----- | ------ | ---- | ----- | ----- | ------ | ----- | ------- | ----- | ----- |  | ------- | ----- | ----- |  | ------- | ----- | ----- |  | ------- | ----- | ----- |  | ------- | ----- | ----- | 
|                                              |                                          | 2000                  |       | 2001  |       | 2002 |       | 2003  |        | 2004 |       | 2005  |        | 2006 |       | 2007  |        | 2008+
|                                              |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |      
|                                              |                                          |                      
|                                              |                                          | (Dollars in Millions)
|First Four States Settlements:               |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |         |       |       |  |         |       |       |  |         |       |       |  |         |       |       |  |         |      
|                                              | Mississippi Annual Payment               |                       | $     | 85    |       |      | $     | 111   |        |      | $     | 111   |        |      | $     | 136   |        |       | $       | 136   |       |  | $       | 136   |       |  | $       | 136   |       |  | $       | 136   |       |  | $       | 136   |      
|                                              | Florida Annual Payment                   |                       |       | 275   |       |      |       | 358   |        |      |       | 358   |        |      |       | 440   |        |       |         | 440   |       |  |         | 440   |       |  |         | 440   |       |  |         | 440   |       |  |         | 440   |      
|                                              | Texas Annual Payment                     |                       |       | 363   |       |      |       | 471   |        |      |       | 471   |        |      |       | 580   |        |       |         | 580   |       |  |         | 580   |       |  |         | 580   |       |  |         | 580   |       |  |         | 580   |      
|                                              | Minnesota Annual Payment                 |                       |       | 128   |       |      |       | 166   |        |      |       | 166   |        |      |       | 204   |        |       |         | 204   |       |  |         | 204   |       |  |         | 204   |       |  |         | 204   |       |  |         | 204   |      
|                                              | Minnesota Initial Payment                |                       |       | 243   |       |      |       | 243   |        |      |       | 243   |        |      |       | 122   |        |       |         |      |       |  |         |      |       |  |         |      |       |  |         |      |       |  |         |      |      
|                                              | Most Favored Nations Agmt (MS, FL, TX)   |                       |       | 1,215 |       |      |       | 1,215 |        |      |       | 1,215 |        |      |       | 609   |        |       |         |      |       |  |         |      |       |  |         |      |       |  |         |      |       |  |         |      |      
|Remaining States Settlement:                 |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |         |       |       |  |         |       |       |  |         |       |       |  |         |       |       |  |         |      
|                                              | Initial Payments (1)                     |                       |       | 2,472 |       |      |       | 2,546 |        |      |       | 2,623 |        |      |       | 2,701 |        |       |         |      |       |  |         |      |       |  |         |      |       |  |         |      |       |  |         |      |      
|                                              | Annual Payments (1)                      |                       |       | 3,940 |       |      |       | 4,378 |        |      |       | 5,691 |        |      |       | 5,691 |        |       |         | 7,004 |       |  |         | 7,004 |       |  |         | 7,004 |       |  |         | 7,004 |       |  |         | 7,126 |      
|                                              | Addl Annual Payments (through 2017) (1) |                       |       |      |       |      |       |      |        |      |       |      |        |      |       |      |        |       |         |      |       |  |         |      |       |  |         |      |       |  |         |      |       |  |         | 861   |      
|                                              | Base Foundation Funding (through 2008)   |                       |       | 25    |       |      |       | 25    |        |      |       | 25    |        |      |       | 25    |        |       |         | 25    |       |  |         | 25    |       |  |         | 25    |       |  |         | 25    |       |  |         | 25    |      
|                                              | Additional Foundation Payments (2)       |                       |       | 300   |       |      |       | 300   |        |      |       | 300   |        |      |       | 300   |        |       |         |      |       |  |         |      |       |  |         |      |       |  |         |      |       |  |         |      |      
|Growers Trust ($295  2009
    and 2010) (3) |                                          |                       | 280   |       |       |      | 400   |       |        |      | 500   |       |        |      | 500   |       |        |       | 500     |       |       |  | 500     |       |       |  | 500     |       |       |  | 500     |       |       |  | 500     |      
|Minnesota Blue Cross and Blue Shield          |                                          |                       | 57    |       |       |      | 57    |       |        |      | 57    |       |        |      | 57    |       |        |       |        |       |       |  |        |       |       |  |        |       |       |  |        |       |       |  |        |      
|                                              |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |         |       |       |  |         |       |       |  |         |       |       |  |         |       |       |  |         |      
|                                              |                                          | Total                 |       | $     | 9,383 |      |       | $     | 10,270 |      |       | $     | 11,760 |      |       | $     | 11,365 |       |         | $     | 8,889 |  |         | $     | 8,889 |  |         | $     | 8,889 |  |         | $     | 8,889 |  |         | $     | 9,872 | 
|                                              |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |         |       |       |  |         |       |       |  |         |       |       |  |         |       |       |  |         |      
|RJR Tobaccos settlement expenses             |                                          | $                     | 2,329 |       |       | $    | 2,584 |       |        | $    | 2,507 |       |        |      |      |       |        |       |        |       |       |  |        |       |       |  |        |       |       |  |        |       |       |  |        |      
|RJR Tobaccos cash payments                   |                                          | $                     | 2,247 |       |       | $    | 2,393 |       |        | $    | 2,461 |       |        |      |      |       |        |       |        |       |       |  |        |       |       |  |        |       |       |  |        |       |       |  |        |      
|RJR Tobaccos expected settlement
    expense |                                          |                       |      |       |       |      |      |       |        |      |      |       |        | $    | 2,200 |       |        |       | >$2,200 |       |       |  | >$2,300 |       |       |  | >$2,300 |       |       |  | >$2,000 |       |       |  | >$2,000 |      
|RJR Tobaccos expected cash payments          |                                          |                       |      |       |       |      |      |       |        |      |      |       |        | $    | 1,900 |       |        |       | >$2,100 |       |       |  | >$2,200 |       |       |  | >$2,200 |       |       |  | >$2,000 |       |       |  | >$2,000 |      






|    |                                                                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Subject to adjustments for changes in sales
    volume, inflation and other factors. All payments are to be
    allocated among the companies on the basis of relative market
    share.               
|(2) | Subject to adjustments for changes in sales
    volume, inflation and other factors.                                                                                                                   
|(3) | Subject to changes in total domestic cigarette
    volume of participating manufacturers and inflation. Generally,
    payment is based on each participating manufacturers
    relative market share.

The MSA also contains provisions restricting the
marketing of cigarettes. Among these are restrictions or
prohibitions on the use of cartoon characters, brand name
sponsorships, brand name non-tobacco products, outdoor and
transit brand advertising, payments for product placement, free
sampling and lobbying. The MSA also required the dissolution of
three industry-sponsored research and advocacy organizations.

The MSA and the other state settlement agreements
have materially adversely affected RJR Tobaccos
shipment volumes. RJR believes that they may materially
adversely affect the results of operations, cash flows or
financial position of RJR and RJR Tobacco in future
periods. The degree of the adverse impact will depend, among
other things, on the rate of decline in United States cigarette
sales in the premium and discount categories,
RJR Tobaccos share of the domestic premium and
discount cigarette categories, and the effect of any resulting
cost advantage of manufacturers not subject to the MSA and the
other state settlement agreements.

Department of Justice
Case.On September 22, 1999, the
United States Department of Justice brought an action in the
United States District Court for the District of Columbia
against various industry members, including RJR Tobacco.
The government sought to recover federal funds expended in
providing health care to smokers who have developed diseases and
injuries alleged to be smoking-related, and, in addition, seeks,

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pursuant to the federal RICO statute,
disgorgement of profits the government contends were earned as a
consequence of a RICO racketeering enterprise. On
December 27, 1999, defendants filed a motion to dismiss
challenging all counts included in the action brought by the
DOJ. On June 6, 2000, the trial court heard oral argument
on the motion. On September 28, 2000, Judge Gladys Kessler of
the United States District Court for the District of Columbia
granted the non-Liggett defendants motion to dismiss the
following counts of plaintiffs complaint: (1) Medical
Care Recovery Act claim, and (2) Medicare Secondary Payer
claim. The court, however, denied the motion with respect to the
RICO claims. Trial is scheduled for September 13, 2004.


In June 2001, the United States Attorney General
assembled a team of three DOJ lawyers to work on a possible
settlement of the federal lawsuit. The DOJ lawyers met with
representatives of the tobacco industry, including RJR Tobacco,
on July 18, 2001. No settlement was reached, and no further
meetings are planned.

Local Government Cases.Some local government entities have
filed lawsuits based largely on the same theories and seeking
the same relief as the state attorney general cases. Three such
cases are pending against RJR Tobacco. On August 8, 2001,
in County of Cook v. Philip Morris, Inc., the Circuit
Court of Cook County, Illinois, granted defendants motion
for judgment on the pleadings based on remoteness grounds and
dismissed plaintiffs complaint in its entirety. Plaintiffs
appealed the dismissal to the Illinois Appellate Court, First
District, on September 5, 2001. Defendants noticed a
cross-appeal on September 17, 2001, from the trial
courts adverse rulings on defendants motions to
dismiss on the grounds of MSA release and lack of standing. The
appeal is in the briefing stage.

International Cases.A number of foreign countries have
filed suit in state and federal courts in the United States
against RJR Tobacco and other tobacco industry defendants to
recover funds for health care, medical and other assistance paid
by those foreign governments to their citizens. In the
Marshall Islands v. American Tobacco Co., the Republic of
the Marshall Islands brought a health-care cost recovery suit
against RJR Tobacco and other cigarette manufacturers. On
May 9, 2002, the Supreme Court of the Marshall Islands
affirmed the dismissal of all claims. Most recently, in
Venezuela v. Philip Morris Cos., Inc.,Floridas
Third District Court of Appeal affirmed the trial courts
dismissal on October 1, 2002. On October 28, 2002,
Venezuela filed a notice to invoke the discretionary
jurisdiction of the Florida Supreme Court to review the decision
of the Third District Court of Appeal. A decision is pending.

Of the 27 international cases currently pending
in the United States, 25 are pending in state court and two are
pending in federal court. Two other cases are pending outside
the United States, one in each of Canada and Israel. The two
federal court cases were transferred to, and remain pending
before, the Judicial Panel on Multi-District Litigation in the
United States District Court for the District of Columbia. Other
foreign governments and entities have stated that they are
considering filing such actions in the United States.

On November 12, 1998, the Canadian Province
of British Columbia brought a case in British Columbia
Provincial Court (federally appointed), similar to the state
attorneys general cases discussed above, against RJR Tobacco and
certain other Canadian and U.S. tobacco companies and their
parent companies, including RJR. This lawsuit depended entirely
on legislation enacted in British Columbia that was separately
challenged by various Canadian tobacco companies. An agreement
was reached with the government in British Columbia to litigate
the separate constitutional challenges prior to the health-care
cost recovery action. On February 21, 2000, the British
Columbia Supreme Court declared the Cost Recovery Act
unconstitutional and dismissed the action. This decision was not
appealed by the government. On January 24, 2001, the
Canadian Province of British Columbia enacted a second and
revised statute and brought a second action in the same court. A
trial of the constitutionality of the second statute and a claim
that the second action be dismissed was heard from November 4
through November 29, 2002. As of February 4, 2003,
judgment is still reserved.

Pursuant to the terms of the 1999 sale of
RJRs international tobacco business, Japan Tobacco Inc.
assumed RJR Tobaccos liability, if any, in the health-care
cost recovery cases brought by foreign countries.

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Other Health-Care Cost Recovery and Aggregated
Claims Cases

Although the MSA settled some of the most
potentially burdensome health-care cost recovery actions, many
other such cases have been brought by other types of plaintiffs.
Unions, groups of health-care insurers, a private entity that
purported to self-insure its employee health-care programs,
Native American tribes, hospitals, universities and taxpayers
have advanced claims similar to those found in the governmental
health-care cost recovery actions. These cases largely have been
unsuccessful on remoteness grounds: one who pays an injured
persons medical expenses is legally too remote to maintain
an action against the person allegedly responsible for the
injury.

Union Cases.Numerous trial court judges have
dismissed union trust fund cases on remoteness grounds. The
first and only union case to go to trial to date was Iron
Workers Local No. 17 v. Philip Morris, Inc., which was
tried in federal court in Ohio. On March 18, 1999, the jury
returned a unanimous verdict for the defendants, including RJR
Tobacco. The plaintiffs dismissed their appeal of the verdict.

Since March 1999, the United States Courts of
Appeals for the Second, Third, Fifth, Seventh, Eighth, Ninth,
Eleventh and District of Columbia Circuits all have ruled in
favor of the industry in similar union cases. The United States
Supreme Court has denied petitions for certiorari filed by
unions in cases from the Second, Third, Ninth and District of
Columbia Circuits.

On March 3, 2000, a New York state court
granted motions to dismiss ten union cases, brought by 14 union
trust funds, Eastern States Health & Welfare Fund v.
Philip Morris, Inc.The plaintiffs in this group of cases
noticed appeals to the Appellate Division of the Supreme Court
of New York. However, the plaintiffs never perfected the
appeals, which resulted in the appeals being dismissed. On
January 25, 2002, in Motion Picture Industry Health Plan
v. Philip Morris, Inc., the California Supreme Court granted
plaintiffs petition for review of a decision by the
California Court of Appeals to affirm a trial court order
dismissing the case with prejudice. On November 20, 2002,
the California Supreme Court dismissed review as improvidently
granted and remanded the case to the California Court of Appeal,
Fourth District, for dismissal. The California Court of Appeal,
Fourth District, in turn, entered the order dismissing the
action on November 26, 2002. On May 31, 2002, in
National Asbestos Workers Medical Fund v. Philip Morris,
Inc.,Judge Weinstein of the United States District Court
for the Eastern District of New York granted plaintiffs
motion to dismiss all claims. On July 3, 2002, Judge
Weinstein denied class certification in Bergeron v. Philip
Morris, Inc., and on July 16, 2002, ordered that the
case be transferred to Massachusetts or dismissed. On
August 7, 2002, the parties stipulated to a voluntary
dismissal.

As of February 4, 2003, there were no
pending lawsuits by union trust funds against cigarette
manufacturers and others.

Insurance Companies.As of February 4, 2003, three
cases brought by insurance companies were pending against RJR
Tobacco. In Group Health Plan, Inc. v. Philip Morris, Inc.and Medica v. Philip Morris, Inc., a federal district
judge in Minnesota dismissed all claims, except a state
antitrust claim and a state conspiracy claim. The federal court
certified to the Minnesota Supreme Court the question whether
these two claims could be pursued under Minnesota law by Group
Health Plan. On January 11, 2001, the Minnesota Supreme
Court ruled that the plaintiff could pursue these claims.
Certain defendants, including RJR Tobacco, filed motions for
summary judgment based on (1) the statutes of limitation
and (2) causation, injury and damages. On January 31,
2002, summary judgment was granted in favor of certain
defendants, including RJR Tobacco, on all causes of action.
In March 2002, plaintiffs appealed the summary judgment rulings
to the United States Court of Appeals for the Eighth Circuit.
Oral argument was scheduled for February 12, 2003, but will
be rescheduled to a later date.

On June 6, 2001, in Blue Cross and Blue
Shield of New Jersey, Inc. v. Philip Morris, Inc., a federal
court jury in Brooklyn returned a verdict in favor of RJR
Tobacco and other tobacco defendants on common law fraud and
civil RICO claims, but found for the plaintiff, Empire Blue
Cross and Blue Shield, on a claim under a New York state
deceptive business practices statute. Empire pursued its claims
against the defendants on behalf of itself directly, as well as
on the behalf of its insureds under a theory of subrogation. The
jury verdict on the direct claim was approximately $17.8
million, and the verdict on the subrogated claim was

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approximately $11.8 million. RJR Tobaccos
portion of these amounts is $6.6 million and $4.4 million,
respectively. Pursuant to New York law, Empire elected the
verdict on the direct claim. The New York statute under which
Empire recovered does not provide for punitive damages, but does
allow for recovery of reasonable attorneys fees. On
February 28, 2002, Judge Weinstein awarded plaintiffs
counsel approximately $38 million in attorneys fees. On
July 2, 2002, Judge Weinstein denied defendants
renewed motion to dismiss. He also refused to transfer the
claims of non-New York plans to their respective states, and
continued the stay of those claims, as well as all remaining
claims of Blue Cross Blue Shield plans until final resolution of
the Empire Blue Cross case. The defendants, including RJR
Tobacco, have appealed to the United States Court of Appeals for
the Second Circuit, and oral argument occurred February 13,
2003.


Native American Tribes.As of February 4, 2003, two cases
brought by Native American tribes were pending against RJR
Tobacco. On July 15, 2002, in Alabama Coushatta Tribe of
Texas v. American Tobacco Co., the United States Court of
Appeals for the Fifth Circuit affirmed the dismissal of a
complaint by a federal district court in Texas. Plaintiffs
petition for rehearing was subsequently denied on
August 15, 2002. Plaintiffs filed a petition for writ of
certiorari in the U.S. Supreme Court, which was denied on
January 21, 2003, thus ending the case. On January 25,
2002, in the Navajo Nation v. Philip Morris, Inc., the
District Court of Navajo Nation granted defendants motion
to dismiss conspiracy, deceptive acts and restraint of trade
claims. The court refused to dismiss plaintiffs product
liability claim. In response, plaintiffs filed a motion to
alter, amend and/or clarify the January 25, 2002 order. No
decision has been made by the court. One other Native American
tribe case remains pending before a tribal court in South Dakota.

Hospitals.As of
February 4, 2003, three cases brought by hospitals were
pending against RJR Tobacco. In May 2000, in A.O. Fox
Memorial Hospital v. American Tobacco Co., Inc., pending in
state court in Nassau County, New York, a group of approximately
175 hospitals filed suit against the tobacco industry seeking at
least $3.6 billion for costs expended to treat smoking-related
illnesses. On December 14, 2001, defendants motion to
dismiss was granted. Plaintiffs appealed the dismissal to the
Appellate Division of the Supreme Court, Second Judicial
Department, which affirmed the trial courts dismissal on
February 10, 2003.

MSA-Enforcement and Validity

As of February 4, 2003, seven cases were
pending against RJR Tobacco concerning the enforcement and
validity of the MSA. The litigation challenging the validity of
the MSA, including claims that the MSA violates antitrust laws,
has not been successful.

Arizona, California, New York and Washington have
alleged that the posting of signage advertising
RJR Tobaccos brand-name sponsorship violates a
provision of the MSA governing the times during which such signs
may be posted. Courts in Arizona, on November 16, 2001, and
California, on November 27, 2001, ruled against RJR
Tobacco. On February 1, 2002, a New York court ruled in
favor of RJR Tobacco. Appeals of all of these decisions are
pending. The Washington matter was rendered moot and was
dismissed.

The State of Ohio alleged that RJR Tobaccos
purchase of advertising space on matchbooks distributed by an
independent third party violates a provision of the MSA
governing brand-name merchandise. On April 25, 2002, the
Ohio court ruled in favor of RJR Tobacco. Oral argument in
Ohios appeal was heard on January 21, 2003.

Finally, the State of California alleged, in the
context of the placement of print advertising, that
RJR Tobacco is in violation of the prohibition in the MSA
against taking any action, directly or indirectly, to
target youth. In a decision issued on July 12, 2002,
the trial judge found that although youth may not have
been directly targeted . . . RJR indirectly targeted youth,
thereby violating the MSA. In addition, the judge issued a
$20 million fine. RJR Tobacco believes the judges decision
to be erroneous as a matter of fact and law and is appealing the
ruling.

Asbestos Contribution Cases

As of February 4, 2003, five lawsuits were
pending against RJR Tobacco in which asbestos companies and/or
asbestos-related trust funds allege that they
overpaid claims brought against them to the extent
that

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tobacco use, not asbestos exposure, was the cause
of the alleged personal injuries for which they paid
compensation. On May 24, 2001, a Mississippi state court
judge dismissed all such claims by Owens-Corning in Estate of
Ezell Thomas v. RJR Tobacco Co.Owens-Corning appealed the
dismissal to the Mississippi Supreme Court on August 15,
2001. That appeal remains pending. A similar case, H.K.
Porter Co., Inc. v. American Tobacco Co., was pending in the
United States District Court for the Eastern District of New
York before Judge Weinstein. However, on July 26, 2001, the
parties stipulated to a dismissal of the action. In
Fibreboard Corp. v. R. J. Reynolds Tobacco Co., a case
pending in state court in California, Owens-Corning and
Fibreboard asserted the same claims as those asserted in the
Mississippi case. Motions to dismiss those claims have been held
in abeyance pending the final determination of the Mississippi
case.


Antitrust Cases

A number of tobacco wholesalers, or indirect
purchasers, sued United States cigarette manufacturers,
including RJR Tobacco, and its parent company, RJR, alleging
that cigarette manufacturers combined and conspired to set the
price of cigarettes, in violation of antitrust statutes and
various state unfair business practices statutes. Of the 36 such
cases pending against RJR Tobacco, 30 cases are pending in state
court, and six cases are pending in federal court. Plaintiffs
are asking the court to certify the lawsuits as class actions on
behalf of other persons that purchased cigarettes directly from
one or more of the defendants. The federal cases were
consolidated and sent by the Judicial Panel on Multi-District
Litigation for pretrial proceedings in the United States
District Court for the Northern District of Georgia. The court
certified a class of direct purchasers on January 27, 2001.
The court granted defendants motion for summary judgment
in the consolidated federal cases on July 11, 2002.
Plaintiffs appealed to the U.S. Court of Appeals for the
Eleventh Circuit on July 19, 2002. Oral argument is
scheduled for between April 1 and April 4, 2003. State
court cases on behalf of indirect purchasers have been dismissed
in Arizona, which is currently on appeal, and New York. In
addition, on November 15, 2002, a District of Columbia
court dismissed all claims arising prior to May 11, 1996. A
Minnesota court denied class certification on November 21,
2001. A Kansas court granted class certification on
November 15, 2001, and a Michigan court denied class
certification on June 11, 2002. New Mexico and North Dakota
courts denied defendants motions to dismiss on
July 8, 2002 and June 25, 2002, respectively.

On July 30, 1999, Cigarettes Cheaper!, a
retailer, filed an antitrust counterclaim against RJR Tobacco in
a gray market trademark suit originally brought by RJR Tobacco
in the United States District Court for the Northern District of
Illinois. Cigarettes Cheaper! alleges that it was denied
promotional resources in violation of the Robinson-Patman Act.
The district court declined to dismiss the counterclaim. On
January 23, 2001, the court granted Cigarettes
Cheaper!s motion to amend its counterclaim to include a
violation of the Sherman Act §1, claiming that RJR Tobacco
conspired with other retailers to deny promotions to Cigarettes
Cheaper!, an allegation that RJR Tobacco denies. On
March 21, 2001, RJR Tobaccos motion to add a
trademark dilution claim against Cigarettes Cheaper! was
granted. On June 28, 2001, the court granted RJR
Tobaccos motion to strike with prejudice several of
Cigarettes Cheaper!s affirmative defenses. These defenses
related to: (1) alleged misrepresentations caused by the
packaging of cigarettes manufactured by RJR Tobacco for export;
(2) RJR Tobaccos No Bull advertising
campaign for its WINSTON cigarettes; (3) antitrust
trademark misuse; (4) nominative fair use; and (5) the
first sale doctrine. The court denied RJR Tobaccos motion
for summary judgment on Cigarettes Cheaper!s counterclaim
on January 21, 2003. The court severed the main claim and
counterclaim. Trial is scheduled to begin on the trademark case,
in which RJR Tobacco is a plaintiff, on March 3, 2003. The
trial date on the antitrust case is yet to be determined.

On February 16, 2000, a class action
complaint, Deloach v. Philip Morris Cos., Inc., was
brought against RJR Tobacco, other cigarette manufacturers and
others, in the United States District Court for the District of
Columbia on behalf of a putative class of all tobacco growers
and tobacco allotment holders. Plaintiffs assert that the
defendants, Philip Morris, Inc., RJR Tobacco, Brown &
Williamson Tobacco Corp. and Lorillard Tobacco Co., engaged in
bid-rigging of American burley and flue-cured tobacco auctions
beginning at least by 1996 and continuing to present.
Defendants actions are alleged to have held the auction
prices of tobacco at artificially low prices resulting in damage
to tobacco growers and allotment holders. In addition,
plaintiffs allege that defendants have engaged in a conspiracy
to force the elimination or destruction of the federal

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governments tobacco quota and price support
program through an alleged illegal group boycott. On
October 9, 2000, defendants filed a motion to dismiss the
second amended complaint and a motion to transfer venue to the
United States District Court for the Middle District of North
Carolina. On November 30, 2000, the court granted the
motion to transfer the case. On December 20, 2000,
plaintiffs moved to amend the complaint to add the leaf-buying
companies Dimon, Universal Leaf and Standard Commercial as
defendants, which motion was allowed. Plaintiffs motion to
certify the class was granted on April 3, 2002. On
April 16, 2002, RJR Tobacco and the other defendants
petitioned the U.S. Court of Appeals for the Fourth Circuit to
review the class certification ruling. On June 12, 2002,
the Fourth Circuit declined to review the class certification
ruling, and on July 8, 2002, the court denied a petition
for rehearing. The case is now in the discovery phase. Trial is
scheduled for April 19, 2004.


On December 4, 2002, Leslie H. Dial, owner
of Leslie H. Dial Enterprises, filed suit against RJR Tobacco,
Wal-Mart Stores, Inc. and Sams Club in the U.S. District
Court for the District of South Carolina. The suit alleges that
Dial Enterprises, a tobacco distribution company, was denied
participation in RJR Tobaccos pricing promotions on
proportionally equal terms to competitors, such as Wal-Mart and
Sams Club, in violation of the Robinson-Patman Act. The
suit also claims that RJR Tobacco conspired with Wal-Mart Stores
and Sams Club to restrain pricing competition in the
marketing of cigarettes, thereby allegedly harming Dial
Enterprises business. The suit seeks unspecified damages.
Plaintiff has requested a bench trial.

Other Litigation and Developments

On January 24, 2003, RJR and RJR Tobacco
were each served with a subpoena dated January 7, 2003, and
issued by a federal grand jury sitting in the Southern District
of New York. The subpoena seeks the production of documents
relating to the sale and distribution of cigarettes in
international markets. RJR and RJR Tobacco intend to respond
appropriately to the subpoena and otherwise cooperate with this
grand jury investigation.

RJR Tobacco is aware of a grand jury
investigation in North Carolina that relates to the cigarette
business of certain of its former affiliates. In connection with
this investigation, RJR Tobacco responded to document subpoenas
dated July 7, 1999 and June 1, 2000, respectively.

On December 22, 1998, Northern Brands
International, Inc. entered into a plea agreement with the
United States Attorney for the Northern District of New York.
Northern Brands is a now-inactive RJR subsidiary that was part
of the business of R. J. Reynolds International B.V., a former
Netherlands subsidiary of RJR Tobacco, which was managed by a
former affiliate, RJR-MacDonald, Inc. On May 12, 1999,
RJR-MacDonald, Inc. was sold to Japan Tobacco Inc. and
subsequently changed its name to JT-MacDonald, Inc. Northern
Brands was charged with aiding and abetting certain customers
who brought merchandise into the United States by means of
false and fraudulent practices . . . . It is understood
that JT-MacDonald, Inc., Japan Tobaccos international
operating company in Canada, is cooperating with an
investigation now being conducted by the Royal Canadian Mounted
Police relating to the same events that gave rise to the
Northern Brands investigation.

On December 21, 1999, the government of
Canada filed a lawsuit in the United States District Court for
the Northern District of New York against RJR Tobacco, RJR,
several currently and formerly related companies, including
Northern Brands, and the Canadian Tobacco Manufacturers Council.
The lawsuit alleges that, beginning in 1991, the defendants
conspired with known distributors and smugglers to illegally
import into Canada tobacco products originally earmarked for
export from Canada, in a fashion that avoided the imposition of
certain excise and retail taxes and duty payments. On
June 30, 2000, this case was dismissed by the United States
District Court for the Northern District of New York. Plaintiff
appealed the dismissal to the United States Court of Appeals for
the Second Circuit, which, on October 12, 2001, affirmed
the district courts dismissal. On December 12, 2001,
the Court of Appeals denied Canadas petition for
rehearing. In March 2002, Canada filed a petition for a writ of
certiorari with the Supreme Court of the United States. The
Supreme Court denied Canadas petition on November 4,
2002, thereby bringing Canadas case to an end. The
government of Canada has indicated that it might pursue these
claims in Canada. Although the

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international tobacco business was sold, RJR and
RJR Tobacco retained certain liabilities relating to the events
disclosed above.


Similar lawsuits have been filed against RJR
Tobacco and its affiliates, along with other cigarette
manufacturers, by the European Community and ten of its member
states (Belgium, Finland, France, Greece, Germany, Italy,
Luxembourg, the Netherlands, Portugal and Spain), as well as by
Ecuador, Belize and Honduras. These suits contend that RJR
Tobacco and other tobacco companies in the United States may be
held responsible for damages caused by cigarette smugglers under
common law and under the federal RICO statute. Each of these
actions seeks compensatory, punitive and treble damages.

On July 17, 2001, the action brought by the
European Community was dismissed by the United States District
Court for the Eastern District of New York. However, the
European Community and its member states filed a similar
complaint in the same jurisdiction on August 6, 2001. On
October 25, 2001, the court denied the European
Communitys request of August 10, 2001, to reinstate
its original complaint. On November 9, 2001, the European
Community and the ten member states amended their complaint
filed on August 6, 2001, to change the name of defendant
Nabisco Group Holdings Corp. to RJR Acquisition Corp. RJR
Tobacco and the other defendants filed motions to dismiss that
complaint on November 14, 2001, and the court heard oral
argument on those motions on January 11, 2002. On
February 25, 2002, the court granted defendants
motion to dismiss the complaint and, on March 25, 2002,
plaintiffs filed a notice of appeal with the United States Court
of Appeals for the Second Circuit. Oral argument occurred on
January 29, 2003.

On October 30, 2002, the European Community
and ten of its member states (Belgium, Finland, France, Greece,
Germany, Italy, Luxembourg, the Netherlands, Portugal and Spain)
filed a third complaint against RJR, RJR Tobacco and several
currently and formerly related companies in the United States
District Court for the Eastern District of New York. The
complaint, which contains many of the same or similar
allegations found in two earlier complaints that were previously
dismissed by the same court, alleges that the defendants,
together with certain identified and unidentified persons,
including organized crime organizations and drug cartels,
engaged in money laundering and other conduct for which they
should be accountable to the plaintiffs under civil RICO and a
variety of common law claims. The complaint also alleges that
the defendants manufactured cigarettes which were eventually
sold in Iraq in violation of U.S. sanctions against such sales.
The plaintiffs are seeking unspecified actual damages (to be
trebled), costs, reasonable attorneys fees and injunctive
relief under their RICO claims, and unspecified compensatory and
punitive damages, and injunctive and equitable relief under
their common law claims.

On December 20, 2000, October 15, 2001,
and January 9, 2003, applications for annulment were filed
in the Court of First Instance in Luxembourg challenging the
competency of the European Community to bring each of the
foregoing actions and seeking an annulment of the decision to
bring each of the actions, respectively. On January 15,
2003, the Court of First Instance entered a judgment denying the
admissibility of the first two applications, principally on the
grounds that the filing of the first two complaints did not
impose binding legal effects on the applicants. RJR and its
affiliates are considering an appeal of that judgment. The
application for annulment filed in connection with the third
action is still pending before the Court of First Instance.

RJR Tobacco and other defendants filed motions to
dismiss the actions brought by Ecuador, Belize and Honduras in
the United States District Court for the Southern District of
Florida. These motions were granted on February 26, 2002,
and the plaintiffs filed a notice of appeal with the United
States Court of Appeals for the Eleventh Circuit on
March 26, 2002. The Eleventh Circuit heard oral argument on
these motions on December 10, 2002, and its decision is
pending.

RJR Tobacco has been served in two reparations
actions brought by descendants of slaves. Plaintiffs in these
actions claim that defendants, including RJR Tobacco, profited
from the use of slave labor. These two actions have been
transferred to the Northern District of Illinois by the Judicial
Panel on Multi-District Litigation for coordinated or
consolidated pretrial proceedings with other reparation actions.
Seven additional cases were originally filed in California,
Illinois and New York. RJR Tobacco is a named defendant in only
one of these additional cases, but it has not been served. The
action in which RJR Tobacco is named but has not been served was
conditionally transferred to the Northern District of Illinois
on January 7, 2003.

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On June 8, 2001, the Attorney General of the
State of California filed a lawsuit against RJR Tobacco in
California state court alleging that RJR Tobacco violated
California state law by distributing free cigarettes and free
coupons for discounts on cigarettes on public
grounds, even though the promotions occurred within an
adult-only facility at a race track and certain
festivals. RJR Tobacco answered the complaint on July 19,
2001, asserting that its promotions complied with all laws,
including California state law and that this California state
law is preempted by the Federal Cigarette Labeling Act. On
March 29, 2002, the court ruled that
RJR Tobaccos distribution of free cigarettes violated
the law, but the distribution of free coupons for discounts on
cigarettes did not. On April 29, 2002, the judge assessed a
civil fine against RJR Tobacco of $14.8 million.
RJR Tobacco is appealing.

On May 23, 2001, Star Scientific, Inc. filed
a patent infringement action against RJR Tobacco in the
United States District Court for the District of Maryland. The
suit alleges infringement of U.S. Patent No. 6,202,649
entitled Method of Treating Tobacco to Reduce Nitrosamine
Content, and Products Produced Thereby. On July 30,
2002, Star filed another infringement action against
RJR Tobacco in the United States District Court for the
District of Maryland alleging infringement of a related patent,
U.S. Patent No. 6,425,401 also entitled Method of
Treating Tobacco to Reduce Nitrosamine Content, and Products
Produced Thereby. RJR Tobacco has filed counterclaims
seeking a declaration that the claims of the two Star patents in
dispute are invalid, unenforceable and not infringed by
RJR Tobacco. The Maryland court has consolidated the two
cases, and discovery is ongoing.



---

Although RJRs management continues to
conclude that the loss of any particular smoking and health
tobacco litigation claim against RJR Tobacco or its
affiliates, when viewed on an individual basis, is not probable,
the possibility of material losses related to tobacco litigation
is more than remote. Litigation is subject to many
uncertainties, and it is not possible to predict the outcome of
the litigation pending against RJR Tobacco, or its
affiliates, including RJR, or indemnitees.

Unfavorable judgments awarding compensatory
damages, punitive damages and/or fines have been returned
against RJR Tobacco in the Engleclass action case,
a small number of individual smoking and health cases, a
Broin IIflight attendant ETS case, an MSA enforcement
action and a California state law enforcement action. Although
RJR Tobacco believes that it has numerous bases for
successful appeals in these cases, and both RJR Tobacco and RJR
believe they have a number of valid defenses to all actions and
intend to defend all actions vigorously, it is possible that
there could be further adverse developments in these cases, and
that additional cases could be decided unfavorably against
RJR Tobacco or its affiliates or indemnitees.
Determinations of liability or adverse rulings in such cases or
in similar cases involving other cigarette manufacturers as
defendants, even if such judgments are not final, could
materially adversely affect the litigation against
RJR Tobacco or its affiliates or indemnitees, and could
encourage the commencement of additional tobacco-related
litigation. In addition, a number of political, legislative,
regulatory and other developments relating to the tobacco
industry and cigarette smoking have received wide media
attention. These developments may negatively affect the outcomes
of tobacco-related legal actions and encourage the commencement
of additional similar litigation.

Although it is impossible to predict the outcome
of such events on pending litigation and the rate new lawsuits
are filed against RJR Tobacco and RJR, a significant
increase in litigation and/or in adverse outcomes for tobacco
defendants could have a material adverse effect on either or
both of these entities. Moreover, notwithstanding the quality of
defenses available to it and its affiliates in litigation
matters, it is possible that RJRs results of operations,
cash flows or financial condition could be materially adversely
affected by the ultimate outcome of certain pending or future
litigation matters.

ERISA Litigation

On May 13, 2002, in Tatum v. The R.J.R.
Pension Investment Committee of the R. J. Reynolds Tobacco
Company Capital Investment Plan, pending in the United
States District Court for the Middle District of North Carolina,
an employee of RJR Tobacco filed a class-action suit
alleging that the defendants, RJR, RJR Tobacco, the
RJR Employee Benefits Committee and the RJR Pension
Investment Committee, violated

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the Employee Retirement Income Security Act of
1974, referred to as ERISA. The actions about which plaintiff
complains stem from a decision made in 1999 by RJR Nabisco
Holdings Corp., subsequently renamed Nabisco Group Holdings
Corp., to spin-off RJR, thereby separating NGHs tobacco
business and food business. As part of the spin-off, the 401(k)
plan for the previously related entities had to be divided into
two separate plans for the now separate tobacco and food
businesses. Plaintiff contends that defendants violated ERISA by
not overriding an amendment to RJRs 401(k) plan requiring
that, prior to February 1, 2000, the stock funds of the
companies involved in the food business  NGH and
Nabisco Holdings Corp.  be eliminated as investment
options from RJRs 401(k) plan. In his complaint, plaintiff
requests, among other things, that the court issue an order
requiring the defendants to pay as damages to the RJR 401(k)
plan an amount equal to the subsequent appreciation that was
purportedly lost as a result of the liquidation of the NGH and
Nabisco Holdings Corp. funds. Defendants filed a motion to
dismiss on July 29, 2002. The court has not yet ruled on
the motion.


Environmental Matters

RJR and its subsidiaries are subject to federal,
state and local environmental laws and regulations concerning
the discharge, storage, handling and disposal of hazardous or
toxic substances. Such laws and regulations provide for
significant fines, penalties and liabilities, sometimes without
regard to whether the owner or operator of the property knew of,
or was responsible for, the release or presence of hazardous or
toxic substances. In addition, third parties may make claims
against owners or operators of properties for personal injuries
and property damage associated with releases of hazardous or
toxic substances. In the past, RJR Tobacco has been named a
potentially responsible party, referred to as a PRP, with third
parties under the Comprehensive Environmental Response,
Compensation and Liability Act, with respect to several
superfund sites.

Regulations promulgated by the U.S. Environmental
Protection Agency and other governmental agencies under various
statutes have resulted in, and likely will continue to result
in, substantial expenditures for pollution control, waste
treatment, plant modification and similar activities. RJR and
its subsidiaries monitor their environmental matters and,
dependent upon the probability of occurrence and reasonable
estimation of cost, accrue or disclose any material liability.

Del Monte Corporation, a former subsidiary of
RJR, is named a defendant in a lawsuit related to a superfund
site in Hawaii, Akee v. The Dow Chemical Co., filed in
the First Circuit Court of the State of Hawaii on
October 7, 1999. The superfund site includes land on which
Del Monte Corporation maintained fresh fruit operations at one
time. In connection with litigation related to the superfund
site, Del Monte Corporation also has received a demand for
indemnity from an entity that was a chemical supplier to Del
Monte Corporation. Del Monte Corporation has sought indemnity
from RJR under the terms of the agreement by which RJR sold Del
Monte Corporation in 1990. RJR, in turn, has provided notice of
these claims to the buyers of the Del Monte fresh fruit
business, asserting the right to be indemnified by the buyers of
the fresh fruit business for any liability arising out of such
claims under the terms of the agreement by which RJR sold the
Del Monte fresh fruit business in 1989.

Pursuant to an agreement dated June 12,
2001, among RJR, the buyers of the Del Monte fresh fruit
business, Del Monte Corporation and others, the buyers of the
Del Monte fresh fruit business agreed, from the date of the
agreement forward, to indemnify RJR for any liabilities imposed
in Akeeand with respect to the environmental
investigation and remediation of the superfund site required by
the EPA.

On June 1, 2001, RJR received notice from
Del Monte Corporation of a claim made against it by a Hawaii
landowner who has been sued by a lessee of its land, claiming
injuries due to pesticide contamination of the soil, allegedly
caused by Del Monte Corporation as a prior lessee of the land.
The landowner-defendant has tendered the claim to Del Monte
Corporation for defense and indemnity. Del Monte Corporation has
in turn tendered the claim to RJR for defense and indemnity,
claiming it is entitled to be indemnified under the terms of the
agreement by which RJR sold Del Monte Corporation. Based on the
plaintiffs failure to provide any factual information in
support of its claim that Del Monte Corporation was a prior
lessee of the subject land, Del Monte Corporation has agreed to
extend indefinitely the period during which RJR must respond to

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Del Monte Corporations tender of the claim
to RJR for defense and indemnity, subject to the right to
terminate the indefinite extension on fifteen days notice
to RJR.


On February 21, 2002, Del Monte Corporation
was served with complaints filed in Nicaragua, referred to as
the Nicaraguan Complaints, asserting claims on behalf of
agricultural workers allegedly harmed or injured by exposure to
certain chemicals used in banana plantations in Nicaragua. Del
Monte Corporation has requested that RJR acknowledge its
obligation to indemnify Del Monte Corporation in connection with
such claims. RJR has provided notice of such claims and a
request for indemnification to the buyers of the Del Monte fresh
fruit business. In response to the notice and request of RJR,
Del Monte Fresh Produce Company accepted the tender of the
claims and agreed to provide a defense to Del Monte Corporation.
Del Monte Corporation has agreed to withdraw its tender of such
claims to RJR, without waiving its right to again tender the
claims to RJR should Del Monte Fresh Produce Company withdraw
its agreement to defend and indemnify Del Monte Corporation.

On June 13, 2002, counsel for plaintiffs in
the Nicaraguan complaints acknowledged that attempted service of
process of all such cases on Del Monte Corporation, doing
business as Del Monte Foods Company, referred to as Del Monte,
was improper. Further, on June 13, 2002, the parties filed
a written stipulation that Del Montes motion to quash the
attempted service of the Nicaraguan Complaints should be granted
and that any future service on Del Monte of any other similar
cases alleging the same material facts and naming the same
defendants also should be deemed to be quashed. Pursuant to the
parties stipulation, the U. S. District Court for the
Northern District of California signed an order on June 13,
2002, granting Del Montes motion to quash the attempted
service of the Nicaraguan complaints.

RJR Tobacco was notified by the EPA on
June 11, 2000, of its potential liability under CERCLA for
a superfund site in Greer, South Carolina. The notice and demand
for reimbursement of costs incurred by the EPA were sent to a
group of approximately 43 potentially responsible parties,
including RJR Tobacco, and involve an aggregate exposure
presently estimated to be approximately $5.1 million.
Apportionment among the PRPs has not been completed, but RJR
Tobacco believes that its apportionment will be immaterial to
its results of operations, cash flows or financial condition.
The PRPs are a group of companies previously involved as
potentially responsible parties in another superfund site. The
EPA alleges that some waste from the cleanup of the other site
was transported to the site in question. RJR Tobacco has
executed and extended a tolling agreement with the EPA. This
tolling agreement provides for entry into good faith
negotiations with the EPA, and is not an admission of fact or
liability. The tolling agreement also should have no impact on
any defense RJR Tobacco may assert, other than a defense based
on the running of the statute of limitations. Information is
being gathered from other potentially responsible parties
notified by the EPA and an environmental consultant working on
behalf of the PRP group, which includes RJR Tobacco.

RJR Tobacco is a named defendant in a lawsuit
related to an existing superfund site in North Carolina,
United States v. AAF-McQuay, Inc.,which was filed in
United States District Court for the Western District of North
Carolina on August 12, 2002. The Jadco-Hughes
superfund site near Belmont, North Carolina, is land on which a
solvent reclamation and disposal business was owned and operated
in the 1970s. It was placed on the National Priorities List in
1986. RJR Tobacco, through its packaging division (formerly
known as RJR Archer), as a member of a group of 24 previously
identified PRPs, executed a waiver of service of summons in this
matter. A joint motion of plaintiff and all defendants for a
stay of all proceedings and for an extension of time for all
defendants to file answers or responses to the complaint was
granted on January 7, 2003. EPA filed the action as a
result of the expiration of a then-existing tolling agreement
that could not be timely renewed. The PRP group had requested
information from the EPA regarding various EPA costs related to
the Jadco-Hughes site. The parties are cooperating to seek a
resolution of this matter. The aggregate exposure for the
Jadco-Hughes site for all PRPs is presently approximately $9.2
million. Apportionment among the PRPs places RJR Tobacco in the
top third.

RJR and its subsidiaries have been engaged in a
continuing program to comply with federal, state and local
environmental laws and regulations. Although it is difficult to
reasonably estimate the portion of capital expenditures or other
costs attributable to compliance with environmental laws and
regulations and to estimate

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the cost of resolving these CERCLA matters, RJR
does not expect such expenditures or other costs to have a
material adverse effect on the business, results of operations
or financial condition of RJR or its subsidiaries.


Other Contingencies

Until the acquisition by merger by Philip Morris
Companies, Inc. of Nabisco from NGH on December 11, 2000,
NGH and Nabisco were members of the consolidated group of NGH
for U.S. federal income tax purposes. Each member of a
consolidated group is jointly and severally liable for the U.S.
federal income tax liability of other members of the group as
well as for pension and funding liabilities of the other group
members. NGH, now known as RJR Acquisition Corp., continues to
be jointly and severally liable for these Nabisco liabilities
prior to December 11, 2000.

In connection with Philip Morris
acquisition by merger of Nabisco and RJRs subsequent
acquisition by merger of NGH, Philip Morris, Nabisco and NGH
entered into a voting and indemnity agreement that generally
seeks to allocate tax liabilities ratably based upon NGHs
taxable income and that of Nabisco, had the parties been
separate taxpayers. If Philip Morris and Nabisco are unable to
satisfy their obligations under this agreement, NGH would be
responsible for satisfying them.

In connection with the sale of the international
tobacco business to Japan Tobacco Inc. on May 12, 1999, RJR
and RJR Tobacco agreed to indemnify Japan Tobacco against
(1) any liabilities, costs and expenses arising out of the
imposition or assessment of any tax with respect to the
international tobacco business arising prior to the sale, other
than as reflected on the closing balance sheet, (2) any
liabilities, costs and expenses that Japan Tobacco or any of its
affiliates, including the acquired entities, may incur after the
sale in respect of any of RJRs or RJR Tobaccos
employee benefit and welfare plans and (3) any liabilities,
costs and expenses incurred by Japan Tobacco or any of its
affiliates arising out of certain activities of Northern Brands.
Although it is impossible to predict the outcome of the Northern
Brands litigation or the amount of liabilities, costs and
expenses, a significant adverse outcome regarding any of these
items could have an adverse effect on either or both of RJR and
RJR Tobacco.

RJR, RJR Tobacco and RJR Acquisition Corp. will
be required to pledge all of their assets to secure their
obligations under RJRs revolving credit facility if the
guaranteed unsecured notes of RJR are rated below BBB- by
Standard & Poors and below Baa3 by Moodys, or
two levels below these thresholds for either of these rating
agencies. If RJR and the guarantors are required to pledge their
assets to secure their obligations under the revolving credit
facility, as amended and restated, they also will be required to
pledge certain of their assets to secure RJRs guaranteed
unsecured notes.

As long as RJRs unsecured, unsubordinated
debt rating remains investment grade, RJR may be required to
post collateral under its interest rate swap agreements if the
fair value of the interest rate swaps results in a liability
position that exceeds specified threshold amounts. If RJRs
unsecured, unsubordinated debt rating is either one level below
BBB- by Standard & Poors or Baa3 by Moodys, any
fair value that results in a liability position of the interest
rate swaps, will require full collateralization. In addition, as
long as RJRs existing revolving credit facility is in
place, if RJR and the guarantors are required to pledge their
assets to secure their obligations under RJRs revolving
credit facility, as amended and restated, such pledge also will
secure their obligations under these interest rate swap
agreements.

Since the spin-off in 1999, RJRs unsecured,
unsubordinated debt notes have maintained the ratings of BBB-by
Standard & Poors and Baa2 by Moodys. In December
2002, Moodys revised its outlook to negative but
maintained its rating, reflecting its concern over the impact of
industry trends including heavy promotional activity in the
premium price-tier and the growth of the deep-discount
price-tier despite the reduction in payments under the MSA.

Employees

At December 31, 2002, RJR and its
subsidiaries had approximately 8,200 full-time employees and
1,100 part-time employees. None of these employees is unionized.
Employee relations are believed to be good. Under a
restructuring plan announced in December 2002, approximately 572
full-time positions will be

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eliminated, primarily in the first half of 2003.
For further information about the restructuring plan, see note 3
to the consolidated financial statements.


Item 2. Properties

RJRs executive offices are located in two
buildings in downtown Winston-Salem, North Carolina, which are
owned by RJR Tobacco. For information about RJR Tobaccos
operating facilities see Business 
Manufacturing and Business  Research and
Development in Item 1.

Item 3. Legal Proceedings

Various legal actions, proceedings and claims,
including legal actions claiming that lung cancer and other
diseases, as well as addiction, have resulted from the use of,
or exposure to, RJRs operating subsidiaries
products, are pending or may be instituted against RJR or its
affiliates, including RJR Tobacco, or indemnitees. In July
2000, a jury in the Florida state court case Engle v. R.J.
Reynolds Tobacco Co.rendered a verdict in favor of the
Florida class of plaintiffs of approximately $145
billion, with approximately $36.3 billion being assigned to
RJR Tobacco. RJR Tobacco and other defendants have
appealed this verdict. RJR Tobacco believes it has numerous
bases for a successful appeal, although it cannot predict the
outcome of the appellate process. For a further discussion of
the Englecase and other litigation and legal proceedings
pending against RJR or its affiliates or indemnitees, see
Business  Litigation Affecting the Cigarette
Industry, Business  ERISA
Litigation and Business  Environmental
Matters in Item 1;  Critical
Accounting Policies and Recent Accounting Developments and
 Governmental Activity in
Managements Discussion and Analysis of Financial
Condition and Results of Operations; note 14 to the
consolidated financial statements; and Exhibit 99.1 to this
report. Even though RJRs management continues to conclude
that the loss of any particular smoking and health tobacco
litigation claim against RJR Tobacco or its affiliates, when
viewed on an individual basis, is not probable, the possibility
of material losses related to tobacco litigation is more than
remote. However, RJRs management is unable to predict the
outcome of such litigation or to reasonably estimate the amount
or range of any possible loss. Moreover, notwithstanding the
quality of defenses available to it and its affiliates in
tobacco-related litigation matters, it is possible that
RJRs results of operations, cash flows or financial
condition could be materially adversely affected by the ultimate
outcome of certain pending or future litigation matters.

You may request a copy of Exhibit 99.1, free of
charge, by writing to the Corporate Secretary, R.J. Reynolds
Tobacco Holdings, Inc., P.O. Box 2866, 401 N. Main Street,
Winston-Salem, NC 27402-2866, or by phoning 336-741-5162.

Item 4. Submission of Matters to a Vote
of Security Holders

None.

Executive Officers and Certain Significant
Employees of the Registrant

The executive officers and certain significant
employees are:

Andrew J. Schindler.Mr. Schindler, 58, has served as
Chief Executive Officer of RJR Tobacco since 1995 and as
President and Chief Executive Officer of RJR since June 1999.
Mr. Schindler has served as Director of RJR Tobacco
since 1989, and as Chairman of the Board of RJR and
RJR Tobacco since July 1999. Mr. Schindler joined RJR
in 1974. He became Senior Vice President  Operations
of RJR Tobacco in 1989 and was elected Executive Vice
President  Operations of RJR Tobacco in 1991.
Mr. Schindler served as Chief Operating Officer of
RJR Tobacco from 1994 until 1995 and as its President from
1994 until January 2002. He achieved the rank of captain in the
U.S. Army, where he held command and staff positions in the
United States and Vietnam. Mr. Schindler currently serves
as Chairman of the Winston-Salem Alliance. He is also a member
of the boards of visitors of Wake Forest University Baptist
Medical Center and the Babcock Graduate School of Management,
and the boards of directors of Winston-Salem Business, Inc. and
!dealliance (formerly the North Carolina Emerging Technology
Alliance).

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Thomas R. Adams.Mr. Adams, 52, has been Senior
Vice President and Controller of RJR and RJR Tobacco since
June 1999. From 1985 until 1999, he was Partner at the
accounting firm of Deloitte & Touche LLP. Mr. Adams is
a member of the board of directors of Technology Concepts &
Design, Inc., an affiliate of RJR.

Lynn J. Beasley.In
January 2002, Ms. Beasley, 45, was promoted to President
and Chief Operating Officer of RJR Tobacco, after serving
as Executive Vice PresidentMarketing since 1997, and has
been Director of RJR Tobacco since March 2000.
Ms. Beasley joined RJR Tobacco in 1982 as a marketing
assistant. After holding a number of positions at
RJR Tobacco, she became Senior Vice President of the
Winston/Camel business unit in 1993. From 1995 until 1997, she
was Senior Vice President of brand marketing for WINSTON, CAMEL
and SALEM. Ms. Beasley is a member of the board of
directors of The Scotts Company. Ms. Beasley is a member of
the board of trustees of Senior Services, the board of directors
of Tanglewood Park Foundation and the Winston-Salem State
University Business Advisory Council for the School of Business
and Economics.

Charles A. Blixt.Mr. Blixt, 51, has been Executive
Vice President and General Counsel of RJR Tobacco since
1998 and Executive Vice President, General Counsel and Assistant
Secretary of RJR since June 1999. He was Senior Vice President
and General Counsel of RJR Tobacco from 1995 until 1998.
Mr. Blixt served as Director of RJR Tobacco from 1995 until
March 2000. He joined RJR Tobacco as Associate
Counsel  Litigation in 1985. Mr. Blixt is a
member of the board of directors of Technology Concepts &
Design, Inc. and Targacept, Inc., both of which are affiliates
of RJR. He also serves on the board of trustees of Salem College
and Academy and the Board of Visitors of Wake Forest University
School of Law.

Richard H. Bogan.Effective July 22, 2002,
Mr. Bogan, 51, was appointed Executive Vice President and
Chief Financial Officer of RJR and RJR Tobacco. From October
2001 until July 2002, he served as an advisor to health-care
industry venture capital firms. Prior to that, from January
until October 2001, Mr. Bogan was President of
northAmerican Logistics, an operating company of Allied
Worldwide, Inc., the worlds largest household relocation
van-line and high-value products logistics company. From 1997
until December 2000, he was President and Chief Financial
Officer of Unisource Worldwide, Inc., the leading North American
distributor of printing and imaging papers, packaging and
sanitary maintenance equipment and supplies. Prior to that,
Mr. Bogan held a variety of senior management positions
during his 20-year career at Philip Morris Companies, Inc.

Frances V. Creighton.In January 2002, Ms. Creighton,
51, was promoted to Senior Vice President  Marketing
of RJR Tobacco, after serving as Vice President of RJR
Tobaccos Camel business unit since 1997. She joined RJR
Tobacco in 1981 as a marketing research analyst. Through a
series of promotions, she became senior marketing manager in
1990 and marketing director in 1994. Ms. Creighton serves
as Secretary of the board of directors of the local chapter of
the American Red Cross and is a member of the board of directors
for the United Way of Forsyth County.

McDara P. Folan, III.Mr. Folan, 44, joined RJR in June
1999 as Vice President, Deputy General Counsel and Secretary. He
also was Vice President, Deputy General Counsel and Secretary of
RJR Tobacco from June 1999 to March 2000, and currently serves
as Assistant Secretary of RJR Tobacco. From 1992 until 1999,
Mr. Folan served as Vice President, Secretary and General
Counsel for Allen Telecom Inc., a manufacturer and distributor
of wireless communications equipment, in Cleveland, Ohio.
Mr. Folan serves on the City of Winston-Salem/Forsyth
County Planning Board, board of directors of the Piedmont Triad
Chapter of the Juvenile Diabetes Research Foundation and the
Advisory Board for Brenner Childrens Hospital.

L. Joe Inman.In July 2002, Mr. Inman, 52, was
promoted to Executive Vice President  Operations of
RJR Tobacco after serving as Vice President 
Manufacturing for eight years. Joining RJR Tobacco in 1969, he
began as an employee in the manufacturing department.
Mr. Inman held a number of positions in production and
research and development before becoming Director 
Brands for Research and Development in 1992. He was named
Director  Manufacturing the following year and was
promoted to Vice President  Manufacturing in 1994.

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Ann A. Johnston.In
January 2002, Ms. Johnston, 49, was promoted to Executive
Vice President  Human Resources of RJR and of RJR
Tobacco after serving as Vice President  Human
Resources of RJR Tobacco since 1998. She joined RJR Tobacco in
1988 as a compensation manager, and was promoted to personnel
manager in 1989 and to director of compensation/benefits/HRIS in
1993. Ms. Johnston also serves as Chairman of the board of
directors for Allegacy Federal Credit Union, is a member of the
Alumni Council for the Babcock Graduate School of Management of
Wake Forest University, and serves on the boards of directors of
the Winston-Salem Symphony and the Winston-Salem Industries for
the Blind.

Lynn L. Lane.In
June 1999, Ms. Lane, 51, rejoined RJR as Senior Vice
President and Treasurer and was named Senior Vice President and
Treasurer of RJR Tobacco. She joined RJR in 1973 and was
promoted to Vice President and Assistant Treasurer of RJR in
1991. In 1995, she was named Vice President and Treasurer of
R.J. Reynolds Tobacco Worldwide. From 1996 until 1999,
Ms. Lane was Vice President  Treasurer and
Investor Relations of Burlington Industries, a manufacturer and
distributor of fabrics and other textile products. She also
serves on the board of directors of the R. J. Reynolds
Foundation, the board of trustees of Greensboro College and is
the Chair of the East Carolina University Foundation Board.

