##### Table of Contents









UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




---

FORM 10-K

(Mark
One)

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


THE SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended December 31,
2003

OR

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

THE SECURITIES EXCHANGE ACT OF 1934


Commission file number: 1-6388



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(RJ REYNOLDS LOGO)

(Exact name of registrant as specified in its
charter)


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

401 North Main Street

Winston-Salem, NC 27102-2866


(Address of principal executive offices) (Zip
Code)


(336) 741-5500

(Registrants telephone number, including
area code)




---

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 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 | 
|8 3/4 Notes due August 15, 2005        |  |                   | New York |                     |  |                                      |  |  |          | 

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

Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past 90 days. 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 30, 2003 was approximately $3.1 billion, based
on the closing price of $37.21. 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 6, 2004:
85,080,693 shares of common stock, par value $.01 per
share.



---






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INDEX

|           |  |                                                                                           |     |  |     | 
|---------- |  | ----------------------------------------------------------------------------------------- | --- |  | --- | 
|Part I     |  |                                                                                           |     |  |     | 
|Item 1.    |  | Business                                                                                  |     |  | 3   | 
|Item 2.    |  | Properties                                                                                |     |  | 38  | 
|Item 3.    |  | Legal Proceedings                                                                         |     |  | 38  | 
|Item 4.    |  | Submission of Matters to a
    Vote of Security Holders                                   |     |  | 38  | 
|          
|Part II    |  |                                                                                           |     |  |     | 
|Item 5.    |  | Market for Registrants
    Common Equity and Related Stockholder Matters                 |     |  | 38  | 
|Item 6.    |  | Selected Financial Data                                                                   |     |  | 40  | 
|Item 7.    |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations |     |  | 41  | 
|Item 7a.   |  | Quantitative and Qualitative
    Disclosures about Market Risk                            |     |  | 65  | 
|Item 8.    |  | Financial Statements and
    Supplementary Data                                           |     |  | 67  | 
|Item 9.    |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure  |     |  | 135 | 
|Item 9a.   |  | Controls and Procedures                                                                   |     |  | 135 | 
|          
|Part III   |  |                                                                                           |     |  |     | 
|Item 10.   |  | Directors and Executive
    Officers of the Registrant                                    |     |  | 135 | 
|Item 11.   |  | Executive Compensation                                                                    |     |  | 142 | 
|Item 12.   |  | Security Ownership of
    Certain Beneficial Owners and Management                        |     |  | 156 | 
|Item 13.   |  | Certain Relationships and
    Related Transactions                                        |     |  | 158 | 
|Item 14.   |  | Principal Accounting Fees
    and Services                                                |     |  | 158 | 
|          
|Part IV    |  |                                                                                           |     |  |     | 
|Item 15.   |  | Exhibits, Financial
    Statement Schedules and Reports on Form 8-K                       |     |  | 159 | 
|Signatures |  |                                                                                           | 168 | 
|EX-2.2    
|EX-2.4    
|EX-10.52  
|EX-10.54  
|EX-10.57  
|EX-10.58  
|EX-12.1   
|EX-21.1   
|EX-23.1   
|EX-31.1   
|EX-31.2   
|EX-32.1   
|EX-99.1   
|EX-99.2   



2



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PART I




Item 1. Business

R.J. Reynolds Tobacco Holdings, Inc. was
incorporated as a holding company in 1970, and is listed on the
New York Stock Exchange under the symbol RJR. RJRs wholly
owned subsidiaries include its operating subsidiaries, R. J.
Reynolds Tobacco Company, referred to as RJR Tobacco, and
Santa Fe Natural Tobacco Company, Inc., referred to as
Santa Fe.

RJRs Internet website address is
www.RJRHoldings.com. RJRs annual report on
Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, insider trading reports on
Forms 3, 4 and 5 and all amendments to those reports are
available free of charge through its web site, as soon as
reasonably practicable after such material is electronically
filed with, or furnished to, the SEC. RJRs Internet web
site and the information contained therein or connected thereto
are not incorporated into this Annual Report on Form 10-K.

RJR has one reportable operating segment, RJR
Tobacco, which is the second largest cigarette manufacturer in
the United States. RJR Tobaccos largest selling cigarette
brands, CAMEL, WINSTON, SALEM and DORAL, were four of the top
ten best-selling brands of cigarettes in the United States in
2003. Those brands, and its other brands, including VANTAGE,
MORE and NOW, are manufactured in a variety of styles and
marketed in the United States to meet a range of adult smoker
preferences. In September 2003, RJR announced a shift in its
brand-portfolio strategy to focus on improving profitability
through emphasis on two of its cigarette brands, CAMEL and
SALEM, with more limited investments in WINSTON and DORAL.
Concurrently, RJR implemented a restructuring plan in an effort
to streamline its cost structure and improve long-term earnings.
The restructuring plan included a significant workforce
reduction, as well as asset impairments and associated exit
activities. For a discussion of RJRs restructuring and
asset impairment charges related to its restructuring plan, see
Restructuring and asset impairment charges and
Goodwill and trademark impairment charges under
Results of Operations  2003 Compared with
2002 in Managements Discussion and Analysis of
Financial Condition and Results of Operations in
Item 7.

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

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

On January 16, 2002, RJR acquired all of the
voting stock of privately held Santa Fe for
$354 million. Santa Fe manufactures and markets
cigarettes and other tobacco products under the NATURAL AMERICAN
SPIRIT brand, primarily in the United States. Although
Santa Fe is an operating segment of RJR, its financial
condition and results of operations do not meet the materiality
criteria to be reportable. As a result, information related to
Santa Fe is not generally disclosed separately in this
document.

On July 16, 2002, RJR 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,
initially marketed its products in France, Spain, the Canary
Islands and Italy, and in 2003, expanded into Andorra and
Belgium. RJRs financial contribution during the first five
years of the joint venture is expected to be $75 million to
$100 million. RJR

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Tobacco licensed REYNOLDS, a new American-blend
brand in a unique Slide Box pack, to the joint venture. This
investment is accounted for using the equity method.


RJR believes that the acquisition of NGH and
Santa Fe, and the joint venture with Gallaher Group Plc,
present meaningful opportunities for RJR to build shareholder
value. The acquisition of NGH provided $1.5 billion of net
cash proceeds to RJR, which has funded RJRs share
repurchase programs and the acquisition of Santa Fe.
Santa Fes approach to building brand equity is
consistent with RJR Tobaccos strategy for its key brands,
and the acquisition was originated in order to enhance
RJRs consolidated earnings. The joint venture provides RJR
an opportunity to compete in the growing international
American-blend market, and RJR believes the joint venture will
be accretive to RJRs earnings within two to three years
from its inception.

On October 27, 2003, RJR announced the
signing of a definitive agreement with Brown &
Williamson Tobacco Corporation, referred to as B&W, a
subsidiary of British American Tobacco p.l.c., referred to as
BAT, to combine RJR Tobacco and the U.S. assets,
liabilities and operations of B&W, subject to specified
exceptions.

The agreement provides for establishing a new
publicly traded holding company, Reynolds American Inc.,
referred to as Reynolds American, with approximately
150 million shares outstanding. Reynolds American will
issue common shares to B&W in exchange for the
U.S. assets, liabilities and operations of B&W, subject
to specified exceptions, and will issue common shares to
existing RJR stockholders in exchange for their existing RJR
shares on a one-for-one basis. Upon completion of the
combination, B&W will own approximately 42% of Reynolds
American, and existing RJR stockholders will own approximately
58%. No indebtedness for borrowed money of B&W will be
assumed by Reynolds American. The transaction is expected to be
tax-free to RJR stockholders, and will be treated as a purchase
for financial accounting purposes.

The agreement provides for B&W to transfer
with its U.S. operations cash in an amount equal to accrued
expenses under the Master Settlement Agreement, referred to as
the MSA. The cash contribution amount is contingent on the
timing of closing the transaction, but averages approximately
$750 million during the year. The RJR Tobacco and B&W
U.S. cigarette and tobacco operations will be combined in
an indirect subsidiary of Reynolds American, and that subsidiary
will indemnify B&W for its historical and current
liabilities related to its U.S. cigarette and tobacco
business.

Under a separate agreement, RJR will pay a
foreign subsidiary of BAT $400 million in cash to acquire
the stock of Lane Limited, a subsidiary that manufactures or
distributes cigar, roll-your-own and pipe tobacco brands and
other tobacco products, including DUNHILL and CAPTAIN BLACK
tobacco products. BAT will retain the rights to use the BAT
trademarks outside the United States. Santa Fe and Lane
will operate as independent subsidiaries of Reynolds American.

The combination transactions are expected to be
completed in mid-2004, pending the necessary approvals from U.S.
and European regulatory authorities and RJR stockholders, as
well as satisfactory IRS rulings and other conditions. The
headquarters and operations of Reynolds American are expected to
be consolidated in Winston-Salem, North Carolina.

RJR believes that the combination transactions
will provide efficiencies and enhance the ability of Reynolds
American to compete effectively in the U.S. market. The
combination is expected to be accretive to earnings. Full
integration of the two companies is expected to take 18 to
24 months after closing and to generate more than
$500 million in annualized savings.

Industry Overview

The U.S. cigarette market is a mature market
in which overall consumer demand is expected to decline over
time. U.S. cigarette shipments as tracked by Management
Science Associates, Inc., referred to as MSAi, decreased at a
compound annual rate of 1.6% from 1987 through 1997. After
declining 4.6% in 1998 and 9% in 1999, shipments remained
relatively stable in 2000, declined 3.2% in 2001 and 3.7% in
2002, and declined 5.1% to 371.4 billion units in 2003. RJR
Tobacco believes that cigarette shipments in the United States
are

4



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significantly higher than the units registered by
MSAi with the difference primarily due to deep-discount brands,
gray market imports and sales through alternative channels that
are not effectively tracked by MSAi. From December 1999 to
December 2003, wholesale cigarette prices of the major
manufacturers increased $0.64 per pack overall. The average
wholesale list price of a pack of RJR Tobaccos full-price
brands was $2.64 at December 31, 2001 and $2.76 at each of
December 31, 2002 and 2003.


Competition

In addition to declining sales volumes,
profitability of the U.S. cigarette industry and RJR
continues to be adversely impacted by increases in state excise
taxes, competitive promotional spending and deep-discount brand
growth. Deep-discount brands are brands manufactured
by companies that are not original participants in the Master
Settlement Agreement, and accordingly, do not have cost
structures burdened with MSA-related payments to the same extent
as the original participating manufacturers. While the premium,
or full, price tier has been negatively impacted by widening
price gaps between those brands and the deep-discount brands for
several years, the price gap remained relatively level during
2003. For further discussion see  Business
Trends and Initiatives and  Governmental
Activity in Managements Discussion and
Analysis of Financial Condition and Results of Operations
in Item 7.

RJRs operating subsidiaries primarily
conduct business in the highly competitive U.S. market with
a few large participants and many smaller participants. Based on
data collected by Information Resources Inc./Capstone, during
2003, 2002 and 2001, Philip Morris USA Incorporated had an
overall retail share of the U.S. cigarette market of
49.37%, 49.35% and 50.45%, respectively. During these same
years, RJR Tobacco had an overall share of 22.52%, 22.93% and
23.42%, respectively, and the remaining participants held lesser
shares.

Competition is primarily based on brand
positioning and price, as well as product attributes and
packaging, consumer loyalty, promotions, advertising and retail
presence. Cigarette brands produced by the major manufacturers
generally require competitive pricing, substantial marketing
support, retail programs and other financial incentives to
maintain or improve a brands market position or to
introduce a new brand.

Increased selling prices and higher cigarette
taxes have resulted in the growth of deep-discount brands and
competitive discounting. The growth in market share of the
deep-discount brands since the MSA was signed in 1998 has had,
and will continue to have, an adverse impact on the
profitability of the remaining industry participants. For
further information regarding the adverse impact of price
increases on RJR Tobaccos sales volume, see
Managements Discussion and Analysis of Financial
Condition and Results of Operations  Results of
Operations in Item 7.

Historically, major manufacturers have had a
competitive advantage in the United States because significant
cigarette marketing restrictions and the scale of investment
required to compete made gaining consumer awareness and trial of
new brands difficult. However, since the MSA was signed in
November 1998, the category of deep-discount brands manufactured
by smaller manufacturers or supplied by importers has grown
substantially. RJR Tobacco believes small manufacturers of
deep-discount brands have increased their combined share of
shipments to approximately 13% to 15% of U.S. industry unit
sales. This growth was driven by their significantly lower
prices due to cost advantages, including lower MSA payments.

Strategy

RJR is focused on strengthening its core
businesses and delivering an attractive return to stockholders.
RJRs key strategies are to:



| |   |                                                                        
| | - | -----------------------------------------------------------------------
| |  | achieve sustainable earnings growth,                                   
|
| |  | grow share of market on RJR Tobaccos and
    Santa Fes key brands and
|
| |  | drive continuous cost improvement.                                     

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Marketing

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. In September 2003 RJR announced a refocused brand
portfolio strategy for RJR Tobacco and significant cost
reduction initiatives. Marketing investments will now focus on
two growth brands, CAMEL and SALEM, with more limited
investments being made in WINSTON and DORAL, to optimize
profitability. The new strategy is currently being implemented.
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. RJR Tobaccos
competitive pricing includes discounting programs, such as
retail buydowns, free product promotions and consumer coupons.
Retail buydowns refer to payments made to the retailer to reduce
the price that consumers pay at retail. Free product promotions
include offers such as Buy 2 packs, Get 1 pack free.
Consumer coupons are distributed by a variety of methods,
including in, or on, the cigarette pack and direct mail.

In addition, RJR Tobacco provides trade
incentives through trade terms, and wholesale partner programs
and retail incentives. Trade discounts are provided to
wholesalers based on compliance with certain terms. The
wholesale partner programs provide incentives to RJR
Tobaccos direct buying customers based on performance
levels. Retail incentives are paid to the retailer based on
compliance with RJR Tobaccos contract terms. During the
fourth quarter of 2003, RJR Tobacco reevaluated its practices
related to replacement of merchandising fixtures and transferred
ownership of the fixtures to the cigarette retailers.

The costs of RJR Tobaccos sales incentive
programs, with the exception of free product promotions, are
recorded as a reduction of net sales in compliance with Emerging
Issues Task Force Issue No. 01-9, Accounting for
Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendors Products). The cost of free
product promotions is recorded in cost of goods sold. For
further information about pricing, net of discounting and
promotional costs, see Managements Discussion and
Analysis of Financial Condition and Results of
Operations  Results of Operations in
Item 7.

During 2003, CAMELs filtered styles
continued to grow based on the strength of the brands
equity, driven by its Pleasure to Burn positioning.
Initiatives launched in prior years to actively market
CAMELs three distinct product families 
Classic, Turkish and Exotic Blends  also contributed
to the brands performance in 2003.

SALEMs share increased in 2003, reflecting
steady momentum since a repositioning was launched in the second
quarter of 2003. The Stir the Senses campaign and
new packaging communicates that SALEM offers adult smokers a
range of choices in menthol taste sensations. The brand has two
distinct product lines: SALEM Green Label, with a lighter
menthol taste, and SALEM Black Label, with a richer
menthol-and-tobacco taste.

Reflecting RJR Tobaccos strategy of limited
investment in WINSTON and DORAL, the retail promotion support of
these brands was reduced and shifted to more targeted, and more
efficient, direct mail offers.

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

During April and May of 2003, RJR Tobacco
expanded the distribution of ECLIPSE to 7-Eleven and Circle-K
stores across the country. ECLIPSE was expanded into additional
retail chains in June 2003, with the goal of making the brand
more conveniently available to adult smokers. The expansion is
being supported by a cost-efficient marketing plan that includes
limited print advertising, point-of-sale and direct-marketing
efforts. ECLIPSE is a new technology cigarette that primarily
heats rather than burns tobacco.

Anti-smoking groups have attempted to restrict
cigarette sales, cigarette advertising and the testing and
introduction of new cigarette products. The MSA and other
federal, state and local laws restrict utilization of
television, radio or billboard advertising or certain other
marketing and promotional tools for cigarettes.

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RJR Tobacco continues to use advertisements
in magazines read primarily by adults, direct mailings to
age-verified adult smokers and other means to market its brands
and enhance their appeal among adult smokers. RJR Tobacco
continues to advertise and promote at retail cigarette locations
and in adult venues where permitted. See note 1 to
consolidated financial statements and Managements
Discussion and Analysis of Financial Condition and Results of
Operations  Results of Operations for further
information, including advertising expense.


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

Manufacturing and
Distribution

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

RJR Tobacco sells its cigarettes primarily to
distributors, wholesalers and other direct customers, some of
which are retail chains. RJR Tobacco distributes its
cigarettes primarily to public warehouses located throughout the
United States that serve as local distribution centers for its
customers. No significant backlog of orders existed at
December 31, 2003 or 2002.

Sales made by RJR Tobacco to McLane Company,
Inc., a distributor to, and former affiliate of, Wal-Mart
Stores, Inc., comprised 31%, 26% and 27% of RJRs
consolidated revenue in 2003, 2002 and 2001, respectively. No
other customer accounted for 10% or more of RJRs revenue
during those years. RJR Tobacco has a good relationship
with McLane Company. RJR Tobaccos sales to McLane are
not governed by any written supply contract; however, McLane and
RJR Tobacco are parties to an arrangement, whereby
RJR Tobacco observes McLanes inventory to manage the
supply and level of McLanes inventory. McLane and RJR
Tobacco also are parties to certain contracts in which
consideration is based on McLanes compliance with
specified performance levels and incentive terms.

Raw Materials

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

Since 2001, RJR Tobacco has primarily purchased
the majority of its U.S. flue-cured and burley leaf
directly through contracts with tobacco growers. These
short-term contracts are frequently renegotiated.
RJR Tobacco believes the relationship with its suppliers is
good.

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

Research and Development

RJR Tobaccos research and development
activities are located in its Bowman Gray Technical Center in
its Whitaker Park complex. Scientists and engineers at these
facilities continue to work to create more efficient methods of
preparing tobacco blends, as well as develop product
enhancements, new products and packaging innovations. A focus
for research and development activity is the development of
products that may present

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less risk associated with smoking. RJR
Tobaccos research and development expense for the years
ended December 31, 2003, 2002 and 2001 was
$54 million, $63 million and $64 million,
respectively.


Intellectual Property

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

In 1999, RJR Tobacco sold most of its trademarks
and patents outside the United States in connection with the
sale of the international tobacco business to Japan Tobacco Inc.
The sale agreement granted Japan Tobacco the right to use
certain of RJR Tobaccos trade secrets outside the
United States, but details of the ingredients or formulas for
flavors and the blends of tobacco may not be provided to any
sub-licensees or sub-contractors. The agreement also prohibits
Japan Tobacco and its licensees and sub-licensees from the sale
or distribution of tobacco products of any description employing
the purchased trademarks and other intellectual property rights
in the United States.

Legislation and Other Matters Affecting the
Cigarette Industry

The tobacco industry is subject to a wide range
of laws and regulations regarding the marketing, sale, taxation
and use of tobacco products imposed by local, state, federal and
foreign governments. Various state governments have adopted or
are considering, among other things, legislation and regulations
that would:



| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | increase their excise taxes on cigarettes;                                                                                      
|
| |  | restrict displays and advertising of tobacco
    products;                                                                      
|
| |  | establish fire safety standards for
    cigarettes;                                                                           
|
| |  | raise the minimum age to possess or purchase
    tobacco products;                                                              
|
| |  | require the disclosure of ingredients used in the
    manufacture of tobacco products;                                          
|
| |  | impose restrictions on smoking in public and
    private areas; and                                                             
|
| |  | restrict the sale of tobacco products directly to
    consumers or other unlicensed recipients, including over the
    Internet.

In addition, in 2004, the U.S. Congress may
consider legislation regarding:



| |   |                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------
| |  | further increases in the federal excise tax;                                                        
|
| |  | regulation of cigarette manufacturing and sale by
    the U.S. Food and Drug Administration;        
|
| |  | amendments to the Federal Cigarette Labeling and
    Advertising Act to require additional warnings;
|
| |  | reduction or elimination of the tax deductibility
    of advertising expenses;                      
|
| |  | implementation of a national standard for
    fire-safe cigarettes;                               
|
| |  | regulation of the retail sale of cigarettes over
    the Internet; and                              
|
| |  | changes to the tobacco price-support program.                                                       

Together with manufacturers price increases
in recent years and substantial increases in state and federal
excise taxes on cigarettes, these developments have had and will
likely continue to have an adverse effect on cigarette sales.
For further discussion of the regulatory and legislative
environment applicable to the cigarette business, see
Managements Discussion and Analysis of Financial
Condition and Results of Operations  Governmental
Activity in Item 7.

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Litigation Affecting the Cigarette
Industry

Overview

Introduction.Various legal actions, proceedings and claims, including
litigation claiming that lung cancer and other diseases, as well
as addiction, have resulted from the use of, or exposure to,
RJRs operating subsidiaries products, are pending or
may be instituted against RJR Tobacco or its affiliates,
including RJR, or indemnitees. During the fourth quarter of
2003, 29 new cases were served against RJR Tobacco or
its affiliates, including RJR, or indemnitees, and 32 cases
were dismissed or otherwise resolved without trial in their
favor. On December 31, 2003, there were 1,592 active
cases pending (including approximately 1,061 individual
smoker cases pending in West Virginia state court as a
consolidated action), as compared with 1,650 on
December 31, 2002, and 1,639 on December 31, 2001. As
of January 23, 2004, 1,577 active tobacco-related
cases were pending against RJR Tobacco and/or its
affiliates or indemnitees: 1,551 in the United States; 20 in
Puerto Rico; 2 in Israel; and 4 in Canada. The U.S. case
number does not include the 2,737 Broin II
cases, which involve individual flight attendants alleging
injuries as a result of exposure to environmental tobacco smoke,
referred to as ETS or secondhand smoke, in aircraft cabins,
pending as of January 23, 2004, and discussed below.

The U.S. cases, exclusive of the
Broin II cases, are pending in the following
32 states and the District of Columbia.

|                     |  |            |       |  
|-------------------- |  | ---------- | ----- | -
|                     |  | Number of 
|State                |  | U.S. Cases
|                     |  |           
|West Virginia        |  |            | 1,071 | *
|Maryland             |  |            | 186   |  
|Florida              |  |            | 72    |  
|Mississippi          |  |            | 49    |  
|New York             |  |            | 26    |  
|Louisiana            |  |            | 23    |  
|California           |  |            | 21    |  
|Nevada               |  |            | 14    |  
|Alabama              |  |            | 13    |  
|Iowa                 |  |            | 10    |  
|Missouri             |  |            | 9     |  
|Illinois             |  |            | 8     |  
|Massachusetts        |  |            | 7     |  
|District of Columbia |  |            | 5     |  
|Tennessee            |  |            | 4     |  
|Connecticut          |  |            | 3     |  
|New Hampshire        |  |            | 3     |  
|New Jersey           |  |            | 3     |  
|Texas                |  |            | 3     |  
|Arizona              |  |            | 2     |  
|Kansas               |  |            | 2     |  
|Minnesota            |  |            | 2     |  
|North Carolina       |  |            | 2     |  
|Ohio                 |  |            | 2     |  
|Pennsylvania         |  |            | 2     |  
|Washington           |  |            | 2     |  
|Georgia              |  |            | 1     |  
|New Mexico           |  |            | 1     |  
|Oklahoma             |  |            | 1     |  
|Oregon               |  |            | 1     |  
|South Carolina       |  |            | 1     |  
|South Dakota         |  |            | 1     |  
|Utah                 |  |            | 1     |  






|  |                                                                   
|- | ------------------------------------------------------------------
|* | 1,061 of the 1,071 cases are pending as a
    consolidated action.

Of the approximately 1,551 active
U.S. cases, 89 are pending in federal court, 1,460 in state
court and 2 in tribal court.

The following table lists the categories of the
U.S. tobacco-related cases pending against RJR Tobacco or
its affiliates, including RJR, or indemnitees; the number of
cases relating to each case type pending as of January 23,
2004; the changes in the number of cases by case type since
October 15, 2003, the cut-off date used to calculate the
number of cases pending against RJR Tobacco or its affiliates or
indemnitees in RJRs

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Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003; and a cross-reference to
the discussion of each case type.


|                                                          |  |             |       |             |  |           |           |  |  |  |    | 
|--------------------------------------------------------- |  | ----------- | ----- | ----------- |  | --------- | --------- |  |  |  | -- | 
|                                                          |  | Number of   |       | Change in   |  |          
|                                                          |  | Cases as    |       | Number of   |  |          
|                                                          |  | of          |       | Cases since |  |          
|                                                          |  | January 23, |       | October 15, |  | Page     
|Case Type                                                 |  | 2004        |       | 2003        |  | Reference
|                                                          |  |             |       |             |  |          
|Individual Smoking and Health                             |  |             | 1,499 |             |  |           | +1        |  |  |  | 18 | 
|Flight Attendant  ETS
    (Broin II)                     |  |             | 2,737 |             |  |           | -48       |  |  |  | 19 | 
|Class Action                                              |  |             | 18    |             |  |           | -1        |  |  |  | 20 | 
|Governmental Health-Care Cost Recovery                    |  |             | 8     |             |  |           | -1        |  |  |  | 24 | 
|Other Health-Care Cost Recovery and Aggregated
    Claims |  |             | 5     |             |  |           | -2        |  |  |  | 27 | 
|Master Settlement Agreement-Enforcement and
    Validity  |  |             | 2     |             |  |           | No Change |  |  |  | 29 | 
|Asbestos Contribution                                     |  |             | 7     |             |  |           | No Change |  |  |  | 29 | 
|Antitrust                                                 |  |             | 6     |             |  |           | -26       |  |  |  | 30 | 
|Other Litigation                                          |  |             | 6     |             |  |           | -5        |  |  |  | 32 | 

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 the other
defendants appealed the verdict. On May 21, 2003,
Floridas Third District Court of Appeal reversed the trial
courts final judgment and remanded the case to the Dade
County Circuit Court with instructions to decertify the class
and dismiss the individual cases. The appellate court denied the
plaintiffs motion for rehearing on September 22,
2003. On October 23, 2003, the plaintiffs filed a notice
asking the Florida Supreme Court to review the case. Briefing on
whether the Florida Supreme Court should review the case is
complete. It is not known when the Florida Supreme Court will
issue a decision. Although RJR Tobacco remains confident in its
bases for appeal in this case, RJR Tobacco cannot predict
the final outcome of the appellate process. See
 Class-Action Suits below for a further
description of the Engle case.

In November 1998, the major U.S. cigarette
manufacturers, including RJR Tobacco, entered into the
Master Settlement Agreement with 46 U.S. states and
certain U.S. territories and possessions. These cigarette
manufacturers previously settled four other cases scheduled to
come to trial, brought on behalf of Mississippi, Florida, Texas
and Minnesota, by separate agreements with each state. The MSA
and other state settlement agreements:



| |   |                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------
| |  | settled all health-care cost recovery actions
    brought by, or on behalf of, the settling jurisdictions;                 
|
| |  | released the major U.S. cigarette
    manufacturers from various additional present and potential
    future claims;       
|
| |  | imposed a stream of future payment obligations on
    RJR Tobacco and the other major U.S. cigarette
    manufacturers; and
|
| |  | placed significant restrictions on their ability
    to market and sell cigarettes.                                        

The aggregate cash payments made by RJR Tobacco
under the MSA and the other state settlement agreements during
the years 2003, 2002 and 2001 were $1.8 billion,
$2.5 billion and $2.4 billion, respectively.
RJR Tobacco estimates these payments will be
$1.9 billion in 2004, and will exceed $1.8 billion per
year thereafter. However, these payments will be subject to
adjustments for, among other things, the volume of cigarettes
sold by RJR Tobacco, RJR Tobaccos market share
and inflation. See  Governmental Health-Care
Cost Recovery Cases  MSA and Other State Settlement
Agreements below for a detailed discussion of the MSA and
the other state settlement agreements, including
RJR Tobaccos monetary obligations under these
agreements.

Certain Terms and
Phrases.Certain terms and phrases
that are used in this disclosure may require some explanation.
The terms judgment or final judgment
refer generally to the final decision of the court resolving the
dispute and determining the rights and obligations of the
parties. At the trial court level, for

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example, a final judgment generally is entered by
the court after a jury verdict and after post-verdict motions
have been decided. As a general proposition, the losing party
can appeal a verdict only after a final judgment has been
entered by the trial court.


The term damages refers to the amount
of money sought by a plaintiff in a complaint, or awarded to a
party by a jury, or in some cases by a judge. Compensatory
damages are awarded to compensate the prevailing party for
actual losses suffered  if liability is proved. In
cases in which there is a finding that a defendant has acted
willfully, maliciously or fraudulently, generally based on a
higher burden of proof than is required for a finding of
liability for compensatory damages, a plaintiff also may be
awarded punitive damages. Although damages may be
awarded at the trial court stage, a losing party generally may
be protected from paying any damages until all appellate avenues
have been exhausted by posting a supersedeas bond. The amount of
such a bond is governed by the law of the relevant jurisdiction
and generally is set at the amount of damages plus some measure
of statutory interest, modified at the discretion of the
appropriate court or subject to a cap set by court or statute.

The term settlement refers to certain
types of cases in which cigarette manufacturers, including
RJR Tobacco, have agreed to resolve disputes with certain
plaintiffs without resolving the case through trial. The
principal terms of settlements entered into by RJR Tobacco
are explained in the following disclosure.

Accounting for Tobacco-Related Litigation
Contingencies.In accordance with
applicable accounting principles, RJR and RJR Tobacco will
record any loss related to tobacco litigation at such time as an
unfavorable outcome becomes probable and the amount can be
reasonably estimated. For the reasons set forth below, except
for Kenyon v. R. J. Reynolds Tobacco Co., discussed
below, RJRs management continues to conclude that the loss
of any particular smoking and health tobacco litigation claim
against RJR Tobacco or its affiliates, when viewed on an
individual basis, is not probable. RJR Tobacco and its
affiliates, including RJR, believe that they have a number of
valid defenses to the tobacco-related litigation claims against
them, as well as valid bases for appeal of adverse verdicts
against RJR Tobacco. RJR and RJR Tobacco have, through
their counsel, filed pleadings and memoranda in pending
tobacco-related litigation that set forth and discuss a number
of grounds and defenses that RJR, RJR Tobacco and their
counsel believe have a valid basis in law and fact. Based on
their experience in the tobacco-related litigation against them
and the strength of the defenses available to them in such
litigation, RJR Tobacco and its affiliates believe that
their successful overall record in the defense of
tobacco-related litigation in the past will continue in the
future. Therefore, no liability for pending tobacco-related
litigation currently is recorded in RJRs consolidated
financial statements.

RJR Tobacco and its affiliates, including RJR,
continue to win the majority of smoking and health tobacco
litigation claims that reach trial, and a very high percentage
of the tobacco-related litigation claims brought against them
continue to be dismissed at or before trial. Generally, and
except as specifically discussed below, RJR Tobacco and its
affiliates, including RJR, have not settled, and currently do
not intend to settle, any smoking and health tobacco litigation
claims. It is the policy of RJR Tobacco and its affiliates,
including RJR, to vigorously defend all tobacco-related
litigation claims.

The only material smoking and health tobacco
litigation claims settled by RJR Tobacco involved:



| |   |                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the MSA, the related settlements with the states
    of Mississippi, Florida, Texas and Minnesota, and the funding by
    various cigarette companies of a $5.2 billion trust fund
    contemplated by the MSA to benefit tobacco growers; and
|
| |  | the original Broin flight attendant case
    discussed below under  Class-Action Suits.                                                                                                                                                    

Despite having valid legal defenses, RJR Tobacco
settled these matters because of unique circumstances that do
not apply to the other tobacco litigation cases pending against
RJR Tobacco and its affiliates, including RJR.

The circumstances surrounding the MSA, the other
state settlement agreements and the funding of a trust fund to
benefit the tobacco growers are readily distinguishable from the
current categories of cases involving RJR Tobacco. The
claims underlying the MSA and the other state settlement
agreements were brought by the states to recover health-care
costs paid on behalf of state citizens suffering from diseases
and

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conditions allegedly related to tobacco use. The
MSA and the other state settlement agreements settled all the
health-care cost recovery actions brought by, or on behalf of,
the settling jurisdictions and contain releases of various
additional present and future claims. In accordance with the
MSA, various tobacco companies agreed to fund a
$5.2 billion trust fund to be used to address the possible
adverse economic impact of the MSA on tobacco growers. A
discussion of the MSA and the other state settlement agreements,
and a table depicting the related payment schedule under these
agreements, is set forth below under
 Governmental Health-Care Cost Recovery
Cases  MSA and Other State Settlement
Agreements.


The states were a unique set of plaintiffs and
are not plaintiffs in any of the smoking and health cases
remaining against RJR or RJR Tobacco. Although
RJR Tobacco continues to be a defendant in certain
health-care cost recovery cases similar in theory to the state
cases but involving other plaintiffs, such as unions, hospitals,
Native American tribes, and local and foreign governments, the
vast majority of such cases have been dismissed on legal
grounds. Indeed, eight federal courts of appeals have ruled
uniformly that unions cannot successfully pursue such cases. As
a result, no union cases are pending against RJR or
RJR Tobacco. RJR and RJR Tobacco believe that the same
legal principles that have resulted in dismissal of union and
other types of health-care cost recovery cases either at the
trial court level or on appeal should compel the dismissal of
the similar pending cases.

Finally, in the U.S. Department of Justice
case brought against various industry members, including
RJR Tobacco, the United States District Court for the
District of Columbia granted the non-Liggett defendants
motion to dismiss plaintiffs Medical Care Recovery Act and
Medicare Secondary Payer claims. In these particular claims, the
federal government made arguments similar to the states and
sought to recover federal funds expended in providing
health-care to smokers who have developed diseases and injuries
alleged to be smoking-related. The only remaining claims in this
case involve alleged violations of the federal RICO statute.

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

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

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

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

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

Scheduled Trials.Trial schedules are subject to change, and many cases are
dismissed before trial. However, an increased number of cases
have gone to trial each year since 2000 against RJR Tobacco
and/or its affiliates, some involving claims for amounts ranging
possibly into the hundreds of millions and even billions of
dollars, and RJR Tobacco expects this trend to continue.
The following table lists the trial schedule, as of
January 23, 2004, for RJR Tobacco or its affiliates,
through December 31, 2004.

|                              |  |                                                             |  |                                 |  |                                                                    
|----------------------------- |  | ----------------------------------------------------------- |  | ------------------------------- |  | -------------------------------------------------------------------
|Trial Date                    |  | Case Name                                                   |  | Case Type                       |  | Jurisdiction                                                       
|                              |  |                                                             |  |                                 |  |                                                                    
|March 29, 2004
    [Phase II] |  | Scott v. American Tobacco Co.,
    Inc.                     |  | Class Action                    |  | District Court, Orleans Parish (New Orleans, LA)                   
|                             
|April 7, 2004                 |  | Prado Alvarez v. R. J. Reynolds Tobacco
    Co.             |  | Individual                      |  | United States District Court (San Juan,
    Puerto Rico)           
|                             
|April 19, 2004                |  | DeLoach [Growers] v. R. J. Reynolds
    Tobacco Co.         |  | Antitrust                       |  | United States District Court, Middle District
    (Greensboro, NC) 
|                             
|April 28, 2004                |  | Major v. Raybestos-Manhattan,
    Inc.                      |  | Asbestos Contribution           |  | Superior Court, Los Angeles County (Los Angeles,
    CA)           
|                             
|May 17, 2004                  |  | Frost v. Philip Morris, Inc.                                |  | Flight Attendant-ETS (Broin II) |  | Circuit Court, Dade County (Miami, FL)                             
|                             
|May 17, 2004                  |  | Roach v. Brown & Williamson
    Tobacco Corp.               |  | Individual                      |  | Circuit Court, Jackson County (Independence, MO)                   
|                             
|June 1, 2004                  |  | Leslie H. Dial Ent., Inc. v.
    R. J. Reynolds Tobacco Co. |  | Antitrust                       |  | United States District Court (Columbia, SC)                        
|                             
|June 28, 2004                 |  | Gaston v. R. J. Reynolds Tobacco
    Co.                    |  | Individual                      |  | Superior Court, Union County (Elizabeth, NJ)                       
|                             
|June 28, 2004                 |  | Short v. R. J. Reynolds Tobacco
    Co.                     |  | Individual                      |  | Superior Court, Union County (Elizabeth, NJ)                       
|                             
|July 5, 2004                  |  | Rosol v. R. J. Reynolds Tobacco
    Co.                     |  | Individual                      |  | United States District Court, Northern District
    (Waverly, IA)  
|                             
|July 12, 2004                 |  | Younger v. Philip Morris Inc.                               |  | Flight Attendant-ETS (Broin II) |  | Circuit Court, Dade County (Miami, FL)                             
|                             
|September 6, 2004             |  | Torres-Rivera v. R. J. Reynolds Tobacco
    Co.             |  | Individual                      |  | Superior Court, Court of First Instance
    (San Juan, Puerto Rico)
|                             
|September 13, 2004            |  | Beckman v. Brown & Williamson
    Tobacco Corp.             |  | Individual                      |  | Circuit Court, Jackson County (Independence, MO)                   
|                             
|September 13, 2004            |  | Kimball v. R. J. Reynolds Tobacco
    Co.                   |  | Individual                      |  | United States District, Western District
    (Seattle, WA)         

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|                   |  |                                                              |  |                           |  |                                                                     
|------------------ |  | ------------------------------------------------------------ |  | ------------------------- |  | --------------------------------------------------------------------
|Trial Date         |  | Case Name                                                    |  | Case Type                 |  | Jurisdiction                                                        
|                   |  |                                                              |  |                           |  |                                                                     
|                  
|September 13, 2004 |  | United States of America [DOJ] v. Philip
    Morris USA Inc. |  | Health-Care Cost Recovery |  | United States District Court (Washington, DC)                       
|                  
|September 20, 2004 |  | Coy v. Philip Morris Inc.                                    |  | ETS                       |  | United States District Court, Southern District
    (Miami, FL)     
|                  
|October 4, 2004    |  | Mason v. British American Tobacco
    (Investments) Ltd.     |  | Individual                |  | United States District Court, Southern District
    (Des Moines, IA)
|                  
|October 26, 2004   |  | Norris v. R. J. Reynolds Tobacco
    Co.                     |  | Individual                |  | United States District Court, Central District
    (Los Angeles, CA)
|                  
|November 15, 2004  |  | Booth v. R. J. Reynolds Tobacco
    Co.                      |  | Individual                |  | Circuit Court, Upshur County (Buckhannon, WV)                       
|                  
|December 1, 2004   |  | Smith Wholesale Co., Inc. v. R. J.
    Reynolds Tobacco Co.  |  | Antitrust                 |  | United States District Court, Eastern District,
    (Greenville, TN)
|                  
|December 1, 2004   |  | Gerrity v. R. J. Reynolds Tobacco
    Co.                    |  | Individual                |  | United States District Court (Hartford, CT)                         
|                  
|December 1, 2004   |  | Harju v. Philip Morris USA Inc.                              |  | Individual                |  | United States District Court (St. Paul, MN)                         

Trial Results.Since
January 1, 1999, 33 smoking and health and health-care cost
recovery cases in which RJR Tobacco was a defendant have been
tried. Verdicts in favor of RJR Tobacco and, in some cases, RJR
Tobacco and other defendants, were returned in 20 of the 33
cases. Four of the cases resulted in mistrials. One of the cases
resulted in a split decision. Of the 20 RJR Tobacco wins, seven
were tried in Florida, two were tried in each of California,
Mississippi and New York, and one was tried in each of
Louisiana, Missouri, New Jersey, Ohio, South Carolina, Tennessee
and West Virginia. Plaintiffs in the California, Florida,
Mississippi and West Virginia cases have filed appeals or
post-trial motions challenging the verdicts.

