##### 









UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




---

FORM 10-K/A




Amendment No. 2





(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



---

(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)




---

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.



---






---



##### 



INDEX




|           |  |                                                                                           |    |  |    | 
|---------- |  | ----------------------------------------------------------------------------------------- | -- |  | -- | 
|Part II    |  |                                                                                           |    |  |    | 
|Item 7.    |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations |    |  | 3  | 
|          
|Part IV    |  |                                                                                           |    |  |    | 
|Item 15.   |  | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                      |    |  | 26 | 
|          
|Signatures |  |                                                                                           | 27 | 




EXPLANATORY NOTE




This Form 10-K/A, Amendment No. 2
amends the annual report of R. J. Reynolds Tobacco Holdings,
Inc. referred to as RJR, on Form 10-K for the year ended
December 31, 2002, referred to as the 2002 Form 10-K,
filed with the SEC on March 3, 2003, and Form 10-K/A
to the 2002 Form 10-K, filed with the SEC on
January 15, 2004. The purpose of this amendment is to
include additional disclosure regarding tobacco-related
litigation under Results of Operations in
Item 7  Managements Discussion and
Analysis of Financial Condition and Results of Operations.







This amendment is limited in scope to the
portions of the 2002 Form 10-K set forth above and does not
amend, update or change any other items or disclosures contained
in the original 2002 Form 10-K.




2



---



##### 



PART II



|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|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.

Although the level and rate of change of retail
sales to consumers, referred to as consumption, are not
independently available, consumption trend estimates are
generated. These estimates are based on shipment volume, retail
share of market, trade inventory levels and pricing in the
marketplace. In recent years, the consumption decline for the
industry has been estimated to be approximately 2% to 3%
annually. RJR Tobacco believes its consumption decline has been
somewhat greater than that of the industry, due to the higher
price sensitivity of its consumers on some of its brands. This
acceleration in the decline is believed to be due to the
substantial increase in state excise taxes and continued pricing
pressure from the deep-discount price-tier, potential
acceleration in industry consumption decline, as well as general
economic conditions.

3



---



##### 



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 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. RJR Tobacco and its
affiliates record their legal expenses and other litigation
costs and related administrative costs as selling, general and
administrative expenses as these costs are incurred.

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.

4



---



##### 



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 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.

5



---



##### 



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.

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 | 

6



---



##### 



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 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.

7



---



##### 



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 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.

8



---



##### 



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 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.

9



---



##### 



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.

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 $70 million 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

10



---



##### 



inclusion of Santa Fes operations,
partially offset by lower expense related to stock-based benefit
plans and advertising.





Selling, general and administrative expenses
include the costs of litigating and administering product
liability claims, as well as other legal expenses. For the years
ended December 31, 2002 and 2001, RJR Tobaccos
product liability defense costs were $192 million and
$165 million, respectively.







Product liability cases generally
include smoking and health related cases. In particular, these
cases include the following categories of cases listed in the
table of cases set forth in Business 
Litigation Affecting the Cigarette Industry 
Overview in Item 1 and note 14 to the consolidated
financial statements:






| |   |                                                               
| | - | --------------------------------------------------------------
|
| |  | Individual Smoking and Health;                                
|
|
|
| |  | Flight Attendant  ETS (Broin
    II);                        
|
|
|
| |  | Class Actions;                                                
|
|
|
| |  | Governmental Health-Care Cost Recovery;                       
|
|
|
| |  | Other Health-Care Cost Recovery and Aggregated
    Claims; and
|
|
|
| |  | Asbestos Contribution.                                        
|




Product liability defense costs
include the following items:






| |   |                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | direct and indirect compensation, fees and
    related costs and expenses for internal legal and related
    administrative staff administering product liability claims;
|
|
|
| |  | fees and cost reimbursements paid to outside
    attorneys;                                                                                                              
|
|
|
| |  | direct and indirect payments to third party
    vendors for litigation support activities;                                                                               
|
|
|
| |  | expert witness costs and fees; and                                                                                                                                       
|
|
|
| |  | payments to the Council for Tobacco
    Research  U.S.A., Inc. which funds are used primarily
    by the CTR to fund its legal defense costs.                           
|




Numerous factors affect the amount of product
liability defense costs. The most important factors are the
number of cases pending and the number of cases in trial or in
preparation for trial (i.e., with active discovery and motions
practice). See Business  Litigation Affecting
the Cigarette Industry  Overview in Item 1
and note 14 to the consolidated financial statements for
detailed information regarding the number and type of cases
pending, and Business  Litigation Affecting the
Cigarette Industry  Scheduled Trials in
Item 1 and note 14 to the consolidated financial statements
for detailed information regarding the number and nature of
cases in trial and scheduled for trial through the end of 2003.
The increase in product liability defense costs in 2002 compared
with 2001 was primarily due to an increase in the level of
activity in cases in preparation for trial, in trial and on
appeal in 2002 compared with 2001.