James V. Maguire.In
July 1999, Mr. Maguire, 51, was promoted to Executive Vice
President  Sales of RJR Tobacco, after serving as
Senior Vice President  Sales of RJR Tobacco since
1994, and has been Director of RJR Tobacco since March
2000. He joined RJR Tobacco in 1973 as a sales
representative, and after holding a number of positions at
RJR Tobacco and RJR, he became Vice President of Sales and
Marketing Development of RJR Tobacco in 1993.

Tommy J. Payne.Mr. Payne, 45, assumed his
current positions as Executive Vice President 
External Relations of RJR Tobacco and of RJR in July 1999,
after serving as Senior Vice President  External
Relations of RJR Tobacco since 1998 and of RJR since June
1999. He joined RJR in 1988 and was promoted to Director of
Federal Government Affairs in 1995. From 1995 until 1998, he was
Vice President  Federal Government Affairs of
RJR Tobacco in Washington, D.C. Mr. Payne serves on the
boards of trustees of Winston-Salem State University and the
Southeast Center for Contemporary Art, the North Carolina
Community Colleges Foundation Board of Advisors and the board of
directors of the R. J. Reynolds Foundation.

Richard M. Sanders.In connection with RJRs acquisition of Santa Fe Natural
Tobacco in January 2002, Mr. Sanders, 49, was named
President and Chief Executive Officer of Santa Fe. From December
1999 until January 2002, he served as Senior Vice
President  Marketing of RJR Tobacco while
continuing his role as President  Sports Marketing
Enterprises, a division of RJR Tobacco. Mr. Sanders
joined RJR Tobacco in Marketing in 1977 and has held
several positions during his career including Vice
President  Advertising and Brand Management, Vice
President  Marketing and Sales Operations and Area
Vice President  Sales. He is Chairman of the board of
directors of the Natural American Spirit Foundation and serves
on the board of directors of the T. Wayne Robertson Memorial
Fund and Minnesota Resources.

David E. Townsend.In October 2000, Dr. Townsend,
54, was promoted to Executive Vice PresidentResearch and
Development of RJR Tobacco after serving as Vice President
of the Research and Development Product Development and
Assessment Group of RJR Tobacco since 1997. He joined
RJR Tobacco in 1977 and, after holding a number of
positions at RJR Tobacco, was promoted to Senior Principal
Scientist of RJR Tobacco in 1995, and to Director of
Product Development and Assessment of RJR Tobacco in 1996.

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PART II

Item 5. Market for Registrants
Common Equity and Related Stockholder Matters

RJRs common stock, par value $.01 per
share, is listed on the NYSE as RJR and began trading on
June 15, 1999. On February 4, 2003, there were
approximately 27,000 holders of record of RJRs common
stock. Stockholders whose shares are held of record by a broker
or clearing agency are not included in this amount; however,
each of those brokers or clearing agencies is included as one
holder of record. The closing price of RJRs common stock
on February 4, 2003 was $42.14.

The high and low sales prices per share for
RJRs common stock on the NYSE Composite Tape, as reported
by the NYSE, were:

|      |                |      |   |       |  |  |   |       | 
|----- | -------------- | ---- | - | ----- |  |  | - | ----- | 
|      |                | High |   | Low  
|      |                |      |   |      
|2002: |                |      |   |       |  |  |   |      
|      | First Quarter  |      | $ | 67.15 |  |  | $ | 56.02 | 
|      | Second Quarter |      |   | 71.90 |  |  |   | 50.38 | 
|      | Third Quarter  |      |   | 60.40 |  |  |   | 39.20 | 
|      | Fourth Quarter |      |   | 44.60 |  |  |   | 34.83 | 
|2001: |                |      |   |       |  |  |   |      
|      | First Quarter  |      | $ | 60.42 |  |  | $ | 44.19 | 
|      | Second Quarter |      |   | 62.70 |  |  |   | 52.33 | 
|      | Third Quarter  |      |   | 59.65 |  |  |   | 47.90 | 
|      | Fourth Quarter |      |   | 61.23 |  |  |   | 54.72 | 

From the third quarter of 1999 through the second
quarter of 2001, RJRs board of directors declared a
quarterly cash dividend of $0.775 per common share, or $3.10 on
an annualized basis. Beginning with the third quarter of 2001,
the board of directors declared a quarterly cash dividend of
$0.875 per common share, or $3.50 on an annualized basis, an
increase of 12.9%. Beginning with the second quarter of 2002,
the board of directors declared a quarterly cash dividend of
$0.95 per common share, or $3.80 on an annualized basis, an
increase of 8.6% from $0.875.

For equity compensation plan information, see
note 17 to the consolidated financial statements.

RJR conducts its business through its
subsidiaries and is dependent on the earnings and cash flow of
its subsidiaries to satisfy its obligations and other cash
needs. RJRs credit facility limits the payment of
dividends on its common stock in excess of specific amounts. For
more information see Managements Discussion and
Analysis of Financial Condition and Results of
Operations  Liquidity and Financial Condition
in Item 7 and note 10 to the consolidated financial
statements. RJR believes that the provisions of its credit
facility will not impair its payment of quarterly dividends.

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Item 6. Selected Financial Data

The selected historical consolidated financial
data as of December 31, 2002 and 2001 and for each of the
years in the three-year period ended December 31, 2002 are
derived from the consolidated financial statements and
accompanying notes, which have been audited by RJRs
independent auditors. The selected historical consolidated
financial data as of December 31, 2000, 1999 and 1998 and
for the years ended December 31, 1999 and 1998 are derived
from audited consolidated financial statements not presented or
incorporated by reference. The financial statements prior to
2000 segregate the account balances and activities of the
international tobacco business and Nabisco and report those
account balances and activities as discontinued operations. For
further information, including the impact of new accounting
developments, acquisitions, restructuring and impairment
charges, you should read this table in conjunction with
Managements Discussion and Analysis of Financial
Condition and Results of Operations in Item 7 and the
consolidated financial statements.

|                                                                                     |  |                                                 |        |      |  |      |        |      |  |      |         |   |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------ |  | ----------------------------------------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                                                     |  |                                                
|                                                                                     |  | For the Years Ended December 31,               
|                                                                                     |  |                                                
|                                                                                     |  | 2002                                            |        | 2001 |  | 2000 |        | 1999 |  | 1998
|                                                                                     |  |                                                 |        |      |  |      |        |      |  |     
|                                                                                     |  |                                                
|                                                                                     |  | (Dollars in Millions, Except Per Share Amounts)
|Results of Operations:                                                               |  |                                                 |        |      |  |      |        |      |  |      |         |   |  |   |         |   |  |   |         |  
|Net sales (1)                                                                        |  | $                                               | 6,211  |      |  | $    | 6,269  |      |  | $    | 6,085   |   |  | $ | 5,898   |   |  | $ | 4,393   |  
|Income (loss) from continuing operations                                             |  |                                                 | 418    |      |  |      | 444    |      |  |      | 352     |   |  |   | 195     |   |  |   | (519    | )
|Income (loss) from discontinued operations                                           |  |                                                 | 40     |      |  |      | (9     | )    |  |      |        |   |  |   | 2,398   |   |  |   | 3       |  
|Extraordinary items  gain (loss)                                                    |  |                                                 |       |      |  |      |       |      |  |      | 1,475   |   |  |   | (250    | ) |  |   |        |  
|Cumulative effect of accounting change, net of
    income taxes                      |  |                                                 | (502   | )    |  |      |       |      |  |      |        |   |  |   |        |   |  |   |        |  
|Net income (loss)                                                                    |  |                                                 | (44    | )    |  |      | 435    |      |  |      | 1,827   |   |  |   | 2,343   |   |  |   | (516    | )
|Per Share Data:                                                                      |  |                                                 |        |      |  |      |        |      |  |      |         |   |  |   |         |   |  |   |         |  
|Basic income (loss) from continuing
    operations                                   |  |                                                 | 4.71   |      |  |      | 4.57   |      |  |      | 3.48    |   |  |   | 1.80    |   |  |   | (4.77   | )
|Diluted income (loss) from continuing
    operations                                 |  |                                                 | 4.64   |      |  |      | 4.48   |      |  |      | 3.46    |   |  |   | 1.80    |   |  |   | (4.77   | )
|Basic income (loss) from discontinued
    operations                                 |  |                                                 | 0.45   |      |  |      | (0.09  | )    |  |      |        |   |  |   | 22.10   |   |  |   | 0.03    |  
|Diluted income (loss) from discontinued
    operations                               |  |                                                 | 0.44   |      |  |      | (0.09  | )    |  |      |        |   |  |   | 22.08   |   |  |   | 0.03    |  
|Basic income (loss) from extraordinary items                                         |  |                                                 |       |      |  |      |       |      |  |      | 14.56   |   |  |   | (2.30   | ) |  |   |        |  
|Diluted income (loss) from extraordinary
    items                                   |  |                                                 |       |      |  |      |       |      |  |      | 14.48   |   |  |   | (2.30   | ) |  |   |        |  
|Basic net loss from cumulative effect of
    accounting change                       |  |                                                 | (5.66  | )    |  |      |       |      |  |      |        |   |  |   |        |   |  |   |        |  
|Diluted net loss from cumulative effect of
    accounting change                     |  |                                                 | (5.57  | )    |  |      |       |      |  |      |        |   |  |   |        |   |  |   |        |  
|Basic net income (loss)                                                              |  |                                                 | (0.50  | )    |  |      | 4.48   |      |  |      | 18.04   |   |  |   | 21.60   |   |  |   | (4.74   | )
|Diluted net income (loss)                                                            |  |                                                 | (0.49  | )    |  |      | 4.39   |      |  |      | 17.94   |   |  |   | 21.58   |   |  |   | (4.74   | )
|Basic weighted average shares, in thousands                                          |  |                                                 | 88,733 |      |  |      | 97,043 |      |  |      | 101,264 |   |  |   | 108,495 |   |  |   | 108,691 |  
|Diluted average shares, in thousands                                                 |  |                                                 | 90,175 |      |  |      | 98,986 |      |  |      | 101,857 |   |  |   | 108,570 |   |  |   | 108,691 |  
|Cash dividends declared per share of common
    stock (2)                            |  | $                                               | 3.73   |      |  | $    | 3.30   |      |  | $    | 3.10    |   |  | $ | 1.55    |   |  | $ |        |  
|Balance Sheet Data (at end of
    periods):                                          |  |                                                 |        |      |  |      |        |      |  |      |         |   |  |   |         |   |  |   |         |  
|Total assets                                                                         |  |                                                 | 14,651 |      |  |      | 15,122 |      |  |      | 15,554  |   |  |   | 14,377  |   |  |   | 19,310  |  
|Long-term debt                                                                       |  |                                                 | 1,755  |      |  |      | 1,631  |      |  |      | 1,674   |   |  |   | 1,653   |   |  |   | 4,861   |  
|Stockholders equity                                                                 |  |                                                 | 6,716  |      |  |      | 8,026  |      |  |      | 8,436   |   |  |   | 7,064   |   |  |   | 9,886   |  
|Cash Flow Data:                                                                      |  |                                                 |        |      |  |      |        |      |  |      |         |   |  |   |         |   |  |   |         |  
|Net cash from operating activities                                                   |  |                                                 | 489    |      |  |      | 626    |      |  |      | 590     |   |  |   | 929     |   |  |   | 367     |  
|Net cash from (used in) investing activities                                         |  |                                                 | (820   | )    |  |      | (307   | )    |  |      | 1,573   |   |  |   | 7,576   |   |  |   | (43     | )
|Net cash used in financing activities                                                |  |                                                 | (105   | )    |  |      | (842   | )    |  |      | (881    | ) |  |   | (5,359  | ) |  |   | (611    | )
|Other Data:                                                                          |  |                                                 |        |      |  |      |        |      |  |      |         |   |  |   |         |   |  |   |         |  
|Ratio of earnings to fixed charges (3)                                               |  |                                                 | 5.2    |      |  |      | 6.4    |      |  |      | 5.1     |   |  |   | 2.8     |   |  |   |        |  
|Deficiency in the coverage of fixed charges by
    earnings before fixed charges (3) |  | $                                               |       |      |  | $    |       |      |  | $    |        |   |  | $ |        |   |  | $ | (679    | )






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Net sales and costs of products sold exclude
    excise taxes of $1.751 billion, $1.529 billion,
    $1.631 billion, $1.173 billion and $1.292 billion
    for the years ended December 31, 2002, 2001, 2000, 1999 and
    1998, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                  
|(2) | RJR began trading as a separate company on
    June 15, 1999. From the third quarter of 1999 through the
    second quarter of 2001, RJRs board of directors declared a
    quarterly cash dividend of $0.775 per common share, or $3.10 on
    an annualized basis. From the third quarter of 2001 through the
    first quarter of 2002, the board of directors declared a cash
    dividend per common share of $0.875 per common share or $3.50 on
    an annualized basis. Since the second quarter of 2002, the board
    of directors has declared a quarterly dividend per common share
    of $0.95 per common share, or $3.80 on an annualized basis.
|(3) | Earnings consist of income before income taxes
    and fixed charges. Fixed charges consist of interest on
    indebtedness, amortization of debt issuance costs and one-third
    of operating rental expense, representative of the interest
    factor.                                                                                                                                                                                                                                                                                                                                                                                                      

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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of
    Financial Condition and Results of Operations

You should read this discussion and analysis of
RJRs consolidated financial condition and results of
operations in conjunction with the consolidated financial
statements and the related notes as of December 31, 2002
and 2001 and for each of the years in the three-year period
ended December 31, 2002.

Business Trends and
Initiatives

RJRs operating subsidiaries primarily
conduct business in the highly competitive U.S. cigarette market
with a few large manufacturers and many smaller participants.
The U.S. cigarette market is believed to be a mature market, and
overall consumer demand is expected to decline over time. Trade
inventory adjustments may result in short-term changes in demand
for RJR Tobaccos products if, and when, wholesale and
retail tobacco distributors adjust the timing of their purchases
of product to manage their inventory level. However, RJR Tobacco
believes it is not appropriate for it to speculate on external
factors that may impact the purchasing decision of the wholesale
and retail tobacco distributors.

Competition is primarily based on a brands
products, positioning, consumer loyalty, retail display,
promotion, price and advertising. Substantial marketing support,
merchandising display, competitive pricing and other financial
incentives generally are required to maintain or improve a
brands market position or to introduce a new brand.
Established cigarette brands historically have had a competitive
advantage in the United States because significant cigarette
marketing restrictions have made gaining consumer awareness and
trial of new brands difficult.

RJRs operating subsidiaries are committed
to building strong brands. RJR Tobaccos marketing programs
are designed to strengthen each brands image, build brand
awareness and loyalty, and attract adult smokers of competing
brands, primarily in an effort to grow share of market on RJR
Tobaccos four key brands. RJR Tobacco has repositioned or
introduced brand styles and line extensions designed to build
each brands equity and attract adult smokers of
competitive brands, but there can be no assurance that such
efforts will be successful.

In addition to building strong brand equity, RJR
Tobaccos marketing approach utilizes a retail pricing
strategy, including discounting at retail, to defend its
brands shares of market against competitive pricing
pressure. Competitive discounting has increased significantly as
a result of higher state excise taxes and the growth of
deep-discount brands. Deep-discount brands are brands
manufactured by manufacturers that are not original participants
in the MSA, and accordingly, which do not have cost structures
burdened with MSA payments to the same extent as the original
participating manufacturers.

Starting in mid-July 2002, RJR Tobaccos
largest competitor significantly increased promotional spending.
These increases, together with the continued growth of the
deep-discount price-tier of the market and the impact of
substantially higher state excise taxes, have resulted in an
adverse business environment. During 2002, excise taxes were
significantly increased in 20 states and New York City. To
maintain competitive prices RJR Tobacco increased its
promotional spending in the second half of 2002. The increased
promotional costs may continue into the foreseeable future.
Management cannot predict the adverse impact, if any, that these
circumstances may have on RJRs results of operations or
financial condition, including the fair value of RJRs
goodwill or RJR Tobaccos trademarks.

During the fourth quarter of 2002, RJR
implemented a restructuring plan in an effort to streamline its
cost structure and improve long-term earnings. The restructuring
plan included a workforce reduction, expected to be primarily
completed in the first half of 2003, and the reclassification of
certain non-tobacco businesses as held-for-sale.

Critical Accounting Policies

Accounting principles generally accepted in the
United States of America require estimates and assumptions to be
made that affect the reported amounts in RJRs consolidated
financial statements and accompanying notes. Some of these
estimates require difficult, subjective and/or complex judgments
about matters that are inherently uncertain, and as a result,
actual results could differ from those estimates. Due to

36



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the estimation processes involved, the following
summarized accounting policies and their application are
considered to be critical to understanding the business
operations, financial condition and results of operations of RJR
and its subsidiaries.


TobaccoRelated Litigation

RJR and RJR Tobacco disclose information
concerning tobacco-related litigation for which an unfavorable
outcome is other than remote.

As discussed in Business 
Litigation Affecting the Cigarette Industry in Item 1
and note 14 to the consolidated financial statements, RJR
Tobacco and its affiliates have been named in a number of
tobacco-related legal actions, proceedings or claims seeking
damages in amounts ranging into the hundreds of millions or even
billions of dollars. Unfavorable judgments awarding compensatory
damages, punitive damages and/or fines have been returned
against RJR Tobacco in the Engleclass action case, a
small number of individual smoking and health cases, a Broin
IIflight attendant ETS case, a healthcare cost recovery
case, an MSA enforcement action and a California state law
enforcement action. However, RJR Tobacco believes that it has
numerous bases for successful appeals in these cases, and both
RJR Tobacco and RJR believe they have a number of valid defenses
to all actions and intend to defend all actions vigorously.
RJRs management continues to conclude that the loss of any
particular smoking and health tobacco litigation claim against
RJR Tobacco or its affiliates, when viewed on an individual
basis, is not probable. Accordingly, no liability for
tobacco-related litigation currently is recorded in RJRs
consolidated financial statements. RJR and RJR Tobacco will
record any loss related to tobacco litigation at such time as an
unfavorable outcome becomes probable and the amount can be
reasonably estimated. When the reasonable estimate is a range,
the recorded loss will be the best estimate within the range. If
no amount in the range is a better estimate than any other
amount, the minimum amount of the range will be recorded.

Litigation is subject to many uncertainties, and
it is possible that some of the tobacco-related legal actions,
proceedings or claims could ultimately be decided against RJR
Tobacco, or its affiliates, including RJR. Any unfavorable
outcome of such actions could have a material adverse effect on
the results of operations, cash flows or financial condition of
RJR or its subsidiaries.

Settlement Agreements

As discussed in Business 
Litigation Affecting the Cigarette Industry in Item 1
and note 14 to the consolidated financial statements, RJRs
operating subsidiaries are participants in the MSA and other
state settlement agreements related to governmental
healthcare cost recovery actions. Their obligations and
the related expense charges under the MSA and other settlement
agreements are subject to adjustments based upon, among other
things, the volume of cigarettes sold by the operating
subsidiaries, their relative market share and inflation. Since
relative market share is based on cigarette shipments, the best
estimate of the allocation of charges under these agreements is
recorded in costs of products sold as the products are shipped.
Settlement expenses under these MSA and other settlement
agreements recorded in the accompanying consolidated statements
of income were $2.5 billion in 2002, $2.6 billion in
2001 and $2.3 billion in 2000. Adjustments to these
estimates, which historically have not been significant, are
recorded in the period that the change becomes probable and the
amount can be reasonably estimated.

RJR Tobacco estimates that its settlement
charges will approximate $2.2 billion in each of 2003 and
2004, and exceed $2.3 billion in 2005, subject to
adjustments, including those discussed above.

Goodwill and Trademarks

As of December 31, 2001, the carrying values
of RJR Tobaccos goodwill and trademarks were
$6.9 billion and $2.8 billion, respectively.
RJR Tobacco recorded goodwill and trademark amortization
expense of $362 million during 2001 and $366 million
during 2000.

On January 1, 2002, RJR adopted the
Financial Accounting Standards Boards Statement of
Financial Accounting Standards No. 141, Business
Combinations, and SFAS No. 142, Goodwill and
Other

37



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Intangible Assets, which provides that
trademarks and goodwill are no longer amortized and requires the
testing of impairment based on fair value. For initial
application of SFAS No. 142, an independent appraisal firm
was engaged to value RJRs goodwill and trademarks as of
January 1, 2002. RJRs goodwill as of January 1,
2002 was attributable to one reporting unit, RJR Tobacco,
which comprises substantially all of RJRs consolidated
results of operations and financial condition. No goodwill
impairment was indicated, since the fair value of RJR was
determined to be greater than its carrying value using several
valuation techniques, including discounted cash flow analysis.


Other intangible assets as of January 1,
2002 consisted of RJR Tobaccos trademarks acquired
through business combinations, which have indefinite useful
lives. However, the trademarks of WINSTON, VANTAGE, SALEM, NOW
and MORE each had a fair value less than its carrying value,
using the present value of estimated future cash flows assuming
a discount rate of 11%, which yielded results consistent with
available market-approach data. Accordingly, a cumulative effect
of an accounting change of $830 million, or
$502 million after tax, was recorded during the quarter
ended March 31, 2002.

In the fourth quarter of 2002, impairment
occurred on two of RJR Tobaccos non-key brands,
VANTAGE and CENTURY. The annual valuation, in accordance with
SFAS No. 142, indicated that the carrying values of these
brands were in excess of their fair values. Accordingly,
RJR Tobacco recorded an impairment charge of
$13 million, $8 million after tax. Factors that may
impact the fair value of goodwill and trademarks include, among
other things, the level of brand support, consumer demand,
governmental regulations, the ability to raise prices and
changes in the competitive environment. As discussed under
 Business Trends and Initiatives, RJR
Tobacco cannot predict the impact of current market
circumstances on the fair value of goodwill or trademarks.

Pension and Post Retirement Benefits

Pension expense is determined in accordance with
the provisions of SFAS Nos. 87 and 88. Gains or losses are
annual changes in the amount of either the benefit obligation or
the market-related value of plan assets resulting from
experience different from that assumed or from changes in
assumptions. The minimum amortization of unrecognized gains or
losses, as described in SFAS No. 87, is included in pension
expense. Prior service costs, which are changes in benefit
obligations due to plan amendments, are amortized on a
straight-line basis over the average remaining service period
for active employees. The market-related value of plan assets
recognizes changes in fair value in a systematic and rational
manner over five years.

During 2002, actual asset returns for RJRs
pension assets were adversely impacted by the continued
deterioration of the equity markets and declining interest
rates. For the year ended December 31, 2002, the asset
return on RJRs pension plan was approximately negative
11%. Additionally, corporate bond yields, which are used in
determining the discount rate for future pension obligations,
continued to decline. The negative asset returns and declining
discount rates unfavorably affected RJRs
2002 year-end SFAS No. 87, Employers
Accounting for Pensions, funded status. Pension expense in
2003 will be adversely impacted due to these events and by RJR
lowering the expected return on asset assumption from 9.5% per
annum for 2002 to 9.0% per annum for 2003. RJR voluntarily
contributed $100 million to its pension plan in January 2003.

At December 31, 2002, the pension benefit
obligation of RJRs pension plans exceeded the fair value
of plan assets by $933 million. As a result of the unfavorable
equity market performance and benefit payments made during 2002,
there has been a reduction in the plan assets of $245 million
during 2002. As a result of the decline in the fair value of
plan assets, and changes in actuarial assumptions, including the
discount rate used to calculate the pension benefit obligation,
pension expense is expected to increase. In 2002, pension
expense totaled $39 million, including $37 million curtailment
and special benefit changes related to the 2002 restructuring
plan. RJR expects pension expense in 2003 to approximate $90
million. Additional cash funding may be made in the future.

Management assumptions were made concerning
future events that determine the amount and timing of benefit
payments, the present value of those benefit payments and the
return on plan assets.

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The weighted average actuarial assumptions used
to determine the funded status of the pension and postretirement
benefit plans as of December 31 were:

|                                       |  |      |     |      |  |  |     |  
|-------------------------------------- |  | ---- | --- | ---- |  |  | --- | -
|                                       |  | 2002 |     | 2001
|                                       |  |      |     |     
|Discount rate                          |  |      | 6.4 | %    |  |  | 7.4 | %
|Expected return on pension plan assets |  |      | 9.0 | %    |  |  | 9.5 | %
|Rate of compensation increase          |  |      | 5.0 | %    |  |  | 5.0 | %

The weighted average actuarial assumptions used
to determine the total benefit cost of these plans during the
years ended December 31 were:

|                                       |  |      |     |      |  |      |     |   |  |  |     |  
|-------------------------------------- |  | ---- | --- | ---- |  | ---- | --- | - |  |  | --- | -
|                                       |  | 2002 |     | 2001 |  | 2000
|                                       |  |      |     |      |  |     
|Discount rate                          |  |      | 7.4 | %    |  |      | 7.5 | % |  |  | 8.0 | %
|Expected return on pension plan assets |  |      | 9.5 | %    |  |      | 9.5 | % |  |  | 9.5 | %
|Rate of compensation increase          |  |      | 5.0 | %    |  |      | 5.0 | % |  |  | 5.0 | %

The discount rate was based on the average yield
of a hypothetical bond portfolio. The portfolio used was
determined by selecting a portfolio of high-quality corporate
bonds to match the estimated future cash flows from the benefit
plans.

The expected long-term rate of return on plan
assets reflects the average rate of earnings expected on the
funds invested or to be invested to provide for the benefits
included in the projected benefit obligation. RJRs
third-party investment consultant calculates an expected return
with regard to realistic and projectable asset return
assumptions reflective of current economic conditions. The
assumptions relied upon reflect a combination of historical
performance analysis and forward-looking views of the financial
markets based upon the yield on long-term bonds and the
price-earnings ratios of the major stock market indices.

Assumed asset return and discount rates have a
significant effect on the amounts reported for the benefit
plans. A one-percentage-point change in the assumed discount
rate for the pension plans would have the following effects:

|                                    |  |              |      |              |  |   |     | 
|----------------------------------- |  | ------------ | ---- | ------------ |  | - | --- | 
|                                    |  | 1-Percentage |      | 1-Percentage
|                                    |  | Point        |      | Point       
|                                    |  | Increase     |      | Decrease    
|                                    |  |              |      |             
|Effect on Net Periodic Benefit Cost |  | $            | (3   | )            |  | $ | 13  | 
|Effect on Benefit Obligation        |  |              | (246 | )            |  |   | 270 | 

A one-percentage-point change in the assumed
asset return for the pension plans would have the following
effects:

|                                    |  |              |     |              |  |   |    | 
|----------------------------------- |  | ------------ | --- | ------------ |  | - | -- | 
|                                    |  | 1-Percentage |     | 1-Percentage
|                                    |  | Point        |     | Point       
|                                    |  | Increase     |     | Decrease    
|                                    |  |              |     |             
|Effect on Net Periodic Benefit Cost |  | $            | (23 | )            |  | $ | 23 | 

A one-percentage-point change in the assumed
discount rate for the post retirement benefits would have the
following effects:

|                                    |  |              |     |              |  |   |    | 
|----------------------------------- |  | ------------ | --- | ------------ |  | - | -- | 
|                                    |  | 1-Percentage |     | 1-Percentage
|                                    |  | Point        |     | Point       
|                                    |  | Increase     |     | Decrease    
|                                    |  |              |     |             
|Effect on Net Periodic Benefit Cost |  | $            | (6  | )            |  | $ | 6  | 
|Effect on Benefit Obligation        |  |              | (87 | )            |  |   | 96 | 

Merchandising Fixtures

In response to changes in industry retail
displays, RJR Tobacco accelerated its replacement of certain
merchandising fixtures beginning in the fourth quarter of 2002.
As a result, accelerated amortization of $43 million, or
$27 million after tax, was recorded during the fourth
quarter of 2002. Additionally, the service

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life of merchandising fixtures has been reduced
from five years to three years for fixtures acquired after
September 30, 2002, reflecting usage of more
technologically dependent components that are subject to
accelerated obsolescence. Amortization expense of fixtures
during 2003 is expected to approximate that of 2002.


RJR Tobacco believes that the assumptions used to
calculate the accelerated amortization charge are reasonable
given current information, and if actual experience differs
materially from current assumptions, the effects on the
accelerated amortization charge will be reflected in the period
it becomes known.

Recent Accounting
Developments

Reductions of Net Sales

Effective January 1, 2002, EITF
No. 00-25, Vendor Income Statement Characterization
of Consideration Paid to a Reseller of the Vendors
Products, requires that consideration paid to a
distributor or retailer to promote the vendors products,
such as slotting fees or buydowns, generally be characterized as
a reduction of revenue when recognized in the vendors
income statement. EITF No. 01-9, Accounting for
Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendors Products), became effective
in November 2001, codifying and reconciling certain issues in
EITF No. 00-25. With respect to estimated amounts of
consideration that will be claimed by customers, costs are
recognized at the latter of the date at which the related
revenue is recognized or the date at which the sales incentive
is offered. As of January 1, 2002, RJRs operating
subsidiaries have characterized the applicable costs as
reductions of net sales rather than as selling, general and
administrative expenses. For the years ended December 31,
2001 and 2000, $2.3 billion and $2.0 billion,
respectively, were reclassified from selling, general and
administrative expenses to a reduction of net sales. The
adoption of EITF No. 00-25, as codified by EITF
No. 01-9, did not impact RJRs consolidated financial
position, operating income or net income.

Effective January 1, 2001, RJR and its
subsidiaries adopted the EITF No. 00-14, Accounting
for Certain Sales Incentives, which addresses the
recognition, measurement and income statement classification for
certain sales incentives, including rebates, coupons and free
products or services. EITF No. 01-9, Accounting for
Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendors Products), became effective
in November 2001, codifying and reconciling certain issues in
EITF No. 00-14. EITF No. 00-14 requires that in the
accompanying consolidated income statements, certain costs that
historically were included in selling, general and
administrative expenses now be classified in cost of products
sold or as reductions of net sales. With respect to estimated
amounts of redemptions or free products that will be claimed by
customers, costs are recognized at the latter of the date at
which the related revenue is recognized or the date at which the
sales incentive is offered. For the year ended December 31,
2000, $220 million was reclassified from selling, general
and administrative expense, with an increase to cost of products
sold of $111 million and a reduction to net sales of
$109 million. The adoption of EITF No. 00-14 did not
impact RJRs consolidated annual net income or cumulative
earnings.

Long-Lived Assets

On January 1, 2002, RJR adopted SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, which supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, and certain portions
of Accounting Principles Board Opinion No. 30,
Reporting the Results of Operations  Reporting
the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. SFAS No. 144 provides updated guidance
concerning the recognition and measurement of an impairment loss
for certain types of long-lived assets, and requires that
long-lived assets to be disposed of by sale be measured at the
lower of the carrying amount or fair value less cost to sell,
and reported separately in the asset and liabilities sections of
the consolidated balance sheet. SFAS No. 144 also expands
the reporting of discontinued operations to include components
of an entity that have been or will be disposed of. The scope of
SFAS No. 144 excludes long-lived assets, goodwill and other
intangibles that are accounted for in accordance with SFAS
No. 142. The adoption

40



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of SFAS No. 144 did not have a material
impact on the consolidated results of operations, financial
position or cash flows.


Guarantees

In November 2002, the FASB issued Interpretation
No. 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN No. 45 requires the
disclosure of certain guarantees existing at December 31,
2002. In addition, FIN No. 45 requires the recognition of a
liability for the fair value of the obligation of qualifying
guarantee activities that are initiated or modified after
December 31, 2002. Accordingly, RJR will apply the
recognition provisions of FIN No. 45 prospectively to
guarantee activities initiated after December 31, 2002. See
note 14 to the consolidated financial statements for
further information regarding guarantees, including indemnities
related to the 1999 sale of the international business to Japan
Tobacco Inc., Nabisco Group Holdings Corp.s sale of
Nabisco Holdings Corp. to Philip Morris Companies, Inc.,
environmental matters and intercompany debt and related
instruments. RJR is not able to estimate the maximum potential
amount of future payments, if any, related to these guarantees.
RJR has recorded liabilities totaling approximately
$130 million at December 31, 2002 relating to these
guarantees.

Stock Compensation

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, an amendment
of SFAS No. 123. SFAS No. 148 amends SFAS
No. 123, to provide alternative methods of transition for a
voluntary change to that statements fair value method of
accounting for stock-based employee compensation. SFAS
No. 148 also amends the disclosure provision of SFAS
No. 123 and APB No. 28, Interim Financial
Reporting, to require disclosure in the summary of
significant accounting policies about the method of accounting
for stock-based compensation and the effects of the method on
reported net income and earnings per share in annual and interim
financial statements. The transition and disclosure provisions
of this statement are effective for financial statements for
fiscal years ending after December 15, 2002. RJR has not
elected the fair value-based method of accounting for
stock-based compensation under SFAS No. 123, as amended by
SFAS No. 148.

Recent Accounting Pronouncements

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities. SFAS No. 146 nullifies EITF
No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring).
SFAS No. 146 requires that a liability for costs associated
with an exit or disposal activity be recognized when it is
incurred. Under EITF No. 94-3, a liability for an exit cost
was recognized at the date of an entitys commitment to an
exit plan. The provisions of SFAS No. 146 are effective for
exit or disposal activities that are initiated after
December 31, 2002. Under SFAS No. 146, an entity may
not restate its previously issued financial statements. RJR does
not expect the adoption of SFAS No. 146 to have a material
impact on its financial position, results of operations or cash
flows.

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest
Entities. This interpretation clarifies the application of
Accounting Research Bulletin No. 51, Consolidated
Financial Statements, to certain entities in which equity
investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional
subordinated financial support from other parties. FIN
No. 46 is effective February 1, 2003 for variable interest
entities created after January 31, 2003, and July 1, 2003
for variable interest entities created prior to

41



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##### 



February 1, 2003. RJR does not expect the
adoption of FIN No. 46 to have a material impact on its
financial position, results of operations or cash flows.


Results of Operations

|                                             |                  |      |       |      |  |      |       |     |  |   |       |     | 
|-------------------------------------------- | ---------------- | ---- | ----- | ---- |  | ---- | ----- | --- |  | - | ----- | --- | 
|                                             |                  | 2002 |       | 2001 |  | 2000
|                                             |                  |      |       |      |  |     
|Net sales                                    |                  | $    | 6,211 |      |  | $    | 6,269 |     |  | $ | 6,085 |    
|Cost of products sold (1)                    |                  |      | 3,732 |      |  |      | 3,560 |     |  |   | 3,436 |    
|Selling, general and administrative expenses |                  |      | 1,463 |      |  |      | 1,429 |     |  |   | 1,369 |    
|Restructuring and asset impairment charges   |                  |      | 224   |      |  |      |      |     |  |   |      |    
|Trademark impairment charge                  |                  |      | 13    |      |  |      |      |     |  |   | 89    |    
|Amortization of trademarks & goodwill        |                  |      |      |      |  |      | 362   |     |  |   | 366   |    
|Other operating expense                      |                  |      |      |      |  |      |      |     |  |   | (3    | )  
|                                             |                  |      |       |      |  |      |       |     |  |   |       |    
|                                             | Operating income |      | $     | 779  |  |      | $     | 918 |  |   | $     | 828 | 
|                                             |                  |      |       |      |  |      |       |     |  |   |       |    






|    |                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes settlement expense of
    $2,514 million, $2,584 million and $2,329 million
    for the years ended 2002, 2001 and 2000, respectively.

2002 Compared with 2001

Net salesof $6.2
billion for the year ended December 31, 2002 decreased 0.9%
from 2001. Of this decrease, $111 million was due to a less
favorable, full-price/savings-brand mix and lower overall volume
partially offset by $53 million of favorable pricing, net of
higher promotional spending.

Domestic shipment volume for RJRs operating
subsidiaries, in billions of units, included:

|                               |                   |                       |       |       |  |        |       |       |  |  |      |       |   
|------------------------------ | ----------------- | --------------------- | ----- | ----- |  | ------ | ----- | ----- |  |  | ---- | ----- | --
|                               |                   |                      
|                               |                   | For the Twelve Months
|                               |                   | Ended December 31,   
|                               |                   |                      
|                               |                   |                       |       | %    
|                               |                   | 2002                  |       | 2001  |  | Change
|                               |                   |                       |       |       |  |       
|RJR Tobacco key brands:        |                   |                       |       |       |  |        |       |       |  |  |      |      
|                               | Camel ex. Regular |                       |       | 22.1  |  |        |       | 20.9  |  |  |      | 5.7   | % 
|                               | Winston Base      |                       |       | 17.9  |  |        |       | 19.0  |  |  |      | (5.5  | )%
|                               | Salem             |                       |       | 9.5   |  |        |       | 10.6  |  |  |      | (11.1 | )%
|                               | Doral             |                       |       | 24.6  |  |        |       | 23.5  |  |  |      | 4.4   | % 
|RJR Tobacco total full-price   |                   |                       | 55.5  |       |  |        | 57.4  |       |  |  | (3.4 | )%   
|RJR Tobacco total savings      |                   |                       | 35.1  |       |  |        | 33.3  |       |  |  | 5.4  | %    
|RJR Tobacco total domestic (1) |                   |                       | 90.6  |       |  |        | 90.7  |       |  |  | (0.2 | )%   
|RJR total domestic (1)         |                   |                       | 91.6  |       |  |        | 90.7  |       |  |  | 1.0  | %    
|Industry: (2)                  |                   |                       |       |       |  |        |       |       |  |  |      |      
|                               | Full-price        |                       |       | 284.8 |  |        |       | 300.1 |  |  |      | (5.1  | )%
|                               | Savings           |                       |       | 106.6 |  |        |       | 106.3 |  |  |      | 0.4   | % 
|                               |                   |                       |       |       |  |        |       |       |  |  |      |      
|Industry total domestic        |                   |                       | 391.4 |       |  |        | 406.4 |       |  |  | (3.7 | )%   
|                               |                   |                       |       |       |  |        |       |       |  |  |      |      






|    |                                                                                                                                                                                                                                                                                                                                                 
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes Puerto Rico and certain other U.S.
    territories volume.                                                                                                                                                                                                                                                                            
|(2) | The source of industry data is Management Science
    Associates. This data may not include all shipments of some
    manufacturers that Management Science Associates is presently
    unable to monitor effectively. RJR Tobacco believes that the
    industry total domestic shipment volume may not fully include
    deep-discount volume.

The 0.2% decline from the prior-year period in
RJR Tobaccos total domestic shipment volume reflected an
overall decline in retail sales to consumers, partially offset
by the estimated slight building of inventories by wholesale and
retail distributors.

42



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##### 



Shipments in the full-priced tier were 61.2% and
63.3% of RJR Tobaccos total domestic shipments for the
years ended December 31, 2002 and 2001, respectively.
Industry full-price shipments were 72.8% and 73.9% of total
domestic shipments for the years ended December 31, 2002
and 2001, respectively.

RJR Tobaccos retail share of market,
according to data from Information Resources Inc./Capstone,
averaged 22.93% for the year ended December 31, 2002, a
decrease of .49 share points when compared with the prior year.

CAMEL, RJR Tobaccos largest full-price
brand, continued its growth trend. CAMELs share of market,
excluding the non-filtered style, was 5.69% in 2002, compared
with 5.52% in 2001. CAMELs growth was based on the
strength of the brands equity, its Pleasure to
Burn positioning and initiatives to market CAMELs
three distinct product families  the Classic, Turkish
and Exotic families, which contributed to the brands
strong performance in 2002.

Base WINSTONs retail share averaged 4.57%
in 2002, compared with 4.84% in 2001. Despite intense
competitive price pressures, its market share has remained
relatively stable since March 2002. In 2003, the brand is
strengthening its positioning with a new Leave the Bull
Behind marketing campaign highlighting WINSTONs
additive-free, naturally smooth tobacco blends. During 2002,
WINSTONs S2 line extension, launched in 2001, was stable,
but did not meet anticipated sales volumes.

SALEMs share declined to 2.41% in 2002
compared with 2.73% in 2001, reflecting reduced levels of
in-market support while the brand evaluated opportunities to
strengthen its positioning. In the second quarter of 2003 the
brand will launch a new Stir the Senses campaign and
expansion of the Slide Box styles into additional markets. The
brands new packaging communicates that SALEM offers adult
smokers a range of choices in menthol styles: SALEM Green Label,
with a lighter menthol taste, and SALEM Black Label, with a
richer menthol-and-tobacco taste.

The retail market share of DORAL, the
nations best-selling brand in the savings-brand tier,
averaged 5.86% in 2002, down slightly from 5.92% in 2001. DORAL
grew market share during the course of 2002, reversing its
prior-year trend primarily due to a comprehensive brand upgrade.
DORALs improved trend reflects increased promotional
support, new tobacco blends on key styles, modernized packaging
and the imaginative Splendidly Blended advertising
campaign.

In 2003, RJR Tobacco will begin a phased
expansion of ECLIPSE, a cigarette that primarily heats rather
than burns tobacco, into a select number of retail chain
outlets. Based on learning garnered from the ECLIPSE test market
in Dallas/Fort Worth since April 2000, where the brand built a
small  but loyal  franchise of adult
smokers, RJR Tobacco believes the brand has business potential
if it is selectively distributed and supported by cost-efficient
communications targeted to specific prospective adult smokers.
This move further underscores RJR Tobaccos commitment to
finding ways to develop and market consumer-acceptable
cigarettes that may present less smoking-related health risk.
RJR Tobacco has concluded that ECLIPSE may present less risk for
certain, but not all, smoking related diseases, when compared
with tobacco-burning cigarettes. This conclusion is based on the
weight of evidence from several scientific studies conducted
internally by RJR Tobacco and externally by several
universities, funded by RJR Tobacco, and reviewed by an outside
expert scientific panel.

Cost of products
soldof $3.7 billion increased
4.8% or $172 million from 2001, primarily due to increased
promotional product costs, raw material costs and the inclusion
of Santa Fes operations. These increases were partially
offset by lower settlement costs.

Selling, general and administrative
expensesincreased $34 million to $1.5
billion in 2002 from the prior year. This change over the prior
year was primarily due to accelerated amortization of
$43 million related to the replacement of merchandising
fixtures. The increase was also impacted by higher legal
expenses and the inclusion of Santa Fes operations,
partially offset by lower expense related to stock-based benefit
plans and advertising.

Restructuring and asset impairment
chargesof $224 million,
$135 million after tax, were recorded in the fourth quarter
2002, related to the 2002 restructuring plan including the sale
of certain non-tobacco

43



---



##### 



businesses. The restructuring was implemented in
an effort to streamline RJRs cost structure and improve
long-term earnings. Included in this charge is $102 million
for employee severance and related benefits associated with
workforce reductions of 572 full-time employees, or
approximately 7% of RJRs full-time employees. This
reduction is expected to be primarily completed in the first
half of 2003.


The non-tobacco businesses included in the
restructuring plan were remeasured at the lower of their
carrying value or fair value less cost to sell, and classified
as assets held for sale and liabilities related to assets held
for sale in the consolidated balance sheet at December 31,
2002, in accordance with SFAS No. 144. This remeasurement
resulted in a $115 million charge in the fourth quarter of
2002.

Contract termination and other exit costs
consisted of $7 million related to contract and lease
termination payments, and exit costs related to the segregation
of the non-tobacco businesses held for sale.

The cash portion of the restructuring charge
primarily relates to employee severance costs and is expected to
be $68 million. No significant amount was expended as of
December 31, 2002. Annual savings are expected to be
approximately $50 million in 2003 and $75 million in
2004.

A trademark impairment chargeof
$13 million, $8 million after tax, was incurred in the
fourth quarter of 2002, on two non-key brands, VANTAGE and
CENTURY. The impairment was indicated during the annual
valuation in accordance with SFAS No. 142, based on their
estimated undiscounted net future cash flows. The impairment
charge was measured as the excess of the brands carrying
values over fair values, determined using the present value of
estimated future cash flows assuming a discount rate of 10.5%.
This impairment charge is reflected as a decrease in the
carrying value of the trademarks in the consolidated balance
sheets, as a trademark impairment charge in the 2002
consolidated income statement and had no impact on cash flows.

Amortization expensewas eliminated in 2002, reflecting the
adoption of SFAS No. 142 on January 1, 2002.
Amortization expense in 2001 was $362 million.

Interest and debt expensewas $147 million and
$150 million in 2002 and 2001, respectively. This reduction
was due to interest rate swaps acquired in the first and second
quarters, mostly offset by the increased average debt balance
resulting from the May 2002 issuance of the $750 million of
notes.

Interest incomeduring 2002 was $62 million, a
decline of $75 million when compared with 2001, primarily
due to lower interest rates in 2002.

Other expense, netdecreased $2 million for the year
ended December 31, 2002 from the prior year, reflecting
lower financing-related fees mostly offset by earnings on
investments accounted for under the equity method.

Provision for income taxeswas $265 million, or an effective
rate of 38.8%, in 2002 compared with $448 million, or an
effective rate of 50.2%, in 2001. The effective tax rate in 2002
exceeded the federal statutory rate of 35% primarily due to the
impact of state taxes and, to a lesser extent, certain
non-deductible items. The effective tax rate in 2001 exceeds the
federal statutory rate of 35% primarily due to the impact of
certain nondeductible items, including goodwill amortization,
and to a lesser extent, state taxes.

Discontinued operationsin 2002 included a $40 million
after-tax reversal of an indemnification accrual, reflecting a
favorable settlement, and in 2001, included a $9 million
after-tax, purchase-price adjustment. Both transactions relate
to the 1999 sale of the international tobacco business to Japan
Tobacco Inc. Including these adjustments, the net after-tax gain
on the sale of the international tobacco business was $2.4
billion.

2001 Compared with 2000

Net salesof $6.3
billion for the year ended December 31, 2001 increased 3.0%
over 2000. This increase was primarily driven by favorable
pricing of $0.7 billion, net of discounting, as a result of
price increases in 2001 and the last half of 2000, partially
offset by volume declines of $0.5 billion.

44



---



##### 



Domestic shipment volume for RJRs operating
subsidiaries, in billions of units, included:

|                               |                   |                       |       |       |  |        |       |       |  |  |      |       |   
|------------------------------ | ----------------- | --------------------- | ----- | ----- |  | ------ | ----- | ----- |  |  | ---- | ----- | --
|                               |                   |                      
|                               |                   | For the Twelve Months
|                               |                   | Ended                
|                               |                   | December 31,         
|                               |                   |                      
|                               |                   |                       |       | %    
|                               |                   | 2001                  |       | 2000  |  | Change
|                               |                   |                       |       |       |  |       
|RJR Tobacco key brands:        |                   |                       |       |       |  |        |       |       |  |  |      |      
|                               | Camel ex. Regular |                       |       | 20.9  |  |        |       | 20.6  |  |  |      | 1.6   | % 
|                               | Winston Base      |                       |       | 19.0  |  |        |       | 19.7  |  |  |      | (3.7  | )%
|                               | Salem             |                       |       | 10.6  |  |        |       | 12.3  |  |  |      | (13.7 | )%
|                               | Doral             |                       |       | 23.5  |  |        |       | 26.2  |  |  |      | (10.1 | )%
|RJR Tobacco total full-price   |                   |                       | 57.4  |       |  |        | 60.9  |       |  |  | (5.7 | )%   
|RJR Tobacco total savings      |                   |                       | 33.3  |       |  |        | 35.5  |       |  |  | (6.2 | )%   
|RJR Tobacco total domestic (1) |                   |                       | 90.7  |       |  |        | 96.4  |       |  |  | (5.9 | )%   
|Industry: (2)                  |                   |                       |       |       |  |        |       |       |  |  |      |      
|                               | Full-price        |                       |       | 300.1 |  |        |       | 308.5 |  |  |      | (2.7  | )%
|                               | Savings           |                       |       | 106.3 |  |        |       | 111.3 |  |  |      | (4.4  | )%
|                               |                   |                       |       |       |  |        |       |       |  |  |      |      
|Industry total domestic        |                   |                       | 406.4 |       |  |        | 419.8 |       |  |  | (3.2 | )%   
|                               |                   |                       |       |       |  |        |       |       |  |  |      |      






|    |                                                                                                                                                                                                                                                                                                                                                 
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes Puerto Rico and certain other U.S.
    territories volume.                                                                                                                                                                                                                                                                            
|(2) | The source of industry data is Management Science
    Associates. This data may not include all shipments of some
    manufacturers that Management Science Associates is presently
    unable to monitor effectively. RJR Tobacco believes that the
    industry total domestic shipment volume may not fully include
    deep-discount volume.

The 5.9% decline from the prior-year period in
RJR Tobaccos total domestic shipment volume was due to
estimated declines in the inventory levels of wholesale and
retail distributors and decreased consumption. Consumption of
RJR Tobaccos products, representing retail sales to
consumers, declined approximately 2.8% during 2001 compared with
2000.

Shipments in the full-priced tier were 63.3% and
63.2% of RJR Tobaccos total domestic shipments for the
years ended December 31, 2001 and 2000, respectively.
Industry full-price shipments were 73.9% and 73.5% of total
domestic shipments for the years ended December 31, 2001
and 2000, respectively.

RJR Tobaccos retail share of market,
according to data from Information Resources Inc./Capstone,
averaged 23.42% for the year ended December 31, 2001, a
decrease of .16 share points when compared with the prior year.

CAMEL continued its growth trend in 2001.
CAMELs share of market, excluding the non-filtered style,
was 5.52% in 2001, compared with 5.14% in 2000. CAMELs
growth was attributed to its strong Pleasure to Burn
positioning, which was enhanced by unique programs such as the
Seven Pleasures of the Exotic consumer events, and
the strength of its Turkish line extensions. Following the
successful launch of CAMEL Turkish Gold in 2000, the brand
launched CAMEL Turkish Jade, a menthol line extension, during
the third quarter of 2001.

Base WINSTONs retail share averaged 4.84%
in 2001, up from 4.76% in 2000. During 2001, WINSTON modernized
its No Boundaries, No Bull positioning by launching
WINSTON S2, a line extension that features a new blend and
high-impact silver embossed packaging. Additionally, the base
WINSTON family was enhanced to incorporate the same silver
highlights.

SALEMs share averaged 2.73% in 2001
compared with 3.01% in 2000. SALEMs decline was due to
increased competitive activity in the menthol category coupled
with reduced marketing support in SALEMs ten emphasis
markets in the latter portion of 2001. While the trend in the
ten emphasis markets had been better than in the balance of the
country, the brand continued evaluating opportunities to
strengthen its performance.

45



---



##### 



Through the last three quarters of 2001,
DORALs share of market declined after holding relatively
steady at 6.1 to 6.2 share points for several quarters. The
retail share of market of DORAL, the nations best-selling
savings brand, was 5.92% for 2001, down from 6.16% in 2000. To
strengthen DORALs performance, the brand launched a
comprehensive upgrade across all categories of DORALs
Imagine Getting More positioning. This upgrade
included a new blend with higher-quality tobaccos, new bold
packaging, new advertising to support the changes and a new
website to enhance DORALs existing relationship marketing
program.

Cost of products soldof $3.6 billion increased
$124 million from 2000, primarily due to an increase of
$255 million in ongoing settlement costs partially offset
by decreased volume and lower raw material costs.

Selling, general and administrative expensesof $1.4 billion in 2001 increased
$60 million from the prior year. This change over the prior
year was primarily due to increased retail discounting.

Amortization expensedecreased $4 million to
$362 million during 2001, reflecting the impact of
trademark impairment during 2000.

An impairment chargeof $89 million,
$54 million after tax, was recorded on two of RJR
Tobaccos non-key brands, MAGNA and CENTURY. The impairment
was the result of a decision, in the fourth quarter of 2000, to
reduce market support of these brands. The related impairment
testing indicated that the carrying amount of these brands would
not be recoverable through future undiscounted cash flows. The
impairment was based on the excess of the brands carrying
value over fair value, determined using the present value of
estimated future cash flows assuming a discount rate of 12.0%.
This impairment charge is reflected as a decrease in trademarks
in the consolidated balance sheets, as an impairment charge in
the 2000 consolidated income statement and had no impact on cash
flows. As a result of this charge, amortization expense related
to trademarks was $4 million lower in 2001 than in 2000.

Tobacco settlement and related expensesincluded a $3 million reversal
for the completion of a $1.4 billion pre-tax tobacco
settlement and related charge recorded in 1998 by
RJR Tobacco. This tobacco settlement and related expense
charge was in response to the MSA and other state settlement
agreements. At December 31, 1998, $1.3 billion had
been utilized. Since December 31, 1998, the remaining
liability for employee severance and related benefits for
workforce reductions totaling approximately 1,300 employees was
utilized through cash expenditures of $76 million and the
reversal of $21 million, due to a less-than-expected
workforce reduction.

Interest and debt expensewas $150 million and
$168 million in 2001 and 2000, respectively. This decrease
primarily resulted from lower debt balances.

Interest incomeduring 2001 increased $18 million
when compared with the prior year, primarily reflecting a higher
average cash balance during 2001 when compared with 2000,
partially offset by declining interest rates.

Other expense, netdecreased $18 million for the
year ended December 31, 2001 from the prior year. This
decrease was primarily due to foreign exchange losses realized
during 2000 on debt denominated in foreign currencies. All debt
denominated in foreign currencies was retired in 2000.

Provision for income taxeswas $448 million, or an effective
rate of 50.2%, in 2001 compared with $396 million, or an
effective rate of 52.9%, in 2000. The effective tax rates exceed
the federal statutory rate of 35% primarily due to the impact of
certain nondeductible items, including goodwill amortization,
and to a lesser extent, state taxes.

Discontinued operationsin 2001 included a $14 million,
$9 million after-tax, purchase-price adjustment of the 1999
gain on the sale of the international tobacco business to Japan
Tobacco Inc. See note 6 to the consolidated financial
statements for further information.

Extraordinary itemincluded a gain of $1.5 billion
realized during the fourth quarter of 2000 in connection with
RJRs acquisition of NGH. See note 2 to the
consolidated financial statements for further discussion.

46



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##### 



Liquidity and Financial Condition

Liquidity

At present, the principal sources of liquidity
for RJRs operating subsidiaries businesses and
operating needs are internally generated funds from their
operations and borrowings through RJR. Cash flows from operating
activities are believed to be sufficient for the foreseeable
future to enable the operating subsidiaries to meet their
obligations under the MSA, to fund their capital expenditures
and to make payments to RJR that will enable RJR to make its
required debt-service payments and to pay dividends to
RJRs stockholders. Additionally, the acquisition of NGH in
December 2000 provided $1.5 billion cash proceeds to
RJR Acquisition Corp., which has funded RJRs share
repurchase programs, the acquisition of Santa Fe and
dividends to its stockholders. The negative impact, if any, on
the sources of liquidity that could result from a decrease in
demand for products due to short-term inventory adjustments by
wholesale and retail distributors cannot be predicted. RJR
cannot predict its cash requirements or those of its
subsidiaries related to any future settlements or judgments,
including cash required to be held in escrow or to bond any
appeals, if necessary, and RJR makes no assurance that it or its
subsidiaries will be able to meet all of those requirements.

Contractual obligations as of December 31,
2002 were:

|                                      |                        |                        |       |           |  |       |     |       |  |            |     |     |  |   |     |     |  |   |     |     | 
|------------------------------------- | ---------------------- | ---------------------- | ----- | --------- |  | ----- | --- | ----- |  | ---------- | --- | --- |  | - | --- | --- |  | - | --- | --- | 
|                                      |                        |                       
|                                      |                        | Payments Due by Period
|                                      |                        |                       
|                                      |                        |                        |       | Less than |  | 1-3   |     | 4-5   |  |           
|                                      |                        | Total                  |       | 1 Year    |  | Years |     | Years |  | Thereafter
|                                      |                        |                        |       |           |  |       |     |       |  |           
|Long-term debt (1)                    |                        | $                      | 2,496 |           |  | $     | 741 |       |  | $          | 644 |     |  | $ | 353 |     |  | $ | 758 |    
|Operating leases (2)                  |                        |                        | 38    |           |  |       | 19  |       |  |            | 16  |     |  |   | 2   |     |  |   | 1   |    
|Non-qualified pension obligations (3) |                        |                        | *     |           |  |       | 5   |       |  |            | 11  |     |  |   | 11  |     |  |   | *   |    
|Joint venture funding (4)             |                        |                        | 29    |           |  |       | 29  |       |  |            |    |     |  |   |    |     |  |   |    |    
|Service agreement (5)                 |                        |                        | 26    |           |  |       | 12  |       |  |            | 12  |     |  |   | 2   |     |  |   |    |    
|Equipment purchase commitment (6)     |                        |                        | 3     |           |  |       | 3   |       |  |            |    |     |  |   |    |     |  |   |    |    
|                                      |                        |                        |       |           |  |       |     |       |  |            |     |     |  |   |     |     |  |   |     |    
|                                      | Total Cash Obligations |                        | $     | 2,592     |  |       | $   | 809   |  |            | $   | 683 |  |   | $   | 368 |  |   | $   | 759 | 
|                                      |                        |                        |       |           |  |       |     |       |  |            |     |     |  |   |     |     |  |   |     |    






| |   |                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
| | * | Obligations beyond five years are not
    estimatable. For more information about RJRs pension plan,
    see note 18 to the consolidated financial statements.

|    |                                                                                                                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | For more information about RJRs long-term
    debt, see  Debt below and note 13 to
    the consolidated financial statements.                                                                                                                                
|(2) | Operating lease obligations represent estimated
    lease payments primarily related to computer equipment, and to a
    lesser extent, aviation services and field sales offices.                                                                               
|(3) | For more information about RJRs pension
    plan, see note 18 to the consolidated financial statements.                                                                                                                                                         
|(4) | Joint venture funding is provided each budget
    year, denominated in euros. For more information about the joint
    venture, see note 2 to the consolidated financial
    statements.                                                                         
|(5) | A service agreement related to the joint venture
    with Gallaher Group Plc. provides for annual payments
    denominated in pounds Sterling. For more information about the
    related joint venture, see note 2 to the consolidated
    financial statements.
|(6) | Equipment purchase commitments are related to
    firm commitments denominated in euros, to purchase manufacturing
    equipment. For more information, see note 15 to the
    consolidated financial statements.                                                

RJR Tobacco estimates that its settlement
charges will approximate $2.2 billion in 2003 and range
from $2.0 billion to $2.3 billion each year
thereafter. For more information about RJR Tobaccos
settlement payments, see Business  Litigation
Affecting the Cigarette Industry in Item 1 and
note 14 to the consolidated financial statements.