The cases in which verdicts were returned in
favor of RJR Tobacco, either by itself or with other defendants,
since January 1, 2003, are described below:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | On February 7, 2003, state court juries in
    California and Florida, respectively, found in favor of RJR
    Tobacco and other cigarette manufacturers in Lucier v.
    Phillip Morris, Inc., an individual smoker case, and
    Seal v. Philip Morris, Inc., a Broin II case.                                                                                                                                                                                                                                             
|
| |  | On February 28, 2003, a Florida federal
    court jury found in favor of RJR Tobacco and Philip Morris in
    Allen v. R. J. Reynolds Tobacco Co., an individual
    smoker case.                                                                                                                                                                                                                                                                                                                                            
|
| |  | On June 17, 2003, a state court jury in
    Missouri found in favor of RJR Tobacco and other cigarette
    manufacturers in Welch v. Brown & Williamson
    Tobacco Corp., an individual smoker case. On July 18,
    2003, the plaintiff in Welch filed a motion for a new
    trial, which was denied on September 18, 2003. On
    September 23, 2003, the plaintiff noticed an appeal to the
    Missouri Court of Appeals for the Western District.                                                                     
|
| |  | On July 28, 2003, a Louisiana state court
    jury returned a split verdict in Scott v. American
    Tobacco Co., a medical monitoring/smoking cessation class
    action. Specifically, the jury found that cigarettes were not
    defective and rejected the classs claim for medical
    monitoring, but found that smoking cessation programs exist and
    have clinical value. A phase II trial is scheduled to begin
    March 29, 2004, to address the scope and cost of a
    statewide smoking cessation program.

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | On September 15, 2003, in Routh
    v. Philip Morris, Inc., a Broin II case, a
    Florida Circuit Court judge declared a mistrial. The case was
    retried and, on October 14, 2003, a Florida state court
    jury returned a verdict in favor of the defendants, including
    RJR Tobacco. Plaintiff filed a motion for a new trial on
    October 24, 2003, which was denied on December 16,
    2003. The plaintiff will not appeal.
|
| |  | Most recently, on December 10, 2003, a
    Florida state court jury returned a verdict in favor of
    defendants, including RJR Tobacco, in Hall v. R. J.
    Reynolds Tobacco Co., an individual smoker case.
    Plaintiffs motion for a new trial was denied on
    January 6, 2004.                                                                                                                                                  

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

|                                                                                  |  |                                                                                                |  |                                                                   |  |                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Date of Verdict                                                                   |  | Case Name/Type                                                                                 |  | Jurisdiction                                                      |  | Verdict                                                                                                                                                                                                      |  | Post-Trial Status                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                  |  |                                                                                                |  |                                                                   |  |                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|July 7, 1999  Phase I
    April 7, 2000  Phase II
    July 14, 2000  Phase III |  | Engle v. R. J. Reynolds Tobacco
    Co.[Class Action]                                          |  | Circuit Court, Dade County (Miami, FL)                            |  | $12.7 million compensatory damages against
    all defendants; $145 billion punitive damages against all
    defendants, of which approximately $36.3 billion was
    assigned to RJR Tobacco                |  | On May 21, 2003, Floridas Third
    District Court of Appeal reversed the trial courts final
    judgment and remanded the case to the Dade County Circuit court
    with instructions to decertify the class. On July 16, 2003,
    plaintiffs filed a motion for rehearing which was denied on
    September 22, 2003. Mandate issued on October 8, 2003.
    Plaintiffs filed a notice seeking review by the Florida Supreme
    Court on October 23, 2003. Both sides have submitted briefs
    on whether the Florida Supreme Court should accept jurisdiction
    of the appeal.                                                                               
|                                                                                 
|March 20, 2000                                                                    |  | Whiteley v. Raybestos- Manhattan, Inc.[Individual]                                             |  | Superior Court, San Francisco County
    (San Francisco, CA)      |  | $1.72 million compensatory damages against
    RJR Tobacco and Philip Morris; $20 million punitive
    damages, of which $10 million was assigned to each of RJR
    Tobacco and Philip Morris, respectively |  | Final judgment on appeal to the California Court
    of Appeal; oral argument was heard on January 21, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                 
|October 12, 2000                                                                  |  | Jones v. Brown & Williamson
    Tobacco Corp.[Individual]                                      |  | Circuit Court, Hillsborough County (Tampa, FL)                    |  | $200,000 compensatory damages against RJR Tobacco                                                                                                                                                            |  | RJR Tobacco granted new trial on
    December 28, 2000; new trial decision affirmed by Second
    District Court of Appeal of Florida on August 30, 2002;
    plaintiffs opening brief filed with the Supreme Court of
    Florida on November 26, 2002. On December 9, 2002, the
    Supreme Court of Florida issued an order to show cause as to why
    Jones notice of appeal should not be treated as a notice
    to invoke discretionary jurisdiction. Jones filed his response
    to the order to show cause, and RJR Tobacco filed its reply on
    December 31, 2002.                                                                                     
|                                                                                 
|June 4, 2001                                                                      |  | Blue Cross and Blue Shield of New
    Jersey v. Philip Morris, Inc.[Health Care Cost Recovery] |  | United States District Court, Eastern District
    (Brooklyn, NY) |  | $17.8 million compensatory damages against
    all defendants, of which $6.6 million was assigned to RJR
    Tobacco. Judge subsequently ordered plaintiffs attorneys
    entitled to $37.8 million in fees |  | On September 16, 2003, the United States
    Court of Appeals for the Second Circuit: (a) reversed
    judgment for Empire on its subrogation claim; and
    (b) reserved ruling on the direct claim pending resolution
    by the New York Court of Appeals of questions concerning
    whether third-party payers are too remote and, if the claims are
    not too remote, whether individual proof is required under the
    New York State Statute pursuant to which the jury found
    liability. On October 30, 2003, the New York Court of
    Appeals decided to review the certified questions. Defendants
    filed their initial brief on January 22, 2004.

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|                   |  |                                                                    |  |                                                          |  |                                                                                            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------------------ |  | ------------------------------------------------------------------ |  | -------------------------------------------------------- |  | ------------------------------------------------------------------------------------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Date of Verdict    |  | Case Name/Type                                                     |  | Jurisdiction                                             |  | Verdict                                                                                    |  | Post-Trial Status                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                   |  |                                                                    |  |                                                          |  |                                                                                            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                  
|December 12, 2001  |  | Kenyon v. R. J. Reynolds
    Tobacco Co.[Individual]               |  | Circuit Court, Hillsborough County (Tampa, FL)           |  | $165,000 compensatory damages against RJR Tobacco                                          |  | On May 30, 2003, the Second District Court
    of Appeal of Florida affirmed per curiam (that is, without
    writing an opinion) the trial courts final judgment in
    favor of plaintiffs. RJR Tobacco filed a petition for rehearing
    or for a written opinion on June 16, 2003. That motion was
    denied on July 11, 2003. RJR Tobacco filed a motion for
    stay of proceedings pending the final outcome of the Engle
    appeal. That motion was denied on July 11, 2003. On
    August 28, 2003, Floridas Second District Court of
    Appeal entered its mandate. RJR Tobacco deposited with the
    plaintiffs counsel the amount of the judgment plus accrued
    interest ($196,000) in order to pursue further appeals without
    the risk of any effort by the plaintiff to execute on the
    judgment. On September 5, 2003, RJR Tobacco filed a
    petition with the Florida Supreme Court asking it to require the
    Second District Court of Appeal to write an opinion. That
    petition remains pending. On November 12, 2003, RJR Tobacco
    filed its petition for certiorari with the United States Supreme
    Court.
|                  
|February 22, 2002  |  | Burton v. R. J. Reynolds
    Tobacco Co.[Individual]               |  | United States District Court (Kansas City, KS)           |  | $198,000 compensatory damages and
    $15 million punitive damages against RJR Tobacco     |  | Final judgment on appeal to the United States
    Court of Appeals for the Tenth Circuit; oral argument was heard
    on January 12, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                  
|June 18, 2002      |  | French v. Philip Morris, Inc.[Flight Attendant-ETS
    (Broin II)] |  | Circuit Court, Dade County (Miami, FL)                   |  | $5.5 million compensatory damages against
    all defendants; reduced by judge to $500,000 |  | Judge reduced damages award to $500,000, of which
    $123,500 was assigned to RJR Tobacco; final judgment on appeal
    to the Third District Court of Appeal of Florida; RJR
    Tobaccos opening brief filed July 16, 2003. The
    appellees brief has not yet been filed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                  
|September 25, 2002 |  | Figueroa-Cruz v. R. J. Reynolds
    Tobacco Co.[Individual]        |  | United States District Court (San Juan,
    Puerto Rico) |  | $500,000 compensatory damages against RJR Tobacco                                          |  | Trial judge granted RJR Tobaccos motion for
    judgment as a matter of law on October 9, 2002. On
    October 28, 2003, the United States Court of Appeals for
    the First Circuit affirmed the trial courts ruling.
    Plaintiffs filed a petition for rehearing on November 13,
    2003, which was denied on December 12, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

Additionally, since January 1, 1999,
verdicts have been returned in 26 tobacco-related cases in which
neither RJR Tobacco nor its affiliates, including RJR, were
defendants. Verdicts were returned in favor of defendants in 14
cases  three in Tennessee, two in Pennsylvania, and
one in each of California, Connecticut, Florida, Missouri, New
Hampshire, New York, Ohio, Rhode Island and Texas. Verdicts
in favor of the plaintiffs were returned in 12 cases, four of
which were tried in California, two in each of Florida and
Oregon and one in each of Arkansas, Illinois, Missouri and
New York. The defendants appeals or post-trial
motions are pending in these cases.

The cases in which verdicts were returned in
favor of the plaintiffs since January 1, 2003, are
described below:



| |   |                                                                                                                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | On March 21, 2003, an Illinois state trial
    judge entered judgment against Philip Morris in Price v.
    Philip Morris (formerly known as Miles v. Philip
    Morris), a lights class-action case discussed
    below under  Class-Action Suits.

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | On April 3, 2003, a Florida state court jury
    returned a verdict against Philip Morris and Brown &
    Williamson in Eastman v. Philip Morris, an
    individual smoker case. The jury awarded compensatory but not
    punitive damages.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | On May 27, 2003, in Boerner v.
    Brown & Williamson Tobacco
    Corp., an Arkansas federal court jury
    returned a verdict against Brown & Williamson in
    another individual smoker action. On July 2, 2003, the
    trial judge dismissed the Boerner jurys
    $15 million punitive damages award, but found in favor of
    the plaintiff on the design defect claim, which was not
    considered by the jury. The final judgment reflected the
    jurys award of $4,025,000 in actual damages. On
    September 26, 2003, the judge denied Brown &
    Williamsons motions for judgment as a matter of law and
    for a new trial. The judge also reinstated the jurys
    original punitive damages award of $15 million.
    Brown & Williamson is appealing this case.                                          
|
| |  | On July 31, 2003, a California state court
    jury found in favor of Philip Morris in Reller v. Philip
    Morris USA Inc. on all counts except fraudulent concealment,
    on which the jury deadlocked. Mr. Reller has since died,
    and the fraudulent concealment claim will not be retried. On
    December 19, 2003, Mr. Rellers estate filed an
    amended wrongful death complaint substituting the representative
    of the estate as the plaintiff.                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | On August 15, 2003, a Pennsylvania state
    court jury found in favor of Brown & Williamson in
    Eiser v. Brown & Williamson Tobacco Corp.,
    an individual lights case. Post-trial motions have
    been filed by the plaintiff, and a hearing took place on
    December 4, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | On September 25, 2003, in Henley v.
    Philip Morris, Inc., the California Court of Appeal affirmed
    the San Francisco County Superior Courts final
    judgment with respect to the $1.5 million compensatory
    damages award to the plaintiff, but reduced the amount of
    punitive damages from $50 million to $9 million based
    on the United States Supreme Courts opinion in State
    Farm v. Campbell. Philip Morriss petition for
    rehearing was denied. On November 4, 2003, Philip Morris
    petitioned the California Supreme Court to review the case. On
    December 23, 2003, the California Supreme Court accepted
    Philip Morriss appeal and remanded the case to the
    California Court of Appeal with directions that it vacate its
    September 25, 2003 ruling and issue a new ruling.
|
| |  | On November 4, 2003, in Thompson v.
    Brown & Williamson Tobacco Corp., a Missouri state
    court jury returned a verdict against Philip Morris and
    Brown & Williamson, and awarded $2.1 million in
    compensatory damages. The jury found Brown & Williamson
    to be 10% at fault, Philip Morris to be 40% at fault, and
    plaintiff to be 50% at fault. On December 11, 2003,
    defendants filed a motion for judgment notwithstanding the
    verdict, or, in the alternative, motion for a new trial.                                                                                                                                                                                                                                                                                                             
|
| |  | On November 24, 2003, a New Hampshire state
    court jury returned a verdict in favor of Philip Morris in
    Longden v. Philip Morris, Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  | Most recently, on December 18, 2003, a
    New York state court jury returned a verdict against
    Brown & Williamson in Frankson v.
    Brown & Williamson Tobacco Corp. The jury awarded
    $350,000 in compensatory damages. The jury found the plaintiff
    to be 50% at fault, thereby causing the compensatory damages
    award to be reduced to $175,000. On January 8, 2004, the
    jury awarded $20 million in punitive damages, of which
    $6 million was assigned to Brown & Williamson,
    $2 million to a predecessor company and $12 million to
    two trade organizations. Defendants post-trial motions are
    to be filed by January 29, 2004.                                                                                                                                                           

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

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Individual Smoking and Health Cases

As of January 23, 2004, 1,499 individual
cases, including approximately 1,061 individual smoker cases
pending in West Virginia state court in a consolidated action,
were pending in the United States against RJR Tobacco. This
category of cases includes smoking and health cases alleging
personal injury brought by or on behalf of individual
plaintiffs, but does not include the Broin II cases
discussed below. A total of 1,491 of the individual pending
cases are brought by or on behalf of individual smokers or their
survivors, while the remaining seven are brought by or on behalf
of individuals or their survivors alleging personal injury as a
result of exposure to ETS.

Below is a description of the individual smoking
and health cases against RJR Tobacco which went to trial or were
decided or remained on appeal, since January 1, 2003.

On March 20, 2000, a California state court
jury found in favor of the plaintiff in Whiteley v.
Raybestos-Manhattan, Inc. The jury awarded the plaintiff
$1.72 million in compensatory damages and $20 million
in punitive damages. RJR Tobacco and Philip Morris were each
assigned $10 million of the punitive damages award. The
defendants appealed the final judgment to the California Court
of Appeal, First District, on May 30, 2000. Oral argument
occurred on January 21, 2004.

In Kenyon v. R. J. Reynolds Tobacco
Co., an individual case in Florida, a jury awarded the
plaintiff $165,000 in compensatory damages, but no punitive
damages, on December 12, 2001. On May 30, 2003,
Floridas Second District Court of Appeal affirmed the
final judgment without an opinion. RJR Tobacco sought rehearing
or a written opinion, which was rejected on July 11, 2003.
The court of appeal entered its mandate on August 28, 2003.
In Florida, a supersedeas bond does not stay execution of a
judgment once the court of appeal enters its mandate in favor of
a plaintiff. Accordingly, RJR Tobacco deposited with the
plaintiffs counsel a check in the amount of the judgment
plus accrued interest ($196,000) to avoid any possible business
disruption during the remaining appeal. On September 5,
2003, RJR Tobacco filed a petition with the Florida Supreme
Court, asking it to require the appeals court to issue a written
opinion. That petition remains pending. On November 12,
2003, RJR Tobacco filed a petition for certiorari with the
United States Supreme Court.

On February 22, 2002, in Burton
v. R. J. Reynolds Tobacco Co., a federal district court
jury in Kansas found in favor of RJR Tobacco and
Brown & Williamson on product defect and conspiracy
claims, but found for the plaintiff on failure to warn, failure
to test and fraudulent concealment claims. The jury apportioned
99% of the fault to RJR Tobacco and 1% to Brown &
Williamson. It awarded the plaintiff $198,400 in compensatory
damages, and determined that the plaintiff was entitled to
punitive damages against RJR Tobacco but not Brown &
Williamson. Brown & Williamson was voluntarily
dismissed as a defendant by the plaintiffs on June 10,
2002. On June 21, 2002, the trial court awarded the
plaintiff $15 million in punitive damages. RJR Tobacco
appealed to the United States Court of Appeals for the Tenth
Circuit. Oral argument was heard on January 12, 2004.

In Figueroa-Cruz v. R. J. Reynolds
Tobacco Co., a federal district court jury in San Juan,
Puerto Rico, found in favor of one of two plaintiffs on
September 25, 2002. On October 9, 2002, however, the
trial judge granted RJR Tobaccos motion for judgment on
the pleadings. The plaintiffs appealed to the United States
Court of Appeals for the First Circuit. On October 28,
2003, the appeals court affirmed the trial courts
decision. Plaintiffs filed a petition for rehearing; however,
that petition was denied on December 12, 2003.

On February 7, 2003, a Florida state court
jury found in favor of RJR Tobacco and Philip Morris in
Lucier v. Phillip Morris, Inc., an individual smoker
case. Plaintiff appealed to the California Court of Appeal,
Third Appellate District, on May 9, 2003. On
December 4, 2003, the appellate court dismissed the appeal
because of the plaintiffs failure to file the initial
brief.

On February 28, 2003, a Florida federal
court jury found in favor of RJR Tobacco and Philip Morris
in Allen v. R. J. Reynolds Tobacco Co., an
individual smoker case. The plaintiff did not appeal.

On May 8, 2003, the Mississippi Supreme
Court, in Lane v. R. J. Reynolds Tobacco Co., ruled
that the Mississippi Product Liability Act does not allow
smoking and health cases based on products liability. RJR

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Tobacco believes that the effect of the
Lane ruling will be to reduce the number, if not
eliminate, smoking and health cases in Mississippi.


On June 17, 2003, in Welch
v. Brown & Williamson Tobacco Corp., a
Missouri state court jury found in favor of RJR Tobacco and
other cigarette manufacturers. The plaintiffs new trial
motion was denied on September 18, 2003. The plaintiff
filed a notice of appeal to the Missouri Court of Appeals on
September 23, 2003. No briefing schedule has been set.

On December 10, 2003, in Hall v. R.
J. Reynolds Tobacco Co., a state court jury in Florida
returned a verdict in favor of RJR Tobacco and Brown &
Williamson. The plaintiff filed a motion for a new trial on
December 19, 2003, which was denied on January 6, 2004.

Broin II Cases

As of January 23, 2004, approximately 2,737
lawsuits brought by individual flight attendants for personal
injury as a result of illness allegedly caused by exposure to
secondhand or environmental tobacco smoke in airplane cabins,
referred to as the Broin II cases, were pending in
Florida. In these lawsuits, filed pursuant to the terms of the
settlement of the Broin v. Philip Morris, Inc. class
action, discussed below under  Class-Action
Suits, each individual flight attendant will be required
to prove that he or she has a disease and that the
individuals exposure to secondhand smoke in airplane
cabins caused the disease. Under the terms of the settlement of
the original Broin case, punitive damages are not
available in the Broin II cases.

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

Below is a description of the
Broin II cases against RJR Tobacco which went
to trial or were decided or remain on appeal, since
January 1, 2003.

In French v. Philip Morris, Inc., a
Florida state court jury found in favor of the plaintiff on
June 18, 2002, and awarded $5.5 million in
compensatory damages. On September 13, 2002, the trial
judge reduced the damages award to $500,000, but denied the
defendants remaining post-trial motions. The
defendants appeal of the trial courts final judgment
is pending in the Third District Court of Appeal of Florida.
Judge Kayes order in Jett v. Philip Morris,
Inc., referred to above, was applied, and the defendants are
appealing that order, as well as other matters. The appeal is in
the briefing phase.

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

In Tucker v. Philip Morris, Inc., a
Florida state court jury found in favor of the defendants,
including RJR Tobacco, on October 4, 2002. The
plaintiffs post-verdict motions were denied on
January 28, 2003. The plaintiff noticed an appeal to
Floridas Third District Court of Appeal on
February 28, 2003, but voluntarily dismissed the appeal on
May 23, 2003.

A Florida state court jury found in favor of RJR
Tobacco and other cigarette manufacturers on February 7,
2003, in Seal v. Philip Morris, Inc. On
February 14, 2003, the plaintiff filed a motion for a new
trial, which was denied on April 24, 2003.

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In Mittan v. Philip Morris, Inc., on
July 16, 2003, the plaintiff accepted an $800 (eight
hundred dollars) offer of judgment tendered by RJR Tobacco,
Philip Morris, Brown & Williamson and Lorillard.
RJR Tobaccos share of the offer was $200.

In Routh v. Philip Morris, Inc., the trial
judge declared a mistrial on September 15, 2003. Retrial
began on September 23, 2003. The jury returned a verdict in
favor of the defendants, including RJR Tobacco, on
October 14, 2003. The plaintiff filed a motion for a new
trial on October 24, 2003; however, that motion was denied
on December 16, 2003. The plaintiff will not appeal.

Class-Action Suits

As of January 23, 2004, 18 class-action
cases were pending in the United States against RJR Tobacco, and
in some cases, RJR. In May 1996, in Castano v. American
Tobacco Co., the Fifth Circuit Court of Appeals overturned
the certification of a nationwide class of persons whose claims
related to alleged addiction to tobacco products. Since this
ruling by the Fifth Circuit, most class-action suits have sought
certification of statewide, rather than nationwide, classes.
Class-action suits based on claims similar to those asserted in
Castano are pending against RJR Tobacco, and in some
cases RJR, in state or federal courts in Alabama, California,
Florida, Illinois, Louisiana, Minnesota, Missouri,
New York, Oklahoma, Oregon, Utah and West Virginia.
Twenty-five virtually identical class-action complaints were
filed by one attorney in Nevada since July 2002. This same
attorney also filed class action complaints in Kentucky,
Massachusetts and Utah. As discussed below, a federal district
court judge recently denied class certification in all 25 of the
Nevada cases; a state court judge denied class certification in
the Kentucky case; the Massachusetts case was voluntarily
dismissed; and the Utah case remains pending.

Class-action suits have been filed in a number of
states against individual cigarette manufacturers and their
parent corporations, alleging that the use of the terms
lights and ultralights constitutes
unfair and deceptive trade practices. In December 2000, a state
court in Pennsylvania refused to certify one such class action,
Oliver v. RJR Tobacco Co. That case was voluntarily
dismissed. Five such suits are pending against RJR Tobacco and
RJR in Florida, Illinois, Louisiana, Missouri and Minnesota.
Classes have been certified in the Illinois case,
Turner v. R. J. Reynolds Tobacco Co., and in the
Missouri case, Collora v. R. J. Reynolds Tobacco Co.
Each of these cases is discussed below. The Florida case,
Rios v. R. J. Reynolds Tobacco Co., is in the class
certification discovery phase. Most recently, in both the
Louisiana and Minnesota actions, Harper v. R. J.
Reynolds Tobacco Co. and Dahl v. R. J. Reynolds
Tobacco Co., defendants removed the cases to federal court.
On December 17, 2003, in Dahl, however, the case was
remanded to state court.

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

Few smoker class-action complaints have been
certified or, if certified, have survived on appeal. Seventeen
federal courts that have considered the issue, including two
courts of appeals, and most state courts have rejected class
certification in smoking and health cases. Only one federal
district court has certified a smoker class action 
In re Simon (II) Litigation  which
was filed in the United States District Court for the Eastern
District of New York before Judge Weinstein. In Simon
(II), on September 19, 2002, Judge Weinstein certified
a nationwide mandatory, non-opt-out punitive damages class.
Defendants sought reconsideration of the certification ruling,
which was denied by Judge Weinstein on October 25, 2002. On
February 14, 2003, the United States Court of Appeals for
the Second Circuit granted the defendants petition to
review the class certification decision. Oral argument was heard
on November 20, 2003. On February 10, 2003, in
Sims v. Philip Morris, Inc., the United States
District Court for the District of Columbia denied certification
of a proposed nationwide class of smokers who purchased
cigarettes while underage. On July 11, 2003, a federal
district court judge in Nevada denied class certification in
five separate cases, brought by the same attorney, which were
consolidated for class certification purposes. On
October 7, 2003, the same federal district court

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judge in Nevada denied class certification in 20
additional cases brought by the same attorney. On
November 21, 2003, in Brown v. Philip Morris
Inc., the Circuit Court of Campbell County, Kentucky, denied
class certification; this case was voluntarily dismissed on
December 12, 2003. Most recently, on December 8, 2003,
in Jackson v. Philip Morris Inc., a federal district
court judge in Utah dismissed the case due to plaintiffs
failure to prosecute.


Classes have been certified in several state
court class-action cases in which RJR Tobacco is a
defendant. On November 5, 1998, in Scott v.
American Tobacco Co., a Louisiana state appeals court
affirmed the certification of a medical monitoring and/or
smoking cessation class of Louisiana residents who were smokers
on or before May 24, 1996. On February 26, 1999, the
Louisiana Supreme Court denied the defendants petition for
writ of certiorari and/or review. Jury selection began on
June 18, 2001. An initial jury was selected by
July 16, 2001. However, the defendants, including RJR
Tobacco, raised multiple challenges to the jury selection
process. At various times, the Louisiana Court of Appeals and/or
the Louisiana Supreme Court removed a number of jurors and
alternate jurors that the trial court had allowed to be seated.
The jury selection process was finally completed on
September 23, 2002, and opening statements occurred on
January 21, 2003. On July 28, 2003, the jury returned
a verdict in favor of the defendants, including
RJR Tobacco, on the plaintiffs claim for medical
monitoring and found that cigarettes were not defectively
designed. In addition, however, the jury made certain findings
against the defendants, including RJR Tobacco, on claims
relating to fraud, conspiracy, marketing to minors and smoking
cessation. With respect to these findings, this portion of the
trial did not determine liability as to any class member or
class representative. What primarily remains in the case is a
class-wide claim that the defendants, including
RJR Tobacco, pay for a program to help people stop smoking.
The trial judge has ordered that a phase two trial begin on
March 29, 2004, to address the scope and cost of a
statewide smoking cessation program. On October 23, 2003,
the defendants, including RJR Tobacco, filed a challenge to
the trial judges phase two trial order with the Louisiana
Court of Appeals. The Court of Appeals declined to accept the
appeal on December 5, 2003. On January 5, 2004, RJR
Tobacco, Brown & Williamson and Lorillard filed a writ
seeking review by the Louisiana Supreme Court.

In Blankenship v. American Tobacco Co.,
the first tobacco-related medical monitoring class action to be
certified and to reach trial, the West Virginia state court jury
found in favor of RJR Tobacco and other cigarette manufacturers
on November 14, 2001. On July 18, 2002, the plaintiffs
petitioned the Supreme Court of West Virginia for leave to
appeal, which was granted on February 25, 2003. Oral
argument was heard on November 5, 2003.

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

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

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

On July 24, 2000, the defendants, including
RJR Tobacco, filed numerous post-verdict motions, including
motions for a new trial and to reduce the amount of the punitive
damages verdict. On November 6, 2000, the trial judge
denied the post-trial motions and entered judgment. On
November 7, 2000, RJR Tobacco posted an appeal bond in the
amount of $100 million, the maximum amount required,
pursuant to a Florida bond cap

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statute enacted on May 9, 2000, and intended
to apply to the Engle case, and initiated the appeals
process. On May 21, 2003, Floridas Third District
Court of Appeals reversed the trial courts final judgment
and remanded the case to the Dade County Circuit Court with
instructions to decertify the class. The appellate court denied
the classs motion for rehearing on September 22,
2003. On October 23, 2003, the plaintiffs filed a notice
asking the Florida Supreme Court to review the case. Briefing on
whether the Florida Supreme Court should review the case is now
complete. It is not known when the Florida Supreme Court will
issue a decision. Although RJR Tobacco remains confident in its
bases for appeal in this case, RJR Tobacco cannot predict the
final outcome of the appellate process.


On May 7, 2001, three of the non-RJR Tobacco
defendants entered into agreements with the Engle class
to deposit an additional $1.86 billion into separate escrow
accounts to ensure that the stay of execution in effect pursuant
to the Florida bond cap statute will remain in effect as to
these three defendants throughout the appellate process,
regardless of the results of a challenge, if any, to the Florida
bond statute. Approximately $700 million of the total
amount deposited by these three defendants is non-refundable and
will go to the trial court to be distributed, regardless of the
result of the appeal. RJR Tobacco has not entered into a similar
agreement with the Engle class. Although RJR Tobacco
cannot predict the outcome of any possible challenges to the
Florida bond statute, RJR Tobacco remains confident of the
applicability and validity of the statute in the Engle
case.

RJR Tobacco has been named as a defendant in
several individual cases filed by members of the Engle
class. One such case (in which RJR Tobacco was dismissed prior
to trial), Lukacs v. Philip Morris, Inc., was tried
against Philip Morris and Brown & Williamson, and
resulted in a verdict for the plaintiffs on June 11, 2002.
The Florida state court jury awarded the plaintiffs a total of
$37.5 million in compensatory damages. On April 1,
2003, the Dade County Circuit Court granted in part the
defendants motion for remittitur and reduced the
jurys award to plaintiff Yolanda Lukacs (on the loss of
consortium claim) from $12.5 million to $0.125 million
decreasing the total award to $25.125 million. These
plaintiffs agreed to stay execution on the judgment pending the
result of the Engle appeal.

On November 30, 2000, in Daniels v.
Philip Morris Cos., Inc., a San Diego Superior Court
judge reversed a prior ruling and, based on a California unfair
business practices statute, certified a class consisting of all
persons who, as California resident minors, smoked one or more
cigarettes in California between April 2, 1994 and
December 1, 1999. Trial was scheduled for October 18,
2002, but the court granted the defendants motions for
summary judgment on preemption and First Amendment grounds on
September 12, 2002, and dismissed the action. At a hearing
on October 21, 2002, the judge made final his original
ruling. The plaintiffs are currently appealing the dismissal to
the California Court of Appeal, Fourth Appellate District,
Division One. Appellants opening brief was filed on
July 30, 2003. Briefing is scheduled to be completed by
March 29, 2004.

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

On November 14, 2001, in Turner v.
R. J. Reynolds Tobacco Co., an Illinois state court judge
(Madison County) certified a class defined as [a]ll
persons who purchased defendants Doral Lights, Winston
Lights, Salem Lights and Camel Lights, in Illinois, for personal
consumption, between the first date that defendants sold Doral
Lights, Winston Lights, Salem Lights and Camel Lights through
the date the court certifies this suit as a class
action .... On June 6, 2003, RJR Tobacco filed a
motion to stay the case pending Philip Morriss appeal of
the Price v. Philip Morris case, which is discussed
below. On July 11, 2003, the judge

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denied the motion, and RJR Tobacco appealed to
the Illinois Fifth District Court of Appeals. The Court of
Appeals denied this motion on October 17, 2003. On
October 20, 2003, the trial judge ordered that the case be
stayed for 90 days, or pending the result of the
Price appeal, which is discussed below. The order stated
that a hearing would be held at the end of the 90 days to
determine if the stay should be continued. On November 5,
2003, the Illinois Supreme Court granted RJR Tobaccos
motion for a stay pending the courts final appeal decision
in Price v. Philip Morris. This case currently
includes both RJR and RJR Tobacco as defendants.


On December 31, 2003, in Collora v.
R. J. Reynolds Tobacco Co., a Missouri state court
judge in St. Louis certified a class defined as [a]ll
persons who purchased defendants Camel Lights, Camel
Special Lights, Salem Lights and Winston Lights cigarettes in
Missouri for personal consumption between the first date the
defendants placed their Camel Lights, Camel Special Lights,
Salem Lights and Winston Lights cigarettes into the stream of
commerce through the date of this Order. On
January 14, 2004, RJR and RJR Tobacco, the only named
defendants, removed this case to the United States District
Court for the Eastern District of Missouri.

A lights class-action case is pending
in the same jurisdiction in Illinois against Philip Morris.
Trial of the case against Philip Morris, Price v. Philip
Morris, Inc. (formerly known as Miles v. Philip
Morris, Inc.), began on January 21, 2003. On
March 21, 2003, the trial judge entered judgment against
Philip Morris in the amount of $7.1 billion in compensatory
damages and $3 billion in punitive damages to the State of
Illinois. Based on Illinois law, the bond required to stay
execution of the judgment was set initially at $12 billion.
Because of the difficulty of posting a bond of that magnitude,
Philip Morris pursued various avenues of relief from the
$12 billion bond requirement. On April 14, 2003, the
trial judge reduced the amount of bond. He ordered the bond to
be secured by $800 million, payable in four equal quarterly
installments beginning in September 2003, and a pre-existing
$6 billion long-term note to be placed in escrow pending
resolution of the case. The plaintiffs appealed the judges
decision to reduce the amount of the bond. On July 14,
2003, the appeals court ruled that the trial judge exceeded his
authority in reducing the bond and ordered the trial judge to
reinstate the original bond. On September 16, 2003, the
Illinois Supreme Court ordered that the reduced bond be
reinstated and agreed to hear Philip Morriss appeal
without need for intermediate appellate court review. The
Price case remains in the Illinois Supreme Court. In the
event RJR Tobacco tries and loses the Turner case,
it could face similar bonding difficulties depending upon the
amount of damages ordered, if any, which could have a material
adverse effect on RJR Tobaccos, and consequently
RJRs, results of operations, cash flows or financial
condition.

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

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Governmental Health-Care Cost Recovery
Cases

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

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

In the settling jurisdictions, the MSA released
RJR Tobacco, its indemnitees and RJR from:



| |   |                                                                                                                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | all claims of the settling states and their
    respective political subdivisions and other recipients of state
    health-care funds, relating to past conduct arising out of the
    use, sale, distribution, manufacture, development, advertising,
    marketing or health effects of, the exposure to, or research,
    statements or warnings about, tobacco products; and
|
| |  | all monetary claims relating to future conduct
    arising out of the use of, or exposure to, tobacco products that
    have been manufactured in the ordinary course of business.                                                                                                                                                                                              

The cash payments made by RJR Tobacco under
the MSA and the other state settlement agreements during the
years 2003, 2002 and 2001 were $1.8 billion,
$2.5 billion and $2.4 billion, respectively.
RJR Tobacco records its allocation of ongoing settlement
charges in cost of products sold as products are shipped. Set
forth below is a table depicting the unadjusted tobacco industry
settlement payment schedule under the MSA and the other state
settlement agreements and related information.

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Unadjusted Original Participating
Manufacturers Settlement Payment Schedule

|                                               |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       | 
|---------------------------------------------- | ---------------------------------------- | --------------------- | ----- | ----- | ----- | ---- | ----- | ----- | ------ | ---- | ----- | ----- | ------ | ---- | ----- | ----- | ------ | ----- | ----- | ----- | ----- | -- | ----- | ----- | ----- | -- | ----- | ----- | ----- | -- | ----- | ----- | ----- | -- | ----- | ----- | ----- | 
|                                               |                                          | 2000                  |       | 2001  |       | 2002 |       | 2003  |        | 2004 |       | 2005  |        | 2006 |       | 2007  |        | 2008+
|                                               |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |      
|                                               |                                          |                      
|                                               |                                          | (Dollars in Millions)
|First Four States Settlements: (1)            |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|                                               | Mississippi Annual Payment               |                       | $     | 85    |       |      | $     | 111   |        |      | $     | 111   |        |      | $     | 136   |        |       | $     | 136   |       |    | $     | 136   |       |    | $     | 136   |       |    | $     | 136   |       |    | $     | 136   |      
|                                               | Florida Annual Payment                   |                       |       | 275   |       |      |       | 358   |        |      |       | 358   |        |      |       | 440   |        |       |       | 440   |       |    |       | 440   |       |    |       | 440   |       |    |       | 440   |       |    |       | 440   |      
|                                               | Texas Annual Payment                     |                       |       | 363   |       |      |       | 471   |        |      |       | 471   |        |      |       | 580   |        |       |       | 580   |       |    |       | 580   |       |    |       | 580   |       |    |       | 580   |       |    |       | 580   |      
|                                               | Minnesota Annual Payment                 |                       |       | 128   |       |      |       | 166   |        |      |       | 166   |        |      |       | 204   |        |       |       | 204   |       |    |       | 204   |       |    |       | 204   |       |    |       | 204   |       |    |       | 204   |      
|                                               | Minnesota Initial Payment                |                       |       | 243   |       |      |       | 243   |        |      |       | 243   |        |      |       | 122   |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|                                               | Most Favored Nations Agmt (MS, FL, TX)   |                       |       | 1,215 |       |      |       | 1,215 |        |      |       | 1,215 |        |      |       | 609   |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|Remaining States Settlement:                  |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|                                               | Initial Payments (1)                     |                       |       | 2,472 |       |      |       | 2,546 |        |      |       | 2,623 |        |      |       | 2,701 |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|                                               | Annual Payments (1)                      |                       |       | 3,940 |       |      |       | 4,378 |        |      |       | 5,691 |        |      |       | 5,691 |        |       |       | 7,004 |       |    |       | 7,004 |       |    |       | 7,004 |       |    |       | 7,004 |       |    |       | 7,126 |      
|                                               | Addl Annual Payments (through 2017) (1) |                       |       |      |       |      |       |      |        |      |       |      |        |      |       |      |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       | 861   |      
|                                               | Base Foundation Funding (through 2008)   |                       |       | 25    |       |      |       | 25    |        |      |       | 25    |        |      |       | 25    |        |       |       | 25    |       |    |       | 25    |       |    |       | 25    |       |    |       | 25    |       |    |       | 25    |      
|                                               | Additional Foundation Payments (2)       |                       |       | 300   |       |      |       | 300   |        |      |       | 300   |        |      |       | 300   |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|                                               | Growers Trust ($2952009 and 2010) (3)  |                       |       | 280   |       |      |       | 400   |        |      |       | 500   |        |      |       | 500   |        |       |       | 500   |       |    |       | 500   |       |    |       | 500   |       |    |       | 500   |       |    |       | 500   |      
|                                               | Minnesota Blue Cross and Blue Shield     |                       |       | 57    |       |      |       | 57    |        |      |       | 57    |        |      |       | 57    |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|                                               |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|                                               |                                          | Total                 |       | $     | 9,383 |      |       | $     | 10,270 |      |       | $     | 11,760 |      |       | $     | 11,365 |       |       | $     | 8,889 |    |       | $     | 8,889 |    |       | $     | 8,889 |    |       | $     | 8,889 |    |       | $     | 9,872 | 
|                                               |                                          |                       |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|RJR Tobaccos settlement expenses              |                                          | $                     | 2,329 |       |       | $    | 2,584 |       |        | $    | 2,507 |       |        | $    | 1,925 |       |        |       |      |       |       |    |      |       |       |    |      |       |       |    |      |       |       |    |      |      
|RJR Tobaccos cash payments                    |                                          | $                     | 2,247 |       |       | $    | 2,393 |       |        | $    | 2,461 |       |        | $    | 1,812 |       |        |       |      |       |       |    |      |       |       |    |      |       |       |    |      |       |       |    |      |      
|RJR Tobaccos expected settlement
    expenses |                                          |                       |      |       |       |      |      |       |        |      |      |       |        |      |      |       |        | >$    | 1,800 |       |       | >$ | 1,900 |       |       | >$ | 1,900 |       |       | >$ | 2,100 |       |       | >$ | 2,100 |      
|RJR Tobaccos expected cash payments           |                                          |                       |      |       |       |      |      |       |        |      |      |       |        |      |      |       |        | >$    | 1,900 |       |       | >$ | 1,800 |       |       | >$ | 1,900 |       |       | >$ | 1,900 |       |       | >$ | 2,100 |      






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

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

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

Department of Justice
Case.On September 22, 1999, the
U.S. Department of Justice brought an action in the United
States District Court for the District of Columbia against
various industry members, including RJR Tobacco. The
government sought to recover federal funds expended in providing
health care to smokers who have developed diseases and injuries
alleged to be smoking-related, and, in addition, seeks, pursuant
to the federal Racketeer Influenced and Corrupt Organizations
Act, disgorgement of profits the government contends were earned
as a consequence of a RICO racketeering enterprise.
On December 27, 1999, the

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defendants filed a motion to dismiss, challenging
all counts included in the action brought by the DOJ. On
June 6, 2000, the trial court heard oral argument on the
motion. On September 28, 2000, Judge Gladys Kessler of the
United States District Court for the District of Columbia
granted the non-Liggett defendants motion to dismiss the
plaintiffs Medical Care Recovery Act claim and Medicare
Secondary Payer claim. The court denied the motion with respect
to the RICO claims.