RJR Tobacco expects that the factors described
above will continue to have the primary impact on its product
liability defense costs in the future. Given the level of
activity in cases in preparation for trial, in trial and on
appeal and the amount of product liability defense costs
incurred by RJR Tobacco over the past three years, RJR
Tobaccos recent experiences in defending its product
liability cases and the reasonably anticipated level of activity
in RJR Tobaccos pending cases and possible new cases, RJR
Tobacco does not expect that the variances in its product
liability defense costs will be significantly different than
they have been historically. However, it is possible that
adverse developments in the factors discussed above, as well as
other circumstances beyond the control of RJR Tobacco, could
have a material adverse effect on the financial condition,
results of operation or cash flows of RJR or its subsidiaries.
Those other circumstances beyond the control of RJR Tobacco
include the results of present and future trials and appeals,
and the development of possible new theories of liability by
plaintiffs and their counsel.




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

11



---



##### 



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.

12



---



##### 



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.

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-

13



---



##### 



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,
partially offset by lower legal expenses.




Selling, general and administrative expenses
include the costs of litigation and administering product
liability claims, as well as other legal expenses. For the years
ended December 31, 2001 and 2000, RJR Tobaccos
product liability defense costs were $165 million and
$179 million, respectively.




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 $449 million, or an
effective rate of 60.0%, 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. Discontinued operations in 2000 included a
$53 million after-tax gain resulting from a re-evaluation
of tax reserves related to

14



---



##### 



the sale of the international tobacco business.
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.

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.

15



---



##### 



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 during 2001 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

16



---



##### 



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.

17



---



##### 



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. Under the credit facility, cumulative
dividends and share repurchases generally may not exceed the sum
of $500 million plus 50% of cumulative adjusted cash net income.
Despite this general restriction, however, the credit facility
further provides that (1) the remaining amount from the
$1.5 billion proceeds from the NGH acquisition, and any
further proceeds thereon, may be used to pay dividends and
repurchase shares, and (2) up to an additional
$500 million in dividends and share repurchases may be
made. Most of the proceeds from the NGH acquisition and the
earnings thereon, however, have been used for these purposes.
Stock repurchases also are limited to the extent that a stated
minimum level of net worth must be maintained. 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

18



---



##### 



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, 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.

19



---



##### 



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 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

20



---



##### 





| |   |                                                                           
| | - | --------------------------------------------------------------------------
| |  | 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 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

21



---



##### 



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 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.

22



---



##### 



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.

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

23



---



##### 



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 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

24



---



##### 



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
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.


25



---



##### 



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                                                                                                                                                                                                                                                                                                                                                                                                         



|    |                                                                                                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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 |      | 
|Number  |      | 
|        |      | 
|        | 23.1 |  |  | Consent of Independent Auditors.                                                                                                                                                                                                                                                                         
|        | 31.1 |  |  | Certification of Chief Executive Officer relating
    to RJRs Annual Report on Form 10-K/A, Amendment
    No. 2 for the period ended December 31, 2002.                                                                                                                                                 
|        | 31.2 |  |  | Certification of Chief Financial Officer relating
    to RJRs Annual Report on Form 10-K/A, Amendment
    No. 2 for the period ended December 31, 2002.                                                                                                                                                 
|        | 32.1 |  |  | Certification of Chief Executive Officer and
    Chief Financial Officer relating to RJRs Annual Report on
    Form 10-K/A, Amendment No. 2 for the period ended
    December 31, 2002, pursuant to Section 18 U.S.C.
    § 1350, adopted pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.




26



---



##### 



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 5, 2004




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

| |                                                         
| | --------------------------------------------------------
| |                                                         
| | Andrew J. Schindler                                     
| | Chairman of the Board, President,                       
| | Chief Executive Officer and Director                    
|
| | /s/ DIANNE M. NEAL                                      
| |                                                         
| | Dianne M. Neal                                          
| | Executive Vice President and Chief Financial
    Officer
| | (principal financial officer)                           

27