47



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Commitments as of December 31, 2002 were:

|                                                                  |                   |                   |    |           |  |   |    |    | 
|----------------------------------------------------------------- | ----------------- | ----------------- | -- | --------- |  | - | -- | -- | 
|                                                                  |                   |                  
|                                                                  |                   | Commitment       
|                                                                  |                   | Expiration Period
|                                                                  |                   |                  
|                                                                  |                   |                   |    | Less than
|                                                                  |                   | Total             |    | 1 Year   
|                                                                  |                   |                   |    |          
|Standby letters of credit backed by revolving
    credit facility |                   | $                 | 17 |           |  | $ | 17 |   
|                                                                  |                   |                   |    |           |  |   |    |   
|                                                                  | Total commitments |                   | $  | 17        |  |   | $  | 17 | 
|                                                                  |                   |                   |    |           |  |   |    |   

Cash Flows

Net cash flows from operating activities
decreased $137 million to $489 million when compared with
2001. This decrease is primarily due to the decreased operating
income as a result of increased promotional expenses in response
to competitive promotions in the second half of 2002. Net cash
flows from operating activities of $626 million in 2001
increased $36 million from 2000. This change primarily reflects
increased revenues from higher pricing and increased interest
income, partially offset by increased tobacco settlement
expenses, raw material purchases and promotional expenses.

Net cash flows used in investing activities
increased $513 million to $820 million compared with 2001. This
change is primarily due to investments in short-term securities,
utilizing the proceeds from the May 2002 issuance of notes; the
cash payment for the acquisition of Santa Fe, net of cash
acquired; and to a lesser extent, an increase in capital
expenditures. These investments were partially offset by
proceeds from the maturity of short-term securities in the
fourth quarter, which were used to make required debt-service
payments and to pay dividends to stockholders. Net cash flows
used in investing activities were $307 million in 2001
compared with net cash inflows of $1.6 billion in 2000.
This change is primarily due to investments in short-term
securities in 2001, compared with $1.5 billion net proceeds from
the NGH acquisition in 2000. Net cash flows used in investing
activities included a $14 million, $9 million after-tax,
purchase-price adjustment of the 1999 gain on the sale of the
international tobacco business.

Net cash flows used in financing activities were
$105 million in 2002 compared with a use of $842 million in
2001. This reduction is primarily due to the funds received from
the May 2002 issuance of $750 million of public notes, partially
offset by an increase in repurchases of common stock. Net cash
flows used in financing activities of $842 million in 2001,
compared with $881 million in 2000, included $314 million
reduction of long-term debt maturities during 2001 mostly offset
by a $263 million increase in the repurchase of common stock.

Net cash flows related to discontinued operations
in 2000 included an $84 million refund of taxes paid on the gain
on the 1999 sale of the international tobacco business.

In connection with the spin-off from NGH in 1999,
RJR has assumed, subject to specified exceptions, all U.S.
pension liabilities and related assets for current and former
tobacco employees. The additional cash required, compared with
1998, to fund these liabilities was $58 million in each of 2001,
2000 and 1999. In January 2002, RJR contributed the expected
additional cash requirement of $58 million for each of 2002 and
2003. As a result, the Pension Benefit Guaranty Corporation
cancelled the related $116 million letter of credit. RJR
contributed $100 million to its pension plan in January 2003.

Stock Repurchases

The following tables summarize stock repurchases
from November 1999 through February 4, 2003. These
repurchases have been made under programs authorized by
RJRs board of directors and funded through cash provided
by operating activities and from RJR Acquisition Corp.,
utilizing the cash proceeds of the NGH acquisition. The
objective of the current program, authorized February 6,
2002 to enhance stockholder value, is to repurchase shares of
RJRs common stock over time in the open market, with a
maximum aggregate cost of $1.0 billion. The timing of
repurchases and the number of shares repurchased under this
authorization amount will depend upon internal operating cash
requirements and market conditions. RJR also purchases stock
through a program designed to repurchase shares related to tax
liability concerning

48



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##### 



certain option exercises and restricted stock
vesting under its 1999 Long-Term Incentive Plan. Shares held by
RJR through repurchase, in addition to shares forfeited pursuant
to employee stock plans, are included in treasury stock in
RJRs consolidated balance sheets.


|                            |                                 |        |           |               |  |   |     |     | 
|--------------------------- | ------------------------------- | ------ | --------- | ------------- |  | - | --- | --- | 
|Repurchases  2002 and 2003 |                                 | Shares |           | Cost         
|                            |                                 |        |           |              
|                            |                                 |        |           | (In Millions)
|$300 million authorization  |                                 |        | 1,600,000 |               |  | $ | 95  |    
|$1 billion authorization    |                                 |        | 7,745,700 |               |  |   | 410 |    
|1999 LTIP tax withholding   |                                 |        | 119,074   |               |  |   | 6   |    
|                            |                                 |        |           |               |  |   |     |    
|                            | Total during 2002.              |        |           | 9,464,774     |  |   |     | 511 | 
|$1 billion authorization    |                                 |        | 926,360   |               |  |   | 42  |    
|1999 LTIP tax withholding   |                                 |        | 237,756   |               |  |   | 10  |    
|                            |                                 |        |           |               |  |   |     |    
|                            | Total during 2003.              |        |           | 1,164,116     |  |   |     | 52  | 
|                            |                                 |        |           |               |  |   |     |    
|                            | Total through February 4, 2003. |        |           | 10,628,890    |  |   | $   | 563 | 
|                            |                                 |        |           |               |  |   |     |    

|                                     |  |                                  |            |        |            |      |       |   |     | 
|------------------------------------ |  | -------------------------------- | ---------- | ------ | ---------- | ---- | ----- | - | --- | 
|Cumulative                           |  | Period Completed                 |            | Shares |            | Cost
|                                     |  |                                  |            |        |            |     
|Programs completed                   |  | November 1999 to February 2002   |            |        | 21,570,739 |      |       | $ | 875 | 
|$1 billion approved February 6, 2002 |  | Ongoing  $548 million remaining |            |        | 8,672,060  |      |       |   | 452 | 
|1999 LTIP tax withholding            |  | Ongoing                          |            |        | 356,830    |      |       |   | 16  | 
|                                     |  |                                  |            |        |            |      |       |   |     | 
|Total as of February 4, 2003         |  |                                  | 30,599,629 |        |            | $    | 1,343 |  
|                                     |  |                                  |            |        |            |      |       |  

Dividends

On February 5, 2003, RJRs board of
directors declared a quarterly cash dividend of $0.95 per common
share. The dividend will be paid on April 1, 2003 to
stockholders of record as of March 11, 2003. On an
annualized basis, the dividend rate is $3.80 per common share.

Capital Expenditures

RJR Tobaccos capital expenditures were
$111 million, $74 million and $60 million in
2002, 2001 and 2000, respectively. RJR Tobaccos
capital expenditure program is expected to continue at a level
sufficient to support its strategic and operating needs.
RJR Tobacco plans to spend $105 million to
$115 million for capital expenditures during 2003, funded
primarily by cash flows from operations. This increase in 2002
and 2003 over recent years is primarily due to increased
equipment replacements. There were no material long-term
commitments for capital expenditures as of December 31,
2002.

Debt

RJRs revolving credit facility with a
syndicate of banks was amended and restated on May 10,
2002. Under the amendment and restatement, the committed amount
will remain at $622 million until May 2003, at which time
the committed amount will be reduced to $531 million
through November 2004. The amendment and restatement was further
amended on January 17, 2003, to modify among other things,
certain financial covenants and definitions to take into account
the effect of the restructuring charges incurred by RJR in the
fourth quarter of 2002. RJR can use the full facility to obtain
loans or letters of credit, at its option. RJR Tobacco and
RJR Acquisition Corp. have guaranteed RJRs
obligations under the revolving credit facility. If RJRs
guaranteed unsecured notes are rated below BBB- by Standard
& Poors or Baa3 by Moodys, RJRs other
material subsidiaries will be required to guarantee the
facility. If RJRs guaranteed unsecured notes, including
the notes issued in May 2002, are rated below BBB- by
Standard & Poors and below Baa3 by Moodys,
or two levels below these thresholds for either of these rating
agencies, RJR and the guarantors will be required to pledge all
of their assets to secure their obligations under RJRs
revolving credit facility. RJR is not required to maintain
compensating balances; however, RJR pays commitment fees of 1%
per annum of the committed amount. The credit facility also
limits RJRs ability to pay dividends, repurchase

49



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stock, incur indebtedness, engage in transactions
with affiliates, create liens, acquire, sell or dispose of
specific assets and engage in specified mergers or
consolidations. Borrowings under the revolving credit facility
bear interest at rates that vary with the prime rate or LIBOR.
At December 31, 2002, RJR and RJR Tobacco had
$17 million in letters of credit outstanding under the
facility. No borrowings were outstanding, and the remaining
$605 million of the facility was available for borrowing.


Since the spin-off in 1999, RJRs unsecured,
unsubordinated debt notes have maintained the ratings of BBB-by
Standard & Poors and Baa2 by Moodys. In
December 2002, Moodys revised its outlook to negative but
maintained its rating, reflecting its concern over the impact of
industry trends including heavy promotional activity in the
premium price-tier and the growth of the deep-discount
price-tier despite the reduction in payments under the MSA.

RJR also has a $30 million uncommitted,
unsecured line of credit with one bank. No borrowings were
outstanding on this line of credit at December 31, 2002.

RJR filed a registration statement, effective in
October 1999, in order to issue publicly registered notes of
$550 million in principal amount at 7.375% due in May 2003,
$500 million in principal amount at 7.75% due in May 2006
and $200 million in principal amount at 7.875% due in May
2009 in exchange for an aggregate $1.25 billion of private
placement debt securities. The net proceeds received from the
private placement were used for general corporate purposes.

RJR filed a shelf registration statement,
effective December 1999, for the issuance of up to
$1.876 billion of debt securities, guaranteed by
RJR Tobacco. RJR filed a second shelf registration
statement, effective in April 2001, superseding the initial
registration and adding RJR Acquisition Corp. as a
guarantor of these debt securities. Under this registration
statement, in May 2002, RJR completed the sale of
$300 million of 6.5% notes due in June 2007, and
$450 million of 7.25% notes due in June 2012. The proceeds
from the sale of these notes are intended to be used to repay
RJRs 7.375% notes due in May 2003, in the principal amount
of $550 million. The remainder of the proceeds is intended
to be used for the repayment of other public notes due through
2004.

The $2.0 billion guaranteed unsecured notes
described above are unsecured obligations and, unlike RJRs
other non-bank debt, are guaranteed by RJR Tobacco and
RJR Acquisition Corp. In addition, any other subsidiaries
of RJR that in the future guarantee the $622 million
revolving credit facility, as amended and restated, will also be
required to guarantee these notes. If RJR and the guarantors are
required to pledge their assets to secure their obligations
under the revolving credit facility, as amended and restated,
they also will be required to pledge certain of their assets to
secure these notes. Excluded from the pledge to secure these
notes are intellectual property, inventory, accounts receivable
and certain other assets. Generally, the terms of these notes
restrict the issuance of guarantees by subsidiaries, the pledge
of collateral, sale/leaseback transactions and the transfer of
all or substantially all of the assets of RJR and its
subsidiaries.

As long as RJRs unsecured, unsubordinated
debt rating remains investment grade, RJR may be required to
post collateral under its interest rate swap agreements if the
fair value of the interest rate swaps results in a liability
position that exceeds specified threshold amounts. If RJRs
unsecured, unsubordinated debt rating is either one level below
BBB- by Standard & Poors or Baa3 by Moodys, any
fair value that results in a liability position of the interest
rate swaps will require full collateralization. In addition, as
long as RJRs existing revolving credit facility is in
place, if RJR and the guarantors are required to pledge their
assets to secure their obligations under RJRs revolving
credit facility, as amended and restated, such pledge also will
secure their obligations under these interest rate swap
agreements.

RJR was in compliance with all covenants and
restrictions imposed by its indebtedness at December 31,
2002.

On December 11, 2000, related to the
acquisition of NGH, RJR acquired $98 million of 9.5% junior
subordinated debentures, due in 2047, with a mandatory
redemption date of September 30, 2003. Interest on these
debentures is paid quarterly in arrears. These debentures are
effectively defeased by an irrevocable trust, which is included
in other current assets in the accompanying consolidated balance
sheet as of December 31,

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2002 and in other assets and deferred charges as
of December 31, 2001. The trust holds certain U.S.
government obligations maturing at such times and in such
amounts sufficient to pay interest and principal.


On December 1, 2002, RJR repaid $43 million
of public notes with a fixed interest rate of 8.625% on their
due date. As of December 31, 2002, RJR had
$288 million of public notes outstanding, at fixed interest
rates of 7.625% through 9.25%, due in 2003 through 2013.

Litigation and Settlements

Various legal actions, proceedings and claims,
including legal actions claiming that lung cancer and other
diseases, as well as addiction, have resulted from the use of,
or exposure to, RJRs operating subsidiaries
products, are pending or may be instituted against
RJR Tobacco or its affiliates, including RJR, or
indemnitees. In July 2000, a jury in the Florida state court
case Engle v. R. J. Reynolds Tobacco Co.rendered a
punitive damages verdict in favor of the Florida
class of plaintiffs of approximately $145 billion,
with approximately $36.3 billion being assigned to
RJR Tobacco. RJR Tobacco and other defendants have
appealed this verdict. RJR Tobacco believes it has numerous
bases for a successful appeal, although it cannot predict the
outcome of the appellate process. For further discussion of the
Englecase and other litigation and legal proceedings
pending against RJR or its affiliates or indemnitees, see
Business  Litigation Affecting the Cigarette
Industry, Business  ERISA
Litigation and Business  Environmental
Matters in Item 1;  Governmental
Activity; note 14 to the consolidated financial
statements; and Exhibit 99.1 to this report. Even though
RJRs management continues to conclude that the loss of any
particular smoking and health tobacco litigation claim against
RJR Tobacco or its affiliates, when viewed on an individual
basis, is not probable, the possibility of material losses
related to tobacco litigation is more than remote. However,
RJRs management is unable to predict the outcome of such
litigation or to reasonably estimate the amount or range of any
possible loss. Moreover, notwithstanding the quality of defenses
available to it and its affiliates in tobacco-related litigation
matters, it is possible that RJRs results of operations,
cash flows or financial condition could be materially adversely
affected by the ultimate outcome of certain pending or future
litigation matters.

In November 1998, RJR Tobacco and the other
major U.S. cigarette manufacturers entered into the MSA with
attorneys general representing most U.S. states, territories and
possessions. As described under Business 
Litigation Affecting the Cigarette Industry in Item 1
and note 14 to the consolidated financial statements, the MSA
imposes a stream of future payment obligations on
RJR Tobacco and the other major U.S. cigarette
manufacturers and places significant restrictions on their
ability to market and sell cigarettes in the future. The cash
payments made by RJR Tobacco under the MSA and other
existing state settlement agreements were $2.5 billion, $2.4
billion and $2.2 billion in 2002, 2001 and 2000, respectively.
RJR Tobacco estimates these payments will be $1.9 billion
in 2003 and will exceed $2 billion per year thereafter. However,
these payments will be subject to adjustments for, among other
things, the volume of cigarettes sold by RJR Tobacco,
RJR Tobaccos market share and inflation.
RJR Tobacco cannot predict the impact on its business,
competitive position or results of operations of the MSA and the
other existing state settlement agreements, the business
activity restrictions to which it is subject under these
agreements or the price increases that it may be required to
make as a result of these agreements.

Governmental Activity

The marketing, sale, taxation and use of
cigarettes have been subject to substantial regulation by
government and health officials for many years. Various state
governments have adopted or are considering, among other things,
legislation and regulations increasing their excise taxes on
cigarettes; restricting displays and advertising of tobacco
products; establishing fire safety standards for cigarettes;
raising the minimum age to possess or purchase tobacco products;
requiring the disclosure of ingredients used in the manufacture
of tobacco products; imposing restrictions on smoking in public
and private areas and restricting the sale of tobacco products
directly to consumers or other unlicensed recipients, including
over the Internet. In addition, in 2003, the U.S. Congress may
consider legislation regarding further increases in the federal
excise tax, regulation of cigarette manufacturing and sale by
the U.S. Food and Drug Administration, amendments to the Federal
Cigarette Labeling and Advertising Act to require additional
warnings, reduction or elimination of the

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tax deductibility of advertising expenses,
implementation of a national standard for fire-safe
cigarettes, regulation of the retail sale of cigarettes over the
Internet and changes to the tobacco price support program.
Together with manufacturers price increases in recent
years and substantial increases in state and federal excise
taxes on cigarettes, these developments have had and will likely
continue to have an adverse effect on cigarette sales.


Cigarettes are subject to substantial excise
taxes in the United States. The federal excise tax per pack of
20 cigarettes is $0.39. All states and the District of Columbia
currently impose excise taxes at levels ranging from $.025 per
pack in Virginia to $1.51 per pack in Massachusetts. During
2002, 20 states and New York City approved an increase in their
excise taxes, raising the weighted average state cigarette
excise tax per pack from $0.42 in 2001 to $0.62.
RJR Tobacco expects state excise taxes to increase even
further in 2003 due to many states having budget shortfalls.
Since January 1, 2003, the District of Columbia has
increased its excise tax on cigarettes to $1.00 per pack and
numerous states have pending legislation proposing further state
excise tax increases.

In 1964, the Report of the Advisory Committee to
the Surgeon General of the U.S. Public Health Service concluded
that cigarette smoking was a health hazard of sufficient
importance to warrant appropriate remedial action. Since 1966,
federal law has required a warning statement on cigarette
packaging. Since 1971, television and radio advertising of
cigarettes has been prohibited in the United States. Cigarette
advertising in other media in the United States is required to
include information with respect to the tar and
nicotine yield of cigarettes, as well as a warning statement.

During the past four decades, various laws
affecting the cigarette industry have been enacted. In 1984,
Congress enacted the Comprehensive Smoking Education Act. Among
other things, the Smoking Education Act:



| |   |                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | establishes an interagency committee on smoking
    and health that is charged with carrying out a program to inform
    the public of any dangers to human health presented by cigarette
    smoking;             
|
| |  | requires a series of four health warnings to be
    printed on cigarette packages and advertising on a rotating
    basis;                                                                                         
|
| |  | increases type size and area of the warning
    required in cigarette advertisements; and                                                                                                                          
|
| |  | requires that cigarette manufacturers provide
    annually, on a confidential basis, a list of ingredients added
    to tobacco in the manufacture of cigarettes to the Secretary of
    Health and Human Services.

The warnings currently required on cigarette
packages and advertisements are:



| |   |                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------
| |  | 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.                                                           

Since the initial report in 1964, the Secretary
of Health, Education and Welfare (now the Secretary of Health
and Human Services) and the Surgeon General have issued a number
of other reports which purport to find the nicotine in
cigarettes addictive and to link cigarette smoking and exposure
to cigarette smoke with certain health hazards, including
various types of cancer, coronary heart disease and chronic
obstructive lung disease. These reports have recommended various
governmental measures to reduce the incidence of smoking. In
1992, the federal Alcohol, Drug Abuse and Mental Health Act was
signed into law. This act requires states to adopt a minimum age
of 18 for purchases of tobacco products and to establish a
system to monitor, report and reduce the illegal sale of tobacco
products to minors in order to continue receiving federal
funding for

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mental health and drug abuse programs. In January
1996, the U.S. Department of Health and Human Services announced
regulations implementing this legislation.


In December 1992, the U.S. Environmental
Protection Agency issued a report that classified environmental
tobacco smoke as a Group A (known human) carcinogen. RJR Tobacco
and others filed suit to challenge the validity of the EPA
report. On July 17, 1998, a U.S. District Court judge held
that the EPAs classification of environmental tobacco
smoke was invalid and vacated those portions of the report
dealing with lung cancer. The judgment of the district court was
in turn vacated by the U. S. Court of Appeals for the Fourth
Circuit on December 11, 2002, on the ground that the
district court lacked jurisdiction to review the EPAs
report. RJR Tobacco has not decided whether to seek review of
the appellate courts decision. The appellate decision
raises important legal issues, but, ten years after the
appearance of the original EPA report, the practical issues are
not compelling because other agencies have reached similar
conclusions and smoking restrictions have increasingly
proliferated.

Legislation imposing various restrictions on
public smoking also has been enacted in 48 states and many local
jurisdictions, and many employers have initiated programs
restricting or eliminating smoking in the workplace. A number of
states have enacted legislation designating a portion of
increased cigarette excise taxes to fund either anti-smoking
programs, health care programs or cancer research. In addition,
educational and research programs addressing health care issues
related to smoking are being funded from industry payments made
or to be made under settlements with state attorneys general.
Federal law prohibits smoking in scheduled passenger aircraft,
and the U.S. Interstate Commerce Commission has banned smoking
on buses transporting passengers inter-state. Certain common
carriers have imposed additional restrictions on passenger
smoking.

Several states have enacted or proposed
legislation or regulations that would require cigarette
manufacturers to disclose the ingredients used in the
manufacture of cigarettes. In July 1996, Massachusetts enacted
legislation requiring manufacturers of tobacco products sold in
Massachusetts to report yearly, beginning December 15,
1997, the ingredients of each brand sold. The statute also
requires the reporting of nicotine yield ratings in accordance
with procedures established by the state. The legislation
contemplates public disclosure of all ingredients in descending
quantitative order, a trade-secret disclosure that
RJR Tobacco believes could damage the competitive position
of its brands. RJR Tobacco, together with other cigarette
manufacturers, filed suit in the U.S. District Court for the
District of Massachusetts seeking to have the statute declared
invalid. In September 2000, the district court permanently
enjoined enforcement of provisions of the law relating to
ingredient reporting and issued a judgment in favor of the
cigarette manufacturers. The United States Court of Appeals for
the First Circuit upheld the district courts judgment on
December 2, 2002. The Massachusetts attorney general has
not announced whether the Commonwealth will seek review by the
Supreme Court.

In August 1998, the Massachusetts Department of
Public Health issued proposed regulations for public comment
that would require annual reporting, beginning July 1,
2000, on a brand-by-brand basis of 43 smoke constituents in both
mainstream smoke and sidestream smoke. RJR Tobacco,
together with other cigarette manufacturers, filed comments with
the MDPH on October 9, 1998. RJR Tobacco and the other
manufacturers believe that the MDPH lacks legal authority to
promulgate these regulations. Nevertheless, RJR Tobacco and
the other manufacturers have conducted a cooperative
benchmarking study to address certain MDPH concerns. The
benchmarking study obtained smoke constituent information on a
representative number of cigarette brand styles. The final
report, including all data, was presented to the MDPH. The MDPH
has drafted additional proposed regulations requiring further
extensive testing of cigarette brands. The MDPH has engaged in
discussions about these additional proposed regulations with
representatives of the cigarette manufacturers and others, but
has not formally issued them for public comment. Although the
MDPH has stated its intention to promulgate additional reporting
requirements, RJR Tobacco cannot predict the form they will
take or the effect they will have on RJR Tobaccos
business or operations.

On May 21, 1999, RJR Tobacco, Lorillard
Tobacco Company, Brown & Williamson Tobacco Corporation and
Philip Morris, Inc. filed lawsuits in the U.S. District Court
for the District of Massachusetts to enjoin implementation of
certain Massachusetts attorney general regulations concerning
the advertisement and

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display of tobacco products. The regulations went
beyond those required by the MSA, and banned outdoor advertising
of tobacco products within 1,000 feet of any school or
playground, as well as any indoor tobacco advertising placed
lower than five feet in stores within the 1,000-foot zone. The
district court ruled against the industry on January 25,
2000, and the U. S. Court of Appeals for the First Circuit
affirmed. The U.S. Supreme Court granted the industrys
petition for writ of certiorari on January 8, 2001, and
ruled in favor of RJR Tobacco and the rest of the industry
on June 28, 2001. The Supreme Court found that the
regulations were preempted by the Federal Cigarette Labeling and
Advertising Act, which precludes states from imposing any
requirement or prohibition based on smoking and health with
respect to the advertising or promotion of cigarettes labeled in
conformity with federal law.


In June 2000, the New York State legislature
passed legislation charging the states Office of Fire
Prevention and Control with developing standards for
fire-safe or self-extinguishing cigarettes. On
December 31, 2002, OFPC issued a proposed standard with
accompanying regulations for public comment. The agency will
decide whether to make amendments and when final regulations
should be issued after review of the information submitted in
response to its notice. Current law requires that all cigarettes
offered for sale in New York will be required to meet the
standard not later than six months after the regulations become
final. If the standard is finalized as proposed on December 31,
2002, there may be an adverse impact on the sale of cigarettes
in New York due to reduced consumer acceptance of the changes in
the cigarette made necessary to meet the standard.
RJR Tobacco is unable to predict the outcome of this
regulatory process. Similar legislation is being considered in
other states.

On September 11, 2001, RJR Tobacco,
together with several retailers who sell RJR Tobaccos
products, filed a Petition for Declaratory Judgment and
Injunctive Relief in the District Court of Lancaster County,
Nebraska, challenging the validity of the Nebraska Department of
Revenues interpretation of 316 N.A.C.
§§ 57-012, 57-015 and 57-016. The Department of
Revenue maintains that this regulation prohibits the
advertisement of RJR Tobaccos manufacturers
promotion known as a buydown to consumers. The
plaintiffs have challenged the Department of Revenues
interpretation of this regulation on the grounds that such
action exceeded the Departments statutory authority,
constituted an unlawful rulemaking, violated the United States
and Nebraska constitutions and is preempted by federal law. On
October 15, 2001, the defendants filed a Demurrer to the
plaintiffs Petition for Declaratory Judgment and
Injunctive Relief. The Court has not yet ruled on the
parties motions.

A price differential exists between cigarettes
manufactured for sale abroad and cigarettes manufactured for
U.S. sale; consequently, a domestic gray market has
developed in cigarettes manufactured for sale abroad. These
cigarettes compete with the cigarettes RJR Tobacco
manufactures for domestic sale. The U.S. federal government and
all 50 states have enacted legislation prohibiting the sale and
distribution of gray market cigarettes. In addition,
RJR Tobacco has taken legal action against certain
distributors and retailers who engage in such practices.

Eighteen states have passed, and various states
are considering, legislation to ensure nonparticipating
manufacturers under the MSA are making required escrow
payments. The National Association of Attorneys General has
endorsed adoption of such legislation. Under this legislation, a
state would only permit distribution of brands by manufacturers
who are deemed by the state to be MSA compliant. Failure to make
escrow payments could result in the loss of a nonparticipating
manufacturers ability to sell tobacco products in a
respective state.

Tobacco leaf is an agricultural product subject
to U.S. Government production controls and price supports that
can affect market prices substantially. The tobacco leaf price
support program is subject to congressional review and may be
changed at any time. In December 1994, Congress enacted the
Uruguay Round Agreements Act to replace a domestic content
requirement with a tariff rate quota system that bases tariffs
on import volumes. The tariff rate quotas have been established
by the United States with overseas tobacco producers and became
effective on September 13, 1995. Because of the importance
of tobacco leaf as a raw material for RJR Tobaccos
products, substantial changes in the legislative or regulatory
environment applicable to tobacco leaf could have a material
effect on RJR Tobaccos results of operations and cash
flows.

54



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##### 



It is not possible to determine what additional
federal, state or local legislation or regulations relating to
smoking or cigarettes will be enacted or to predict the effect
of new legislation or regulations on RJR Tobacco or the
cigarette industry in general, but any new legislation or
regulations could have an adverse effect on RJR Tobacco or
the cigarette industry in general.

For further discussion of litigation and legal
proceedings pending against RJR, its affiliates, including
RJR Tobacco, or indemnitees, see Business 
Litigation Affecting the Cigarette Industry,
Business  ERISA Litigation and
Business  Environmental Matters in
Item 1; note 14 to the consolidated financial statements;
and Exhibit 99.1 to this report.

Environmental Matters

RJR and its subsidiaries are subject to federal,
state and local environmental laws and regulations concerning
the discharge, storage, handling and disposal of hazardous or
toxic substances. RJR and its subsidiaries have been engaged in
a continuing program to assure compliance with these
environmental laws and regulations. Although it is difficult to
identify precisely the portion of capital expenditures or other
costs attributable to compliance with environmental laws and
regulations, RJR does not expect such expenditures or other
costs to have a material adverse effect on the business or
financial condition of RJR or its subsidiaries.

For further discussion of environmental matters,
see Business  Environmental Matters in
Item 1 and note 14 to the consolidated financial
statements.

Other Contingencies

Until the acquisition by merger by Philip Morris
Companies, Inc. of Nabisco from NGH on December 11, 2000,
NGH and Nabisco were members of the consolidated group of NGH
for U.S. federal income tax purposes. Each member of a
consolidated group is jointly and severally liable for the U.S.
federal income tax liability of other members of the group, as
well as for pension and funding liabilities of the other group
members. NGH, now known as RJR Acquisition Corp., continues
to be jointly and severally liable for these Nabisco liabilities
prior to December 11, 2000.

In connection with Philip Morris
acquisition by merger of Nabisco and RJRs subsequent
acquisition by merger of NGH, Philip Morris, Nabisco and NGH
entered into a voting and indemnity agreement that generally
seeks to allocate tax liabilities ratably based upon NGHs
taxable income and that of Nabisco, had the parties been
separate taxpayers. If Philip Morris and Nabisco are unable to
satisfy their obligations under this agreement, NGH, now known
as RJR Acquisition Corp., would be responsible for
satisfying them.

In connection with the sale of the international
tobacco business to Japan Tobacco Inc. on May 12, 1999, RJR
and RJR Tobacco agreed to indemnify Japan Tobacco against
(1) any liabilities, costs and expenses arising out of the
imposition or assessment of any tax with respect to the
international tobacco business arising prior to the sale, other
than as reflected on the closing balance sheet, (2) any
liabilities, costs and expenses that Japan Tobacco or any of its
affiliates, including the acquired entities, may incur after the
sale in respect of any of RJRs or RJR Tobacco
Tobaccos employee benefit and welfare plans and
(3) any liabilities, costs and expenses incurred by Japan
Tobacco or any of its affiliates arising out of certain
activities of Northern Brands. See Business 
Litigation Affecting the Cigarette Industry in Item 1
and note 14 to the consolidated financial statements for a
description of the Northern Brands litigation. Although it is
impossible to predict the outcome of the Northern Brands
litigation or the amount of liabilities, costs and expenses, a
significant adverse outcome regarding any of these items could
have an adverse effect on either or both of RJR and
RJR Tobacco.

RJR and the guarantors will be required to pledge
all of their assets to secure their obligations under RJRs
revolving credit facility if RJRs guaranteed unsecured
notes are rated below BBB- by Standard & Poors and
below Baa3 by Moodys, or two levels below these thresholds
for either of these rating agencies. If RJR and the guarantors
are required to pledge their assets to secure their obligations
under the revolving credit facility, as amended and restated,
they also will be required to pledge certain of their assets to
secure

55



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##### 



RJRs guaranteed unsecured notes. For a
further discussion of RJRs revolving credit facility and
other debt, see  Liquidity and Financial
Condition  Debt above.


As long as RJRs unsecured, unsubordinated
debt rating remains investment grade, RJR may be required to
post collateral under its interest rate swap agreements if the
fair value of the interest rate swaps results in a liability
position that exceeds specified threshold amounts. If RJRs
unsecured, unsubordinated debt is rated either one level below
BBB- by Standard & Poors or Baa3 by Moodys, any
fair value that results in a liability position of the interest
rate swaps will require full collateralization. In addition, as
long as RJRs existing revolving credit facility is in
place, if RJR and the guarantors are required to pledge their
assets to secure their obligations under RJRs revolving
credit facility, as amended and restated, such pledge also will
secure their obligations under these interest rate swap
agreements.

Acquisition and Joint Venture

On January 16, 2002, RJR acquired, with
cash, 100% of the voting stock of privately held Santa Fe.
Fiesta Acquisition Corp., a wholly owned subsidiary of RJR,
merged with and into Santa Fe, and Santa Fe, being the surviving
corporation, became a wholly owned subsidiary of RJR. The
acquisition was accounted for as a purchase, with its cost of
$354 million allocated on the basis of the estimated fair market
value of the assets acquired and liabilities assumed. The
results of operations of Santa Fe have been included in the
accompanying consolidated statements of income since
January 16, 2002. Although Santa Fe is an operating segment
of RJR, its financial condition and results of operations do not
meet the criteria to be reportable. As a result, information
related to Santa Fe is not generally disclosed separately in
this document.

Santa Fe manufactures and markets cigarettes and
other tobacco products, under the NATURAL AMERICAN SPIRIT brand,
primarily in the United States. RJR believes that Santa Fe will
enhance RJRs consolidated earnings, and that its approach
to building brand equity is consistent with RJR Tobacco
Tobaccos strategy for its key brands. Santa Fe has posted
solid increases in volume, revenue, earnings and share of market
over the past three years, based on the success of cigarettes
and pouch tobaccos sold under the NATURAL AMERICAN SPIRIT brand
name. NATURAL AMERICAN SPIRIT cigarettes are made with
no-additive tobacco blends and are marketed in distinctive
packages bearing the silhouette of an American Indian in a
feathered headdress. The NATURAL AMERICAN SPIRIT retail share of
market during 2002 was 0.26% in the United States. Santa Fe also
has a small, but growing international tobacco business.

On July 16, 2002, RJR, through its wholly
owned subsidiary, R. J. Reynolds Tobacco C.V., acquired a 50%
interest in R.J. Reynolds-Gallaher International Sarl, a joint
venture created with Gallaher Group Plc., to manufacture and
market a limited portfolio of American-blend cigarette brands.
The joint venture, headquartered in Switzerland, will initially
market its products in France, Spain, the Canary Islands and
Italy. RJRs financial contribution over the next five
years is expected to be $75 million to $100 million. As a part
of the transaction, RJR Tobacco is licensing REYNOLDS, a new
American-blend brand in a unique Slide Box pack, to the joint
venture. This investment is accounted for using the equity
method.



---

Statements included in Managements
Discussion and Analysis of Financial Condition and Results of
Operations which are not historical in nature are
forward-looking statements made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of
1995. These statements regarding RJRs future performance
and financial results inherently are subject to a variety of
risks and uncertainties, many of which are beyond the control of
RJR, that could cause actual results to differ materially from
those described in the forward-looking statements. These risks
include the substantial and increasing regulation and taxation
of the cigarette industry; various legal actions, proceedings
and claims arising out of the tobacco business and claimed
health effects of cigarettes that are pending or may be
instituted against RJR or its subsidiaries; the substantial
payment obligations and limitations on the advertising and
marketing of cigarettes under various litigation settlement
agreements; the continuing decline in volume in the domestic
cigarette industry; competition from other cigarette
manufacturers, including increased promotional activities and
the growth of the deep-discount category; the success of new
product innovations and acquisitions; the effect of market

56



---



##### 



conditions on the performance of pension assets,
foreign currency exchange rate risk, interest rate risk and the
return on corporate cash; and the ratings of RJRs
securities. Due to these uncertainties and risks, you are
cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date of this report.


Item 7a. Quantitative and Qualitative
Disclosures about Market Risk

Market risk represents the risk of loss that may
impact the consolidated financial position, results of
operations and cash flows due to adverse changes in financial
market prices and rates. RJR and its subsidiaries are exposed to
interest rate risk directly related to their normal investing
and funding activities. In addition, RJR Tobacco has exposure to
foreign currency exchange rate risk related to unrecognized firm
commitments for the purchase of equipment, as well as
obligations for, and service agreements related to, foreign
operations denominated in euros and Great British pounds. RJR
and its subsidiaries have established policies and procedures to
manage their exposure to market risks and use major institutions
that are creditworthy to minimize their investment and credit
risk. Derivative financial instruments are not used for trading
or speculative purposes. See note 15 to the consolidated
financial statements for further information regarding financial
instruments entered into by RJR or its operating subsidiaries.

The value-at-risk model is used to statistically
measure the maximum fair value, cash flows and earnings loss
over one year from adverse changes in interest rates and foreign
currency rates. The computation assumes a 95% confidence level
under normal market conditions. The actual observed correlation
method is used for aggregating value at risk amounts across
market risk exposure categories. This model indicates that
near-term changes in interest rates and foreign currency rates
will not have a material impact on the future earnings, fair
values or cash flows, based on the historical movements in
interest rates, foreign currency rates and the fair value of
market-rate sensitive instruments at December 31, 2002.

57



---



##### 



Item 8. Financial Statements and
Supplementary Data

Independent Auditors Report

The Board of Directors 
 R.J. Reynolds Tobacco Holdings, Inc.:

We have audited the accompanying consolidated
balance sheets of R.J. Reynolds Tobacco Holdings, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the
related consolidated statements of income, stockholders
equity and comprehensive income, and cash flows for each of the
years in the three-year period ended December 31, 2002.
These consolidated financial statements are the responsibility
of the Companys management. Our responsibility is to
express an opinion on these consolidated financial statements
based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States of
America. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial
statements referred to above present fairly, in all material
respects, the financial position of R.J. Reynolds Tobacco
Holdings, Inc. and subsidiaries as of December 31, 2002 and
2001, and the results of their operations and their cash flows
for the years then ended in conformity with accounting
principles generally accepted in the United States of America.

As discussed in Note 1 to the consolidated
financial statements, effective January 1, 2002, R.J.
Reynolds Tobacco Holdings, Inc. and subsidiaries adopted the
provisions of Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets.

/s/ KPMG LLP

January 28, 2003, except as to note 14,
which is as of February 14, 2003

58



---



##### 



Report of Managements Responsibility for
Financial Statements

The financial statements presented in this report
are the responsibility of management, and have been prepared in
accordance with generally accepted accounting principles using,
where appropriate, managements best estimates and
judgment. Management maintains a system of internal controls to
provide reasonable assurance that RJRs assets are
safeguarded and transactions are executed as authorized and
properly recorded. The system includes established policies and
procedures, a program of internal audits, management reviews and
careful selection and training of qualified personnel.

The audit committee of RJRs board of
directors is composed solely of outside directors. It meets
periodically with management, the internal auditors and the
independent auditors, to discuss and address internal accounting
control, auditing and financial reporting matters. Both
independent and internal auditors have unrestricted access to
the audit committee.



|                                     | 
|------------------------------------ | 
|/s/ Andrew J. Schindler              | 
|                                     | 
|Chairman of the Board, President and | 
|Chief Executive Officer              | 
|                                    
|/s/ Richard H. Bogan                 | 
|                                     | 
|Executive Vice President and         | 
|Chief Financial Officer              | 

59



---



##### 



CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Millions, Except Per Share
Amounts)


|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |       |     |       | 
|-------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------- | -------------------------------- | ------------------------------------------------------------------------------- | ----- | --- | ----- | ----- | ----- | --- | ---- | ----- | ----- | --- | ----- | 
|                                                                     |                                                                                                       |                                 
|                                                                     |                                                                                                       | For the Years Ended December 31,
|                                                                     |                                                                                                       |                                 
|                                                                     |                                                                                                       | 2002                             |                                                                                 | 2001  |     | 2000 
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |      
|Net sales (1)                                                        |                                                                                                       | $                                | 6,211                                                                           |       |     | $     | 6,269 |       |     | $    | 6,085 |      
|Costs and expenses:                                                  |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|                                                                     | Cost of products sold (1) (2)                                                                         |                                  |                                                                                 | 3,732 |     |       |       | 3,560 |     |      |       | 3,436 |    
|                                                                     | Selling, general and administrative expenses                                                          |                                  |                                                                                 | 1,463 |     |       |       | 1,429 |     |      |       | 1,369 |    
|                                                                     | Restructuring and asset impairment charges                                                            |                                  |                                                                                 | 224   |     |       |       |      |     |      |       |      |    
|                                                                     | Trademark impairment charges                                                                          |                                  |                                                                                 | 13    |     |       |       |      |     |      |       | 89    |    
|                                                                     | Amortization of trademarks and goodwill                                                               |                                  |                                                                                 |      |     |       |       | 362   |     |      |       | 366   |    
|                                                                     | Tobacco settlement and related expenses                                                               |                                  |                                                                                 |      |     |       |       |      |     |      |       | (3    | )  
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|                                                                     |                                                                                                       | Operating income                 |                                                                                 |       | 779 |       |       |       | 918 |      |       |       | 828 |      
|Interest and debt expense                                            |                                                                                                       |                                  | 147                                                                             |       |     |       | 150   |       |     |      | 168   |      
|Interest income                                                      |                                                                                                       |                                  | (62                                                                             | )     |     |       | (137  | )     |     |      | (119  | )    
|Other expense, net                                                   |                                                                                                       |                                  | 11                                                                              |       |     |       | 13    |       |     |      | 31    |      
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|                                                                     |                                                                                                       |                                  | Income from continuing operations before
    income taxes                       |       |     | 683   |       |       |     | 892  |       |       |     | 748   | 
|Provision for income taxes                                           |                                                                                                       |                                  | 265                                                                             |       |     |       | 448   |       |     |      | 396   |      
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|                                                                     |                                                                                                       |                                  | Income from continuing operations                                               |       |     | 418   |       |       |     | 444  |       |       |     | 352   | 
|Discontinued operations:                                             |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|                                                                     | Gain (loss) on sale of discontinued
    businesses, net of income taxes (2002  $22;
    2001  $(5)) |                                  |                                                                                 | 40    |     |       |       | (9    | )   |      |       |      |    
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|                                                                     |                                                                                                       |                                  | Income before extraordinary item and
    cumulative effect of accounting change |       |     | 458   |       |       |     | 435  |       |       |     | 352   | 
|Extraordinary item  gain on
    acquisition, net of $0 income taxes |                                                                                                       |                                  |                                                                                |       |     |       |      |       |     |      | 1,475 |      
|Cumulative effect of accounting change, net of
    $328 income taxes |                                                                                                       |                                  | (502                                                                            | )     |     |       |      |       |     |      |      |      
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|                                                                     |                                                                                                       |                                  | Net income (loss)                                                               |       | $   | (44   | )     |       | $   | 435  |       |       | $   | 1,827 | 
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|Basic income (loss) per share:                                       |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|                                                                     | Income from continuing operations                                                                     |                                  | $                                                                               | 4.71  |     |       | $     | 4.57  |     |      | $     | 3.48  |    
|                                                                     | Gain (loss) on sale of discontinued
    businesses                                                    |                                  |                                                                                 | 0.45  |     |       |       | (0.09 | )   |      |       |      |    
|                                                                     | Extraordinary item  gain on
    acquisition                                                          |                                  |                                                                                 |      |     |       |       |      |     |      |       | 14.56 |    
|                                                                     | Cumulative effect of accounting change                                                                |                                  |                                                                                 | (5.66 | )   |       |       |      |     |      |       |      |    
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|                                                                     |                                                                                                       |                                  | Net income (loss)                                                               |       | $   | (0.50 | )     |       | $   | 4.48 |       |       | $   | 18.04 | 
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|Diluted income (loss) per
    share:                                 |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|                                                                     | Income from continuing operations                                                                     |                                  | $                                                                               | 4.64  |     |       | $     | 4.48  |     |      | $     | 3.46  |    
|                                                                     | Gain (loss) on sale of discontinued
    businesses                                                    |                                  |                                                                                 | 0.44  |     |       |       | (0.09 | )   |      |       |      |    
|                                                                     | Extraordinary item  gain on
    acquisition                                                          |                                  |                                                                                 |      |     |       |       |      |     |      |       | 14.48 |    
|                                                                     | Cumulative effect of accounting change                                                                |                                  |                                                                                 | (5.57 | )   |       |       |      |     |      |       |      |    
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|                                                                     |                                                                                                       |                                  | Net income (loss)                                                               |       | $   | (0.49 | )     |       | $   | 4.39 |       |       | $   | 17.94 | 
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      
|Dividends declared per share                                         |                                                                                                       | $                                | 3.73                                                                            |       |     | $     | 3.30  |       |     | $    | 3.10  |      
|                                                                     |                                                                                                       |                                  |                                                                                 |       |     |       |       |       |     |      |       |      






|    |                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes excise taxes of $1,751 million, $1,529
    million and $1,631 million for the years 2002, 2001 and 2000,
    respectively.      
|(2) | Includes settlement expense of $2,514 million,
    $2,584 million and $2,329 million for the years 2002, 2001 and
    2000, respectively.

See Notes to Consolidated Financial
Statements

60



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##### 



CONSOLIDATED STATEMENTS OF CASH
FLOWS

(Dollars in Millions)


|                                                    |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |       |        |      |  
|--------------------------------------------------- | ---------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------- | ------------------------------------------------------------------- | ---- | ---- | ---- | ----- | ---- | ---- | ---- | ----- | ----- | ------ | ---- | -
|                                                    |                                                                                                |                                                                          
|                                                    |                                                                                                | For the Years Ended December 31,                                         
|                                                    |                                                                                                |                                                                          
|                                                    |                                                                                                | 2002                                                                      |                                                                     | 2001 |      | 2000
|                                                    |                                                                                                |                                                                           |                                                                     |      |      |     
|Cash flows from (used in) operating
    activities: |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|                                                    | Net income (loss)                                                                              |                                                                           | $                                                                   | (44  | )    |      | $     | 435  |      |      | $     | 1,827 |       
|                                                    | Less (income) loss from discontinued
    operations                                            |                                                                           |                                                                     | (40  | )    |      |       | 9    |      |      |       |      |       
|                                                    | Adjustments to reconcile to net cash flows from
    (used in) continuing operating activities: |                                                                           |                                                                     |      |      |      |       |      |      |      |       |       |       
|                                                    |                                                                                                | Cumulative effect of accounting change, net of
    income taxes           |                                                                     |      | 502  |      |       |      |     |      |       |       |       |     
|                                                    |                                                                                                | Restructuring and asset impairment charges                                |                                                                     |      | 224  |      |       |      |     |      |       |       |       |     
|                                                    |                                                                                                | Depreciation and amortization                                             |                                                                     |      | 184  |      |       |      | 491  |      |       |       | 485    |     
|                                                    |                                                                                                | Trademark impairment charge                                               |                                                                     |      | 13   |      |       |      |     |      |       |       | 89     |     
|                                                    |                                                                                                | Deferred income tax expense (benefit)                                     |                                                                     |      | 18   |      |       |      | (43  | )    |       |       | (31    | )   
|                                                    |                                                                                                | Extraordinary gain on acquisition                                         |                                                                     |      |     |      |       |      |     |      |       |       | (1,475 | )   
|                                                    |                                                                                                | Other changes, net of acquisition effects, that
    provided (used) cash: |                                                                     |      |      |      |       |      |      |      |       |       |        |     
|                                                    |                                                                                                |                                                                           | Accounts and notes receivable                                       |      |      | 5    |       |      |      | (6   | )     |       |        | (12  | )
|                                                    |                                                                                                |                                                                           | Inventories                                                         |      |      | (56  | )     |      |      | (141 | )     |       |        | (23  | )
|                                                    |                                                                                                |                                                                           | Accounts payable and accrued liabilities
    including income taxes |      |      | (282 | )     |      |      | (211 | )     |       |        | (194 | )
|                                                    |                                                                                                | Litigation bonds                                                          |                                                                     |      | (55  | )    |       |      |     |      |       |       | (118   | )   
|                                                    |                                                                                                | Tobacco settlement and related expenses                                   |                                                                     |      | 17   |      |       |      | 123  |      |       |       | 82     |     
|                                                    |                                                                                                | Other, net                                                                |                                                                     |      | 3    |      |       |      | (31  | )    |       |       | (40    | )   
|                                                    |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|                                                    |                                                                                                | Net cash flows from operating activities                                  |                                                                     |      | 489  |      |       |      | 626  |      |       |       | 590    |     
|                                                    |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|Cash flows from (used in) investing
    activities: |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|                                                    | Purchases of short-term investments                                                            |                                                                           |                                                                     | (508 | )    |      |       | (207 | )    |      |       | 110   |       
|                                                    | Proceeds from short-term investments                                                           |                                                                           |                                                                     | 120  |      |      |       |     |      |      |       |      |       
|                                                    | Capital expenditures                                                                           |                                                                           |                                                                     | (111 | )    |      |       | (74  | )    |      |       | (60   | )     
|                                                    | Net proceeds from (used in) acquisitions                                                       |                                                                           |                                                                     | (339 | )    |      |       |     |      |      |       | 1,519 |       
|                                                    | Net proceeds from the sale of the international
    tobacco business                           |                                                                           |                                                                     |     |      |      |       | (14  | )    |      |       |      |       
|                                                    | Other, net                                                                                     |                                                                           |                                                                     | 18   |      |      |       | (12  | )    |      |       | 4     |       
|                                                    |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|                                                    |                                                                                                | Net cash flows from (used in) investing activities                        |                                                                     |      | (820 | )    |       |      | (307 | )    |       |       | 1,573  |     
|                                                    |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|Cash flows from (used in) financing
    activities: |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|                                                    | Repurchase of common stock                                                                     |                                                                           |                                                                     | (511 | )    |      |       | (494 | )    |      |       | (231  | )     
|                                                    | Dividends paid on common stock                                                                 |                                                                           |                                                                     | (335 | )    |      |       | (320 | )    |      |       | (322  | )     
|                                                    | Repayments of long-term debt                                                                   |                                                                           |                                                                     | (43  | )    |      |       | (73  | )    |      |       | (387  | )     
|                                                    | Proceeds from exercise of stock options                                                        |                                                                           |                                                                     | 39   |      |      |       | 45   |      |      |       | 59    |       
|                                                    | Proceeds from issuance of long-term debt                                                       |                                                                           |                                                                     | 745  |      |      |       |     |      |      |       |      |       
|                                                    |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|                                                    |                                                                                                | Net cash flows used in financing activities                               |                                                                     |      | (105 | )    |       |      | (842 | )    |       |       | (881   | )   
|                                                    |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|Net cash flows related to discontinued operations   |                                                                                                |                                                                           |                                                                    |      |      |      |      |      |      |      | 84    |      
|                                                    |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|Net change in cash and cash equivalents             |                                                                                                |                                                                           | (436                                                                | )    |      |      | (523  | )    |      |      | 1,366 |      
|Cash and cash equivalents at beginning of year      |                                                                                                |                                                                           | 2,020                                                               |      |      |      | 2,543 |      |      |      | 1,177 |      
|                                                    |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|Cash and cash equivalents at end of year            |                                                                                                | $                                                                         | 1,584                                                               |      |      | $    | 2,020 |      |      | $    | 2,543 |      
|                                                    |                                                                                                |                                                                           |                                                                     |      |      |      |       |      |      |      |       |      
|Income taxes paid, net of refunds                   |                                                                                                | $                                                                         | 203                                                                 |      |      | $    | 457   |      |      | $    | 309   |      
|Interest paid                                       |                                                                                                | $                                                                         | 135                                                                 |      |      | $    | 141   |      |      | $    | 153   |      
|Tobacco settlement and related expense payments     |                                                                                                | $                                                                         | 2,464                                                               |      |      | $    | 2,393 |      |      | $    | 2,247 |      

See Notes to Consolidated Financial
Statements

61



---



##### 



CONSOLIDATED BALANCE SHEETS

(Dollars in Millions)


|                                                                             |                                                                                                                                    |                                     |                               |                                    |       |       |        |       |       |       |       | 
|---------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------- | ----------------------------- | ---------------------------------- | ----- | ----- | ------ | ----- | ----- | ----- | ----- | 
|                                                                             |                                                                                                                                    |                                    
|                                                                             |                                                                                                                                    | December 31,                       
|                                                                             |                                                                                                                                    |                                    
|                                                                             |                                                                                                                                    | 2002                                |                               | 2001                              
|                                                                             |                                                                                                                                    |                                     |                               |                                   
|Assets                                                                       |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|Current assets:                                                              |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             | Cash and cash equivalents                                                                                                          |                                     | $                             | 1,584                              |       |       | $      | 2,020 |      
|                                                                             | Short-term investments                                                                                                             |                                     |                               | 595                                |       |       |        | 207   |      
|                                                                             | Accounts and notes receivable, net of allowance
    (2002  $3; 2001  $13)                                                        |                                     |                               | 96                                 |       |       |        | 106   |      
|                                                                             | Inventories                                                                                                                        |                                     |                               | 762                                |       |       |        | 730   |      
|                                                                             | Deferred income taxes                                                                                                              |                                     |                               | 588                                |       |       |        | 610   |      
|                                                                             | Other current assets                                                                                                               |                                     |                               | 289                                |       |       |        | 255   |      
|                                                                             | Assets held for sale                                                                                                               |                                     |                               | 78                                 |       |       |        |      |      
|                                                                             |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             |                                                                                                                                    | Total current assets                |                               |                                    | 3,992 |       |        |       | 3,928 |      
|Property, plant and equipment, at cost:                                      |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             | Land and land improvements                                                                                                         |                                     |                               | 89                                 |       |       |        | 94    |      
|                                                                             | Buildings and leasehold improvements                                                                                               |                                     |                               | 636                                |       |       |        | 668   |      
|                                                                             | Machinery and equipment                                                                                                            |                                     |                               | 1,359                              |       |       |        | 1,557 |      
|                                                                             | Construction-in-process                                                                                                            |                                     |                               | 77                                 |       |       |        | 61    |      
|                                                                             |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             |                                                                                                                                    | Total property, plant and equipment |                               |                                    | 2,161 |       |        |       | 2,380 |      
|                                                                             |                                                                                                                                    |                                     | Less accumulated depreciation |                                    |       | 1,221 |        |       |       | 1,330 |      
|                                                                             |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             |                                                                                                                                    |                                     |                               | Property, plant and equipment, net |       |       | 940    |       |       |       | 1,050 | 
|Trademarks, net of accumulated amortization
    (2002  $481; 2001  $1,450) |                                                                                                                                    |                                     | 2,085                         |                                    |       |       | 2,773  |      
|Goodwill, net of accumulated amortization (2002
    and 2001  $3,359)       |                                                                                                                                    |                                     | 7,090                         |                                    |       |       | 6,875  |      
|Other assets and deferred charges                                            |                                                                                                                                    |                                     | 544                           |                                    |       |       | 496    |      
|                                                                             |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             |                                                                                                                                    | $                                   | 14,651                        |                                    |       | $     | 15,122 |      
|                                                                             |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|Liabilities and stockholders
    equity                                     |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|Current liabilities:                                                         |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             | Accounts payable                                                                                                                   |                                     | $                             | 60                                 |       |       | $      | 74    |      
|                                                                             | Tobacco settlement and related accruals                                                                                            |                                     |                               | 1,543                              |       |       |        | 1,520 |      
|                                                                             | Accrued liabilities and other                                                                                                      |                                     |                               | 1,075                              |       |       |        | 1,155 |      
|                                                                             | Current maturities of long-term debt                                                                                               |                                     |                               | 741                                |       |       |        | 43    |      
|                                                                             | Liabilities related to assets held for sale                                                                                        |                                     |                               | 8                                  |       |       |        |      |      
|                                                                             |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             |                                                                                                                                    | Total current liabilities           |                               |                                    | 3,427 |       |        |       | 2,792 |      
|Long-term debt (less current maturities)                                     |                                                                                                                                    |                                     | 1,755                         |                                    |       |       | 1,631  |      
|Deferred income taxes                                                        |                                                                                                                                    |                                     | 1,236                         |                                    |       |       | 1,798  |      
|Long-term retirement benefits                                                |                                                                                                                                    |                                     | 1,176                         |                                    |       |       | 514    |      
|Other noncurrent liabilities                                                 |                                                                                                                                    |                                     | 341                           |                                    |       |       | 361    |      
|Commitments and contingencies:                                               |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|Stockholders equity:                                                        |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             | Common stock (shares issued:
    2002  115,413,501;
    2001  114,046,712)                                                       |                                     |                               | 1                                  |       |       |        | 1     |      
|                                                                             | Paid-in capital                                                                                                                    |                                     |                               | 7,401                              |       |       |        | 7,371 |      
|                                                                             | Retained earnings                                                                                                                  |                                     |                               | 1,217                              |       |       |        | 1,593 |      
|                                                                             | Accumulated other comprehensive
    loss  (cumulative minimum pension liability
    adjustment: 2002  $(599);
    2001  $(121)) |                                     |                               | (598                               | )     |       |        | (121  | )    
|                                                                             | Unamortized restricted stock                                                                                                       |                                     |                               | (19                                | )     |       |        | (42   | )    
|                                                                             |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             |                                                                                                                                    |                                     | 8,002                         |                                    |       |       | 8,802  |      
|                                                                             | Less treasury stock (shares:
    2002  29,365,197;
    2001  19,810,832), at cost                                                |                                     |                               | (1,286                             | )     |       |        | (776  | )    
|                                                                             |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             |                                                                                                                                    |                                     | Total stockholders equity    |                                    |       | 6,716 |        |       |       | 8,026 |      
|                                                                             |                                                                                                                                    |                                     |                               |                                    |       |       |        |      
|                                                                             |                                                                                                                                    | $                                   | 14,651                        |                                    |       | $     | 15,122 |      
|                                                                             |                                                                                                                                    |                                     |                               |                                    |       |       |        |      

See Notes to Consolidated Financial
Statements

62



---



##### 



CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

AND COMPREHENSIVE INCOME


(Dollars in Millions)


|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |       |   |  |   |       |  
|-------------------------------------------------- |  | ------ | - | ------- |  | ------------ | ----- | ------------- |  | ----------- | ----- | -------- |  | ------------- | ---- | ------------- |  | - | --- | - |  | - | ------ | - |  | - | ----- | - |  | - | ----- | -
|                                                   |  |        |   |         |  | Retained     |       | Accumulated   |  |             |       |          |  |               |      |              
|                                                   |  |        |   |         |  | Earnings     |       | Other         |  | Unamortized |       |          |  | Total         |      |              
|                                                   |  | Common |   | Paid-In |  | (Accumulated |       | Comprehensive |  | Restricted  |       | Treasury |  | Stockholders |      | Comprehensive
|                                                   |  | Stock  |   | Capital |  | Deficit)     |       | Income (Loss) |  | Stock       |       | Stock    |  | Equity        |      | Income (Loss)
|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |              
|Balance at December 31, 1999                       |  | $      | 1 |         |  | $            | 7,287 |               |  | $           | (131  | )        |  | $             | (13  | )             |  | $ | (25 | ) |  | $ | (55    | ) |  | $ | 7,064 |   |  |   |       |  
|Net income                                         |  |        |  |         |  |              |      |               |  |             | 1,827 |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 1,827 |   |  | $ | 1,827 |  
|Minimum pension liability, net of $3 tax expense   |  |        |  |         |  |              |      |               |  |             |      |          |  |               | 5    |               |  |   |    |   |  |   |       |   |  |   | 5     |   |  |   | 5     |  
|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |       |   |  |   |       |  
|Total comprehensive income                         |  |        |  |         |  |              |      |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   |      |   |  | $ | 1,832 |  
|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |       |   |  |   |       |  
|Dividends                                          |  |        |  |         |  |              | (102  | )             |  |             | (215  | )        |  |               |     |               |  |   |    |   |  |   |       |   |  |   | (317  | ) |  |   |       |  
|Stock options exercised                            |  |        |  |         |  |              | 62    |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 62    |   |  |   |       |  
|Tax benefit on stock options exercised             |  |        |  |         |  |              | 7     |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 7     |   |  |   |       |  
|Restricted stock awarded                           |  |        |  |         |  |              | 37    |               |  |             |      |          |  |               |     |               |  |   | (37 | ) |  |   |       |   |  |   |      |   |  |   |       |  
|Restricted stock amortization                      |  |        |  |         |  |              |      |               |  |             |      |          |  |               |     |               |  |   | 19  |   |  |   |       |   |  |   | 19    |   |  |   |       |  
|Restricted stock forfeited                         |  |        |  |         |  |              |      |               |  |             |      |          |  |               |     |               |  |   | 2   |   |  |   | (2     | ) |  |   |      |   |  |   |       |  
|Common stock repurchased                           |  |        |  |         |  |              |      |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   | (231   | ) |  |   | (231  | ) |  |   |       |  
|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |       |   |  |   |       |  
|Balance at December 31, 2000                       |  |        | 1 |         |  |              | 7,291 |               |  |             | 1,481 |          |  |               | (8   | )             |  |   | (41 | ) |  |   | (288   | ) |  |   | 8,436 |   |  |   |       |  
|Net income                                         |  |        |  |         |  |              |      |               |  |             | 435   |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 435   |   |  | $ | 435   |  
|Minimum pension liability, net of $61 tax expense  |  |        |  |         |  |              |      |               |  |             |      |          |  |               | (113 | )             |  |   |    |   |  |   |       |   |  |   | (113  | ) |  |   | (113  | )
|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |       |   |  |   |       |  
|Total comprehensive income                         |  |        |  |         |  |              |      |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   |      |   |  | $ | 322   |  
|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |       |   |  |   |       |  
|Dividends                                          |  |        |  |         |  |              |      |               |  |             | (324  | )        |  |               |     |               |  |   |    |   |  |   |       |   |  |   | (324  | ) |  |   |       |  
|Stock options exercised                            |  |        |  |         |  |              | 42    |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 42    |   |  |   |       |  
|Tax benefit on stock options exercised             |  |        |  |         |  |              | 20    |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 20    |   |  |   |       |  
|Restricted stock awarded                           |  |        |  |         |  |              | 18    |               |  |             |      |          |  |               |     |               |  |   | (26 | ) |  |   | 8      |   |  |   |      |   |  |   |       |  
|Restricted stock amortization                      |  |        |  |         |  |              |      |               |  |             |      |          |  |               |     |               |  |   | 23  |   |  |   |       |   |  |   | 23    |   |  |   |       |  
|Restricted stock forfeited                         |  |        |  |         |  |              |      |               |  |             | 1     |          |  |               |     |               |  |   | 2   |   |  |   | (2     | ) |  |   | 1     |   |  |   |       |  
|Common stock repurchased                           |  |        |  |         |  |              |      |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   | (494   | ) |  |   | (494  | ) |  |   |       |  
|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |       |   |  |   |       |  
|Balance at December 31, 2001                       |  |        | 1 |         |  |              | 7,371 |               |  |             | 1,593 |          |  |               | (121 | )             |  |   | (42 | ) |  |   | (776   | ) |  |   | 8,026 |   |  |   |       |  
|Net loss                                           |  |        |  |         |  |              |      |               |  |             | (44   | )        |  |               |     |               |  |   |    |   |  |   |       |   |  |   | (44   | ) |  | $ | (44   | )
|Minimum pension liability, net of $258 tax benefit |  |        |  |         |  |              |      |               |  |             |      |          |  |               | (478 | )             |  |   |    |   |  |   |       |   |  |   | (478  | ) |  |   | (478  | )
|Other                                              |  |        |  |         |  |              |      |               |  |             |      |          |  |               | 1    |               |  |   |    |   |  |   |       |   |  |   | 1     |   |  |   | 1     |  
|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |       |   |  |   |       |  
|Total comprehensive loss                           |  |        |  |         |  |              |      |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   |      |   |  | $ | (521  | )
|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |       |   |  |   |       |  
|Dividends                                          |  |        |  |         |  |              |      |               |  |             | (332  | )        |  |               |     |               |  |   |    |   |  |   |       |   |  |   | (332  | ) |  |   |       |  
|Stock options exercised                            |  |        |  |         |  |              | 40    |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 40    |   |  |   |       |  
|Tax benefit on stock options exercised             |  |        |  |         |  |              | 14    |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 14    |   |  |   |       |  
|Restricted stock awarded                           |  |        |  |         |  |              | (28   | )             |  |             |      |          |  |               |     |               |  |   | 14  |   |  |   | 14     |   |  |   |      |   |  |   |       |  
|Restricted stock forfeited                         |  |        |  |         |  |              | 4     |               |  |             |      |          |  |               |     |               |  |   | 9   |   |  |   | (13    | ) |  |   |      |   |  |   |       |  
|Common stock repurchased                           |  |        |  |         |  |              |      |               |  |             |      |          |  |               |     |               |  |   |    |   |  |   | (511   | ) |  |   | (511  | ) |  |   |       |  
|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |       |   |  |   |       |  
|Balance at December 31, 2002                       |  | $      | 1 |         |  | $            | 7,401 |               |  | $           | 1,217 |          |  | $             | (598 | )             |  | $ | (19 | ) |  | $ | (1,286 | ) |  | $ | 6,716 |   |  |   |       |  
|                                                   |  |        |   |         |  |              |       |               |  |             |       |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |       |   |  |   |       |  

See Notes to Consolidated Financial
Statements

63



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS

Note 1  Summary of
Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the
accounts of R.J. Reynolds Tobacco Holdings, Inc., referred
to as RJR, and its wholly owned subsidiaries. RJRs wholly
owned subsidiaries include its operating subsidiaries,
R. J. Reynolds Tobacco Company, referred to as
RJR Tobacco, and Santa Fe Natural Tobacco Company,
Inc., referred to as Santa Fe. RJR also wholly owns
RJR Acquisition Corp.