In June 2001, the U.S. Attorney General
assembled a team of three DOJ lawyers to work on a possible
settlement of the federal lawsuit. The DOJ lawyers met with
representatives of the tobacco industry, including
RJR Tobacco, on July 18, 2001. No settlement was
reached.

On May 23, 2003, Judge Kessler denied the
defendants first motion for partial summary judgment,
which sought legal preclusion of many aspects of the DOJs
lawsuit regarding advertising, marketing, promotion and warning
claims. The court simultaneously granted partial summary
judgment for the government on certain affirmative defenses. As
of July 16, 2003, the parties had completed briefing on the
defendants motion for partial reconsideration of the
May 23, 2003 order striking certain affirmative defenses,
or alternatively for certification for interlocutory appeal
pursuant to 28 U.S.C. § 1292(b).

Each side filed additional summary judgment
motions in the fall of 2003. The defendants as a group have now
filed nine summary judgment motions, with a request for
additional motions pending with the court. The government has
filed six summary judgment motions, including motions regarding
various affirmative defenses, including those affirmative
defenses addressing the standard for seeking disgorgement under
RICO. On January 23, 2004, the court granted the
governments motion for partial summary judgment on certain
of defendants equitable defenses, including waiver,
equitable estoppel, laches and unclean hands. Although the order
dismissed these particular affirmative defenses, it did not
address or limit the evidence that may be introduced regarding
the remaining RICO claims nor did it address the applicability
of the legal doctrines to issues related to equitable relief
should liability be established.

Trial is scheduled for September 13, 2004.

Local Government
Cases.Some local government entities
have filed lawsuits based largely on the same theories and
seeking the same relief as the state attorneys general cases.
Two such cases are pending against RJR Tobacco. On
August 8, 2001, in County of Cook v. Philip Morris,
Inc., the Circuit Court of Cook County, Illinois, granted
the defendants motion for judgment on the pleadings based
on remoteness grounds and dismissed the plaintiffs
complaint in its entirety. The plaintiffs appealed the dismissal
to the Illinois Appellate Court, First District, on
September 5, 2001. The defendants noticed a cross-appeal on
September 17, 2001, from the trial courts adverse
rulings on the defendants motions to dismiss on the
grounds of MSA release and lack of standing. Briefing has been
completed, although oral argument has not been scheduled. Most
recently, on November 14, 2003, plaintiff voluntarily
dismissed the complaint in St. Louis County v.
American Tobacco Co.

International Cases.A number of foreign countries have
filed suit in state and federal courts in the United States
against RJR Tobacco and other tobacco industry defendants
to recover funds for health care, medical and other assistance
paid by those foreign governments to their citizens. In
Marshall Islands v. American Tobacco Co., the
Republic of the Marshall Islands brought a health-care cost
recovery suit against RJR Tobacco and other cigarette
manufacturers. On May 9, 2002, the Supreme Court of the
Marshall Islands affirmed the dismissal of all claims. In
Venezuela v. Philip Morris Cos., Inc.,
Floridas Third District Court of Appeal affirmed the trial
courts dismissal on October 1, 2002. On
October 28, 2002, Venezuela filed a notice to invoke the
discretionary jurisdiction of the Florida Supreme Court to
review the decision of the Third District Court of Appeal. On
June 10, 2003, the Florida Supreme Court declined
Venezuelas petition for review. The court further
indicated that it would not entertain a motion for rehearing. In
light of the Venezuela decision, on August 25, 2003, the
Circuit Court of Miami-Dade County, Florida, granted the
defendants motion for judgment on the pleadings in two
additional cases brought by foreign sovereigns 
Republic of Tajikistan v. Brooke Group Ltd., Inc.and State of Tocantins, Brazil v. Brooke Group
Ltd., Inc. This most recent ruling led 22 other
foreign nations to voluntarily dismiss their cases.

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Of the four international cases currently pending
in the United States, one is pending in state court and three
are pending in federal court. Two of the three federal court
cases are pending before the Judicial Panel on Multi-District
Litigation in the United States District Court for the District
of Columbia. Twenty other cases are pending outside the United
States, two in Israel, three in Canada, and 15 in Puerto Rico.
Other foreign governments and entities have stated that they are
considering filing such actions in the United States.

On November 12, 1998, the Canadian Province
of British Columbia brought a case in British Columbia
Provincial Court (federally appointed), similar to the state
attorneys general cases discussed above, against
RJR Tobacco and certain other Canadian and
U.S. tobacco companies and their parent companies,
including RJR. This lawsuit depended entirely on legislation
enacted in British Columbia that was separately challenged by
various Canadian tobacco companies. An agreement was reached
with the government in British Columbia to litigate the separate
constitutional challenges prior to the health-care cost recovery
action. On February 21, 2000, the British Columbia Supreme
Court declared the Cost Recovery Act unconstitutional and
dismissed the action. This decision was not appealed by the
government. On January 24, 2001, the Canadian Province of
British Columbia enacted a second and revised statute and
brought a second action in the same court. A trial of the
constitutionality of the second statute and a claim that the
second action be dismissed was heard from November 4 through
November 29, 2002. On June 5, 2003, the trial court
ruled in favor of the defendants, again finding that the
legislation was unconstitutional. The Province appealed this
ruling. The appeal was heard before the British Columbia Court
of Appeal at a five-day hearing that commenced on
November 24, 2003. Judgment was reserved. Although it could
be announced at any time, a decision is expected to come down
some time between mid-February and mid-March 2004.

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

Other Health-Care Cost Recovery and Aggregated
Claims Cases

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

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

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

As of January 23, 2004, there were no
pending lawsuits by union trust funds against cigarette
manufacturers and others.

Insurance-Related
Cases.As of January 23, 2004,
one insurance-related case was pending against RJR Tobacco.

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

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$11.8 million. RJR Tobaccos portion of
these amounts is $6.6 million and $4.4 million,
respectively. The New York statute under which Empire
recovered does not provide for punitive damages, but does allow
for recovery of reasonable attorneys fees. On
February 28, 2002, Judge Weinstein awarded plaintiffs
counsel approximately $38 million in attorneys fees.
On July 2, 2002, Judge Weinstein denied the
defendants renewed motion to dismiss. He also refused to
transfer the claims of non-New York plans to their
respective states, and continued the stay of those claims, as
well as all remaining claims of Blue Cross Blue Shield plans,
until final resolution of the Empire Blue Cross case. The
defendants, including RJR Tobacco, appealed to the United States
Court of Appeals for the Second Circuit. On September 16,
2003, the Second Circuit:




| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | reversed the judgment for Empire on its
    subrogation claim, and                                                              
|
| |  | reserved ruling on Empires direct claim
    pending resolution by the New York Court of Appeals of two
    certified questions:



| |   |                                                                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Are claims by a third party payer of health care
    costs seeking to recover costs of services provided to
    subscribers as a result of those subscribers being harmed by a
    defendants or defendants violation of N.Y. Gen. Bus.
    Law § 349 too remote to permit suit under that statute?                                                        
|
| |  | If such an action is not too remote to permit
    suit, is individualized proof of harm to subscribers required
    when a third party payer of health care costs seeks to recover
    costs of services provided to subscribers as a result of those
    subscribers being harmed by a defendants or
    defendants violation of N.Y. Gen. Bus. Law § 349?

On October 30, 2003, the New York Court
of Appeals agreed to review the two certified questions. The
tobacco defendants, including RJR Tobacco, filed their initial
brief on January 22, 2004.

In Group Health Plan, Inc. v. Philip Morris,
Inc. and Medica v. Philip Morris, Inc., a
federal district judge in Minnesota dismissed all claims, except
a state antitrust claim and a state conspiracy claim. The
federal court certified to the Minnesota Supreme Court the
question whether these two claims could be pursued under
Minnesota law by Group Health Plan. On January 11, 2001,
the Minnesota Supreme Court ruled that the plaintiff could
pursue these claims. Certain defendants, including RJR Tobacco,
filed motions for summary judgment based on the statutes of
limitation and causation, injury and damages. On
January 31, 2002, summary judgment was granted in favor of
certain defendants, including RJR Tobacco. Plaintiffs appealed
to the United States Court of Appeals for the Eighth Circuit.
Argument occurred on May 15, 2003. On September 16,
2003, the United States Court of Appeals for the Eighth Circuit
upheld the dismissal of the damages claims, but remanded the
cases to the trial court to consider whether injunctive relief
is available. Shortly after the appeals court ruling, the
plaintiffs decided to dismiss the respective cases, and, on
October 21, 2003, the judge entered an order dismissing the
cases with prejudice.

Native American
Tribes.Two Native American Tribe
cases remain pending against RJR Tobacco. On January 25,
2002, in Navajo Nation v. Philip Morris, Inc., the
District Court of Navajo Nation granted the defendants
motion to dismiss conspiracy, deceptive acts and restraint of
trade claims. The court refused to dismiss the plaintiffs
product liability claim. In response, the plaintiffs filed a
motion to alter, amend and/or clarify the January 25, 2002
order. No decision has been made by the court. One other Native
American tribe case remains pending before a tribal court in
South Dakota.

Hospitals.As of
January 23, 2004, two cases brought by hospitals were
pending against RJR Tobacco, City of St. Louis v.
American Tobacco Co., Inc., pending in the Circuit Court of
the City of St. Louis, Missouri, and County of
McHenry v. Philip Morris, Inc., pending in the Circuit
Court of Cook County, Illinois. In May 2000, in A.O. Fox
Memorial Hospital v. American Tobacco Co., Inc.,
pending in state court in Nassau County, New York, a group
of approximately 175 hospitals filed suit against the
tobacco industry seeking at least $3.6 billion for costs
expended to treat smoking-related illnesses. On
December 14, 2001, the defendants motion to dismiss
was granted. The Appellate Division of the Supreme Court, Second
Judicial Department affirmed the trial courts dismissal on
February 10, 2003. In March 2003, the plaintiffs asked the
Court of Appeals of New York, the highest state appellate
court, for permission to appeal; their petition was denied on
May 13, 2003.

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Taxpayers.On
October 2, 2003, in Mason v. American Tobacco
Co., the United States Court of Appeals for the Second
Circuit affirmed the United States District Court for the
Eastern District of New Yorks ruling that granted the
defendants motion to dismiss and denied the
plaintiffs motion for class certification. On
October 16, 2003, the plaintiffs filed a motion for
rehearing by the entire Court of Appeals. That motion was denied
on December 8, 2003.

MSA-Enforcement and Validity

As of January 23, 2004, two cases were
pending against RJR Tobacco concerning the enforcement and
validity of the MSA.

The litigation challenging the validity of the
MSA, including claims that the MSA violates antitrust laws, has
not been successful. On February 12, 2003, in Forces
Action Project, LLC v. California, a case in which a
smokers rights organization challenged the propriety of
the MSA on antitrust grounds, the United States Court of Appeals
for the Ninth Circuit affirmed the United States District Court
for the Northern District of Californias January 5,
2000 order that granted defendants motion to dismiss. On
January 6, 2004, in Freedom Holdings, Inc. v.
Spitzer, the United States Court of Appeals for the Second
Circuit reversed the dismissal of a complaint asserting an
antitrust challenge to legislation adopted by New York
State in furtherance of the MSA and remanded the case for
further proceedings.

Arizona, California, New York and Washington
have alleged that the posting of signage advertising
RJR Tobaccos former brand-name sponsorship of the
NASCAR Winston Cup Series violates a provision of the MSA
governing the times during which such signs may be posted. On
February 1, 2002, a New York court ruled in favor of
RJR Tobacco. On April 10, 2003, the New York Court of
Appeals Appellate Division, First Department, of the
New York Supreme Court affirmed this ruling. On
September 2, 2003, the New York Court of Appeals
denied the States petition for review. On
November 27, 2001, the trial court in California ruled
against RJR Tobacco. On March 27, 2003, the California
Court of Appeal affirmed the trial courts ruling against
RJR Tobacco. On June 25, 2003, the California Supreme Court
denied RJR Tobaccos petition for review. On
November 16, 2001, the Arizona trial court ruled against
RJR Tobacco. On September 9, 2003, the Arizona Court of
Appeals affirmed the trial courts ruling. The Washington
matter was rendered moot and was dismissed. RJR Tobacco
ended its sponsorship of the NASCAR Winston Cup Series at the
end of the 2003 season, so it will not pursue any further
appeals of these cases.

The State of Ohio alleged that RJR Tobaccos
purchase of advertising space on matchbooks distributed by an
independent third party violates a provision of the MSA
governing brand-name merchandise. On April 25, 2002, the
Franklin County Common Pleas Court ruled in favor of RJR
Tobacco. The state appealed the decision to the Ohio Court of
Appeals, Tenth Appellate District, which, on March 31,
2003, reversed the trial courts decision. RJR Tobacco
appealed to the Ohio Supreme Court, which accepted RJR
Tobaccos petition on September 10, 2003. Briefing is
ongoing and a date for oral argument has not been set.

Finally, the State of California alleged, in the
context of the placement of print advertising, that
RJR Tobacco is in violation of the prohibition in the MSA
against taking any action, directly or indirectly, to
target youth. In a decision issued on July 12, 2002,
the trial judge found that although youth may not have
been directly targeted ... RJR indirectly targeted youth,
thereby violating the MSA. In addition, the judge issued a
$20 million fine. RJR Tobacco appealed this ruling to the
California Court of Appeal, Fourth Appellate District. Oral
argument was heard on December 9, 2003, and a decision is
pending.

Asbestos Contribution Cases

As of January 23, 2004, seven lawsuits were
pending against RJR Tobacco in which asbestos companies and/or
asbestos-related trust funds allege that they
overpaid claims brought against them to the extent
that tobacco use, not asbestos exposure, was the cause of the
alleged personal injuries for which they paid compensation. On
May 24, 2001, a Mississippi state court judge dismissed all
such claims by Owens-Corning in Estate of Ezell
Thomas v. RJR Tobacco Co. Owens-Corning appealed the
dismissal to the Mississippi Supreme Court on August 15,
2001. Oral argument was heard on October 1, 2003. A
decision is pending. A similar case, H.K. Porter Co.,
Inc. v. American Tobacco Co., was pending in the United
States District Court

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for the Eastern District of New York before
Judge Weinstein. However, on July 26, 2001, the parties
stipulated to a dismissal of the action. In Fibreboard
Corp. v. R. J. Reynolds Tobacco Co., a case pending in
state court in California, Owens-Corning and Fibreboard asserted
the same claims as those asserted in the Mississippi case.
Motions to dismiss those claims have been held in abeyance
pending the final determination of the Mississippi case.


Antitrust Cases

A number of tobacco wholesalers, as well as
indirect purchasers, have sued U.S. cigarette
manufacturers, including RJR Tobacco, and its parent company,
RJR, in federal and state courts, alleging that cigarette
manufacturers combined and conspired to set the price of
cigarettes, in violation of antitrust statutes and various state
unfair business practices statutes. In these cases, the
plaintiffs ask the court to certify the lawsuits as class
actions on behalf of other persons who purchased cigarettes
directly from one or more of the defendants. The federal cases
against RJR Tobacco were consolidated and sent by the Judicial
Panel on Multi-District Litigation for pretrial proceedings in
the United States District Court for the Northern District of
Georgia. The court certified a class of direct purchasers on
January 27, 2001. The court granted the defendants
motion for summary judgment in the consolidated federal cases on
July 11, 2002, and the United States Court of Appeals for
the Eleventh Circuit affirmed that decision on
September 22, 2003. As of January 23, 2004, all state
court cases on behalf of indirect purchasers have been
dismissed, except for two which are pending in Kansas and New
Mexico. The Kansas court granted class certification on
November 15, 2001, while the New Mexico court granted class
certification on April 11, 2003, and certified that
decision for interlocutory appeal on June 24, 2003.

On July 30, 1999, Cigarettes Cheaper!, a
retailer, filed an antitrust counterclaim against RJR Tobacco in
a gray market trademark suit originally brought by RJR Tobacco
in the United States District Court for the Northern District of
Illinois. Cigarettes Cheaper! alleges that it was denied
promotional resources in violation of the Robinson-Patman Act.
The District Court declined to dismiss the counterclaim. On
January 23, 2001, the court granted Cigarettes
Cheaper!s motion to amend its counterclaim to include a
violation of Section 1 of the Sherman Antitrust Act,
claiming that RJR Tobacco conspired with other retailers to deny
promotions to Cigarettes Cheaper!, an allegation that RJR
Tobacco denies. On March 21, 2001, RJR Tobaccos
motion to add a trademark dilution claim against Cigarettes
Cheaper! was granted. On June 28, 2001, the court granted
RJR Tobaccos motion to strike with prejudice several of
Cigarettes Cheaper!s affirmative defenses. These defenses
related to:



| |   |                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------
| |  | alleged misrepresentations caused by the
    packaging of cigarettes manufactured by RJR Tobacco for export;
|
| |  | RJR Tobaccos No Bull
    advertising campaign for its Winston cigarettes;                                
|
| |  | antitrust trademark misuse;                                                                                 
|
| |  | nominative fair use; and                                                                                    
|
| |  | the first sale doctrine.                                                                                    

On June 25, 2003, the court granted RJR
Tobaccos motion for summary judgment on Cigarettes
Cheaper!s counterclaim alleging an illegal conspiracy
under the Sherman Antitrust Act, but denied the motion with
respect to the counterclaims alleging price discrimination under
the Robinson-Patman Act. Trial on RJR Tobaccos trademark
claims and the remaining antitrust counterclaims began on
January 12, 2004. The court declared a mistrial on
January 13, 2004 because of inappropriate opening
statements by Cigarettes Cheaper!s counsel. The court has
not set a new trial date.

On February 16, 2000, a class-action
complaint, Deloach v. Philip Morris Cos., Inc., was
filed against RJR Tobacco, other cigarette manufacturers and
others, in the United States District Court for the District of
Columbia on behalf of a putative class of all tobacco growers
and tobacco allotment holders. The plaintiffs assert that the
defendants, Philip Morris, Inc., RJR Tobacco, Brown &
Williamson Tobacco Corp. and Lorillard Tobacco Co., engaged in
bid-rigging of American burley and flue-cured tobacco auctions
beginning

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at least by 1996 and continuing to present. The
defendants actions are alleged to have held the auction
prices of tobacco at artificially low prices resulting in damage
to tobacco growers and allotment holders. In addition, the
plaintiffs allege that the defendants have engaged in a
conspiracy to force the elimination or destruction of the
federal governments tobacco quota and price support
program through an alleged illegal group boycott. On
October 9, 2000, the defendants filed a motion to dismiss
the second amended complaint and a motion to transfer venue to
the United States District Court for the Middle District of
North Carolina. On November 30, 2000, the court granted the
motion to transfer the case. On December 20, 2000, the
plaintiffs moved to amend the complaint to add the leaf-buying
companies Dimon, Universal Leaf and Standard Commercial as the
defendants, which motion was allowed. The plaintiffs
motion to certify the class was granted on April 3, 2002.
On April 16, 2002, RJR Tobacco and the other defendants
petitioned the United States Court of Appeals for the Fourth
Circuit to review the class certification ruling. On
June 12, 2002, the Fourth Circuit declined to review the
class certification ruling, and on July 8, 2002, the court
denied a petition for rehearing. In May 2003, the plaintiffs and
all defendants but RJR Tobacco entered into a class-wide
settlement which was approved by Judge Osteen on October 1,
2003. The case continues against RJR Tobacco. Discovery has now
been completed and dispositive motions have been filed by RJR
Tobacco, but not yet argued. Trial has been set for
April 19, 2004.


On December 4, 2002, in Leslie H. Dial
Ent., Inc. v. R. J. Reynolds Tobacco Co.,
Leslie H. Dial Enterprises, Inc. sued RJR Tobacco, Wal-Mart
Stores, Inc. and Sams Club in the United States District
Court for the District of South Carolina. The suit alleges that
RJR Tobacco violated the Robinson-Patman Act by refusing
to allow Dial, the operator of four small grocery stores,
to participate in RJR Tobacco promotional programs and by not
making RJR Tobacco promotional programs available to Dial on
terms proportionately equal to those offered other retailers.
The suit also alleges that RJR Tobacco conspired with Wal-Mart
Stores and Sams Club to reduce competition in the sale of
cigarettes in violation of Section 1 of the Sherman
Antitrust Act and South Carolina civil conspiracy law. In
addition, the complaint charges that RJR Tobacco has violated
the South Carolina Unfair Trade Practices Act allegedly by
denying promotional services and facilities to Dial that were
offered to other retailers. The suit seeks unspecified damages.
The plaintiff has requested a bench trial. RJR Tobacco has
answered the complaint and asserted a number of defenses. On
September 3, 2003, the court granted the plaintiffs
motion to file an amended complaint, the purpose of which is to
name Sams East, Inc. as a defendant. Discovery is
currently underway and, with the exception of expert discovery,
must be completed by March 31, 2004. Trial is scheduled for
November 1, 2004.

On January 31, 2003, in Smith Wholesale
Co., Inc. v. R. J. Reynolds Tobacco Co., Smith
Wholesale Company, Inc. sued RJR Tobacco under the federal
antitrust laws in the United States District Court for the
Eastern District of Tennessee in connection with RJR
Tobaccos termination of Smiths RJR Tobacco
distribution agreement consistent with its terms. That same day,
Smith moved for an order to prevent RJR Tobacco from terminating
Smiths agreement. The court granted Smiths motion on
February 7, 2003, and required RJR Tobacco to reinstate
Smiths contract. Prior to the courts order that day,
RJR Tobacco terminated its distribution agreement with Rice
Wholesale Company, Inc. consistent with the terms of the
distribution agreement. On February 18, 2003, Smith moved
to amend its complaint to add Rice as a plaintiff and allege
similar claims on behalf of Rice, a motion the court immediately
granted, and Rice filed a motion for a preliminary injunction to
prevent RJR Tobacco from terminating it. The court granted
Rices motion on March 4, 2003. RJR Tobacco appealed
the courts February 7 order on February 11,
2003, and its March 4 order on March 6, 2003. On
April 1, 2003, the United States Court of Appeals for the
Sixth Circuit granted RJR Tobaccos motion to consolidate
the appeals and expedite oral argument. The parties have
completed briefing the appeal and had oral argument on
September 12, 2003. No decision on the appeal has been
issued to date. In the meantime, on June 10, 2003, nine
other wholesalers joined the lawsuit, and ten of the 11
plaintiffs filed another motion for a preliminary injunction,
this time asking the federal district court to enjoin RJR from
implementing amendments to its distribution agreements that were
scheduled to become effective on June 30, 2003. A hearing
on this motion was held on July 24, 2003, and the district
court issued an order granting the motion on August 6,
2003. (Prior to issuing its decision, the district court granted
the State of Tennessees motion to intervene as a plaintiff
on July 3, 2003, and the State of Mississippis motion
to intervene as a plaintiff on July 14, 2003.) RJR Tobacco
appealed to the United States Court of Appeals for

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the Sixth Circuit on August 8, 2003.
Briefing is complete. Oral argument has not been scheduled. On
September 24, 2003, the district court granted RJR
Tobaccos emergency motion for a stay of the August 6,
2003 order, pending RJR Tobaccos appeal. Plaintiffs
subsequently filed a fourth amended complaint to add nine new
plaintiffs, bringing the total of private plaintiffs to 20. Fact
discovery is scheduled to close on August 13, 2004, with
expert discovery to be completed by September 15, 2004.
Trial is set to begin on November 30, 2004.


Other Litigation and Developments

On December 10, 2003, the Attorney General
of Vermont issued a civil subpoena to RJR Tobacco, asserting
that he had reason to believe that R. J. Reynolds Tobacco
Company ha[d] engaged in unfair and deceptive acts and practices
.... by publishing false or misleading claims about its product,
Eclipse brand cigarettes, by failing to disclose material facts
and/or by otherwise engaging in deceptive or unfair practices in
marketing and selling Eclipse brand cigarettes. The
Vermont Attorney General indicated that his office was
working cooperatively with the offices of the attorneys
general of California, Connecticut, Maine and
New York .... At this time, no lawsuit or
enforcement action relating to Eclipse has been filed against
RJR Tobacco in any of these five states. RJR Tobacco has
obtained an extension of time for filing its response to the
subpoena.

On July 3, 2003, the Securities and Exchange
Commission, referred to as the SEC, issued a subpoena to RJR
pursuant to a formal order of investigation of potential
violations of the securities laws. The subpoena, and discussions
to date with the SEC staff, focus on whether the disclosure of
specific amounts of certain expenses of RJR should have been
quantified separately rather than aggregated with other expense
items. RJR is endeavoring to cooperate with the SEC in a way
that protects its rights. On August 14, 2003, the SEC
filed, in the United States District Court for the District of
Columbia, an Application for an order to show cause and an order
requiring obedience to subpoena duces tecum. On August 29,
2003, RJR filed, in the same court, a motion for a protective
order and its opposition to the SECs application for an
order to show cause. As of October 11, 2003, both the
SECs application and RJRs motion for a protective
order have been fully briefed and are pending before the court.
Oral argument on these matters was heard on January 8,
2004. RJR is unable to predict the outcome of this investigation.

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

RJR Tobacco is aware of a grand jury
investigation in North Carolina that is related to the cigarette
business of certain of its former affiliates. In connection with
this investigation, RJR Tobacco responded to document subpoenas
dated July 7, 1999 and June 1, 2000, respectively. On
January 20, 2004, RJR and RJR Tobacco were informed by the
government that the investigation is now closed.

On December 22, 1998, Northern Brands
International, Inc., referred to as Northern Brands, entered
into a plea agreement with the United States Attorney for the
Northern District of New York. Northern Brands is a
now-inactive RJR subsidiary that was part of the business of R.
J. Reynolds International B.V., a former Netherlands subsidiary
of RJR Tobacco, which was managed by a former affiliate,
RJR-MacDonald, Inc., referred to as RJR-MI. On May 12,
1999, RJR-MI was sold to Japan Tobacco Inc. and subsequently
changed its name to JT-MacDonald, Corp. Northern Brands was
charged with aiding and abetting certain customers who brought
merchandise into the United States by means of false and
fraudulent practices .... It is understood that, at
all relevant times over the past several years, JT-MacDonald,
Corp., Japan Tobaccos international operating company in
Canada, cooperated with an investigation conducted by the Royal
Canadian Mounted Police, referred to as RCMP, relating to the
same events that gave rise to the Northern Brands investigation.
On or about February 27, 2003, the RCMP filed criminal
charges against and served summonses on JT-MacDonald, Corp.,
Northern Brands, R.J. Reynolds Tobacco International, Inc.,
referred to as RJR-TI, R. J. Reynolds Tobacco Co. (Puerto Rico),
referred to as RJR-PR, and eight individuals

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associated with RJR-MI and/or RJR-TI during the
period January 1, 1991 through December 31, 1996. The
charges filed are for alleged fraud and conspiracy to defraud
Canada and the Provinces of Ontario and Quebec in connection
with the purchase, sale, export, import and/or re-export of
cigarettes and/or fine cut tobacco. Although the international
business was sold, RJR and RJR Tobacco retained certain
liabilities relating to the Northern Brands guilty plea and the
RCMPs investigation of the activities that led to the
plea. In October 2003, Northern Brands, RJR-TI and RJR-PR filed
an application challenging both the propriety of the service of
the summons on each of them as well as the jurisdiction of the
Canadian court over each of them. A hearing on the application
was held in December 2003 and the decision of the court is still
pending, but is likely to be announced in early 2004.


On September 18, 2003, RJR, RJR Tobacco,
RJR-TI, RJR-PR, and Northern Brands were served with a statement
of claim filed by the Attorney General of Canada in the Superior
Court of Justice, Ontario, Canada. Also named as defendants are
Japan Tobacco, Inc. and a number of its affiliates. The
statement of claim seeks to recover under various legal theories
taxes and duties allegedly not paid as a result of cigarette
smuggling and related activities. The Attorney General is
seeking to recover $1.5 billion in compensatory damages and
$50 million in punitive damages, as well as equitable and
other forms of relief.

Over the past few years, several civil lawsuits
have been filed against RJR Tobacco and its affiliates, along
with other cigarette manufacturers, by the European Community
and the following ten member states: Belgium, Finland, France,
Greece, Germany, Italy, Luxembourg, the Netherlands, Portugal
and Spain; as well as by Ecuador, Belize, and Honduras. These
suits contend that RJR Tobacco and other tobacco companies in
the United States may be held responsible variously under the
federal RICO statute, the common law and other legal theories
for taxes and duties allegedly unpaid as a result of cigarette
smuggling. Each of these actions, which are discussed below,
seeks compensatory, punitive and treble damages.

On July 17, 2001, the action brought by the
European Community was dismissed by the United States District
Court for the Eastern District of New York. However, the
European Community and its member states filed a similar
complaint in the same jurisdiction on August 6, 2001. On
October 25, 2001, the court denied the European
Communitys request of August 10, 2001, to reinstate
its original complaint. On November 9, 2001, the European
Community and the ten member states amended their complaint
filed on August 6, 2001, to change the name of defendant
Nabisco Group Holdings Corp. to RJR Acquisition Corp. RJR
Tobacco and the other defendants filed motions to dismiss that
complaint on November 14, 2001, and the court heard oral
argument on those motions on January 11, 2002. On
February 25, 2002, the court granted the defendants
motion to dismiss the complaint and, on March 25, 2002, the
plaintiffs filed a notice of appeal with the United States Court
of Appeals for the Second Circuit. On January 14, 2004, the
Second Circuit affirmed the dismissal of the case.

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

On December 20, 2000, October 15, 2001,
and January 9, 2003, applications for annulment were filed
in the Court of First Instance in Luxembourg challenging the
competency of the European Community to bring each of the
foregoing actions and seeking an annulment of the decision to
bring each of the actions, respectively. On January 15,
2003, the Court of First Instance entered a judgment denying the
admissibility of the first two applications, principally on the
grounds that the filing of the first two complaints did not
impose

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binding legal effects on the applicants. On
March 21, 2003, RJR and its affiliates appealed that
judgment to the Court of Justice of the European Communities.
The application for annulment filed in connection with the third
action is still pending before the Court of First Instance. On
September 18, 2003, however, the Court of First Instance
stayed the proceedings in the third action, pending resolution
of the appeals from the January 15, 2003 judgment denying
the admissibility of the first two applications.


RJR Tobacco and other defendants filed
motions to dismiss the civil RICO actions seeking to recover
taxes and revenues allegedly lost as a result of cigarette
smuggling and related activities brought by Ecuador, Belize and
Honduras in the United States District Court for the Southern
District of Florida. These motions were granted on
February 26, 2002, and the plaintiffs filed a notice of
appeal with the United States Court of Appeals for the Eleventh
Circuit on March 26, 2002. On August 14, 2003, the
Eleventh Circuit announced its decision affirming the dismissal
of the cases. On January 12, 2004, the Supreme Court of the
United States announced that it had declined to review the
decision of the Eleventh Circuit.

RJR Tobacco has been served in two
reparations actions brought by descendants of slaves. Plaintiffs
in these actions claim that defendants, including RJR Tobacco,
profited from the use of slave labor. These two actions have
been transferred to Judge Norgle in the Northern District of
Illinois by the Judicial Panel on Multi-District Litigation for
coordinated or consolidated pretrial proceedings with other
reparation actions. Seven additional cases were originally filed
in California, Illinois and New York. RJR Tobacco is a
named defendant in only one of these additional cases, but it
has not been served. The action in which RJR Tobacco is
named but has not been served was conditionally transferred to
the Northern District of Illinois on January 7, 2003, but
the plaintiffs contested that transfer, and the Judicial Panel
on Multi-District Litigation has not yet issued a final ruling
on the transfer. The plaintiffs filed a consolidated complaint
on June 17, 2003. On July 18, 2003, the defendants
moved to dismiss plaintiffs complaint. That motion was
granted on January 26, 2004. The plaintiffs might seek to
file an amended complaint or appeal the dismissal to the United
States Court of Appeals for the Seventh Circuit.

On June 8, 2001, the Attorney General of the
State of California filed a lawsuit against RJR Tobacco in
California state court alleging that RJR Tobacco violated
California state law by distributing free cigarettes and free
coupons for discounts on cigarettes on public
grounds, even though the promotions occurred within an
adult-only facility at a race track and certain
festivals. RJR Tobacco answered the complaint on July 19,
2001, asserting that its promotions complied with all laws,
including California state law and that this California state
law is preempted by the Federal Cigarette Labeling and
Advertising Act. On March 29, 2002, the court ruled that
RJR Tobaccos distribution of free cigarettes violated the
law, but the distribution of free coupons for discounts on
cigarettes did not. On April 29, 2002, the judge assessed a
civil fine against RJR Tobacco of $14.8 million. On
October 30, 2003, the California Court of Appeal, Second
Appellate District, affirmed the trial courts decision. On
December 8, 2003, RJR Tobacco filed its petition for
review with the California Supreme Court.

On May 23, 2001, Star Scientific, Inc.,
referred to as Star, filed a patent infringement action against
RJR Tobacco in the United States District Court for the District
of Maryland. The suit alleges infringement of U.S. Patent
No. 6,202,649 entitled Method of Treating Tobacco to
Reduce Nitrosamine Content, and Products Produced Thereby.
On July 30, 2002, Star filed another infringement action
against RJR Tobacco in the United States District Court for the
District of Maryland alleging infringement of a related patent,
U.S. Patent No. 6,425,401 also entitled Method
of Treating Tobacco to Reduce Nitrosamine Content, and Products
Produced Thereby. RJR Tobacco has filed counterclaims
seeking a declaration that the claims of the two Star patents in
dispute are invalid, unenforceable and not infringed by
RJR Tobacco. The Maryland court consolidated the two cases.
No trial date has been set. Both sides have filed motions for
summary judgment. On August 28, 2003, the court held a
hearing on the pending motions, and heard oral arguments. On
September 15, 2003, the court appointed a special master to
issue a report and recommendation on certain of the pending
motions by December 15, 2003. On December 4, 2003, the
special master issued a report and recommendation regarding
Stars motion for claim construction and summary judgment
on definiteness. On December 23, 2003, the special master
issued a report and recommendation regarding
RJR Tobaccos motion for summary judgment that
RJR Tobacco has not infringed the patents in the case.
RJR Tobacco anticipates that the special master will issue
reports and recommendations on the remaining four motions
assigned to him,

34



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##### Table of Contents



all of which are summary judgment motions filed
by RJR Tobacco, in the near future. The order of reference
to the special master includes a briefing schedule so that both
sides have an opportunity to submit objections to each of the
special masters reports and recommendations.




---

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

Unfavorable judgments awarding compensatory
damages, punitive damages and/or fines have been returned
against RJR Tobacco in the Engle class-action case,
which was reversed by the intermediate appellate court on
May 21, 2003, a small number of individual smoking and
health cases, a Broin II flight attendant ETS case,
an insurance-related action, an MSA enforcement action and a
California state law enforcement action. Although
RJR Tobacco believes that it has numerous bases for
successful appeals in these cases, and both RJR Tobacco and
RJR believe they have a number of valid defenses to all actions,
and intend to defend all actions vigorously, it is possible that
there could be further adverse developments in these cases, and
that additional cases could be decided unfavorably against
RJR Tobacco or its affiliates or indemnitees.
Determinations of liability or adverse rulings in such cases or
in similar cases involving other cigarette manufacturers as
defendants, even if such judgments are not final, could
materially adversely affect the litigation against
RJR Tobacco or its affiliates or indemnitees, and could
encourage the commencement of additional tobacco-related
litigation. In addition, a number of political, legislative,
regulatory and other developments relating to the tobacco
industry and cigarette smoking have received wide media
attention. These developments may negatively affect the outcomes
of tobacco-related legal actions and encourage the commencement
of additional similar litigation.

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

ERISA Litigation

On May 13, 2002, in Tatum v. The
RJR Pension Investment Committee of the
R. J. Reynolds Tobacco Company Capital Investment
Plan, pending in the United States District Court for the
Middle District of North Carolina, an employee of
RJR Tobacco filed a class-action suit alleging that the
defendants, RJR, RJR Tobacco, the RJR Employee Benefits
Committee and the RJR Pension Investment Committee violated
the Employee Retirement Income Security Act of 1974, referred to
as ERISA. The actions about which the plaintiff complains stem
from a decision made in 1999 by RJR Nabisco Holdings Corp.,
subsequently renamed Nabisco Group Holdings Corp., to spin off
RJR, thereby separating NGHs tobacco business and food
business. As part of the spin-off, the 401(k) plan for the
previously related entities had to be divided into two separate
plans for the now separate tobacco and food businesses. The
plaintiff contends that the defendants violated ERISA by not
overriding an amendment to RJRs 401(k) plan requiring
that, prior to February 1, 2000, the stock funds of the
companies involved in the food business  NGH and
Nabisco Holdings Corp.  be eliminated as investment
options from RJRs 401(k) plan. In his complaint, the
plaintiff requests, among other things, that the court issue an
order requiring the defendants to pay as damages to the RJR
401(k) plan an amount equal to the subsequent appreciation that
was purportedly lost as a result of the liquidation of the NGH
and Nabisco Holdings Corp. funds. On July 29, 2002,
defendants filed a motion to dismiss, which the court granted on
December 10, 2003. On January 7, 2004, the plaintiff
appealed to the United States Court of Appeals for the Fourth
Circuit.

35



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##### Table of Contents



Environmental Matters

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

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

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

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

On June 1, 2001, RJR received notice from
Del Monte Corporation of a claim made against it by a Hawaii
landowner who has been sued by a lessee of its land, claiming
injuries due to pesticide contamination of the soil, allegedly
caused by Del Monte Corporation as a prior lessee of the land.
The landowner-defendant has tendered the claim to Del Monte
Corporation for defense and indemnity. Del Monte Corporation has
in turn tendered the claim to RJR for defense and indemnity,
claiming it is entitled to be indemnified under the terms of the
agreement by which RJR sold Del Monte Corporation. Based on the
plaintiffs failure to provide any factual information in
support of its claim that Del Monte Corporation was a prior
lessee of the subject land, Del Monte Corporation has agreed to
extend indefinitely the period during which RJR must respond to
Del Monte Corporations tender of the claim to RJR for
defense and indemnity, subject to the right to terminate the
indefinite extension on 15 days notice to RJR.

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

36



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##### Table of Contents



is being gathered from other potentially
responsible parties notified by the EPA and an environmental
consultant working on behalf of the PRP group, which includes
RJR Tobacco.