The equity method is used to account for
investments in businesses that RJR does not control, but has the
ability to significantly influence operating and financial
policies. The cost method is used to account for investments in
which RJR does not have the ability to significantly influence
operating and financial policies. All material intercompany
balances have been eliminated. We have no investments greater
than 20% in entities for which we account by the cost method,
and we have no investments greater than 50% in entities for
which we account by the equity method.

The preparation of the consolidated financial
statements in conformity with accounting principles generally
accepted in the United States of America requires estimates and
assumptions to be made that affect the reported amounts in the
consolidated financial statements and accompanying notes. Actual
results could differ from those estimates. Certain
reclassifications were made to conform prior years
financial statements to the current presentation.

All dollar amounts are presented in millions
unless otherwise noted.

Cash Equivalents and Short-Term
Investments

Cash equivalents include money market funds,
commercial paper and time deposits in major institutions with
high credit ratings to minimize investment risk. As short-term,
highly liquid investments readily convertible to known amounts
of cash, with remaining maturities of three months or less at
the time of purchase, cash equivalents have carrying values that
approximate fair values. Debt securities included in cash
equivalents are classified and accounted for as held-to-maturity
or, in certain instances, available-for-sale securities. The
appropriate classification of cash equivalents and short-term
investments is determined at the time of purchase and the
classification is reassessed at each reporting date. Short-term
investments include investment pools that are classified and
accounted for as available-for-sale securities.

Investment securities classified as
available-for-sale are reported at fair value based on current
market quotes with unrealized gains and losses, net of any tax
effect, recorded as a separate component of comprehensive income
in stockholders equity until realized. Interest income and
amortization of premiums and discounts are included in interest
income. Gains and losses on investment securities sold are
determined based on the specific identification method and are
included in other expense, net. Unrealized losses that are other
than temporary are recognized in net income. No securities are
held for speculative or trading purposes.

Accounts Receivable

Accounts receivable are reported net of allowance
for doubtful accounts. A summary of activity in the allowance
for doubtful accounts is summarized as follows:

|                             |                        |   |    |     |  
|---------------------------- | ---------------------- | - | -- | --- | -
|Balance at December 31, 1999 |                        | $ | 11 |    
|Balance at December 31, 2000 |                        |   | 11 |    
|                             | Provision for bad debt |   |    | 2   |  
|                             |                        |   |    |    
|Balance at December 31, 2001 |                        |   | 13 |    
|                             | Reduction in allowance |   |    | (10 | )
|                             |                        |   |    |    
|Balance at December 31, 2002 |                        | $ | 3  |    
|                             |                        |   |    |    

64



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Inventories

Inventories are stated at the lower of cost or
market. The cost of tobacco inventories is determined
principally under the last-in, first-out, or LIFO, method. The
cost of work in process and finished goods includes materials,
direct labor, and variable costs and full absorption of fixed
manufacturing overhead. Stocks of tobacco, which have an
operating cycle that exceeds 12 months due to curing
requirements, are classified as current assets, consistent with
recognized industry practice.

Property, Plant and Equipment

Property, plant and equipment are recorded at
cost and depreciated using the straight-line method over the
estimated useful lives of the assets. Useful lives range from 20
to 50 years for buildings and improvements and from 3 to
30 years for machinery and equipment. The cost and related
accumulated depreciation of assets sold or retired are removed
from the accounts and the gain or loss on disposition is
recognized in income.

Long-lived Assets

Long-lived assets such as property, plant and
equipment, and purchased intangibles are reviewed for impairment
whenever events or changes in circumstances indicate that the
book value of the asset may not be recoverable. The carrying
value of long-lived assets would be impaired if the best
estimate of future undiscounted cash flows expected to be
generated by the asset is less than the carrying value. If an
asset is impaired, the loss is measured as the difference
between estimated fair value and carrying value.

On January 1, 2002, RJR adopted the
Financial Accounting Standards Boards Statement of
Financial Accounting Standards No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets, which
supersedes SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of, and certain portions of Accounting Principles
Board Opinion No. 30, Reporting the Results of
OperationsReporting the Effects of Disposal of a Segment
of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions. SFAS No. 144
provides updated guidance concerning the recognition and
measurement of an impairment loss for certain types of
long-lived assets, and requires that long-lived assets to be
disposed of by sale be measured at the lower of the carrying
amount or fair value less cost to sell, no longer be depreciated
and be reported separately in the asset and liabilities sections
of the consolidated balance sheet. SFAS No. 144 also
expands the reporting of discontinued operations to include
components of an entity that have been or will be disposed of.
The scope of SFAS No. 144 excludes goodwill and other
intangibles that are accounted for in accordance with SFAS
No. 142. The adoption of SFAS No. 144 did not have a
material impact on RJRs consolidated results of
operations, financial position or cash flows.

Prior to the adoption of SFAS No. 144, RJR
accounted for long-lived assets in accordance with SFAS
No. 121, Accounting for Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of.

Merchandising Fixtures

Merchandising fixtures consist of permanent racks
placed in retail store locations to promote and store
cigarettes. Merchandising fixtures are recorded at cost and for
those acquired prior to October 1, 2002, to the extent that
they will not be replaced as part of RJR Tobaccos
accelerated replacement program discussed below, are amortized
over five years. Beginning October 1, 2002, all
merchandising fixture additions are amortized over three years.
Merchandising fixtures are classified as other assets in the
accompanying balance sheets.

In response to changes in industry retail
displays, RJR Tobacco is replacing significant portions of
its merchandising fixtures on an accelerated basis, beginning in
the fourth quarter of 2002 through the end of 2003. As a result,
accelerated amortization of $43 million, or $27 million after
tax, was recorded during the fourth quarter of 2002.
Additionally, the service life of merchandising fixture
additions beginning in the fourth

65



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


quarter of 2002 and beyond was reduced from five
years to three years, reflecting usage of more technologically
dependent components that are subject to accelerated
obsolescence. Total amortization expense of fixtures during 2003
is expected to approximate that of 2002.

Goodwill and Intangibles

Intangibles include primarily goodwill and
trademarks. Trademarks are capitalized when acquired. For the
periods presented through December 31, 2001, these
intangibles have been amortized using the straight-line method,
principally over 40 years, and tested for impairment, by
comparison of their carrying value to estimated future
undiscounted cash flows expected to be generated by the asset,
when events and circumstances indicate that the asset might be
impaired.

On January 1, 2002, RJR adopted SFAS
No. 141, Business Combinations, and SFAS
No. 142, Goodwill and Other Intangible Assets.
As a result, trademarks and goodwill are no longer amortized but
rather are tested annually for impairment or more frequently if
events and circumstances indicate that the asset might be
impaired. An impairment loss is recognized to the extent that
the carrying amount exceeds the assets fair value.

The following table presents net income and
earnings per share as if the provisions of SFAS No. 142 had
been applied as of January 1, 2000:

|                                          |                                    |              |      |              |  |   |       |      | 
|----------------------------------------- | ---------------------------------- | ------------ | ---- | ------------ |  | - | ----- | ---- | 
|                                          |                                    | Year Ended   |      | Year Ended  
|                                          |                                    | December 31, |      | December 31,
|                                          |                                    | 2001         |      | 2000        
|                                          |                                    |              |      |             
|Reported income before extraordinary item |                                    | $            | 435  |              |  | $ | 352   |     
|Add back: goodwill amortization           |                                    |              | 260  |              |  |   | 260   |     
|                                          | trademark amortization, net of tax |              |      | 62           |  |   |       | 64   | 
|                                          |                                    |              |      |              |  |   |       |     
|Adjusted income before extraordinary item |                                    | $            | 757  |              |  | $ | 676   |     
|                                          |                                    |              |      |              |  |   |       |     
|Adjusted net income                       |                                    | $            | 757  |              |  | $ | 2,151 |     
|                                          |                                    |              |      |              |  |   |       |     
|Basic income per share:                   |                                    |              |      |              |  |   |       |     
|Reported income before extraordinary item |                                    | $            | 4.48 |              |  | $ | 3.48  |     
|Add back: goodwill amortization           |                                    |              | 2.68 |              |  |   | 2.57  |     
|                                          | trademark amortization, net of tax |              |      | 0.64         |  |   |       | 0.63 | 
|                                          |                                    |              |      |              |  |   |       |     
|Adjusted income before extraordinary item |                                    | $            | 7.80 |              |  | $ | 6.68  |     
|                                          |                                    |              |      |              |  |   |       |     
|Adjusted net income                       |                                    | $            | 7.80 |              |  | $ | 21.24 |     
|                                          |                                    |              |      |              |  |   |       |     
|Diluted income per share:                 |                                    |              |      |              |  |   |       |     
|Reported income before extraordinary item |                                    | $            | 4.39 |              |  | $ | 3.46  |     
|Add back: goodwill amortization           |                                    |              | 2.63 |              |  |   | 2.55  |     
|                                          | trademark amortization, net of tax |              |      | 0.63         |  |   |       | 0.63 | 
|                                          |                                    |              |      |              |  |   |       |     
|Adjusted income before extraordinary item |                                    | $            | 7.65 |              |  | $ | 6.64  |     
|                                          |                                    |              |      |              |  |   |       |     
|Adjusted net income                       |                                    | $            | 7.65 |              |  | $ | 21.12 |     
|                                          |                                    |              |      |              |  |   |       |     

For the initial application of SFAS No. 142,
an independent appraisal firm was engaged to value RJRs
goodwill and trademarks as of January 1, 2002. RJRs
goodwill as of January 1, 2002 was attributable to one
reporting unit, RJR Tobacco, which comprises substantially all
of RJRs consolidated results of operations and financial
condition.

No goodwill impairment was indicated, since the
fair value of RJR was determined to be greater than its carrying
value using several valuation techniques, including discounted
cash flow analysis.

66



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


As of November 30, 2002, RJR Tobaccos
and Santa Fes fair value determination resulted in an
amount that substantially exceeded the carrying value,
indicating there was no goodwill impairment at December 31,
2002.

The changes in the carrying amount of goodwill
during the year ended December 31, 2002 were:

|                                |  |         |       |          |  |              |     |  |  |   |       | 
|------------------------------- |  | ------- | ----- | -------- |  | ------------ | --- |  |  | - | ----- | 
|                                |  | RJR     |       |          |  |             
|                                |  | Tobacco |       | Santa Fe |  | Consolidated
|                                |  |         |       |          |  |             
|Balance as of January 1, 2002.  |  | $       | 6,875 |          |  | $            |    |  |  | $ | 6,875 | 
|Goodwill acquired               |  |         |      |          |  |              | 215 |  |  |   | 215   | 
|                                |  |         |       |          |  |              |     |  |  |   |       | 
|Balance as of December 31, 2002 |  | $       | 6,875 |          |  | $            | 215 |  |  | $ | 7,090 | 
|                                |  |         |       |          |  |              |     |  |  |   |       | 

The fair values of the trademarks were determined
using an income approach, discounted at an appropriate
risk-adjusted rate, which yielded results consistent with
available market-approach data. The fair values of WINSTON,
VANTAGE, SALEM, NOW and MORE were less than their carrying
values. Accordingly, a cumulative effect of an accounting change
of $830 million, or $502 million after tax, was recorded during
the quarter ended March 31, 2002. For information related
to additional trademark impairment charges see note 4 to
the consolidated financial statements.

The changes in the carrying amount of trademarks
during the year ended December 31, 2002 were:

|                                        |  |         |       |          |  |              |     |  |  |   |       |  
|--------------------------------------- |  | ------- | ----- | -------- |  | ------------ | --- |  |  | - | ----- | -
|                                        |  | RJR     |       |          |  |             
|                                        |  | Tobacco |       | Santa Fe |  | Consolidated
|                                        |  |         |       |          |  |             
|Balance as of January 1, 2002           |  | $       | 2,773 |          |  | $            |    |  |  | $ | 2,773 |  
|Trademarks acquired                     |  |         |      |          |  |              | 155 |  |  |   | 155   |  
|Impairment due to accounting change     |  |         | (830  | )        |  |              |    |  |  |   | (830  | )
|Impairment included in operating income |  |         | (13   | )        |  |              |    |  |  |   | (13   | )
|                                        |  |         |       |          |  |              |     |  |  |   |       |  
|Balance as of December 31, 2002.        |  | $       | 1,930 |          |  | $            | 155 |  |  | $ | 2,085 |  
|                                        |  |         |       |          |  |              |     |  |  |   |       |  

Accounting for Derivative Instruments and
Hedging Activities

Effective January 1, 2001, RJR adopted SFAS
No. 133, Accounting for Derivative Instruments and
Hedging Activities, and its corresponding amendments under
SFAS No. 138. There was no cumulative effect adjustment of
adopting this accounting standard. SFAS No. 133 requires
RJR to measure every derivative instrument, including certain
derivative instruments embedded in other contracts, at fair
value and record them in the balance sheet as either an asset or
liability. Changes in fair value of derivatives are recorded
currently in earnings unless special hedge accounting criteria
are met. For derivatives designated as fair value hedges, the
changes in fair value of both the derivative instrument and the
hedged item are recorded in earnings. For derivatives designated
as cash flow hedges, the effective portions of changes in the
fair value of the derivative are reported in other comprehensive
income. The ineffective portions of hedges are recognized in
earnings in the current period.

RJR formally assesses, both at inception of the
hedge and on an ongoing basis, whether each derivative is highly
effective in offsetting changes in fair values or cash flows of
the hedged item. If it is determined that a derivative is not
highly effective as a hedge or if a derivative ceases to be a
highly effective hedge, RJR will discontinue hedge accounting
prospectively.

Software Costs

In accordance with Statement of Position
No. 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, certain
computer software and software development costs incurred in
connection with developing or obtaining computer software for
internal use that has a useful life of greater than one year are
capitalized. These costs are amortized over five years or less.
During 2002 and 2001, costs of $20 million and $12 million,
respectively, were capitalized, and at December 31, 2002,
the unamortized

67



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


balance was $36 million. Related amortization
expense was $11 million, $8 million and $4 million for
the years ended December 31, 2002, 2001 and 2000,
respectively.

Revenue Recognition

Revenue from product sales is recognized when
persuasive evidence of an arrangement exists, delivery has
occurred, the sellers price to the buyer is fixed or
determinable, and collectibility is reasonably assured. For
RJRs operating subsidiaries, these criteria are met upon
shipment, when title and risk of loss pass to the customer.
Shipping and handling costs are classified as cost of products
sold. Certain sales incentives, including coupons, buydowns and
slotting allowances, are classified as reductions of net sales
in accordance with Emerging Issues Task Force Issue
No. 01-9.

Effective January 1, 2002, EITF
No. 00-25, Vendor Income Statement Characterization
of Consideration Paid to a Reseller of the Vendors
Products, requires that consideration paid to a
distributor or retailer to promote the vendors products,
such as slotting fees or buydowns, generally be characterized as
a reduction of revenue when recognized in the vendors
income statement. EITF No. 01-9, Accounting for
Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendors Products), became effective
in November 2001, codifying and reconciling certain issues in
EITF No. 00-25. As of January 1, 2002, the operating
subsidiaries have characterized the applicable costs as
reductions of net sales rather than as selling, general and
administrative expenses. For the years ended December 31,
2001 and 2000, $2.3 billion and $2.0 billion, respectively, were
reclassified from selling, general and administrative expenses
to a reduction of net sales. The adoption of EITF
No. 00-25, as codified by EITF No. 01-9, did not
impact RJRs consolidated financial position, operating
income or net income.

Effective January 1, 2001, RJR and its
subsidiaries adopted the EITF No. 00-14, Accounting for
Certain Sales Incentives, which addresses the recognition,
measurement and income statement classification for certain
sales incentives, including rebates, coupons and free products
or services. EITF No. 01-9, Accounting for
Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendors Products), became effective
in November 2001, codifying and reconciling certain issues in
EITF No. 00-14. EITF No. 00-14 requires that in the
accompanying consolidated income statements, certain costs that
historically were included in selling, general and
administrative expenses now be classified in cost of products
sold or as reductions of net sales. With respect to estimated
amounts of redemptions or free products that will be claimed by
customers, costs are recognized at the latter of the date at
which the related revenue is recognized or the date at which the
sales incentive is offered. For the year ended December 31,
2000, $220 million was reclassified from selling, general
and administrative expense, with an increase to cost of products
sold of $111 million and a reduction to net sales of $109
million. The adoption of EITF No. 00-14 did not impact
RJRs consolidated annual net income or cumulative earnings.

Advertising and Research and
Development

Advertising costs, which are expensed as
incurred, were $55 million, $73 million and $137 million in
the years ended December 31, 2002, 2001 and 2000,
respectively. Research and development costs, which are expensed
as incurred, were $63 million, $64 million and $58 million in
the years ended December 31, 2002, 2001 and 2000,
respectively.

Income Taxes

Income taxes are accounted for under the asset
and liability method. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases
and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period

68



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


that includes the enactment date. Income taxes
for RJR, RJR Tobacco and RJR Acquisition Corp. are calculated on
a separate return basis.

Stock-Based Compensation

Compensation costs related to employee stock
plans are recognized utilizing the intrinsic value-based method
prescribed by APB No. 25, Accounting for Stock Issued
to Employees, and related Interpretations. RJR has adopted
the disclosure requirements of SFAS No. 123,
Accounting for Stock-Based Compensation, as amended
by SFAS No. 148. Accordingly, no compensation cost is
recorded for stock options, since all options granted had an
exercise price equal to the market value of the underlying
common stock on the date of the grant. The value of restricted
stock is charged to stockholders equity as unearned
compensation and is amortized over the vesting period.

At December 31, 2002, RJR had stock-based
employee compensation plans, which are described more fully in
note 17 to the consolidated financial statements.

The following table illustrates the effect on net
income and earnings per share if RJR had applied the fair value
recognition provisions of SFAS No. 123 for the years ended
December 31:

|                               |                                                                                                                                     |      |     |       |   |      |     |      |  |   |       |       | 
|------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------- | ---- | --- | ----- | - | ---- | --- | ---- |  | - | ----- | ----- | 
|                               |                                                                                                                                     | 2002 |     | 2001  |   | 2000
|                               |                                                                                                                                     |      |     |       |   |     
|Net income (loss), as reported |                                                                                                                                     | $    | (44 | )     |   | $    | 435 |      |  | $ | 1,827 |      
|                               | Add: Total stock-based employee compensation
    expense included in net income, net of tax                                         |      |     |      |   |      |     | 11   |  |   |       | 8     | 
|                               | Deduct: Total stock-based employee compensation
    expense determined under fair value based method for all awards,
    net of tax |      |     | 8     |   |      |     | 10   |  |   |       | 8     | 
|                               |                                                                                                                                     |      |     |       |   |      |     |      |  |   |       |      
|Pro forma net income (loss)    |                                                                                                                                     | $    | (52 | )     |   | $    | 436 |      |  | $ | 1,827 |      
|                               |                                                                                                                                     |      |     |       |   |      |     |      |  |   |       |      
|Earnings (loss) per share:     |                                                                                                                                     |      |     |       |   |      |     |      |  |   |       |      
|                               | Basic  as reported                                                                                                                 |      | $   | (0.50 | ) |      | $   | 4.48 |  |   | $     | 18.04 | 
|                               | Basic  pro forma                                                                                                                   |      |     | (0.59 | ) |      |     | 4.49 |  |   |       | 18.04 | 
|                               | Diluted  as reported                                                                                                               |      |     | (0.49 | ) |      |     | 4.39 |  |   |       | 17.94 | 
|                               | Diluted  pro forma                                                                                                                 |      |     | (0.58 | ) |      |     | 4.40 |  |   |       | 17.94 | 

Prior periods have been adjusted to reflect the
incremental impact related to variable restricted stock grants.

Pension and Postretirement

Gains or losses are annual changes in the amount
of either the benefit obligation or the market-related value of
plan assets resulting from experience different from that
assumed or from changes in assumptions. The minimum amortization
of unrecognized gains or losses, as described in SFAS
No. 87, was included in pension expense. Prior service
costs, which are changes in benefit obligations due to plan
amendments, are amortized on a straight-line basis over the
average remaining service period for active employees. The
market-related value of plan assets recognizes changes in fair
value in a systematic and rational manner over five years. For
further information, see note 18 to the consolidated financial
statements.

Tobacco-Related Litigation
Contingencies

In accordance with SFAS No. 5,
Accounting for Contingencies, RJR and RJR Tobacco
will record any loss related to tobacco litigation at such time
an unfavorable outcome becomes probable and the amount can be
reasonably estimated. When the reasonable estimate is a range,
the recorded loss will be the best estimate within the range. If
no amount in the range is a better estimate than any other
amount, the minimum amount of the range will be recorded. RJR
and RJR Tobacco disclose information under note 14,

69



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Commitments and Contingencies to the
consolidated financial statements, concerning tobacco-related
litigation for which an unfavorable outcome is other than remote.

Recently Adopted Accounting
Pronouncements

In November 2002, the FASB issued Interpretation
No. 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN No. 45 requires the
disclosure of certain guarantees existing at December 31,
2002. In addition, FIN No. 45 requires the recognition of a
liability for the fair value of the obligation of qualifying
guarantee activities that are initiated or modified after
December 31, 2002. Accordingly, RJR will apply the
recognition provisions of FIN No. 45 prospectively to
guarantee activities initiated after December 31, 2002. See
note 14 to the consolidated financial statements for
further information regarding guarantees, including indemnities
related to the 1999 sale of the international business to Japan
Tobacco Inc., Nabisco Group Holdings Corp.s sale of
Nabisco Holdings Corp. to Philip Morris Companies, Inc.,
environmental matters and intercompany debt and related
instruments. RJR is not able to estimate the maximum potential
amount of future payments, if any, related to these guarantees.
RJR has recorded liabilities totaling approximately
$130 million at December 31, 2002 relating to these
guarantees.

Recently Issued Accounting
Pronouncements

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, an amendment
of SFAS No. 123. SFAS No. 148 amends SFAS
No. 123, to provide alternative methods of transition for a
voluntary change to that statements fair value method of
accounting for stock-based employee compensation. SFAS
No. 148 also amends the disclosure provisions of SFAS
No. 123 and APB No. 28, Interim Financial
Reporting, to require disclosure in the summary of
significant accounting policies of the effects of an
entitys accounting policy with respect to stock-based
employee compensation on reported net income and earnings per
share in annual and interim financial statements. The transition
and disclosure provisions of this statement are effective for
financial statements for fiscal years ending after
December 15, 2002.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities. SFAS No. 146 nullifies EITF
No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring).
SFAS No. 146 requires that a liability for costs associated
with an exit or disposal activity be recognized when they are
incurred. Under EITF No. 94-3, a liability for an exit cost
was recognized at the date of an entitys commitment to an
exit plan. The provisions of SFAS No. 146 are effective for
exit or disposal activities that are initiated after
December 31, 2002. Under SFAS No. 146, an entity may
not restate its previously issued financial statements. RJR does
not expect the adoption of SFAS No. 146 to have a material
impact on its financial position, results of operations or cash
flows.

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest
Entities. This interpretation clarifies the application of
Accounting Research Bulletin No. 51, Consolidated
Financial Statements, to certain entities in which equity
investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional
subordinated financial support from other parties. FIN
No. 46 is effective February 1, 2003 for variable interest
entities created after January 31, 2003, and July 31, 2003
for variable interest entities created prior to February 1,
2003. RJR does not expect the adoption of FIN No. 46 to
have a material impact on its financial position, results of
operations or cash flows.

Note 2  Acquisitions and Joint
Venture

On July 16, 2002, RJR, through its wholly
owned subsidiary, R. J. Reynolds C.V., acquired a 50% interest
in R.J. Reynolds-Gallaher International Sarl, a joint venture
created with Gallaher Group Plc., to

70



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


manufacture and market a limited portfolio of
American-blend cigarette brands. The joint venture,
headquartered in Switzerland, will initially market its products
in France, Spain, the Canary Islands and Italy. RJRs
financial contribution over the next five years is expected to
be $75 million to $100 million. As a part of this transaction,
RJR Tobacco is licensing REYNOLDS, a new American-blend brand in
a unique Slide Box pack, to the joint venture. This investment
is accounted for using the equity method.

On January 16, 2002, RJR acquired, with
cash, 100% of the voting stock of privately held Santa Fe.
Fiesta Acquisition Corp., a wholly owned subsidiary of RJR,
merged with and into Santa Fe, and Santa Fe, being the surviving
corporation, became a wholly owned subsidiary of RJR. The
acquisition was accounted for as a purchase, with its cost of
$354 million allocated on the basis of the estimated fair
market value of the assets acquired and liabilities assumed. The
results of operations of Santa Fe have been included in the
accompanying consolidated statements of income since
January 16, 2002. Although Santa Fe is an operating segment
of RJR, its financial condition and results of operations do not
meet the materiality criteria to be reportable. As a result,
information related to Santa Fe is not generally disclosed
separately in this document.

On December 11, 2000, RJR acquired its
former parent, Nabisco Group Holdings Corp. Pursuant to an
agreement and plan of merger dated June 25, 2000, as
amended, RJR Acquisition Corp. was merged into NGH, with NGH
being the surviving corporation. After the merger, NGH changed
its name to RJR Acquisition Corp. At the time of the
acquisition, NGH was a non-operating public shell company with
no material assets or liabilities other than $11.8 billion
in cash. RJR accounted for the acquisition as a purchase, and
accordingly, the cost of the acquisition was allocated on the
basis of the estimated fair market value of the assets acquired
and liabilities assumed. As consideration, RJR Acquisition Corp.
paid $30 for each outstanding share of NGH, or $9.8 billion
in the aggregate. The $1.5 billion net cash proceeds, after
costs related to the transaction, were recognized as an
extraordinary gain on acquisition in the fourth quarter of 2000.
Presentation of pro forma results of operations would not be
meaningful as NGH was a non-operating public shell company.

Note 3  Restructuring and Asset
Impairment Charges

In response to the competitive changes in the
tobacco industry during 2002, RJR implemented a restructuring
plan. RJR Tobacco incurred restructuring expenses and asset
impairment charges of $224 million, $135 million after
tax, in the fourth quarter 2002, related to the 2002
restructuring plan. The charge consists of employee severance
and related benefits, contract termination and other exit costs
and impairment charges related to certain non-tobacco businesses
that are held for sale. The employee severance and related
benefits charge associated with workforce reductions of
572 full-time employees, in operations support and
corporate functions, is $102 million. This reduction is
expected to be mostly completed in the first half of 2003.

The non-tobacco businesses included in RJR
Tobaccos restructuring plan were remeasured at the lower
of their carrying value or fair value less cost to sell, and
classified as assets held for sale and liabilities related to
assets held for sale in the consolidated balance sheet at
December 31, 2002, in accordance with SFAS No. 144.
This remeasurement resulted in a $115 million charge in the
fourth quarter. The carrying amounts of the major classes of
assets and liabilities included as part of the disposal group
include $15 million of accounts receivable,
$52 million of inventories, $11 million of property,
plant and equipment and $8 million of accounts payable and
accrued liabilities. RJR Tobacco expects to complete the sale of
these businesses within one year.

For assets held for sale in which a continuing
business relationship is intended, SFAS No. 144 requires
that their results of operations be reported in continuing
operations.

Contract termination and other exit costs
consisted of $7 million related to contract and lease
termination payments, and exit costs related to the non-tobacco
businesses held for sale.

The cash portion of the restructuring charge
primarily relates to employee severance costs and is expected to
be $68 million. No significant amount was expended as of
December 31, 2002.

71



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 4  Trademark Impairment
Charges

In the fourth quarter of 2002, impairment
occurred on two of RJR Tobaccos non-key brands, VANTAGE
and CENTURY. The annual valuation in accordance with SFAS
No. 142, indicated that the carrying values of these brands
were in excess of their fair values. Accordingly, RJR Tobacco
recorded an impairment charge of $13 million, $8 million after
tax, based on the excess of the brands carrying values
over their fair values, determined using the present value of
estimated future cash flows assuming a discount rate of 10.5%.
This impairment charge is reflected as a decrease in the
carrying value of the trademarks in the consolidated balance
sheets, as a trademark impairment charge in the 2002
consolidated income statement and had no impact on cash flows.

In the fourth quarter of 2000, impairment
occurred on two of RJR Tobaccos non-key brands, MAGNA and
CENTURY. This impairment charge was the result of a decision, in
the fourth quarter of 2000, to reduce market support of these
brands. The related impairment testing indicated that the
carrying amount of these brands would not be recoverable through
future undiscounted cash flows. Accordingly, RJR Tobacco
recorded an impairment charge of $89 million, $54 million after
tax, based on the excess of the brands carrying values
over their fair values, determined using the present value of
estimated future cash flows assuming a discount rate of 12.0%.
This impairment charge is reflected as an asset impairment
charge in the 2000 consolidated income statement and had no
impact on cash flows. As a result of this charge, amortization
expense related to trademarks was $4 million lower in 2001
than in 2000.

Note 5  Tobacco Settlement and
Related Expenses

During 1998, RJR Tobacco recorded pre-tax charges
totaling $1.442 billion for the following tobacco settlement and
related expenses: Master Settlement Agreement, $620 million;
Minnesota Settlement Agreement, $312 million; Most Favored
Nation adjustment of previously settled states, $145
million; rationalization of manufacturing operations, $214
million; and employee severance and related benefits,
$151 million. The employee severance and related benefits
portion of this charge was for workforce reductions totaling
approximately 1,300 employees in response to the changing
business conditions expected to result from the MSA signed in
November 1998. At December 31, 1998, $1.3 billion had been
utilized. Since December 31, 1998, the remaining liability
of $97 million for employee severance and related benefits was
utilized through cash expenditures of $76 million and the
reversal of $21 million, due to a less-than-expected
workforce reduction.

For more information about the MSA and other
state settlement agreements, see note 14 to the
consolidated financial statements.

Note 6  Discontinued
Operations

Discontinued operations in 2002 included a $40
million after-tax reversal of an indemnification accrual, and in
2001, a $9 million after-tax, purchase-price adjustment. Both
transactions related to the 1999 sale of the international
tobacco business to Japan Tobacco Inc. Including these
adjustments, the net after-tax gain on the sale of the
international tobacco business was $2.4 billion.

72



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 7  Income Per Share

The components of the calculation of income per
share were:

|                                                 |                                      |                                  |        |      |     |      |        |   |       |   |         |  |     | 
|------------------------------------------------ | ------------------------------------ | -------------------------------- | ------ | ---- | --- | ---- | ------ | - | ----- | - | ------- |  | --- | 
|                                                 |                                      |                                 
|                                                 |                                      | For the Years Ended December 31,
|                                                 |                                      |                                 
|                                                 |                                      | 2002                             |        | 2001 |     | 2000
|                                                 |                                      |                                  |        |      |     |     
|Income from continuing operations                |                                      | $                                | 418    |      |     | $    | 444    |   |       | $ | 352     | 
|Income (loss) from discontinued operations       |                                      |                                  | 40     |      |     |      | (9     | ) |       |   |        | 
|Extraordinary item  gain (loss)                 |                                      |                                  |       |      |     |      |       |   |       |   | 1,475   | 
|Cumulative effect of accounting change           |                                      |                                  | (502   | )    |     |      |       |   |       |   |        | 
|                                                 |                                      |                                  |        |      |     |      |        |   |       |   |         | 
|Net income (loss)                                |                                      | $                                | (44    | )    |     | $    | 435    |   |       | $ | 1,827   | 
|                                                 |                                      |                                  |        |      |     |      |        |   |       |   |         | 
|Basic weighted average shares, in thousands(1)   |                                      |                                  | 88,733 |      |     |      | 97,043 |   |       |   | 101,264 | 
|                                                 | Effect of dilutive potential shares: |                                  |        |      |     |      |        |   |       |   |         |  |    
|                                                 |                                      | Options                          |        |      | 897 |      |        |   | 1,472 |   |         |  | 371 | 
|                                                 |                                      | Restricted stock                 |        |      | 545 |      |        |   | 471   |   |         |  | 222 | 
|                                                 |                                      |                                  |        |      |     |      |        |   |       |   |         | 
|Diluted weighted average shares, in thousands(2) |                                      |                                  | 90,175 |      |     |      | 98,986 |   |       |   | 101,857 | 
|                                                 |                                      |                                  |        |      |     |      |        |   |       |   |         | 






|    |                                                                                                                                                                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Outstanding shares of contingently issuable
    restricted stock of 1.6 million, 1.7 million and
    1.6 million were excluded from the basic share calculation
    for the years ended December 31, 2002, 2001 and 2000,
    respectively, as the related vesting provisions had not been met.
|(2) | During 2002, 300,000 common stock equivalents
    were excluded from diluted per share amounts, as they would have
    been anti-dilutive. No anti-dilution existed during 2001 or 2000.                                                                                                       

Note 8  Short-Term
Investments

Short-term investments classified as
available-for-sale as of December 31 were:

|                                               |  |      |     |      |  |   |     | 
|---------------------------------------------- |  | ---- | --- | ---- |  | - | --- | 
|                                               |  | 2002 |     | 2001
|                                               |  |      |     |     
|Commercial paper and asset-backed securities   |  | $    | 263 |      |  | $ |    | 
|Money market funds and certificates of deposit |  |      | 151 |      |  |   |    | 
|Federal agency securities                      |  |      | 126 |      |  |   | 61  | 
|Master notes                                   |  |      | 25  |      |  |   |    | 
|U.S. government treasury bills                 |  |      | 6   |      |  |   | 146 | 
|Other investments                              |  |      | 24  |      |  |   |    | 
|                                               |  |      |     |      |  |   |     | 
|                                               |  | $    | 595 |      |  | $ | 207 | 
|                                               |  |      |     |      |  |   |     | 

The contractual maturities of these securities
averaged less than one year. Realized and unrealized gains and
losses of available-for-sale securities for the years ended
December 31, 2002 and 2001 were not significant, and
accordingly, the amortized cost of these securities approximated
fair value.

73



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 9  Inventories

The major components of inventories at
December 31 were:

|                    |  |      |     |      |  |   |     | 
|------------------- |  | ---- | --- | ---- |  | - | --- | 
|                    |  | 2002 |     | 2001
|                    |  |      |     |     
|Leaf tobacco        |  | $    | 599 |      |  | $ | 550 | 
|Raw materials       |  |      | 18  |      |  |   | 25  | 
|Work in process     |  |      | 35  |      |  |   | 49  | 
|Finished products   |  |      | 110 |      |  |   | 118 | 
|Other               |  |      | 26  |      |  |   | 26  | 
|                    |  |      |     |      |  |   |     | 
|Total               |  |      | 788 |      |  |   | 768 | 
|Less LIFO allowance |  |      | 26  |      |  |   | 38  | 
|                    |  |      |     |      |  |   |     | 
|                    |  | $    | 762 |      |  | $ | 730 | 
|                    |  |      |     |      |  |   |     | 

Inventories valued under the LIFO method were
approximately $736 million and $682 million at December 31,
2002 and 2001, respectively. The LIFO allowance reflects the
excess of the current cost of LIFO inventories at
December 31, 2002 and 2001 over the amount at which these
inventories were carried on the consolidated balance sheets.
During 2002, 2001 and 2000, there was no impact on net income
from LIFO inventory liquidations.

Note 10  Short-Term Borrowings and
Borrowing Arrangements

RJRs revolving credit facility with a
syndicate of banks was amended and restated on May 10,
2002. Under the amendment and restatement, the committed amount
will remain at $622 million until May 2003, at which time
the committed amount will be reduced to $531 million through
November 2004. RJR can use the full facility to obtain loans or
letters of credit, at its option. RJR Tobacco and RJR
Acquisition Corp. have guaranteed RJRs obligations under
the revolving credit facility. If RJRs guaranteed
unsecured notes are rated below BBB- by Standard &
Poors or Baa3 by Moodys, RJRs other material
subsidiaries will be required to guarantee the facility. If
RJRs guaranteed unsecured notes, including the notes
issued in May 2002, are rated below BBB- by Standard &
Poors and below Baa3 by Moodys, or two levels below
these thresholds for either of these rating agencies, RJR and
the guarantors will be required to pledge all of their assets to
secure their obligations under RJRs revolving credit
facility. RJR is not required to maintain compensating balances;
however, RJR pays commitment fees of 1% per annum of the
committed amount. The credit facility also limits RJRs
ability to pay dividends, repurchase stock, incur indebtedness,
engage in transactions with affiliates, create liens, acquire,
sell or dispose of specific assets and engage in specified
mergers or consolidations. Borrowings under the revolving credit
facility bear interest at rates that vary with the prime rate or
LIBOR. At December 31, 2002, RJR had $17 million in letters
of credit outstanding under the facility. No borrowings were
outstanding, and the remaining $605 million of the facility was
available for borrowing.

Since the spin-off in 1999, RJRs unsecured,
unsubordinated debt notes have maintained the ratings of BBB-by
Standard & Poors and Baa2 by Moodys. In December
2002, Moodys revised its outlook to negative but
maintained its rating, reflecting its concern over the impact of
industry trends including heavy promotional activity in the
premium price-tier and the growth of the deep-discount
price-tier despite the reduction in payments under the MSA.

RJR has a $30 million uncommitted, unsecured line
of credit with one bank. No borrowings were outstanding on this
line of credit at December 31, 2002.

74



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 11  Accrued Liabilities and
Other

Accrued liabilities at December 31 included:

|                              |  |      |       |      |  |   |       | 
|----------------------------- |  | ---- | ----- | ---- |  | - | ----- | 
|                              |  | 2002 |       | 2001
|                              |  |      |       |     
|Payroll and employee benefits |  | $    | 310   |      |  | $ | 398   | 
|Marketing and advertising     |  |      | 345   |      |  |   | 378   | 
|Accrued interest              |  |      | 28    |      |  |   | 20    | 
|Other                         |  |      | 392   |      |  |   | 359   | 
|                              |  |      |       |      |  |   |       | 
|                              |  | $    | 1,075 |      |  | $ | 1,155 | 
|                              |  |      |       |      |  |   |       | 

Note 12  Income Taxes

The components of the provision for income taxes
from continuing operations were:

|                           |                 |                     |     |      |   |      |     |     |   |   |     |     |  
|-------------------------- | --------------- | ------------------- | --- | ---- | - | ---- | --- | --- | - | - | --- | --- | -
|                           |                 |                    
|                           |                 | For the Years Ended
|                           |                 | December 31,       
|                           |                 |                    
|                           |                 | 2002                |     | 2001 |   | 2000
|                           |                 |                     |     |      |   |     
|Current:                   |                 |                     |     |      |   |      |     |     |   |   |     |    
|                           | Federal         |                     | $   | 202  |   |      | $   | 426 |   |   | $   | 368 |  
|                           | State and other |                     |     | 45   |   |      |     | 65  |   |   |     | 59  |  
|                           |                 |                     |     |      |   |      |     |     |   |   |     |    
|                           |                 |                     | 247 |      |   |      | 491 |     |   |   | 427 |    
|                           |                 |                     |     |      |   |      |     |     |   |   |     |    
|Deferred:                  |                 |                     |     |      |   |      |     |     |   |   |     |    
|                           | Federal         |                     |     | 30   |   |      |     | (36 | ) |   |     | (30 | )
|                           | State and other |                     |     | (12  | ) |      |     | (7  | ) |   |     | (1  | )
|                           |                 |                     |     |      |   |      |     |     |   |   |     |    
|                           |                 |                     | 18  |      |   |      | (43 | )   |   |   | (31 | )  
|                           |                 |                     |     |      |   |      |     |     |   |   |     |    
|Provision for income taxes |                 | $                   | 265 |      |   | $    | 448 |     |   | $ | 396 |    
|                           |                 |                     |     |      |   |      |     |     |   |   |     |    

The current deferred income tax asset shown on
the consolidated balance sheets at December 31 included:

|                     |                                                                       |      |     |      |   |   |     |      |  
|-------------------- | --------------------------------------------------------------------- | ---- | --- | ---- | - | - | --- | ---- | -
|                     |                                                                       | 2002 |     | 2001
|                     |                                                                       |      |     |     
|Deferred tax assets: |                                                                       |      |     |      |   |   |     |     
|                     | LIFO inventories                                                      |      | $   | (237 | ) |   | $   | (149 | )
|                     | Pension and other postretirement liabilities                          |      |     | 71   |   |   |     | 71   |  
|                     | Tobacco settlement related accruals and other
    accrued liabilities |      |     | 754  |   |   |     | 688  |  
|                     |                                                                       |      |     |      |   |   |     |     
|                     |                                                                       | $    | 588 |      |   | $ | 610 |     
|                     |                                                                       |      |     |      |   |   |     |     

75



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The non-current deferred income tax liability
shown on the consolidated balance sheets at December 31
included:

|                          |                                                                       |      |       |      |   |   |       |       |  
|------------------------- | --------------------------------------------------------------------- | ---- | ----- | ---- | - | - | ----- | ----- | -
|                          |                                                                       | 2002 |       | 2001
|                          |                                                                       |      |       |     
|Deferred tax assets:      |                                                                       |      |       |      |   |   |       |      
|                          | Pension and other postretirement liabilities                          |      | $     | (413 | ) |   | $     | (186  | )
|                          | Tobacco settlement related accruals and other
    accrued liabilities |      |       | (92  | ) |   |       | (40   | )
|                          |                                                                       |      |       |      |   |   |       |      
|                          |                                                                       |      | (505  | )    |   |   | (226  | )    
|                          |                                                                       |      |       |      |   |   |       |      
|Deferred tax liabilities: |                                                                       |      |       |      |   |   |       |      
|                          | Property and equipment                                                |      |       | 284  |   |   |       | 305   |  
|                          | Trademarks                                                            |      |       | 823  |   |   |       | 1,099 |  
|                          | Other                                                                 |      |       | 634  |   |   |       | 620   |  
|                          |                                                                       |      |       |      |   |   |       |      
|                          |                                                                       |      | 1,741 |      |   |   | 2,024 |      
|                          |                                                                       |      |       |      |   |   |       |      
|                          |                                                                       | $    | 1,236 |      |   | $ | 1,798 |      
|                          |                                                                       |      |       |      |   |   |       |      

The total deferred tax assets were $1,330 million
and $985 million as of December 31, 2002 and 2001,
respectively. The total deferred tax liabilities were $1,978
million and $2,173 million as of December 31, 2002 and
2001, respectively. There was no valuation allowance for
deferred taxes as of December 31, 2002 and 2001.

The differences between the provision for income
taxes from continuing operations and income taxes computed at
statutory U.S. federal income tax rates were:

|                                                                     |  |                     |       |      |  |      |       |  |  |   |       | 
|-------------------------------------------------------------------- |  | ------------------- | ----- | ---- |  | ---- | ----- |  |  | - | ----- | 
|                                                                     |  |                    
|                                                                     |  | For the Years Ended
|                                                                     |  | December 31,       
|                                                                     |  |                    
|                                                                     |  | 2002                |       | 2001 |  | 2000
|                                                                     |  |                     |       |      |  |     
|Income taxes computed at statutory U.S. federal
    income tax rates |  | $                   | 239   |      |  | $    | 312   |  |  | $ | 262   | 
|State and local income taxes, net of federal tax
    benefits        |  |                     | 21    |      |  |      | 37    |  |  |   | 33    | 
|Goodwill amortization                                                |  |                     |      |      |  |      | 91    |  |  |   | 91    | 
|Other items, net                                                     |  |                     | 5     |      |  |      | 8     |  |  |   | 10    | 
|                                                                     |  |                     |       |      |  |      |       |  |  |   |       | 
|Provision for income taxes from continuing
    operations            |  | $                   | 265   |      |  | $    | 448   |  |  | $ | 396   | 
|                                                                     |  |                     |       |      |  |      |       |  |  |   |       | 
|Effective tax rate                                                   |  |                     | 38.8% |      |  |      | 50.2% |  |  |   | 52.9% | 
|                                                                     |  |                     |       |      |  |      |       |  |  |   |       | 

Note 13  Long-Term Debt

Long-term debt as of December 31 consisted
of:

|                                                              |  |      |       |      |  |   |       |  
|------------------------------------------------------------- |  | ---- | ----- | ---- |  | - | ----- | -
|                                                              |  | 2002 |       | 2001
|                                                              |  |      |       |     
|7.625%-9.25% unsecured notes, due 2003 to 2013                |  | $    | 288   |      |  | $ | 330   |  
|6.5%-7.875% guaranteed unsecured notes, due 2003
    to 2012. |  |      | 2,110 |      |  |   | 1,246 |  
|9.5% junior subordinated debentures, due 2047                 |  |      | 98    |      |  |   | 98    |  
|Current maturities of long-term debt                          |  |      | (741  | )    |  |   | (43   | )
|                                                              |  |      |       |      |  |   |       |  
|                                                              |  | $    | 1,755 |      |  | $ | 1,631 |  
|                                                              |  |      |       |      |  |   |       |  

76



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The maturities of long-term debt, net of discount
and excluding fair value adjustments of $118, are as follows:

|           |  |        |       | 
|---------- |  | ------ | ----- | 
|Year       |  | Amount
|           |  |       
|2004       |  | $      | 56    | 
|2005       |  |        | 50    | 
|2006       |  |        | 499   | 
|2007       |  |        | 328   | 
|Thereafter |  |        | 704   | 
|           |  |        |       | 
|           |  | $      | 1,637 | 
|           |  |        |       | 

In October 1999, RJR issued publicly registered
notes of $550 million in principal amount at 7.375% due in
May 2003, $500 million in principal amount at 7.75% due in
May 2006 and $200 million in principal amount at 7.875% due
in May 2009 in exchange for an aggregate $1.25 billion of
private placement debt securities.

RJR filed a shelf registration statement,
effective December 22, 1999, for the issuance of up to
$1.876 billion of debt securities, guaranteed by
RJR Tobacco. RJR filed a second shelf registration
statement, effective April 2001, superseding the initial
registration and adding RJR Acquisition Corp. as a
guarantor of these debt securities. Under this registration
statement, in May 2002, RJR completed the sale of
$300 million of 6.5% notes due in June 2007, and
$450 million of 7.25% notes due in June 2012. The proceeds
from the sale of these notes are intended to be used to repay
RJRs 7.375% notes due in May 2003, in the principal amount
of $550 million. The remainder of the proceeds is intended
to be used for the repayment of other public notes due through
2004.

The $2.0 billion guaranteed unsecured notes
described above are unsecured obligations and, unlike RJRs
other non-bank debt, are guaranteed by RJR Tobacco and
RJR Acquisition Corp. In addition, any other subsidiaries
of RJR that in the future guarantee the $622 million
revolving credit facility, as amended and restated, will also be
required to guarantee these notes. If RJR and the guarantors are
required to pledge their assets to secure their obligations
under the revolving credit facility, as amended and restated,
they also will be required to pledge certain of their assets to
secure these notes. Excluded from the pledge to secure these
notes are intellectual property, inventory, accounts receivable
and certain other assets. Generally, the terms of these notes
restrict the issuance of guarantees by subsidiaries, the pledge
of collateral, sale/leaseback transactions and the transfer of
all or substantially all of the assets of RJR and its
subsidiaries.

On December 11, 2000, related to the
acquisition of NGH, RJR acquired $98 million of 9.5% junior
subordinated debentures, due in 2047, with a mandatory
redemption date of September 30, 2003. Interest on these
debentures is paid quarterly in arrears. These debentures are
effectively defeased by an irrevocable trust, which is included
in other current assets in the accompanying consolidated balance
sheets as of December 31, 2002 and in other assets and
deferred charges as of December 31, 2001. The trust holds
certain U.S. government obligations maturing at such times and
in such amounts sufficient to pay interest and principal.

On December 1, 2002, RJR repaid
$43 million of public notes with a fixed interest rate of
8.625% on their due date. The estimated fair value of RJRs
long-term debt was $2.5 billion, with a weighted average
rate of 5.44%, including the effects of the interest rate swaps
as of December 31, 2002, and $1.8 billion, with an
effective average rate of 7.89%, as of December 31, 2001.
The fair values are based on available market quotes, discounted
cash flows and book values, as appropriate.

77



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 14  Commitments and
Contingencies

Litigation Affecting the Cigarette
Industry

Overview

Introduction.Various legal actions, proceedings and
claims, including litigation claiming that lung cancer and other
diseases, as well as addiction, have resulted from the use of,
or exposure to, RJRs operating subsidiaries
products, are pending or may be instituted against
RJR Tobacco or its affiliates, including RJR, or
indemnitees. During the fourth quarter of 2002, 67 new cases
were served against RJR Tobacco or its affiliates, including
RJR, or indemnitees, and 38 cases were dismissed or otherwise
resolved without trial in their favor. On December 31,
2002, there were 1,650 active cases pending, including
approximately 1,184 individual smoker cases pending in West
Virginia state court as a consolidated action, as compared with
1,639 on December 31, 2001, and 1,664 on December 31,
2000. As of February 4, 2003, 1,541 active tobacco-related
cases were pending against RJR Tobacco and/or its affiliates or
indemnitees: 1,530 in the United States; eight in Puerto Rico;
two in Israel; and one in Canada. The U.S. case number does not
include the 2,791 Broin IIcases, which involve
individual flight attendants alleging injuries as a result of
exposure to environmental tobacco smoke, referred to as ETS or
secondhand smoke, in aircraft cabins, pending as of
February 4, 2003, and discussed below.

The U.S. cases, exclusive of the Broin IIcases, are pending in 36 states and the District of
Columbia: 1,086 in West Virginia (nearly 100 cases were
dismissed in the West Virginia consolidated action between
December 31, 2002 and February 4, 2003); 98 in
Florida; 56 in California; 47 in New York; 41 in Mississippi; 27
in Nevada; 25 in Louisiana; 24 in Maryland; 15 in Alabama; 13 in
Iowa; 12 in Missouri; 8 in each of Illinois, Massachusetts and
New Jersey; 6 in each of the District of Columbia, Georgia and
Texas; 5 in each of Arizona and Tennessee; 4 in each of
Minnesota, Ohio and Pennsylvania; 3 in each of Connecticut and
New Hampshire; 2 in each of Kansas, South Carolina and South
Dakota; and 1 in each of Arkansas, Kentucky, Maine, Michigan,
North Carolina, North Dakota, New Mexico, Oregon, Utah and
Wisconsin. Of the 1,530 active U.S. cases, 138 are pending in
federal court, 1,390 in state court and 2 in tribal court.

The following table lists the categories of the
U.S. tobacco-related cases currently pending against
RJR Tobacco or its affiliates, including RJR, or
indemnitees; the number of cases relating to each case type
pending as of February 4, 2003; the changes in the number
of cases by case type since October 14, 2002, the cut-off date
used to calculate the number of cases pending against RJR
Tobacco or its affiliates or indemnitees in RJRs Quarterly
Report on Form 10-Q for the quarter ended
September 30, 2002; and a cross-reference to the discussion
of each case type.

|                                                           |  |             |       |             |  |           |           |  |  |  |    | 
|---------------------------------------------------------- |  | ----------- | ----- | ----------- |  | --------- | --------- |  |  |  | -- | 
|                                                           |  |             |       | Change in   |  |          
|                                                           |  | Number of   |       | Number of   |  |          
|                                                           |  | Cases as of |       | Cases since |  |          
|                                                           |  | February 4, |       | October 14, |  | Page     
|Case Type                                                  |  | 2003        |       | 2002        |  | Reference
|                                                           |  |             |       |             |  |          
|Individual Smoking and Health                              |  |             | 1,377 |             |  |           | -91       |  |  |  | 84 | 
|Flight Attendant-ETS (Broin II)                            |  |             | 2,791 |             |  |           | -10       |  |  |  | 85 | 
|Class Action                                               |  |             | 49    |             |  |           | +15       |  |  |  | 86 | 
|Governmental Health-Care Cost Recovery                     |  |             | 33    |             |  |           | +1        |  |  |  | 88 | 
|Other Health-Care Cost Recovery and Aggregated
    Claims  |  |             | 8     |             |  |           | -2        |  |  |  | 91 | 
|Master Settlement Agreement 
    Enforcement and Validity |  |             | 7     |             |  |           | -1        |  |  |  | 93 | 
|Asbestos Contribution                                      |  |             | 5     |             |  |           | -3        |  |  |  | 93 | 
|Antitrust                                                  |  |             | 39    |             |  |           | +2        |  |  |  | 93 | 
|Other Litigation                                           |  |             | 12    |             |  |           | No Change |  |  |  | 94 | 

In July 2000, a jury in the Florida state court
case Engle v. R.J. Reynolds Tobacco Co.rendered a
punitive damages verdict in favor of the Florida
class of plaintiffs of approximately $145 billion, with
approximately $36.3 billion being assigned to RJR Tobacco. RJR
Tobacco and other defendants have appealed this verdict. Oral
argument occurred before Floridas Third District Court of
Appeal on November 6,

78



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


2002. An opinion from this intermediate appellate
court is expected in 2003. RJR Tobacco believes it has numerous
bases for a successful appeal, although it cannot predict the
outcome of the appellate process. See
 Class-Action Suits below for a further
description of the Englecase.

In November 1998, the major U.S. cigarette
manufacturers, including RJR Tobacco, entered into the MSA with
46 U.S. states and certain U.S. territories and possessions.
These cigarette manufacturers previously settled four other
cases scheduled to come to trial, brought on behalf of
Mississippi, Florida, Texas and Minnesota, by separate
agreements with each state. The MSA and the other state
settlement agreements settled all health-care cost recovery
actions brought by, or on behalf of, the settling jurisdictions,
released the major U.S. cigarette manufacturers from various
additional present and potential future claims, imposed a stream
of future payment obligations on RJR Tobacco and the other major
U.S. cigarette manufacturers and placed significant restrictions
on their ability to market and sell cigarettes in the future.
The cash payments made by RJR Tobacco under the MSA and the
other state settlement agreements were $2.5 billion,
$2.4 billion and $2.2 billion in 2002, 2001 and 2000,
respectively. RJR Tobacco estimates these payments will be
$1.9 billion in 2003 and will exceed $2 billion per
year thereafter. However, these payments will be subject to
adjustments for, among other things, the volume of cigarettes
sold by RJR Tobacco, RJR Tobaccos market share and
inflation. See  Governmental Health-Care Cost
Recovery Cases  MSA and Other State Settlement
Agreements below for a detailed discussion of the MSA and
the other state settlement agreements, including RJR
Tobaccos monetary obligations under these agreements.

Accounting for Tobacco-Related Litigation
Contingencies.In accordance with
applicable accounting principles, RJR and RJR Tobacco will
record any loss related to tobacco litigation at such time as an
unfavorable outcome becomes probable and the amount can be
reasonably estimated. For the reasons set forth below,
RJRs management continues to conclude that the loss of any
particular smoking and health tobacco litigation claim against
RJR Tobacco or its affiliates, when viewed on an individual
basis, is not probable. Therefore, no liability for pending
tobacco-related litigation currently is recorded in RJRs
consolidated financial statements.

Neither RJR Tobacco nor its affiliates, including
RJR, have paid any damages as the result of a final judgment
entered after a fully litigated smoking and health tobacco
litigation claim, and a very high percentage of the
tobacco-related litigation claims brought against them continue
to be dismissed at or before trial. Generally, RJR Tobacco and
its affiliates, including RJR, have not settled, and currently
do not intend to settle, any smoking and health tobacco
litigation claims. It is the policy of RJR Tobacco and its
affiliates, including RJR, to vigorously defend all
tobacco-related litigation claims. RJR Tobacco and its
affiliates, including RJR, believe that they have a number of
valid defenses to the tobacco-related litigation claims against
them, and that their consistently successful defense of
tobacco-related litigation in the past will continue in the
future.

The only smoking and health tobacco litigation
claims settled by RJR Tobacco involved (1) the MSA, the
related settlements with the states of Mississippi, Florida,
Texas and Minnesota, and the funding of a $5.2 billion
trust fund contemplated by the MSA to benefit tobacco growers,
and (2) the original Broinflight attendant case
discussed below under  Class-Action
Suits. Despite valid legal defenses, the decision to
settle these matters resulted from unique circumstances that do
not apply to the other tobacco litigation cases pending against
RJR Tobacco and its affiliates, including RJR.

The circumstances surrounding the MSA, the
state-specific settlements and the funding of a trust fund to
benefit the tobacco growers, are readily distinguishable from
the current categories of cases involving RJR Tobacco. The
claims underlying the MSA and the state-specific settlements
were brought on behalf of the states to recover funds paid for
health care and medical and other assistance to state citizens
suffering from diseases and conditions allegedly related to
tobacco use. The MSA and the state-specific settlements settled
all the health-care cost recovery actions brought by, or on
behalf of, the settling jurisdictions and contain releases of
various additional present and future claims. In accordance with
the MSA, various tobacco companies agreed to fund a $5.2 billion
trust fund to be used to address the possible adverse economic
impact

79



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


of the MSA on tobacco growers. A discussion of
the MSA and the other state settlement agreements, and a table
depicting the related payment schedule under these agreements,
is set forth below under  Governmental
Health-Care Cost Recovery Cases  MSA and Other State
Settlement Agreements.

The states were a unique set of plaintiffs and
are not involved in any of the smoking and health cases
remaining against RJR or RJR Tobacco. Additionally, few smoker
class-action complaints have been certified or, if certified,
have survived on appeal. Seventeen federal courts that have
considered the issue, including two courts of appeals, and most
state courts have rejected class certification in smoking and
health cases. Most of the health-care cost recovery actions
similar in theory to the state cases involving other plaintiffs,
such as unions, hospitals, Indian tribes, and local and foreign
governments, have been dismissed, have been won by
RJR Tobacco at trial or have not involved punitive damages.
Finally, in the Department of Justice case brought against
various industry members, including RJR Tobacco, the United
States District Court for the District of Columbia granted the
non-Liggett defendants motion to dismiss plaintiffs
Medical Care Recovery Act and Medicare Secondary Payer claims,
whereby the federal government made arguments similar to the
states and sought to recover federal funds expended in providing
health care to smokers who have developed diseases and injuries
alleged to be smoking-related. The only remaining claims in this
case involve alleged violations of the federal RICO statute.

Similarly, the original Broincase,
discussed below under  Class-Action
Suits, was settled in the middle of trial during
discussions with the federal government concerning the possible
settlement of the claims underlying the MSA and the
state-specific settlements, among other things. The Broincase was settled at that time in an attempt to remove this
case as a political distraction during the industrys
settlement discussions with the federal government and a belief
that further Broinlitigation would be resolved by a
settlement at the federal level.

Following is a description of the material
pending tobacco-related litigation to which RJR Tobacco and its
affiliates, including RJR, are subject. Even though RJRs
management continues to conclude that the loss of any particular
smoking and health tobacco litigation claim against RJR Tobacco
or its affiliates, when viewed on an individual basis, is not
probable, the possibility of material losses related to tobacco
litigation is more than remote. However, RJRs management
is unable to predict the outcome of such litigation or to
reasonably estimate the amount or range of any possible loss.
Moreover, notwithstanding the quality of defenses available to
it and its affiliates in tobacco-related litigation matters, it
is possible that RJRs results of operations, cash flows or
financial condition could be materially adversely affected by
the ultimate outcome of certain pending or future litigation
matters.

Theories of
Recovery.The plaintiffs seek recovery
on a variety of legal theories, including negligence, strict
liability in tort, design defect, special duty, voluntary
undertaking, breach of warranty, failure to warn, fraud,
misrepresentation, unfair trade practices, conspiracy, unjust
enrichment, medical monitoring, public nuisance and violations
of state and federal antitrust and RICO laws. In certain of
these cases, plaintiffs claim that cigarette smoking exacerbated
injuries caused by exposure to asbestos.

Plaintiffs seek various forms of relief,
including compensatory and punitive damages, treble/multiple
damages and statutory damages and penalties, creation of medical
monitoring and smoking cessation funds, disgorgement of profits,
and injunctive and other equitable relief. Although pleaded
damages often are not determinable from a complaint, and the law
governing the pleading and calculation of damages varies from
state to state and jurisdiction to jurisdiction, compensatory
and punitive damages have been specifically pleaded in a number
of cases, sometimes in amounts ranging into the hundreds of
millions and even billions of dollars.

Defenses.The
defenses raised by RJR Tobacco and/or its affiliates, including
RJR, include, where applicable, preemption by the Federal
Cigarette Labeling and Advertising Act of some or all claims
arising after 1969, the lack of any defect in the product,
assumption of the risk, contributory or comparative fault, lack
of proximate cause, remoteness, lack of standing and statutes of
limitations or repose. RJR has asserted additional defenses,
including jurisdictional defenses, in many of the cases in which
it is named.

80



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Scheduled Trials.Trial schedules are subject to change,
and many cases are dismissed before trial. However, it is likely
that there will be an increased number of tobacco cases against
RJR Tobacco and/or its affiliates, including RJR, some involving
claims for amounts ranging possibly into the hundreds of
millions and even billions of dollars, coming to trial during
2003. The following table lists the trial schedule, as of
February 4, 2003, for RJR Tobacco or its affiliates,
through the end of 2003.

|                  |  |                                                                     |  |                                     |  |                                                                 
|----------------- |  | ------------------------------------------------------------------- |  | ----------------------------------- |  | ----------------------------------------------------------------
|Trial Date        |  | Case Name                                                           |  | Case Type                           |  | Jurisdiction                                                    
|                  |  |                                                                     |  |                                     |  |                                                                 
|February 3, 2003  |  | Allen v. R. J. Reynolds Tobacco Co.                                 |  | Individual                          |  | U.S. District Court,
    Southern District
    (Miami, FL)      
|February 24, 2003 |  | Harvey v. ABB Lummus Global, Inc.                                   |  | Individual                          |  | Superior Court,
    San Francisco County
    (San Francisco, CA)
|April 14, 2003    |  | Brown v. Philip Morris, Inc.                                        |  | Flight Attendant-
    ETS(Broin II) |  | Circuit Court,
    Dade County
    (Miami, FL)                  
|April 21, 2003    |  | Krigbaum v. American Tobacco Co.                                    |  | Individual                          |  | Superior Court,
    Santa Clara County
    (San Jose, CA)       
|April 28, 2003    |  | Williams v. Philip Morris, Inc.                                     |  | Flight Attendant-
    ETS(Broin II) |  | Circuit Court,
    Dade County
    (Miami, FL)                  
|May 5, 2003       |  | DeLuca v. Liggett & Myers, Inc.                                     |  | Individual                          |  | U.S. District Court,
    Northern District
    (Chicago, IL)    
|May 12, 2003      |  | Welch v. Brown & Williamson Tobacco
    Corp.                       |  | Individual                          |  | Superior Court,
    Jackson County
    (Independence, MO)       
|May 30, 2003      |  | Brown v. American Tobacco Co., Inc.                                 |  | Class Action                        |  | Superior Court,
    San Diego County
    (San Diego, CA)        
|June 2003         |  | Levine v. R. J. Reynolds Tobacco Co.                                |  | Individual                          |  | Circuit Court,
    Palm Beach County
    (West Palm Beach, FL)  
|June 6, 2003      |  | In Re Tobacco
    Litigation  Individual
    Personal Injury Cases |  | Individual                          |  | West Virginia
    Mass Litigation Panel
    (Charleston, WV)    
|June 16, 2003     |  | Sheppard v. R. J. Reynolds Tobacco
    Co.                          |  | Individual                          |  | U.S. District Court,
    Southern District
    (Miami, FL)      
|June 23, 2003     |  | Baker v. Philip Morris, Inc.                                        |  | Flight Attendant-
    ETS(Broin II) |  | Circuit Court,
    Dade County
    (Miami, FL)                  
|June 23, 2003     |  | Burkes v. Philip Morris, Inc.                                       |  | Flight Attendant-
    ETS(Broin II) |  | Circuit Court,
    Dade County
    (Miami, FL)                  
|June 23, 2003     |  | Leopard v. R. J. Reynolds Tobacco
    Co.                           |  | Individual                          |  | U.S. District Court,
    Eastern District
    (Little Rock, AR) 
|June 30, 2003     |  | Brumfield v. Philip Morris, Inc.                                    |  | Individual                          |  | U.S. District Court,
    Northern District
    (Oakland, CA)    

81



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                   |  |                                                  |  |                                     |  |                                                                
|------------------ |  | ------------------------------------------------ |  | ----------------------------------- |  | ---------------------------------------------------------------
|Trial Date         |  | Case Name                                        |  | Case Type                           |  | Jurisdiction                                                   
|                   |  |                                                  |  |                                     |  |                                                                
|July 14, 2003      |  | Leon v. Philip Morris, Inc.                      |  | Flight Attendant-
    ETS(Broin II) |  | Circuit Court
    Dade County
    (Miami, FL)                  
|August 4, 2003     |  | Frost v. Philip Morris, Inc.                     |  | Flight Attendant-
    ETS(Broin II) |  | Circuit Court,
    Dade County
    (Miami, FL)                 
|August 4, 2003     |  | Thompson v. Brown & Williamson Tobacco
    Corp. |  | Individual                          |  | Circuit Court,
    Jackson County
    (Independence, MO)       
|August 18, 2003    |  | Mittan v. Philip Morris, Inc.                    |  | Flight Attendant-
    ETS(Broin II) |  | Circuit Court,
    Dade County
    (Miami, FL)                 
|September 2, 2003  |  | Sargeant v. R. J. Reynolds Tobacco
    Co.       |  | Individual                          |  | Circuit Court,
    Brevard County
    (Cocoa, FL)              
|September 8, 2003  |  | Smith v. Philip Morris Cos., Inc.                |  | Antitrust                           |  | District Court,
    Seward County
    (Liberal, KS)            
|September 19, 2003 |  | Coy v. Philip Morris, Inc.                       |  | Individual                          |  | U.S. District Court,
    Southern District
    (Miami, FL)     
|October 6, 2003    |  | Roach v. Brown & Williamson Tobacco
    Corp.    |  | Individual                          |  | Circuit Court,
    Jackson County
    (Independence, MO)       
|October 6, 2003    |  | Turner v. R. J. Reynolds Tobacco Co.             |  | Class Action                        |  | Circuit Court,
    Madison County
    (Edwardsville, IL)       
|October 6, 2003    |  | Coleman v. R. J. Reynolds Tobacco
    Co.        |  | Individual                          |  | U.S. District Court,
    Eastern District
    (St. Louis, MO)  
|October 6, 2003    |  | Davis v. R. J. Reynolds Tobacco Co.              |  | Individual                          |  | U.S. District Court,
    Southern District
    (Des Moines, IA)
|November 3, 2003   |  | Hall v. R. J. Reynolds Tobacco Co.               |  | Individual                          |  | Circuit Court,
    Hillsborough County
    (Tampa, FL)         
|November 3, 2003   |  | Stitt vs. Philip Morris Cos., Inc.               |  | Individual                          |  | U.S. District Court,
    Western District
    (Pittsburgh, PA) 

Trial Results.Since
January 1, 1999, 27 smoking and health and health-care cost
recovery cases in which RJR Tobacco was a defendant have been
tried. Verdicts in favor of RJR Tobacco and, in some cases, RJR
Tobacco and other defendants, were returned in 16 of the 27
cases. Of the 16 RJR Tobacco wins, four were tried in Florida,
two were tried in each of California, Mississippi and New York,
and one was tried in each of Louisiana, New Jersey, Ohio, South
Carolina, Tennessee and West Virginia. Most recently, in
Conley v. R. J. Reynolds Tobacco Co.,a California
federal court judge granted RJR Tobaccos and Philip Morris
Inc.s motion for directed verdict on December 31,
2002. On February 6, 2003, however, plaintiffs filed an
appeal to the California Court of Appeals. On February 7,
2003, state court juries in California and Florida,
respectively, found in favor of RJR Tobacco and other cigarette
manufacturers in Lucier v. Phillip Morris, Inc.(an
individual smoker case) and Seal v. Philip Morris, Inc.(a Broin IIcase). Plaintiffs in the California,
Florida, Mississippi and West Virginia cases have filed appeals
or post-trial motions challenging the verdicts.

82



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Three of the cases resulted in a mistrial. Most
recently, in May 2002, a mistrial was declared in a Broin IIcase brought by a flight attendant, Queipo,and the
case subsequently was dismissed.

The following chart reflects the verdicts and
post-trial developments in the eight cases that have been tried
since January 1999 in which juries have returned verdicts in
favor of plaintiffs and against RJR Tobacco. In addition, RJR
Tobacco has been fined a total of $34.8 million in two other
lawsuits filed by the Attorney General of California, discussed
below under  MSA  Enforcement and
Validity and  Other Litigation and
Developments. RJR Tobacco is appealing both cases.

|                                                                                  |  |                                                                         |  |                               |  |                                                                  |  |                                                                                                                                                                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------- |  | ----------------------------- |  | ---------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Date of Verdict                                                                   |  | Case Name                                                               |  | Case Type                     |  | Jurisdiction                                                     |  | Verdict                                                                                                                                                                                                              |  | Post-Trial Status                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                  |  |                                                                         |  |                               |  |                                                                  |  |                                                                                                                                                                                                                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|July 7, 1999  Phase I
    April 7, 2000  Phase II
    July 14, 2000  Phase III |  | Engle v. R. J. Reynolds
    Tobacco Co.                                 |  | Class Action                  |  | Circuit Court,
    Dade County
    (Miami, FL)                   |  | $12.7 million compensatory damages against all
    defendants, including RJR Tobacco; $145 billion punitive damages
    against all defendants, of which approximately $36.3 billion was
    assigned to RJR Tobacco |  | Final judgment on appeal to the Third District
    Court of Appeal of Florida; oral argument heard November 6,
    2002; decision pending                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|March 20, 2000                                                                    |  | Whiteley v. Raybestos-
    Manhattan, Inc.                              |  | Individual                    |  | Superior Court,
    San Francisco County
    (San Francisco, CA) |  | $1.72 million compensatory damages against RJR
    Tobacco and another tobacco defendant; $20 million punitive
    damages, of which $10 million was assigned to RJR Tobacco                                         |  | Final judgment on appeal to the California Court
    of Appeal; briefing complete; oral argument has not been
    scheduled                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|October 12, 2000                                                                  |  | Jones v. Brown &
    Williamson Tobacco
    Corp.                       |  | Individual                    |  | Circuit Court,
    Hillsborough County
    (Tampa, FL)           |  | $200,000 compensatory damages against RJR Tobacco                                                                                                                                                                    |  | RJR Tobacco granted new trial on
    December 28, 2000; new trial decision affirmed by Second
    District Court of Appeal of Florida on August 30, 2002;
    plaintiffs opening brief filed with the Supreme Court of
    Florida on November 26, 2002. On December 9, 2002, the
    Supreme Court of Florida issued an order to show cause as to why
    Jones notice of appeal should not be treated as a notice
    to invoke discretionary jurisdiction. Jones filed his response
    to the order to show cause, and RJR Tobacco filed its reply to
    appellants response to the show cause order.
|June 4, 2001                                                                      |  | Blue Cross and Blue
    Shield of New Jersey v.
    Philip Morris, Inc. |  | Health-Care
    Cost Recovery |  | U.S. District Court,
    Eastern District
    (Brooklyn, NY)     |  | $17.8 million compensatory damages against all
    defendants, of which $6.6 million was assigned to RJR Tobacco.
    Judge subsequently ordered plaintiffs attorneys entitled
    to $37.8 million in fees         |  | Final judgment on appeal to the U.S. Court of
    Appeals for the Second Circuit; briefing complete; oral argument
    occurred on February 13, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|December 12, 2001                                                                 |  | Kenyon v. R. J.
    Reynolds Tobacco Co.                                |  | Individual                    |  | Circuit Court,
    Hillsborough County
    (Tampa, FL)           |  | $165,000 compensatory damages against RJR Tobacco                                                                                                                                                                    |  | Final judgment on appeal to the Second District
    Court of Appeal of Florida; briefing complete; oral argument has
    been scheduled for April 23, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|February 22, 2002                                                                 |  | Burton v. R. J. Reynolds
    Tobacco Co.                                |  | Individual                    |  | U.S. District Court
    (Kansas City, KS)                        |  | $198,000 compensatory damages and $15 million
    punitive damages against RJR Tobacco                                                                                                                               |  | Final judgment on appeal to the U.S. Court of
    Appeals for the Tenth Circuit; RJR Tobaccos opening brief
    was filed February 12, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

83



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                   |  |                                                 |  |                                     |  |                                                     |  |                                                                                     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|------------------ |  | ----------------------------------------------- |  | ----------------------------------- |  | --------------------------------------------------- |  | ----------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Date of Verdict    |  | Case Name                                       |  | Case Type                           |  | Jurisdiction                                        |  | Verdict                                                                             |  | Post-Trial Status                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                   |  |                                                 |  |                                     |  |                                                     |  |                                                                                     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|June 18, 2002      |  | French v. Philip Morris,
    Inc.               |  | Flight Attendant-
    ETS(Broin II) |  | Circuit Court,
    Dade County
    (Miami, FL)      |  | $5.5 million compensatory damages against all
    defendants, including RJR Tobacco |  | Judge reduced damages award to $500,000, of which
    $123,500 was assigned to RJR Tobacco; final judgment on appeal
    to the Third District Court of Appeal of Florida; opening brief
    due March 21, 2003                                                                                                                                                                                                                                                                   
|September 25, 2002 |  | Figueroa-Cruz v. R. J.
    Reynolds Tobacco Co. |  | Individual                          |  | U.S. District Court
    (San Juan,
    Puerto Rico) |  | $500,000 compensatory damages against RJR Tobacco                                   |  | Trial judge granted RJR Tobaccos motion for
    judgment as a matter of law on October 9, 2002, and entered
    judgment in RJR Tobaccos favor; plaintiffs appealed to
    U.S. Court of Appeals for the First Circuit; no briefing
    schedule has been set. On January 28, 2003, RJR Tobacco
    filed a response to appellants docketing statement, a
    motion to amend the caption of the case, and a motion to dismiss
    appellants appeal for failure to prosecute.

Additionally, since January 1, 1999,
verdicts have been returned in 16 tobacco-related cases in which
neither RJR Tobacco nor its affiliates, including RJR, were
defendants. Verdicts were returned in favor of defendants in 10
cases  three in Tennessee, and one in each of
Connecticut, Florida, Missouri, Ohio, Pennsylvania, Rhode Island
and Texas. Most recently, a Philadelphia state court jury
returned a verdict in favor of Philip Morris on January 27,
2003. Plaintiffs appeal is pending in the Ohio case.
Verdicts in favor of plaintiffs were returned in six cases,
three of which were tried in California, two in Oregon and one
in Florida. Defendants appeals or post-trial motions are
pending in these cases.

Finally, the California Supreme Court heard oral
argument in the Naegele v. Raybestos-Manhattan, Inc. and
Myers v. Philip Morris, Inc. cases on May 7, 2002.
The court assessed the retroactive effect of Californias
amended Civil Code Section 1714.45, which repealed a
California statute that limited plaintiffs ability to sue
manufacturers of tobacco products from 1988 through 1998. On
August 5, 2002, the court ruled that the immunity repeal
could not be applied retroactively and the immunity remains for
the ten-year period the statute was in effect. In addition, the
court found that the immunity applied to fraud claims but not to
claims of adulteration. RJR Tobacco believes that these
decisions should have a favorable impact on cases currently on
appeal (e.g., Whiteley v. Raybestos-Manhattan, Inc.) and
cases at the trial court.

Individual Smoking and Health Cases

As of February 4, 2003, approximately 1,377
individual cases were pending in the United States against
RJR Tobacco. This category of cases includes smoking and
health cases alleging personal injury brought by or on behalf of
individual plaintiffs (but does not include the Broin IIcases discussed below). A total of 1,364 of the pending
cases are brought by or on behalf of individual smokers or their
survivors. Thirteen of the cases are brought by or on behalf of
individuals or their survivors alleging personal injury as a
result of exposure to ETS.

In 2002, three individual cases were tried in
which RJR Tobacco was a party. On February 22, 2002,
in Burton v. R. J. Reynolds Tobacco Co., a federal
district court jury in Kansas found in favor of RJR Tobacco
and Brown & Williamson on product defect and conspiracy
claims, but found for the plaintiff on failure to warn, failure
to test and fraudulent concealment claims. The jury apportioned
99 percent of the fault to RJR Tobacco and
1 percent to Brown & Williamson. It awarded the
plaintiff $198,400 in compensatory damages, and determined that
the plaintiff was entitled to punitive damages against
RJR Tobacco but not Brown & Williamson. On
June 21, 2002, the trial court awarded the plaintiff $15
million in punitive damages. RJR Tobacco appealed to the
United States Court of Appeals for the Tenth Circuit, and filed
its opening appellate brief on February 12, 2003.

84



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##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


In Figueroa-Cruz v. R. J. Reynolds Tobacco
Co., a federal district court jury in San Juan, Puerto Rico,
found in favor of one of two plaintiffs on September 25,
2002. On October 9, 2002, however, the trial judge granted
RJR Tobaccos motion for judgment on the pleadings.
Plaintiffs are appealing the ruling to the U.S. Court of
Appeals for the First Circuit.

Most recently, RJR Tobacco has prevailed in
two individual smoker lawsuits in California. In Conley v. R.
J. Reynolds Tobacco Co., a California federal court judge
granted RJR Tobaccos and Philip Morris, Inc.s
motion for directed verdict on December 31, 2002.
Plaintiffs appealed to the California Court of Appeals on
February 6, 2003. And, in Lucier v. Philip Morris, Inc.,a California state court jury found in favor of
RJR Tobacco and Philip Morris, Inc. on February 7,
2003.

Broin II Cases

As of February 4, 2003, approximately 2,791
lawsuits brought by individual flight attendants for personal
injury as a result of illness allegedly caused by exposure to
secondhand or environmental tobacco smoke in airplane cabins,
referred to as the Broin IIcases, were pending in
Florida. In these lawsuits, filed pursuant to the terms of the
settlement of the Broin v. Philip Morris, Inc.class
action, discussed below under  Class-Action
Suits, each individual flight attendant will be required
to prove that he or she has a disease and that the
individuals exposure to secondhand smoke in airplane
cabins caused the disease. Under the terms of the settlement of
the original Broincase, punitive damages are not
available in the Broin IIcases.

On October 5, 2000, Judge Robert Kaye
entered an order applicable to all Broin IIcases that
the terms of the Broinsettlement agreement do not
require the individual Broin IIplaintiffs to prove the
elements of strict liability, breach of warranty or negligence.
Under this order, there is a rebuttable presumption in
plaintiffs favor on those elements, and plaintiffs bear
the burden of proving that their alleged adverse health effects
actually were caused by exposure to environmental tobacco smoke.
Although defendants still may prevail on causation and other
theories, RJR Tobacco does not believe that the order is correct
under Florida law or that it accurately reflects the intent of
the Broinsettlement agreement. RJR Tobacco, along with
the other defendants, initially appealed this order in Jett
v. Philip Morris, Inc.In October 2001, the intermediate
appellate court dismissed the appeal as premature without
addressing the Kaye order. Defendants asked the court to
reconsider its ruling, but the court refused to do so.
Defendants asked the Florida Supreme Court to review the order,
but the court declined to accept jurisdiction on June 24,
2002.

On April 5, 2001, in the first Broin IIflight attendant case to go to trial, Fontana v. Philip
Morris, Inc., a Florida state court jury returned a verdict
in favor of the defendants, including RJR Tobacco. On
April 16, 2001, plaintiff filed motions for a mistrial,
judgment notwithstanding the verdict or for a new trial. On
October 1, 2001, the trial judge denied plaintiffs
post-trial motions. Plaintiff appealed to the Florida Third
District Court of Appeal. Defendants cross-appealed on
November 8, 2001, raising objections to the Judge Kaye
order described above. On December 30, 2002, the plaintiff
voluntarily dismissed her appeal of the final judgment, thereby
rendering defendants cross-appeal moot.

Jury selection began in state court in Florida on
May 20, 2002 in Queipo v. Philip Morris, Inc. The
court declared a mistrial shortly after the plaintiff began
presenting evidence. The plaintiff voluntarily dismissed the
action on June 3, 2002.

In French v. Philip Morris, Inc., a
Florida state court jury found in favor of the plaintiff on
June 18, 2002, and awarded $5.5 million in compensatory
damages. On September 13, 2002, the trial judge reduced the
damages award to $500,000, but denied the defendants
remaining post-trial motions. Defendants appeal of the
trial courts final judgment is pending in the Third
District Court of Appeal of Florida. Their initial brief is due
on March 21, 2003.

In Janoff v. Philip Morris, Inc., a
Florida state court jury found in favor of the defendants,
including RJR Tobacco, on September 5, 2002. On
September 12, 2002, plaintiff filed a motion for a new
trial, which

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STATEMENTS  (Continued)


the judge granted on January 8, 2003.
Defendants appealed the ruling to the Third District Court of
Appeal of Florida on February 3, 2003.

In Tucker v. Philip Morris,
Inc., a Florida state court jury found
in favor of the defendants, including RJR Tobacco, on
October 4, 2002. Plaintiffs post-verdict motions were
denied on January 28, 2003.

Most recently, a Florida state court jury found
in favor of RJR Tobacco and other cigarette manufacturers
on February 7, 2003, in Seal v. Philip Morris, Inc.

Class-Action Suits

As of February 4, 2003, approximately
49 class-action cases were pending in the United States
against RJR Tobacco, and in some cases, RJR. In May 1996,
in Castano v. American Tobacco Co., the Fifth Circuit
Court of Appeals overturned the certification of a nationwide
class of persons whose claims related to alleged addiction to
tobacco products. Since this ruling by the Fifth Circuit, most
class-action suits have sought certification of statewide,
rather than nationwide, classes. Class-action suits based on
claims similar to those asserted in Castanoare pending
against RJR Tobacco, and in some cases RJR, in state or federal
courts in Alabama, California, the District of Columbia,
Florida, Illinois, Louisiana, Missouri, Nevada, New York, Ohio,
Oregon, Tennessee, Texas, Utah and West Virginia. Twenty-five
virtually identical class-action complaints have been filed by
one attorney in Nevada since July 2002.

Class-action suits have been filed in a number of
states against individual cigarette manufacturers and their
parent corporations, alleging that the use of the terms
lights and ultralights constitutes
unfair and deceptive trade practices. In December 2000, a state
court in Pennsylvania refused to certify one such class action,
Oliver v. RJR Tobacco Co. That case was later voluntarily
dismissed. Three such suits are pending against RJR Tobacco and
RJR in Florida, Illinois and Missouri. A class has been
certified in the Illinois case, Turner v. R. J. Reynolds
Tobacco Co., discussed below. A class certification decision
is pending in the Missouri case, Collora v. R. J. Reynolds
Tobacco Co., while the Florida case is in the class
certification discovery phase.

Other types of class-action suits also are
pending in additional jurisdictions. Most of these suits assert
claims on behalf of classes of individuals who claim to be
addicted, injured or at greater risk of injury by the use of
tobacco or exposure to environmental tobacco smoke, or the legal
survivors of such persons. A number of unions and other
third-party payers have filed health-care cost recovery actions
in the form of class actions. These cases are discussed
separately below. Class certification motions are pending in
several state and federal courts.

Few smoker class-action complaints have been
certified or, if certified, have survived on appeal. Seventeen
federal courts that have considered the issue, including two
courts of appeals, and most state courts have rejected class
certification in smoking and health cases. Only one federal
district court has certified a smoker class action 
In re Simon (II) Litigation  which is
pending in the U.S. District Court for the Eastern District of
New York before Judge Weinstein. In Simon (II), on
September 19, 2002, Judge Weinstein certified a
nationwide mandatory, non-opt-out punitive damages class.
Defendants sought reconsideration of the certification ruling,
although it was denied by Judge Weinstein on
October 25, 2002. On February 14, 2003, the U.S. Court
of Appeals for the Second Circuit granted the defendants
petition to review the class certification decision. Most
recently, on February 10, 2003, in Sims v. Philip
Morris, Inc.,the U.S. District Court for the District
of Columbia denied certification of a proposed class of smokers
who purchased cigarettes while underage.

Classes have been certified in several state
court class-action cases in which RJR Tobacco is a defendant. On
November 5, 1998, in Scott v. American Tobacco Co.,
a Louisiana state appeals court affirmed the certification of a
medical monitoring and/or smoking cessation class of Louisiana
residents who were smokers on or before May 24, 1996. On
February 26, 1999, the Louisiana Supreme Court denied the
defendants petition for writ of certiorari and/or review.
Jury selection began on June 18, 2001. An initial jury was
selected

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STATEMENTS  (Continued)


by July 16, 2001. However, the defendants,
including RJR Tobacco, raised multiple challenges to the jury
selection process. At various times, the Louisiana Court of
Appeals and/or the Louisiana Supreme Court removed a number of
jurors and alternate jurors that the trial court had allowed to
be seated. The jury selection process was finally completed on
September 23, 2002, and opening statements occurred on
January 21, 2003. The trial is now in progress.

Trial began in July 1998 in Florida state court
in Engle v. R. J. Reynolds Tobacco Co., in which a class
consisting of Florida residents, or their survivors, alleges
diseases or medical conditions caused by their alleged
addiction to cigarettes. On July 7, 1999, the
jury found against RJR Tobacco and the other cigarette
manufacturer defendants in the initial phase, which included
common issues related to certain elements of liability, general
causation and a potential award of, or entitlement to, punitive
damages.

The second phase of the trial, which consisted of
the claims of three of the named class representatives, began on
November 1, 1999. On April 7, 2000, the jury returned
a verdict against all defendants. They awarded plaintiff Mary
Farnan $2.85 million, the estate of plaintiff Angie Della
Vecchia $4.023 million and plaintiff Frank Amodeo
$5.831 million. The jury also found, however, that Frank
Amodeo knew or should have known of his claim prior to
May 5, 1990. RJR Tobacco believes that the legal effect of
that finding should be to bar his claim based on the applicable
statute of limitations.

The trial court also ordered the jury in the
second phase of the trial to determine punitive damages, if any,
on a class-wide basis. On July 14, 2000, the jury returned
a punitive damages verdict in favor of the Florida
class of approximately $145 billion against all the
defendants, with approximately $36.3 billion being assigned
to RJR Tobacco.

On July 24, 2000, the defendants, including
RJR Tobacco, filed numerous post-verdict motions, including
motions for a new trial and to reduce the amount of the punitive
damages verdict. On November 6, 2000, the trial judge
denied the post-trial motions and entered judgment. On
November 7, 2000, RJR Tobacco posted an appeal bond in the
amount of $100 million, pursuant to a Florida statute
enacted on May 9, 2000, and intended to apply to the
Englecase, and initiated the appeals process. The
opening appellate brief of certain defendants, including RJR
Tobacco, was filed on November 26, 2001. The plaintiff
class filed its responsive brief on June 7, 2002;
defendants reply brief was filed on September 26,
2002. Oral argument before Floridas Third District Court
of Appeal took place on November 6, 2002. A decision is
expected in 2003. Although RJR Tobacco believes it has numerous
bases for a successful appeal, it cannot predict the outcome of
the appellate process.

On May 7, 2001, three of the non-RJR Tobacco
defendants entered into agreements with the Engleclass
to deposit an additional $1.86 billion into separate escrow
accounts to ensure that the stay of execution in effect pursuant
to the Florida bond statute will remain in effect as to these
three defendants throughout the appellate process, regardless of
the results of a challenge, if any, to the Florida bond statute.
Approximately $700 million of the total amount deposited by
these three defendants is non-refundable and will go to the
trial court to be distributed, regardless of the result of the
appeal. RJR Tobacco has not entered into a similar agreement
with the Engleclass. Although RJR Tobacco cannot predict
the outcome of any possible challenges to the Florida bond
statute, RJR Tobacco remains confident of the applicability and
validity of the statute in the Englecase. In addition,
12 other states, Georgia, Indiana, Kentucky, Louisiana,
Michigan, Nevada, North Carolina, Ohio, Oklahoma, South
Carolina, Virginia and West Virginia, have enacted legislation
similar to the Florida bond statute. The Mississippi Supreme
Court also has placed limits on appeal bonds by court rule.

RJR Tobacco has been named as a defendant in 11
individual cases filed by members of the Engleclass. One
such case (in which RJR Tobacco was dismissed prior to trial),
Lukacs v. Philip Morris, Inc., was tried against Philip
Morris and Brown & Williamson, and resulted in a verdict for
the plaintiffs on June 11, 2002. The Florida state court
jury awarded the plaintiffs a total of $37.5 million in
compensatory damages. The plaintiffs have agreed to stay
execution on the judgment pending the result of the Engleappeal.

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NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


On November 30, 2000, in Daniels v.
Philip Morris Cos., Inc., a San Diego Superior Court judge
reversed a prior ruling and, based on a California unfair
business practices statute, certified a class consisting of all
persons who, as California resident minors, smoked one or more
cigarettes in California between April 2, 1994 and
December 1, 1999. Trial was scheduled for October 18,
2002, but the court granted defendants motions for summary
judgment on preemption and First Amendment grounds on
September 12, 2002, and dismissed the action. At a hearing
on October 21, 2002, the judge made final his original ruling.
The plaintiffs are currently appealing the dismissal to the
California Court of Appeal, Fourth Appellate District, Division
One.

On April 11, 2001, in Brown v. American
Tobacco Co., Inc., the same judge in San Diego granted in
part plaintiffs motion for class certification. The class
is composed of adult residents of California who smoked at least
one of defendants cigarettes from 1993 through 2000, and
who were exposed to defendants marketing and advertising
activities in California. Certification was granted as to
plaintiffs claims that defendants violated §17200 of
the California Business and Professions Code. The court,
however, refused to certify the class under the California Legal
Remedies Act. Class certification on plaintiffs common law
claims was denied on April 10, 2000. Defendants petitioned
the California Supreme Court to review the trial courts
class certification ruling, but the Supreme Court denied the
petition on January 16, 2002. The defendants, including
RJR Tobacco, filed their motion for summary judgment on
January 31, 2003. Trial is scheduled to begin on
May 30, 2003.

On November 14, 2001, in Turner v. R. J.
Reynolds Tobacco Co., an Illinois state court judge
certified a class defined as [a]ll persons who purchased
defendants Doral Lights, Winston Lights, Salem Lights and
Camel Lights, in Illinois, for personal consumption, between the
first date that defendants sold Doral Lights, Winston Lights,
Salem Lights and Camel Lights through the date the court
certifies this suit as a class
action . . . . Trial is scheduled to
begin on October 6, 2003. This case currently includes both
RJR and RJR Tobacco as defendants. Similar class-action
cases in the same jurisdiction have been certified against
Philip Morris and Brown & Williamson.

RJR Tobacco and other cigarette manufacturer
defendants settled one class-action suit, Broin v. Phillip
Morris, Inc., in October 1997. This case had been brought in
Florida state court on behalf of all flight attendants of U.S.
airlines alleged to be suffering from diseases or ailments
caused by exposure to secondhand smoke in airplane cabins. The
settlement agreement required the participating tobacco
companies to pay a total of $300 million in three annual
$100 million installments, allocated among the companies by
market share, to fund research on the early detection and cure
of diseases associated with tobacco smoke. It also required
those companies to pay a total of $49 million for
plaintiffs counsels fees and expenses.
RJR Tobaccos portion of these payments was
approximately $86 million. The settlement agreement bars
class members from bringing aggregate claims or obtaining
punitive or exemplary damages and also bars individual claims to
the extent that they are based on fraud, misrepresentation,
conspiracy to commit fraud or misrepresentation, RICO,
suppression, concealment or any other alleged intentional or
willful conduct. The defendants agreed that, in any individual
case brought by a class member, the defendant will bear the
burden of proof with respect to whether ETS can cause certain
specifically enumerated diseases (general
causation). With respect to all other issues relating to
liability, including whether an individual plaintiffs
disease was caused by his or her exposure to ETS in aircraft
cabins (specific causation), the individual
plaintiff will have the burden of proof. Floridas Third
District Court of Appeal denied various challenges to this
settlement on March 24, 1999, and subsequently denied
motions to reconsider. On September 7, 1999, the Florida
Supreme Court dismissed all proceedings, and the settlement and
judgment became final. The Broin IIcases, discussed
above, arose out of the settlement of this case.

Governmental Health-Care Cost Recovery
Cases

MSA and Other State Settlement
Agreements.In June 1994, the
Mississippi attorney general brought an action, Moore v.
American Tobacco Co., against various industry members,
including RJR Tobacco. This case was brought on behalf of
the state to recover state funds paid for health care and
medical and other assistance to state citizens suffering from
diseases and conditions allegedly related to tobacco use. Most
other states,

88



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NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


through their attorneys general or other state
agencies, sued RJR Tobacco and other U.S. cigarette
manufacturers based on similar theories. The cigarette
manufacturer defendants, including RJR Tobacco, settled the
first four of these cases scheduled to come to trial, those of
Mississippi, Florida, Texas and Minnesota, by separate
agreements between each state and those manufacturers in each
case.

On November 23, 1998, the major U.S.
cigarette manufacturers, including RJR Tobacco, entered
into the MSA with attorneys general representing the remaining
46 states, the District of Columbia, Puerto Rico, Guam, the
Virgin Islands, American Samoa and the Northern Marianas. The
MSA became effective on November 12, 1999, and settled all
the health-care cost recovery actions brought by, or on behalf
of, the settling jurisdictions and contained releases of various
additional present and future claims.

In the settling jurisdictions, the MSA released
RJR Tobacco, its indemnitees and RJR from: (1) all claims
of the settling states and their respective political
subdivisions and other recipients of state health-care funds,
relating to past conduct arising out of the use, sale,
distribution, manufacture, development, advertising, marketing
or health effects of, the exposure to, or research, statements
or warnings about, tobacco products and (2) all monetary
claims relating to future conduct arising out of the use of, or
exposure to, tobacco products that have been manufactured in the
ordinary course of business.

The cash payments made by RJR Tobacco under the
MSA and other existing settlement agreements were
$2.5 billion, $2.4 billion and $2.2 billion under
these agreements in 2002, 2001 and 2000, respectively. RJR
Tobacco records its allocation of ongoing settlement charges in
cost of products sold as products are shipped. Set forth below
is a table depicting the unadjusted tobacco industry settlement
payment schedule under the MSA and the other settlement
agreements and related information.

|                                          |                                         |                                                         |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       | 
|----------------------------------------- | --------------------------------------- | ------------------------------------------------------- | ----- | ----- | ----- | ---- | ----- | ----- | ------ | ---- | ----- | ----- | ------ | ---- | ----- | ----- | ------ | ----- | ----- | ----- | ----- | -- | ----- | ----- | ----- | -- | ----- | ----- | ----- | -- | ----- | ----- | ----- | -- | ----- | ----- | ----- | 
|                                          |                                         |                                                        
|                                          |                                         | Unadjusted Tobacco Industry Settlement Payment Schedule
|                                          |                                         |                                                        
|                                          |                                         | 2000                                                    |       | 2001  |       | 2002 |       | 2003  |        | 2004 |       | 2005  |        | 2006 |       | 2007  |        | 2008+
|                                          |                                         |                                                         |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |      
|                                          |                                         |                                                        
|                                          |                                         | (Dollars in Millions)                                  
|First Four States Settlements:           |                                         |                                                         |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|                                          | Mississippi Annual Payment              |                                                         | $     | 85    |       |      | $     | 111   |        |      | $     | 111   |        |      | $     | 136   |        |       | $     | 136   |       |    | $     | 136   |       |    | $     | 136   |       |    | $     | 136   |       |    | $     | 136   |      
|                                          | Florida Annual Payment                  |                                                         |       | 275   |       |      |       | 358   |        |      |       | 358   |        |      |       | 440   |        |       |       | 440   |       |    |       | 440   |       |    |       | 440   |       |    |       | 440   |       |    |       | 440   |      
|                                          | Texas Annual Payment                    |                                                         |       | 363   |       |      |       | 471   |        |      |       | 471   |        |      |       | 580   |        |       |       | 580   |       |    |       | 580   |       |    |       | 580   |       |    |       | 580   |       |    |       | 580   |      
|                                          | Minnesota Annual Payment                |                                                         |       | 128   |       |      |       | 166   |        |      |       | 166   |        |      |       | 204   |        |       |       | 204   |       |    |       | 204   |       |    |       | 204   |       |    |       | 204   |       |    |       | 204   |      
|                                          | Minnesota Initial Payment               |                                                         |       | 243   |       |      |       | 243   |        |      |       | 243   |        |      |       | 122   |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|                                          | Most Favored Nations Agmt (MS, FL, TX)  |                                                         |       | 1,215 |       |      |       | 1,215 |        |      |       | 1,215 |        |      |       | 609   |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|Remaining States Settlement:             |                                         |                                                         |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|                                          | Initial Payments(1)                     |                                                         |       | 2,472 |       |      |       | 2,546 |        |      |       | 2,623 |        |      |       | 2,701 |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|                                          | Annual Payments(1)                      |                                                         |       | 3,940 |       |      |       | 4,378 |        |      |       | 5,691 |        |      |       | 5,691 |        |       |       | 7,004 |       |    |       | 7,004 |       |    |       | 7,004 |       |    |       | 7,004 |       |    |       | 7,126 |      
|                                          | Addl Annual Payments (through 2017)(1) |                                                         |       |      |       |      |       |      |        |      |       |      |        |      |       |      |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       | 861   |      
|                                          | Base Foundation Funding (through 2008)  |                                                         |       | 25    |       |      |       | 25    |        |      |       | 25    |        |      |       | 25    |        |       |       | 25    |       |    |       | 25    |       |    |       | 25    |       |    |       | 25    |       |    |       | 25    |      
|                                          | Additional Foundation Payments(2)       |                                                         |       | 300   |       |      |       | 300   |        |      |       | 300   |        |      |       | 300   |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|Growers Trust ($295-2009 and 2010)(3)    |                                         |                                                         | 280   |       |       |      | 400   |       |        |      | 500   |       |        |      | 500   |       |        |       | 500   |       |       |    | 500   |       |       |    | 500   |       |       |    | 500   |       |       |    | 500   |      
|Minnesota Blue Cross and Blue Shield      |                                         |                                                         | 57    |       |       |      | 57    |       |        |      | 57    |       |        |      | 57    |       |        |       |      |       |       |    |      |       |       |    |      |       |       |    |      |       |       |    |      |      
|                                          |                                         |                                                         |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|                                          |                                         | Total                                                   |       | $     | 9,383 |      |       | $     | 10,270 |      |       | $     | 11,760 |      |       | $     | 11,365 |       |       | $     | 8,889 |    |       | $     | 8,889 |    |       | $     | 8,889 |    |       | $     | 8,889 |    |       | $     | 9,872 | 
|                                          |                                         |                                                         |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|RJR Tobaccos settlement expenses         |                                         | $                                                       | 2,329 |       |       | $    | 2,584 |       |        | $    | 2,507 |       |        | $    |      |       |        | $     |      |       |       | $  |      |       |       | $  |      |       |       | $  |      |       |       | $  |      |      
|RJR Tobaccos cash payments               |                                         | $                                                       | 2,247 |       |       | $    | 2,393 |       |        | $    | 2,461 |       |        | $    |      |       |        | $     |      |       |       | $  |      |       |       | $  |      |       |       | $  |      |       |       | $  |      |      
|RJR Tobaccos expected settlement expense |                                         |                                                         |      |       |       |      |      |       |        |      |      |       |        | $    | 2,200 |       |        | >$    | 2,200 |       |       | >$ | 2,300 |       |       | >$ | 2,300 |       |       | >$ | 2,000 |       |       | >$ | 2,000 |      
|RJR Tobaccos expected cash payments      |                                         |                                                         |      |       |       |      |      |       |        |      |      |       |        | $    | 1,900 |       |        | >$    | 2,100 |       |       | >$ | 2,200 |       |       | >$ | 2,200 |       |       | >$ | 2,000 |       |       | >$ | 2,000 |      






|    |                                                                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Subject to adjustments for changes in sales
    volume, inflation and other factors. All payments are to be
    allocated among the companies on the basis of relative market
    share.               
|(2) | Subject to adjustments for changes in sales
    volume, inflation and other factors.                                                                                                                   
|(3) | Subject to changes in total domestic cigarette
    volume of participating manufacturers and inflation. Generally,
    payment is based on each participating manufacturers
    relative market share.

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NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The MSA also contains provisions restricting the
marketing of cigarettes. Among these are restrictions or
prohibitions on the use of cartoon characters, brand name
sponsorships, brand name non-tobacco products, outdoor and
transit brand advertising, payments for product placement, free
sampling and lobbying. The MSA also required the dissolution of
three industry-sponsored research and advocacy organizations.

The MSA and the other state settlement agreements
have materially adversely affected RJR Tobaccos shipment
volumes. RJR believes that they may materially adversely affect
the results of operations, cash flows or financial position of
RJR and RJR Tobacco in future periods. The degree of the adverse
impact will depend, among other things, on the rate of decline
in United States cigarette sales in the premium and discount
categories, RJR Tobaccos share of the domestic premium and
discount cigarette categories, and the effect of any resulting
cost advantage of manufacturers not subject to the MSA and the
other state settlement agreements.

Department of Justice
Case.On September 22, 1999, the
United States Department of Justice brought an action in the
United States District Court for the District of Columbia
against various industry members, including RJR Tobacco. The
government sought to recover federal funds expended in providing
health care to smokers who have developed diseases and injuries
alleged to be smoking-related, and, in addition, seeks, pursuant
to the federal RICO statute, disgorgement of profits the
government contends were earned as a consequence of a RICO
racketeering enterprise. On December 27, 1999,
defendants filed a motion to dismiss challenging all counts
included in the action brought by the DOJ. On June 6, 2000,
the trial court heard oral argument on the motion. On
September 28, 2000, Judge Gladys Kessler of the United
States District Court for the District of Columbia granted the
non-Liggett defendants motion to dismiss the following
counts of plaintiffs complaint: (1) Medical Care
Recovery Act claim, and (2) Medicare Secondary Payer claim.
The court, however, denied the motion with respect to the RICO
claims. Trial is scheduled for September 13, 2004.

In June 2001, the United States Attorney General
assembled a team of three DOJ lawyers to work on a possible
settlement of the federal lawsuit. The DOJ lawyers met with
representatives of the tobacco industry, including RJR Tobacco,
on July 18, 2001. No settlement was reached, and no further
meetings are planned.

Local Government
Cases.Some local government entities
have filed lawsuits based largely on the same theories and
seeking the same relief as the state attorney general cases.
Three such cases are pending against RJR Tobacco. On
August 8, 2001, in County of Cook v. Philip Morris,
Inc., the Circuit Court of Cook County, Illinois, granted
defendants motion for judgment on the pleadings based on
remoteness grounds and dismissed plaintiffs complaint in
its entirety. Plaintiffs appealed the dismissal to the Illinois
Appellate Court, First District, on September 5, 2001.
Defendants noticed a cross-appeal on September 17, 2001,
from the trial courts adverse rulings on defendants
motions to dismiss on the grounds of MSA release and lack of
standing. The appeal is in the briefing stage.

International Cases.A number of foreign countries have filed suit in state and
federal courts in the United States against RJR Tobacco and
other tobacco industry defendants to recover funds for health
care, medical and other assistance paid by those foreign
governments to their citizens. In the Marshall Islands v.
American Tobacco Co., the Republic of the Marshall Islands
brought a health-care cost recovery suit against RJR Tobacco and
other cigarette manufacturers. On May 9, 2002, the Supreme
Court of the Marshall Islands affirmed the dismissal of all
claims. Most recently, in Venezuela v. Philip Morris Cos.,
Inc.,Floridas Third District Court of Appeal affirmed
the trial courts dismissal on October 1, 2002. On
October 28, 2002, Venezuela filed a notice to invoke the
discretionary jurisdiction of the Florida Supreme Court to
review the decision of the Third District Court of Appeal. A
decision is pending.

Of the 27 international cases currently pending
in the United States, 25 are pending in state court and two are
pending in federal court. Two other cases are pending outside
the United States, one in each of Canada and Israel. The two
federal court cases were transferred to, and remain pending
before, the Judicial Panel on Multi-District Litigation in the
United States District Court for the District of Columbia. Other
foreign governments and entities have stated that they are
considering filing such actions in the United States.

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On November 12, 1998, the Canadian Province
of British Columbia brought a case in British Columbia
Provincial Court (federally appointed), similar to the state
attorneys general cases discussed above, against RJR Tobacco and
certain other Canadian and U.S. tobacco companies and their
parent companies, including RJR. This lawsuit depended entirely
on legislation enacted in British Columbia that was separately
challenged by various Canadian tobacco companies. An agreement
was reached with the government in British Columbia to litigate
the separate constitutional challenges prior to the health-care
cost recovery action. On February 21, 2000, the British
Columbia Supreme Court declared the Cost Recovery Act
unconstitutional and dismissed the action. This decision was not
appealed by the government. On January 24, 2001, the
Canadian Province of British Columbia enacted a second and
revised statute and brought a second action in the same court. A
trial of the constitutionality of the second statute and a claim
that the second action be dismissed was heard from November 4
through November 29, 2002. As of February 4, 2003,
judgment is still reserved.

Pursuant to the terms of the 1999 sale of
RJRs international tobacco business, Japan Tobacco Inc.
assumed RJR Tobaccos liability, if any, in the
health-care cost recovery cases brought by foreign countries.

Other Health-Care Cost Recovery and Aggregated
Claims Cases

Although the MSA settled some of the most
potentially burdensome health-care cost recovery actions, many
other such cases have been brought by other types of plaintiffs.
Unions, groups of health-care insurers, a private entity that
purported to self-insure its employee health-care programs,
Native American tribes, hospitals, universities and taxpayers
have advanced claims similar to those found in the governmental
health-care cost recovery actions. These cases largely have been
unsuccessful on remoteness grounds: one who pays an injured
persons medical expenses is legally too remote to maintain
an action against the person allegedly responsible for the
injury.

Union Cases.Numerous trial court judges have dismissed union trust fund
cases on remoteness grounds. The first and only union case to go
to trial to date was Iron Workers Local No. 17 v. Philip
Morris, Inc., which was tried in federal court in Ohio. On
March 18, 1999, the jury returned a unanimous verdict for
the defendants, including RJR Tobacco. The plaintiffs
dismissed their appeal of the verdict.

Since March 1999, the United States Courts of
Appeals for the Second, Third, Fifth, Seventh, Eighth, Ninth,
Eleventh and District of Columbia Circuits all have ruled in
favor of the industry in similar union cases. The United States
Supreme Court has denied petitions for certiorari filed by
unions in cases from the Second, Third, Ninth and District of
Columbia Circuits.

On March 3, 2000, a New York state court
granted motions to dismiss ten union cases, brought by 14 union
trust funds, Eastern States Health & Welfare Fund v.
Philip Morris, Inc.The plaintiffs in this group of cases
noticed appeals to the Appellate Division of the Supreme Court
of New York. However, the plaintiffs never perfected the
appeals, which resulted in the appeals being dismissed. On
January 25, 2002, in Motion Picture Industry Health Plan
v. Philip Morris, Inc., the California Supreme Court granted
plaintiffs petition for review of a decision by the
California Court of Appeals to affirm a trial court order
dismissing the case with prejudice. On November 20, 2002,
the California Supreme Court dismissed review as improvidently
granted and remanded the case to the California Court of Appeal,
Fourth District, for dismissal. The California Court of Appeal,
Fourth District, in turn, entered the order dismissing the
action on November 26, 2002. On May 31, 2002, in
National Asbestos Workers Medical Fund v. Philip Morris,
Inc.,Judge Weinstein of the United States District Court
for the Eastern District of New York granted plaintiffs
motion to dismiss all claims. On July 3, 2002, Judge
Weinstein denied class certification in Bergeron v. Philip
Morris, Inc., and on July 16, 2002, ordered that the
case be transferred to Massachusetts or dismissed. On
August 7, 2002, the parties stipulated to a voluntary
dismissal.

As of February 4, 2003, there were no
pending lawsuits by union trust funds against cigarette
manufacturers and others.