RJR Tobacco is a named defendant in a
lawsuit related to an existing superfund site in North Carolina,
United States v. AAF-McQuay, Inc., which was filed
in United States District Court for the Western District of
North Carolina on August 12, 2002. The
Jadco-Hughes superfund site near Belmont, North
Carolina, is land on which a solvent reclamation and disposal
business was owned and operated in the 1970s. It was placed on
the National Priorities List in 1986. RJR Tobacco, through
its former packaging division (now a wholly owned subsidiary
known as RJR Packaging, LLC), as a member of a group of 24
previously identified PRPs, executed a waiver of service of
summons in this matter. A joint motion of plaintiff and all
defendants for an extension of the stay of all proceedings and
for an extension of time for all defendants to file answers or
responses to the complaint was again granted on
November 12, 2003. EPA filed the action as a result of the
expiration of a then-existing tolling agreement that could not
be timely renewed. The PRP group had requested information from
the EPA regarding various EPA costs related to the Jadco-Hughes
site. The parties are cooperating to seek a resolution of this
matter. The aggregate exposure for the Jadco-Hughes site for all
PRPs is presently approximately $9.2 million. Currently,
RJR Tobaccos apportionment among the PRPs of the
costs associated with the remediation of the sites is
approximately 32%.

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

Other Contingencies

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

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

In connection with the sale of the international
tobacco business to Japan Tobacco Inc. on May 12,
1999, RJR and RJR Tobacco agreed to indemnify Japan Tobacco
against



| |   |                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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;    
|
| |  | any liabilities, costs and expenses that Japan
    Tobacco or any of its affiliates, including the acquired
    entities, may incur after the sale in respect of any of
    RJRs or RJR Tobaccos employee benefit and welfare
    plans; and
|
| |  | any liabilities, costs and expenses incurred by
    Japan Tobacco or any of its affiliates arising out of certain
    activities of Northern Brands.                                                                                          

Although it is impossible to predict the outcome
of the Northern Brands litigation or the amount of liabilities,
costs and expenses, a significant adverse outcome regarding any
of these items could have an adverse effect on either or both of
RJR and RJR Tobacco.

37



---



##### Table of Contents



RJR Tobacco has entered into agreements to
indemnify certain distributors and retailers from liability and
related defense costs arising out of the sale or distribution of
RJR Tobaccos products. The cost of such defense
indemnification has been, and is expected to be, insignificant.
RJR Tobacco believes that the indemnified claims are
substantially similar in nature and extent to the claims that
RJR Tobacco is already exposed to by virtue of its having
manufactured those products. For further information related to
these guarantees, including probability and estimates of loss,
see  Litigation Affecting the Cigarette
Industry  Accounting for Tobacco-Related Litigation
Contingencies.

As long as RJRs unsecured, unsubordinated
debt rating remains 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 with cash or
securities.

Employees

At December 31, 2003, RJR and its
subsidiaries had approximately 6,600 full-time employees,
400 part-time employees and 1,100 employees receiving
severance benefits as a result of the 2002 and 2003
restructuring plans. None of these employees are unionized.
Employee relations are believed to be good.






|        |           
|------- | ----------
|Item 2. | Properties

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






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

Various legal actions, proceedings and claims,
including legal actions claiming that lung cancer and other
diseases, as well as addiction, have resulted from the use of,
or exposure to, RJRs operating subsidiaries
products, are pending or may be instituted against RJR or its
affiliates, including RJR Tobacco, or indemnitees. For a further
discussion of these legal actions, proceedings and claims and
other litigation and legal proceedings pending against RJR or
its affiliates or indemnitees, see Business 
Litigation Affecting the Cigarette Industry,
Business  ERISA Litigation and
Business  Environmental Matters in
Item 1;  Critical Accounting Policies and
Recent Accounting Developments and
 Governmental Activity in
Managements Discussion and Analysis of Financial
Condition and Results of Operations; note 14 to the
consolidated financial statements; and Exhibit 99.1 to this
report. You may request a copy of Exhibit 99.1, free of
charge, by writing to the Corporate Secretary,
R.J. Reynolds Tobacco Holdings, Inc.,
P.O. Box 2866, 401 N. Main Street,
Winston-Salem, NC 27402-2866, or by phoning 336-741-5162.






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

None.




PART II






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

RJRs common stock, par value $.01 per
share, is listed on the NYSE as RJR and began trading on
June 15, 1999. On January 23, 2004, there were
approximately 26,000 holders of record of RJRs common
stock. Stockholders whose shares are held of record by a broker
or clearing agency are not included in this amount; however,
each of those brokers or clearing agencies is included as one
holder of record. The closing price of RJRs common stock
on February 6, 2004 was $59.49.

38



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##### Table of Contents



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

|      |                |      |   |       |  |  |   |       | 
|----- | -------------- | ---- | - | ----- |  |  | - | ----- | 
|      |                | High |   | Low  
|      |                |      |   |      
|2003: |                |      |   |       |  |  |   |      
|      | First Quarter  |      | $ | 47.32 |  |  | $ | 31.13 | 
|      | Second Quarter |      |   | 38.77 |  |  |   | 27.52 | 
|      | Third Quarter  |      |   | 40.54 |  |  |   | 31.10 | 
|      | Fourth Quarter |      |   | 60.14 |  |  |   | 39.80 | 
|     
|2002: |                |      |   |       |  |  |   |      
|      | First Quarter  |      | $ | 67.15 |  |  | $ | 56.02 | 
|      | Second Quarter |      |   | 71.90 |  |  |   | 50.38 | 
|      | Third Quarter  |      |   | 60.40 |  |  |   | 39.20 | 
|      | Fourth Quarter |      |   | 44.60 |  |  |   | 34.83 | 

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

For equity compensation plan information, see
note 16 to consolidated financial statements.

RJR conducts its business through its
subsidiaries and is dependent on the earnings and cash flow of
its subsidiaries to satisfy its obligations and other cash
needs. RJRs credit facility limits the payment of
dividends on its common stock in excess of specific amounts. For
more information, see Managements Discussion and
Analysis of Financial Condition and Results of
Operations  Liquidity and Financial Condition
in Item 7 and note 12 to the consolidated financial
statements. RJR believes that the provisions of its revolving
credit facility and the guarantees of its revolving credit
facility, interest rate swaps and guaranteed, previously
unsecured notes will not impair its payment of quarterly
dividends.

39



---



##### Table of Contents








|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The selected historical consolidated financial
data as of December 31, 2003 and 2002 and for each of the
years in the three-year period ended December 31, 2003 are
derived from the consolidated financial statements and
accompanying notes, which have been audited by RJRs
independent auditors. The selected historical consolidated
financial data as of December 31, 2001, 2000 and 1999 and
for the years ended December 31, 2000 and 1999 are derived
from audited consolidated financial statements not presented or
incorporated by reference. Effective in 1999, the financial
statements segregate the account balances and activities of the
international tobacco business and Nabisco and report those
account balances and activities as discontinued operations. For
further information, including the impact of new accounting
developments, acquisitions, restructuring and impairment
charges, you should read this table in conjunction with
Managements Discussion and Analysis of Financial
Condition and Results of Operations in Item 7 and the
consolidated financial statements.

|                                                                                     |  |                                                 |        |      |  |      |        |      |  |      |        |   |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------ |  | ----------------------------------------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ | - |  | - | ------- | - |  | - | ------- | -
|                                                                                     |  |                                                
|                                                                                     |  | For the Years Ended December 31,               
|                                                                                     |  |                                                
|                                                                                     |  | 2003                                            |        | 2002 |  | 2001 |        | 2000 |  | 1999
|                                                                                     |  |                                                 |        |      |  |      |        |      |  |     
|                                                                                     |  |                                                
|                                                                                     |  | (Dollars in Millions, Except Per Share Amounts)
|Results of Operations:                                                               |  |                                                 |        |      |  |      |        |      |  |      |        |   |  |   |         |   |  |   |         |  
|Net sales (1)                                                                        |  | $                                               | 5,267  |      |  | $    | 6,211  |      |  | $    | 6,269  |   |  | $ | 6,085   |   |  | $ | 5,898   |  
|Income (loss) from continuing operations                                             |  |                                                 | (3,689 | )    |  |      | 418    |      |  |      | 444    |   |  |   | 299     |   |  |   | 195     |  
|Income (loss) from discontinued operations                                           |  |                                                 | 122    |      |  |      | 40     |      |  |      | (9     | ) |  |   | 53      |   |  |   | 2,398   |  
|Extraordinary items  gain (loss)                                                    |  |                                                 | 121    |      |  |      |       |      |  |      |       |   |  |   | 1,475   |   |  |   | (250    | )
|Cumulative effect of accounting change                                               |  |                                                 |       |      |  |      | (502   | )    |  |      |       |   |  |   |        |   |  |   |        |  
|Net income (loss)                                                                    |  |                                                 | (3,446 | )    |  |      | (44    | )    |  |      | 435    |   |  |   | 1,827   |   |  |   | 2,343   |  
|Per Share Data:                                                                      |  |                                                 |        |      |  |      |        |      |  |      |        |   |  |   |         |   |  |   |         |  
|Basic income (loss) from continuing operations                                       |  |                                                 | (44.08 | )    |  |      | 4.71   |      |  |      | 4.57   |   |  |   | 2.96    |   |  |   | 1.80    |  
|Diluted income (loss) from continuing operations                                     |  |                                                 | (44.08 | )    |  |      | 4.64   |      |  |      | 4.48   |   |  |   | 2.94    |   |  |   | 1.80    |  
|Basic income (loss) from discontinued operations                                     |  |                                                 | 1.46   |      |  |      | 0.45   |      |  |      | (0.09  | ) |  |   | 0.52    |   |  |   | 22.10   |  
|Diluted income (loss) from discontinued operations                                   |  |                                                 | 1.46   |      |  |      | 0.44   |      |  |      | (0.09  | ) |  |   | 0.52    |   |  |   | 22.08   |  
|Basic income (loss) from extraordinary items                                         |  |                                                 | 1.45   |      |  |      |       |      |  |      |       |   |  |   | 14.56   |   |  |   | (2.30   | )
|Diluted income (loss) from extraordinary items                                       |  |                                                 | 1.45   |      |  |      |       |      |  |      |       |   |  |   | 14.48   |   |  |   | (2.30   | )
|Basic net loss from cumulative effect of
    accounting change                       |  |                                                 |       |      |  |      | (5.66  | )    |  |      |       |   |  |   |        |   |  |   |        |  
|Diluted net loss from cumulative effect of
    accounting change                     |  |                                                 |       |      |  |      | (5.57  | )    |  |      |       |   |  |   |        |   |  |   |        |  
|Basic net income (loss)                                                              |  |                                                 | (41.17 | )    |  |      | (0.50  | )    |  |      | 4.48   |   |  |   | 18.04   |   |  |   | 21.60   |  
|Diluted net income (loss)                                                            |  |                                                 | (41.17 | )    |  |      | (0.49  | )    |  |      | 4.39   |   |  |   | 17.94   |   |  |   | 21.58   |  
|Basic weighted average shares, in thousands                                          |  |                                                 | 83,697 |      |  |      | 88,733 |      |  |      | 97,043 |   |  |   | 101,264 |   |  |   | 108,495 |  
|Diluted average shares, in thousands                                                 |  |                                                 | 83,697 |      |  |      | 90,175 |      |  |      | 98,986 |   |  |   | 101,857 |   |  |   | 108,570 |  
|Cash dividends declared per share of common stock
    (2)                            |  | $                                               | 3.80   |      |  | $    | 3.73   |      |  | $    | 3.30   |   |  | $ | 3.10    |   |  | $ | 1.55    |  
|Balance Sheet Data (at end of
    periods):                                          |  |                                                 |        |      |  |      |        |      |  |      |        |   |  |   |         |   |  |   |         |  
|Total assets                                                                         |  |                                                 | 9,677  |      |  |      | 14,651 |      |  |      | 15,122 |   |  |   | 15,554  |   |  |   | 14,377  |  
|Long-term debt                                                                       |  |                                                 | 1,671  |      |  |      | 1,755  |      |  |      | 1,631  |   |  |   | 1,674   |   |  |   | 1,653   |  
|Stockholders equity                                                                 |  |                                                 | 3,057  |      |  |      | 6,716  |      |  |      | 8,026  |   |  |   | 8,436   |   |  |   | 7,064   |  
|Cash Flow Data:                                                                      |  |                                                 |        |      |  |      |        |      |  |      |        |   |  |   |         |   |  |   |         |  
|Net cash from operating activities                                                   |  |                                                 | 581    |      |  |      | 489    |      |  |      | 626    |   |  |   | 590     |   |  |   | 929     |  
|Net cash from (used in) investing activities                                         |  |                                                 | 480    |      |  |      | (820   | )    |  |      | (307   | ) |  |   | 1,573   |   |  |   | 7,576   |  
|Net cash used in financing activities                                                |  |                                                 | (1,122 | )    |  |      | (105   | )    |  |      | (842   | ) |  |   | (881    | ) |  |   | (5,359  | )
|Other Data:                                                                          |  |                                                 |        |      |  |      |        |      |  |      |        |   |  |   |         |   |  |   |         |  
|Ratio of earnings to fixed charges (3)                                               |  |                                                 |       |      |  |      | 5.2    |      |  |      | 6.4    |   |  |   | 5.1     |   |  |   | 2.8     |  
|Deficiency in the coverage of fixed charges by
    earnings before fixed charges (3) |  | $                                               | (3,913 | )    |  | $    |       |      |  | $    |       |   |  | $ |        |   |  | $ |        |  






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Net sales and costs of products sold exclude
    excise taxes of $1.572 billion, $1.751 billion, $1.529
    billion, $1.631 billion and $1.173 billion for the years ended
    December 31, 2003, 2002, 2001, 2000 and 1999, respectively.                                                                                                                                                                                                                                                                                                                                                                                                    
|(2) | RJR began trading as a separate company on
    June 15, 1999. From the third quarter of 1999 through the
    second quarter of 2001, RJRs board of directors declared a
    quarterly cash dividend of $0.775 per common share, or
    $3.10 on an annualized basis. From the third quarter 2001
    through the first quarter of 2002, the board of directors
    declared a quarterly cash dividend of $0.875 per common
    share or $3.50 on an annualized basis. Since the second quarter
    of 2002, the board of directors has declared a quarterly cash
    dividend of $0.95 per common share, or $3.80 on an
    annualized basis.
|(3) | Earnings consist of income before income taxes
    and fixed charges. Fixed charges consist of interest on
    indebtedness, amortization of debt issuance costs and one-third
    of operating rental expense, representative of the interest
    factor.                                                                                                                                                                                                                                                                                                                                                                                    

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

The following is a discussion and analysis of
RJRs business, initiatives, critical accounting policies
and its consolidated results of operations and financial
condition. Following the overview and discussion of business
initiatives, the critical accounting policies disclose certain
accounting policies that are material to RJRs results of
operations and financial condition for the periods presented in
this report. The discussion and analysis of RJRs results
of operations is presented in two comparative sections, 2003
compared with 2002 and 2002 compared with 2001. Disclosures
related to liquidity and financial condition completes
managements discussion and analysis. 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, 2003 and 2002 and for each of the years in the
three-year period ended December 31, 2003.

Overview and Business
Initiatives

RJRs operating subsidiaries include RJR
Tobacco and Santa Fe. RJRs single reportable
operating segment, RJR Tobacco, is the second largest cigarette
manufacturer in the United States. Santa Fe, acquired by
RJR in 2002, manufactures and markets cigarettes and other
tobacco products primarily in the United States.

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 brand
positioning and price, as well as product attributes and
packaging, consumer loyalty, promotions, advertising and retail
presence. Cigarette brands produced by the major manufacturers
generally require competitive pricing, substantial marketing
support, retail programs and other financial incentives to
maintain or improve a brands market position or to
introduce a new brand.

RJRs operating subsidiaries are committed
to building and maintaining a portfolio of 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. 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, do not have cost structures
burdened with MSA payments to the same extent as the original
participating manufacturers.

Starting in mid-2002, RJR Tobaccos largest
competitor significantly increased promotional spending. These
increases, together with the continued strength 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. To maintain competitive prices,
RJR Tobacco has increased its promotional spending since the
second half of 2002. The increased promotional costs are
expected to continue into the foreseeable future.

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 2004, and the reclassification of
certain non-tobacco businesses as held-for-sale.

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In April 2003, in response to continuing
challenges of an intensely competitive environment, RJR
announced initiatives to fundamentally rethink RJR
Tobaccos approach to the marketplace and realign the cost
structures of RJR Tobacco and RJR. These initiatives included a
new brand-portfolio strategy focused on its two premium growth
brands to optimize profitability and significant cost
reductions, which resulted in restructuring and impairment
charges. Certain of these initiatives resulted in restructuring
and impairment charges in 2003, and are expected to result in
additional charges through 2004. Additionally, during the fourth
quarter of 2003, RJR Tobacco reevaluated its practices related
to replacement of merchandising fixtures and transferred
ownership to the cigarette retailers. For more information about
these initiatives, related costs and savings, see
 Results of Operations.

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. 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 pension
plans funded status. Pension expense in 2003 was adversely
impacted due to these factors and the lowering of the expected
return on asset assumption from 9.5% per annum for 2002 to
9.0% per annum for 2003.

During 2003, plan assets increased
$391 million, as a result of the favorable 2003 equity
market performance and contributions, partially offset by
benefit payments. However, at December 31, 2003, the
pension benefit obligation of RJRs pension plans exceeded
the fair value of plan assets by $750 million. The amount
by which the projected benefit obligation exceeds the fair value
of the plan assets could increase to the extent of a decline in
the fair value of plan assets, as well as adverse changes in
actuarial assumptions, including a reduction in the discount
rate used to calculate the projected benefit obligation.

Pension expense in 2004 is expected to be within
a range of $70 million to $80 million, primarily due
to an expected reduction in service cost as a result of the 2003
workforce reduction and a more favorable than expected return on
plan assets during 2003. This decrease will be partially offset
by the use of the lower discount rate of 6.15%. RJR contributed
$110 million to its pension plan in January 2004.
Additional cash funding may be made in the future.

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 those costs are incurred.

As discussed in note 13 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 Engle
class-action case, reversed by the intermediate appellate court
on May 21, 2003, a small number of individual smoking and
health cases, a Broin II flight attendant ETS case,
a health-care 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. Except for Kenyon v.

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R. J. Reynolds Tobacco
Co. , discussed in
Business  Litigation Affecting the Cigarette
Industry in Item 1 and note 13 to consolidated
financial statements, for which RJR Tobacco expensed
approximately $196,000 during the third quarter, 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 financial condition, results of operations or cash flows of
RJR or its subsidiaries.

Settlement Agreements

As discussed in Business 
Litigation Affecting the Cigarette Industry in Item 1
and note 13 to 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 $1.9 billion in 2003, $2.5 billion in
2002 and $2.6 billion in 2001. RJR Tobacco estimates that
its settlement charges will approximate $1.8 billion in
2004 and exceed $1.9 billion in 2005 and 2006, subject to
adjustments, including those discussed above. 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.

Goodwill and Trademarks

As of January 1, 2002, RJR adopted Statement
of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assets. See note 1 to
consolidated financial statements for a discussion of the impact
of the initial adoption of SFAS No. 142 on goodwill
and trademarks and for additional impairment charges in
connection with RJRs ongoing application of
SFAS No. 142 in 2002 and 2003.

RJR engaged an independent appraisal firm to
assist it in determining the fair value of its reporting units
and trademarks. The determination of fair value involves
considerable estimates and judgment. In particular, the fair
value of a reporting unit involves, among other things,
developing forecasts of future cash flows, determining an
appropriate discount rate, and when goodwill impairment is
implied, the determination of the fair values of individual
assets and liabilities, including unrecorded intangibles.
Although RJR believes it has based its impairment testing and
impairment charges on reasonable estimates and assumptions, the
use of different estimates and assumptions could result in
materially different results.

As a result of the current competitive changes in
the tobacco industry, RJR initiated comprehensive changes in its
strategies and cost structure that resulted in a restructuring
of its current business. Management can not predict the impact
that the current competitive environment and RJRs
strategic initiatives may have on the fair value of RJRs
goodwill and RJR Tobaccos trademarks in future periods.

Pension and Postretirement Benefits

Pension expense is determined in accordance with
the provisions of SFAS No. 87, Employers
Accounting for Pensions, and SFAS No. 88,
Employers Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for
Termination Benefits. Postretirement benefit expense is
determined in

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accordance with the provisions of SFAS
No. 106, Employers Accounting for
Postretirement Benefits Other Than Pensions. Because
pension and post-retirement obligations will ultimately be
settled in future periods, the determination of annual expense
and liabilities is subject to estimates and assumptions. With
the assistance of an independent actuarial firm, RJR reviews
these assumptions annually and modifies them based on historic
experience and expected future trends. The most critical
assumptions and their sensitivity to change are presented below.


Assumptions:

|                                                                                                          |                                          |      |  |             |     |  |  |       | 
|--------------------------------------------------------------------------------------------------------- | ---------------------------------------- | ---- |  | ----------- | --- |  |  | ----- | 
|                                                                                                          |                                          | 2003 |  | 2002       
|                                                                                                          |                                          |      |  |            
|Weighted-average assumption used to determine
    benefit obligations at December 31:                     |                                          |      |  |             |     |  |  |      
|                                                                                                          | Discount rate                            |      |  | 6.15%       |     |  |  | 6.40% | 
|                                                                                                          | Rate of compensation increase            |      |  | 5.00%       |     |  |  | 5.00% | 
|Weighted-average assumptions used to determine
    net periodic benefit cost for years ended December 31: |                                          |      |  |             |     |  |  |      
|                                                                                                          | Discount rate                            |      |  | 6.40%/6.50% | (1) |  |  | 7.40% | 
|                                                                                                          | Expected long-term return on plan assets |      |  | 9.00%       |     |  |  | 9.50% | 
|                                                                                                          | Rate of compensation increase            |      |  | 5.00%       |     |  |  | 5.00% | 






|    |                                                                                                                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | A discount rate of 6.40% was used for the period
    from January 1, 2003 to August 31, 2003, and adjusted
    to a discount rate of 6.50% for the period from August 31,
    2003 to December 31, 2003 to reflect the impact of the 2003
    restructuring plan.

The overall expected long-term rate of return on
assets assumption is based on: (1) the target asset
allocation for plan assets, (2) long-term capital markets
forecasts for asset classes employed, and (3) active
management excess return expectations to the extent asset
classes are actively managed.

Assumption Sensitivity:

Assumed asset return and discount rates have a
significant effect on the amounts reported for the benefit
plans. A one-percentage-point change in 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    |  | $            | (13  | )            |  | $ | 11  | 
|Effect on projected benefit obligation |  |              | (249 | )            |  |   | 271 | 

A one-percentage-point change in 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 |  | $            | (21 | )            |  | $ | 21 | 

A one-percentage-point change in assumed discount
rate for the other postretirement benefit plans would have the
following effects:

|                                            |  |              |     |              |  |   |    | 
|------------------------------------------- |  | ------------ | --- | ------------ |  | - | -- | 
|                                            |  | 1-Percentage |     | 1-Percentage
|                                            |  | Point        |     | Point       
|                                            |  | Increase     |     | Decrease    
|                                            |  |              |     |             
|Effect on net periodic benefit cost         |  | $            | (6  | )            |  | $ | 6  | 
|Effect on postretirement benefit obligation |  |              | (70 | )            |  |   | 76 | 

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On December 8, 2003, President Bush signed
into law the Medicare Prescription Drug, Improvement and
Modernization Act of 2003, referred to as the Act. The Act
expanded Medicare to include, for the first time, coverage for
prescription drugs. RJR sponsors retiree medical programs, which
include coverage for prescription drugs

RJR has elected to defer financial recognition of
this legislation until the FASB issues final accounting
guidance. When issued, that final guidance could require RJR to
change previously reported information. This deferral election
is permitted under FASB Staff Position FAS 106-1,
Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug Improvement and Modernization Act of
2003.

Differences between actual results and actuarial
assumptions are accumulated and amortized over future periods.
In recent years, actual results have varied significantly from
actuarial assumptions. In particular, pension plan assets have
declined due to the overall decline in the capital markets, and
pension and postretirement liabilities have increased as a
result of the decline in the discount rate. These changes have
resulted in charges to comprehensive income and an increase in
pension expense in 2003. Postretirement expense decreased in
2003 due to changes in plan benefits, partially offset by the
decline in the discount rate.

Pension expense in 2004 is expected to be within
a range from $70 million to $80 million, primarily due
to an expected reduction in service cost as a result of the 2003
workforce reduction and a more favorable than expected return on
plan assets during 2003. This decrease will be partially offset
by the use of the lower discount rate of 6.15%. RJR contributed
$110 million to its pension plan in January 2004.
Additional cash funding may be made in the future.

Restructuring and Asset Impairment
Charges

RJR and RJR Tobacco have recorded charges related
to workforce reductions, asset impairments and associated exit
costs during 2003 and 2002. The workforce reduction charges were
recorded in accordance with SFAS No. 112,
Employers Accounting for Postemployment
Benefits, and SFAS No. 88. The calculation of
severance pay requires management to estimate the population of
employees to be terminated and the timing of their severance
from employment. The calculation of benefits charges requires
actuarial assumptions including determination of discount rates.

The asset impairments were recorded in accordance
with SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets, which requires
management to estimate the fair value of assets to be disposed
of.

On January 1, 2003, RJR adopted
SFAS No. 146, Accounting for Costs Associated
with Exit and Disposal Activities. Charges related to
restructuring activities initiated after this date were recorded
when incurred. Prior to this date, charges were recorded at the
date of an entitys commitment to an exit plan, in
accordance with EITF 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring).

These restructuring charges were based on
managements best estimate at the time of the
restructuring. The status of the restructuring activities is
reviewed on a quarterly basis and any adjustments to the
reserve, which could differ materially from previous estimates,
would be recorded as an adjustment to operating income.

Merchandising Fixtures

Beginning in the fourth quarter of 2002, in
response to changes in industry retail display, RJR Tobacco
began replacing significant portions of its merchandising
fixtures on an accelerated basis that resulted in accelerated
amortization. During the second quarter of 2003, it became
evident that the scope, extent and timing of competitors
similar replacement actions were reduced significantly from RJR
Tobaccos original expectations. As a result, RJR Tobacco
reevaluated its practices related to replacement of
merchandising fixtures, and determined to reduce significantly
any further replacement of its merchandising fixtures and to
continue to utilize its current merchandising fixtures.
Accordingly, the service lives of those fixtures targeted for
near-term replacement, which were shortened in the fourth
quarter of 2002, were extended to their original

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service lives. Additionally, the percentage
salvageable became higher than previously estimated. As a
result, there was no additional book value to amortize on an
accelerated basis. Accordingly, RJR Tobacco ceased accelerated
amortization. Amortization of merchandising fixtures during 2003
was $66 million, of which $21 million was accelerated
amortization, compared with 2002 amortization expense of
$96 million, of which $43 million was accelerated
amortization. The change in estimate and resulting accelerated
amortization adversely impacted net income $0.15 per basic
and diluted share during the year ended December 31, 2003
and $0.29 per basic and diluted share during 2002. During
the fourth quarter of 2003, RJR Tobacco reevaluated its strategy
related to merchandising fixtures and transferred its ownership
of these fixtures to the cigarette retailers, resulting in an
impairment charge of $106 million.


Revenue Recognition

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

Accounting for Returned Goods

During the second quarter of 2003, RJR Tobacco
announced a revision of its policy related to returned goods.
Previously, RJR Tobacco accepted all damaged and
out-of-code-date products. Under its revised policy, RJR Tobacco
will accept only returns of unintentionally damaged products.
During the second quarter of 2003, all retail returns other than
unintentionally damaged products were suspended. Returns other
than unintentionally damaged products shipped from wholesalers
under the previous return policy were last accepted during the
third quarter of 2003.

At June 30, 2003, the reserve for returned
goods consisted of (1) an estimate of returns for
unintentionally damaged product and (2) an estimate of
returned goods from wholesalers under the previous policy. These
estimates resulted in a $54 million reduction of the
reserve for returned goods balance as of June 30, 2003,
having the effect of increasing net sales $54 million. The
change in the estimate of the reserve for returned goods was
made in the second quarter, as that is the period that RJR
Tobaccos policy change was effected and announced to its
customers. Reflecting the results of the revised returned goods
policy, the returned goods reserve was reduced $42 million
during the second half of 2003, for a total of $96 million
during 2003. The change in the returned goods policy benefited
net income $0.69 per basic and diluted share during the
year ended December 31, 2003. The 2004 impact is expected
to approximate the 2003 impact.

Recent Accounting
Developments

Stock-Based Compensation

RJR adopted the prospective method of transition
of SFAS No. 148, Accounting for Stock-Based
Compensations  Transition and Disclosure 
an Amendment of FASB Statement No. 123, effective
January 1, 2003. Accordingly, all compensation costs
related to employee stock plans that were granted prior to
January 1, 2003, will continue to be recognized using the
intrinsic value-based method under the provisions of Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and related Interpretations. However,
any compensation costs related to grants or modifications of
existing grants subsequent to January 1, 2003 will be
recognized under the fair value method of
SFAS No. 123, Accounting for Stock-Based
Compensation, as amended. All compensation costs related
to employee stock plans for all grant dates will be disclosed
under the provisions of SFAS No. 123, as amended.
Stock compensation is described more fully in note 16 to
consolidated financial statements.

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Results of Operations



| |                        
| | -----------------------
| | 2003 Compared with 2002

|                                             |  |      |        |      |  |          |       |  |  |  |       |   
|-------------------------------------------- |  | ---- | ------ | ---- |  | -------- | ----- |  |  |  | ----- | --
|                                             |  | 2003 |        | 2002 |  | % Change
|                                             |  |      |        |      |  |         
|Net sales (1)                                |  | $    | 5,267  |      |  | $        | 6,211 |  |  |  | (15.2 | )%
|Cost of products sold (1) (2)                |  |      | 3,218  |      |  |          | 3,732 |  |  |  | (13.8 | )%
|Selling, general and administrative expenses |  |      | 1,327  |      |  |          | 1,463 |  |  |  | (9.3  | )%
|Fixture impairment                           |  |      | 106    |      |  |          |      |  |  |  |      |   
|Restructuring and impairment charges         |  |      | 368    |      |  |          | 224   |  |  |  | 64.3  | % 
|Goodwill and trademark impairment charges    |  |      | 4,089  |      |  |          | 13    |  |  |  |      |   
|                                             |  |      |        |      |  |          |       |  |  |  |       |   
|Operating Income                             |  | $    | (3,841 | )    |  | $        | 779   |  |  |  |      |   
|                                             |  |      |        |      |  |          |       |  |  |  |       |   






|    |                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes excise taxes of $1,572 million and
    $1,751 million for the years ended December 31, 2003
    and 2002, respectively.      
|(2) | Includes settlement expense of
    $1,934 million and $2,514 million for the years ended
    December 31, 2003 and 2002, respectively.

Net salesfor the
year ended December 31, 2003 decreased $944 million
from the prior year due to $989 million lower overall
volume and $113 million increased promotional spending, net
of higher pricing, partially offset by a benefit of
$96 million related to RJR Tobaccos change in
returned goods policy. RJRs net sales are dependent upon
its shipment volume in a declining market, full-price versus
savings-brand mix, and list pricing, offset by promotional
spending and trade incentives.

Shipment volume in the domestic category for
RJRs operating segments, in billions of units, included:

|                               |                         |                       |       |       |  |        |       |       |  |  |       |       |   
|------------------------------ | ----------------------- | --------------------- | ----- | ----- |  | ------ | ----- | ----- |  |  | ----- | ----- | --
|                               |                         |                      
|                               |                         | For the Twelve Months
|                               |                         | Ended December 31,   
|                               |                         |                      
|                               |                         |                       |       | %    
|                               |                         | 2003                  |       | 2002  |  | Change
|                               |                         |                       |       |       |  |       
|RJR Tobacco key brands:        |                         |                       |       |       |  |        |       |       |  |  |       |      
|                               | Camel excluding Regular |                       |       | 20.0  |  |        |       | 22.1  |  |  |       | (9.5  | )%
|                               | Salem                   |                       |       | 9.3   |  |        |       | 9.5   |  |  |       | (1.6  | )%
|                               | Base Winston            |                       |       | 15.5  |  |        |       | 17.9  |  |  |       | (13.5 | )%
|                               | Doral                   |                       |       | 21.2  |  |        |       | 24.6  |  |  |       | (13.7 | )%
|RJR Tobacco total full-price   |                         |                       | 49.7  |       |  |        | 55.5  |       |  |  | (10.3 | )%   
|RJR Tobacco total savings      |                         |                       | 30.3  |       |  |        | 35.1  |       |  |  | (13.8 | )%   
|                               |                         |                       |       |       |  |        |       |       |  |  |       |      
|RJR Tobacco total domestic (1) |                         |                       | 80.0  |       |  |        | 90.6  |       |  |  | (11.7 | )%   
|Santa Fe total domestic        |                         |                       | 1.2   |       |  |        | 1.0   |       |  |  | 12.5  | %    
|                               |                         |                       |       |       |  |        |       |       |  |  |       |      
|RJR total domestic (1)         |                         |                       | 81.2  |       |  |        | 91.6  |       |  |  | (11.4 | )%   
|                               |                         |                       |       |       |  |        |       |       |  |  |       |      
|Industry (2):                  |                         |                       |       |       |  |        |       |       |  |  |       |      
|                               | Full-price              |                       |       | 274.5 |  |        |       | 284.8 |  |  |       | (3.6  | )%
|                               | Savings                 |                       |       | 96.9  |  |        |       | 106.6 |  |  |       | (9.2  | )%
|                               |                         |                       |       |       |  |        |       |       |  |  |       |      
|Industry total domestic        |                         |                       | 371.4 |       |  |        | 391.4 |       |  |  | (5.1  | )%   
|                               |                         |                       |       |       |  |        |       |       |  |  |       |      






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

RJR Tobaccos full-year total domestic
shipment volume declined 11.7% due to underlying declines in
consumption, or retail sales to consumers, and shifts in trade
inventory levels.

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Shipments in the full-priced tier increased to
62.2% of RJR Tobaccos total domestic shipments during 2003
as compared with 61.2% in 2002. Industry full-price shipments as
a percentage of total domestic shipments increased to 73.9% in
2003 from 72.8% in 2002.

Retail share of market as a percentage of total
retail sales of RJRs operating segments according to data
from Information Resources, Inc./Capstone(1) were:

|                           |                         |                |       |       |   |        |       |      |   |  |       |       |  
|-------------------------- | ----------------------- | -------------- | ----- | ----- | - | ------ | ----- | ---- | - |  | ----- | ----- | -
|                           |                         |                |       |      
|                           |                         | For the Twelve |       |      
|                           |                         | Months Ended   |       |      
|                           |                         | December 31,   |       | Share
|                           |                         |                |       | Point
|                           |                         | 2003           |       | 2002  |   | Change
|                           |                         |                |       |       |   |       
|RJR Tobacco key brands:    |                         |                |       |       |   |        |       |      |   |  |       |      
|                           | Camel excluding Regular |                |       | 5.94  | % |        |       | 5.69 | % |  |       | 0.25  |  
|                           | Salem                   |                |       | 2.54  | % |        |       | 2.41 | % |  |       | 0.13  |  
|                           | Base Winston            |                |       | 4.42  | % |        |       | 4.57 | % |  |       | (0.15 | )
|                           | Doral                   |                |       | 5.54  | % |        |       | 5.86 | % |  |       | (0.32 | )
|RJR Tobacco total domestic |                         |                | 22.52 | %     |   |        | 22.93 | %    |   |  | (0.41 | )    
|Santa Fe total domestic    |                         |                | 0.29  | %     |   |        | 0.26  | %    |   |  | 0.03  |      






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Retail share of market data is included in this
    document because it is used by RJR primarily as an indicator of
    the relative performance of industry participants and brands and
    market trends. You should not rely on the market share data
    reported by industry tracking organizations as being a precise
    measurement of actual market share because these organizations
    are not able to effectively track the volume of all
    deep-discount brands, which RJR believes represent approximately
    13% to 15% of U.S. industry unit sales. Accordingly, the retail
    share of market of RJR Tobaccos and Santa Fes
    brands as reported by Information Resources, Inc./ Capstone may
    overstate their actual market share. Moreover, in an industry
    experiencing overall declining consumption, a particular product
    can experience increasing market share relative to competing
    products, yet still be subject to declining consumption volumes.

In 2003, RJR Tobaccos full-price share
position of 14.24% of the market, was relatively level with 2002
at 14.20%. Full-price share performance was based on the growth
of RJR Tobaccos focus brands  CAMEL and SALEM,
which posted a combined full-year gain of 0.38 share
points  more than offsetting declines in other
full-price brands.

In 2003, CAMELs filtered styles posted a
gain of 0.25 share points, on the strength of CAMELs
Classic and Turkish families. SALEM has shown steady momentum
since its Stir the Senses re-launch in April 2003,
gaining 0.38 share points since the first quarter compared
with the fourth quarter of 2003. SALEM has posted increases in
both its Green Label and Black Label styles, with growth coming
from competitive switching and increased franchise loyalty. Base
WINSTON and DORAL retail share of market declined in 2003,
reflecting competitive pricing pressures on their
price-sensitive, adult, franchise smokers.

Santa Fes NATURAL AMERICAN SPIRIT
brand delivered higher volume, share and profits in 2003
compared to 2002.

Cost of products
solddecreased $514 million from
2002 primarily due to $580 million lower MSA costs, and to
a much lesser extent, lower promotional product and
volume-related manufacturing costs, partially offset by the
adverse impact of higher costs of materials of $69 million.
MSA expenses were $1.9 billion in 2003 and are expected to
remain relatively level through 2006, subject to adjustment for
changes in volume and other factors. For more information
related to the MSA, see note 13 to consolidated financial
statements.

Selling, general and administrative
expensesof $1,327 million during
2003 decreased $136 million, compared with 2002, primarily
due to lower overall marketing expense. The decrease in
marketing expense, net of an $80 million increase in
advertising expense, was the result of the strategic marketing
changes initiated during 2003. The decreases in SG&A were
partially offset by $14 million fixed general expense,
including higher special compensation and benefits and higher
selling, general and administrative expenses of entities
acquired in 2002, partially offset by lower legal expenses.

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Selling, general and administrative expenses
include the costs of litigating and administering product
liability claims, as well as other legal expenses. During the
first, second, third and fourth quarters of 2003,
RJR Tobaccos product liability defense costs were
$37 million, $42 million, $29 million and
$36 million, respectively, for a total of $144 million
during 2003. During the first, second, third and fourth quarters
of 2002, RJR Tobaccos product liability defense costs
were $43 million, $51 million, $51 million and
$47 million, respectively, for a total $192 million
during 2002.

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 in note 13 to 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
in note 13 to consolidated financial statements for
detailed information regarding the number and type of cases
pending, and Litigation Affecting the Cigarette
Industry  Scheduled Trials in Item 1
and in note 13 to consolidated financial statements for
detailed information regarding the number and nature of cases in
trial and scheduled for trial through the end of 2004. The
decrease in product liability defense costs in 2003 compared
with 2002 was primarily due to a decrease in the level of
activity in cases in preparation for trial, in trial and on
appeal in 2003 compared with 2002.

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.

Fixture impairment
chargesof $106 million in 2003
were recorded in the fourth quarter of 2003. These non-cash
charges related to transfer of ownership of RJR Tobaccos
retail merchandising fixtures to cigarette

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retailers and reflect the elimination of the
carrying value of the fixtures. As a result of this transfer, no
further amortization is required. During 2003 and 2002,
amortization related to the fixtures was $66 million and
$96 million, respectively.


Restructuring and asset impairment
chargesof $368 million, or
$224 million after tax, and $224 million, or
$135 million after tax, were recorded during the years
ended December 31, 2003 and 2002, respectively.
Restructuring charges for employee severance and benefits are
based upon RJRs ongoing benefit arrangement plan and are
recognized when it becomes probable that a liability has been
incurred and the amount of the liability can be estimated.