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Insurance Companies.As of February 4, 2003, three cases brought by insurance
companies were pending against RJR Tobacco. In Group
Health Plan, Inc. v. Philip Morris, Inc.and Medica v.
Philip Morris, Inc., a federal district judge in Minnesota
dismissed all claims, except a state antitrust claim and a state
conspiracy claim. The federal court certified to the Minnesota
Supreme Court the question whether these two claims could be
pursued under Minnesota law by Group Health Plan. On
January 11, 2001, the Minnesota Supreme Court ruled that
the plaintiff could pursue these claims. Certain defendants,
including RJR Tobacco, filed motions for summary judgment
based on (1) the statutes of limitation and
(2) causation, injury and damages. On January 31,
2002, summary judgment was granted in favor of certain
defendants, including RJR Tobacco, on all causes of action.
In March 2002, plaintiffs appealed the summary judgment rulings
to the United States Court of Appeals for the Eighth Circuit.
Oral argument was scheduled for February 12, 2003, but will
be rescheduled to a later date.

On June 6, 2001, in Blue Cross and Blue
Shield of New Jersey, Inc. v. Philip Morris, Inc., a federal
court jury in Brooklyn returned a verdict in favor of
RJR Tobacco and other tobacco defendants on common law
fraud and civil RICO claims, but found for the plaintiff, Empire
Blue Cross and Blue Shield, on a claim under a New York state
deceptive business practices statute. Empire pursued its claims
against the defendants on behalf of itself directly, as well as
on the behalf of its insureds under a theory of subrogation. The
jury verdict on the direct claim was approximately
$17.8 million, and the verdict on the subrogated claim was
approximately $11.8 million. RJR Tobaccos
portion of these amounts is $6.6 million and
$4.4 million, respectively. Pursuant to New York law,
Empire elected the verdict on the direct claim. The New York
statute under which Empire recovered does not provide for
punitive damages, but does allow for recovery of reasonable
attorneys fees. On February 28, 2002, Judge Weinstein
awarded plaintiffs counsel approximately $38 million
in attorneys fees. On July 2, 2002, Judge Weinstein
denied defendants renewed motion to dismiss. He also
refused to transfer the claims of non-New York plans to their
respective states, and continued the stay of those claims, as
well as all remaining claims of Blue Cross Blue Shield plans
until final resolution of the Empire Blue Cross case. The
defendants, including RJR Tobacco, have appealed to the
United States Court of Appeals for the Second Circuit, and oral
argument occurred February 13, 2003.

Native American
Tribes.As of February 4, 2003,
two cases brought by Native American tribes were pending against
RJR Tobacco. On July 15, 2002, in Alabama Coushatta
Tribe of Texas v. American Tobacco Co., the United States
Court of Appeals for the Fifth Circuit affirmed the dismissal of
a complaint by a federal district court in Texas.
Plaintiffs petition for rehearing was subsequently denied
on August 15, 2002. Plaintiffs filed a petition for writ of
certiorari in the U.S. Supreme Court, which was denied on
January 21, 2003, thus ending the case. On January 25,
2002, in the Navajo Nation v. Philip Morris, Inc., the
District Court of Navajo Nation granted defendants motion
to dismiss conspiracy, deceptive acts and restraint of trade
claims. The court refused to dismiss plaintiffs product
liability claim. In response, plaintiffs filed a motion to
alter, amend and/or clarify the January 25, 2002 order. No
decision has been made by the court. One other Native American
tribe case remains pending before a tribal court in South Dakota.

Hospitals.As of
February 4, 2003, three cases brought by hospitals were
pending against RJR Tobacco. In May 2000, in A.O. Fox
Memorial Hospital v. American Tobacco Co., Inc., pending in
state court in Nassau County, New York, a group of approximately
175 hospitals filed suit against the tobacco industry
seeking at least $3.6 billion for costs expended to treat
smoking-related illnesses. On December 14, 2001,
defendants motion to dismiss was granted. Plaintiffs
appealed the dismissal to the Appellate Division of the Supreme
Court, Second Judicial Department, which affirmed the trial
courts dismissal on February 10, 2003.

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MSA-Enforcement and Validity

As of February 4, 2003, seven cases were
pending against RJR Tobacco concerning the enforcement and
validity of the MSA. The litigation challenging the validity of
the MSA, including claims that the MSA violates antitrust laws,
has not been successful.

Arizona, California, New York and Washington have
alleged that the posting of signage advertising
RJR Tobaccos brand-name sponsorship violates a
provision of the MSA governing the times during which such signs
may be posted. Courts in Arizona, on November 16, 2001, and
California, on November 27, 2001, ruled against
RJR Tobacco. On February 1, 2002, a New York court
ruled in favor of RJR Tobacco. Appeals of all of these
decisions are pending. The Washington matter was rendered moot
and was dismissed.

The State of Ohio alleged that
RJR Tobaccos purchase of advertising space on
matchbooks distributed by an independent third party violates a
provision of the MSA governing brand-name merchandise. On
April 25, 2002, the Ohio court ruled in favor of
RJR Tobacco. Oral argument in Ohios appeal was heard
on January 21, 2003.

Finally, the State of California alleged, in the
context of the placement of print advertising, that
RJR Tobacco is in violation of the prohibition in the MSA
against taking any action, directly or indirectly, to
target youth. In a decision issued on July 12, 2002,
the trial judge found that although youth may not have
been directly targeted . . . RJR indirectly targeted youth,
thereby violating the MSA. In addition, the judge issued a
$20 million fine. RJR Tobacco believes the judges
decision to be erroneous as a matter of fact and law and is
appealing the ruling.

Asbestos Contribution Cases

As of February 4, 2003, five lawsuits were
pending against RJR Tobacco in which asbestos companies
and/or asbestos-related trust funds allege that they
overpaid claims brought against them to the extent
that tobacco use, not asbestos exposure, was the cause of the
alleged personal injuries for which they paid compensation. On
May 24, 2001, a Mississippi state court judge dismissed all
such claims by Owens-Corning in Estate of Ezell Thomas v.
RJR Tobacco Co.Owens-Corning appealed the dismissal to
the Mississippi Supreme Court on August 15, 2001. That
appeal remains pending. A similar case, H.K. Porter Co., Inc.
v. American Tobacco Co., was pending in the United States
District Court for the Eastern District of New York before Judge
Weinstein. However, on July 26, 2001, the parties
stipulated to a dismissal of the action. In Fibreboard Corp.
v. R. J. Reynolds Tobacco Co., a case pending in state court
in California, Owens-Corning and Fibreboard asserted the same
claims as those asserted in the Mississippi case. Motions to
dismiss those claims have been held in abeyance pending the
final determination of the Mississippi case.

Antitrust Cases

A number of tobacco wholesalers, or indirect
purchasers, sued United States cigarette manufacturers,
including RJR Tobacco, and its parent company, RJR,
alleging that cigarette manufacturers combined and conspired to
set the price of cigarettes, in violation of antitrust statutes
and various state unfair business practices statutes. Of the 36
such cases pending against RJR Tobacco, 30 cases are
pending in state court, and six cases are pending in federal
court. Plaintiffs are asking the court to certify the lawsuits
as class actions on behalf of other persons that purchased
cigarettes directly from one or more of the defendants. The
federal cases were consolidated and sent by the Judicial Panel
on Multi-District Litigation for pretrial proceedings in the
United States District Court for the Northern District of
Georgia. The court certified a class of direct purchasers on
January 27, 2001. The court granted defendants motion
for summary judgment in the consolidated federal cases on
July 11, 2002. Plaintiffs appealed to the U.S. Court of
Appeals for the Eleventh Circuit on July 19, 2002. Oral
argument is scheduled for between April 1 and April 4,
2003. State court cases on behalf of indirect purchasers have
been dismissed in Arizona, which is currently on appeal, and New
York. In addition, on November 15, 2002, a District of
Columbia court dismissed all claims arising prior to
May 11, 1996. A Minnesota court denied class certification
on November 21, 2001. A Kansas court granted class

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certification on November 15, 2001, and a
Michigan court denied class certification on June 11, 2002.
New Mexico and North Dakota courts denied defendants
motions to dismiss on July 8, 2002 and June 25, 2002,
respectively.

On July 30, 1999, Cigarettes Cheaper!, a
retailer, filed an antitrust counterclaim against
RJR Tobacco in a gray market trademark suit originally
brought by RJR Tobacco in the United States District Court
for the Northern District of Illinois. Cigarettes Cheaper!
alleges that it was denied promotional resources in violation of
the Robinson-Patman Act. The district court declined to dismiss
the counterclaim. On January 23, 2001, the court granted
Cigarettes Cheaper!s motion to amend its counterclaim to
include a violation of the Sherman Act §1, claiming that
RJR Tobacco conspired with other retailers to deny
promotions to Cigarettes Cheaper!, an allegation that
RJR Tobacco denies. On March 21, 2001,
RJR Tobaccos motion to add a trademark dilution claim
against Cigarettes Cheaper! was granted. On June 28, 2001,
the court granted RJR Tobaccos motion to strike with
prejudice several of Cigarettes Cheaper!s affirmative
defenses. These defenses related to: (1) alleged
misrepresentations caused by the packaging of cigarettes
manufactured by RJR Tobacco for export;
(2) RJR Tobaccos No Bull advertising
campaign for its WINSTON cigarettes; (3) antitrust
trademark misuse; (4) nominative fair use; and (5) the
first sale doctrine. The court denied RJR Tobaccos
motion for summary judgment on Cigarettes Cheaper!s
counterclaim on January 21, 2003. The court severed the
main claim and counterclaim. Trial is scheduled to begin on the
trademark case, in which RJR Tobacco is a plaintiff, on
March 3, 2003. The trial date on the antitrust case is yet
to be determined.

On February 16, 2000, a class action
complaint, Deloach v. Philip Morris Cos., Inc., was
brought against RJR Tobacco, other cigarette manufacturers
and others, in the United States District Court for the District
of Columbia on behalf of a putative class of all tobacco growers
and tobacco allotment holders. Plaintiffs assert that the
defendants, Philip Morris, Inc., RJR Tobacco, Brown &
Williamson Tobacco Corp. and Lorillard Tobacco Co., engaged in
bid-rigging of American burley and flue-cured tobacco auctions
beginning at least by 1996 and continuing to present.
Defendants actions are alleged to have held the auction
prices of tobacco at artificially low prices resulting in damage
to tobacco growers and allotment holders. In addition,
plaintiffs allege that defendants have engaged in a conspiracy
to force the elimination or destruction of the federal
governments tobacco quota and price support program
through an alleged illegal group boycott. On October 9,
2000, defendants filed a motion to dismiss the second amended
complaint and a motion to transfer venue to the United States
District Court for the Middle District of North Carolina. On
November 30, 2000, the court granted the motion to transfer
the case. On December 20, 2000, plaintiffs moved to amend
the complaint to add the leaf-buying companies Dimon, Universal
Leaf and Standard Commercial as defendants, which motion was
allowed. Plaintiffs motion to certify the class was
granted on April 3, 2002. On April 16, 2002,
RJR Tobacco and the other defendants petitioned the U.S.
Court of Appeals for the Fourth Circuit to review the class
certification ruling. On June 12, 2002, the Fourth Circuit
declined to review the class certification ruling, and on
July 8, 2002, the court denied a petition for rehearing.
The case is now in the discovery phase. Trial is scheduled for
April 19, 2004.

On December 4, 2002, Leslie H. Dial, owner
of Leslie H. Dial Enterprises, filed suit against
RJR Tobacco, Wal-Mart Stores, Inc. and Sams Club in
the U.S. District Court for the District of South Carolina. The
suit alleges that Dial Enterprises, a tobacco distribution
company, was denied participation in RJR Tobaccos
pricing promotions on proportionally equal terms to competitors,
such as Wal-Mart and Sams Club, in violation of the
Robinson-Patman Act. The suit also claims that RJR Tobacco
conspired with Wal-Mart Stores and Sams Club to restrain
pricing competition in the marketing of cigarettes, thereby
allegedly harming Dial Enterprises business. The suit
seeks unspecified damages. Plaintiff has requested a bench trial.

Other Litigation and Developments

On January 24, 2003, RJR and
RJR Tobacco were each served with a subpoena dated
January 7, 2003, and issued by a federal grand jury sitting
in the Southern District of New York. The subpoena seeks the
production of documents relating to the sale and distribution of
cigarettes in international markets. RJR and

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RJR Tobacco intend to respond appropriately
to the subpoena and otherwise cooperate with this grand jury
investigation.

RJR Tobacco is aware of a grand jury
investigation in North Carolina that relates to the cigarette
business of certain of its former affiliates. In connection with
this investigation, RJR Tobacco responded to document
subpoenas dated July 7, 1999 and June 1, 2000,
respectively.

On December 22, 1998, Northern Brands
International, Inc. entered into a plea agreement with the
United States Attorney for the Northern District of New York.
Northern Brands is a now-inactive RJR subsidiary that was part
of the business of R. J. Reynolds International B.V.,
a former Netherlands subsidiary of RJR Tobacco, which was
managed by a former affiliate, RJR-MacDonald, Inc. On
May 12, 1999, RJR-MacDonald, Inc. was sold to Japan Tobacco
Inc. and subsequently changed its name to JT-MacDonald, Inc.
Northern Brands was charged with aiding and abetting certain
customers who brought merchandise into the United States
by means of false and fraudulent practices . . . .
It is understood that JT-MacDonald, Inc., Japan Tobaccos
international operating company in Canada, is cooperating with
an investigation now being conducted by the Royal Canadian
Mounted Police relating to the same events that gave rise to the
Northern Brands investigation.

On December 21, 1999, the government of
Canada filed a lawsuit in the United States District Court for
the Northern District of New York against RJR Tobacco, RJR,
several currently and formerly related companies, including
Northern Brands, and the Canadian Tobacco Manufacturers Council.
The lawsuit alleges that, beginning in 1991, the defendants
conspired with known distributors and smugglers to illegally
import into Canada tobacco products originally earmarked for
export from Canada, in a fashion that avoided the imposition of
certain excise and retail taxes and duty payments. On
June 30, 2000, this case was dismissed by the United States
District Court for the Northern District of New York. Plaintiff
appealed the dismissal to the United States Court of Appeals for
the Second Circuit, which, on October 12, 2001, affirmed
the district courts dismissal. On December 12, 2001,
the Court of Appeals denied Canadas petition for
rehearing. In March 2002, Canada filed a petition for a writ of
certiorari with the Supreme Court of the United States. The
Supreme Court denied Canadas petition on November 4,
2002, thereby bringing Canadas case to an end. The
government of Canada has indicated that it might pursue these
claims in Canada. Although the international tobacco business
was sold, RJR and RJR Tobacco retained certain liabilities
relating to the events disclosed above.

Similar lawsuits have been filed against RJR
Tobacco and its affiliates, along with other cigarette
manufacturers, by the European Community and ten of its member
states (Belgium, Finland, France, Greece, Germany, Italy,
Luxembourg, the Netherlands, Portugal and Spain), as well as by
Ecuador, Belize and Honduras. These suits contend that RJR
Tobacco and other tobacco companies in the United States may be
held responsible for damages caused by cigarette smugglers under
common law and under the federal RICO statute. Each of these
actions seeks compensatory, punitive and treble damages.

On July 17, 2001, the action brought by the
European Community was dismissed by the United States District
Court for the Eastern District of New York. However, the
European Community and its member states filed a similar
complaint in the same jurisdiction on August 6, 2001. On
October 25, 2001, the court denied the European
Communitys request of August 10, 2001, to reinstate
its original complaint. On November 9, 2001, the European
Community and the ten member states amended their complaint
filed on August 6, 2001, to change the name of defendant
Nabisco Group Holdings Corp. to RJR Acquisition Corp. RJR
Tobacco and the other defendants filed motions to dismiss that
complaint on November 14, 2001, and the court heard oral
argument on those motions on January 11, 2002. On
February 25, 2002, the court granted defendants
motion to dismiss the complaint and, on March 25, 2002,
plaintiffs filed a notice of appeal with the United States Court
of Appeals for the Second Circuit. Oral argument occurred on
January 29, 2003.

On October 30, 2002, the European Community
and ten of its member states (Belgium, Finland, France, Greece,
Germany, Italy, Luxembourg, the Netherlands, Portugal and Spain)
filed a third complaint against RJR, RJR Tobacco and several
currently and formerly related companies in the United States
District Court

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STATEMENTS  (Continued)


for the Eastern District of New York. The
complaint, which contains many of the same or similar
allegations found in two earlier complaints that were previously
dismissed by the same court, alleges that the defendants,
together with certain identified and unidentified persons,
including organized crime organizations and drug cartels,
engaged in money laundering and other conduct for which they
should be accountable to the plaintiffs under civil RICO and a
variety of common law claims. The complaint also alleges that
the defendants manufactured cigarettes which were eventually
sold in Iraq in violation of U.S. sanctions against such sales.
The plaintiffs are seeking unspecified actual damages (to be
trebled), costs, reasonable attorneys fees and injunctive
relief under their RICO claims, and unspecified compensatory and
punitive damages, and injunctive and equitable relief under
their common law claims.

On December 20, 2000, October 15, 2001,
and January 9, 2003, applications for annulment were filed
in the Court of First Instance in Luxembourg challenging the
competency of the European Community to bring each of the
foregoing actions and seeking an annulment of the decision to
bring each of the actions, respectively. On January 15,
2003, the Court of First Instance entered a judgment denying the
admissibility of the first two applications, principally on the
grounds that the filing of the first two complaints did not
impose binding legal effects on the applicants. RJR and its
affiliates are considering an appeal of that judgment. The
application for annulment filed in connection with the third
action is still pending before the Court of First Instance.

RJR Tobacco and other defendants filed motions to
dismiss the actions brought by Ecuador, Belize and Honduras in
the United States District Court for the Southern District of
Florida. These motions were granted on February 26, 2002,
and the plaintiffs filed a notice of appeal with the United
States Court of Appeals for the Eleventh Circuit on
March 26, 2002. The Eleventh Circuit heard oral argument on
these motions on December 10, 2002, and its decision is
pending.

RJR Tobacco has been served in two reparations
actions brought by descendants of slaves. Plaintiffs in these
actions claim that defendants, including RJR Tobacco, profited
from the use of slave labor. These two actions have been
transferred to the Northern District of Illinois by the Judicial
Panel on Multi-District Litigation for coordinated or
consolidated pretrial proceedings with other reparation actions.
Seven additional cases were originally filed in California,
Illinois and New York. RJR Tobacco is a named defendant in only
one of these additional cases, but it has not been served. The
action in which RJR Tobacco is named but has not been served was
conditionally transferred to the Northern District of Illinois
on January 7, 2003.

On June 8, 2001, the Attorney General of the
State of California filed a lawsuit against RJR Tobacco in
California state court alleging that RJR Tobacco violated
California state law by distributing free cigarettes and free
coupons for discounts on cigarettes on public
grounds, even though the promotions occurred within an
adult-only facility at a race track and certain
festivals. RJR Tobacco answered the complaint on July 19,
2001, asserting that its promotions complied with all laws,
including California state law and that this California state
law is preempted by the Federal Cigarette Labeling Act. On
March 29, 2002, the court ruled that RJR Tobaccos
distribution of free cigarettes violated the law, but the
distribution of free coupons for discounts on cigarettes did
not. On April 29, 2002, the judge assessed a civil fine
against RJR Tobacco of $14.8 million. RJR Tobacco is appealing.

On May 23, 2001, Star Scientific, Inc. filed
a patent infringement action against RJR Tobacco in the United
States District Court for the District of Maryland. The suit
alleges infringement of U.S. Patent No. 6,202,649 entitled
Method of Treating Tobacco to Reduce Nitrosamine Content,
and Products Produced Thereby. On July 30, 2002, Star
filed another infringement action against RJR Tobacco in the
United States District Court for the District of Maryland
alleging infringement of a related patent, U.S. Patent
No. 6,425,401 also entitled Method of Treating
Tobacco to Reduce Nitrosamine Content, and Products Produced
Thereby. RJR Tobacco has filed counterclaims seeking a
declaration that the claims of the two Star patents in dispute
are invalid, unenforceable and not infringed by RJR Tobacco. The
Maryland court has consolidated the two cases, and discovery is
ongoing.



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STATEMENTS  (Continued)


Although RJRs management continues to
conclude that the loss of any particular smoking and health
tobacco litigation claim against RJR Tobacco or its affiliates,
when viewed on an individual basis, is not probable, the
possibility of material losses related to tobacco litigation is
more than remote. Litigation is subject to many uncertainties,
and it is not possible to predict the outcome of the litigation
pending against RJR Tobacco, or its affiliates, including RJR,
or indemnitees.

Unfavorable judgments awarding compensatory
damages, punitive damages and/or fines have been returned
against RJR Tobacco in the Engleclass action case, a
small number of individual smoking and health cases, a Broin
IIflight attendant ETS case, an MSA enforcement action and
a California state law enforcement action. Although RJR Tobacco
believes that it has numerous bases for successful appeals in
these cases, and both RJR Tobacco and RJR believe they have a
number of valid defenses to all actions and intend to defend all
actions vigorously, it is possible that there could be further
adverse developments in these cases, and that additional cases
could be decided unfavorably against RJR Tobacco or its
affiliates or indemnitees. Determinations of liability or
adverse rulings in such cases or in similar cases involving
other cigarette manufacturers as defendants, even if such
judgments are not final, could materially adversely affect the
litigation against RJR Tobacco or its affiliates or indemnitees,
and could encourage the commencement of additional
tobacco-related litigation. In addition, a number of political,
legislative, regulatory and other developments relating to the
tobacco industry and cigarette smoking have received wide media
attention. These developments may negatively affect the outcomes
of tobacco-related legal actions and encourage the commencement
of additional similar litigation.

Although it is impossible to predict the outcome
of such events on pending litigation and the rate new lawsuits
are filed against RJR Tobacco and RJR, a significant increase in
litigation and/or in adverse outcomes for tobacco defendants
could have a material adverse effect on either or both of these
entities. Moreover, notwithstanding the quality of defenses
available to it and its affiliates in litigation matters, it is
possible that RJRs results of operations, cash flows or
financial condition could be materially adversely affected by
the ultimate outcome of certain pending or future litigation
matters.

ERISA Litigation

On May 13, 2002, in Tatum v. The R.J.R.
Pension Investment Committee of the R. J. Reynolds Tobacco
Company Capital Investment Plan, pending in the United
States District Court for the Middle District of North Carolina,
an employee of RJR Tobacco filed a class action suit alleging
that the defendants, RJR, RJR Tobacco, the RJR Employee Benefits
Committee and the RJR Pension Investment Committee, violated the
Employee Retirement Income Security Act of 1974, referred to as
ERISA. The actions about which plaintiff complains stem from a
decision made in 1999 by RJR Nabisco Holdings Corp.,
subsequently renamed Nabisco Group Holdings Corp., to spin-off
RJR, thereby separating NGHs tobacco business and food
business. As part of the spin-off, the 401(k) plan for the
previously related entities had to be divided into two separate
plans for the now separate tobacco and food businesses.
Plaintiff contends that defendants violated ERISA by not
overriding an amendment to RJRs 401(k) plan requiring
that, prior to February 1, 2000, the stock funds of the
companies involved in the food business  NGH and Nabisco
Holdings Corp.  be eliminated as investment options from
RJRs 401(k) plan. In his complaint, plaintiff requests,
among other things, that the court issue an order requiring the
defendants to pay as damages to the RJR 401(k) plan an amount
equal to the subsequent appreciation that was purportedly lost
as a result of the liquidation of the NGH and Nabisco Holdings
Corp. funds. Defendants filed a motion to dismiss on
July 29, 2002. The court has not yet ruled on the motion.

Environmental Matters

RJR and its subsidiaries are subject to federal,
state and local environmental laws and regulations concerning
the discharge, storage, handling and disposal of hazardous or
toxic substances. Such laws and regulations provide for
significant fines, penalties and liabilities, sometimes without
regard to whether the owner or operator of the property knew of,
or was responsible for, the release or presence of hazardous or
toxic

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STATEMENTS  (Continued)


substances. In addition, third parties may make
claims against owners or operators of properties for personal
injuries and property damage associated with releases of
hazardous or toxic substances. In the past, RJR Tobacco has been
named a potentially responsible party, referred to as a PRP,
with third parties under the Comprehensive Environmental
Response, Compensation and Liability Act, with respect to
several superfund sites.

Regulations promulgated by the U.S. Environmental
Protection Agency and other governmental agencies under various
statutes have resulted in, and likely will continue to result
in, substantial expenditures for pollution control, waste
treatment, plant modification and similar activities. RJR and
its subsidiaries monitor their environmental matters and,
dependent upon the probability of occurrence and reasonable
estimation of cost, accrue or disclose any material liability.

Del Monte Corporation, a former subsidiary of
RJR, is named a defendant in a lawsuit related to a superfund
site in Hawaii, Akee v. The Dow Chemical Co., filed in
the First Circuit Court of the State of Hawaii on
October 7, 1999. The superfund site includes land on which
Del Monte Corporation maintained fresh fruit operations at one
time. In connection with litigation related to the superfund
site, Del Monte Corporation also has received a demand for
indemnity from an entity that was a chemical supplier to Del
Monte Corporation. Del Monte Corporation has sought indemnity
from RJR under the terms of the agreement by which RJR sold Del
Monte Corporation in 1990. RJR, in turn, has provided notice of
these claims to the buyers of the Del Monte fresh fruit
business, asserting the right to be indemnified by the buyers of
the fresh fruit business for any liability arising out of such
claims under the terms of the agreement by which RJR sold the
Del Monte fresh fruit business in 1989.

Pursuant to an agreement dated June 12,
2001, among RJR, the buyers of the Del Monte fresh fruit
business, Del Monte Corporation and others, the buyers of the
Del Monte fresh fruit business agreed, from the date of the
agreement forward, to indemnify RJR for any liabilities imposed
in Akeeand with respect to the environmental
investigation and remediation of the superfund site required by
the EPA.

On June 1, 2001, RJR received notice from
Del Monte Corporation of a claim made against it by a Hawaii
landowner who has been sued by a lessee of its land, claiming
injuries due to pesticide contamination of the soil, allegedly
caused by Del Monte Corporation as a prior lessee of the land.
The landowner-defendant has tendered the claim to Del Monte
Corporation for defense and indemnity. Del Monte Corporation has
in turn tendered the claim to RJR for defense and indemnity,
claiming it is entitled to be indemnified under the terms of the
agreement by which RJR sold Del Monte Corporation. Based on the
plaintiffs failure to provide any factual information in
support of its claim that Del Monte Corporation was a prior
lessee of the subject land, Del Monte Corporation has agreed to
extend indefinitely the period during which RJR must respond to
Del Monte Corporations tender of the claim to RJR for
defense and indemnity, subject to the right to terminate the
indefinite extension on fifteen days notice to RJR.

On February 21, 2002, Del Monte Corporation
was served with complaints filed in Nicaragua, referred to as
the Nicaraguan Complaints, asserting claims on behalf of
agricultural workers allegedly harmed or injured by exposure to
certain chemicals used in banana plantations in Nicaragua. Del
Monte Corporation has requested that RJR acknowledge its
obligation to indemnify Del Monte Corporation in connection with
such claims. RJR has provided notice of such claims and a
request for indemnification to the buyers of the Del Monte fresh
fruit business. In response to the notice and request of RJR,
Del Monte Fresh Produce Company accepted the tender of the
claims and agreed to provide a defense to Del Monte Corporation.
Del Monte Corporation has agreed to withdraw its tender of such
claims to RJR, without waiving its right to again tender the
claims to RJR should Del Monte Fresh Produce Company withdraw
its agreement to defend and indemnify Del Monte Corporation.

On June 13, 2002, counsel for plaintiffs in
the Nicaraguan complaints acknowledged that attempted service of
process of all such cases on Del Monte Corporation, doing
business as Del Monte Foods Company, referred to as Del Monte,
was improper. Further, on June 13, 2002, the parties filed
a written stipulation that Del Montes motion to quash the
attempted service of the Nicaraguan Complaints should be granted
and that

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STATEMENTS  (Continued)


any future service on Del Monte of any other
similar cases alleging the same material facts and naming the
same defendants also should be deemed to be quashed. Pursuant to
the parties stipulation, the U. S. District Court for the
Northern District of California signed an order on June 13,
2002, granting Del Montes motion to quash the attempted
service of the Nicaraguan complaints.

RJR Tobacco was notified by the EPA on
June 11, 2000, of its potential liability under CERCLA for
a superfund site in Greer, South Carolina. The notice and demand
for reimbursement of costs incurred by the EPA were sent to a
group of approximately 43 potentially responsible parties,
including RJR Tobacco, and involve an aggregate exposure
presently estimated to be approximately $5.1 million.
Apportionment among the PRPs has not been completed, but RJR
Tobacco believes that its apportionment will be immaterial to
its results of operations, cash flows or financial condition.
The PRPs are a group of companies previously involved as
potentially responsible parties in another superfund site. The
EPA alleges that some waste from the cleanup of the other site
was transported to the site in question. RJR Tobacco has
executed and extended a tolling agreement with the EPA. This
tolling agreement provides for entry into good faith
negotiations with the EPA, and is not an admission of fact or
liability. The tolling agreement also should have no impact on
any defense RJR Tobacco may assert, other than a defense based
on the running of the statute of limitations. Information is
being gathered from other potentially responsible parties
notified by the EPA and an environmental consultant working on
behalf of the PRP group, which includes RJR Tobacco.

RJR Tobacco is a named defendant in a lawsuit
related to an existing superfund site in North Carolina,
United States v. AAF-McQuay, Inc.,which was filed in
U.S. District Court for the Western District of North Carolina
on August 12, 2002. The Jadco-Hughes superfund
site near Belmont, North Carolina, is land on which a solvent
reclamation and disposal business was owned and operated in the
1970s. It was placed on the National Priorities List in 1986.
RJR Tobacco, through its packaging division (formerly known as
RJR Archer), as a member of a group of 24 previously identified
PRPs, executed a waiver of service of summons in this matter. A
joint motion of plaintiff and all defendants for a stay of all
proceedings and for an extension of time for all defendants to
file answers or responses to the complaint was granted on
January 7, 2003. EPA filed the action as a result of the
expiration of a then-existing tolling agreement that could not
be timely renewed. The PRP group had requested information from
the EPA regarding various EPA costs related to the Jadco-Hughes
site. The parties are cooperating to seek a resolution of this
matter. The aggregate exposure for the Jadco-Hughes site for all
PRPs is presently approximately $9.2 million. Apportionment
among the PRPs places RJR Tobacco in the top third.

RJR and its subsidiaries have been engaged in a
continuing program to comply with federal, state and local
environmental laws and regulations. Although it is difficult to
reasonably estimate the portion of capital expenditures or other
costs attributable to compliance with environmental laws and
regulations and to estimate the cost of resolving these CERCLA
matters, RJR does not expect such expenditures or other costs to
have a material adverse effect on the business, results of
operations or financial condition of RJR or its subsidiaries.

Other Contingencies

Until the acquisition by merger by Philip Morris
Companies, Inc. of Nabisco from NGH on December 11, 2000,
NGH and Nabisco were members of the consolidated group of NGH
for U.S. federal income tax purposes. Each member of a
consolidated group is jointly and severally liable for the U.S.
federal income tax liability of other members of the group as
well as for pension and funding liabilities of the other group
members. NGH, now known as RJR Acquisition Corp., continues to
be jointly and severally liable for these Nabisco liabilities
prior to December 11, 2000.

In connection with Philip Morris
acquisition by merger of Nabisco and RJRs subsequent
acquisition by merger of NGH, Philip Morris, Nabisco and NGH
entered into a voting and indemnity agreement that generally
seeks to allocate tax liabilities ratably based upon NGHs
taxable income and that of Nabisco, had the parties been
separate taxpayers. If Philip Morris and Nabisco are unable to
satisfy their obligations under this agreement, NGH would be
responsible for satisfying them.

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NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


In connection with the sale of the international
tobacco business to Japan Tobacco Inc. on May 12, 1999, RJR
and RJR Tobacco agreed to indemnify Japan Tobacco against
(1) any liabilities, costs and expenses arising out of the
imposition or assessment of any tax with respect to the
international tobacco business arising prior to the sale, other
than as reflected on the closing balance sheet, (2) any
liabilities, costs and expenses that Japan Tobacco or any of its
affiliates, including the acquired entities, may incur after the
sale in respect of any of RJRs or RJR Tobaccos
employee benefit and welfare plans and (3) any liabilities,
costs and expenses incurred by Japan Tobacco or any of its
affiliates arising out of certain activities of Northern Brands.
Although it is impossible to predict the outcome of the Northern
Brands litigation or the amount of liabilities, costs and
expenses, a significant adverse outcome regarding any of these
items could have an adverse effect on either or both of RJR and
RJR Tobacco.

RJR, RJR Tobacco and RJR Acquisition Corp. will
be required to pledge all of their assets to secure their
obligations under RJRs revolving credit facility if the
guaranteed unsecured notes of RJR are rated below BBB- by
Standard & Poors and below Baa3 by Moodys, or
two levels below these thresholds for either of these rating
agencies. If RJR and the guarantors are required to pledge their
assets to secure their obligations under the revolving credit
facility, as amended and restated, they also will be required to
pledge certain of their assets to secure RJRs guaranteed
unsecured notes.

As long as RJRs unsecured, unsubordinated
debt rating remains investment grade, RJR may be required to
post collateral under its interest rate swap agreements if the
fair value of the interest rate swaps results in a liability
position that exceeds specified threshold amounts. If RJRs
unsecured, unsubordinated debt rating is either one level below
BBB- by Standard & Poors or Baa3 by Moodys, any
fair value that results in a liability position of the interest
rate swaps, will require full collateralization. In addition, as
long as RJRs existing revolving credit facility is in
place, if RJR and the guarantors are required to pledge their
assets to secure their obligations under RJRs revolving
credit facility, as amended and restated, such pledge also will
secure their obligations under these interest rate swap
agreements.

Since the spin-off in 1999, RJRs unsecured,
unsubordinated debt notes have maintained the ratings of BBB-by
Standard & Poors and Baa2 by Moodys. In December
2002, Moodys revised its outlook to negative but
maintained its rating, reflecting its concern over the impact of
industry trends including heavy promotional activity in the
premium price-tier and the growth of the deep-discount
price-tier despite the reduction in payments under the MSA.

Note 15  Financial
Instruments

Interest Rate Arrangements

RJR uses interest rate swaps to manage interest
rate risk on a portion of its debt obligations. When entered
into, these financial instruments are designated as hedges of
underlying exposures. Because of the high correlation between
the hedging instrument and the underlying exposure being hedged,
fluctuations in the value of the instruments generally are
offset by changes in the underlying exposures.

During the first and second quarters of 2002, RJR
entered into interest rate swap agreements to modify the
interest characteristics of $1.25 billion, a portion of its
publicly registered notes, with fixed rates of 6.5% to 7.75%,
due in 2006 to 2012, so that the interest payable effectively
becomes variable. As a result, as of December 31, 2002, the
average interest rate on RJRs $2.5 billion long-term debt
was 5.44%. The interest rate swaps notional amounts and
termination dates match those of the outstanding registered
notes. These interest rate swap agreements are guaranteed by RJR
Tobacco and RJR Acquisition Corp. As of December 31, 2002,
these fair value hedges were perfectly effective, resulting in
no recognized net gain or loss. The unrealized gain of the
hedges resulting from the change in the hedges fair value
from inception to December 31, 2002, was $118 million,
included in other assets and deferred charges, and is equal to
the increase in the fair value of the hedged long-term debt.

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NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


As long as RJRs unsecured, unsubordinated
debt rating remains investment grade, RJR may be required to
post collateral under its interest rate swap agreements if the
fair value of the swaps results in a liability position that
exceeds specified threshold amounts. If RJRs unsecured,
unsubordinated debt rating is either one level below BBB-by
Standard & Poors or Baa3 by Moodys, any fair
value that results in a liability position of the interest rate
swaps will result in full collateralization. In addition, as
long as RJRs existing revolving credit facility is in
place, if RJR and the guarantors are required to pledge their
assets to secure their obligations under RJRs revolving
credit facility, as amended and restated, such pledge also will
secure their obligations under these interest rate swap
agreements.

Since the spin-off in 1999, RJRs unsecured,
unsubordinated debt notes have maintained the ratings of BBB-by
Standard & Poors and Baa2 by Moodys. In December
2002, Moodys revised its outlook to negative but
maintained its rating, reflecting its concern over the impact of
industry trends including heavy promotional activity in the
premium price-tier and the growth of the deep-discount
price-tier despite the reduction in payments under the MSA.

Foreign Currency Arrangements

During 2002, RJR Tobacco settled forward currency
exchange contracts to purchase 12.9 million euros, which hedged
unrecognized firm commitments for the purchase of equipment. The
$1 million effective unrealized loss is included in accumulated
other comprehensive income and will be recognized as the
underlying equipment cost is recognized in earnings, generally
over its depreciable life. The ineffective portion of the hedge
was insignificant and was recorded as a foreign exchange gain in
other expense.

At December 31, 2002, RJR Tobacco held
forward currency exchange contracts as hedges of unrecognized
firm commitments for the purchase of equipment, for a net
purchase of 3.2 million euros, with maturities that average less
than 12 months. As of December 31, 2002, the insignificant
net increase in the fair value of the effective portion of the
foreign currency cash flow hedges resulted in an unrealized
gain, and was recorded in accumulated other comprehensive income
in the accompanying consolidated balance sheet. The ineffective
portion of the hedges was insignificant and was recorded as a
foreign exchange gain in other expense during the year ended
December 31, 2002.

See notes 8 and 13 for additional disclosures of
fair value for short-term investments and long-term debt.

Credit Risk

RJR and its subsidiaries minimize counterparty
credit risk related to their financial instruments by using
major institutions with high credit ratings.

Note 16  Stockholders
Equity

RJRs authorized capital stock at
December 31, 2002 consisted of 50 million shares of
preferred stock, par value $0.01 per share, and 290 million
shares of common stock, par value $0.01 per share. The preferred
stock, none of which is issued or outstanding, ranks senior to
common stock as to dividends and liquidation preferences. From
the third quarter of 1999 through the second quarter of 2001,
RJRs board of directors declared a quarterly cash dividend
of $0.775 per common share, or $3.10 on an annualized basis.
Beginning with the third quarter of 2001, the board of directors
declared a quarterly cash dividend of $0.875 per common share,
or $3.50 on an annualized basis. Beginning with the second
quarter of 2002, the board of directors declared a quarterly
cash dividend of $0.95 per common share, or $3.80 on an
annualized basis.

The following tables summarize stock repurchases
from November 1999 to December 31, 2002. These repurchases
have been made under programs authorized by RJRs board of
directors and funded through cash provided by operating
activities and from RJR Acquisition Corp., utilizing the cash
proceeds of the NGH acquisition. The objective of the current
program, authorized February 6, 2002 is to enhance
stockholder value, through the repurchase of shares of
RJRs common stock over time in the open market, with a

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NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


maximum aggregate cost of $1.0 billion. The
timing of repurchases and the number of shares repurchased under
this authorization amount will depend upon internal operating
cash requirements and market conditions. RJR also purchases
stock through a program designed to repurchase shares related to
the tax liability concerning certain option exercises and
restricted stock vesting transactions related to its 1999
Long-Term Incentive Plan. Shares held by RJR through repurchase,
in addition to shares forfeited pursuant to employee stock
plans, are included in treasury stock in RJRs consolidated
balance sheets.

|                           |                   |        |           |               |  |   |     |     | 
|-------------------------- | ----------------- | ------ | --------- | ------------- |  | - | --- | --- | 
|Repurchases  2002         |                   | Shares |           | Cost         
|                           |                   |        |           |              
|                           |                   |        |           | (in millions)
|$300 million authorization |                   |        | 1,600,000 |               |  | $ | 95  |    
|$1 billion authorization   |                   |        | 7,745,700 |               |  |   | 410 |    
|1999 LTIP tax withholding  |                   |        | 119,074   |               |  |   | 6   |    
|                           |                   |        |           |               |  |   |     |    
|                           | Total during 2002 |        |           | 9,464,774     |  |   | $   | 511 | 
|                           |                   |        |           |               |  |   |     |    

|                                     |                               |                                |  |        |            |            |  |   |     |       | 
|------------------------------------ | ----------------------------- | ------------------------------ |  | ------ | ---------- | ---------- |  | - | --- | ----- | 
|Cumulative                           |                               | Period Completed               |  | Shares |            | Cost      
|                                     |                               |                                |  |        |            |           
|Programs completed                   |                               | November 1999 to February 2002 |  |        | 21,570,739 |            |  | $ | 875 |      
|$1 billion approved February 6, 2002 |                               | Ongoing-$590 million remaining |  |        | 7,745,700  |            |  |   | 410 |      
|1999 LTIP tax withholding            |                               | Ongoing                        |  |        | 119,074    |            |  |   | 6   |      
|                                     |                               |                                |  |        |            |            |  |   |     |      
|                                     | Total as of December 31, 2002 |                                |  |        |            | 29,435,513 |  |   | $   | 1,291 | 
|                                     |                               |                                |  |        |            |            |  |   |     |      

Note 17  Stock Plans

As of December 31, 2002, RJR had two stock
plans, the Amended and Restated Equity Incentive Award Plan for
Directors, referred to as the EIAP, and the 1999 Long Term
Incentive Plan, referred to as the 1999 LTIP.

The EIAP currently provides for (1) grants
of stock options and deferred stock units to outside directors
upon becoming a director and (2) grants of deferred units
on a quarterly and annual basis thereafter. Directors may elect
to receive shares of common stock in lieu of their annual grant
of deferred stock units. A maximum of 500,000 shares of
common stock may be issued under this plan, of which
360,353 shares were available for grant as of
December 31, 2002. Options granted upon becoming a director
may be exercised between six months and ten years at a price
that is the market value of the stock on the grant date.
Effective in April 2000, the EIAP was amended to provide for
quarterly grants of deferred stock units in lieu of annual
grants of stock options. The annual stock option grants awarded
prior to the amendment of the EIAP in April 2000 each fully
vested in 2002 and are exercisable for ten years from the date
of grant. Deferred stock units granted under the EIAP have a
value equal to, and bear dividend equivalents at the same rate
as, one share of RJRs common stock at date of grant, and
have no voting rights. The dividends are paid as additional
units in an amount equal to the number of common shares that
could be purchased with the dividends on the date of payment. As
soon as practicable following his or her last year of service on
the board, the director is paid in cash for the units granted
quarterly and in common stock for the units granted annually,
unless the director elects to receive cash for the annual
grants. Cash payments are based on the average closing price of
RJRs common stock during December of the year preceding
payment.

The 1999 LTIP provides for grants of incentive
stock options, other stock options, stock appreciation rights,
restricted stock, performance units and performance shares to
key employees. The total number of shares of common stock
authorized for grant under the plan is 8,000,000 shares, plus
5,772,814 shares issuable under the NGH Long Term Incentive Plan
awards that, in connection with the spin-off, were converted
into 5,456,114 RJR options and 316,700 shares of restricted
common stock. Of this authorization, 4,289,116 shares were
available for grant as of December 31, 2002.

The spin-off did not change the value of the
option grant, ratio of exercise price to market value, vesting
provision or exercise period. The allocation of RJR options was
transferred into the 1999 LTIP. The resulting

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NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


316,700 restricted shares were transferred into
the 1999 LTIP. The five-year vesting provisions of the
restricted shares remain unchanged for those held by continuing
employees of RJR and its subsidiaries and lapsed on those held
by employees of the sold international tobacco business and NGH.
Compensation expense related to the restricted shares held by
continuing employees of RJR and its subsidiaries was
insignificant in each of 2002, 2001 and 2000. At
December 31, 2002, 35,832 shares remained restricted.
Unless forfeited, restrictions on all of these shares will lapse
in 2003. The unamortized portion remaining in stockholders
equity at December 31, 2002 was insignificant.

In 1999, RJR granted 777,000 shares of restricted
stock in tandem with 3,108,000 options, included in the
following option table, to eligible employees under the 1999
LTIP. On each vesting date, each eligible employee will receive
the portion of the tandem award with the highest value, the
vesting shares of RJR common stock or tandem stock options,
unless he or she has previously made an affirmative election
otherwise. Generally, these shares may not be disposed of, or
transferred while restricted during the three- to five-year
vesting period. Of these restrictions, 142,250 will lapse in
each of 2003 and 2004, unless the related shares are forfeited.
Since the date of grant, 492,500 shares have been forfeited. The
market price of the stock on the grant date was charged to
stockholders equity as unearned compensation and was
amortized on a straight-line basis over the vesting periods
through September 2000. Since the fourth quarter of 2000, it has
been more probable that holders will forfeit the restricted
stock grant at vesting and elect to exercise the related tandem
options. Accordingly, amortization of the unamortized equity to
compensation expense was suspended. As a result, the unamortized
portion of the shares vesting in 2002 was eliminated and the
previously recognized compensation expense was credited to
paid-in capital. During 2002, compensation expense was $1
million, including the dividends paid on unvested restricted
shares and the reversal of previous compensation expense that
resulted from the forfeiture of unvested restricted shares.
During 2001, a reversal of previous compensation expense of $1
million resulted from the forfeiture of unvested restricted
shares. Compensation expense of $4 million was recorded in 2000.
The unamortized portion remaining in stockholders equity
at December 31, 2002 was $6 million.

In 2000, RJR granted 673,898 shares of restricted
stock at $17.03 to eligible employees under the 1999 LTIP.
Generally, these shares may not be disposed of or transferred
during the three-year vesting period. These restrictions will
lapse in February 2003, unless the related shares are forfeited.
Since the date of grant, 41,541 shares have been forfeited and
restrictions on the remaining shares have lapsed. Because the
actual number of shares granted may increase or decrease based
on certain performance factors, this grant is accounted for as a
variable grant and, accordingly, the fair value is being charged
to stockholders equity as unearned compensation and is
being amortized over the three-year vesting period. Including
amortization of expected performance shares and dividends on
forfeited shares, compensation expense in 2002 was a credit of
$3 million, and in 2001 and 2000 was an expense of $17 million
and $11 million, respectively. The unamortized portion remaining
in stockholders equity at December 31, 2002 was $1
million.

In 2001, RJR granted 304,590 shares of restricted
stock at $52.96 to eligible employees under the 1999 LTIP.
Generally, these shares may not be disposed of or transferred
during the three-year vesting period. These restrictions will
lapse in 2004, unless the related shares are forfeited. Because
the actual number of shares granted may increase or decrease
based on certain performance factors, this grant is accounted
for as a variable grant and, accordingly, the fair value is
being charged to stockholders equity as unearned
compensation and is being amortized over the three-year vesting
period. During 2002, 20,422 restricted shares were forfeited and
restrictions on 17,537 shares lapsed. During 2002 and 2001,
including amortization of expected performance shares and
dividends on forfeited shares, compensation expense was $1
million and $6 million, respectively. The unamortized portion
remaining in stockholders equity at December 31, 2002
was $3 million.

In 2002, RJR granted 334,766 shares of restricted
stock at $53.49 to eligible employees under the 1999 LTIP.
Generally, these shares may not be disposed of or transferred
during the three-year vesting period. These restrictions will
lapse in 2005, unless the related shares are forfeited. Because
the actual number of shares granted may increase or decrease
based on certain performance factors, this grant is accounted
for as a

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NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


variable grant and, accordingly, the fair value
is being charged to stockholders equity as unearned
compensation and is being amortized over the three-year vesting
period. During 2002, 4,362 restricted shares were forfeited and
restrictions on 740 shares lapsed. During 2002, including
amortization of expected performance shares and dividends on
forfeited shares, compensation expense was $2 million and the
unamortized portion remaining in stockholders equity at
December 31, 2002 was $9 million.

In the EIAP and the 1999 LTIP, for various price
ranges, the weighted average characteristics of stock options
outstanding and exercisable at December 31, 2002 were:

|                     |  |                     |           |                     |  |          |     |        |  |          |       |  |  |  |           |  |  |   |       | 
|-------------------- |  | ------------------- | --------- | ------------------- |  | -------- | --- | ------ |  | -------- | ----- |  |  |  | --------- |  |  | - | ----- | 
|                     |  |                     |           |                    
|                     |  | Options Outstanding |           | Exercisable Options
|                     |  |                     |           |                    
|                     |  |                     |           | Average             |  | Weighted |     |        |  | Weighted
|                     |  |                     |           | Remaining           |  | Average  |     |        |  | Average 
|                     |  |                     |           | Contractual         |  | Exercise |     |        |  | Exercise
|Exercise Price Range |  | Shares              |           | Life (Years)        |  | Price    |     | Shares |  | Price   
|                     |  |                     |           |                     |  |          |     |        |  |         
|$23.32  $33.71      |  |                     | 2,833,090 |                     |  |          | 6.4 |        |  | $        | 29.05 |  |  |  | 1,695,090 |  |  | $ | 28.99 | 
|36.24   48.33       |  |                     | 33,162    |                     |  |          | 3.7 |        |  |          | 39.52 |  |  |  | 33,162    |  |  |   | 39.52 | 
|69.79   69.79       |  |                     | 10,000    |                     |  |          | 9.4 |        |  |          | 69.79 |  |  |  | 10,000    |  |  |   | 69.79 | 

The changes in RJRs stock options during
2002, 2001 and 2000 were:

|                                         |  |         |            |          |  |         |       |          |  |         |            |          |  |   |       |  |  |  |            |   |  |   |       | 
|---------------------------------------- |  | ------- | ---------- | -------- |  | ------- | ----- | -------- |  | ------- | ---------- | -------- |  | - | ----- |  |  |  | ---------- | - |  | - | ----- | 
|                                         |  |         |            |          |  |        
|                                         |  | 2002    |            | 2001     |  | 2000   
|                                         |  |         |            |          |  |        
|                                         |  |         |            | Weighted |  |         |       | Weighted |  |         |            | Weighted
|                                         |  |         |            | Average  |  |         |       | Average  |  |         |            | Average 
|                                         |  |         |            | Exercise |  |         |       | Exercise |  |         |            | Exercise
|                                         |  | Options |            | Price    |  | Options |       | Price    |  | Options |            | Price   
|                                         |  |         |            |          |  |         |       |          |  |         |            |         
|Options outstanding at beginning of year |  |         | 4,393,776  |          |  | $       | 29.01 |          |  |         | 6,096,570  |          |  | $ | 28.76 |  |  |  | 8,492,564  |   |  | $ | 28.43 | 
|Options granted                          |  |         | 10,000     |          |  |         | 69.79 |          |  |         |           |          |  |   |      |  |  |  |           |   |  |   |      | 
|Options forfeited                        |  |         | (160,735   | )        |  |         | 29.14 |          |  |         | (220,000   | )        |  |   | 27.50 |  |  |  | (138,371   | ) |  |   | 27.52 | 
|Options exercised                        |  |         | (1,366,789 | )        |  |         | 28.65 |          |  |         | (1,482,794 | )        |  |   | 28.23 |  |  |  | (2,257,623 | ) |  |   | 27.58 | 
|                                         |  |         |            |          |  |         |       |          |  |         |            |          |  |   |       |  |  |  |            |   |  |   |       | 
|Options outstanding at end of year       |  |         | 2,876,252  |          |  |         | 29.31 |          |  |         | 4,393,776  |          |  |   | 29.01 |  |  |  | 6,096,570  |   |  |   | 28.76 | 
|                                         |  |         |            |          |  |         |       |          |  |         |            |          |  |   |       |  |  |  |            |   |  |   |       | 
|Exercisable at end of year               |  |         | 1,738,252  |          |  |         | 29.42 |          |  |         | 1,713,866  |          |  |   | 28.76 |  |  |  | 3,108,731  |   |  |   | 28.55 | 
|                                         |  |         |            |          |  |         |       |          |  |         |            |          |  |   |       |  |  |  |            |   |  |   |       | 

Equity compensation plan information is as
follows:

|                                                                   |       |                      |           |                      |  |                         |       |       |  |  |           |           | 
|------------------------------------------------------------------ | ----- | -------------------- | --------- | -------------------- |  | ----------------------- | ----- | ----- |  |  | --------- | --------- | 
|                                                                   |       |                      |           |                      |  | Number of Securities   
|                                                                   |       |                      |           |                      |  | Remaining Available for
|                                                                   |       | Number of Securities |           |                      |  | Future Issuance under  
|                                                                   |       | to be Issued Upon    |           | Weighted-Average     |  | Equity Compensation    
|                                                                   |       | Exercise of          |           | Exercise Prices of   |  | Plans (Excluding       
|                                                                   |       | Outstanding Options, |           | Outstanding Options, |  | Securities Reflected in
|Plan Category                                                      |       | Warrants and Rights  |           | Warrants and Rights  |  | Column(a))             
|                                                                   |       |                      |           |                      |  |                        
|                                                                   |       | (a)                  |           | (b)                  |  | (c)                    
|Equity Compensation Plans Approved by Security
    Holders         |       |                      | 2,799,752 |                      |  | $                       | 29.12 |       |  |  | 4,289,116 |          
|Equity Compensation Plans Not Approved by
    Security Holders (1) |       |                      | 76,500    | (2)                  |  |                         | 36.57 |       |  |  | 360,353   |          
|                                                                   |       |                      |           |                      |  |                         |       |       |  |  |           |          
|                                                                   | Total |                      |           | 2,876,252            |  |                         |       | 29.31 |  |  |           | 4,649,469 | 
|                                                                   |       |                      |           |                      |  |                         |       |       |  |  |           |          






|    |                                                                                                                                                                                                         
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The EIAP is the only equity compensation plan not
    approved by RJRs public stockholders. The EIAP was
    approved by RJRs sole shareholder, NGH, prior to
    RJRs spin-off on June 15, 1999.    
|   
|(2) | Excludes annual grants totaling 36,147 deferred
    stock units that are convertible into 36,147 shares of stock, or
    equivalent cash, by the election of the holder upon termination
    of service.

RJR recognizes compensation costs related to
employee stock plans utilizing the intrinsic value based method
prescribed by APB No. 25, Accounting for Stock Issued
to Employee, and related Interpretations

104



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


and applies the disclosure-only option under SFAS
No. 123, Accounting for Stock-Based
Compensation. Accordingly, no compensation expense is
recognized for stock options granted, as all options granted had
an exercise price equal to the market value of the underlying
common stock on the date of grant. The fair value of stock
options granted in 2002 was not material.

Note 18  Retirement
Benefits

RJR and its subsidiaries sponsor a number of
non-contributory defined benefit pension plans covering most
employees, and also provide certain health and life insurance
benefits for retired employees and their dependents. The changes
in benefit obligations and plan assets, as well as the funded
status of these plans at December 31 were:

|                                                                      |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |      |  
|--------------------------------------------------------------------- | ------------------------------------------------------- | ---------------- | - | -------------- | - | ---- | - | ----- | - |  | - | ---- | - |  | - | ---- | -
|                                                                      |                                                         |                  |   |                |   |     
|                                                                      |                                                         |                  |   | Postretirement
|                                                                      |                                                         | Pension Benefits |   | Benefits      
|                                                                      |                                                         |                  |   |               
|                                                                      |                                                         | 2002             |   | 2001           |   | 2002 |   | 2001 
|                                                                      |                                                         |                  |   |                |   |      |   |      
|Change in benefit obligation:                                         |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Obligation at beginning of year                         |                  | $ | 2,529          |   |      | $ | 2,462 |   |  | $ | 740  |   |  | $ | 675  |  
|                                                                      | Service cost                                            |                  |   | 38             |   |      |   | 35    |   |  |   | 6    |   |  |   | 6    |  
|                                                                      | Interest cost                                           |                  |   | 181            |   |      |   | 179   |   |  |   | 60   |   |  |   | 54   |  
|                                                                      | Actuarial loss                                          |                  |   | 264            |   |      |   | 48    |   |  |   | 177  |   |  |   | 69   |  
|                                                                      | Plan amendments                                         |                  |   | 5              |   |      |   | 6     |   |  |   |     |   |  |   |     |  
|                                                                      | Benefits paid                                           |                  |   | (194           | ) |      |   | (188  | ) |  |   | (71  | ) |  |   | (64  | )
|                                                                      | Settlements                                             |                  |   | (11            | ) |      |   | (13   | ) |  |   |     |   |  |   |     |  
|                                                                      | Special termination benefits                            |                  |   | 34             |   |      |   |      |   |  |   |     |   |  |   |     |  
|                                                                      | Curtailment                                             |                  |   | 2              |   |      |   |      |   |  |   | 7    |   |  |   |     |  
|                                                                      |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Obligation at end of year                               |                  | $ | 2,848          |   |      | $ | 2,529 |   |  | $ | 919  |   |  | $ | 740  |  
|                                                                      |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|Change in plan assets:                                                |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Fair value of plan assets at beginning of year          |                  | $ | 2,160          |   |      | $ | 2,260 |   |  | $ |     |   |  | $ |     |  
|                                                                      | Actual return on plan assets                            |                  |   | (240           | ) |      |   | 1     |   |  |   |     |   |  |   |     |  
|                                                                      | Employer contributions                                  |                  |   | 200            |   |      |   | 100   |   |  |   | 71   |   |  |   | 64   |  
|                                                                      | Benefits paid                                           |                  |   | (194           | ) |      |   | (188  | ) |  |   | (71  | ) |  |   | (64  | )
|                                                                      | Settlements                                             |                  |   | (11            | ) |      |   | (13   | ) |  |   |     |   |  |   |     |  
|                                                                      |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Fair value of plan assets at end of year                |                  | $ | 1,915          |   |      | $ | 2,160 |   |  | $ |     |   |  | $ |     |  
|                                                                      |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|Funded status:                                                        |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Funded status                                           |                  | $ | (933           | ) |      | $ | (369  | ) |  | $ | (919 | ) |  | $ | (740 | )
|                                                                      | Unrecognized transition asset                           |                  |   |               |   |      |   |      |   |  |   | (9   | ) |  |   | (15  | )
|                                                                      | Unrecognized prior service cost                         |                  |   | 15             |   |      |   | 9     |   |  |   |     |   |  |   |     |  
|                                                                      | Unrecognized net actuarial loss                         |                  |   | 1,097          |   |      |   | 379   |   |  |   | 330  |   |  |   | 169  |  
|                                                                      |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Net amount recognized                                   |                  | $ | 179            |   |      | $ | 19    |   |  | $ | (598 | ) |  | $ | (586 | )
|                                                                      |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|Amounts recognized in the consolidated balance
    sheets consist of: |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Accrued benefit  current liability                     |                  | $ | (100           | ) |      | $ | (183  | ) |  | $ | (82  | ) |  | $ | (72  | )
|                                                                      | Accrued benefit  long-term
    liability               |                  |   | (660           | ) |      |   |      |   |  |   | (516 | ) |  |   | (514 | )
|                                                                      | Pension overfunding asset  other
    noncurrent assets |                  |   |               |   |      |   | 2     |   |  |   |     |   |  |   |     |  
|                                                                      | Intangible asset                                        |                  |   | 16             |   |      |   | 13    |   |  |   |     |   |  |   |     |  
|                                                                      | Accumulated other comprehensive income                  |                  |   | 923            |   |      |   | 187   |   |  |   |     |   |  |   |     |  
|                                                                      |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Net amount recognized                                   |                  | $ | 179            |   |      | $ | 19    |   |  | $ | (598 | ) |  | $ | (586 | )
|                                                                      |                                                         |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     

105



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The weighted average actuarial assumptions used
to determine the funded status of these plans as of
December 31 were:

|                              |  |      |      |      |  |  |      | 
|----------------------------- |  | ---- | ---- | ---- |  |  | ---- | 
|                              |  | 2002 |      | 2001
|                              |  |      |      |     
|Discount rate                 |  |      | 6.4% |      |  |  | 7.4% | 
|Rate of compensation increase |  |      | 5.0% |      |  |  | 5.0% | 

As of December 31, 2002, all of the pension
plans experienced accumulated benefit obligations in excess of
plan assets, for which the projected benefit obligation,
accumulated benefit obligation and fair value of plan assets
were $2,848 million, $2,673 million and $1,915 million,
respectively. As of December 31, 2001, for the plans with
accumulated benefit obligations in excess of plan assets, the
projected benefit obligation, accumulated benefit obligation and
fair value of plan assets were $2,529 million, $2,340 million
and $2,160 million, respectively.

|                                           |                                    |                             |   |                |    |      |   |      |    |      |   |      |     |   |   |    |    |  |   |    |    |  |   |    |    | 
|------------------------------------------ | ---------------------------------- | --------------------------- | - | -------------- | -- | ---- | - | ---- | -- | ---- | - | ---- | --- | - | - | -- | -- |  | - | -- | -- |  | - | -- | -- | 
|                                           |                                    |                             |   |                |    |      |   |     
|                                           |                                    |                             |   | Postretirement
|                                           |                                    | Pension Benefits            |   | Benefits      
|                                           |                                    |                             |   |               
|                                           |                                    | 2002                        |   | 2001           |    | 2000 |   | 2002 |    | 2001 |   | 2000
|                                           |                                    |                             |   |                |    |      |   |      |    |      |   |     
|Components of total benefit cost (income): |                                    |                             |   |                |    |      |   |      |    |      |   |      |     |   |   |    |    |  |   |    |    |  |   |   
|                                           | Service cost                       |                             | $ | 38             |    |      | $ | 35   |    |      | $ | 31   |     |   | $ | 6  |    |  | $ | 6  |    |  | $ | 6  |   
|                                           | Interest cost                      |                             |   | 181            |    |      |   | 179  |    |      |   | 176  |     |   |   | 60 |    |  |   | 54 |    |  |   | 49 |   
|                                           | Expected return on plan assets     |                             |   | (222           | )  |      |   | (220 | )  |      |   | (229 | )   |   |   |   |    |  |   |   |    |  |   |   |   
|                                           | Amortization of transition asset   |                             |   |               |    |      |   |     |    |      |   |     |     |   |   | (6 | )  |  |   | (6 | )  |  |   | (6 | ) 
|                                           | Amortization of prior service cost |                             |   | (2             | )  |      |   | (3   | )  |      |   | (3   | )   |   |   |   |    |  |   |   |    |  |   |   |   
|                                           | Amortization of net loss(gain)     |                             |   | 4              |    |      |   | 2    |    |      |   | (7   | )   |   |   | 16 |    |  |   | 9  |    |  |   | 1  |   
|                                           |                                    |                             |   |                |    |      |   |      |    |      |   |      |     |   |   |    |    |  |   |    |    |  |   |   
|                                           | Net periodic benefit cost (income) |                             |   | (1             | )  |      |   | (7   | )  |      |   | (32  | )   |   |   | 76 |    |  |   | 63 |    |  |   | 50 |   
|                                           | Curtailment/special benefits       |                             |   | 37             |    |      |   |     |    |      |   |     |     |   |   | 7  |    |  |   |   |    |  |   |   |   
|                                           | Settlements                        |                             |   | 3              |    |      |   | 4    |    |      |   | 2    |     |   |   |   |    |  |   |   |    |  |   |   |   
|                                           |                                    |                             |   |                |    |      |   |      |    |      |   |      |     |   |   |    |    |  |   |    |    |  |   |   
|                                           |                                    | Total benefit cost (income) |   | $              | 39 |      |   | $    | (3 | )    |   | $    | (30 | ) |   | $  | 83 |  |   | $  | 63 |  |   | $  | 50 | 
|                                           |                                    |                             |   |                |    |      |   |      |    |      |   |      |     |   |   |    |    |  |   |    |    |  |   |   

The weighted average actuarial assumptions used
to determine the total benefit cost of these plans during the
years ended December 31 were:

|                                       |  |      |      |      |  |      |      |  |  |  |      | 
|-------------------------------------- |  | ---- | ---- | ---- |  | ---- | ---- |  |  |  | ---- | 
|                                       |  | 2002 |      | 2001 |  | 2000
|                                       |  |      |      |      |  |     
|Discount rate                          |  |      | 7.4% |      |  |      | 7.5% |  |  |  | 8.0% | 
|Expected return on pension plan assets |  |      | 9.5% |      |  |      | 9.5% |  |  |  | 9.5% | 
|Rate of compensation increase          |  |      | 5.0% |      |  |      | 5.0% |  |  |  | 5.0% | 

SFAS No. 87, Employers
Accounting for Pensions, permits the delayed recognition
of pension fund gains and losses in ratable periods of up to
five years. RJR uses a five-year period wherein pension fund
gains and losses are reflected in the pension calculation at 20%
per year, beginning the year after the gains or losses occur.
Recent stock market declines have resulted in deferred losses,
which in turn resulted in the recording of additional minimum
pension liabilities through a charge of $736 million, $478
million after tax, to other comprehensive income in 2002. The
amortization of deferred losses will negatively impact pension
cost in future periods.

For 2002 measurement purposes, a 13.1% annual
rate of increase in the pre-65 per capita cost of covered health
care was used for the HMO plan. The rate was assumed to decrease
to 9.5% for 2003 and then to decrease by 0.5% per year to an
ultimate rate of 5.0%. The 2002 annual rate of increase for
post-65 per capita cost of covered care for the HMO plan was
13.1%, 12.5% for 2003, decreasing 1.0% per year through 2008,
then decreasing 0.5% per year to an ultimate rate of 5.0%.
Additionally, for the indemnity plan, an 11.0% annual rate of
increase in the pre-65 per capita cost of covered health care
was used for 2002. The rate was assumed to decrease to 10.0% for
2003, 9.5% for 2004, then decrease by 0.5% per year through
2007, then to a rate of 5.5% in 2013 and beyond. The annual rate
of increase for post-65 per capita cost of covered care for the

106



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


indemnity plan was 14.0% for 2002, decreasing by
1.0% to a rate of 8.0% in 2008, then decreasing by 0.5% to an
ultimate rate of 5.5%.

Assumed health care cost trend rates have a
significant effect on the amounts reported for the health care
plans. A one-percentage-point change in assumed health care cost
trend rates would have the following effects:

|                                                            |  |              |    |              |  |   |     |  
|----------------------------------------------------------- |  | ------------ | -- | ------------ |  | - | --- | -
|                                                            |  | 1-Percentage |    | 1-Percentage
|                                                            |  | Point        |    | Point       
|                                                            |  | Increase     |    | Decrease    
|                                                            |  |              |    |             
|Effect on Total of Service and Interest Cost
    Components |  | $            | 3  |              |  | $ | (3  | )
|Effect on Benefit Obligation                                |  |              | 48 |              |  |   | (42 | )

In connection with the 2002 restructuring plan,
curtailment and special termination benefits costs were $37
million for pension benefits and $7 million for postretirement
benefits.

RJR and its subsidiaries sponsor a qualified
defined contribution plan, and following a participants
contribution, match 50% based on a maximum of 6% of a
participants compensation. The expense related to this
plan was $12 million in each of 2002, 2001 and 2000.

Note 19  Segment
Information

RJR has one reportable operating segment, RJR
Tobacco, which is the second largest cigarette manufacturer in
the United States. RJR Tobaccos largest selling cigarette
brands, CAMEL, WINSTON, SALEM and DORAL, were four of the top
ten best-selling brands of cigarettes in the United States in
2002. Those brands, and its other brands, including VANTAGE,
MORE and NOW, are manufactured in a variety of styles and
marketed in the United States to meet a range of adult smoker
preferences.

The disclosures classified as all other include
the total assets and results of operations of Santa Fe, which
was acquired by RJR on January 16, 2002. Santa Fes
total assets and results of operations do not meet the
materiality criteria to be reportable. Santa Fe manufactures
cigarettes under the NATURAL AMERICAN SPIRIT brand and other
tobacco products in the United States and markets its products
primarily in the United States. Santa Fe also has a small, but
growing, international tobacco business.

On July 15, 2002, RJR, through its wholly
owned subsidiary R. J. Reynolds Tobacco C.V., acquired a 50%
interest in R.J. Reynolds-Gallaher International Sarl, a joint
venture created with Gallaher Group Plc, to manufacture and
market a limited portfolio of American-blend cigarette brands.
The joint venture, headquartered in Switzerland, is initially
marketing its products in France, Spain, the Canary Islands and
Italy. As a part of the transaction, RJR Tobacco is licensing
REYNOLDS, a new American-blend brand to the joint venture. The
investment is accounted for using the equity method. Segment
disclosures related to RJRs interest in the joint venture
are included in the classification all other.

Corporate assets consist primarily of cash and
short-term investments. There are no material intersegment
sales. RJR had no material net sales, operating income or assets
related to international operations during 2002, 2001 or 2000.
The accounting policies of the segments are the same as those
described in the summary of significant accounting policies.

107



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Segment Data:

|                      |                   |                                   |   |        |        |      |   |        |        |  |   |        |        | 
|--------------------- | ----------------- | --------------------------------- | - | ------ | ------ | ---- | - | ------ | ------ |  | - | ------ | ------ | 
|                      |                   | 2002                              |   | 2001   |        | 2000
|                      |                   |                                   |   |        |        |     
|Net sales:            |                   |                                   |   |        |        |      |   |        |        |  |   |       
|                      | RJR Tobacco       |                                   | $ | 6,026  |        |      | $ | 6,195  |        |  | $ | 6,013  |       
|                      | All other         |                                   |   | 185    |        |      |   | 74     |        |  |   | 72     |       
|                      |                   |                                   |   |        |        |      |   |        |        |  |   |       
|                      |                   | Consolidated net sales            |   | $      | 6,211  |      |   | $      | 6,269  |  |   | $      | 6,085  | 
|                      |                   |                                   |   |        |        |      |   |        |        |  |   |       
|Operating income:     |                   |                                   |   |        |        |      |   |        |        |  |   |       
|                      | RJR Tobacco       |                                   | $ | 733    |        |      | $ | 926    |        |  | $ | 848    |       
|                      | All other         |                                   |   | 73     |        |      |   | 25     |        |  |   | 23     |       
|                      | Corporate expense |                                   |   | (27    | )      |      |   | (33    | )      |  |   | (43    | )     
|                      |                   |                                   |   |        |        |      |   |        |        |  |   |       
|                      |                   | Consolidated operating income     |   | $      | 779    |      |   | $      | 918    |  |   | $      | 828    | 
|                      |                   |                                   |   |        |        |      |   |        |        |  |   |       
|Assets:               |                   |                                   |   |        |        |      |   |        |        |  |   |       
|                      | RJR Tobacco       |                                   | $ | 11,968 |        |      | $ | 13,233 |        |  | $ | 13,488 |       
|                      | All other         |                                   |   | 693    |        |      |   | 269    |        |  |   | 261    |       
|                      | Corporate         |                                   |   | 1,990  |        |      |   | 1,620  |        |  |   | 1,805  |       
|                      |                   |                                   |   |        |        |      |   |        |        |  |   |       
|                      |                   | Consolidated assets               |   | $      | 14,651 |      |   | $      | 15,122 |  |   | $      | 15,554 | 
|                      |                   |                                   |   |        |        |      |   |        |        |  |   |       
|Capital expenditures: |                   |                                   |   |        |        |      |   |        |        |  |   |       
|                      | RJR Tobacco       |                                   | $ | 94     |        |      | $ | 69     |        |  | $ | 55     |       
|                      | All other         |                                   |   | 17     |        |      |   | 5      |        |  |   | 5      |       
|                      |                   |                                   |   |        |        |      |   |        |        |  |   |       
|                      |                   | Consolidated capital expenditures |   | $      | 111    |      |   | $      | 74     |  |   | $      | 60     | 
|                      |                   |                                   |   |        |        |      |   |        |        |  |   |       
|Depreciation expense: |                   |                                   |   |        |        |      |   |        |        |  |   |       
|                      | RJR Tobacco       |                                   | $ | 180    |        |      | $ | 126    |        |  | $ | 117    |       
|                      | All other         |                                   |   | 4      |        |      |   | 3      |        |  |   | 2      |       
|                      |                   |                                   |   |        |        |      |   |        |        |  |   |       
|                      |                   |                                   |   | $      | 184    |      |   | $      | 129    |  |   | $      | 119    | 
|                      |                   |                                   |   |        |        |      |   |        |        |  |   |       

Sales made by RJR Tobacco to McLane Company, Inc.
and its affiliate, Wal-Mart Stores, Inc., comprised 20% of
RJRs consolidated revenue in both 2002 and 2001 and 19% in
2000. No other customer accounted for 10% or more of RJRs
revenue during those years.

For further information related to restructuring
and asset impairment charges, see note 3 to the
consolidated financial statements. For further information
related to trademark impairment charges, see note 4 to the
consolidated financial statements.

108



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 20  Quarterly Results of
Operations (Unaudited)

|                                                                |                                                                 |       |       |        |   |       |       |        |  |   |       |       |   |   |       |       |  
|--------------------------------------------------------------- | --------------------------------------------------------------- | ----- | ----- | ------ | - | ----- | ----- | ------ |  | - | ----- | ----- | - | - | ----- | ----- | -
|2002                                                            |                                                                 | First |       | Second |   | Third |       | Fourth
|                                                                |                                                                 |       |       |        |   |       |       |       
|Net sales                                                       |                                                                 | $     | 1,515 |        |   | $     | 1,705 |        |  | $ | 1,585 |       |   | $ | 1,406 |      
|Gross profit                                                    |                                                                 |       | 633   |        |   |       | 729   |        |  |   | 600   |       |   |   | 517   |      
|Income (loss) from continuing operations                        |                                                                 |       | 167   |        |   |       | 211   |        |  |   | 139   |       |   |   | (99   | )    
|Discontinued operations, net of income taxes                    |                                                                 |       |      |        |   |       |      |        |  |   |      |       |   |   | 40    |      
|Cumulative effect of accounting change, net of
    income taxes |                                                                 |       | (502  | )      |   |       |      |        |  |   |      |       |   |   |      |      
|Net income (loss)                                               |                                                                 |       | (335  | )      |   |       | 211   |        |  |   | 139   |       |   |   | (59   | )    
|Per share data (2):                                             |                                                                 |       |       |        |   |       |       |        |  |   |       |       |   |   |       |      
|Basic:                                                          |                                                                 |       |       |        |   |       |       |        |  |   |       |       |   |   |       |      
|                                                                | Income (loss) from continuing operations                        |       |       | 1.83   |   |       |       | 2.35   |  |   |       | 1.58  |   |   |       | (1.16 | )
|                                                                | Discontinued operations, net of income taxes                    |       |       |       |   |       |       |       |  |   |       |      |   |   |       | 0.47  |  
|                                                                | Cumulative effect of accounting change, net of
    income taxes |       |       | (5.49  | ) |       |       |       |  |   |       |      |   |   |       |      |  
|                                                                | Net income (loss)                                               |       |       | (3.66  | ) |       |       | 2.35   |  |   |       | 1.58  |   |   |       | (0.69 | )
|Diluted:                                                        |                                                                 |       |       |        |   |       |       |        |  |   |       |       |   |   |       |      
|                                                                | Income (loss) from continuing operations                        |       |       | 1.79   |   |       |       | 2.29   |  |   |       | 1.56  |   |   |       | (1.16 | )
|                                                                | Discontinued operations, net of income taxes                    |       |       |       |   |       |       |       |  |   |       |      |   |   |       | 0.47  |  
|                                                                | Cumulative effect of accounting change, net of
    income taxes |       |       | (5.37  | ) |       |       |       |  |   |       |      |   |   |       |      |  
|                                                                | Net income (loss)                                               |       |       | (3.58  | ) |       |       | 2.29   |  |   |       | 1.56  |   |   |       | (0.69 | )
|                                                               
|2001                                                            |                                                                 |       |       |        |   |       |       |        |  |   |       |       |   |   |       |      
|                                                                |                                                                 |       |       |        |   |       |       |        |  |   |       |       |   |   |       |      
|Net sales (1)                                                   |                                                                 | $     | 1,456 |        |   | $     | 1,704 |        |  | $ | 1,628 |       |   | $ | 1,481 |      
|Gross profit                                                    |                                                                 |       | 619   |        |   |       | 728   |        |  |   | 712   |       |   |   | 650   |      
|Income from continuing operations                               |                                                                 |       | 100   |        |   |       | 127   |        |  |   | 128   |       |   |   | 89    |      
|Discontinued operations, net of income taxes                    |                                                                 |       |      |        |   |       |      |        |  |   | (9    | )     |   |   |      |      
|Net income                                                      |                                                                 |       | 100   |        |   |       | 127   |        |  |   | 119   |       |   |   | 89    |      
|Per share data (2):                                             |                                                                 |       |       |        |   |       |       |        |  |   |       |       |   |   |       |      
|Basic:                                                          |                                                                 |       |       |        |   |       |       |        |  |   |       |       |   |   |       |      
|                                                                | Income from continuing operations                               |       |       | 1.00   |   |       |       | 1.29   |  |   |       | 1.34  |   |   |       | 0.95  |  
|                                                                | Discontinued operations, net of income taxes                    |       |       |       |   |       |       |       |  |   |       | (0.10 | ) |   |       |      |  
|                                                                | Net income                                                      |       |       | 1.00   |   |       |       | 1.29   |  |   |       | 1.24  |   |   |       | 0.95  |  
|Diluted:                                                        |                                                                 |       |       |        |   |       |       |        |  |   |       |       |   |   |       |      
|                                                                | Income from continuing operations                               |       |       | 0.98   |   |       |       | 1.26   |  |   |       | 1.31  |   |   |       | 0.93  |  
|                                                                | Discontinued operations, net of income taxes                    |       |       |       |   |       |       |       |  |   |       | (0.09 | ) |   |       |      |  
|                                                                | Net income                                                      |       |       | 0.98   |   |       |       | 1.26   |  |   |       | 1.22  |   |   |       | 0.93  |  






|    |                                                                                                                                                                                                                                                                                                                                               
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Restated for adoption of EITF No. 00-25, as
    codified by EITF No. 01-9, requires that consideration paid
    to a distributor or retailer to promote the vendors
    products, such as slotting fees or buydowns, generally be
    classified as a reduction to net sales rather than as selling,
    general and administrative expenses.
|(2) | Income per share is computed independently for
    each of the periods presented. The sum of the income per share
    amounts for the quarters may not equal the total for the year.                                                                                                                                                          

Note 21  Condensed Consolidating
Financial Statements

Separate financial statements and other
disclosures have not been presented concerning RJR Tobacco and
RJR Acquisition Corp. because such information is not believed
to be material to holders of the exchange notes. RJR Tobacco and
RJR Acquisition Corp. are wholly owned subsidiaries of RJR, and
have fully and unconditionally guaranteed the exchange notes.
Because the guarantees are full and unconditional and joint and
several, the following condensed consolidating financial
statements include: the accounts and activities of RJR, the
issuer of the debt securities; RJR Tobacco and RJR Acquisition
Corp., the guarantors; other subsidiaries of RJR and RJR Tobacco
that are not guarantors; and elimination adjustments.

109



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Condensed Consolidating Statements of
Income

(Dollars in Millions) (Unaudited)


|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |       |  
|---------------------------------------------------------------------- | --------------------------------------------------------- | ------ | ------ | ---------- |  | -------------- | ----- | ------------ |  | ------------ | ---- | ---- | - | - | ------ | ------ | - | - | ----- | ----- | -
|                                                                       |                                                           | Issuer |        | Guarantors |  | Non-Guarantors |       | Eliminations |  | Consolidated
|                                                                       |                                                           |        |        |            |  |                |       |              |  |             
|For the Year Ended December 31,
    2002                               |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|Net sales                                                              |                                                           | $      |       |            |  | $              | 6,098 |              |  | $            | 170  |      |   | $ | (57    | )      |   | $ | 6,211 |      
|Cost of products sold                                                  |                                                           |        |       |            |  |                | 3,740 |              |  |              | 49   |      |   |   | (57    | )      |   |   | 3,732 |      
|Selling, general and administrative expenses                           |                                                           |        | 25     |            |  |                | 1,667 |              |  |              | (229 | )    |   |   |       |        |   |   | 1,463 |      
|Restructuring and asset impairment charges                             |                                                           |        | 2      |            |  |                | 221   |              |  |              | 1    |      |   |   |       |        |   |   | 224   |      
|Trademark impairment charge                                            |                                                           |        |       |            |  |                |      |              |  |              | 13   |      |   |   |       |        |   |   | 13    |      
|Interest and debt expense                                              |                                                           |        | 136    |            |  |                | 11    |              |  |              |     |      |   |   |       |        |   |   | 147   |      
|Interest income                                                        |                                                           |        | (11    | )          |  |                | (49   | )            |  |              | (2   | )    |   |   |       |        |   |   | (62   | )    
|Intercompany interest (income) expense                                 |                                                           |        | (19    | )          |  |                | 155   |              |  |              | (136 | )    |   |   |       |        |   |   |      |      
|Intercompany dividend                                                  |                                                           |        | (1,098 | )          |  |                | (644  | )            |  |              |     |      |   |   | 1,742  |        |   |   |      |      
|Other expense (income), net                                            |                                                           |        | (3     | )          |  |                | 13    |              |  |              | 1    |      |   |   |       |        |   |   | 11    |      
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|                                                                       | Income from continuing operations before
    income taxes |        |        | 968        |  |                |       | 984          |  |              |      | 473  |   |   |        | (1,742 | ) |   |       | 683   |  
|Provision for (benefit from) income taxes                              |                                                           |        | (71    | )          |  |                | 143   |              |  |              | 193  |      |   |   |       |        |   |   | 265   |      
|Equity income (loss) from subsidiaries                                 |                                                           |        | 660    |            |  |                | (286  | )            |  |              | 8    |      |   |   | (382   | )      |   |   |      |      
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|                                                                       | Income from continuing operations                         |        |        | 1,699      |  |                |       | 555          |  |              |      | 288  |   |   |        | (2,124 | ) |   |       | 418   |  
|Gain on sale of discontinued businesses, net of
    income taxes       |                                                           |        |       |            |  |                | 40    |              |  |              |     |      |   |   |       |        |   |   | 40    |      
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|                                                                       | Income before cumulative effect of accounting
    change  |        |        | 1,699      |  |                |       | 595          |  |              |      | 288  |   |   |        | (2,124 | ) |   |       | 458   |  
|Cumulative effect of accounting change, net of
    income taxes        |                                                           |        |       |            |  |                | 37    |              |  |              | (539 | )    |   |   |       |        |   |   | (502  | )    
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|                                                                       | Net income (loss)                                         |        | $      | 1,699      |  |                | $     | 632          |  |              | $    | (251 | ) |   | $      | (2,124 | ) |   | $     | (44   | )
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|For the Year Ended December 31,
    2001                               |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|Net sales                                                              |                                                           | $      |       |            |  | $              | 6,269 |              |  | $            | 50   |      |   | $ | (50    | )      |   | $ | 6,269 |      
|Cost of products sold                                                  |                                                           |        |       |            |  |                | 3,607 |              |  |              | 3    |      |   |   | (50    | )      |   |   | 3,560 |      
|Selling, general and administrative expenses                           |                                                           |        | 32     |            |  |                | 1,749 |              |  |              | (352 | )    |   |   |       |        |   |   | 1,429 |      
|Amortization of trademarks and goodwill                                |                                                           |        |       |            |  |                | 260   |              |  |              | 102  |      |   |   |       |        |   |   | 362   |      
|Interest and debt expense                                              |                                                           |        | 138    |            |  |                | 12    |              |  |              |     |      |   |   |       |        |   |   | 150   |      
|Interest income                                                        |                                                           |        | (4     | )          |  |                | (129  | )            |  |              | (4   | )    |   |   |       |        |   |   | (137  | )    
|Intercompany interest (income) expense                                 |                                                           |        | (10    | )          |  |                | 274   |              |  |              | (264 | )    |   |   |       |        |   |   |      |      
|Intercompany dividend                                                  |                                                           |        | (1,632 | )          |  |                | (698  | )            |  |              |     |      |   |   | 2,330  |        |   |   |      |      
|Other expense (income), net                                            |                                                           |        | (3     | )          |  |                | 16    |              |  |              |     |      |   |   |       |        |   |   | 13    |      
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|                                                                       | Income from continuing operations before
    income taxes |        |        | 1,479      |  |                |       | 1,178        |  |              |      | 565  |   |   |        | (2,330 | ) |   |       | 892   |  
|Provision for (benefit from) income taxes                              |                                                           |        | (51    | )          |  |                | 300   |              |  |              | 199  |      |   |   |       |        |   |   | 448   |      
|Equity income (loss) from subsidiaries                                 |                                                           |        | 1,235  |            |  |                | 357   |              |  |              |     |      |   |   | (1,592 | )      |   |   |      |      
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|                                                                       | Income from continuing operations                         |        |        | 2,765      |  |                |       | 1,235        |  |              |      | 366  |   |   |        | (3,922 | ) |   |       | 444   |  
|Loss on sale of discontinued businesses, net of
    income taxes       |                                                           |        |       |            |  |                |      |              |  |              | (9   | )    |   |   |       |        |   |   | (9    | )    
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|                                                                       | Net income                                                |        | $      | 2,765      |  |                | $     | 1,235        |  |              | $    | 357  |   |   | $      | (3,922 | ) |   | $     | 435   |  
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|For the Year Ended December 31,
    2000                               |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|Net sales                                                              |                                                           | $      |       |            |  | $              | 6,087 |              |  | $            | 48   |      |   | $ | (50    | )      |   | $ | 6,085 |      
|Cost of products sold                                                  |                                                           |        |       |            |  |                | 3,483 |              |  |              | 3    |      |   |   | (50    | )      |   |   | 3,436 |      
|Selling, general and administrative expenses                           |                                                           |        | 42     |            |  |                | 1,642 |              |  |              | (315 | )    |   |   |       |        |   |   | 1,369 |      
|Amortization of trademarks and goodwill                                |                                                           |        |       |            |  |                | 260   |              |  |              | 106  |      |   |   |       |        |   |   | 366   |      
|Impairment charge                                                      |                                                           |        |       |            |  |                |      |              |  |              | 89   |      |   |   |       |        |   |   | 89    |      
|Other operating expense                                                |                                                           |        |       |            |  |                | (3    | )            |  |              |     |      |   |   |       |        |   |   | (3    | )    
|Interest and debt expense                                              |                                                           |        | 164    |            |  |                | 4     |              |  |              |     |      |   |   |       |        |   |   | 168   |      
|Interest income                                                        |                                                           |        | (1     | )          |  |                | (111  | )            |  |              | (7   | )    |   |   |       |        |   |   | (119  | )    
|Intercompany interest (income) expense                                 |                                                           |        | (11    | )          |  |                | 394   |              |  |              | (383 | )    |   |   |       |        |   |   |      |      
|Intercompany dividend                                                  |                                                           |        | (238   | )          |  |                | (861  | )            |  |              |     |      |   |   | 1,099  |        |   |   |      |      
|Other expense (income), net                                            |                                                           |        | 6      |            |  |                | 26    |              |  |              | (1   | )    |   |   |       |        |   |   | 31    |      
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|                                                                       | Income before income taxes                                |        |        | 38         |  |                |       | 1,253        |  |              |      | 556  |   |   |        | (1,099 | ) |   |       | 748   |  
|Provision for (benefit from) income taxes                              |                                                           |        | (64    | )          |  |                | 264   |              |  |              | 196  |      |   |   |       |        |   |   | 396   |      
|Equity income (loss) from subsidiaries                                 |                                                           |        | 2,825  |            |  |                | 360   |              |  |              |     |      |   |   | (3,185 | )      |   |   |      |      
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|                                                                       | Income before extraordinary item                          |        |        | 2,927      |  |                |       | 1,349        |  |              |      | 360  |   |   |        | (4,284 | ) |   |       | 352   |  
|Extraordinary itemgain (loss) on
    acquisition, net of income taxes |                                                           |        | (1     | )          |  |                | 1,476 |              |  |              |     |      |   |   |       |        |   |   | 1,475 |      
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      
|                                                                       | Net income (loss)                                         |        | $      | 2,926      |  |                | $     | 2,825        |  |              | $    | 360  |   |   | $      | (4,284 | ) |   | $     | 1,827 |  
|                                                                       |                                                           |        |        |            |  |                |       |              |  |              |      |      |   |   |        |        |   |   |       |      

110



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Condensed Consolidating Statements of Cash
Flows

(Dollars in Millions) (Unaudited)


|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |       |       |  
|----------------------------------------------- | ---------------------------------------- | -------------------------------------------------- | ----- | ---------- | ---- | -------------- | ----- | ------------ | ------ | ------------ | --- | ---- | ------ | - | ------ | ----- | ----- | - | ----- | ----- | ----- | -
|                                                |                                          | Issuer                                             |       | Guarantors |      | Non-Guarantors |       | Eliminations |        | Consolidated
|                                                |                                          |                                                    |       |            |      |                |       |              |        |             
|For the Year Ended December 31,
    2002        |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash flows from operating activities            |                                          | $                                                  | 824   |            |      | $              | 710   |              |        | $            | 721 |      |        | $ | (1,766 | )     |       | $ | 489   |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash flows from (used in) investing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                | Purchases of short-term investments      |                                                    |       | (504       | )    |                |       | (4           | )      |              |     |     |        |   |        |      |       |   |       | (508  | )    
|                                                | Proceeds from short-term investments     |                                                    |       |           |      |                |       | 120          |        |              |     |     |        |   |        |      |       |   |       | 120   |      
|                                                | Capital Expenditures                     |                                                    |       |           |      |                |       | (98          | )      |              |     | (13  | )      |   |        |      |       |   |       | (111  | )    
|                                                | Acquisition, net of cash acquired        |                                                    |       | (339       | )    |                |       |             |        |              |     |     |        |   |        |      |       |   |       | (339  | )    
|                                                | Other, net                               |                                                    |       |           |      |                |       | 18           |        |              |     |     |        |   |        |      |       |   |       | 18    |      
|                                                | Intercompany notes receivable            |                                                    |       | 214        |      |                |       | 160          |        |              |     | (386 | )      |   |        | 12    |       |   |       |      |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                |                                          | Net cash flows from (used in) investing activities |       |            | (629 | )              |       |              | 196    |              |     |      | (399   | ) |        |       | 12    |   |       |       | (820  | )
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash flows from (used in) financing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                | Repurchase of common stock               |                                                    |       | (511       | )    |                |       |             |        |              |     |     |        |   |        |      |       |   |       | (511  | )    
|                                                | Dividends paid on common stock           |                                                    |       | (335       | )    |                |       | (1,098       | )      |              |     | (644 | )      |   |        | 1,742 |       |   |       | (335  | )    
|                                                | Repayments of long-term debt             |                                                    |       | (43        | )    |                |       |             |        |              |     |     |        |   |        |      |       |   |       | (43   | )    
|                                                | Proceeds from issuance of long-term debt |                                                    |       | 745        |      |                |       |             |        |              |     |     |        |   |        |      |       |   |       | 745   |      
|                                                | Proceeds from exercise of stock options  |                                                    |       | 39         |      |                |       |             |        |              |     |     |        |   |        |      |       |   |       | 39    |      
|                                                | Intercompany notes payables              |                                                    |       | 188        |      |                |       | (536         | )      |              |     | 336  |        |   |        | 12    |       |   |       |      |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                |                                          | Net cash flows from (used in) financing activities |       |            | 83   |                |       |              | (1,634 | )            |     |      | (308   | ) |        |       | 1,754 |   |       |       | (105  | )
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Net change in cash and cash equivalents         |                                          |                                                    | 278   |            |      |                | (728  | )            |        |              | 14  |      |        |   |       |       |       |   | (436  | )    
|Cash and cash equivalents at beginning of year  |                                          |                                                    | 185   |            |      |                | 1,734 |              |        |              | 101 |      |        |   |       |       |       |   | 2,020 |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash and cash equivalents at end of year        |                                          | $                                                  | 463   |            |      | $              | 1,006 |              |        | $            | 115 |      |        | $ |       |       |       | $ | 1,584 |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|For the Year Ended December 31,
    2001        |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash flows from operating activities            |                                          | $                                                  | 1,003 |            |      | $              | 895   |              |        | $            | 420 |      |        | $ | (1,692 | )     |       | $ | 626   |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash flows from (used in) investing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                | Purchases of short-term investments      |                                                    |       |           |      |                |       | (207         | )      |              |     |     |        |   |        |      |       |   |       | (207  | )    
|                                                | Intercompany notes receivable            |                                                    |       | (5         | )    |                |       | (9           | )      |              |     | 281  |        |   |        | (267  | )     |   |       |      |      
|                                                | Other, net                               |                                                    |       |           |      |                |       | (85          | )      |              |     | (15  | )      |   |        |      |       |   |       | (100  | )    
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                |                                          | Net cash flows from (used in) investing activities |       |            | (5   | )              |       |              | (301   | )            |     |      | 266    |   |        |       | (267  | ) |       |       | (307  | )
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash flows from (used in) financing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                | Repurchase of common stock               |                                                    |       | (494       | )    |                |       |             |        |              |     |     |        |   |        |      |       |   |       | (494  | )    
|                                                | Dividends paid on common stock           |                                                    |       | (320       | )    |                |       | (994         | )      |              |     | (698 | )      |   |        | 1,692 |       |   |       | (320  | )    
|                                                | Repayments of long-term debt             |                                                    |       | (73        | )    |                |       |             |        |              |     |     |        |   |        |      |       |   |       | (73   | )    
|                                                | Proceeds from exercise of stock options  |                                                    |       | 45         |      |                |       |             |        |              |     |     |        |   |        |      |       |   |       | 45    |      
|                                                | Intercompany notes payables              |                                                    |       | 15         |      |                |       | (290         | )      |              |     | 8    |        |   |        | 267   |       |   |       |      |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                |                                          | Net cash flows used in financing activities        |       |            | (827 | )              |       |              | (1,284 | )            |     |      | (690   | ) |        |       | 1,959 |   |       |       | (842  | )
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Net change in cash and cash equivalents         |                                          |                                                    | 171   |            |      |                | (690  | )            |        |              | (4  | )    |        |   |       |       |       |   | (523  | )    
|Cash and cash equivalents at beginning of year  |                                          |                                                    | 14    |            |      |                | 2,424 |              |        |              | 105 |      |        |   |       |       |       |   | 2,543 |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash and cash equivalents at end of year        |                                          | $                                                  | 185   |            |      | $              | 1,734 |              |        | $            | 101 |      |        | $ |       |       |       | $ | 2,020 |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|For the Year Ended December 31,
    2000        |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash flows from operating activities            |                                          | $                                                  | 615   |            |      | $              | 641   |              |        | $            | 432 |      |        | $ | (1,098 | )     |       | $ | 590   |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash flows from (used in) investing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                | Short-term investments                   |                                                    |       |           |      |                |       | 109          |        |              |     | 1    |        |   |        |      |       |   |       | 110   |      
|                                                | Intercompany notes receivable            |                                                    |       | 2          |      |                |       | 34           |        |              |     | 811  |        |   |        | (847  | )     |   |       |      |      
|                                                | Net proceeds from acquisition            |                                                    |       |           |      |                |       | 1,519        |        |              |     |     |        |   |        |      |       |   |       | 1,519 |      
|                                                | Other, net                               |                                                    |       | (5         | )    |                |       | (50          | )      |              |     | (1   | )      |   |        |      |       |   |       | (56   | )    
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                |                                          | Net cash flows from (used in) investing activities |       |            | (3   | )              |       |              | 1,612  |              |     |      | 811    |   |        |       | (847  | ) |       |       | 1,573 |  
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash flows from (used in) financing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                | Repurchase of common stock               |                                                    |       | (231       | )    |                |       |             |        |              |     |     |        |   |        |      |       |   |       | (231  | )    
|                                                | Dividends paid on common stock           |                                                    |       | (322       | )    |                |       | (238         | )      |              |     | (860 | )      |   |        | 1,098 |       |   |       | (322  | )    
|                                                | Repayments of long-term debt             |                                                    |       | (387       | )    |                |       |             |        |              |     |     |        |   |        |      |       |   |       | (387  | )    
|                                                | Intercompany notes payables              |                                                    |       | 1          |      |                |       | (470         | )      |              |     | (377 | )      |   |        | 846   |       |   |       |      |      
|                                                | Other, net                               |                                                    |       | 238        |      |                |       | (164         | )      |              |     | (16  | )      |   |        | 1     |       |   |       | 59    |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                |                                          | Net cash flows used in financing activities        |       |            | (701 | )              |       |              | (872   | )            |     |      | (1,253 | ) |        |       | 1,945 |   |       |       | (881  | )
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|                                                |                                          | Net cash flows related to discontinued operations  |       |            | 103  |                |       |              | (19    | )            |     |      |       |   |        |       |      |   |       |       | 84    |  
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Net change in cash and cash equivalents         |                                          |                                                    | 14    |            |      |                | 1,362 |              |        |              | (10 | )    |        |   |       |       |       |   | 1,366 |      
|Cash and cash equivalents at beginning of year  |                                          |                                                    |      |            |      |                | 1,062 |              |        |              | 115 |      |        |   |       |       |       |   | 1,177 |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      
|Cash and cash equivalents at end of year        |                                          | $                                                  | 14    |            |      | $              | 2,424 |              |        | $            | 105 |      |        | $ |       |       |       | $ | 2,543 |      
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |        |   |        |       |       |   |       |      

111



---



##### 



NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Condensed Consolidating Balance
Sheets

(Dollars in Millions)


(Unaudited)


|                                            |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |        | 
|------------------------------------------- | ------------------------------------------ | ------ | ------ | ---------- |  | -------------- | ------ | ------------ |  | ------------ | ----- | ----- |  | - | ------- | ------- | - | - | ----- | ------ | 
|                                            |                                            | Issuer |        | Guarantors |  | Non-Guarantors |        | Eliminations |  | Consolidated
|                                            |                                            |        |        |            |  |                |        |              |  |             
|December 31, 2002                           |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|Assets                                      |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|Cash and cash equivalents                   |                                            | $      | 463    |            |  | $              | 1,006  |              |  | $            | 115   |       |  | $ |        |         |   | $ | 1,584 |       
|Short-term investments                      |                                            |        | 504    |            |  |                | 91     |              |  |              |      |       |  |   |        |         |   |   | 595   |       
|Assets held for sale                        |                                            |        |       |            |  |                | 76     |              |  |              | 2     |       |  |   |        |         |   |   | 78    |       
|Other current assets                        |                                            |        | 80     |            |  |                | 2,043  |              |  |              | 70    |       |  |   | (458    | )       |   |   | 1,735 |       
|Trademarks, net                             |                                            |        |       |            |  |                |       |              |  |              | 2,085 |       |  |   |        |         |   |   | 2,085 |       
|Goodwill, net                               |                                            |        |       |            |  |                | 6,875  |              |  |              | 215   |       |  |   |        |         |   |   | 7,090 |       
|Intercompany notes receivable               |                                            |        | 360    |            |  |                | 174    |              |  |              | 3,436 |       |  |   | (3,970  | )       |   |   |      |       
|Investment in subsidiaries                  |                                            |        | 8,705  |            |  |                | 4,834  |              |  |              | 8     |       |  |   | (13,547 | )       |   |   |      |       
|Other noncurrent assets                     |                                            |        | 188    |            |  |                | 1,258  |              |  |              | 38    |       |  |   |        |         |   |   | 1,484 |       
|                                            |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|                                            | Total assets                               |        | $      | 10,300     |  |                | $      | 16,357       |  |              | $     | 5,969 |  |   | $       | (17,975 | ) |   | $     | 14,651 | 
|                                            |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|Liabilities and stockholders
    equity    |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|Liabilities related to assets held for sale |                                            | $      |       |            |  | $              | 8      |              |  | $            |      |       |  | $ |        |         |   | $ | 8     |       
|Tobacco settlement and related accruals     |                                            |        |       |            |  |                | 1,536  |              |  |              | 7     |       |  |   |        |         |   |   | 1,543 |       
|Other current liabilities                   |                                            |        | 1,233  |            |  |                | 1,079  |              |  |              | 22    |       |  |   | (458    | )       |   |   | 1,876 |       
|Intercompany notes payable                  |                                            |        | 257    |            |  |                | 3,369  |              |  |              | 344   |       |  |   | (3,970  | )       |   |   |      |       
|Long-term debt (less current maturities)    |                                            |        | 1,755  |            |  |                |       |              |  |              |      |       |  |   |        |         |   |   | 1,755 |       
|Other noncurrent liabilities                |                                            |        | 339    |            |  |                | 1,669  |              |  |              | 745   |       |  |   |        |         |   |   | 2,753 |       
|Stockholders equity                        |                                            |        | 6,716  |            |  |                | 8,696  |              |  |              | 4,851 |       |  |   | (13,547 | )       |   |   | 6,716 |       
|                                            |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|                                            | Total liabilities and stockholders equity |        | $      | 10,300     |  |                | $      | 16,357       |  |              | $     | 5,969 |  |   | $       | (17,975 | ) |   | $     | 14,651 | 
|                                            |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|December 31, 2001                           |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|Assets                                      |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|Cash and cash equivalents                   |                                            | $      | 185    |            |  | $              | 1,734  |              |  | $            | 101   |       |  | $ |        |         |   | $ | 2,020 |       
|Short-term investments                      |                                            |        |       |            |  |                | 207    |              |  |              |      |       |  |   |        |         |   |   | 207   |       
|Other current assets                        |                                            |        | 95     |            |  |                | 2,055  |              |  |              | 37    |       |  |   | (486    | )       |   |   | 1,701 |       
|Trademarks, net                             |                                            |        |       |            |  |                |       |              |  |              | 2,773 |       |  |   |        |         |   |   | 2,773 |       
|Goodwill, net                               |                                            |        |       |            |  |                | 6,875  |              |  |              |      |       |  |   |        |         |   |   | 6,875 |       
|Intercompany notes receivable               |                                            |        | 146    |            |  |                | 14     |              |  |              | 3,822 |       |  |   | (3,982  | )       |   |   |      |       
|Investment in subsidiaries                  |                                            |        | 10,585 |            |  |                | 5,772  |              |  |              |      |       |  |   | (16,357 | )       |   |   |      |       
|Other noncurrent assets                     |                                            |        | 65     |            |  |                | 1,496  |              |  |              | 16    |       |  |   | (31     | )       |   |   | 1,546 |       
|                                            |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|                                            | Total assets                               |        | $      | 11,076     |  |                | $      | 18,153       |  |              | $     | 6,749 |  |   | $       | (20,856 | ) |   | $     | 15,122 | 
|                                            |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|Liabilities and stockholders
    equity    |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|Tobacco settlement and related accruals     |                                            | $      |       |            |  | $              | 1,520  |              |  | $            |      |       |  | $ |        |         |   | $ | 1,520 |       
|Other current liabilities                   |                                            |        | 664    |            |  |                | 1,080  |              |  |              | 14    |       |  |   | (486    | )       |   |   | 1,272 |       
|Intercompany notes payable                  |                                            |        | 69     |            |  |                | 3,905  |              |  |              | 8     |       |  |   | (3,982  | )       |   |   |      |       
|Long-term debt (less current maturities)    |                                            |        | 1,534  |            |  |                | 97     |              |  |              |      |       |  |   |        |         |   |   | 1,631 |       
|Other noncurrent liabilities                |                                            |        | 783    |            |  |                | 947    |              |  |              | 974   |       |  |   | (31     | )       |   |   | 2,673 |       
|Stockholders equity                        |                                            |        | 8,026  |            |  |                | 10,604 |              |  |              | 5,753 |       |  |   | (16,357 | )       |   |   | 8,026 |       
|                                            |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       
|                                            | Total liabilities and stockholders equity |        | $      | 11,076     |  |                | $      | 18,153       |  |              | $     | 6,749 |  |   | $       | (20,856 | ) |   | $     | 15,122 | 
|                                            |                                            |        |        |            |  |                |        |              |  |              |       |       |  |   |         |         |   |   |       |       

112



---



##### 





|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants
    on Accounting and Financial Disclosure

None.

PART III



|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

Item 10 is incorporated by reference to
Item 1: Election of Class I Directors and
Stock Ownership-Section 16(a) beneficial ownership of
reporting compliance of RJRs Definitive Proxy
Statement to be filed with the SEC on or before March 19,
2003. For information regarding the executive officers, see
Executive Officers and Certain Significant Employees of
the Registrant in Item 4 of Part I of this report.



|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

Item 11 is incorporated by reference to
Executive Compensation and Transactions with
Management and to Item 1: Election of
Class I Directors  Compensation Committee
interlocks and insider participation and
 Director compensation of RJRs
Definitive Proxy Statement to be filed with the SEC on or before
March 19, 2003.



|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management

Item 12 is incorporated by reference to
Stock Ownership of RJRs Definitive Proxy
Statement to be filed with the SEC on or before March 19,
2003.



|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

None.



|         |                        
|-------- | -----------------------
|Item 14. | Controls and Procedures



|    |                                                                                                                                                                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | RJRs chief executive officer and chief
    financial officer have concluded that RJRs disclosure
    controls and procedures are effective, based on their evaluation
    of these controls and procedures within 90 days of the date
    of this report.
|   
|(b) | There have been no significant changes in
    RJRs internal controls or in other factors that could
    significantly affect these controls subsequent to the date of
    their evaluation.                                                               

PART IV



|         |                                                                     
|-------- | --------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K



|    |                                                                
|--- | ---------------------------------------------------------------
|(a) | The following documents are filed as a part of
    this report:



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                       
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Consolidated Statements of Income for the years
    ended December 31, 2002, 2001 and 2000. 
     Consolidated Statements of Cash Flows for the years ended
    December 31, 2002, 2001 and 2000. 
     Consolidated Balance Sheets as of December 31, 2002 and
    2001. 
     Consolidated Statements of Stockholders Equity and
    Comprehensive Income for the years ended December 31, 2002,
    2001 and 2000.
|
| | (2) | Financial Statement Schedules have been omitted
    because the information required has been separately disclosed
    in the consolidated financial statements or notes.                                                                                                                                                                                                                                             
|
| | (3) | See (c) below                                                                                                                                                                                                                                                                                                                                                                                                         

113



---



##### 





|    |                                                                                                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(b) | RJR filed a Current Report on Form 8-K,
    dated December 20, 2002, disclosing Amendment No. 2,
    dated as of December 18, 2002, to the Rights Agreement,
    dated as of May 17, 1999, between R.J. Reynolds Tobacco
    Holdings, Inc. and The Bank of New York, as rights agent.
|   
|(c) | The following exhibits are filed as part of this
    report, Exhibit Numbers 10.20 through 10.69 are management
    contracts, compensatory plans or arrangements:                                                                                                                    

|        |     |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|------- | --- |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |     | 
|Number  |     | 
|        |     | 
|        | 2.1 |  |  | Distribution Agreement dated as of May 12,
    1999, among RJR Nabisco Holdings Corp., RJR Nabisco, Inc. and R.
    J. Reynolds Tobacco Company (incorporated by reference to
    Exhibit 2.1 to Registrants Form 8-A filed
    May 19, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|        | 2.2 |  |  | Amendment No. 1, dated as of June 28,
    2001, to the Distribution Agreement, dated as of May 12,
    1999, among RJR Nabisco Holdings Corp. (now known as RJR
    Acquisition Corp.), RJR Nabisco, Inc. (now known as R.J.
    Reynolds Tobacco Holdings, Inc.) and R. J. Reynolds Tobacco
    Company (incorporated by reference to Exhibit 2.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2001, filed August 1, 2001).                                                                                                                                                                                                                                                                                                                    
|        | 2.3 |  |  | Certificate of Merger and Agreement and Plan of
    Merger among RJR Nabisco Holdings Corp., RJR Nabisco, Inc. and
    R.J. Reynolds Tobacco Holdings, Inc. (incorporated by reference
    to Exhibit 2.2 to Registrants Form 8-K filed
    May 28, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|        | 2.4 |  |  | Agreement and Plan of Merger dated as of
    June 25, 2000, among Nabisco Group Holdings Corp., R.J.
    Reynolds Tobacco Holdings, Inc. and RJR Acquisition Corp.
    (incorporated by reference to Exhibit 2.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2000, filed August 7, 2000).                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|        | 2.5 |  |  | Amendment No. 1, dated September 20,
    2000, to the Agreement and Plan of Merger dated as of
    June 25, 2000, among Nabisco Group Holdings Corp., R.J.
    Reynolds Tobacco Holdings, Inc. and RJR Acquisition Corp.
    (incorporated by reference to Exhibit 2.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2000, filed November 3,
    2000).                                                                                                                                                                                                                                                                                                                                                                                     
|        | 2.6 |  |  | Letter dated October 19, 2000, from R.J.
    Reynolds Tobacco Holdings, Inc. to Nabisco Group Holdings Corp.,
    electing that Nabisco Group Holdings Corp. be merged with and
    into RJR Acquisition Corp. under the Agreement and Plan of
    Merger dated as of June 25, 2000, as amended, among Nabisco
    Group Holdings Corp., R.J. Reynolds Tobacco Holdings, Inc. and
    RJR Acquisition Corp. (incorporated by reference to
    Exhibit 2.2 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 2000,
    filed November 3, 2000).                                                                                                                                                                                                      
|        | 2.7 |  |  | Letter dated November 20, 2000, from R.J.
    Reynolds Tobacco Holdings, Inc. to Nabisco Group Holdings Corp.,
    withdrawing its previous election made on October 19, 2000,
    and electing that RJR Acquisition Corp. be merged with and into
    Nabisco Group Holdings Corp. under the Agreement and Plan of
    Merger dated as of June 25, 2000, as amended, among Nabisco
    Group Holdings Corp., R.J. Reynolds Tobacco Holdings, Inc. and
    RJR Acquisition Corp. (incorporated by reference to
    Exhibit 2.4 to Registrants Form 8-K dated
    December 11, 2000).                                                                                                                                                                                                   
|        | 2.8 |  |  | Letter dated October 27, 2000, from R.J.
    Reynolds Tobacco Holdings, Inc. to Nabisco Group Holdings Corp.,
    agreeing that it will pay or cause to be paid to stockholders of
    Nabisco Group Holdings Corp., in circumstances described in
    Section 2.02(b) of the Agreement and Plan of Merger dated
    as of June 25, 2000, as amended, among Nabisco Group
    Holdings Corp., R.J. Reynolds Tobacco Holdings, Inc. and RJR
    Acquisition Corp., an amount equal to 100% of the difference
    between the Net Proceeds (as defined in the Agreement and Plan
    of Merger) and $11.729 billion (incorporated by reference
    to Exhibit 2.3 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 2000,
    filed November 3, 2000).
|        | 3.1 |  |  | Restated Certificate of Incorporation of R.J.
    Reynolds Tobacco Holdings, Inc. (incorporated by reference to
    Exhibit 3.1 to Registrants Form 8-K dated
    June 14, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

114



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##### 



|        |      |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|------- | ---- |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      | 
|Number  |      | 
|        |      | 
|        | 3.2  |  |  | Bylaws of R.J. Reynolds Tobacco Holdings, Inc.,
    as amended and restated effective April 25, 2001
    (incorporated by reference to Exhibit 4.2 to
    Registrants Registration Statement on Form S-8 filed
    April 27, 2001).                                                                                                                                                                                                                                                                                        
|        | 4.1  |  |  | Rights Agreement dated as of May 18, 1999,
    between R.J. Reynolds Tobacco Holdings, Inc. and its rights
    agent (incorporated by reference to Exhibit 4.1 to
    Registrants Form 8-K dated June 14, 1999).                                                                                                                                                                                                                                                                                                           
|        | 4.2  |  |  | Amendment No. 1, dated as of August 9,
    2002, to the Rights Agreement dated as of May 17, 1999,
    between R.J. Reynolds Tobacco Holdings, Inc. and The Bank of New
    York, as rights agent (incorporated by reference to
    Exhibit 4.1 to Registrants Form 8-A/A filed
    August 19, 2002).                                                                                                                                                                                                                      
|        | 4.3  |  |  | Amendment No. 2, dated as of
    December 18, 2002, to the Rights Agreement dated as of
    May 17, 1999, between R.J. Reynolds Tobacco Holdings, Inc.
    and The Bank of New York, as rights agent (incorporated by
    reference to Exhibit 4.1 to Registrants
    Form 8-A/A filed December 20, 2002).                                                                                                                                                                                                                 
|        | 4.4  |  |  | Amended and Restated Indenture dated as of
    July 24, 1995, between RJR Nabisco, Inc. and The Bank of
    New York (incorporated by reference to Exhibit 4.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1995, filed August 8, 1995).                                                                                                                                                                                                                                            
|        | 4.5  |  |  | First Supplemental Indenture and Waiver dated as
    of April 27, 1999, between RJR Nabisco, Inc. and The Bank
    of New York, to the Amended and Restated Indenture dated as of
    July 24, 1995, between RJR Nabisco, Inc. and The Bank of
    New York, as successor trustee (incorporated by reference to
    Exhibit 10.3 to Registrants Form 8-A filed
    May 19, 1999).                                                                                                                                          
|        | 4.6  |  |  | Second Supplemental Indenture and Waiver dated as
    of April 27, 1999, between RJR Nabisco, Inc. and The Bank
    of New York, to the Amended and Restated Indenture dated as of
    May 18, 1992 between RJR Nabisco, Inc. and The Bank of New
    York, as successor trustee, as amended by the Form of First
    Supplemental Indenture and Waiver thereto dated as of
    June 2, 1995 (incorporated by reference to
    Exhibit 10.4 to Registrants Form 8-A filed
    May 19, 1999).                               
|        | 4.7  |  |  | Indenture dated as of May 15, 1999, among
    RJR Nabisco, Inc., R. J. Reynolds Tobacco Company and The Bank
    of New York, as trustee (incorporated by reference to
    Exhibit 10.2 to Registrants Form 8-A filed
    May 19, 1999).                                                                                                                                                                                                                                                                                   
|        | 4.8  |  |  | First Supplemental Indenture dated as of
    December 12, 2000, among RJR Acquisition Corp., R.J.
    Reynolds Tobacco Holdings, Inc., R. J. Reynolds Tobacco Company
    and The Bank of New York, as Trustee, to the Indenture dated as
    of May 15, 1999, among RJR Nabisco, Inc., R. J. Reynolds
    Tobacco Company and The Bank of New York, as Trustee
    (incorporated by reference to Exhibit 4.6 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2000, filed March 1, 2001).
|        | 4.9  |  |  | Form of Note for the 6 1/2% Note due 2007
    (incorporated by reference to Exhibit 4.1 to
    Registrants Form 8-K dated May 15, 2002).                                                                                                                                                                                                                                                                                                                                                                                   
|        | 4.10 |  |  | Form of Note for the 7 1/4% Note due 2012
    (incorporated by reference to Exhibit 4.2 to
    Registrants Form 8-K dated May 15, 2002).                                                                                                                                                                                                                                                                                                                                                                                   
|        | 4.11 |  |  | Indenture dated as of May 20, 2002, by and
    among R.J. Reynolds Tobacco Holdings, Inc., R. J. Reynolds
    Tobacco Company, RJR Acquisition Corp. and The Bank of New York
    (incorporated by reference to Exhibit 4.3 to
    Registrants Form 8-K dated May 15, 2002).                                                                                                                                                                                                                                               
|        | 10.1 |  |  | Second Amended and Restated Credit Agreement
    dated as of May 10, 2002, among R.J. Reynolds Tobacco
    Holdings, Inc. and the lending institutions listed and to be
    listed from time to time on Annex I thereto (incorporated as
    Exhibit 10.1 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2002, filed
    August 1, 2002).                                                                                                                                                 
|        | 10.2 |  |  | First Amendment to the Credit Agreement dated as
    of January 17, 2003, among R.J. Reynolds Tobacco Holdings,
    Inc. and lending institutions party to the Credit Agreement.                                                                                                                                                                                                                                                                                                                                            