The components of the 2003 restructuring and
impairment charges, recorded and utilized through
December 31, 2003, were:

|                               |                                |              |     |            |   |              |    |       |   |   |    |     |   |   |     |      |  
|------------------------------ | ------------------------------ | ------------ | --- | ---------- | - | ------------ | -- | ----- | - | - | -- | --- | - | - | --- | ---- | -
|                               |                                | Employee     |     |            |   | Contract     |    |      
|                               |                                | Severance    |     | Asset      |   | Termination/ |    |      
|                               |                                | and Benefits |     | Impairment |   | Exit Costs   |    | Total
|                               |                                |              |     |            |   |              |    |      
|Incurred during second quarter |                                | $            |    |            |   | $            | 18 |       |   | $ | 37 |     |   | $ | 55  |     
|                               | Utilized in second quarter     |              |     |           |   |              |    | (18   | ) |   |    | (22 | ) |   |     | (40  | )
|                               |                                |              |     |            |   |              |    |       |   |   |    |     |   |   |     |     
|Balance, June 30, 2003         |                                |              |    |            |   |              |   |       |   |   | 15 |     |   |   | 15  |     
|                               | Incurred during third quarter  |              |     | 292        |   |              |    | 10    |   |   |    | 9   |   |   |     | 311  |  
|                               | Utilized in third quarter      |              |     | (80        | ) |              |    | (10   | ) |   |    | (24 | ) |   |     | (114 | )
|                               |                                |              |     |            |   |              |    |       |   |   |    |     |   |   |     |     
|Balance, September 30, 2003    |                                |              | 212 |            |   |              |   |       |   |   |   |     |   |   | 212 |     
|                               |                                |              |     |            |   |              |    |       |   |   |    |     |   |   |     |     
|                               | Incurred during fourth quarter |              |     |           |   |              |    |      |   |   |    | 7   |   |   |     | 7    |  
|                               | Utilized in fourth quarter     |              |     | (12        | ) |              |    |      |   |   |    | (6  | ) |   |     | (18  | )
|                               |                                |              |     |            |   |              |    |       |   |   |    |     |   |   |     |     
|Balance, December 31, 2003     |                                | $            | 200 |            |   | $            |   |       |   | $ | 1  |     |   | $ | 201 |     
|                               |                                |              |     |            |   |              |    |       |   |   |    |     |   |   |     |     

In April 2003, in response to continuing
challenges of an intensely competitive environment, primarily
pricing pressures, RJR announced initiatives to fundamentally
rethink RJR Tobaccos approach to the marketplace and
realign the cost structures of RJR Tobacco and RJR. As a
result, during the second quarter of 2003, RJR and
RJR Tobacco incurred initial restructuring and impairment
charges of $55 million. RJR Tobacco recorded a non-cash
$18 million impairment charge to fully write off certain
production equipment that it abandoned. RJR Tobacco also
incurred contract termination expenses of $29 million
related to the discontinuation of certain event-marketing
programs, and RJR incurred other restructuring associated costs
of $8 million during the second quarter of 2003.

In September 2003, RJR announced a refocused
brand portfolio strategy for RJR Tobacco and a significant
cost reduction initiative. Marketing investments now focus on
two growth brands, CAMEL and SALEM, with more limited
investments in WINSTON and DORAL, to optimize profitability.
Certain of these initiatives resulted in consolidated
restructuring and impairment charges of $311 million, or
$189 million after tax, in the third quarter of 2003. Of
these charges, RJR Tobacco incurred $287 million
related to severance and benefits, $10 million related to
asset impairments and $1 million related to associated exit
costs. RJR incurred $5 million severance and benefits and
$8 million associated exit costs.

Of the third quarter charges, the employee
severance and benefits relate to an expected workforce reduction
of approximately 2,600 full-time employees in operations
and corporate functions. Approximately 1,400 reductions
were completed as of December 31, 2003. The workforce
reduction is expected to be completed during 2004. The asset
impairment resulted from the abandonment of certain
merchandising fixtures not yet shipped to retailers. The third
quarter exit costs included professional fees for valuation and
consulting services.

In conjunction with the 2003 restructuring plan,
during the fourth quarter, RJR incurred $3 million of
consulting fees, and RJR Tobacco incurred $4 million
of charges related primarily to aircraft lease termination and
outplacement service fees.

Additional charges of approximately
$20 million are expected to be incurred during 2004 in
connection with the 2003 restructuring plan. The cash portion of
the 2003 restructuring and impairment charges is

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expected to be $265 million, of which
$212 million relates to employee severance costs and
$53 million relates to contract terminations and other exit
costs. As of December 31, 2003, $64 million of this
amount had been paid. Of the $108 million non-cash portion
of the charges, $80 million related to benefit charges, and
$28 million related to asset impairments. Cost savings
related to the 2003 restructuring charges were $54 million
during 2003, and are expected to be approximately
$271 million during 2004 and $318 million on an
annualized basis thereafter.


The components of the 2002 restructuring and
impairment charges, recorded and utilized through
December 31, 2003, were:

|                           |                  |              |     |            |   |              |     |       |   |   |   |    |   |   |     |      |  
|-------------------------- | ---------------- | ------------ | --- | ---------- | - | ------------ | --- | ----- | - | - | - | -- | - | - | --- | ---- | -
|                           |                  | Employee     |     |            |   | Contract     |     |      
|                           |                  | Severance    |     | Asset      |   | Termination/ |     |      
|                           |                  | and Benefits |     | Impairment |   | Exit Costs   |     | Total
|                           |                  |              |     |            |   |              |     |      
|Original charge            |                  | $            | 102 |            |   | $            | 115 |       |   | $ | 7 |    |   | $ | 224 |     
|                           | Utilized in 2002 |              |     | (44        | ) |              |     | (115  | ) |   |   | (2 | ) |   |     | (161 | )
|                           |                  |              |     |            |   |              |     |       |   |   |   |    |   |   |     |     
|Balance, December 31, 2002 |                  |              | 58  |            |   |              |    |       |   |   | 5 |    |   |   | 63  |     
|                           | Utilized in 2003 |              |     | (27        | ) |              |     |      |   |   |   |   |   |   |     | (27  | )
|                           | Adjusted in 2003 |              |     | (2         | ) |              |     |      |   |   |   | (3 | ) |   |     | (5   | )
|                           |                  |              |     |            |   |              |     |       |   |   |   |    |   |   |     |     
|Balance, December 31, 2003 |                  | $            | 29  |            |   | $            |    |       |   | $ | 2 |    |   | $ | 31  |     
|                           |                  |              |     |            |   |              |     |       |   |   |   |    |   |   |     |     

In the fourth quarter of 2002, RJR Tobacco
recorded a pre-tax restructuring charge of $224 million,
$135 million after tax, in response to changing competitive
practices within the tobacco industry during the second half of
2002.

The employee severance and benefits relate to
572 full-time employee workforce reductions in operations
support and corporate functions, of which 25 positions
remained at December 31, 2003, and are expected to be
eliminated in the first quarter of 2004.

The asset impairment resulted from the
remeasurement of the non-tobacco businesses at the lower of
their carrying value or fair value less cost to sell. The
non-tobacco businesses are classified as assets held for sale
and liabilities related to assets held for sale in the
consolidated balance sheets, in accordance with
SFAS No. 144. As of December 31, 2003, the
carrying amounts of the major classes of assets and liabilities
in the disposal group included $13 million of accounts
receivable, $31 million of inventories, $40 million of
property, plant and equipment and other, and $10 million of
accounts payable and accrued liabilities. As of
December 31, 2002, the carrying amounts of the major
classes of assets and liabilities in the disposal group included
$15 million of accounts receivable, $52 million of
inventories, $11 million of property, plant and equipment
and other, and $8 million of accounts payable and accrued
liabilities. RJR Tobacco completed the sale of one of the
non-tobacco businesses in the second quarter of 2003, and
expects to complete the sale of the remaining business during
the first half of 2004.

Contract termination and exit costs included
certain contract terminations and lease terminations of 15 sales
offices. Exit costs also included the separation of the
non-tobacco businesses held for sale. During 2003,
$5 million of the charge, concerning expected severance and
related benefits and exit costs of field sales offices, was
reversed, and was a reduction in restructuring and impairment
charges in the consolidated statement of income for 2003.

The cash portion of the 2002 restructuring and
impairment charges is expected to be $58 million and
primarily relates to employee severance costs. As of
December 31, 2003, $27 million of this amount had been
paid. The $161 million non-cash portion included
$44 million related to employee benefits, $115 million
related to asset impairments and $2 million related to the
write-off of prepaid promotional rights that were terminated.
Cost savings related to the 2002 restructuring charges were
$39 million during 2003, and are expected to be
$60 million in 2004.

Goodwill and trademark impairment
chargesof $4,089 million were
incurred during 2003. In response to competitive changes in the
tobacco industry, RJR Tobacco initiated comprehensive
changes in its strategies and cost structure that resulted in a
restructuring primarily during the third quarter of 2003. The
extent of the

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adverse impact of these competitive changes was
not anticipated during the annual testing of trademarks and
goodwill, performed in the fourth quarter of 2002. Accordingly,
as provided in SFAS No. 142, RJR Tobacco tested its
trademarks and goodwill for impairment, based on its revised
forecast of expected sales and cash flows.


The trademark impairment testing indicated that
impairment occurred on certain of RJR Tobaccos
brands, primarily WINSTON and DORAL, reflecting
RJR Tobaccos decision in the third quarter of 2003 to
limit investment in these brands in an effort to optimize
profitability. Accordingly, RJR Tobacco recorded an
impairment charge of $326 million, $197 million after
tax, in the third quarter of 2003. This charge was based on the
excess of the brands carrying values over their estimated
fair values, determined using the present value of estimated
future cash flows assuming a discount rate of 10.5%. The
discount rate was determined by adjusting the RJR Tobacco
enterprise discount rate by an appropriate risk premium to
reflect an asset group risk. This impairment charge was included
in goodwill and trademark impairment charges in the consolidated
statements of income, as a decrease in the carrying value of
trademarks in the consolidated balance sheet as of
December 31, 2003, and had no impact on cash flows.

For the purpose of testing goodwill, the fair
value of RJR Tobacco was determined by an independent
appraisal firm, based on the present value of the estimated
future cash flows of the reporting unit assuming a discount rate
of 10.0%. The determination of this discount rate is based on a
weighted average cost of capital using a risk-free rate adjusted
by a stock-beta adjusted risk premium. The valuation, in
accordance with SFAS No. 142, indicated that the
carrying value of RJR Tobacco exceeded its implied fair
value. Preliminary estimated fair values were assigned to
RJR Tobaccos assets and liabilities to estimate the
implied fair value of RJR Tobaccos goodwill. As a
result, the carrying amount of the goodwill of RJR Tobacco
exceeded its implied fair value by $3.3 billion, and an
impairment charge equal to that estimated excess was recognized
in the third quarter of 2003. During the fourth quarter of 2003,
RJR Tobacco completed its impairment measurement and
recorded an additional $0.5 billion charge. These impairment
charges were included in goodwill and trademark impairment
charges in the consolidated income statements, as a decrease in
the carrying value of goodwill in the consolidated balance sheet
as of December 31, 2003, and had no impact on cash flows.

Interest and debt
expensewas $111 million for the
year ended December 31, 2003, a decrease of
$36 million from 2002. This decrease is primarily due to
the repayment of $550 million and $191 million in debt
in the second and third quarters of 2003, respectively, and to a
lesser extent, lower interest rates in 2003.

Interest incomedecreased $33 million in 2003 compared with the prior year
due to a lower average cash balance combined with lower interest
rates.

Other (income) expense,
netincluded $5 million of income
in 2003 compared with $11 million of expense in the
prior-year period. The change was primarily due to
$10 million in proceeds from a lease termination in the
first quarter of 2003.

Provision for (benefit from) income
taxeswas a benefit of
$229 million, or an effective rate of 5.8%, for the year
ended December 31, 2003, compared with a provision of
$265 million, or an effective rate of 38.8%, in 2002. The
2003 effective tax rate included a benefit of $169 million
from a favorable resolution of prior years tax matters,
offset primarily by the effect of non-deductible goodwill
impairment. 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. RJR
expects its effective tax rate to approximate 39.5% in 2004.

Discontinued
operationsreflect transactions
related to the 1999 sale of the international tobacco business
to Japan Tobacco Inc. During 2003, these transactions included a
$106 million favorable resolution of tax matters. During
2003 and 2002, these transactions included $16 million and
$40 million, respectively, of after-tax reversals of
indemnification accruals. Including these adjustments, the net
after-tax gain on the sale of the international tobacco business
was $2.5 billion.

Extraordinary itemsincluded a gain of $121 million related to the favorable
resolution of tax matters related to the acquisition of NGH in
2000. Including this adjustment, the net after-tax gain on the
acquisition was $1.6 billion.

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2002 Compared with 2001

|                                             |  |      |       |      |  |          |       |  |  |  |       |   
|-------------------------------------------- |  | ---- | ----- | ---- |  | -------- | ----- |  |  |  | ----- | --
|                                             |  | 2002 |       | 2001 |  | % Change
|                                             |  |      |       |      |  |         
|Net sales (1)                                |  | $    | 6,211 |      |  | $        | 6,269 |  |  |  | (0.9  | )%
|Cost of products sold (1) (2)                |  |      | 3,732 |      |  |          | 3,560 |  |  |  | 4.8   | % 
|Selling, general and administrative expenses |  |      | 1,463 |      |  |          | 1,429 |  |  |  | 2.4   | % 
|Restructuring and impairment charges         |  |      | 224   |      |  |          |      |  |  |  |      |   
|Goodwill and trademark impairment charges    |  |      | 13    |      |  |          |      |  |  |  |      |   
|Amortization of trademarks & goodwill        |  |      |      |      |  |          | 362   |  |  |  |      |   
|                                             |  |      |       |      |  |          |       |  |  |  |       |   
|Operating income                             |  | $    | 779   |      |  | $        | 918   |  |  |  | (15.1 | )%
|                                             |  |      |       |      |  |          |       |  |  |  |       |   






|    |                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes excise taxes of $1,751 million and
    $1,529 million for the years ended December 31, 2002
    and 2001, respectively.      
|(2) | Includes settlement expense of
    $2,514 million and $2,584 million for the years ended
    December 31, 2002 and 2001, respectively.

Net salesfor the
year ended December 31, 2002 decreased $58 million
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.

Shipment volume in the domestic category for
RJRs operating segments, in billions of units, included:

|                                           |                         |                       |       |       |  |        |       |       |  |  |       |       |   
|------------------------------------------ | ----------------------- | --------------------- | ----- | ----- |  | ------ | ----- | ----- |  |  | ----- | ----- | --
|                                           |                         |                      
|                                           |                         | For the Twelve Months
|                                           |                         | Ended December 31,   
|                                           |                         |                      
|                                           |                         |                       |       | %    
|                                           |                         | 2002                  |       | 2001  |  | Change
|                                           |                         |                       |       |       |  |       
|RJR Tobacco key brands:                    |                         |                       |       |       |  |        |       |       |  |  |       |      
|                                           | Camel excluding Regular |                       |       | 22.1  |  |        |       | 20.9  |  |  |       | 5.7   | % 
|                                           | Salem                   |                       |       | 9.5   |  |        |       | 10.6  |  |  |       | (11.1 | )%
|                                           | Base Winston            |                       |       | 17.9  |  |        |       | 19.0  |  |  |       | (5.5  | )%
|                                           | 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  | )%   
|Santa Fe total domestic                    |                         |                       | 1.0   |       |  |        |      |       |  |  | 100.0 | %    
|                                           |                         |                       |       |       |  |        |       |       |  |  |       |      
|RJR total domestic (1) (includes Santa Fe) |                         |                       | 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, Inc. These data may not include all shipments of
    some manufacturers that MSAi is currently unable to monitor
    effectively. RJR Tobacco believes that the industry total
    domestic shipment volume may not fully include deep-discount
    volume.

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

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.

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Retail share of market as a percentage of total
retail sales of RJRs operating segments according to data
from Information Resources, Inc./Capstone(1) were:

|                           |                         |                       |        |       |  |        |        |       |  |  |       |       |  
|-------------------------- | ----------------------- | --------------------- | ------ | ----- |  | ------ | ------ | ----- |  |  | ----- | ----- | -
|                           |                         |                      
|                           |                         | For the Twelve Months
|                           |                         | Ended December 31,   
|                           |                         |                      
|                           |                         |                       |        | Share
|                           |                         |                       |        | Point
|                           |                         | 2002                  |        | 2001  |  | Change
|                           |                         |                       |        |       |  |       
|RJR Tobacco key brands:    |                         |                       |        |       |  |        |        |       |  |  |       |      
|                           | Camel excluding Regular |                       |        | 5.69% |  |        |        | 5.52% |  |  |       | 0.17  |  
|                           | Salem                   |                       |        | 2.41% |  |        |        | 2.73% |  |  |       | (0.32 | )
|                           | Base Winston            |                       |        | 4.57% |  |        |        | 4.84% |  |  |       | (0.27 | )
|                           | Doral                   |                       |        | 5.86% |  |        |        | 5.92% |  |  |       | (0.06 | )
|RJR Tobacco total domestic |                         |                       | 22.93% |       |  |        | 23.42% |       |  |  | (0.49 | )    
|Santa Fe total domestic    |                         |                       | 0.26%  |       |  |        |       |       |  |  |      |      






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Retail share of market data is included in this
    document because it is used by RJR primarily as an indicator of
    the relative performance of industry participants and brands and
    market trends. You should not rely on the market share data
    reported by industry tracking organizations as being a precise
    measurement of actual market share because these organizations
    are not able to effectively track the volume of all
    deep-discount brands, which RJR believes represent approximately
    13% to 15% of U.S. industry unit sales. Accordingly, the retail
    share of market of RJR Tobaccos and Santa Fes
    brands as reported by Information Resources, Inc./ Capstone may
    overstate their actual market share. Moreover, in an industry
    experiencing overall declining consumption, a particular product
    can experience increasing market share relative to competing
    products, yet still be subject to declining consumption volumes.

CAMEL, RJR Tobaccos largest full-price
brand, continued its growth trend in 2002 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.

Despite intense competitive price pressures, base
WINSTONs market share remained relatively stable for the
last three quarters of 2002. During 2002, WINSTONs S2 line
extension, launched in 2001, was stable, but did not meet
anticipated sales volumes.

SALEMs share declined in 2002, reflecting
reduced levels of in-market support while the brand evaluated
opportunities to strengthen its positioning.

Although DORALs 2002 market share declined
slightly compared with 2001, its trend showed improvement
during 2002, due to increased promotional support, new tobacco
blends on key styles, modernized packaging and the imaginative
Splendidly Blended advertising campaign.

Cost of products
soldincreased $172 million in
2002 from the prior year. The increase was due to higher
promotional products, raw material costs and the inclusion of
the cost of Santa Fes production operations,
partially offset by $70 million of lower MSA costs.

Selling, general and administrative
expensesincreased $34 million
compared with 2001, due primarily to accelerated amortization of
$43 million related to the replacement of merchandising
fixtures. This increase was combined with higher product
liability defense costs as discussed below, and the inclusion of
Santa Fes selling, general and administrative
expenses. These increases were partially offset by lower
expenses 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. During the
first, second, third and fourth quarters of 2002,
RJR Tobaccos product liability defense costs were
$43 million, $51 million, $51 million and
$47 million, respectively, for a total of $192 million
during 2002. During the first, second, third and fourth quarters
of 2001, RJR Tobaccos product liability defense costs
were $42 million, $42 million, $39 million and
$42 million, respectively, for a total $165 million
during 2001. The increase in product liability defense costs was
primarily

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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.


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

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.

A trademark impairment charge of
$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
expensedecreased $3 million in
the year ended December 31, 2002 from the prior year due to
interest rate swaps acquired in the first and second quarters of
2002, mostly offset by the increased average debt balance
resulting from the May 2002 issuance of the $750 million of
notes.

Interest incomedeclined $75 million from 2001 primarily due to lower
interest rates in 2002.

Provision for (benefit from) 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 exceeded 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 operations in 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.

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, combined with RJRs cash
balance, will enable RJR to make its required debt-service
payments and to pay dividends to RJRs 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,
changes in competitive pricing, or accelerated declines in
consumption, cannot be predicted. RJR cannot predict its cash
requirements or those of its subsidiaries related to any future
settlements or judgments,

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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,
2003 were:

|                                       |                        |                        |       |           |  |       |     |       |  |            |     |     |  |   |     |     |  |   |     |       | 
|-------------------------------------- | ---------------------- | ---------------------- | ----- | --------- |  | ----- | --- | ----- |  | ---------- | --- | --- |  | - | --- | --- |  | - | --- | ----- | 
|                                       |                        |                       
|                                       |                        | Payments Due by Period
|                                       |                        |                       
|                                       |                        |                        |       | Less than |  | 1-3   |     | 4-5   |  |           
|                                       |                        | Total                  |       | 1 Year    |  | Years |     | Years |  | Thereafter
|                                       |                        |                        |       |           |  |       |     |       |  |           
|Long-term debt (1)                     |                        | $                      | 1,639 |           |  | $     | 56  |       |  | $          | 549 |     |  | $ | 329 |     |  | $ | 705 |      
|Operating leases (2)                   |                        |                        | 22    |           |  |       | 13  |       |  |            | 6   |     |  |   | 2   |     |  |   | 1   |      
|Non-qualified pension obligations (3)  |                        |                        | 29    |           |  |       | 4   |       |  |            | 9   |     |  |   | 11  |     |  |   | 5   |      
|Postretirement benefit obligations (3) |                        |                        | 643   |           |  |       | 58  |       |  |            | 130 |     |  |   | 132 |     |  |   | 323 |      
|Joint venture funding (4)              |                        |                        | 5     |           |  |       | 5   |       |  |            |    |     |  |   |    |     |  |   |    |      
|Service agreement (5)                  |                        |                        | 15    |           |  |       | 9   |       |  |            | 6   |     |  |   |    |     |  |   |    |      
|Purchase obligations (6)               |                        |                        | 214   |           |  |       | 190 |       |  |            | 24  |     |  |   |    |     |  |   |    |      
|                                       |                        |                        |       |           |  |       |     |       |  |            |     |     |  |   |     |     |  |   |     |      
|                                       | Total cash obligations |                        | $     | 2,567     |  |       | $   | 335   |  |            | $   | 724 |  |   | $   | 474 |  |   | $   | 1,034 | 
|                                       |                        |                        |       |           |  |       |     |       |  |            |     |     |  |   |     |     |  |   |     |      






|    |                                                                                                                                                                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | For more information about RJRs long-term
    debt, see  Debt below and note 12 to
    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
    plans and postretirement benefits, see note 17 to
    consolidated financial statements. Postretirement benefit
    obligations captioned under Thereafter include
    obligations during the next five years only. Non-qualified
    pension obligations beyond five years are not estimable.
|(4) | Joint venture funding is provided for each budget
    year, denominated in euros. For more information about the joint
    venture, see note 3 to consolidated financial statements.                                                                                                                                                         
|(5) | A service agreement related to the joint venture
    with Gallaher Group Plc provides for annual payments denominated
    in Great British pounds. For more information about the related
    joint venture, see note 14 to consolidated financial
    statements.                                                                           
|(6) | Purchase obligations include commitments to
    acquire tobacco leaf, media services, aircraft and software
    maintenance.                                                                                                                                                                                                                 

RJR Tobacco estimates that its settlement charges
will exceed $1.8 billion in 2004 and each year thereafter.
For more information about RJR Tobaccos settlement
payments, see Business  Litigation Affecting
the Cigarette Industry in Item 1 and note 13 to
consolidated financial statements.

Commitments as of December 31, 2003 were:

|                                                                  |                   |                   |    |           |  |   |    |    | 
|----------------------------------------------------------------- | ----------------- | ----------------- | -- | --------- |  | - | -- | -- | 
|                                                                  |                   |                  
|                                                                  |                   | Commitment       
|                                                                  |                   | Expiration Period
|                                                                  |                   |                  
|                                                                  |                   |                   |    | Less than
|                                                                  |                   | Total             |    | 1 Year   
|                                                                  |                   |                   |    |          
|Standby letters of credit backed by revolving
    credit facility |                   | $                 | 20 |           |  | $ | 20 |   
|                                                                  |                   |                   |    |           |  |   |    |   
|                                                                  | Total commitments |                   | $  | 20        |  |   | $  | 20 | 
|                                                                  |                   |                   |    |           |  |   |    |   

Cash Flows

Net cash flows from operating activities of
$581 million in 2003 increased $92 million from 2002.
This change primarily reflects benefits related to income taxes
and lower MSA tobacco settlement expenses partially offset by
decreased revenues due primarily to decreased volume, and to a
lesser extent, increased promotional expenses. Net cash flows
from operating activities decreased $137 million to
$489 million in 2002, 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 investing activities were
$480 million in 2003 compared with a use of
$820 million in 2002. Net cash flows from investing during
2003 included proceeds from the sale of short-term investments

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and the liquidation of a trust which effectively
defeased subordinated debentures that were acquired with NGH in
2000. Net cash flows used in investing activities during 2002
included the purchase of $508 million of short-term
investments, the 2002 acquisition of Santa Fe, net of cash
acquired, and increased capital expenditures related to
equipment replacements. Net cash flows used in investing
activities in 2002 increased $513 million from
$307 million in 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 financing activities were
$1,122 million in 2003 compared with $105 million used
in financing in 2002. This change is primarily due to the use of
$741 million to repay notes that matured in 2003, compared
with the $745 million cash proceeds provided from the
issuance of notes in May 2002. This change is combined with
decreased proceeds from the exercise of stock options and
partially offset by the $436 million decrease in the
repurchase of common stock. 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.

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. In 2001, the additional cash required
to fund these liabilities was $58 million. 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, previously provided by RJR
pursuant to an agreement with the PBGC. RJR contributed
$110 million to its pension plan in January 2004.

Stock Repurchases

The following tables summarize stock repurchases
from November 1999 through February 6, 2004. These
repurchases were 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. In April 2003, to increase
financial flexibility, RJR indefinitely suspended repurchases
under its $1.0 billion repurchase program authorized by the
board of directors in February 2002.

RJR continues to repurchase shares forfeited in
respect of the tax liability associated with certain option
exercises and restricted stock vesting under its 1999 Long Term
Incentive Plan, referred to as the 1999 LTIP. 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  2003 and 2004       |                                | Shares |           | Cost         
|                                  |                                |        |           |              
|                                  |                                |        |           | (In millions)
|$1 billion authorization          |                                |        | 1,441,460 |               |  | $ | 60 |   
|1999 LTIP tax withholding         |                                |        | 348,414   |               |  |   | 15 |   
|                                  |                                |        |           |               |  |   |    |   
|                                  | Total during 2003              |        |           | 1,789,874     |  |   |    | 75 | 
|1999 LTIP tax withholding in 2004 |                                |        | 99,091    |               |  |   | 6  |   
|                                  |                                |        |           |               |  |   |    |   
|                                  | Total through February 6, 2004 |        |           | 1,888,965     |  |   | $  | 81 | 
|                                  |                                |        |           |               |  |   |    |   

|                                     |  |                                  |            |        |            |      |       |   |     | 
|------------------------------------ |  | -------------------------------- | ---------- | ------ | ---------- | ---- | ----- | - | --- | 
|Cumulative                           |  | Period Completed                 |            | Shares |            | Cost
|                                     |  |                                  |            |        |            |     
|Programs completed                   |  | November 1999 to February 2002   |            |        | 21,570,739 |      |       | $ | 875 | 
|$1 billion approved February 6, 2002 |  | Ongoing  $530 million remaining |            |        | 9,187,160  |      |       |   | 470 | 
|1999 LTIP tax withholding            |  | Ongoing                          |            |        | 566,579    |      |       |   | 27  | 
|                                     |  |                                  |            |        |            |      |       |   |     | 
|Total as of February 6, 2004         |  |                                  | 31,324,478 |        |            | $    | 1,372 |  
|                                     |  |                                  |            |        |            |      |       |  

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Dividends

On February 4, 2004, RJRs board of
directors declared a quarterly cash dividend of $0.95 per
common share. The dividend will be paid on April 1, 2004 to
stockholders of record as of March 10, 2004. On an
annualized basis, the dividend rate is $3.80 per common
share.

Capital Expenditures

RJR Tobaccos capital expenditures were
$70 million, $111 million and $74 million in
2003, 2002 and 2001, 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 $55 million to $65 million for
capital expenditures during 2004, funded primarily by cash flows
from operations. The increase in 2002 was primarily due to
increased equipment replacements. There were no material
long-term commitments for capital expenditures as of
December 31, 2003.

Debt

RJRs revolving credit facility with a
syndicate of banks was amended and restated on May 10,
2002. Under the amendment and restatement, in May 2003 the
committed amount was reduced from $622 million to
$531 million through November 2004. The facility was
further amended on September 25, 2003, primarily to modify
certain definitions of terms related to negative covenants. RJR
can use the full facility to obtain loans or letters of credit,
at its option.

Since prior to 2002, two of RJRs material
subsidiaries, RJR Tobacco and RJR Acquisition Corp., have
guaranteed RJRs obligations under the revolving credit
facility. During 2003, Moodys lowered its rating of
RJRs guaranteed, previously unsecured notes below
investment grade, to Ba2, and Standard & Poors
lowered its rating to BB+. These downgrades required RJRs
other material subsidiaries, including Santa Fe, to also
guarantee the facility and to pledge all of their assets to
secure their obligations under RJRs revolving credit
facility. These actions reflected the rating agencies
concern over recent industry trends including heavy promotional
activity, the growth of the deep-discount price tier, the
volatility of tobacco litigation, and RJRs competitive
position. On October 28, 2003, Moodys changed its
ratings outlook from negative to stable, reflecting
opportunities offered by the proposed combination of RJR and
B&Ws U.S. tobacco operations. The outlook for
Standard & Poors ratings remains negative.
Concerns about, or further lowering of, the ratings of
RJRs guaranteed, previously unsecured unsubordinated debt
notes by Standard & Poors or Moodys could
have an adverse impact on RJRs ability to access the debt
markets. However, given that RJR has significant cash balances
and has no significant debt maturities prior to 2006, RJRs
management believes that such concerns about, or further
lowering of, such ratings would not have a material adverse
impact on RJRs cash flows.

RJR is not required to maintain compensating
balances; however, RJR pays commitment fees of 1.5% per
annum of the revolving credit facility committed amount.
Borrowings under the revolving credit facility bear interest at
rates that vary with the prime rate or LIBOR. 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 up to an additional
$500 million in dividends and share repurchases may be
made. Stock repurchases also are limited to the extent that a
stated minimum level of net worth must be maintained. At
December 31, 2003, RJR had $20 million in letters of
credit outstanding under the facility. No borrowings were
outstanding, and the remaining $511 million of the facility
was available for borrowing.

RJR uses interest rate swaps to manage interest
rate risk on a portion of its debt obligations. As long as
RJRs unsecured, unsubordinated debt rating remains 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 with cash or securities. In addition, because
RJR and the guarantors have pledged their assets

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to secure their obligations under RJRs
revolving credit facility, as amended and restated, such pledge
also has secured their obligations under these interest rate
swap agreements.


RJR has a $30 million uncommitted, unsecured
line of credit with one bank. No borrowings were outstanding on
this line of credit at December 31, 2003.

In May 2003, RJR repaid $550 million of the
guaranteed, previously unsecured notes. The remaining $1.45
billion guaranteed, previously unsecured notes, unlike
RJRs other non-bank debt, are guaranteed by RJRs
material subsidiaries, including RJR Tobacco and Santa Fe.
Because RJR and the guarantors have pledged their assets to
secure their obligations under the revolving credit facility, as
amended and restated, certain of the guarantors, which are
considered restricted subsidiaries under the guaranteed,
previously unsecured notes, also have pledged certain of their
assets to secure these notes. Excluded from the pledge to secure
these notes are intellectual property, inventory, accounts
receivable, cash and certain other assets. Generally, the terms
of these notes restrict the issuance of guarantees by
subsidiaries, the pledge of collateral, sale/leaseback
transactions and the transfer of all or substantially all of the
assets of RJR and its subsidiaries.

On the mandatory redemption date of
September 30, 2003, RJR used an associated irrevocable
trust to repay the $98 million 9.5% junior subordinated
debentures, due in 2047, acquired December 2000 in connection
with the acquisition of NGH. Interest on these debentures was
paid quarterly in arrears. These debentures were effectively
defeased by an irrevocable trust, which was included in other
current assets in the accompanying consolidated balance sheets
as of December 31, 2002.

On their due date of September 15, 2003, RJR
repaid $93 million of unsecured public notes with a fixed
interest rate of 7.625%. As of December 31, 2003, RJR had
$195 million of unsecured public notes outstanding, at
fixed interest rates of 8.25% through 9.25%, due in 2004 through
2013.

The estimated fair value of RJRs long-term
debt was $1.7 billion, $2.5 billion and $1.8 billion, with
an effective average interest rate of 4.31%, 5.44% and 7.89%, as
of December 31, 2003, 2002 and 2001, respectively. The fair
values are based on available market quotes and discounted cash
flows, as appropriate.

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 the other
defendants appealed the verdict. On May 21, 2003,
Floridas Third District Court of Appeal reversed the trial
courts final judgment and remanded the case to the Dade
County Circuit Court with instructions to decertify the class
and dismiss the individual cases. Plaintiffs filed a motion for
rehearing on July 16, 2003. The appellate court denied that
motion on September 22, 2003, and issued its mandate on
October 8, 2003 (which officially concluded proceedings
before that court). The class filed its notice of intent to seek
discretionary review by the Florida Supreme Court on
October 22, 2003. Although RJR Tobacco remains confident in
its bases for appeal in this case, RJR Tobacco cannot predict
the final outcome of the appellate process. For further
discussion of the Engle case 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 13 to 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 financial condition, results of operations or
cash

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flows 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 13 to 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 the other state settlement agreements were
$1.8 billion, $2.5 billion and $2.4 billion in
2003, 2002 and 2001, respectively. RJR Tobacco estimates these
payments will be $1.9 billion in 2004 and will exceed
$1.8 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 state settlement agreements,
the business activity restrictions to which it is subject under
these agreements or the price increases that it may be required
to make as a result of these agreements.

Governmental Activity

The marketing, sale, taxation and use of
cigarettes have been subject to substantial regulation by
government and health officials for many years. Various state
governments have adopted or are considering, among other things,
legislation and regulations that would:



| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | increase their excise taxes on cigarettes;                                                                                      
|
| |  | restrict displays and advertising of tobacco
    products;                                                                      
|
| |  | establish fire safety standards for cigarettes;                                                                                 
|
| |  | raise the minimum age to possess or purchase
    tobacco products;                                                              
|
| |  | require the disclosure of ingredients used in the
    manufacture of tobacco products;                                          
|
| |  | impose restrictions on smoking in public and
    private areas; and                                                             
|
| |  | restrict the sale of tobacco products directly to
    consumers or other unlicensed recipients, including over the
    Internet.

In addition, in 2004, 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 $2.05 per pack in New
Jersey. During 2003, 15 states increased their excise
taxes. When fully implemented, these increases will raise the
weighted average state cigarette excise tax per

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pack from $0.62 at the beginning of 2003 to
$0.66. RJR Tobacco expects state excise taxes to increase even
further in 2004 due to many states having budget shortfalls.
Several states have pending legislation proposing further state
excise tax increases.


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

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



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

The warnings currently required on cigarette
packages and advertisements are:



| |   |                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------
| |  | SURGEON GENERALS WARNING: Smoking
    Causes Lung Cancer, Heart Disease, Emphysema, And May Complicate
    Pregnancy;             
|
| |  | SURGEON GENERALS WARNING: Quitting
    Smoking Now Greatly Reduces Serious Risks To Your Health;                                  
|
| |  | SURGEON GENERALS WARNING: Smoking By
    Pregnant Women May Result in Fetal Injury, Premature Birth, and
    Low Birth Weight; and
|
| |  | SURGEON GENERALS WARNING: Cigarette
    Smoke Contains Carbon Monoxide.                                                           

Since the initial report in 1964, the Secretary
of Health, Education and Welfare (now the Secretary of Health
and Human Services) and the Surgeon General have issued a number
of other reports which purport to find the nicotine in
cigarettes addictive and to link cigarette smoking and exposure
to cigarette smoke with certain health hazards, including
various types of cancer, coronary heart disease and chronic
obstructive lung disease. These reports have recommended various
governmental measures to reduce the incidence of smoking. In
1992, the federal Alcohol, Drug Abuse and Mental Health Act was
signed into law. This act requires states to adopt a minimum age
of 18 for purchases of tobacco products and to establish a
system to monitor, report and reduce the illegal sale of tobacco
products to minors in order to continue receiving federal
funding for mental health and drug abuse programs. In January
1996, the U.S. Department of Health and Human Services
announced regulations implementing this legislation.

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 interstate. Certain
common carriers have imposed additional restrictions on
passenger smoking.

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In December 2003, the California Environmental
Protection Agency Air Resources Board issued a Proposed
Identification of Environmental Tobacco Smoke as a Toxic Air
Contaminant for public review. If environmental tobacco
smoke is identified as a toxic air contaminant, the
Air Resources Board is required to prepare a report assessing
the need and appropriate degree of control of environmental
tobacco smoke. RJR Tobacco cannot predict the form any future
California regulation may take.

Several states have enacted or have proposed
legislation or regulations that would require cigarette
manufacturers to disclose the ingredients used in the
manufacture of cigarettes. In September 2003, the Massachusetts
Department of Public Health announced its intention to hold
public hearings on amendments to its tobacco regulations. The
proposed regulations would delete any ingredients-reporting
requirement. (The U.S. Court of Appeals for the Second
Circuit previously affirmed a ruling that the Massachusetts
ingredient-reporting law was unconstitutional.) MDPH has
proposed to inaugurate extensive changes to its regulations
requiring tobacco companies to report nicotine yield ratings for
cigarettes according to methods prescribed by MDPH. Because MDPH
withdrew its notice for a public hearing in November 2003, it is
impossible to predict the final form any new regulations will
take or the effect they will have on the business or results of
operations of RJR Tobacco.

On May 21, 1999, RJR Tobacco, Lorillard
Tobacco Company, Brown & Williamson Tobacco Corporation
and Philip Morris, Inc. filed lawsuits in the United States
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 United States
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, 2003, OFPC issued a final standard with
accompanying regulations that will require all cigarettes
offered for sale in New York State after June 28, 2004
to achieve specified test results when placed on ten layers of
filter paper in controlled laboratory conditions. Certain design
and manufacturing changes will be necessary for cigarettes
manufactured for sale in New York to comply with the
standard. There may be an adverse impact on the sale of
cigarettes in New York due to reduced consumer acceptance
of the changes in cigarettes made necessary to meet the
standard. Inventories of cigarettes existing in the wholesale
and retail trade as of June 28, 2004 that do not comply
with the standard may continue to be sold, provided
New York tax stamps have been affixed and such inventories
have been purchased in comparable quantities in the same period
in the previous year. Similar legislation is being considered in
other states. Varying standards from state to state could have
an adverse effect on the business or results of operations of
RJR Tobacco.

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
states, except Massachusetts, 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.

Forty-four states have passed, and various states
are considering, legislation to ensure nonparticipating
manufacturers, referred to as NPMs, under the MSA are making
required escrow payments. Under this legislation, a state would
only permit distribution of brands by manufacturers who are
deemed by the states 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. Early efforts to enact legislation, from

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2001 to early 2002, resulted in a range of NPM
laws, some containing only minimal requirements. However, once
the National Association of Attorneys General, referred to as
NAAG, became involved in the legislative initiative, model
complementary NPM language was developed and
introduced in the states where either no NPM laws existed or
where existing laws needed to be amended to bring them in line
with the model language.


Additionally, 20 states have approved
legislation that closes a loophole in the MSA. The loophole
allows nonparticipating manufacturers to recover most of the
funds from their escrow accounts. To obtain the refunds, the
manufacturers must establish that their escrow deposit was
greater than the amount the state would have received had the
manufacturer been a subsequent participating
manufacturer under the MSA. NAAG has endorsed adoption of
these legislative efforts.

Finally, two states have enacted equity
assessments on NPMs products, a legislative
initiative that has not been endorsed by NAAG.

Collectively, these forms of NPM legislation
attempt to address some of the competitive inequities in the
domestic cigarette market that benefit cigarette manufacturers
that are not parties to the MSA.

Twenty-six states have passed and several
additional states are considering statutes limiting the amount
of the bonds required to file an appeal of an adverse judgment
in state court. The limitation on the amount of such bonds
generally ranges from $25 million to $100 million.
Such bonding statutes allow defendants that are subject to large
adverse judgments, such as cigarette manufacturers, to
reasonably bond such adverse judgments and pursue the appellate
process.

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. Post-MSA cigarette volume declines have
dictated significant reductions in tobacco marketing quotas,
which in turn have led many farmers to support legislation
eliminating the current tobacco quota program with compensation
for the lost value of their quotas. Such quota
buyout legislation, funded by a tax on manufacturers and
importers, has been introduced and could be considered during
this session of Congress. 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.

On May 21, 2003, the World Health
Organization adopted a broad tobacco-control treaty. The treaty
recommends and requires enactment of legislation establishing
specific actions to prevent youth smoking, restrict and
gradually eliminate tobacco products marketing, provide greater
regulation and disclosure of ingredients, increase the size and
scope of package warning labels to cover at least 30% of each
package and include graphic pictures on packages. Although the
United States delegate to the World Health Organization Assembly
voted for the treaty, it is not known whether the treaty will be
signed by the President and sent to the United States Senate for
ratification. Ratification of the treaty by the United States
Senate could lead to broader regulation of the industry.

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 13 to 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

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

In connection with the sale of the international
tobacco business to Japan Tobacco Inc. on May 12, 1999, RJR
and RJR Tobacco agreed to indemnify Japan Tobacco against



| |   |                                                                                                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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;      
|
| |  | any liabilities, costs and expenses that Japan
    Tobacco or any of its affiliates, including the acquired
    entities, may incur after the sale with respect of any of
    RJRs or RJR Tobaccos employee benefit and welfare
    plans; and
|
| |  | any liabilities, costs and expenses incurred by
    Japan Tobacco or any of its affiliates arising out of certain
    activities of Northern Brands.                                                                                            

Although it is impossible to predict the outcome
of the Northern Brands litigation or the amount of liabilities,
costs and expenses, a significant adverse outcome regarding any
of these items could have an adverse effect on either or both of
RJR and RJR Tobacco.

RJR Tobacco has entered into agreements to
indemnify certain distributors and retailers from liability and
related defense costs arising out of the sale or distribution of
RJR Tobaccos products. The cost of such defense
indemnification has been, and is expected to be, insignificant.
RJR Tobacco believes that the indemnified claims are
substantially similar in nature and extent to the claims that
RJR Tobacco is already exposed to by virtue of its having
manufactured those products. For further information related to
these guarantees, including probability and estimates of loss,
see Business  Litigation Affecting the
Cigarette Industry  Accounting for
Tobacco  Related Litigation Contingencies in
Item 1.

As long as RJRs unsecured, unsubordinated
debt rating remains 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 with cash or
securities.

Cautionary Information Regarding
Forward-Looking Statements

Statements included in Managements
Discussion and Analysis of Financial Condition and Results of
Operations that 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

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performance and financial results inherently are
subject to a variety of risks and uncertainties, described in
the forward-looking statements. These risks include:




| |   |                                                                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The substantial and increasing regulation and
    taxation of the cigarette industry;                                                                                                                                                                             
|
| |  | various legal actions, proceedings and claims
    relating to the sale, distribution, manufacture, development,
    advertising, marketing 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
    deep-discount brands;                                                                                                                        
|
| |  | the success or failure 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;                                                                                           
|
| |  | any potential costs or savings associated with
    realigning the cost structure of RJR and its subsidiaries;                                                                                                                                                     
|
| |  | the ability to achieve efficiencies in
    manufacturing and distribution operations without negatively
    affecting sales;                                                                                                                                      
|
| |  | the cost of tobacco leaf and other raw materials
    and other commodities used in products;                                                                                                                                                                      
|
| |  | the responsiveness of both the trade and
    consumers to new products and marketing and promotional
    programs; and                                                                                                                                            
|
| |  | the rating of RJRs securities.                                                                                                                                                                                                                                   

In addition, RJR can give no assurance that the
proposed formation of Reynolds American, the combination of RJR
Tobacco and the U.S. assets, liabilities and operations of
B&W, and the related combination transactions, will be
consummated, or if consummated, that any expectations relating
thereto will be realized. Factors that could affect whether
these transactions are consummated include obtaining approvals
from U.S. and European regulatory authorities and RJR
stockholders, the receipt of satisfactory IRS rulings and the
satisfaction or waiver of certain other conditions.

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.
Except as provided by federal securities laws, RJR is not
required to publicly update or revise any forward-looking
statement, whether as a result of new information, future events
or otherwise.




Item 7a. Quantitative and Qualitative
Disclosures about Market Risk

Market risk represents the risk of loss that may
impact the consolidated financial position, results of
operations and cash flows due to adverse changes in financial
market prices and rates. RJR and its subsidiaries are exposed to
interest rate risk directly related to their normal investing
and funding activities. In addition, RJR and its subsidiaries
have exposure to foreign currency exchange rate risk related to
unrecognized firm commitments for the purchase of equipment, as
well as obligations for, and service agreements related to,
foreign operations denominated in euros and Great British
pounds. RJR and its subsidiaries have established policies and
procedures to manage their exposure to market risks and use
major institutions that are creditworthy to minimize their
investment and credit risk. Derivative financial instruments are
not used for trading or speculative purposes. See note 14
to consolidated financial statements for further information
regarding financial instruments entered into by RJR or its
operating subsidiaries.

The value-at-risk model is used to statistically
measure the maximum fair value, cash flows and earnings loss
over one year from adverse changes in interest rates and foreign
currency rates. The computation assumes

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a 95% confidence level under normal market
conditions. The actual observed correlation method is used for
aggregating value at risk amounts across market risk exposure
categories. This model indicates that near-term changes in
interest rates and foreign currency rates will not have a
material impact on the future earnings, fair values or cash
flows, based on the historical movements in interest rates,
foreign currency rates and the fair value of market-rate
sensitive instruments at December 31, 2003.


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Item 8. Financial Statements and
Supplementary Data

Independent Auditors Report

The Board of Directors

R.J. Reynolds Tobacco Holdings, Inc.:


We have audited the accompanying consolidated
balance sheets of R.J. Reynolds Tobacco Holdings, Inc. and
subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of income, stockholders
equity and comprehensive income, and cash flows for each of the
years in the three-year period ended December 31, 2003.
These consolidated financial statements are the responsibility
of the Companys management. Our responsibility is to
express an opinion on these consolidated financial statements
based on our audits.

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

In our opinion, the consolidated financial
statements referred to above present fairly, in all material
respects, the financial position of R.J. Reynolds Tobacco
Holdings, Inc. and subsidiaries as of December 31, 2003 and
2002, and the results of their operations and their cash flows
for the years then ended in conformity with accounting
principles generally accepted in the United States of America.

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

/s/ KPMG LLP

Greensboro, North Carolina

January 30, 2004


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Report of Managements Responsibility for
Financial Statements

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

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



|                                     | 
|------------------------------------ | 
|/s/ Andrew J. Schindler              | 
|                                     | 
|Chairman of the Board, President and | 
|Chief Executive
    Officer          | 
|                                    
|/s/ Dianne M. Neal                   | 
|                                     | 
|Executive Vice President and         | 
|Chief Financial
    Officer          | 

68



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##### Table of Contents



CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Millions, Except Per Share
Amounts)


|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |       |      | 
|-------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------- | ----- | ------ | ------ | ---- | ----- | ----- | ----- | - | ----- | ----- | ---- | 
|                                                                     |                                                                                                                   |                                                                                       
|                                                                     |                                                                                                                   | For the Years Ended December 31,                                                      
|                                                                     |                                                                                                                   |                                                                                       
|                                                                     |                                                                                                                   | 2003                                                                                   |       | 2002   |        | 2001
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |     
|Net sales (1)                                                        |                                                                                                                   | $                                                                                      | 5,267 |        |        | $    | 6,211 |       |       | $ | 6,269 |      
|Costs and expenses:                                                  |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|                                                                     | Cost of products sold (1) (2)                                                                                     |                                                                                        |       | 3,218  |        |      |       | 3,732 |       |   |       | 3,560 |     
|                                                                     | Selling, general and administrative expenses                                                                      |                                                                                        |       | 1,327  |        |      |       | 1,463 |       |   |       | 1,429 |     
|                                                                     | Fixture impairment                                                                                                |                                                                                        |       | 106    |        |      |       |      |       |   |       |      |     
|                                                                     | Restructuring and asset impairment charges                                                                        |                                                                                        |       | 368    |        |      |       | 224   |       |   |       |      |     
|                                                                     | Goodwill and trademark impairment charges                                                                         |                                                                                        |       | 4,089  |        |      |       | 13    |       |   |       |      |     
|                                                                     | Amortization of trademarks and goodwill                                                                           |                                                                                        |       |       |        |      |       |      |       |   |       | 362   |     
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|                                                                     |                                                                                                                   | Operating income (loss)                                                                |       |        | (3,841 | )    |       |       | 779   |   |       |       | 918  | 
|Interest and debt expense                                            |                                                                                                                   |                                                                                        | 111   |        |        |      | 147   |       |       |   | 150   |      
|Interest income                                                      |                                                                                                                   |                                                                                        | (29   | )      |        |      | (62   | )     |       |   | (137  | )    
|Other (income) expense, net                                          |                                                                                                                   |                                                                                        | (5    | )      |        |      | 11    |       |       |   | 13    |      
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|                                                                     |                                                                                                                   | Income (loss) from continuing operations
    before income taxes                       |       |        | (3,918 | )    |       |       | 683   |   |       |       | 892  | 
|Provision for (benefit from) income taxes                            |                                                                                                                   |                                                                                        | (229  | )      |        |      | 265   |       |       |   | 448   |      
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|                                                                     |                                                                                                                   | Income (loss) from continuing
    operations                                           |       |        | (3,689 | )    |       |       | 418   |   |       |       | 444  | 
|Discontinued operations:                                             |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|                                                                     | Gain (loss) on sale of discontinued businesses,
    net of income taxes (2003  $97; 2002  $22;
    2001  $(5)) |                                                                                        |       | 122    |        |      |       | 40    |       |   |       | (9    | )   
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|                                                                     |                                                                                                                   | Income (loss) before extraordinary item and
    cumulative effect of accounting change |       |        | (3,567 | )    |       |       | 458   |   |       |       | 435  | 
|Extraordinary item  gain on acquisition                             |                                                                                                                   |                                                                                        | 121   |        |        |      |      |       |       |   |      |      
|Cumulative effect of accounting change, net of
    $328 income taxes |                                                                                                                   |                                                                                        |      |        |        |      | (502  | )     |       |   |      |      
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|                                                                     |                                                                                                                   | Net income (loss)                                                                      |       | $      | (3,446 | )    |       | $     | (44   | ) |       | $     | 435  | 
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|Basic income (loss) per share:                                       |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|                                                                     | Income (loss) from continuing operations                                                                          |                                                                                        | $     | (44.08 | )      |      | $     | 4.71  |       |   | $     | 4.57  |     
|                                                                     | Gain (loss) on sale of discontinued businesses                                                                    |                                                                                        |       | 1.46   |        |      |       | 0.45  |       |   |       | (0.09 | )   
|                                                                     | Extraordinary item                                                                                                |                                                                                        |       | 1.45   |        |      |       |      |       |   |       |      |     
|                                                                     | Cumulative effect of accounting change                                                                            |                                                                                        |       |       |        |      |       | (5.66 | )     |   |       |      |     
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|                                                                     |                                                                                                                   | Net income (loss)                                                                      |       | $      | (41.17 | )    |       | $     | (0.50 | ) |       | $     | 4.48 | 
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|Diluted income (loss) per share:                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|                                                                     | Income (loss) from continuing operations                                                                          |                                                                                        | $     | (44.08 | )      |      | $     | 4.64  |       |   | $     | 4.48  |     
|                                                                     | Gain (loss) on sale of discontinued businesses                                                                    |                                                                                        |       | 1.46   |        |      |       | 0.44  |       |   |       | (0.09 | )   
|                                                                     | Extraordinary item                                                                                                |                                                                                        |       | 1.45   |        |      |       |      |       |   |       |      |     
|                                                                     | Cumulative effect of accounting change                                                                            |                                                                                        |       |       |        |      |       | (5.57 | )     |   |       |      |     
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|                                                                     |                                                                                                                   | Net income (loss)                                                                      |       | $      | (41.17 | )    |       | $     | (0.49 | ) |       | $     | 4.39 | 
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      
|Dividends declared per share                                         |                                                                                                                   | $                                                                                      | 3.80  |        |        | $    | 3.73  |       |       | $ | 3.30  |      
|                                                                     |                                                                                                                   |                                                                                        |       |        |        |      |       |       |       |   |       |      






|    |                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes excise taxes of $1,572 million,
    $1,751 million and $1,529 million for the years 2003,
    2002 and 2001 respectively.       
|(2) | Includes settlement expense of
    $1,934 million, $2,514 million and $2,584 million
    for the years 2003, 2002 and 2001, respectively.

See Notes to Consolidated Financial
Statements

69



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##### Table of Contents



CONSOLIDATED STATEMENTS OF CASH
FLOWS

(Dollars in Millions)


|                                                    |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |      |      |      |  
|--------------------------------------------------- | ---------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- | ------ | ------ | ---- | ----- | ---- | ---- | --- | ----- | ---- | ---- | ---- | -
|                                                    |                                                                                                |                                                                          
|                                                    |                                                                                                | For the Years Ended December 31,                                         
|                                                    |                                                                                                |                                                                          
|                                                    |                                                                                                | 2003                                                                      |                                                                                               | 2002   |        | 2001
|                                                    |                                                                                                |                                                                           |                                                                                               |        |        |     
|Cash flows from (used in) operating
    activities: |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |     
|                                                    | Net income (loss)                                                                              |                                                                           | $                                                                                             | (3,446 | )      |      | $     | (44  | )    |     | $     | 435  |     
|                                                    | Less (gain) loss from discontinued operations                                                  |                                                                           |                                                                                               | (122   | )      |      |       | (40  | )    |     |       | 9    |     
|                                                    | Adjustments to reconcile to net cash flows from
    (used in) continuing operating activities: |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |      |     
|                                                    |                                                                                                | Cumulative effect of accounting change, net of
    income taxes           |                                                                                               |        |       |      |       |      | 502  |     |       |      |     |     
|                                                    |                                                                                                | Fixture impairment                                                        |                                                                                               |        | 106    |      |       |      |      |     |       |      |      |     
|                                                    |                                                                                                | Restructuring and asset impairment charges                                |                                                                                               |        | 277    |      |       |      | 224  |     |       |      |     |     
|                                                    |                                                                                                | Goodwill and trademark impairment charges                                 |                                                                                               |        | 4,089  |      |       |      | 13   |     |       |      |     |     
|                                                    |                                                                                                | Depreciation and amortization                                             |                                                                                               |        | 151    |      |       |      | 184  |     |       |      | 491  |     
|                                                    |                                                                                                | Deferred income tax expense (benefit)                                     |                                                                                               |        | (470   | )    |       |      | 18   |     |       |      | (43  | )   
|                                                    |                                                                                                | Extraordinary gain on acquisition                                         |                                                                                               |        | (121   | )    |       |      |     |     |       |      |     |     
|                                                    |                                                                                                | Other changes, net of acquisition effects, that
    provided (used) cash: |                                                                                               |        |        |      |       |      |      |     |       |      |      |     
|                                                    |                                                                                                |                                                                           | Accounts and notes receivable                                                                 |        |        | 29   |       |      |      | 5   |       |      |      | (6   | )
|                                                    |                                                                                                |                                                                           | Inventories                                                                                   |        |        | 79   |       |      |      | (56 | )     |      |      | (141 | )
|                                                    |                                                                                                |                                                                           | Accounts payable and accrued liabilities
    including income taxes and other working capital |        |        | (49  | )     |      |      | (88 | )     |      |      | (109 | )
|                                                    |                                                                                                | Litigation bonds                                                          |                                                                                               |        | (10    | )    |       |      | (55  | )   |       |      |     |     
|                                                    |                                                                                                | Tobacco settlement and related expenses                                   |                                                                                               |        | 83     |      |       |      | 17   |     |       |      | 123  |     
|                                                    |                                                                                                | Pension and postretirement                                                |                                                                                               |        | (18    | )    |       |      | (194 | )   |       |      | (102 | )   
|                                                    |                                                                                                | Other, net                                                                |                                                                                               |        | 3      |      |       |      | 3    |     |       |      | (31  | )   
|                                                    |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |     
|                                                    |                                                                                                | Net cash flows from operating activities                                  |                                                                                               |        | 581    |      |       |      | 489  |     |       |      | 626  |     
|                                                    |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |     
|Cash flows from (used in) investing
    activities: |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |     
|                                                    | Purchases of short-term investments                                                            |                                                                           |                                                                                               | (4     | )      |      |       | (508 | )    |     |       | (207 | )   
|                                                    | Proceeds from short-term investments                                                           |                                                                           |                                                                                               | 492    |        |      |       | 120  |      |     |       |     |     
|                                                    | Capital expenditures                                                                           |                                                                           |                                                                                               | (70    | )      |      |       | (111 | )    |     |       | (74  | )   
|                                                    | Increases in equity investments                                                                |                                                                           |                                                                                               | (36    | )      |      |       |     |      |     |       |     |     
|                                                    | Acquisitions, net of cash acquired                                                             |                                                                           |                                                                                               | (9     | )      |      |       | (339 | )    |     |       |     |     
|                                                    | Net proceeds from (used in) the sale of businesses                                             |                                                                           |                                                                                               | 6      |        |      |       |     |      |     |       | (14  | )   
|                                                    | Proceeds from liquidation of trusts                                                            |                                                                           |                                                                                               | 99     |        |      |       |     |      |     |       |     |     
|                                                    | Other, net                                                                                     |                                                                           |                                                                                               | 2      |        |      |       | 18   |      |     |       | (12  | )   
|                                                    |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |     
|                                                    |                                                                                                | Net cash flows from (used in) investing activities                        |                                                                                               |        | 480    |      |       |      | (820 | )   |       |      | (307 | )   
|                                                    |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |     
|Cash flows from (used in) financing
    activities: |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |     
|                                                    | Repurchase of common stock                                                                     |                                                                           |                                                                                               | (75    | )      |      |       | (511 | )    |     |       | (494 | )   
|                                                    | Dividends paid on common stock                                                                 |                                                                           |                                                                                               | (323   | )      |      |       | (335 | )    |     |       | (320 | )   
|                                                    | Repayments of long-term debt                                                                   |                                                                           |                                                                                               | (741   | )      |      |       | (43  | )    |     |       | (73  | )   
|                                                    | Proceeds from exercise of stock options                                                        |                                                                           |                                                                                               | 17     |        |      |       | 39   |      |     |       | 45   |     
|                                                    | Proceeds from issuance of long-term debt                                                       |                                                                           |                                                                                               |       |        |      |       | 745  |      |     |       |     |     
|                                                    |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |     
|                                                    |                                                                                                | Net cash flows used in financing activities                               |                                                                                               |        | (1,122 | )    |       |      | (105 | )   |       |      | (842 | )   
|                                                    |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |     
|Net change in cash and cash equivalents             |                                                                                                |                                                                           | (61                                                                                           | )      |        |      | (436  | )    |      |     | (523  | )   
|Cash and cash equivalents at beginning of year      |                                                                                                |                                                                           | 1,584                                                                                         |        |        |      | 2,020 |      |      |     | 2,543 |     
|                                                    |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |     
|Cash and cash equivalents at end of year            |                                                                                                | $                                                                         | 1,523                                                                                         |        |        | $    | 1,584 |      |      | $   | 2,020 |     
|                                                    |                                                                                                |                                                                           |                                                                                               |        |        |      |       |      |      |     |       |     
|Income taxes paid, net of refunds                   |                                                                                                | $                                                                         | 231                                                                                           |        |        | $    | 203   |      |      | $   | 457   |     
|Interest paid                                       |                                                                                                | $                                                                         | 99                                                                                            |        |        | $    | 135   |      |      | $   | 141   |     
|Tobacco settlement and related expense payments     |                                                                                                | $                                                                         | 1,819                                                                                         |        |        | $    | 2,464 |      |      | $   | 2,393 |     

See Notes to Consolidated Financial
Statements

70



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##### Table of Contents



CONSOLIDATED BALANCE SHEETS

(Dollars in Millions)


|                                                                           |                                                                                                                     |                                     |                               |                                    |       |       |        |        |       |       |     | 
|-------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------- | ----------------------------------- | ----------------------------- | ---------------------------------- | ----- | ----- | ------ | ------ | ----- | ----- | --- | 
|                                                                           |                                                                                                                     |                                    
|                                                                           |                                                                                                                     | December 31,                       
|                                                                           |                                                                                                                     |                                    
|                                                                           |                                                                                                                     | 2003                                |                               | 2002                              
|                                                                           |                                                                                                                     |                                     |                               |                                   
|Assets                                                                     |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|Current assets:                                                            |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           | Cash and cash equivalents                                                                                           |                                     | $                             | 1,523                              |       |       | $      | 1,584  |      
|                                                                           | Short-term investments                                                                                              |                                     |                               | 107                                |       |       |        | 595    |      
|                                                                           | Accounts and notes receivable, net of allowance
    (2003  $3; 2002  $3)                                          |                                     |                               | 67                                 |       |       |        | 96     |      
|                                                                           | Inventories                                                                                                         |                                     |                               | 684                                |       |       |        | 762    |      
|                                                                           | Deferred income taxes                                                                                               |                                     |                               | 713                                |       |       |        | 588    |      
|                                                                           | Other current assets                                                                                                |                                     |                               | 153                                |       |       |        | 289    |      
|                                                                           | Assets held for sale                                                                                                |                                     |                               | 84                                 |       |       |        | 78     |      
|                                                                           |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           |                                                                                                                     | Total current assets                |                               |                                    | 3,331 |       |        |        | 3,992 |      
|Property, plant and equipment, at cost:                                    |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           | Land and land improvements                                                                                          |                                     |                               | 92                                 |       |       |        | 89     |      
|                                                                           | Buildings and leasehold improvements                                                                                |                                     |                               | 636                                |       |       |        | 636    |      
|                                                                           | Machinery and equipment                                                                                             |                                     |                               | 1,416                              |       |       |        | 1,359  |      
|                                                                           | Construction-in-process                                                                                             |                                     |                               | 39                                 |       |       |        | 77     |      
|                                                                           |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           |                                                                                                                     | Total property, plant and equipment |                               |                                    | 2,183 |       |        |        | 2,161 |      
|                                                                           |                                                                                                                     |                                     | Less accumulated depreciation |                                    |       | 1,289 |        |        |       | 1,221 |    
|                                                                           |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           |                                                                                                                     |                                     |                               | Property, plant and equipment, net |       |       | 894    |        |       |       | 940 | 
|Trademarks, net of accumulated amortization
    (2003  $481; 2002  $481) |                                                                                                                     |                                     | 1,759                         |                                    |       |       | 2,085  |       
|Goodwill, net of accumulated amortization
    (2003  $0; 2002  $3,359)   |                                                                                                                     |                                     | 3,292                         |                                    |       |       | 7,090  |       
|Other assets and deferred charges                                          |                                                                                                                     |                                     | 401                           |                                    |       |       | 544    |       
|                                                                           |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           |                                                                                                                     | $                                   | 9,677                         |                                    |       | $     | 14,651 |       
|                                                                           |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|Liabilities and stockholders
    equity                                   |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|Current liabilities:                                                       |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           | Accounts payable                                                                                                    |                                     | $                             | 36                                 |       |       | $      | 60     |      
|                                                                           | Tobacco settlement and related accruals                                                                             |                                     |                               | 1,629                              |       |       |        | 1,543  |      
|                                                                           | Accrued liabilities and other                                                                                       |                                     |                               | 1,134                              |       |       |        | 1,075  |      
|                                                                           | Current maturities of long-term debt                                                                                |                                     |                               | 56                                 |       |       |        | 741    |      
|                                                                           | Liabilities related to assets held for sale                                                                         |                                     |                               | 10                                 |       |       |        | 8      |      
|                                                                           |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           |                                                                                                                     | Total current liabilities           |                               |                                    | 2,865 |       |        |        | 3,427 |      
|Long-term debt (less current maturities)                                   |                                                                                                                     |                                     | 1,671                         |                                    |       |       | 1,755  |       
|Deferred income taxes                                                      |                                                                                                                     |                                     | 806                           |                                    |       |       | 1,236  |       
|Long-term retirement benefits                                              |                                                                                                                     |                                     | 1,034                         |                                    |       |       | 1,176  |       
|Other noncurrent liabilities                                               |                                                                                                                     |                                     | 244                           |                                    |       |       | 341    |       
|Commitments and contingencies:                                             |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|Stockholders equity:                                                      |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           | Common stock (shares issued: 2003 
    116,430,211; 2002  115,413,501)                                            |                                     |                               | 1                                  |       |       |        | 1      |      
|                                                                           | Paid-in capital                                                                                                     |                                     |                               | 7,377                              |       |       |        | 7,401  |      
|                                                                           | Retained earnings (accumulated deficit)                                                                             |                                     |                               | (2,469                             | )     |       |        | 1,217  |      
|                                                                           | Accumulated other comprehensive loss 
    (cumulative minimum pension liability: 2003  $(462);
    2002  $(599)) |                                     |                               | (462                               | )     |       |        | (598   | )    
|                                                                           | Unamortized restricted stock                                                                                        |                                     |                               | (23                                | )     |       |        | (19    | )    
|                                                                           |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           |                                                                                                                     |                                     | 4,424                         |                                    |       |       | 8,002  |       
|                                                                           | Less treasury stock (shares: 2003 
    31,326,603; 2002  29,365,197), at cost                                     |                                     |                               | (1,367                             | )     |       |        | (1,286 | )    
|                                                                           |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           |                                                                                                                     | Total stockholders equity          |                               |                                    | 3,057 |       |        |        | 6,716 |      
|                                                                           |                                                                                                                     |                                     |                               |                                    |       |       |        |       
|                                                                           |                                                                                                                     | $                                   | 9,677                         |                                    |       | $     | 14,651 |       
|                                                                           |                                                                                                                     |                                     |                               |                                    |       |       |        |       

See Notes to Consolidated Financial
Statements

71



---



##### Table of Contents



CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

AND COMPREHENSIVE INCOME (LOSS)


(Dollars in Millions)


|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|-------------------------------------------------- |  | ------ | - | ------- |  | ------------ | ----- | ------------- |  | ----------- | ------ | -------- |  | ------------- | ---- | ------------- |  | - | --- | - |  | - | ------ | - |  | - | ------ | - |  | - | ------ | -
|                                                   |  |        |   |         |  | Retained     |       | Accumulated   |  |             |        |          |  |               |      |              
|                                                   |  |        |   |         |  | Earnings     |       | Other         |  | Unamortized |        |          |  | Total         |      |              
|                                                   |  | Common |   | Paid-In |  | (Accumulated |       | Comprehensive |  | Restricted  |        | Treasury |  | Stockholders |      | Comprehensive
|                                                   |  | Stock  |   | Capital |  | Deficit)     |       | Income (Loss) |  | Stock       |        | Stock    |  | Equity        |      | Income (Loss)
|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |              
|Balance at December 31, 2000                       |  | $      | 1 |         |  | $            | 7,291 |               |  | $           | 1,481  |          |  | $             | (8   | )             |  | $ | (41 | ) |  | $ | (288   | ) |  | $ | 8,436  |   |  |   |        |  
|Net income                                         |  |        |  |         |  |              |      |               |  |             | 435    |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 435    |   |  | $ | 435    |  
|Minimum pension liability, net of $61 tax expense  |  |        |  |         |  |              |      |               |  |             |       |          |  |               | (113 | )             |  |   |    |   |  |   |       |   |  |   | (113   | ) |  |   | (113   | )
|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Total comprehensive income                         |  |        |  |         |  |              |      |               |  |             |       |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   |       |   |  | $ | 322    |  
|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Dividends                                          |  |        |  |         |  |              |      |               |  |             | (324   | )        |  |               |     |               |  |   |    |   |  |   |       |   |  |   | (324   | ) |  |   |        |  
|Stock options exercised                            |  |        |  |         |  |              | 42    |               |  |             |       |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 42     |   |  |   |        |  
|Tax benefit on stock options exercised             |  |        |  |         |  |              | 20    |               |  |             |       |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 20     |   |  |   |        |  
|Restricted stock awarded                           |  |        |  |         |  |              | 18    |               |  |             |       |          |  |               |     |               |  |   | (26 | ) |  |   | 8      |   |  |   |       |   |  |   |        |  
|Restricted stock amortization                      |  |        |  |         |  |              |      |               |  |             |       |          |  |               |     |               |  |   | 23  |   |  |   |       |   |  |   | 23     |   |  |   |        |  
|Restricted stock forfeited                         |  |        |  |         |  |              |      |               |  |             | 1      |          |  |               |     |               |  |   | 2   |   |  |   | (2     | ) |  |   | 1      |   |  |   |        |  
|Common stock repurchased                           |  |        |  |         |  |              |      |               |  |             |       |          |  |               |     |               |  |   |    |   |  |   | (494   | ) |  |   | (494   | ) |  |   |        |  
|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Balance at December 31, 2001                       |  |        | 1 |         |  |              | 7,371 |               |  |             | 1,593  |          |  |               | (121 | )             |  |   | (42 | ) |  |   | (776   | ) |  |   | 8,026  |   |  |   |        |  
|Net income                                         |  |        |  |         |  |              |      |               |  |             | (44    | )        |  |               |     |               |  |   |    |   |  |   |       |   |  |   | (44    | ) |  | $ | (44    | )
|Minimum pension liability, net of $258 tax expense |  |        |  |         |  |              |      |               |  |             |       |          |  |               | (478 | )             |  |   |    |   |  |   |       |   |  |   | (478   | ) |  |   | (478   | )
|Other                                              |  |        |  |         |  |              |      |               |  |             |       |          |  |               | 1    |               |  |   |    |   |  |   |       |   |  |   | 1      |   |  |   | 1      |  
|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Total comprehensive income                         |  |        |  |         |  |              |      |               |  |             |       |          |  |               |      |               |  |   |    |   |  |   |       |   |  |   |       |   |  | $ | (521   | )
|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Dividends                                          |  |        |  |         |  |              |      |               |  |             | (332   | )        |  |               |     |               |  |   |    |   |  |   |       |   |  |   | (332   | ) |  |   |        |  
|Stock options exercised                            |  |        |  |         |  |              | 40    |               |  |             |       |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 40     |   |  |   |        |  
|Tax benefit on stock options exercised             |  |        |  |         |  |              | 14    |               |  |             |       |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 14     |   |  |   |        |  
|Restricted stock awarded                           |  |        |  |         |  |              | (28   | )             |  |             |       |          |  |               |     |               |  |   | 14  |   |  |   | 14     |   |  |   |       |   |  |   |        |  
|Restricted stock forfeited                         |  |        |  |         |  |              | 4     |               |  |             |       |          |  |               |     |               |  |   | 9   |   |  |   | (13    | ) |  |   |       |   |  |   |        |  
|Common stock repurchased                           |  |        |  |         |  |              |      |               |  |             |       |          |  |               |     |               |  |   |    |   |  |   | (511   | ) |  |   | (511   | ) |  |   |        |  
|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Balance at December 31, 2002                       |  |        | 1 |         |  |              | 7,401 |               |  |             | 1,217  |          |  |               | (598 | )             |  |   | (19 | ) |  |   | (1,286 | ) |  |   | 6,716  |   |  |   |        |  
|Net income                                         |  |        |  |         |  |              |      |               |  |             | (3,446 | )        |  |               |     |               |  |   |    |   |  |   |       |   |  |   | (3,446 | ) |  | $ | (3,446 | )
|Minimum pension liability, net of $76 tax expense  |  |        |  |         |  |              |      |               |  |             |       |          |  |               | 137  |               |  |   |    |   |  |   |       |   |  |   | 137    |   |  |   | 137    |  
|Other                                              |  |        |  |         |  |              |      |               |  |             |       |          |  |               | (1   | )             |  |   |    |   |  |   |       |   |  |   | (1     | ) |  |   | (1     | )
|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Total comprehensive income                         |  |        |  |         |  |              |      |               |  |             |       |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   |       |   |  | $ | (3,310 | )
|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Dividends                                          |  |        |  |         |  |              | (81   | )             |  |             | (240   | )        |  |               |     |               |  |   |    |   |  |   |       |   |  |   | (321   | ) |  |   |        |  
|Stock options exercised                            |  |        |  |         |  |              | 17    |               |  |             |       |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 17     |   |  |   |        |  
|Tax benefit on equity awards                       |  |        |  |         |  |              | 14    |               |  |             |       |          |  |               |     |               |  |   |    |   |  |   |       |   |  |   | 14     |   |  |   |        |  
|Restricted stock awarded                           |  |        |  |         |  |              | 23    |               |  |             |       |          |  |               |     |               |  |   | (23 | ) |  |   |       |   |  |   |       |   |  |   |        |  
|Restricted stock amortization                      |  |        |  |         |  |              |      |               |  |             |       |          |  |               |     |               |  |   | 16  |   |  |   |       |   |  |   | 16     |   |  |   |        |  
|Restricted stock forfeited                         |  |        |  |         |  |              | 3     |               |  |             |       |          |  |               |     |               |  |   | 3   |   |  |   | (6     | ) |  |   |       |   |  |   |        |  
|Common stock repurchased                           |  |        |  |         |  |              |      |               |  |             |       |          |  |               |     |               |  |   |    |   |  |   | (75    | ) |  |   | (75    | ) |  |   |        |  
|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Balance at December 31, 2003                       |  | $      | 1 |         |  | $            | 7,377 |               |  | $           | (2,469 | )        |  | $             | (462 | )             |  | $ | (23 | ) |  | $ | (1,367 | ) |  | $ | 3,057  |   |  |   |        |  
|                                                   |  |        |   |         |  |              |       |               |  |             |        |          |  |               |      |               |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  

See Notes to Consolidated Financial
Statements

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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

Note 1  Summary of
Significant Accounting Policies

Basis of Presentation

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

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

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

All dollar amounts are presented in millions
unless otherwise noted.

Cash Equivalents and Short-Term
Investments

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

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

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Accounts Receivable

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

|                             |                        |   |    |     |  
|---------------------------- | ---------------------- | - | -- | --- | -
|Balance at December 31, 2000 |                        | $ | 11 |    
|                             | Bad debt expense       |   |    | 2   |  
|                             |                        |   |    |    
|Balance at December 31, 2001 |                        |   | 13 |    
|                             | Reduction in allowance |   |    | (10 | )
|                             |                        |   |    |    
|Balance at December 31, 2002 |                        |   | 3  |    
|                             | Bad debt expense       |   |    | 2   |  
|                             | Write-off of bad debt  |   |    | (2  | )
|                             |                        |   |    |    
|Balance at December 31, 2003 |                        | $ | 3  |    
|                             |                        |   |    |    

Inventories

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

Property, Plant and Equipment

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

Long-lived Assets

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

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

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Accounting for Returned Goods

During the second quarter of 2003,
RJR Tobacco announced a revision of its policy related to
returned goods. Previously, RJR Tobacco accepted all
damaged and out-of-code-date products. Under its revised policy,
RJR Tobacco will accept only returns of unintentionally
damaged products. During the second quarter of 2003, all retail
returns other than unintentionally damaged products were
suspended. Returns other than unintentionally damaged products
shipped from wholesalers under the previous return policy were
last accepted during the third quarter of 2003.

At June 30, 2003, the reserve for returned
goods consisted of (1) an estimate of returns for
unintentionally damaged product and (2) an estimate of
goods to be returned from wholesalers under the previous policy.
These estimates resulted in a $54 million reduction of the
reserve for returned goods balance as of June 30, 2003,
having the effect of increasing net sales $54 million. The
change in the estimate of the reserve for returned goods was
made in the second quarter, as that is the period that
RJR Tobaccos policy change was effected and announced
to its customers. Reflecting the results of the revised returned
good policy, the returned goods reserve was reduced
$42 million during the second half of 2003, for a total of
$96 million during 2003. The change in the returned goods
policy benefited net income $0.69 per basic and diluted
share during the year ended December 31, 2003.

Merchandising Fixtures

Beginning in the fourth quarter of 2002, in
response to changes in industry retail display, RJR Tobacco
began replacing significant portions of its merchandising
fixtures on an accelerated basis that resulted in accelerated
amortization. During the second quarter of 2003, it became
evident that the scope, extent and timing of competitors
similar replacement actions were reduced significantly from
RJR Tobaccos original expectations. As a result,
RJR Tobacco significantly reduced further replacement of
its merchandising fixtures. Accordingly, the service lives of
those fixtures targeted for near-term replacement, which were
shortened in the fourth quarter of 2002, were extended to their
original service life. Additionally, the percentage salvageable
became higher than previously estimated. As a result, there was
no additional book value to amortize on an accelerated basis.
Accordingly, RJR Tobacco ceased accelerated amortization.
Amortization of merchandising fixtures during 2003 was
$66 million, of which $21 million was accelerated
amortization, compared with amortization expense of
$96 million, of which $43 million was accelerated
amortization, for 2002. The change in estimate and resulting
accelerated amortization adversely impacted net income
$0.15 per basic and diluted share during 2003 and
$0.29 per basic and diluted share during 2002.

In response to marketplace activity, during the
fourth quarter of 2003, RJR Tobacco reevaluated its strategy
related to merchandising fixtures and transferred its ownership
of these fixtures to the cigarette retailers, resulting in an
impairment charge of $106 million.

Goodwill and Trademarks

Intangibles include primarily goodwill and
trademarks that have indefinite lives. Trademarks are
capitalized when acquired. During 2001, these intangibles were
amortized using the straight-line method, principally over 40
years, and tested for impairment, by comparison of their
carrying value with estimated future undiscounted cash flows
expected to be generated by the asset, when events and
circumstances indicated that the asset might be impaired.

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

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The following table presents net income and
income per share as if the provisions of SFAS No. 142 had
been applied as of January 1, 2001:

|                                          |  |              |      | 
|----------------------------------------- |  | ------------ | ---- | 
|                                          |  | Year Ended  
|                                          |  | December 31,
|                                          |  | 2001        
|                                          |  |             
|Reported income before extraordinary item |  | $            | 435  | 
|Add back: goodwill amortization           |  |              | 260  | 
|trademark amortization, net of tax        |  |              | 62   | 
|                                          |  |              |      | 
|Adjusted income before extraordinary item |  | $            | 757  | 
|                                          |  |              |      | 
|Adjusted net income                       |  | $            | 757  | 
|                                          |  |              |      | 
|Basic income per share:                   |  |              |      | 
|Reported income before extraordinary item |  | $            | 4.48 | 
|Add back: goodwill amortization           |  |              | 2.68 | 
|trademark amortization, net of tax        |  |              | 0.64 | 
|                                          |  |              |      | 
|Adjusted income before extraordinary item |  | $            | 7.80 | 
|                                          |  |              |      | 
|Adjusted net income                       |  | $            | 7.80 | 
|                                          |  |              |      | 
|Diluted income per share:                 |  |              |      | 
|Reported income before extraordinary item |  | $            | 4.39 | 
|Add back: goodwill amortization           |  |              | 2.63 | 
|trademark amortization, net of tax        |  |              | 0.63 | 
|                                          |  |              |      | 
|Adjusted income before extraordinary item |  | $            | 7.65 | 
|                                          |  |              |      | 
|Adjusted net income                       |  | $            | 7.65 | 
|                                          |  |              |      | 

For the initial application of
SFAS No. 142, an independent appraisal firm was
engaged to value RJRs goodwill and trademarks as of
January 1, 2002. RJRs goodwill as of January 1,
2002 was attributable to one reporting unit, RJR Tobacco, which
comprises substantially all of RJRs consolidated results
of operations and financial condition. No goodwill impairment
was indicated, since the fair value of RJR was determined to be
greater than its carrying value using several valuation
techniques, including discounted cash flow analysis. However,
the fair values of WINSTON, SALEM, VANTAGE, NOW and MORE, using
an income approach, were less than their carrying values, which
resulted in an $830 million, or $502 million after
tax, impairment charge, reported as a cumulative effect of a
change in accounting during the quarter ended March 31,
2002.