115



---



##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|------- | ----- |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.3  |  |  | Third Amended and Restated Subsidiary Guaranty by
    R. J. Reynolds Tobacco Company and RJR Acquisition Corp. to the
    creditors defined therein, issued in connection with the Credit
    Agreement dated as of May 18, 1999 and amended and restated
    as of November 17, 2000 and further amended and restated as
    of May 10, 2002, among R.J. Reynolds Tobacco Holdings, Inc.
    and the lending institutions listed and to be listed from time
    to time on Annex I thereto.
|        | 10.4  |  |  | Guarantee dated as of May 18, 1999, by R. J.
    Reynolds Tobacco Company to the holders and to The Bank of New
    York, as trustee, issued in connection with the Indenture dated
    as of May 15, 1999, among RJR Nabisco, Inc., R. J. Reynolds
    Tobacco Company and The Bank of New York, as trustee
    (incorporated by reference to Exhibit 10.6 to
    Registrants Form 8-A filed May 19, 1999).                                                                               
|        | 10.5  |  |  | Tax Sharing Agreement dated as of June 14,
    1999, among RJR Nabisco Holdings Corp., R.J. Reynolds Tobacco
    Holdings, Inc., R. J. Reynolds Tobacco Company and Nabisco
    Holdings Corp. (incorporated by reference to Exhibit 10.1
    to Registrants Form 8-K dated June 14, 1999).                                                                                                                                                                                                
|        | 10.6  |  |  | Amendment to Tax Sharing Agreement dated
    June 25, 2000, among Nabisco Group Holdings Corp., R.J.
    Reynolds Tobacco Holdings, Inc., Nabisco Holdings Corp. and R.
    J. Reynolds Tobacco Company (incorporated by reference to
    Exhibit 10.2 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2000, filed
    August 7, 2000).                                                                                                                    
|        | 10.7  |  |  | Agreement dated as of May 20, 1999, among
    Pension Benefit Guaranty Corporation, RJR Nabisco Holdings Corp.
    and R. J. Reynolds Tobacco Company (incorporated by reference to
    Exhibit 10.16 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1999, filed
    August 16, 1999).                                                                                                                                                                    
|        | 10.8  |  |  | Amendment effective as of June 14, 1999, to
    the Agreement effective as of May 20, 1999, by and among
    the Pension Benefit Guaranty Corporation, R.J. Reynolds Tobacco
    Holdings, Inc. and R. J. Reynolds Tobacco Company (incorporated
    by reference to Exhibit 10.3 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2000, filed August 7, 2000).                                                                                         
|        | 10.9  |  |  | Second Amendment effective as of January 7,
    2002, to the Agreement effective as of May 20, 1999, by and
    among the Pension Benefit Guaranty Corporation, R.J. Reynolds
    Tobacco Holdings, Inc. and R. J. Reynolds Tobacco Company
    (incorporated by reference to Exhibit 10.9 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2001, filed February 28, 2002).                                                                               
|        | 10.10 |  |  | Purchase Agreement dated as of March 9,
    1999, as amended and restated as of May 11, 1999, among R.
    J. Reynolds Tobacco Company, RJR Nabisco, Inc. and Japan Tobacco
    Inc. (incorporated by reference to Exhibit 2.1 to
    Registrants Form 8-K dated May 12, 1999).                                                                                                                                                                                                            
|        | 10.11 |  |  | Settlement Agreement dated August 25, 1997,
    between the State of Florida and settling defendants in The
    State of Florida v. American Tobacco Co. (incorporated by
    reference to Exhibit 2 to Registrants Form 8-K
    dated August 25, 1997).                                                                                                                                                                                                                                   
|        | 10.12 |  |  | Comprehensive Settlement Agreement and Release
    dated January 16, 1998, between the State of Texas and
    settling defendants in The State of Texas v. American Tobacco
    Co. (incorporated by reference to Exhibit 2 to
    Registrants Form 8-K dated January 16, 1998).                                                                                                                                                                                                           
|        | 10.13 |  |  | Settlement Agreement and Release in re: The State
    of Minnesota v. Philip Morris, Inc., by and among the State of
    Minnesota, Blue Cross and Blue Shield of Minnesota and the
    various tobacco company defendants named therein, dated as of
    May 8, 1998 (incorporated by reference to Exhibit 99.1
    to Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 30, 1998, filed May 15, 1998).                                                           

116



---



##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|------- | ----- |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.14 |  |  | Settlement Agreement and Stipulation for Entry of
    Consent Judgment in re: The State of Minnesota v. Philip Morris,
    Inc., by and among the State of Minnesota, Blue Cross and Blue
    Shield of Minnesota and the various tobacco company defendants
    named therein, dated as of May 8, 1998 (incorporated by
    reference to Exhibit 99.2 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended March 30,
    1998, filed May 15, 1998).
|        | 10.15 |  |  | Form of Consent Judgment by Judge Kenneth J.
    Fitzpatrick, Judge of District Court in re: The State of
    Minnesota v. Philip Morris, Inc. (incorporated by reference to
    Exhibit 99.3 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended March 30, 1998, filed
    May 15, 1998).                                                                                                                                                         
|        | 10.16 |  |  | Stipulation of Amendment to Settlement Agreement
    and for Entry of Agreed Order dated July 2, 1998, by and
    among the Mississippi Defendants, Mississippi and the
    Mississippi Counsel in connection with the Mississippi Action
    (incorporated by reference to Exhibit 99.2 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1998, filed August 14, 1998).                                                            
|        | 10.17 |  |  | Stipulation of Amendment to Settlement Agreement
    and for Entry of Consent Decree dated July 24, 1998, by and
    among the Texas Defendants, Texas and the Texas Counsel in
    connection with the Texas Action (incorporated by reference to
    Exhibit 99.4 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1998, filed
    August 14, 1998).                                                                                 
|        | 10.18 |  |  | Stipulation of Amendment to Settlement Agreement
    and for Entry of Consent Decree dated September 11, 1998,
    by and among the State of Florida and the tobacco companies
    named therein (incorporated by reference to Exhibit 99.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 1998, filed November 12,
    1998).                                                                                              
|        | 10.19 |  |  | Master Settlement Agreement (the MSA)
    dated November 23, 1998, between the Settling States named
    in the MSA and the Participating Manufacturers also named
    therein (incorporated by reference to Exhibit 4 to
    Registrants Form 8-K dated November 23, 1998).                                                                                                                                                                                        
|        | 10.20 |  |  | Amended and Restated Equity Incentive Award Plan
    for Directors of R.J. Reynolds Tobacco Holdings, Inc. and
    Subsidiaries (the EIAP) (incorporated by reference
    to Exhibit 10.1 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended March 31, 2000, filed
    May 9, 2000).                                                                                                                                                            
|        | 10.21 |  |  | Form of Deferred Stock Unit Agreement between
    R.J. Reynolds Tobacco Holdings, Inc. and the Director named
    therein, pursuant to the EIAP (incorporated by reference to
    Exhibit 10.9 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1999, filed
    August 16, 1999).                                                                                                                                                      
|        | 10.22 |  |  | Form of Stock Option Agreement (Initial) between
    R.J. Reynolds Tobacco Holdings, Inc. and the Director named
    therein, pursuant to the EIAP (incorporated by reference to
    Exhibit 10.10 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1999, filed
    August 16, 1999).                                                                                                                                                  
|        | 10.23 |  |  | Form of Stock Option Agreement (Annual) between
    R.J. Reynolds Tobacco Holdings, Inc. and the Director named
    therein, pursuant to the EIAP, dated as of June 15, 1999
    (incorporated by reference to Exhibit 10.11 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1999, filed August 16, 1999).                                                                                                                        
|        | 10.24 |  |  | Deferred Compensation Plan for Directors between
    R.J. Reynolds Tobacco Holdings, Inc. (Effective June 14,
    1999) (incorporated by reference to Exhibit 10.12 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1999, filed August 16, 1999).                                                                                                                                                                                 
|        | 10.25 |  |  | R.J. Reynolds Tobacco Holdings, Inc. 1999 Long
    Term Incentive Plan (incorporated by reference to
    Exhibit 10.2 to Registrants Form 8-K dated
    June 15, 1999).                                                                                                                                                                                                                                                                                               
|        | 10.26 |  |  | Amendments to the R.J. Reynolds Tobacco Holdings,
    Inc. 1999 Long Term Incentive Plan dated December 5, 2001
    (incorporated by reference to Exhibit 10.26 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2001, filed February 28, 2002).                                                                                                                                                                                     

117



---



##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------- | ----- |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.27 |  |  | Amendment No. 2 to R.J. Reynolds Tobacco
    Holdings, Inc. 1999 Long Term Incentive Plan dated
    December 10, 2002.                                                                                                                                                                                                                                                                                                                                         
|        | 10.28 |  |  | Form of 1999 Performance Appreciation Rights
    Agreement under R.J. Reynolds Tobacco Holdings, Inc. 1999 Long
    Term Incentive Plan between R.J. Reynolds Tobacco Holdings, Inc.
    and the grantee named therein (incorporated by reference to
    Exhibit 10.1 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                                                                
|        | 10.29 |  |  | Form of Tandem Restricted Stock/Stock Option
    Agreement dated June 15, 1999, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.2 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 1999, filed November 12,
    1999).                                                                                                                    
|        | 10.30 |  |  | Form of Tandem Restricted Stock/Stock Option
    Agreement dated June 15, 1999, between R.J. Reynolds
    Tobacco Holdings, Inc. and Andrew J. Schindler (incorporated by
    reference to Exhibit 10.3 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended
    September 30, 1999, filed November 12, 1999).                                                                                                                              
|        | 10.31 |  |  | Amendment No. 1 to Tandem Restricted
    Stock/Stock Option Agreement Dated June 15, 1999, dated
    December 5, 2001 (incorporated by reference to
    Exhibit 10.30 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2001, filed
    February 28, 2002).                                                                                                                                                                       
|        | 10.32 |  |  | Form of Tandem Restricted Stock/Stock Option
    Agreement dated July 28, 1999, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.4 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 1999, filed November 12,
    1999).                                                                                                                    
|        | 10.33 |  |  | Amendment No. 1 to Tandem Restricted
    Stock/Stock Option Agreement Dated July 28, 1999, dated
    December 5, 2001 (incorporated by reference to
    Exhibit 10.32 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2001, filed
    February 28, 2002).                                                                                                                                                                       
|        | 10.34 |  |  | Form of Amendment No. 2 to Tandem Restricted
    Stock/Stock Option Agreement dated as of April 24, 2002,
    amending the Tandem Restricted Stock/Stock Option Agreements
    dated June 15 and July 28, 1999, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.3 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2002, filed August 6, 2002).
|        | 10.35 |  |  | Amendment No. 3 to Tandem Restricted
    Stock/Stock Option Agreements dated December 10, 2002,
    amending the Tandem Restricted Stock/Stock Option Agreements
    dated June 15 and July 28, 1999.                                                                                                                                                                                                                                                          
|        | 10.36 |  |  | Form of Restricted Stock Agreement dated
    February 2, 2000, between R.J. Reynolds Tobacco Holdings,
    Inc. and the grantee named therein (incorporated by reference to
    Exhibit 10.35 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 1999, filed
    March 8, 2000).                                                                                                                                                   
|        | 10.37 |  |  | Form of Performance Unit Agreement (three-year
    vesting) dated February 2, 2000, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.36 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 1999, filed March 8, 2000).                                                                                                                              
|        | 10.38 |  |  | Form of Restricted Stock Agreement dated
    January 31, 2001, between R.J. Reynolds Tobacco Holdings,
    Inc. and the grantee named therein (incorporated by reference to
    Exhibit 10.36 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2000, filed
    March 1, 2001).                                                                                                                                                   

118



---



##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                           
|------- | ----- |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.39 |  |  | Form of Performance Unit Agreement (three-year
    vesting) dated January 31, 2001, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.38 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2000, filed March 1, 2001).                                                                                         
|        | 10.40 |  |  | Form of Performance Unit Agreement (one-year
    vesting) dated February 6, 2002, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 31, 2002, filed May 1, 2002).                                                                                           
|        | 10.41 |  |  | Form of Restricted Stock Agreement dated
    July 26, 2002, between R.J. Reynolds Tobacco Holdings, Inc.
    and the grantee named therein (incorporated by reference to
    Exhibit 10.5 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2002, filed
    August 6, 2002).                                                                                                               
|        | 10.42 |  |  | Form of Performance Unit Agreement (three-year
    vesting) dated July 26, 2002, between R.J. Reynolds Tobacco
    Holdings, Inc. and the grantee named therein (incorporated by
    reference to Exhibit 10.4 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2002, filed August 6, 2002).                                                                                          
|        | 10.43 |  |  | Form of Amendment No. 1 to Restricted Stock
    Agreements dated as of December 10, 2002, amending the
    Restricted Stock Agreements dated February 2, 2000,
    January 31, 2001 and July 26, 2002, between R.J.
    Reynolds Tobacco Holdings, Inc. and the grantee named therein.                                                                                                                                    
|        | 10.44 |  |  | Amendment No. 1 to Performance Unit
    Agreements dated December 5, 2001, amending the Performance
    Unit agreements dated February 2, 2000 and January 31,
    2001, between R.J. Reynolds Tobacco Holdings, Inc. and the
    grantee named therein (incorporated by reference to
    Exhibit 10.37 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2001, filed
    February 28, 2002).
|        | 10.45 |  |  | Form of Performance Unit Agreement (one-year
    vesting) dated February 5, 2003, between R.J. Reynolds
    Holdings, Inc. and the grantee named therein                                                                                                                                                                                                                                                                  
|        | 10.46 |  |  | R.J. Reynolds Tobacco Holdings, Inc. Annual
    Incentive Award Plan, Effective January 1, 1987 Amended and
    Restated Effective January 1, 2002 (incorporated by
    reference to Exhibit 10.38 to Registrants Annual
    Report on Form 10-K for the year ended December 31,
    2001, filed February 28, 2002).                                                                                                     
|        | 10.47 |  |  | Master Trust Agreement, as amended and restated
    as of October 12, 1988, between RJR Nabisco, Inc. and
    Wachovia Bank and Trust Company, N.A. (incorporated by reference
    to Exhibit 10.18 to the Registration Statement on
    Form S-4 of RJR Holdings Corp. and RJR Holdings Group,
    Inc., Registration No. 33-27894, filed April 5, 1989,
    as amended).                                                
|        | 10.48 |  |  | Amendment No. 1 to Master Trust Agreement,
    dated January 27, 1989 (incorporated by reference to
    Exhibit 10(g)(ii) to Registrants Annual Report on
    Form 10-K for the fiscal year ended December 31, 1988,
    filed March 9, 1989).                                                                                                                                                                           
|        | 10.49 |  |  | Amendment No. 2 to Master Trust Agreement,
    dated January 27, 1989 (incorporated by reference to
    Exhibit 10(g)(iii) to Registrants Annual Report on
    Form 10-K for the fiscal year ended December 31, 1988,
    filed March 9, 1989).                                                                                                                                                                          
|        | 10.50 |  |  | Excess Benefit Master Trust Agreement, as amended
    and restated as of October 12, 1988, between RJR Nabisco,
    Inc. and Wachovia Bank and Trust Company, N.A. (incorporated by
    reference to Exhibit 10.21 to Registrants
    Registration Statement on Form S-4 of RJR Holdings Corp.
    and RJR Holdings Group, Inc., Registration No. 33-27894,
    filed April 5, 1989, as amended).                        
|        | 10.51 |  |  | Amendment No. 1 to Excess Benefit Master
    Trust Agreement, dated January 27, 1989 (incorporated by
    reference to Exhibit 10(h)(ii) to Registrants Annual
    Report on Form 10-K for the fiscal year ended
    December 31, 1988, filed March 9, 1989).                                                                                                                                                            

119



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##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|------- | ----- |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.52 |  |  | RJR Nabisco, Inc. Supplemental Executive
    Retirement Plan, as amended on July 21, 1988 (incorporated
    by reference to Exhibit 10.32 to the Registration Statement
    on Form S-4 of RJR Holdings Corp. and RJR Holdings Group,
    Inc., Registration No. 33-27894, filed April 5, 1989,
    as amended).                                                                                                                                         
|        | 10.53 |  |  | Amendment to Supplemental Executive Retirement
    Plan, dated November 23, 1988 (incorporated by reference to
    Exhibit 10(m)(ii) to Registrants Annual Report on
    Form 10-K for the fiscal year ended December 31, 1998,
    filed March 9, 1989).                                                                                                                                                                                               
|        | 10.54 |  |  | Amendment No. 2 to Supplemental Executive
    Retirement Plan, dated January 27, 1989 (incorporated by
    reference to Exhibit 10(m)(iii) to Registrants Annual
    Report on Form 10-K for the fiscal year ended
    December 31, 1988, filed March 9, 1989).                                                                                                                                                                                         
|        | 10.55 |  |  | Amendment to Supplemental Executive Retirement
    Plan, dated April 10, 1993 (incorporated by reference to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 1993, filed February 24, 1994).                                                                                                                                                                                                                              
|        | 10.56 |  |  | Retention Trust Agreement dated May 13,
    1998, by and between RJR Nabisco, Inc. and Wachovia Bank, N.A.
    (incorporated by reference to Registrants Quarterly Report
    on Form 10-Q for the quarter ended June 30, 1998,
    filed August 14, 1998).                                                                                                                                                                                             
|        | 10.57 |  |  | Form of Employment Agreement dated as of
    October 31, 1988, by and between RJR Nabisco, Inc. and
    Andrew J. Schindler (incorporated by reference to
    Exhibit 10 to Registrants Schedule 14D-9 filed
    on November 8, 1988).                                                                                                                                                                                                                  
|        | 10.58 |  |  | Form of Special Addendum dated December 20,
    1988, to the Employment Agreement dated as of October 31,
    1988, between RJR Nabisco, Inc. and Andrew J. Schindler
    (incorporated by reference to Exhibit 10(d)(i) to
    Registrants Annual Report on Form 10-K for the fiscal
    year ended December 31, 1988, filed March 8, 1989).                                                                                                           
|        | 10.59 |  |  | Amendment dated June 7, 1999, to the
    Employment Agreement dated as of October 31, 1988, and
    previously amended as of December 20, 1988, between RJR
    Nabisco, Inc. and Andrew J. Schindler (incorporated by reference
    to Exhibit 10.8 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                                                                           
|        | 10.60 |  |  | Amendment dated January 4, 2002, to the
    Employment Agreement dated as of October 31, 1988, and
    previously amended as of December 20, 1988 and June 7,
    1999, between R.J. Reynolds Tobacco Holdings, Inc. (formerly
    known as RJR Nabisco, Inc.) and Andrew J. Schindler
    (incorporated by reference to Exhibit 10.52 to Registrants
    Annual Report on Form 10-K for the year ended
    December 31, 2001, filed February 28, 2002).
|        | 10.61 |  |  | Change of Control Letter Agreement dated
    October 25, 1999, by and among R.J. Reynolds Tobacco
    Holdings, Inc. and Andrew J. Schindler (incorporated by
    reference to Exhibit 10.53 to Registrants Annual
    Report on Form 10-K for the year ended December 31,
    2001, filed February 28, 2002).                                                                                                                                          
|        | 10.62 |  |  | Participation Agreement, RJR Nabisco, Inc.
    Supplemental Executive Retirement Plan, for Andrew J. Schindler
    dated December 28, 1995 (incorporated by reference to
    Exhibit 10.45 to Registrants Annual Report on
    Form 10-K for the fiscal year ended December 31, 1995,
    filed February 22, 1996).                                                                                                                                     
|        | 10.63 |  |  | Amendment dated October 25, 1999, to the
    Participation Agreement  R.J. Reynolds Supplemental
    Executive Retirement Plan dated as of December 28, 1995,
    between R.J. Reynolds Tobacco Holdings, Inc. and Andrew J.
    Schindler (incorporated by reference to Exhibit 10.55 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2001, filed February 28, 2002).                                               

120



---



##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                        
|------- | ----- |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.64 |  |  | Cash Retention Grant Letter Agreement dated
    August 17, 1999, between R.J. Reynolds Tobacco Holdings,
    Inc. and Andrew J. Schindler (incorporated by reference to
    Exhibit 10.9 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                     
|        | 10.65 |  |  | Offer of Employment Letter dated June 12,
    2002, by R.J. Reynolds Tobacco Holdings, Inc. to Richard H.
    Bogan, accepted by Mr. Bogan on June 18, 2002
    (incorporated by reference to Exhibit 10.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2002, filed November 1,
    2002).
|        | 10.66 |  |  | Severance Agreement dated July 10, 2002, by
    and between R.J. Reynolds Tobacco Holdings, Inc. and
    Kenneth J. Lapiejko (incorporated by reference to
    Exhibit 10.2 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 2002,
    filed November 1, 2002).                                   
|        | 10.67 |  |  | Form of Change of Control Letter Agreement
    between R.J. Reynolds Tobacco Holdings, Inc. and the executive
    officer named therein (incorporated by reference to
    Exhibit 10.5 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                       
|        | 10.68 |  |  | Form of Special Severance Benefits Letter
    Agreement between R. J. Reynolds Tobacco Company and the
    executive officer named therein (incorporated by reference to
    Exhibit 10.6 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                    
|        | 10.69 |  |  | Form of Amendment to Special Severance Benefits
    Letter Agreement between R. J. Reynolds Tobacco Company and
    the executive officer named therein (incorporated by reference
    to Exhibit 10.7 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).       
|        | 12.1  |  |  | Computation of Ratio of Earnings to Combined
    Fixed Charges and Preferred Stock Dividends/Deficiency in the
    Coverage of Combined Fixed Charges and Preferred Stock Dividends
    by Earnings Before Fixed Charges for each of the five years
    within the period ended December 31, 2002.                                     
|        | 21.1  |  |  | Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                        
|        | 23.1  |  |  | Consent of Independent Auditors.                                                                                                                                                                                                                                                                                                       
|        | 99.1  |  |  | Expanded Litigation Disclosure.                                                                                                                                                                                                                                                                                                        
|        | 99.2  |  |  | Certification of Chief Executive Officer relating
    to RJRs Annual Report on Form 10-K for the year ended
    December 31, 2002, pursuant to Section 18 U.S.C.
    §1350, adopted pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                                                    
|        | 99.3  |  |  | Certification of Chief Financial Officer relating
    to RJRs Annual Report on Form 10-K for the year ended
    December 31, 2002, pursuant to Section 18 U.S.C.
    §1350, adopted pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                                                    

121



---



##### 



SIGNATURES

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



| |                                     
| | ------------------------------------
| | R.J. REYNOLDS TOBACCO HOLDINGS, INC.

Dated: March 3, 2003

| |     |                        
| | --- | -----------------------
| | By: | /s/ ANDREW J. SCHINDLER

| |                                     
| | ------------------------------------
| |                                     
| | Andrew J. Schindler                 
| | Chairman of the Board, President,   
| | Chief Executive Officer and Director

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and on the date indicated.

|                                           |  |                                                                                                          |  |              
|------------------------------------------ |  | -------------------------------------------------------------------------------------------------------- |  | -------------
|Signature                                  |  | Title                                                                                                    |  | Date         
|                                           |  |                                                                                                          |  |              
|                                          
|/s/ ANDREW J. SCHINDLERAndrew J. Schindler |  | Chairman of the Board, President, Chief Executive
    Officer and Director (principal executive officer) |  | March 3, 2003
|                                          
|/s/ RICHARD H. BOGANRichard H. Bogan       |  | Executive Vice President and Chief Financial
    Officer (principal financial officer)                   |  | March 3, 2003
|                                          
|/s/ THOMAS R. ADAMSThomas R. Adams         |  | Senior Vice President and Controller (principal
    accounting officer)                                  |  | March 3, 2003
|                                          
|/s/ MARY K. BUSHMary K. Bush               |  | Director                                                                                                 |  | March 3, 2003
|                                          
|/s/ JOHN T. CHAIN, JR.John T. Chain, Jr.   |  | Director                                                                                                 |  | March 3, 2003
|                                          
|/s/ A.D. FRAZIER, JR.A.D. Frazier, Jr.     |  | Director                                                                                                 |  | March 3, 2003
|                                          
|/s/ E.V. GOINGSE.V. Goings                 |  | Director                                                                                                 |  | March 3, 2003
|                                          
|/s/ DENISE ILITCHDenise Ilitch             |  | Director                                                                                                 |  | March 3, 2003
|                                          
|/s/ JOHN G. MEDLIN, JR.John G. Medlin, Jr. |  | Director                                                                                                 |  | March 3, 2003
|                                          
|/s/ NANA MENSAHNana Mensah                 |  | Director                                                                                                 |  | March 3, 2003
|                                          
|/s/ JOSEPH P. VIVIANOJoseph P. Viviano     |  | Director                                                                                                 |  | March 3, 2003
|                                          
|/s/ THOMAS C. WAJNERTThomas C. Wajnert     |  | Director                                                                                                 |  | March 3, 2003

122



---



##### 



CERTIFICATIONS

I, Andrew J. Schindler, certify that:

1. I have reviewed this annual report on
Form 10-K of R.J. Reynolds Tobacco Holdings, Inc.;

2. Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4. The registrants other certifying
officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b. evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c. presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

5. The registrants other certifying
officer and I have disclosed, based on our most recent
evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b. any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6. The registrants other certifying
officer and I have indicated in this annual report whether there
were significant changes in internal controls or in other
factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |                                     
| | ------------------------------------
| | /s/ ANDREW J. SCHINDLER             
| |                                     
| | Andrew J. Schindler                 
| | Chairman of the Board, President and
| | Chief Executive Officer             

Date: March 3, 2003

123



---



##### 



I, Richard H. Bogan, certify that:

1. I have reviewed this annual report on
Form 10-K of R.J. Reynolds Tobacco Holdings, Inc.;

2. Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4. The registrants other certifying
officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b. evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c. presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

5. The registrants other certifying
officer and I have disclosed, based on our most recent
evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b. any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6. The registrants other certifying
officer and I have indicated in this annual report whether there
were significant changes in internal controls or in other
factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |                             
| | ----------------------------
| | /s/ RICHARD H. BOGAN        
| |                             
| | Richard H. Bogan            
| | Executive Vice President and
| | Chief Financial Officer     

Date: March 3, 2003

124



---



##### 



EXHIBIT INDEX

|        |     |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|------- | --- |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |     | 
|Number  |     | 
|        |     | 
|        | 2.1 |  |  | Distribution Agreement dated as of May 12,
    1999, among RJR Nabisco Holdings Corp., RJR Nabisco, Inc. and R.
    J. Reynolds Tobacco Company (incorporated by reference to
    Exhibit 2.1 to Registrants Form 8-A filed
    May 19, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|        | 2.2 |  |  | Amendment No. 1, dated as of June 28,
    2001, to the Distribution Agreement, dated as of May 12,
    1999, among RJR Nabisco Holdings Corp. (now known as RJR
    Acquisition Corp.), RJR Nabisco, Inc. (now known as R.J.
    Reynolds Tobacco Holdings, Inc.) and R. J. Reynolds Tobacco
    Company (incorporated by reference to Exhibit 2.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2001, filed August 1, 2001).                                                                                                                                                                                                                                                                                                                    
|        | 2.3 |  |  | Certificate of Merger and Agreement and Plan of
    Merger among RJR Nabisco Holdings Corp., RJR Nabisco, Inc. and
    R.J. Reynolds Tobacco Holdings, Inc. (incorporated by reference
    to Exhibit 2.2 to Registrants Form 8-K filed
    May 28, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|        | 2.4 |  |  | Agreement and Plan of Merger dated as of
    June 25, 2000, among Nabisco Group Holdings Corp., R.J.
    Reynolds Tobacco Holdings, Inc. and RJR Acquisition Corp.
    (incorporated by reference to Exhibit 2.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2000, filed August 7, 2000).                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|        | 2.5 |  |  | Amendment No. 1, dated September 20,
    2000, to the Agreement and Plan of Merger dated as of
    June 25, 2000, among Nabisco Group Holdings Corp., R.J.
    Reynolds Tobacco Holdings, Inc. and RJR Acquisition Corp.
    (incorporated by reference to Exhibit 2.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2000, filed November 3,
    2000).                                                                                                                                                                                                                                                                                                                                                                                     
|        | 2.6 |  |  | Letter dated October 19, 2000, from R.J.
    Reynolds Tobacco Holdings, Inc. to Nabisco Group Holdings Corp.,
    electing that Nabisco Group Holdings Corp. be merged with and
    into RJR Acquisition Corp. under the Agreement and Plan of
    Merger dated as of June 25, 2000, as amended, among Nabisco
    Group Holdings Corp., R.J. Reynolds Tobacco Holdings, Inc. and
    RJR Acquisition Corp. (incorporated by reference to
    Exhibit 2.2 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 2000,
    filed November 3, 2000).                                                                                                                                                                                                      
|        | 2.7 |  |  | Letter dated November 20, 2000, from R.J.
    Reynolds Tobacco Holdings, Inc. to Nabisco Group Holdings Corp.,
    withdrawing its previous election made on October 19, 2000,
    and electing that RJR Acquisition Corp. be merged with and into
    Nabisco Group Holdings Corp. under the Agreement and Plan of
    Merger dated as of June 25, 2000, as amended, among Nabisco
    Group Holdings Corp., R.J. Reynolds Tobacco Holdings, Inc. and
    RJR Acquisition Corp. (incorporated by reference to
    Exhibit 2.4 to Registrants Form 8-K dated
    December 11, 2000).                                                                                                                                                                                                   
|        | 2.8 |  |  | Letter dated October 27, 2000, from R.J.
    Reynolds Tobacco Holdings, Inc. to Nabisco Group Holdings Corp.,
    agreeing that it will pay or cause to be paid to stockholders of
    Nabisco Group Holdings Corp., in circumstances described in
    Section 2.02(b) of the Agreement and Plan of Merger dated
    as of June 25, 2000, as amended, among Nabisco Group
    Holdings Corp., R.J. Reynolds Tobacco Holdings, Inc. and RJR
    Acquisition Corp., an amount equal to 100% of the difference
    between the Net Proceeds (as defined in the Agreement and Plan
    of Merger) and $11.729 billion (incorporated by reference
    to Exhibit 2.3 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 2000,
    filed November 3, 2000).
|        | 3.1 |  |  | Restated Certificate of Incorporation of R.J.
    Reynolds Tobacco Holdings, Inc. (incorporated by reference to
    Exhibit 3.1 to Registrants Form 8-K dated
    June 14, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      





---



##### 



|        |      |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|------- | ---- |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      | 
|Number  |      | 
|        |      | 
|        | 3.2  |  |  | Bylaws of R.J. Reynolds Tobacco Holdings, Inc.,
    as amended and restated effective April 25, 2001
    (incorporated by reference to Exhibit 4.2 to
    Registrants Registration Statement on Form S-8 filed
    April 27, 2001).                                                                                                                                                                                                                                                                                        
|        | 4.1  |  |  | Rights Agreement dated as of May 18, 1999,
    between R.J. Reynolds Tobacco Holdings, Inc. and its rights
    agent (incorporated by reference to Exhibit 4.1 to
    Registrants Form 8-K dated June 14, 1999).                                                                                                                                                                                                                                                                                                           
|        | 4.2  |  |  | Amendment No. 1, dated as of August 9,
    2002, to the Rights Agreement dated as of May 17, 1999,
    between R.J. Reynolds Tobacco Holdings, Inc. and The Bank of New
    York, as rights agent (incorporated by reference to
    Exhibit 4.1 to Registrants Form 8-A/A filed
    August 19, 2002).                                                                                                                                                                                                                      
|        | 4.3  |  |  | Amendment No. 2, dated as of
    December 18, 2002, to the Rights Agreement dated as of
    May 17, 1999, between R.J. Reynolds Tobacco Holdings, Inc.
    and The Bank of New York, as rights agent (incorporated by
    reference to Exhibit 4.1 to Registrants
    Form 8-A/A filed December 20, 2002).                                                                                                                                                                                                                 
|        | 4.4  |  |  | Amended and Restated Indenture dated as of
    July 24, 1995, between RJR Nabisco, Inc. and The Bank of
    New York (incorporated by reference to Exhibit 4.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1995, filed August 8, 1995).                                                                                                                                                                                                                                            
|        | 4.5  |  |  | First Supplemental Indenture and Waiver dated as
    of April 27, 1999, between RJR Nabisco, Inc. and The Bank
    of New York, to the Amended and Restated Indenture dated as of
    July 24, 1995, between RJR Nabisco, Inc. and The Bank of
    New York, as successor trustee (incorporated by reference to
    Exhibit 10.3 to Registrants Form 8-A filed
    May 19, 1999).                                                                                                                                          
|        | 4.6  |  |  | Second Supplemental Indenture and Waiver dated as
    of April 27, 1999, between RJR Nabisco, Inc. and The Bank
    of New York, to the Amended and Restated Indenture dated as of
    May 18, 1992 between RJR Nabisco, Inc. and The Bank of New
    York, as successor trustee, as amended by the Form of First
    Supplemental Indenture and Waiver thereto dated as of
    June 2, 1995 (incorporated by reference to
    Exhibit 10.4 to Registrants Form 8-A filed
    May 19, 1999).                               
|        | 4.7  |  |  | Indenture dated as of May 15, 1999, among
    RJR Nabisco, Inc., R. J. Reynolds Tobacco Company and The Bank
    of New York, as trustee (incorporated by reference to
    Exhibit 10.2 to Registrants Form 8-A filed
    May 19, 1999).                                                                                                                                                                                                                                                                                   
|        | 4.8  |  |  | First Supplemental Indenture dated as of
    December 12, 2000, among RJR Acquisition Corp., R.J.
    Reynolds Tobacco Holdings, Inc., R. J. Reynolds Tobacco Company
    and The Bank of New York, as Trustee, to the Indenture dated as
    of May 15, 1999, among RJR Nabisco, Inc., R. J. Reynolds
    Tobacco Company and The Bank of New York, as Trustee
    (incorporated by reference to Exhibit 4.6 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2000, filed March 1, 2001).
|        | 4.9  |  |  | Form of Note for the 6 1/2% Note due 2007
    (incorporated by reference to Exhibit 4.1 to
    Registrants Form 8-K dated May 15, 2002).                                                                                                                                                                                                                                                                                                                                                                                   
|        | 4.10 |  |  | Form of Note for the 7 1/4% Note due 2012
    (incorporated by reference to Exhibit 4.2 to
    Registrants Form 8-K dated May 15, 2002).                                                                                                                                                                                                                                                                                                                                                                                   
|        | 4.11 |  |  | Indenture dated as of May 20, 2002, by and
    among R.J. Reynolds Tobacco Holdings, Inc., R. J. Reynolds
    Tobacco Company, RJR Acquisition Corp. and The Bank of New York
    (incorporated by reference to Exhibit 4.3 to
    Registrants Form 8-K dated May 15, 2002).                                                                                                                                                                                                                                               
|        | 10.1 |  |  | Second Amended and Restated Credit Agreement
    dated as of May 10, 2002, among R.J. Reynolds Tobacco
    Holdings, Inc. and the lending institutions listed and to be
    listed from time to time on Annex I thereto (incorporated as
    Exhibit 10.1 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2002, filed
    August 1, 2002).                                                                                                                                                 
|        | 10.2 |  |  | First Amendment to the Credit Agreement dated as
    of January 17, 2003, among R.J. Reynolds Tobacco Holdings,
    Inc. and lending institutions party to the Credit Agreement.                                                                                                                                                                                                                                                                                                                                            





---



##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|------- | ----- |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.3  |  |  | Third Amended and Restated Subsidiary Guaranty by
    R. J. Reynolds Tobacco Company and RJR Acquisition Corp. to the
    creditors defined therein, issued in connection with the Credit
    Agreement dated as of May 18, 1999 and amended and restated
    as of November 17, 2000 and further amended and restated as
    of May 10, 2002, among R.J. Reynolds Tobacco Holdings, Inc.
    and the lending institutions listed and to be listed from time
    to time on Annex I thereto.
|        | 10.4  |  |  | Guarantee dated as of May 18, 1999, by R. J.
    Reynolds Tobacco Company to the holders and to The Bank of New
    York, as trustee, issued in connection with the Indenture dated
    as of May 15, 1999, among RJR Nabisco, Inc., R. J. Reynolds
    Tobacco Company and The Bank of New York, as trustee
    (incorporated by reference to Exhibit 10.6 to
    Registrants Form 8-A filed May 19, 1999).                                                                               
|        | 10.5  |  |  | Tax Sharing Agreement dated as of June 14,
    1999, among RJR Nabisco Holdings Corp., R.J. Reynolds Tobacco
    Holdings, Inc., R. J. Reynolds Tobacco Company and Nabisco
    Holdings Corp. (incorporated by reference to Exhibit 10.1
    to Registrants Form 8-K dated June 14, 1999).                                                                                                                                                                                                
|        | 10.6  |  |  | Amendment to Tax Sharing Agreement dated
    June 25, 2000, among Nabisco Group Holdings Corp., R.J.
    Reynolds Tobacco Holdings, Inc., Nabisco Holdings Corp. and R.
    J. Reynolds Tobacco Company (incorporated by reference to
    Exhibit 10.2 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2000, filed
    August 7, 2000).                                                                                                                    
|        | 10.7  |  |  | Agreement dated as of May 20, 1999, among
    Pension Benefit Guaranty Corporation, RJR Nabisco Holdings Corp.
    and R. J. Reynolds Tobacco Company (incorporated by reference to
    Exhibit 10.16 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1999, filed
    August 16, 1999).                                                                                                                                                                    
|        | 10.8  |  |  | Amendment effective as of June 14, 1999, to
    the Agreement effective as of May 20, 1999, by and among
    the Pension Benefit Guaranty Corporation, R.J. Reynolds Tobacco
    Holdings, Inc. and R. J. Reynolds Tobacco Company (incorporated
    by reference to Exhibit 10.3 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2000, filed August 7, 2000).                                                                                         
|        | 10.9  |  |  | Second Amendment effective as of January 7,
    2002, to the Agreement effective as of May 20, 1999, by and
    among the Pension Benefit Guaranty Corporation, R.J. Reynolds
    Tobacco Holdings, Inc. and R. J. Reynolds Tobacco Company
    (incorporated by reference to Exhibit 10.9 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2001, filed February 28, 2002).                                                                               
|        | 10.10 |  |  | Purchase Agreement dated as of March 9,
    1999, as amended and restated as of May 11, 1999, among R.
    J. Reynolds Tobacco Company, RJR Nabisco, Inc. and Japan Tobacco
    Inc. (incorporated by reference to Exhibit 2.1 to
    Registrants Form 8-K dated May 12, 1999).                                                                                                                                                                                                            
|        | 10.11 |  |  | Settlement Agreement dated August 25, 1997,
    between the State of Florida and settling defendants in The
    State of Florida v. American Tobacco Co. (incorporated by
    reference to Exhibit 2 to Registrants Form 8-K
    dated August 25, 1997).                                                                                                                                                                                                                                   
|        | 10.12 |  |  | Comprehensive Settlement Agreement and Release
    dated January 16, 1998, between the State of Texas and
    settling defendants in The State of Texas v. American Tobacco
    Co. (incorporated by reference to Exhibit 2 to
    Registrants Form 8-K dated January 16, 1998).                                                                                                                                                                                                           
|        | 10.13 |  |  | Settlement Agreement and Release in re: The State
    of Minnesota v. Philip Morris, Inc., by and among the State of
    Minnesota, Blue Cross and Blue Shield of Minnesota and the
    various tobacco company defendants named therein, dated as of
    May 8, 1998 (incorporated by reference to Exhibit 99.1
    to Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 30, 1998, filed May 15, 1998).                                                           





---



##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|------- | ----- |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.14 |  |  | Settlement Agreement and Stipulation for Entry of
    Consent Judgment in re: The State of Minnesota v. Philip Morris,
    Inc., by and among the State of Minnesota, Blue Cross and Blue
    Shield of Minnesota and the various tobacco company defendants
    named therein, dated as of May 8, 1998 (incorporated by
    reference to Exhibit 99.2 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended March 30,
    1998, filed May 15, 1998).
|        | 10.15 |  |  | Form of Consent Judgment by Judge Kenneth J.
    Fitzpatrick, Judge of District Court in re: The State of
    Minnesota v. Philip Morris, Inc. (incorporated by reference to
    Exhibit 99.3 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended March 30, 1998, filed
    May 15, 1998).                                                                                                                                                         
|        | 10.16 |  |  | Stipulation of Amendment to Settlement Agreement
    and for Entry of Agreed Order dated July 2, 1998, by and
    among the Mississippi Defendants, Mississippi and the
    Mississippi Counsel in connection with the Mississippi Action
    (incorporated by reference to Exhibit 99.2 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1998, filed August 14, 1998).                                                            
|        | 10.17 |  |  | Stipulation of Amendment to Settlement Agreement
    and for Entry of Consent Decree dated July 24, 1998, by and
    among the Texas Defendants, Texas and the Texas Counsel in
    connection with the Texas Action (incorporated by reference to
    Exhibit 99.4 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1998, filed
    August 14, 1998).                                                                                 
|        | 10.18 |  |  | Stipulation of Amendment to Settlement Agreement
    and for Entry of Consent Decree dated September 11, 1998,
    by and among the State of Florida and the tobacco companies
    named therein (incorporated by reference to Exhibit 99.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 1998, filed November 12,
    1998).                                                                                              
|        | 10.19 |  |  | Master Settlement Agreement (the MSA)
    dated November 23, 1998, between the Settling States named
    in the MSA and the Participating Manufacturers also named
    therein (incorporated by reference to Exhibit 4 to
    Registrants Form 8-K dated November 23, 1998).                                                                                                                                                                                        
|        | 10.20 |  |  | Amended and Restated Equity Incentive Award Plan
    for Directors of R.J. Reynolds Tobacco Holdings, Inc. and
    Subsidiaries (the EIAP) (incorporated by reference
    to Exhibit 10.1 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended March 31, 2000, filed
    May 9, 2000).                                                                                                                                                            
|        | 10.21 |  |  | Form of Deferred Stock Unit Agreement between
    R.J. Reynolds Tobacco Holdings, Inc. and the Director named
    therein, pursuant to the EIAP (incorporated by reference to
    Exhibit 10.9 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1999, filed
    August 16, 1999).                                                                                                                                                      
|        | 10.22 |  |  | Form of Stock Option Agreement (Initial) between
    R.J. Reynolds Tobacco Holdings, Inc. and the Director named
    therein, pursuant to the EIAP (incorporated by reference to
    Exhibit 10.10 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1999, filed
    August 16, 1999).                                                                                                                                                  
|        | 10.23 |  |  | Form of Stock Option Agreement (Annual) between
    R.J. Reynolds Tobacco Holdings, Inc. and the Director named
    therein, pursuant to the EIAP, dated as of June 15, 1999
    (incorporated by reference to Exhibit 10.11 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1999, filed August 16, 1999).                                                                                                                        
|        | 10.24 |  |  | Deferred Compensation Plan for Directors between
    R.J. Reynolds Tobacco Holdings, Inc. (Effective June 14,
    1999) (incorporated by reference to Exhibit 10.12 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1999, filed August 16, 1999).                                                                                                                                                                                 
|        | 10.25 |  |  | R.J. Reynolds Tobacco Holdings, Inc. 1999 Long
    Term Incentive Plan (incorporated by reference to
    Exhibit 10.2 to Registrants Form 8-K dated
    June 15, 1999).                                                                                                                                                                                                                                                                                               
|        | 10.26 |  |  | Amendments to the R.J. Reynolds Tobacco Holdings,
    Inc. 1999 Long Term Incentive Plan dated December 5, 2001
    (incorporated by reference to Exhibit 10.26 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2001, filed February 28, 2002).                                                                                                                                                                                     





---



##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------- | ----- |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.27 |  |  | Amendment No. 2 to R.J. Reynolds Tobacco
    Holdings, Inc. 1999 Long Term Incentive Plan dated
    December 10, 2002.                                                                                                                                                                                                                                                                                                                                         
|        | 10.28 |  |  | Form of 1999 Performance Appreciation Rights
    Agreement under R.J. Reynolds Tobacco Holdings, Inc. 1999 Long
    Term Incentive Plan between R.J. Reynolds Tobacco Holdings, Inc.
    and the grantee named therein (incorporated by reference to
    Exhibit 10.1 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                                                                
|        | 10.29 |  |  | Form of Tandem Restricted Stock/Stock Option
    Agreement dated June 15, 1999, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.2 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 1999, filed November 12,
    1999).                                                                                                                    
|        | 10.30 |  |  | Form of Tandem Restricted Stock/Stock Option
    Agreement dated June 15, 1999, between R.J. Reynolds
    Tobacco Holdings, Inc. and Andrew J. Schindler (incorporated by
    reference to Exhibit 10.3 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended
    September 30, 1999, filed November 12, 1999).                                                                                                                              
|        | 10.31 |  |  | Amendment No. 1 to Tandem Restricted
    Stock/Stock Option Agreement Dated June 15, 1999, dated
    December 5, 2001 (incorporated by reference to
    Exhibit 10.30 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2001, filed
    February 28, 2002).                                                                                                                                                                       
|        | 10.32 |  |  | Form of Tandem Restricted Stock/Stock Option
    Agreement dated July 28, 1999, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.4 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 1999, filed November 12,
    1999).                                                                                                                    
|        | 10.33 |  |  | Amendment No. 1 to Tandem Restricted
    Stock/Stock Option Agreement Dated July 28, 1999, dated
    December 5, 2001 (incorporated by reference to
    Exhibit 10.32 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2001, filed
    February 28, 2002).                                                                                                                                                                       
|        | 10.34 |  |  | Form of Amendment No. 2 to Tandem Restricted
    Stock/Stock Option Agreement dated as of April 24, 2002,
    amending the Tandem Restricted Stock/Stock Option Agreements
    dated June 15 and July 28, 1999, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.3 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2002, filed August 6, 2002).
|        | 10.35 |  |  | Amendment No. 3 to Tandem Restricted
    Stock/Stock Option Agreements dated December 10, 2002,
    amending the Tandem Restricted Stock/Stock Option Agreements
    dated June 15 and July 28, 1999.                                                                                                                                                                                                                                                          
|        | 10.36 |  |  | Form of Restricted Stock Agreement dated
    February 2, 2000, between R.J. Reynolds Tobacco Holdings,
    Inc. and the grantee named therein (incorporated by reference to
    Exhibit 10.35 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 1999, filed
    March 8, 2000).                                                                                                                                                   
|        | 10.37 |  |  | Form of Performance Unit Agreement (three-year
    vesting) dated February 2, 2000, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.36 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 1999, filed March 8, 2000).                                                                                                                              
|        | 10.38 |  |  | Form of Restricted Stock Agreement dated
    January 31, 2001, between R.J. Reynolds Tobacco Holdings,
    Inc. and the grantee named therein (incorporated by reference to
    Exhibit 10.36 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2000, filed
    March 1, 2001).                                                                                                                                                   





---



##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                           
|------- | ----- |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.39 |  |  | Form of Performance Unit Agreement (three-year
    vesting) dated January 31, 2001, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.38 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2000, filed March 1, 2001).                                                                                         
|        | 10.40 |  |  | Form of Performance Unit Agreement (one-year
    vesting) dated February 6, 2002, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 31, 2002, filed May 1, 2002).                                                                                           
|        | 10.41 |  |  | Form of Restricted Stock Agreement dated
    July 26, 2002, between R.J. Reynolds Tobacco Holdings, Inc.
    and the grantee named therein (incorporated by reference to
    Exhibit 10.5 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2002, filed
    August 6, 2002).                                                                                                               
|        | 10.42 |  |  | Form of Performance Unit Agreement (three-year
    vesting) dated July 26, 2002, between R.J. Reynolds Tobacco
    Holdings, Inc. and the grantee named therein (incorporated by
    reference to Exhibit 10.4 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2002, filed August 6, 2002).                                                                                          
|        | 10.43 |  |  | Form of Amendment No. 1 to Restricted Stock
    Agreements dated as of December 10, 2002, amending the
    Restricted Stock Agreements dated February 2, 2000,
    January 31, 2001 and July 26, 2002, between R.J.
    Reynolds Tobacco Holdings, Inc. and the grantee named therein.                                                                                                                                    
|        | 10.44 |  |  | Amendment No. 1 to Performance Unit
    Agreements dated December 5, 2001, amending the Performance
    Unit agreements dated February 2, 2000 and January 31,
    2001, between R.J. Reynolds Tobacco Holdings, Inc. and the
    grantee named therein (incorporated by reference to
    Exhibit 10.37 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2001, filed
    February 28, 2002).
|        | 10.45 |  |  | Form of Performance Unit Agreement (one-year
    vesting) dated February 5, 2003, between R.J. Reynolds
    Holdings, Inc. and the grantee named therein                                                                                                                                                                                                                                                                  
|        | 10.46 |  |  | R.J. Reynolds Tobacco Holdings, Inc. Annual
    Incentive Award Plan, Effective January 1, 1987 Amended and
    Restated Effective January 1, 2002 (incorporated by
    reference to Exhibit 10.38 to Registrants Annual
    Report on Form 10-K for the year ended December 31,
    2001, filed February 28, 2002).                                                                                                     
|        | 10.47 |  |  | Master Trust Agreement, as amended and restated
    as of October 12, 1988, between RJR Nabisco, Inc. and
    Wachovia Bank and Trust Company, N.A. (incorporated by reference
    to Exhibit 10.18 to the Registration Statement on
    Form S-4 of RJR Holdings Corp. and RJR Holdings Group,
    Inc., Registration No. 33-27894, filed April 5, 1989,
    as amended).                                                
|        | 10.48 |  |  | Amendment No. 1 to Master Trust Agreement,
    dated January 27, 1989 (incorporated by reference to
    Exhibit 10(g)(ii) to Registrants Annual Report on
    Form 10-K for the fiscal year ended December 31, 1988,
    filed March 9, 1989).                                                                                                                                                                           
|        | 10.49 |  |  | Amendment No. 2 to Master Trust Agreement,
    dated January 27, 1989 (incorporated by reference to
    Exhibit 10(g)(iii) to Registrants Annual Report on
    Form 10-K for the fiscal year ended December 31, 1988,
    filed March 9, 1989).                                                                                                                                                                          
|        | 10.50 |  |  | Excess Benefit Master Trust Agreement, as amended
    and restated as of October 12, 1988, between RJR Nabisco,
    Inc. and Wachovia Bank and Trust Company, N.A. (incorporated by
    reference to Exhibit 10.21 to Registrants
    Registration Statement on Form S-4 of RJR Holdings Corp.
    and RJR Holdings Group, Inc., Registration No. 33-27894,
    filed April 5, 1989, as amended).                        
|        | 10.51 |  |  | Amendment No. 1 to Excess Benefit Master
    Trust Agreement, dated January 27, 1989 (incorporated by
    reference to Exhibit 10(h)(ii) to Registrants Annual
    Report on Form 10-K for the fiscal year ended
    December 31, 1988, filed March 9, 1989).                                                                                                                                                            





---



##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|------- | ----- |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.52 |  |  | RJR Nabisco, Inc. Supplemental Executive
    Retirement Plan, as amended on July 21, 1988 (incorporated
    by reference to Exhibit 10.32 to the Registration Statement
    on Form S-4 of RJR Holdings Corp. and RJR Holdings Group,
    Inc., Registration No. 33-27894, filed April 5, 1989,
    as amended).                                                                                                                                         
|        | 10.53 |  |  | Amendment to Supplemental Executive Retirement
    Plan, dated November 23, 1988 (incorporated by reference to
    Exhibit 10(m)(ii) to Registrants Annual Report on
    Form 10-K for the fiscal year ended December 31, 1998,
    filed March 9, 1989).                                                                                                                                                                                               
|        | 10.54 |  |  | Amendment No. 2 to Supplemental Executive
    Retirement Plan, dated January 27, 1989 (incorporated by
    reference to Exhibit 10(m)(iii) to Registrants Annual
    Report on Form 10-K for the fiscal year ended
    December 31, 1988, filed March 9, 1989).                                                                                                                                                                                         
|        | 10.55 |  |  | Amendment to Supplemental Executive Retirement
    Plan, dated April 10, 1993 (incorporated by reference to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 1993, filed February 24, 1994).                                                                                                                                                                                                                              
|        | 10.56 |  |  | Retention Trust Agreement dated May 13,
    1998, by and between RJR Nabisco, Inc. and Wachovia Bank, N.A.
    (incorporated by reference to Registrants Quarterly Report
    on Form 10-Q for the quarter ended June 30, 1998,
    filed August 14, 1998).                                                                                                                                                                                             
|        | 10.57 |  |  | Form of Employment Agreement dated as of
    October 31, 1988, by and between RJR Nabisco, Inc. and
    Andrew J. Schindler (incorporated by reference to
    Exhibit 10 to Registrants Schedule 14D-9 filed
    on November 8, 1988).                                                                                                                                                                                                                  
|        | 10.58 |  |  | Form of Special Addendum dated December 20,
    1988, to the Employment Agreement dated as of October 31,
    1988, between RJR Nabisco, Inc. and Andrew J. Schindler
    (incorporated by reference to Exhibit 10(d)(i) to
    Registrants Annual Report on Form 10-K for the fiscal
    year ended December 31, 1988, filed March 8, 1989).                                                                                                           
|        | 10.59 |  |  | Amendment dated June 7, 1999, to the
    Employment Agreement dated as of October 31, 1988, and
    previously amended as of December 20, 1988, between RJR
    Nabisco, Inc. and Andrew J. Schindler (incorporated by reference
    to Exhibit 10.8 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                                                                           
|        | 10.60 |  |  | Amendment dated January 4, 2002, to the
    Employment Agreement dated as of October 31, 1988, and
    previously amended as of December 20, 1988 and June 7,
    1999, between R.J. Reynolds Tobacco Holdings, Inc. (formerly
    known as RJR Nabisco, Inc.) and Andrew J. Schindler
    (incorporated by reference to Exhibit 10.52 to Registrants
    Annual Report on Form 10-K for the year ended
    December 31, 2001, filed February 28, 2002).
|        | 10.61 |  |  | Change of Control Letter Agreement dated
    October 25, 1999, by and among R.J. Reynolds Tobacco
    Holdings, Inc. and Andrew J. Schindler (incorporated by
    reference to Exhibit 10.53 to Registrants Annual
    Report on Form 10-K for the year ended December 31,
    2001, filed February 28, 2002).                                                                                                                                          
|        | 10.62 |  |  | Participation Agreement, RJR Nabisco, Inc.
    Supplemental Executive Retirement Plan, for Andrew J. Schindler
    dated December 28, 1995 (incorporated by reference to
    Exhibit 10.45 to Registrants Annual Report on
    Form 10-K for the fiscal year ended December 31, 1995,
    filed February 22, 1996).                                                                                                                                     
|        | 10.63 |  |  | Amendment dated October 25, 1999, to the
    Participation Agreement  R.J. Reynolds Supplemental
    Executive Retirement Plan dated as of December 28, 1995,
    between R.J. Reynolds Tobacco Holdings, Inc. and Andrew J.
    Schindler (incorporated by reference to Exhibit 10.55 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2001, filed February 28, 2002).                                               





---



##### 



|        |       |  |  |                                                                                                                                                                                                                                                                                                                                        
|------- | ----- |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       | 
|Number  |       | 
|        |       | 
|        | 10.64 |  |  | Cash Retention Grant Letter Agreement dated
    August 17, 1999, between R.J. Reynolds Tobacco Holdings,
    Inc. and Andrew J. Schindler (incorporated by reference to
    Exhibit 10.9 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                     
|        | 10.65 |  |  | Offer of Employment Letter dated June 12,
    2002, by R.J. Reynolds Tobacco Holdings, Inc. to Richard H.
    Bogan, accepted by Mr. Bogan on June 18, 2002
    (incorporated by reference to Exhibit 10.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2002, filed November 1,
    2002).
|        | 10.66 |  |  | Severance Agreement dated July 10, 2002, by
    and between R.J. Reynolds Tobacco Holdings, Inc. and
    Kenneth J. Lapiejko (incorporated by reference to
    Exhibit 10.2 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 2002,
    filed November 1, 2002).                                   
|        | 10.67 |  |  | Form of Change of Control Letter Agreement
    between R.J. Reynolds Tobacco Holdings, Inc. and the executive
    officer named therein (incorporated by reference to
    Exhibit 10.5 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                       
|        | 10.68 |  |  | Form of Special Severance Benefits Letter
    Agreement between R. J. Reynolds Tobacco Company and the
    executive officer named therein (incorporated by reference to
    Exhibit 10.6 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                    
|        | 10.69 |  |  | Form of Amendment to Special Severance Benefits
    Letter Agreement between R. J. Reynolds Tobacco Company and
    the executive officer named therein (incorporated by reference
    to Exhibit 10.7 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).       
|        | 12.1  |  |  | Computation of Ratio of Earnings to Combined
    Fixed Charges and Preferred Stock Dividends/Deficiency in the
    Coverage of Combined Fixed Charges and Preferred Stock Dividends
    by Earnings Before Fixed Charges for each of the five years
    within the period ended December 31, 2002.                                     
|        | 21.1  |  |  | Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                        
|        | 23.1  |  |  | Consent of Independent Auditors.                                                                                                                                                                                                                                                                                                       
|        | 99.1  |  |  | Expanded Litigation Disclosure.                                                                                                                                                                                                                                                                                                        
|        | 99.2  |  |  | Certification of Chief Executive Officer relating
    to RJRs Annual Report on Form 10-K for the year ended
    December 31, 2002, pursuant to Section 18 U.S.C.
    §1350, adopted pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                                                    
|        | 99.3  |  |  | Certification of Chief Financial Officer relating
    to RJRs Annual Report on Form 10-K for the year ended
    December 31, 2002, pursuant to Section 18 U.S.C.
    §1350, adopted pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.