The following impairment charges were based on
the results of appraisals performed by an independent appraisal
firm. In connection with the annual impairment testing in the
fourth quarter of 2002, impairment occurred on two of RJR
Tobaccos non-key brands, VANTAGE and CENTURY. The related
impairment testing indicated that the carrying amounts of these
brands would not be recoverable through future undiscounted cash
flows. Accordingly, RJR Tobacco recorded impairment charges of
$13 million, $8 million after tax, based on the excess
of the brands carrying values over their fair values,
determined using the present value of estimated future cash
flows assuming a discount rate of 10.5%. The discount rate was
determined by adjusting the RJR Tobacco enterprise discount rate
by an appropriate risk premium to reflect an asset group risk.
These impairment charges are reflected as decreases in the
carrying value of the trademarks in the consolidated balance
sheets and as trademark impairment charges in the 2002
consolidated income statement and had no impact on cash flows.

In response to competitive changes in the tobacco
industry, RJR Tobacco initiated comprehensive changes in its
strategies and cost structure that resulted in a restructuring
primarily during the third quarter of 2003. The extent of the
adverse impact of these competitive changes was not anticipated
during the annual testing of trademarks and goodwill, performed
in the fourth quarter of 2002. Accordingly, as provided by

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


SFAS No. 142, RJR Tobacco tested its
trademarks and goodwill for impairment based on its revised
forecast of expected sales and cash flows. The trademark
impairment testing indicated that impairment occurred on certain
of RJR Tobaccos brands, primarily WINSTON and DORAL,
reflecting RJR Tobaccos decision in the third quarter of
2003 to limit investment in these brands in an effort to
optimize profitability. Accordingly, RJR Tobacco recorded an
impairment charge of $326 million, $197 million after
tax, in the third quarter of 2003. This charge was based on the
excess of the brands carrying values over their fair
values, determined using the present value of estimated future
cash flows assuming a discount rate of 10.5%. This impairment
charge was included in goodwill and trademark impairment charges
in the 2003 consolidated statement of income, as a decrease in
the carrying value of trademarks in the consolidated balance
sheet as of December 31, 2003, and had no impact on cash
flows.

For the purpose of testing goodwill, the fair
value of RJR Tobacco was based on the present value of the
estimated future cash flows of the reporting unit assuming a
discount rate of 10.0%. The determination of this discount rate
is based on a weighted average cost of capital using a risk-free
rate adjusted by a stock-beta adjusted risk premium. The
valuation indicated that the carrying value of RJR Tobacco
exceeded its implied fair value. Preliminary estimated fair
values were assigned to RJR Tobaccos assets and
liabilities to estimate the implied fair value of
RJR Tobaccos goodwill. As a result, the carrying
amount of the goodwill of RJR Tobacco exceeded its implied
fair value by $3.3 billion, and an impairment charge equal
to that estimated excess was recognized in the third quarter of
2003. During the fourth quarter of 2003, RJR Tobacco
completed its impairment measurement and recorded an additional
$0.5 billion charge, primarily due to finalized appraisal
values of property, plant and equipment. These impairment
charges were included in goodwill and trademark impairment
charges in the 2003 consolidated income statement and as a
decrease in the carrying value of goodwill in the consolidated
balance sheet as of December 31, 2003, and had no impact on
cash flows.

The $9 million goodwill acquired by
Santa Fe is attributable to its acquisition of the
externally owned portion of a joint venture, Santa Fe
Natural Tobacco Company: Europe GmbH, in April 2003.

The changes in the carrying amount of trademarks
during the years ended December 31, 2002 and 2003,
respectively, were:

|                                |                                         |             |       |          |   |              |     |     |  |   |       |      |  
|------------------------------- | --------------------------------------- | ----------- | ----- | -------- | - | ------------ | --- | --- |  | - | ----- | ---- | -
|                                |                                         | RJR Tobacco |       | Santa Fe |   | Consolidated
|                                |                                         |             |       |          |   |             
|Balance as of January 1, 2002   |                                         | $           | 2,773 |          |   | $            |    |     |  | $ | 2,773 |     
|                                | Trademarks acquired                     |             |       |         |   |              |     | 155 |  |   |       | 155  |  
|                                | Impairment due to accounting change     |             |       | (830     | ) |              |     |    |  |   |       | (830 | )
|                                | Impairment included in operating income |             |       | (13      | ) |              |     |    |  |   |       | (13  | )
|                                |                                         |             |       |          |   |              |     |     |  |   |       |     
|Balance as of December 31, 2002 |                                         |             | 1,930 |          |   |              | 155 |     |  |   | 2,085 |     
|                                | Impairment included in operating income |             |       | (326     | ) |              |     |    |  |   |       | (326 | )
|                                |                                         |             |       |          |   |              |     |     |  |   |       |     
|Balance as of December 31, 2003 |                                         | $           | 1,604 |          |   | $            | 155 |     |  | $ | 1,759 |     
|                                |                                         |             |       |          |   |              |     |     |  |   |       |     

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The changes in the carrying amount of goodwill
during the years ended December 31, 2002 and 2003,
respectively, were:

|                                |                                                                  |             |       |          |   |              |     |     |  |   |       |        |  
|------------------------------- | ---------------------------------------------------------------- | ----------- | ----- | -------- | - | ------------ | --- | --- |  | - | ----- | ------ | -
|                                |                                                                  | RJR Tobacco |       | Santa Fe |   | Consolidated
|                                |                                                                  |             |       |          |   |             
|Balance as of January 1, 2002   |                                                                  | $           | 6,875 |          |   | $            |    |     |  | $ | 6,875 |       
|                                | Goodwill acquired                                                |             |       |         |   |              |     | 215 |  |   |       | 215    |  
|                                |                                                                  |             |       |          |   |              |     |     |  |   |       |       
|Balance as of December 31, 2002 |                                                                  |             | 6,875 |          |   |              | 215 |     |  |   | 7,090 |       
|                                | Goodwill acquired                                                |             |       |         |   |              |     | 9   |  |   |       | 9      |  
|                                | Impairment included in operating income                          |             |       | (3,763   | ) |              |     |    |  |   |       | (3,763 | )
|                                | Adjustment due to resolution of pre-LBO tax
    exposure accrual |             |       | (44      | ) |              |     |    |  |   |       | (44    | )
|                                |                                                                  |             |       |          |   |              |     |     |  |   |       |       
|Balance as of December 31, 2003 |                                                                  | $           | 3,068 |          |   | $            | 224 |     |  | $ | 3,292 |       
|                                |                                                                  |             |       |          |   |              |     |     |  |   |       |       

Accounting for Derivative Instruments and
Hedging Activities

SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended,
requires RJR to measure every derivative instrument, including
certain derivative instruments embedded in other contracts, at
fair value and record them in the balance sheet as either an
asset or liability. Changes in fair value of derivatives are
recorded currently in earnings unless special hedge accounting
criteria are met. For derivatives designated as fair value
hedges, the changes in fair value of both the derivative
instrument and the hedged item are recorded in earnings. For
derivatives designated as cash flow hedges, the effective
portions of changes in the fair value of the derivative are
reported in other comprehensive income. The ineffective portions
of hedges are recognized in earnings in the current period.

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

Software Costs

In accordance with Statement of Position
No. 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, certain
computer software and software development costs incurred in
connection with developing or obtaining computer software for
internal use that has a useful life of greater than one year are
capitalized. These costs are amortized over five years or less.
During 2003 and 2002, costs of $12 million and
$20 million, respectively, were capitalized, and at
December 31, 2003 and December 31, 2002, the
unamortized balance was $33 million and $36 million,
respectively. Related amortization expense was $15 million,
$11 million and $8 million for the years ended
December 31, 2003, 2002 and 2001, respectively.

Revenue Recognition

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

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

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


revenue when recognized in the vendors
income statement. EITF No. 01-9 became effective in
November 2001, codifying and reconciling certain issues in EITF
No. 00-25. As of January 1, 2002, the operating
subsidiaries have characterized the applicable costs as
reductions of net sales rather than as selling, general and
administrative expenses. For the year ended December 31,
2001, $2.3 billion was 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.

Advertising and Research and
Development

Advertising costs, which are expensed as
incurred, were $135 million, $55 million and
$73 million in the years ended December 31, 2003, 2002
and 2001, respectively. The increased advertising expense during
2003 reflects RJR Tobaccos refocused marketing strategy on
CAMEL and SALEM. Research and development costs, which are
expensed as incurred, were $54 million, $63 million
and $64 million in the years ended December 31, 2003,
2002 and 2001, respectively.

Income Taxes

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

Stock-Based Compensation

Effective January 1, 2003, RJR adopted the
prospective method of transition of SFAS No. 148,
Accounting for Stock-Based Compensation 
Transition and Disclosure, an amendment of
SFAS No. 123. SFAS No. 148 amends
SFAS No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition
for a voluntary change to that statements fair value
method of accounting for stock-based employee compensation.
SFAS No. 148 also amends the disclosure provisions of
SFAS No. 123 and APB No. 28, Interim
Financial Reporting, to require disclosure in the summary
of significant accounting policies, or its equivalent, of the
effects of an entitys accounting policy with respect to
stock-based employee compensation on reported net income and
earnings per share for all periods presented in the financial
statements. The transition and disclosure provisions of this
statement are effective for financial statements for fiscal
years ending after December 15, 2002.

All of RJRs compensation costs related to
employee stock plans that were granted prior to January 1,
2003, will continue to be recognized using the intrinsic
value-based method under the provisions of APB No. 25,
Accounting for Stock Issued to Employees, and
related Interpretations. However, any compensation costs related
to grants or modifications of existing grants subsequent to
January 1, 2003, will be recognized under the fair value
method of SFAS No. 123, as amended. All compensation
costs related to employee stock plans for all grant dates will
be disclosed under the provisions of SFAS No. 123, as
amended. Stock compensation is described more fully in
note 16 to the consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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

|                               |                                                                                                                               |      |        |        |   |      |     |       |   |   |     |      | 
|------------------------------ | ----------------------------------------------------------------------------------------------------------------------------- | ---- | ------ | ------ | - | ---- | --- | ----- | - | - | --- | ---- | 
|                               |                                                                                                                               | 2003 |        | 2002   |   | 2001
|                               |                                                                                                                               |      |        |        |   |     
|Net income (loss), as reported |                                                                                                                               | $    | (3,446 | )      |   | $    | (44 | )     |   | $ | 435 |     
|                               | Add: Stock-based employee compensation expense
    included in reported net income, net of tax                                |      |        | 10     |   |      |     |      |   |   |     | 11   | 
|                               | Deduct: Stock-based employee compensation expense
    determined under fair value based method for all awards, net of
    tax |      |        | 9      |   |      |     | 8     |   |   |     | 10   | 
|                               |                                                                                                                               |      |        |        |   |      |     |       |   |   |     |     
|Pro forma net income (loss)    |                                                                                                                               | $    | (3,445 | )      |   | $    | (52 | )     |   | $ | 436 |     
|                               |                                                                                                                               |      |        |        |   |      |     |       |   |   |     |     
|Income (loss) per share:       |                                                                                                                               |      |        |        |   |      |     |       |   |   |     |     
|                               | Basic  as reported                                                                                                           |      | $      | (41.17 | ) |      | $   | (0.50 | ) |   | $   | 4.48 | 
|                               | Basic  pro forma                                                                                                             |      |        | (41.16 | ) |      |     | (0.59 | ) |   |     | 4.49 | 
|                               | Diluted  as reported                                                                                                         |      |        | (41.17 | ) |      |     | (0.49 | ) |   |     | 4.39 | 
|                               | Diluted  pro forma                                                                                                           |      |        | (41.16 | ) |      |     | (0.58 | ) |   |     | 4.40 | 

Pension and Postretirement

Gains or losses are annual changes in the amount
of either the benefit obligation or the market-related value of
plan assets resulting from experience different from that
assumed or from changes in assumptions. The minimum amortization
of unrecognized gains or losses, as described in
SFAS No. 87, Employers Accounting for
Pensions, 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. For
further information and detailed disclosure in accordance with
SFAS No. 132(R), Employers Disclosures
about Pensions and Other Postretirement Benefits, see
note 17 to consolidated financial statements.

Tobacco-Related Litigation
Contingencies

In accordance with SFAS No. 5,
Accounting for Contingencies, RJR and
RJR Tobacco will record any loss related to tobacco
litigation at such time that 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 would be recorded. See note 13, Commitments and
Contingencies, to consolidated financial statements,
concerning tobacco-related litigation for which an unfavorable
outcome is other than remote.

Recently Adopted Accounting
Pronouncements

The adoption of the following accounting
pronouncements has not had, or is not expected to have, a
material effect on RJRs financial position, results of
operations or cash flows.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | On January 1, 2003, the provisions of
    SFAS No. 146, Accounting for Costs Associated
    with Exit or Disposal Activities, became effective and
    nullified 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 those costs are incurred, and that the total
    amount expected to be incurred in connection with the activity
    be disclosed. 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.
|
| |  | In January 2003, the FASB issued Interpretation
    No. 46, Consolidation of Variable Interest
    Entities. This Interpretation, as amended by FIN
    No. 46(R), clarifies the application of Accounting Research                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | In April 2003, the FASB issued
    SFAS No. 149, Amendment of Statement 133 on
    Derivative Instruments and Hedging Activities. This
    statement amends SFAS No. 133, for implementation
    issues related to the definition of a derivative and other FASB
    projects related to financial instruments.
    SFAS No. 149 requires that contracts with comparable
    characteristics be accounted for in a similar fashion.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | In May 2003, the FASB issued
    SFAS No. 150, Accounting for Certain Financial
    Instruments with Characteristics of both Liabilities and
    Equity. This statement establishes standards for how an
    issuer classifies and measures certain financial instruments
    with characteristics of both liabilities and equity.
    SFAS No. 150 requires that financial instruments
    within the scope of SFAS No. 150 be classified as a
    liability or an asset.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | In December 2003, the FASB issued
    SFAS No. 132(R), which replaces
    SFAS No. 132, Employers Disclosures about
    Pensions and Other Postretirement Benefits.
    SFAS No. 132(R) does not change the measurement and
    recognition provisions of SFAS No. 87,
    SFAS No. 88, Employers Accounting for
    Settlements and Curtailments of Defined Benefit Pension Plans
    and for Termination Benefits, and SFAS No. 106,
    Employers Accounting for Postretirement Benefits
    Other Than Pensions, however, it includes additional
    disclosure provisions for annual reporting, including detailed
    plan asset information by category, expanded benefit obligation
    disclosure and key assumptions. In addition, interim disclosures
    related to the individual elements of plan costs and
    employers current year contributions are required. See
    note 17 to consolidated financial statements for further
    information regarding RJRs pension and postretirement
    plans.

Note 2  Pending Business
Combination Transactions

On October 27, 2003, RJR announced the
signing of a definitive agreement with Brown &
Williamson Tobacco Corporation, referred to as B&W, a
subsidiary of British American Tobacco p.l.c., referred to
as BAT, to combine RJR Tobacco and the U.S. assets,
liabilities and operations of B&W, subject to specified
exceptions.

The agreement provides for establishing a new
publicly traded holding company, Reynolds American Inc.,
referred to as Reynolds American, with approximately
150 million shares outstanding. Reynolds American will
issue common shares to B&W in exchange for the
U.S. assets, liabilities and operations of B&W, subject
to specified exceptions, and will issue common shares to
existing RJR stockholders in exchange for their existing RJR
shares on a one-for-one basis. Upon completion of the
combination, B&W will own approximately 42% of Reynolds
American, and existing RJR stockholders will own approximately
58%. No indebtedness for borrowed money of B&W will be
assumed by Reynolds American. The transaction is expected to be
tax-free to RJR stockholders, and will be treated as a purchase
for financial accounting purposes.

The agreement provides for B&W to transfer
with its U.S. operations cash in an amount equal to accrued
expenses under the Master Settlement Agreement, referred to as
the MSA. The cash balance is contingent on the timing of closing
the transaction, but averages approximately $750 million
during the year. The RJR Tobacco and B&W U.S. tobacco
operations will be combined in an indirect subsidiary of
Reynolds American, and that subsidiary will indemnify B&W
for its historical and current litigation liabilities.

Under a separate agreement, RJR will pay a
subsidiary of BAT $400 million in cash to acquire the stock
of Lane Limited, a subsidiary that manufactures or distributes
cigar, roll-your-own and pipe tobacco brands and other tobacco
products, including DUNHILL and CAPTAIN BLACK tobacco products.
BAT will retain

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


the rights to use the BAT trademarks outside the
United States. Santa Fe and Lane will operate as
independent subsidiaries of Reynolds American.

The combination transactions are expected to be
completed during mid-2004, pending the necessary approvals from
U.S. and European regulatory authorities and RJR stockholders,
as well as satisfactory IRS rulings and other conditions. The
headquarters and operations of Reynolds American are expected to
be consolidated in Winston-Salem, North Carolina.

Note 3  Acquisitions and Joint
Venture

On July 16, 2002, RJR 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, has initially
marketed its products in France, Spain, the Canary Islands and
Italy, and in 2003, expanded into Andorra and Belgium.
RJRs financial contribution during the first five years is
expected to be $75 million to $100 million. RJR
Tobacco has licensed REYNOLDS, a new American-blend brand in a
unique Slide Box pack, to the joint venture. This investment is
accounted for using the equity method.

On January 16, 2002, RJR acquired all of the
voting stock of privately held Santa Fe. The acquisition
was accounted for as a purchase, with its cost of
$354 million allocated on the basis of the estimated fair
market value of the assets acquired and liabilities assumed. The
results of operations of Santa Fe have been included in the
accompanying consolidated statements of income since
January 16, 2002. Although Santa Fe is an operating
segment of RJR, its financial condition and results of
operations do not meet the materiality criteria to be separately
reportable.

In April 2003, Santa Fe, through a wholly
owned subsidiary, acquired with cash, the externally owned
portion of a joint venture, Santa Fe Natural Tobacco
Company: Europe GmbH. The cost of the acquisition, net of cash
acquired, was $9 million.

Note 4  Restructuring and
Impairment Charges

2003 Restructuring and Asset Impairment
Charges

The components of the 2003 restructuring and
asset impairment charges, recorded and utilized through
December 31, 2003, were:

|                               |                                |           |     |            |   |              |    |       |   |   |    |     |   |   |     |      |  
|------------------------------ | ------------------------------ | --------- | --- | ---------- | - | ------------ | -- | ----- | - | - | -- | --- | - | - | --- | ---- | -
|                               |                                | Employee  |     |            |   |              |    |      
|                               |                                | Severance |     |            |   | Contract     |    |      
|                               |                                | and       |     | Asset      |   | Termination/ |    |      
|                               |                                | Benefits  |     | Impairment |   | Exit Costs   |    | Total
|                               |                                |           |     |            |   |              |    |      
|Incurred during second quarter |                                | $         |    |            |   | $            | 18 |       |   | $ | 37 |     |   | $ | 55  |     
|                               | Utilized in second quarter     |           |     |           |   |              |    | (18   | ) |   |    | (22 | ) |   |     | (40  | )
|                               |                                |           |     |            |   |              |    |       |   |   |    |     |   |   |     |     
|Balance, June 30, 2003         |                                |           |    |            |   |              |   |       |   |   | 15 |     |   |   | 15  |     
|                               | Incurred during third quarter  |           |     | 292        |   |              |    | 10    |   |   |    | 9   |   |   |     | 311  |  
|                               | Utilized in third quarter      |           |     | (80        | ) |              |    | (10   | ) |   |    | (24 | ) |   |     | (114 | )
|                               |                                |           |     |            |   |              |    |       |   |   |    |     |   |   |     |     
|Balance, September 30, 2003    |                                |           | 212 |            |   |              |   |       |   |   |   |     |   |   | 212 |     
|                               |                                |           |     |            |   |              |    |       |   |   |    |     |   |   |     |     
|                               | Incurred during fourth quarter |           |     |           |   |              |    |      |   |   |    | 7   |   |   |     | 7    |  
|                               | Utilized in fourth quarter     |           |     | (12        | ) |              |    |      |   |   |    | (6  | ) |   |     | (18  | )
|                               |                                |           |     |            |   |              |    |       |   |   |    |     |   |   |     |     
|Balance, December 31, 2003     |                                | $         | 200 |            |   | $            |   |       |   | $ | 1  |     |   | $ | 201 |     
|                               |                                |           |     |            |   |              |    |       |   |   |    |     |   |   |     |     

In April 2003, in response to continuing
challenges of an intensely competitive environment, primarily
pricing pressures, RJR announced initiatives to fundamentally
rethink RJR Tobaccos approach to the marketplace and
realign the cost structures of RJR Tobacco and RJR. As a result,
during the second quarter of 2003, RJR and RJR Tobacco incurred
initial restructuring and impairment charges of
$55 million. RJR

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Tobacco recorded a non-cash $18 million
impairment charge to fully write off certain production
equipment that it abandoned. RJR Tobacco also incurred contract
termination expenses of $29 million related to the
discontinuation of certain event-marketing programs, and RJR
incurred other restructuring associated costs of $8 million
during the second quarter of 2003.

In September 2003, RJR announced a refocused
brand portfolio strategy for RJR Tobacco and a significant cost
reduction initiative. Marketing investments now focus on two
growth brands, CAMEL and SALEM, with more limited investments in
WINSTON and DORAL, to optimize profitability. Certain of these
initiatives resulted in consolidated restructuring and
impairment charges of $311 million, or $189 million
after tax, in the third quarter of 2003. Of these charges, RJR
Tobacco incurred $287 million related to severance and
benefits, $10 million related to asset impairments and
$1 million related to associated exit costs. The remaining
$13 million was incurred by RJR.

Of the third quarter charges, the employee
severance and benefits relate to a workforce reduction of 40%,
or approximately 2,600 full-time employees, in operations
and corporate functions. Approximately 1,400 reductions were
completed as of December 31, 2003. The workforce reduction
is expected to be materially completed during 2004. The asset
impairment resulted from the abandonment of certain
merchandising fixtures. The third quarter exit costs included
professional fees for valuation and consulting services.

In conjunction with the 2003 restructuring plan,
during the fourth quarter, RJR incurred $3 million of
consulting fees and RJR Tobacco incurred $4 million of
charges related primarily to aircraft lease termination and
outplacement service fees related to restructuring.

Additional charges of approximately
$20 million are expected to be incurred during 2004 in
connection with the 2003 restructuring plans. The cash portion
of the 2003 restructuring and impairment charges is expected to
be $265 million, of which $212 million relates to
employee severance costs and $53 million relates to exit
costs. As of December 31, 2003, $64 million of this
amount had been paid. Of the $108 million non-cash portion
of the charges, $80 million related to benefit charges, and
$28 million related to asset impairments. In the
consolidated balance sheet as of December 31, 2003,
$132 million is included in accrued liabilities and other
and $69 million is included in other noncurrent liabilities.

2002 Restructuring and Asset Impairment
Charges

The components of the 2002 restructuring and
asset impairment charges, recorded and utilized through
December 31, 2003, were:

|                           |                  |           |     |            |   |              |     |       |   |   |   |    |   |   |     |      |  
|-------------------------- | ---------------- | --------- | --- | ---------- | - | ------------ | --- | ----- | - | - | - | -- | - | - | --- | ---- | -
|                           |                  | Employee  |     |            |   |              |     |      
|                           |                  | Severance |     |            |   | Contract     |     |      
|                           |                  | and       |     | Asset      |   | Termination/ |     |      
|                           |                  | Benefits  |     | Impairment |   | Exit Costs   |     | Total
|                           |                  |           |     |            |   |              |     |      
|Original charge            |                  | $         | 102 |            |   | $            | 115 |       |   | $ | 7 |    |   | $ | 224 |     
|                           | Utilized in 2002 |           |     | (44        | ) |              |     | (115  | ) |   |   | (2 | ) |   |     | (161 | )
|                           |                  |           |     |            |   |              |     |       |   |   |   |    |   |   |     |     
|Balance, December 31, 2002 |                  |           | 58  |            |   |              |    |       |   |   | 5 |    |   |   | 63  |     
|                           | Utilized in 2003 |           |     | (27        | ) |              |     |      |   |   |   |   |   |   |     | (27  | )
|                           | Adjusted in 2003 |           |     | (2         | ) |              |     |      |   |   |   | (3 | ) |   |     | (5   | )
|                           |                  |           |     |            |   |              |     |       |   |   |   |    |   |   |     |     
|Balance, December 31, 2003 |                  | $         | 29  |            |   | $            |    |       |   | $ | 2 |    |   | $ | 31  |     
|                           |                  |           |     |            |   |              |     |       |   |   |   |    |   |   |     |     

In the fourth quarter of 2002, RJR Tobacco
recorded a pre-tax restructuring charge of $224 million,
$135 million after tax, in response to changing competitive
practices within the tobacco industry during the second half of
2002.

The employee severance and benefits relate to
572 full-time employee workforce reductions in operations
support and corporate functions, of which 25 positions
remained at December 31, 2003. These remaining positions
are expected to be eliminated in the first quarter of 2004.

83



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The asset impairment resulted from the
remeasurement of the non-tobacco businesses at the lower of
their carrying value or fair value less cost to sell. The
non-tobacco businesses are classified as assets held for sale
and liabilities related to assets held for sale in the
consolidated balance sheets, in accordance with
SFAS No. 144. As of December 31, 2003, the
carrying amounts of the major classes of assets and liabilities
in the disposal group included $13 million of accounts
receivable, $31 million of inventories, $40 million of
property, plant and equipment and other, and $10 million of
accounts payable and accrued liabilities. As of
December 31, 2002, the carrying amounts of the major
classes of assets and liabilities in the disposal group included
$15 million of accounts receivable, $52 million of
inventories, $11 million of property, plant and equipment
and other, and $8 million of accounts payable and accrued
liabilities. RJR Tobacco completed the sale of one of the
non-tobacco businesses in the second quarter of 2003, and
expects to complete the sale of the remaining business,
currently in negotiation, during the first half of 2004.

Contract termination and exit costs included
certain contract terminations and lease terminations of 15 sales
offices. Exit costs also included the separation of the
non-tobacco businesses held for sale. During 2003,
$5 million of the charge, concerning expected severance and
related benefits and exit costs of field sales offices, was
reversed, and was included as a reduction in restructuring and
asset impairment charges in the consolidated statement of income
for 2003.

The cash portion of the 2002 restructuring and
impairment charges is expected to be $58 million and
primarily relates to employee severance costs. As of
December 31, 2003, $27 million of this amount had been
paid. The $161 million non-cash portion included
$44 million related to employee benefits, $115 million
related to asset impairments and $2 million related to the
write-off of prepaid promotional rights that were terminated. In
the consolidated balance sheet as of December 31, 2003,
$25 million is included in accrued liabilities and other
and $6 million is included in other noncurrent liabilities.

Note 5  Discontinued
Operations

Discontinued operations reflect transactions
related to the 1999 sale of the international tobacco business
to Japan Tobacco Inc. During 2003, these transactions included a
$106 million favorable resolution of tax matters and a
$16 million after-tax reversal of an indemnification
accrual. Transactions during 2002 and 2001 included a
$40 million after-tax reversal of an indemnification
accrual and a $9 million after-tax, purchase-price
adjustment, respectively. Including these adjustments, the net
after-tax gain on the sale of the international tobacco business
was $2.5 billion.

84



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 6  Income Per
Share

The components of the calculation of income per
share were:

|                                                 |                                      |                     |        |        |   |      |        |     |     |   |        |     |       | 
|------------------------------------------------ | ------------------------------------ | ------------------- | ------ | ------ | - | ---- | ------ | --- | --- | - | ------ | --- | ----- | 
|                                                 |                                      |                    
|                                                 |                                      | For the Years Ended
|                                                 |                                      | December 31,       
|                                                 |                                      |                    
|                                                 |                                      | 2003                |        | 2002   |   | 2001
|                                                 |                                      |                     |        |        |   |     
|Income (loss) from continuing operations         |                                      | $                   | (3,689 | )      |   | $    | 418    |     |     | $ | 444    |    
|Gain (loss) from discontinued operations         |                                      |                     | 122    |        |   |      | 40     |     |     |   | (9     | )  
|Extraordinary item  gain on acquisition         |                                      |                     | 121    |        |   |      |       |     |     |   |       |    
|Cumulative effect of accounting change           |                                      |                     |       |        |   |      | (502   | )   |     |   |       |    
|                                                 |                                      |                     |        |        |   |      |        |     |     |   |        |    
|                                                 | Net income (loss)                    |                     | $      | (3,446 | ) |      | $      | (44 | )   |   | $      | 435 |      
|                                                 |                                      |                     |        |        |   |      |        |     |     |   |        |    
|Basic weighted average shares, in thousands(1)   |                                      |                     | 83,697 |        |   |      | 88,733 |     |     |   | 97,043 |    
|                                                 | Effect of dilutive potential shares: |                     |        |        |   |      |        |     |     |   |        |     |      
|                                                 |                                      | Options             |        |        |  |      |        |     | 897 |   |        |     | 1,472 | 
|                                                 |                                      | Restricted stock    |        |        |  |      |        |     | 545 |   |        |     | 471   | 
|                                                 |                                      |                     |        |        |   |      |        |     |     |   |        |    
|Diluted weighted average shares, in thousands(2) |                                      |                     | 83,697 |        |   |      | 90,175 |     |     |   | 98,986 |    
|                                                 |                                      |                     |        |        |   |      |        |     |     |   |        |    






|    |                                                                                                                                                                                                                                                                                                                              
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Outstanding contingently issuable restricted
    stock of 1.0 million shares, 1.6 million shares and
    1.7 million shares were excluded from the basic share
    calculation for the years ended December 31, 2003, 2002 and
    2001, respectively, as the related vesting provisions had not
    been met.               
|(2) | Potentially dilutive shares of 0.4 million
    options and 0.3 million restricted shares were excluded
    from diluted amounts for 2003 and 0.3 million common stock
    equivalents were excluded from diluted per share amounts for
    2002, as they would have been anti-dilutive. No anti-dilution
    existed in 2001.

Note 7  Short-Term
Investments

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

|                                               |                              |      |    |      |  |   |     |     | 
|---------------------------------------------- | ---------------------------- | ---- | -- | ---- |  | - | --- | --- | 
|                                               |                              | 2003 |    | 2002
|                                               |                              |      |    |     
|Commercial paper and asset-backed securities   |                              | $    | 83 |      |  | $ | 263 |    
|Money market funds and certificates of deposit |                              |      |   |      |  |   | 151 |    
|Federal agency securities                      |                              |      | 3  |      |  |   | 126 |    
|Master notes                                   |                              |      |   |      |  |   | 25  |    
|U.S. government treasury bills                 |                              |      |   |      |  |   | 6   |    
|Other investments                              |                              |      | 21 |      |  |   | 24  |    
|                                               |                              |      |    |      |  |   |     |    
|                                               | Total short-term investments |      | $  | 107  |  |   | $   | 595 | 
|                                               |                              |      |    |      |  |   |     |    

The contractual maturities of these securities
averaged less than one year. Realized and unrealized gains and
losses on available-for-sale securities for the years ended
December 31, 2003 and 2002 were not significant, and
accordingly, the amortized cost of these securities approximated
fair value.

85



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 8  Inventories

The major components of inventories at
December 31 were:

|                    |       |      |     |      |  |   |     |     | 
|------------------- | ----- | ---- | --- | ---- |  | - | --- | --- | 
|                    |       | 2003 |     | 2002
|                    |       |      |     |     
|Leaf tobacco        |       | $    | 605 |      |  | $ | 599 |    
|Raw materials       |       |      | 19  |      |  |   | 18  |    
|Work in process     |       |      | 36  |      |  |   | 35  |    
|Finished products   |       |      | 86  |      |  |   | 110 |    
|Other               |       |      | 19  |      |  |   | 26  |    
|                    |       |      |     |      |  |   |     |    
|                    | Total |      |     | 765  |  |   |     | 788 | 
|Less LIFO allowance |       |      | 81  |      |  |   | 26  |    
|                    |       |      |     |      |  |   |     |    
|                    |       | $    | 684 |      |  | $ | 762 |    
|                    |       |      |     |      |  |   |     |    

Inventories valued under the LIFO method were
approximately $639 million and $736 million at
December 31, 2003 and 2002, respectively. The LIFO
allowance reflects the excess of the current cost of LIFO
inventories at December 31, 2003 and 2002, over the amount
at which these inventories were carried on the consolidated
balance sheets. During 2003 net income increased by
$4 million due to LIFO inventory liquidations. During 2002
and 2001, there was no impact on net income from LIFO inventory
liquidations.

Note 9  Short-Term
Borrowings and Borrowing Arrangements

RJRs revolving credit facility with a
syndicate of banks was amended and restated on May 10,
2002. Under the amendment and restatement, in May 2003 the
committed amount was reduced from $622 million to
$531 million through November 2004. The facility was
further amended on September 25, 2003, primarily to modify
certain definitions of terms related to negative covenants. RJR
can use the full facility to obtain loans or letters of credit,
at its option.

Since prior to 2002, two of RJRs material
subsidiaries, RJR Tobacco and RJR Acquisition Corp.,
have guaranteed RJRs obligations under the revolving
credit facility. During 2003, Moodys lowered its rating of
RJRs guaranteed, previously unsecured notes below
investment grade, to Ba2, and Standard & Poors
lowered its rating to BB+. These downgrades required RJRs
other material subsidiaries, including Santa Fe, to also
guarantee the facility and to pledge all of their assets to
secure their obligations under RJRs revolving credit
facility. These actions reflected the rating agencies
concern over recent industry trends including heavy promotional
activity, the growth of the deep-discount price tier, the
volatility of tobacco litigation and RJRs competitive
position. On October 28, 2003, Moodys changed its
ratings outlook from negative to stable, reflecting
opportunities offered by the proposed combination of RJR and
B&Ws U.S. tobacco operations. The outlook for
Standard & Poors ratings remains negative.
Concerns about, or further lowering of, the ratings of
RJRs guaranteed, previously unsecured unsubordinated debt
notes by Standard & Poors or Moodys could
have an adverse impact on RJRs ability to access the debt
markets. However, given that RJR has significant cash balances
and does not anticipate a need to issue additional public debt
prior to 2006, RJRs management believes that such concerns
about, or further lowering of, such ratings would not have a
material adverse impact on RJRs cash flows.

RJR is not required to maintain compensating
balances; however, RJR pays commitment fees of 1.5% per
annum of the revolving credit facility committed amount.
Borrowings under the revolving credit facility bear interest at
rates that vary with the prime rate or LIBOR. 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 up to an additional
$500 million in dividends and share repurchases may be
made. Stock

86



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


repurchases also are limited to the extent that a
stated minimum level of net worth must be maintained. At
December 31, 2003, RJR had $20 million in letters of
credit outstanding under the facility. No borrowings were
outstanding, and the remaining $511 million of the facility
was available for borrowing.

RJR has a $30 million uncommitted, unsecured
line of credit with one bank. No borrowings were outstanding on
this line of credit at December 31, 2003.

Note 10  Accrued
Liabilities and Other

Accrued liabilities at December 31 included:

|                              |  |      |       |      |  |   |       | 
|----------------------------- |  | ---- | ----- | ---- |  | - | ----- | 
|                              |  | 2003 |       | 2002
|                              |  |      |       |     
|Payroll and employee benefits |  | $    | 325   |      |  | $ | 310   | 
|Marketing and advertising     |  |      | 383   |      |  |   | 345   | 
|Accrued interest              |  |      | 21    |      |  |   | 28    | 
|Accrued restructuring charges |  |      | 163   |      |  |   | 41    | 
|Other                         |  |      | 242   |      |  |   | 351   | 
|                              |  |      |       |      |  |   |       | 
|                              |  | $    | 1,134 |      |  | $ | 1,075 | 
|                              |  |      |       |      |  |   |       | 

Note 11  Income
Taxes

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

|                                          |                 |                     |      |      |   |      |     |     |   |   |     |     |  
|----------------------------------------- | --------------- | ------------------- | ---- | ---- | - | ---- | --- | --- | - | - | --- | --- | -
|                                          |                 |                    
|                                          |                 | For the Years Ended
|                                          |                 | December 31,       
|                                          |                 |                    
|                                          |                 | 2003                |      | 2002 |   | 2001
|                                          |                 |                     |      |      |   |     
|Current:                                  |                 |                     |      |      |   |      |     |     |   |   |     |    
|                                          | Federal         |                     | $    | 200  |   |      | $   | 202 |   |   | $   | 426 |  
|                                          | State and other |                     |      | 41   |   |      |     | 45  |   |   |     | 65  |  
|                                          |                 |                     |      |      |   |      |     |     |   |   |     |    
|                                          |                 |                     | 241  |      |   |      | 247 |     |   |   | 491 |    
|                                          |                 |                     |      |      |   |      |     |     |   |   |     |    
|Deferred:                                 |                 |                     |      |      |   |      |     |     |   |   |     |    
|                                          | Federal         |                     |      | (413 | ) |      |     | 30  |   |   |     | (36 | )
|                                          | State and other |                     |      | (57  | ) |      |     | (12 | ) |   |     | (7  | )
|                                          |                 |                     |      |      |   |      |     |     |   |   |     |    
|                                          |                 |                     | (470 | )    |   |      | 18  |     |   |   | (43 | )  
|                                          |                 |                     |      |      |   |      |     |     |   |   |     |    
|Provision for (benefit from) income taxes |                 | $                   | (229 | )    |   | $    | 265 |     |   | $ | 448 |    
|                                          |                 |                     |      |      |   |      |     |     |   |   |     |    

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

|                                   |                                                                       |      |     |      |   |   |     |      |  
|---------------------------------- | --------------------------------------------------------------------- | ---- | --- | ---- | - | - | --- | ---- | -
|                                   |                                                                       | 2003 |     | 2002
|                                   |                                                                       |      |     |     
|Deferred tax assets (liabilities): |                                                                       |      |     |      |   |   |     |     
|                                   | LIFO inventories                                                      |      | $   | (184 | ) |   | $   | (237 | )
|                                   | Pension and other postretirement liabilities                          |      |     | 62   |   |   |     | 71   |  
|                                   | Tobacco settlement related accruals and other
    accrued liabilities |      |     | 644  |   |   |     | 608  |  
|                                   | Other accrued liabilities                                             |      |     | 191  |   |   |     | 146  |  
|                                   |                                                                       |      |     |      |   |   |     |     
|                                   |                                                                       | $    | 713 |      |   | $ | 588 |     
|                                   |                                                                       |      |     |      |   |   |     |     

No valuation allowance has been provided, as RJR
believes it is more likely than not that all of the deferred tax
assets will be realized.

87



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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

|                          |                                              |      |       |      |   |   |       |      |  
|------------------------- | -------------------------------------------- | ---- | ----- | ---- | - | - | ----- | ---- | -
|                          |                                              | 2003 |       | 2002
|                          |                                              |      |       |     
|Deferred tax assets:      |                                              |      |       |      |   |   |       |     
|                          | Pension and other postretirement liabilities |      | $     | (368 | ) |   | $     | (413 | )
|                          | Other accrued liabilities                    |      |       | (62  | ) |   |       | (92  | )
|                          |                                              |      |       |      |   |   |       |     
|                          |                                              |      | (430  | )    |   |   | (505  | )   
|                          |                                              |      |       |      |   |   |       |     
|Deferred tax liabilities: |                                              |      |       |      |   |   |       |     
|                          | Property and equipment                       |      |       | 266  |   |   |       | 284  |  
|                          | Trademarks                                   |      |       | 695  |   |   |       | 823  |  
|                          | Other                                        |      |       | 275  |   |   |       | 634  |  
|                          |                                              |      |       |      |   |   |       |     
|                          |                                              |      | 1,236 |      |   |   | 1,741 |     
|                          |                                              |      |       |      |   |   |       |     
|                          |                                              | $    | 806   |      |   | $ | 1,236 |     
|                          |                                              |      |       |      |   |   |       |     

The total deferred tax assets were
$1,327 million and $1,330 million as of
December 31, 2003 and 2002, respectively. The total
deferred tax liabilities were $1,420 million and
$1,978 million as of December 31, 2003 and 2002,
respectively.

Pre-tax income (loss) for domestic and foreign
operations consisted of the following:

|                                 |  |                     |        |      |  |      |     |  |  |   |     | 
|-------------------------------- |  | ------------------- | ------ | ---- |  | ---- | --- |  |  | - | --- | 
|                                 |  |                    
|                                 |  | For the Years Ended
|                                 |  | December 31,       
|                                 |  |                    
|                                 |  | 2003                |        | 2002 |  | 2001
|                                 |  |                     |        |      |  |     
|Domestic (includes U.S. exports) |  | $                   | (3,936 | )    |  | $    | 679 |  |  | $ | 892 | 
|Foreign                          |  |                     | 18     |      |  |      | 4   |  |  |   |    | 
|                                 |  |                     |        |      |  |      |     |  |  |   |     | 
|Pre-tax income (loss)            |  | $                   | (3,918 | )    |  | $    | 683 |  |  | $ | 892 | 
|                                 |  |                     |        |      |  |      |     |  |  |   |     | 

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

|                                                                         |  |                     |        |      |  |      |       |  |  |   |      |  
|------------------------------------------------------------------------ |  | ------------------- | ------ | ---- |  | ---- | ----- |  |  | - | ---- | -
|                                                                         |  |                    
|                                                                         |  | For the Years Ended
|                                                                         |  | December 31,       
|                                                                         |  |                    
|                                                                         |  | 2003                |        | 2002 |  | 2001
|                                                                         |  |                     |        |      |  |     
|Income taxes computed at statutory
    U.S. federal income tax rates     |  | $                   | (1,371 | )    |  | $    | 239   |  |  | $ | 312  |  
|State and local income taxes, net of federal tax
    benefits            |  |                     | (12    | )    |  |      | 21    |  |  |   | 37   |  
|Goodwill amortization                                                    |  |                     |       |      |  |      |      |  |  |   | 91   |  
|Goodwill impairment                                                      |  |                     | 1,317  |      |  |      |      |  |  |   |     |  
|Resolution of prior years tax matters                                   |  |                     | (169   | )    |  |      |      |  |  |   |     |  
|Other items, net                                                         |  |                     | 6      |      |  |      | 5     |  |  |   | 8    |  
|                                                                         |  |                     |        |      |  |      |       |  |  |   |      |  
|Provision for (benefit from) income taxes from
    continuing operations |  | $                   | (229   | )    |  | $    | 265   |  |  | $ | 448  |  
|                                                                         |  |                     |        |      |  |      |       |  |  |   |      |  
|Effective tax rate                                                       |  |                     | 5.8    | %    |  |      | 38.8% |  |  |   | 50.2 | %
|                                                                         |  |                     |        |      |  |      |       |  |  |   |      |  

At December 31, 2003, there was
$22 million of accumulated and undistributed income of
foreign subsidiaries. These earnings were reinvested by
management abroad indefinitely. Accordingly, no applicable
deferred income taxes have been provided.

In the fourth quarter of 2003, RJR recorded an
adjustment of $121 million to the gain related to the
acquisition of NGH, which occurred in 2000, reflecting the
favorable resolution of associated tax matters. Including this
adjustment, the net after-tax gain on the acquisition of NGH was
$1.6 billion.

88



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 12  Long-Term
Debt

Long-term debt as of December 31 consisted
of:

|                                                           |  |      |       |      |  |   |       |  
|---------------------------------------------------------- |  | ---- | ----- | ---- |  | - | ----- | -
|                                                           |  | 2003 |       | 2002
|                                                           |  |      |       |     
|8.25%9.25% unsecured notes, due 2004 to 2013              |  | $    | 195   |      |  | $ | 288   |  
|6.5%7.875% guaranteed secured notes, due
    2006 to 2012 |  |      | 1,532 |      |  |   | 2,110 |  
|9.5% junior subordinated debentures, due 2047              |  |      |      |      |  |   | 98    |  
|Current maturities of long-term debt                       |  |      | (56   | )    |  |   | (741  | )
|                                                           |  |      |       |      |  |   |       |  
|                                                           |  | $    | 1,671 |      |  | $ | 1,755 |  
|                                                           |  |      |       |      |  |   |       |  

The maturities of long-term debt, net of discount
and excluding fair value adjustments associated with interest
rate swaps of $88 million, are as follows:

|           |  |        |       | 
|---------- |  | ------ | ----- | 
|Year       |  | Amount
|           |  |       
|2005       |  | $      | 50    | 
|2006       |  |        | 499   | 
|2007       |  |        | 329   | 
|2008       |  |        |      | 
|Thereafter |  |        | 705   | 
|           |  |        |       | 
|           |  | $      | 1,583 | 
|           |  |        |       | 

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

RJR filed a shelf registration statement,
effective December 22, 1999 and superseded in April 2001,
for the issuance of up to $1.876 billion of 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 remaining $1.45 billion guaranteed,
previously unsecured notes described above, unlike RJRs
other non-bank debt, are guaranteed by RJRs material
subsidiaries, including RJR Tobacco and Santa Fe.
Because RJR and the guarantors have pledged their assets to
secure their obligations under the revolving credit facility, as
amended and restated, certain of the guarantors, which are
considered restricted subsidiaries under the guaranteed,
previously unsecured notes, also have pledged certain of their
assets to secure these notes. Excluded from the pledge to secure
these notes are intellectual property, inventory, accounts
receivable, cash and certain other assets. Generally, the terms
of these notes restrict the issuance of guarantees by
subsidiaries, the pledge of collateral, sale/leaseback
transactions and the transfer of all or substantially all of the
assets of RJR and its subsidiaries.

On June 16, 2003, Moodys lowered its
rating of RJRs guaranteed, previously unsecured notes
below investment grade, to Ba1. On June 30, 2003,
Standard & Poors lowered its rating of RJRs
guaranteed, previously unsecured notes below investment grade,
to BB+. On August 7, 2003, Moodys further lowered its
rating on RJRs guaranteed, previously unsecured notes to
Ba2. On October 28, 2003, Moodys changed its ratings
outlook from negative to stable, reflecting opportunities
offered by the proposed combination of RJR Tobacco and
B&Ws U.S. tobacco operations. The outlook for
Standard & Poors ratings remains negative,
reflecting a continuing difficult U.S. tobacco operating
environment, as well as legal uncertainty.

In May 2003, RJR repaid $550 million
guaranteed, unsecured notes with a fixed interest rate of
7.375%, utilizing the proceeds from the issuance of notes in May
2002.

On their due date of September 15, 2003, RJR
repaid $93 million of unsecured public notes with a fixed
interest rate of 7.625%.

89



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


On the mandatory redemption date of
September 30, 2003, RJR used an associated irrevocable
trust to repay the $98 million 9.5% junior subordinated
debentures, due in 2047, acquired December 2000 in connection
with the acquisition of NGH. Interest on these debentures was
paid quarterly in arrears. These debentures were effectively
defeased by an irrevocable trust, which was included in other
current assets in the accompanying consolidated balance sheets
as of December 31, 2002.

As of December 31, 2003, RJR had
$195 million of unsecured public notes outstanding, at
fixed interest rates of 8.25% through 9.25%, due in 2004 through
2013. The estimated fair value of RJRs long-term debt was
$1.7 billion, $2.5 billion and $1.8 billion, with an
effective average rate of 4.31%, 5.44% and 7.89%, as of
December 31, 2003, 2002 and 2001, respectively. The fair
values are based on available market quotes and discounted cash
flows, as appropriate.

Note 13  Commitments and
Contingencies

Litigation Affecting the Cigarette
Industry

Overview

Introduction.Various legal actions, proceedings and
claims, including litigation claiming that lung cancer and other
diseases, as well as addiction, have resulted from the use of,
or exposure to, RJRs operating subsidiaries
products, are pending or may be instituted against RJR Tobacco
or its affiliates, including RJR, or indemnitees. During the
fourth quarter of 2003, 29 new cases were served against
RJR Tobacco or its affiliates, including RJR, or
indemnitees, and 32 cases were dismissed or otherwise resolved
without trial in their favor. During 2003, 256 new cases were
served and 314 cases were dismissed or otherwise resolved. On
December 31, 2003, there were 1,592 active cases pending
(including approximately 1,061 individual smoker cases pending
in West Virginia state court as a consolidated action), as
compared with 1,650 on December 31, 2002, and 1,639 on
December 31, 2001. As of January 23, 2004, 1,577
active tobacco-related cases were pending against RJR Tobacco
and/or its affiliates or indemnitees: 1,551 in the United
States; 20 in Puerto Rico; 2 in Israel; and 4 in Canada. The
U.S. case number does not include the 2,737
Broin II cases, which involve individual flight
attendants alleging injuries as a result of exposure to
environmental tobacco smoke, referred to as ETS or secondhand
smoke, in aircraft cabins, pending as of January 23, 2004,
and discussed below.

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NOTES TO CONSOLIDATED FINANCIAL
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The U.S. cases, exclusive of the
Broin II cases, are pending in the following
32 states and the District of Columbia.

|                     |  |            |       |  
|-------------------- |  | ---------- | ----- | -
|                     |  | Number of 
|State                |  | U.S. Cases
|                     |  |           
|West Virginia        |  |            | 1,071 | *
|Maryland             |  |            | 186   |  
|Florida              |  |            | 72    |  
|Mississippi          |  |            | 49    |  
|New York             |  |            | 26    |  
|Louisiana            |  |            | 23    |  
|California           |  |            | 21    |  
|Nevada               |  |            | 14    |  
|Alabama              |  |            | 13    |  
|Iowa                 |  |            | 10    |  
|Missouri             |  |            | 9     |  
|Illinois             |  |            | 8     |  
|Massachusetts        |  |            | 7     |  
|District of Columbia |  |            | 5     |  
|Tennessee            |  |            | 4     |  
|Connecticut          |  |            | 3     |  
|New Hampshire        |  |            | 3     |  
|New Jersey           |  |            | 3     |  
|Texas                |  |            | 3     |  
|Arizona              |  |            | 2     |  
|Kansas               |  |            | 2     |  
|Minnesota            |  |            | 2     |  
|North Carolina       |  |            | 2     |  
|Ohio                 |  |            | 2     |  
|Pennsylvania         |  |            | 2     |  
|Washington           |  |            | 2     |  
|Georgia              |  |            | 1     |  
|New Mexico           |  |            | 1     |  
|Oklahoma             |  |            | 1     |  
|Oregon               |  |            | 1     |  
|South Carolina       |  |            | 1     |  
|South Dakota         |  |            | 1     |  
|Utah                 |  |            | 1     |  






|  |                                                                   
|- | ------------------------------------------------------------------
|* | 1,061 of the 1,071 cases are pending as a
    consolidated action.

Of the approximately 1,551 active
U.S. cases, 89 are pending in federal court, 1,460 in state
court and 2 in tribal court.

The following table lists the categories of the
U.S. tobacco-related cases pending against RJR Tobacco or
its affiliates, including RJR, or indemnitees; the number of
cases relating to each case type pending as of January 23,
2004; the changes in the number of cases by case type since
October 15, 2003, the cut-off date used to calculate the
number of cases pending against RJR Tobacco or its
affiliates or indemnitees in RJRs Quarterly Report on
Form 10-Q for the quarter ended September 30, 2003;
and a cross-reference to the discussion of each case type.

|                                                          |  |             |       |             |  |           |           |  |  |  |     | 
|--------------------------------------------------------- |  | ----------- | ----- | ----------- |  | --------- | --------- |  |  |  | --- | 
|                                                          |  |             |       | Change in   |  |          
|                                                          |  | Number of   |       | Number of   |  |          
|                                                          |  | Cases as of |       | Cases since |  |          
|                                                          |  | January 23, |       | October 15, |  | Page     
|Case Type                                                 |  | 2004        |       | 2003        |  | Reference
|                                                          |  |             |       |             |  |          
|Individual Smoking and Health                             |  |             | 1,499 |             |  |           | +1        |  |  |  | 101 | 
|Flight Attendant-ETS (Broin II)                           |  |             | 2,737 |             |  |           | -48       |  |  |  | 102 | 
|Class Action                                              |  |             | 18    |             |  |           | -1        |  |  |  | 103 | 
|Governmental Health-Care Cost Recovery                    |  |             | 8     |             |  |           | -1        |  |  |  | 107 | 
|Other Health-Care Cost Recovery and Aggregated
    Claims |  |             | 5     |             |  |           | -2        |  |  |  | 110 | 
|Master Settlement Agreement-Enforcement and
    Validity  |  |             | 2     |             |  |           | No Change |  |  |  | 112 | 
|Asbestos Contribution                                     |  |             | 7     |             |  |           | No Change |  |  |  | 113 | 
|Antitrust                                                 |  |             | 6     |             |  |           | -26       |  |  |  | 113 | 
|Other Litigation                                          |  |             | 6     |             |  |           | -5        |  |  |  | 115 | 

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 the other defendants
appealed the verdict. On May 21, 2003, Floridas Third
District Court of Appeal reversed the trial courts final

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STATEMENTS  (Continued)


judgment and remanded the case to the Dade County
Circuit Court with instructions to decertify the class and
dismiss the individual cases. The appellate court denied the
plaintiffs motion for rehearing on September 22,
2003. On October 23, 2003, the plaintiffs filed a notice
asking the Florida Supreme Court to review the case. Briefing on
whether the Florida Supreme Court should review the case is
complete. It is not known when the Florida Supreme Court will
issue a decision. Although RJR Tobacco remains confident in
its bases for appeal in this case, RJR Tobacco cannot predict
the final outcome of the appellate process. See
 Class-Action Suits below for a further
description of the Engle case.

In November 1998, the major U.S. cigarette
manufacturers, including RJR Tobacco, entered into the
Master Settlement Agreement with 46 U.S. states and certain
U.S. territories and possessions. These cigarette
manufacturers previously settled four other cases scheduled to
come to trial, brought on behalf of Mississippi, Florida, Texas
and Minnesota, by separate agreements with each state. The MSA
and other state settlement agreements:



| |   |                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------
| |  | settled all health-care cost recovery actions
    brought by, or on behalf of, the settling jurisdictions;                 
|
| |  | released the major U.S. cigarette
    manufacturers from various additional present and potential
    future claims;       
|
| |  | imposed a stream of future payment obligations on
    RJR Tobacco and the other major U.S. cigarette
    manufacturers; and
|
| |  | placed significant restrictions on their ability
    to market and sell cigarettes.                                        

The aggregate cash payments made by
RJR Tobacco under the MSA and the other state settlement
agreements during the years 2003, 2002 and 2001 were
$1.8 billion, $2.5 billion and $2.4 billion,
respectively. RJR Tobacco estimates these payments will be
$1.9 billion in 2004, and will exceed $1.8 billion per
year thereafter. However, these payments will be subject to
adjustments for, among other things, the volume of cigarettes
sold by RJR Tobacco, RJR Tobaccos market share
and inflation. See  Governmental Health-Care
Cost Recovery Cases  MSA and Other State Settlement
Agreements below for a detailed discussion of the MSA and
the other state settlement agreements, including
RJR Tobaccos monetary obligations under these
agreements.

Certain Terms and
Phrases.Certain terms and phrases
that are used in this disclosure may require some explanation.
The terms judgment or final judgment
refer generally to the final decision of the court resolving the
dispute and determining the rights and obligations of the
parties. At the trial court level, for example, a final judgment
generally is entered by the court after a jury verdict and after
post-verdict motions have been decided. As a general
proposition, the losing party can appeal a verdict only after a
final judgment has been entered by the trial court.

The term damages refers to the amount
of money sought by a plaintiff in a complaint, or awarded to a
party by a jury, or in some cases by a judge. Compensatory
damages are awarded to compensate the prevailing party for
actual losses suffered  if liability is proved. In
cases in which there is a finding that a defendant has acted
willfully, maliciously or fraudulently, generally based on a
higher burden of proof than is required for a finding of
liability for compensatory damages, a plaintiff also may be
awarded punitive damages. Although damages may be
awarded at the trial court stage, a losing party generally may
be protected from paying any damages until all appellate avenues
have been exhausted by posting a supersedeas bond. The amount of
such a bond is governed by the law of the relevant jurisdiction
and generally is set at the amount of damages plus some measure
of statutory interest, modified at the discretion of the
appropriate court or subject to a cap set by court or statute.

The term settlement refers to certain
types of cases in which cigarette manufacturers, including
RJR Tobacco, have agreed to resolve disputes with certain
plaintiffs without resolving the case through trial. The
principal terms of settlements entered into by RJR Tobacco
are explained in the following disclosure.

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STATEMENTS  (Continued)


Accounting for Tobacco-Related Litigation
Contingencies.In accordance with
applicable accounting principles, RJR and RJR Tobacco will
record any loss related to tobacco litigation at such time as an
unfavorable outcome becomes probable and the amount can be
reasonably estimated. For the reasons set forth below, except
for Kenyon v. R. J. Reynolds Tobacco Co., discussed
below, RJRs management continues to conclude that the loss
of any particular smoking and health tobacco litigation claim
against RJR Tobacco or its affiliates, when viewed on an
individual basis, is not probable. RJR Tobacco and its
affiliates, including RJR, believe that they have a number of
valid defenses to the tobacco-related litigation claims against
them, as well as valid bases for appeal of adverse verdicts
against RJR Tobacco. RJR and RJR Tobacco have, through
their counsel, filed pleadings and memoranda in pending
tobacco-related litigation that set forth and discuss a number
of grounds and defenses that RJR, RJR Tobacco and their
counsel believe have a valid basis in law and fact. Based on
their experience in the tobacco-related litigation against them
and the strength of the defenses available to them in such
litigation, RJR Tobacco and its affiliates believe that their
successful overall record in the defense of tobacco-related
litigation in the past will continue in the future. Therefore,
no liability for pending tobacco-related litigation currently is
recorded in RJRs consolidated financial statements.

RJR Tobacco and its affiliates, including RJR,
continue to win the majority of smoking and health tobacco
litigation claims that reach trial, and a very high percentage
of the tobacco-related litigation claims brought against them
continue to be dismissed at or before trial. Generally, and
except as specifically discussed below, RJR Tobacco and its
affiliates, including RJR, have not settled, and currently do
not intend to settle, any smoking and health tobacco litigation
claims. It is the policy of RJR Tobacco and its affiliates,
including RJR, to vigorously defend all tobacco-related
litigation claims.

The only material smoking and health tobacco
litigation claims settled by RJR Tobacco involved:



| |   |                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the MSA, the related settlements with the states
    of Mississippi, Florida, Texas and Minnesota, and the funding by
    various cigarette companies of a $5.2 billion trust fund
    contemplated by the MSA to benefit tobacco growers; and
|
| |  | the original Broin flight attendant case
    discussed below under  Class-Action Suits.                                                                                                                                                    

Despite having valid legal defenses,
RJR Tobacco settled these matters because of unique
circumstances that do not apply to the other tobacco litigation
cases pending against RJR Tobacco and its affiliates,
including RJR.

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

The states were a unique set of plaintiffs and
are not plaintiffs in any of the smoking and health cases
remaining against RJR or RJR Tobacco. Although
RJR Tobacco continues to be a defendant in certain
health-care cost recovery cases similar in theory to the state
cases but involving other plaintiffs, such as unions, hospitals,
Native American tribes, and local and foreign governments, the
vast majority of such cases have been dismissed on legal
grounds. Indeed, eight federal courts of appeals have ruled
uniformly that unions cannot successfully pursue such cases. As
a result, no union cases are pending against RJR or
RJR Tobacco. RJR and RJR Tobacco believe that the same
legal principles that have resulted in dismissal of union and

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


other types of health-care cost recovery cases
either at the trial court level or on appeal should compel the
dismissal of the similar pending cases.

Finally, in the U.S. Department of Justice
case brought against various industry members, including RJR
Tobacco, the United States District Court for the District of
Columbia granted the non-Liggett defendants motion to
dismiss plaintiffs Medical Care Recovery Act and Medicare
Secondary Payer claims. In these particular claims, the federal
government made arguments similar to the states and sought to
recover federal funds expended in providing health-care to
smokers who have developed diseases and injuries alleged to be
smoking-related. The only remaining claims in this case involve
alleged violations of the federal RICO statute.

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

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

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

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

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

Scheduled Trials.Trial schedules are subject to change, and many cases are
dismissed before trial. However, an increased number of cases
have gone to trial each year since 2000 against RJR Tobacco
and/or its affiliates, some involving claims for amounts ranging
possibly into the hundreds of millions and even billions

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


of dollars, and RJR Tobacco expects this
trend to continue. The following table lists the trial schedule,
as of January 23, 2004, for RJR Tobacco or its
affiliates, through December 31, 2004.

|                          |  |                                                             |  |                                |  |                                                                        
|------------------------- |  | ----------------------------------------------------------- |  | ------------------------------ |  | -----------------------------------------------------------------------
|Trial Date                |  | Case Name                                                   |  | Case Type                      |  | Jurisdiction                                                           
|                          |  |                                                             |  |                                |  |                                                                        
|March 29, 2004 [Phase II] |  | Scott v. American Tobacco Co.,
    Inc.                     |  | Class Action                   |  | District Court,
    Orleans Parish
    (New Orleans, LA)               
|                         
|April 7, 2004             |  | Prado Alvarez v. R. J. Reynolds
    Tobacco Co.             |  | Individual                     |  | United States District Court
    (San Juan, Puerto Rico)               
|                         
|April 19, 2004            |  | DeLoach [Growers] v. R. J. Reynolds
    Tobacco Co.         |  | Antitrust                      |  | United States District Court,
    Middle District
    (Greensboro, NC) 
|                         
|April 28, 2004            |  | Major v. Raybestos-Manhattan,
    Inc.                      |  | Asbestos
    Contribution      |  | Superior Court,
    Los Angeles County
    (Los Angeles, CA)           
|                         
|May 17, 2004              |  | Frost v. Philip Morris, Inc.                                |  | Flight Attendant-ETS(Broin II) |  | Circuit Court,
    Dade County
    (Miami, FL)                         
|                         
|May 17, 2004              |  | Roach v. Brown & Williamson
    Tobacco Corp.               |  | Individual                     |  | Circuit Court,
    Jackson County
    (Independence, MO)               
|                         
|June 1, 2004              |  | Leslie H. Dial Ent., Inc. v. R. J.
    Reynolds Tobacco Co. |  | Antitrust                      |  | United States District Court
    (Columbia, SC)                        
|                         
|June 28, 2004             |  | Gaston v. R. J. Reynolds Tobacco
    Co.                    |  | Individual                     |  | Superior Court,
    Union County
    (Elizabeth, NJ)                   
|                         
|June 28, 2004             |  | Short v. R. J. Reynolds Tobacco
    Co.                     |  | Individual                     |  | Superior Court,
    Union County
    (Elizabeth, NJ)                   
|                         
|July 5, 2004              |  | Rosol v. R. J. Reynolds Tobacco
    Co.                     |  | Individual                     |  | United States District Court,
    Northern District
    (Waverly, IA)  
|                         
|July 12, 2004             |  | Younger v. Philip Morris Inc.                               |  | Flight Attendant-ETS(Broin II) |  | Circuit Court,
    Dade County
    (Miami, FL)                         
|                         
|September 6, 2004         |  | Torres-Rivera v. R. J. Reynolds
    Tobacco Co.             |  | Individual                     |  | Superior Court,
    Court of First Instance
    (San Juan, Puerto Rico)
|                         
|September 13, 2004        |  | Beckman v. Brown & Williamson
    Tobacco Corp.             |  | Individual                     |  | Circuit Court,
    Jackson County
    (Independence, MO)               
|                         
|September 13, 2004        |  | Kimball v. R. J. Reynolds Tobacco
    Co.                   |  | Individual                     |  | United States District,
    Western District
    (Seattle, WA)         

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|                   |  |                                                              |  |                               |  |                                                                         
|------------------ |  | ------------------------------------------------------------ |  | ----------------------------- |  | ------------------------------------------------------------------------
|Trial Date         |  | Case Name                                                    |  | Case Type                     |  | Jurisdiction                                                            
|                   |  |                                                              |  |                               |  |                                                                         
|                  
|September 13, 2004 |  | United States of America [DOJ] v.
    Philip Morris USA Inc. |  | Health-Care
    Cost Recovery |  | United States District Court
    (Washington, DC)                       
|                  
|September 20, 2004 |  | Coy v. Philip Morris Inc.                                    |  | ETS                           |  | United States District Court,
    Southern District
    (Miami, FL)     
|                  
|October 4, 2004    |  | Mason v. British American Tobacco
    (Investments) Ltd.     |  | Individual                    |  | United States District Court,
    Southern District
    (Des Moines, IA)
|                  
|October 26, 2004   |  | Norris v. R. J. Reynolds Tobacco
    Co.                     |  | Individual                    |  | United States District Court,
    Central District
    (Los Angeles, CA)
|                  
|November 15, 2004  |  | Booth v. R. J. Reynolds Tobacco
    Co.                      |  | Individual                    |  | Circuit Court,
    Upshur County
    (Buckhannon, WV)                   
|                  
|December 1, 2004   |  | Smith Wholesale Co., Inc. v. R. J.
    Reynolds Tobacco Co., |  | Antitrust                     |  | United States District Court,
    Eastern District,
    (Greenville, TN)
|                  
|December 1, 2004   |  | Gerrity v. R. J. Reynolds Tobacco
    Co.                    |  | Individual                    |  | United States District Court
    (Hartford, CT)                         
|                  
|December 1, 2004   |  | Harju v. Philip Morris USA Inc.                              |  | Individual                    |  | United States District Court
    (St. Paul, MN)                         

Trial Results.Since
January 1, 1999, 33 smoking and health and health-care
cost recovery cases in which RJR Tobacco was a defendant
have been tried. Verdicts in favor of RJR Tobacco and, in
some cases, RJR Tobacco and other defendants, were returned
in 20 of the 33 cases. Four of the cases resulted in mistrials.
One of the cases resulted in a split decision. Of the 20
RJR Tobacco wins, seven were tried in Florida, two were
tried in each of California, Mississippi and New York, and
one was tried in each of Louisiana, Missouri, New Jersey, Ohio,
South Carolina, Tennessee and West Virginia. Plaintiffs in the
California, Florida, Mississippi and West Virginia cases have
filed appeals or post-trial motions challenging the verdicts.

The cases in which verdicts were returned in
favor of RJR Tobacco, either by itself or with other
defendants, since January 1, 2003, are described below:



| |   |                                                                                                                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | On February 7, 2003, state court juries in
    California and Florida, respectively, found in favor of RJR
    Tobacco and other cigarette manufacturers in Lucier v.
    Phillip Morris, Inc., an individual smoker case, and
    Seal v. Philip Morris, Inc., a Broin II case.                                                 
|
| |  | On February 28, 2003, a Florida federal
    court jury found in favor of RJR Tobacco and Philip Morris
    in Allen v. R. J. Reynolds Tobacco Co., an
    individual smoker case.                                                                                                                                                
|
| |  | On June 17, 2003, a state court jury in
    Missouri found in favor of RJR Tobacco and other cigarette
    manufacturers in Welch v. Brown & Williamson
    Tobacco Corp., an individual smoker case. On July 18,
    2003, the plaintiff in Welch filed a motion for a new
    trial, which was denied on September 18, 2003. On

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | September 23, 2003, the plaintiff noticed an
    appeal to the Missouri Court of Appeals for the Western District.                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | On July 28, 2003, a Louisiana state court
    jury returned a split verdict in Scott v. American
    Tobacco Co., a medical monitoring/smoking cessation class
    action. Specifically, the jury found that cigarettes were not
    defective and rejected the classs claim for medical
    monitoring, but found that smoking cessation programs exist and
    have clinical value. A phase II trial is scheduled to begin
    March 29, 2004, to address the scope and cost of a
    statewide smoking cessation program.
|
| |  | On September 15, 2003, in Routh v. Philip
    Morris, Inc., a Broin II case, a Florida Circuit
    Court judge declared a mistrial. The case was retried and, on
    October 14, 2003, a Florida state court jury returned a
    verdict in favor of the defendants, including RJR Tobacco.
    Plaintiff filed a motion for a new trial on October 24,
    2003, which was denied on December 16, 2003. The plaintiff
    will not appeal.                                                                                  
|
| |  | Most recently, on December 10, 2003, a
    Florida state court jury returned a verdict in favor of
    defendants, including RJR Tobacco, in Hall v. R. J.
    Reynolds Tobacco Co., an individual smoker case.
    Plaintiffs motion for a new trial was denied on
    January 6, 2004.                                                                                                                                                                                                                                    

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

|                                                                                  |  |                                                           |  |                                                              |  |                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--------------------------------------------------------------------------------- |  | --------------------------------------------------------- |  | ------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Date of Verdict                                                                   |  | Case Name/Type                                            |  | Jurisdiction                                                 |  | Verdict                                                                                                                                                                                                      |  | Post-Trial Status                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                  |  |                                                           |  |                                                              |  |                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|July 7, 1999  Phase I
    April 7, 2000  Phase II
    July 14, 2000  Phase III |  | Engle v. R. J.
    Reynolds Tobacco Co.[Class Action]     |  | Circuit Court,
    Dade County
    (Miami, FL)               |  | $12.7 million compensatory damages against
    all defendants; $145 billion punitive damages against all
    defendants, of which approximately $36.3 billion was
    assigned to RJR Tobacco                |  | On May 21, 2003, Floridas Third
    District Court of Appeal reversed the trial courts final
    judgment and remanded the case to the Dade County Circuit court
    with instructions to decertify the class. On July 16, 2003,
    plaintiffs filed a motion for rehearing, which was denied on
    September 22, 2003. Mandate issued on October 8, 2003.
    Plaintiffs filed a notice seeking review by the Florida Supreme
    Court on October 23, 2003. Both sides have submitted briefs
    on whether the Florida Supreme Court should accept jurisdiction
    of the appeal.
|                                                                                 
|March 20, 2000                                                                    |  | Whiteley v. Raybestos- Manhattan, Inc.[Individual]        |  | Superior Court, San Francisco County
    (San Francisco, CA) |  | $1.72 million compensatory damages against
    RJR Tobacco and Philip Morris; $20 million punitive
    damages, of which $10 million was assigned to each of RJR
    Tobacco and Philip Morris, respectively |  | Final judgment on appeal to the California Court
    of Appeal; oral argument was heard on January 21, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                 
|October 12, 2000                                                                  |  | Jones v. Brown & Williamson
    Tobacco Corp.[Individual] |  | Circuit Court, Hillsborough County (Tampa, FL)               |  | $200,000 compensatory damages against RJR Tobacco                                                                                                                                                            |  | RJR Tobacco granted new trial on
    December 28, 2000; new trial decision affirmed by Second
    District Court of Appeal of Florida on August 30, 2002;
    plaintiffs opening brief filed with the Supreme Court of
    Florida on November 26, 2002. On December 9, 2002, the
    Supreme Court of Florida issued an order to show cause as to why
    Jones notice of appeal should not be treated as a notice
    to invoke discretionary jurisdiction. Jones filed his response
    to the order to show cause, and RJR Tobacco filed its reply on
    December 31, 2002.       

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|                   |  |                                                                                                |  |                                                                   |  |                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------------------ |  | ---------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Date of Verdict    |  | Case Name/Type                                                                                 |  | Jurisdiction                                                      |  | Verdict                                                                                                                                                                                                      |  | Post-Trial Status                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                   |  |                                                                                                |  |                                                                   |  |                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                  
|June 4, 2001       |  | Blue Cross and Blue Shield of New
    Jersey v. Philip Morris, Inc.[Health-Care Cost Recovery] |  | United States District Court, Eastern District
    (Brooklyn, NY) |  | $17.8 million compensatory damages against
    all defendants, of which $6.6 million was assigned to RJR
    Tobacco. Judge subsequently ordered plaintiffs attorneys
    entitled to $37.8 million in fees |  | On September 16, 2003, the United States
    Court of Appeals for the Second Circuit: (a) reversed judgment
    for Empire on its subrogation claim; and (b) reserved
    ruling on the direct claim pending resolution by the
    New York Court of Appeals of questions concerning whether
    third-party payers are too remote and, if the claims are not too
    remote, whether individual proof is required under the
    New York State Statute pursuant to which the jury found
    liability. On October 30, 2003, the New York Court of
    Appeals decided to review the certified questions. Defendants
    filed their initial brief on January 22, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                  
|December 12, 2001  |  | Kenyon v. R. J. Reynolds
    Tobacco Co.[Individual]                                           |  | Circuit Court, Hillsborough County (Tampa, FL)                    |  | $165,000 compensatory damages against RJR Tobacco                                                                                                                                                            |  | On May 30, 2003, the Second District Court
    of Appeal of Florida affirmed per curiam (that is, without
    writing an opinion) the trial courts final judgment in
    favor of plaintiffs. RJR Tobacco filed a petition for rehearing
    or for a written opinion on June 16, 2003. That motion was
    denied on July 11, 2003. RJR Tobacco filed a motion for
    stay of proceedings pending the final outcome of the Engle
    appeal. That motion was denied on July 11, 2003. On
    August 28, 2003, Floridas Second District Court of
    Appeal entered its mandate. RJR Tobacco deposited with the
    plaintiffs counsel the amount of the judgment plus accrued
    interest ($196,000) in order to pursue further appeals without
    the risk of any effort by the plaintiff to execute on the
    judgment. On September 5, 2003, RJR Tobacco filed a
    petition with the Florida Supreme Court asking it to require the
    Second District Court of Appeal to write an opinion. That
    petition remains pending. On November 12, 2003, RJR Tobacco
    filed its petition for certiorari with the United States Supreme
    Court.
|                  
|February 22, 2002  |  | Burton v. R. J. Reynolds Tobacco Co.[Individual]                                               |  | United States District Court (Kansas City, KS)                    |  | $198,000 compensatory damages and
    $15 million punitive damages against RJR Tobacco                                                                                                                       |  | Final judgment on appeal to the United States
    Court of Appeals for the Tenth Circuit; oral argument was heard
    on January 12, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                  
|June 18, 2002      |  | French v. Philip Morris, Inc.[Flight Attendant-ETS
    (Broin II)]                             |  | Circuit Court, Dade County
    (Miami, FL)                        |  | $5.5 million compensatory damages against
    all defendants; reduced by judge to $500,000                                                                                                                   |  | Judge reduced damages award to $500,000, of which
    $123,500 was assigned to RJR Tobacco; final judgment on appeal
    to the Third District Court of Appeal of Florida; RJR
    Tobaccos opening brief filed July 16, 2003. The
    appellees brief has not yet been filed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                  
|September 25, 2002 |  | Figueroa-Cruz v. R.J. Reynolds
    Tobacco Co.[Individual]                                     |  | United States District Court (San Juan,
    Puerto Rico)          |  | $500,000 compensatory damages against RJR Tobacco                                                                                                                                                            |  | Trial judge granted RJR Tobaccos motion for
    judgment as a matter of law on October 9, 2002. On
    October 28, 2003, the United States Court of Appeals for
    the First Circuit affirmed the trial courts ruling.
    Plaintiffs filed a petition for rehearing on November 13,
    2003, which was denied on December 12, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

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Additionally, since January 1, 1999,
verdicts have been returned in 26 tobacco-related cases in which
neither RJR Tobacco nor its affiliates, including RJR, were
defendants. Verdicts were returned in favor of defendants in 14
cases  three in Tennessee, two in Pennsylvania, and
one in each of California, Connecticut, Florida, Missouri, New
Hampshire, New York, Ohio, Rhode Island and Texas. Verdicts
in favor of the plaintiffs were returned in 12 cases, four of
which were tried in California, two in each of Florida and
Oregon and one in each of Arkansas, Illinois, Missouri and
New York. The defendants appeals or post-trial
motions are pending in these cases.

The cases in which verdicts were returned in
favor of the plaintiffs since January 1, 2003, are
described below:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | On March 21, 2003, an Illinois state trial
    judge entered judgment against Philip Morris in Price v.
    Philip Morris (formerly known as Miles v. Philip
    Morris), a lights class-action case discussed
    below under  Class-Action Suits.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | On April 3, 2003, a Florida state court jury
    returned a verdict against Philip Morris and Brown &
    Williamson in Eastman v. Philip Morris, an
    individual smoker case. The jury awarded compensatory but not
    punitive damages.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | On May 27, 2003, in Boerner v.
    Brown & Williamson Tobacco Corp., an Arkansas
    federal court jury returned a verdict against Brown &
    Williamson in another individual smoker action. On July 2,
    2003, the trial judge dismissed the Boerner jurys
    $15 million punitive damages award, but found in favor of
    the plaintiff on the design defect claim, which was not
    considered by the jury. The final judgment reflected the
    jurys award of $4,025,000 in actual damages. On
    September 26, 2003, the judge denied Brown &
    Williamsons motions for judgment as a matter of law and
    for a new trial. The judge also reinstated the jurys
    original punitive damages award of $15 million.
    Brown & Williamson is appealing this case.                                              
|
| |  | On July 31, 2003, a California state court
    jury found in favor of Philip Morris in Reller v. Philip
    Morris USA Inc.on all counts except fraudulent concealment,
    on which the jury deadlocked. Mr. Reller has since died,
    and the fraudulent concealment claim will not be retried. On
    December 19, 2003, Mr. Rellers estate filed an
    amended wrongful death complaint substituting the representative
    of the estate as the plaintiff.                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | On August 15, 2003, a Pennsylvania state
    court jury found in favor of Brown & Williamson in
    Eiser v. Brown & Williamson Tobacco Corp.,
    an individual lights case. Post-trial motions have
    been filed by the plaintiff, and a hearing took place on
    December 4, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | On September 25, 2003, in Henley v.
    Philip Morris, Inc., the California Court of Appeal affirmed
    the San Francisco County Superior Courts final
    judgment with respect to the $1.5 million compensatory
    damages award to the plaintiff, but reduced the amount of
    punitive damages from $50 million to $9 million based
    on the United States Supreme Courts opinion in State
    Farm v. Campbell. Philip Morriss petition for
    rehearing was denied. On November 4, 2003, Philip Morris
    petitioned the California Supreme Court to review the case. On
    December 23, 2003, the California Supreme Court accepted
    Philip Morriss appeal and remanded the case to the
    California Court of Appeal with directions that it vacate its
    September 25, 2003 ruling and issue a new ruling.
|
| |  | On November 4, 2003, in Thompson v.
    Brown & Williamson Tobacco Corp., a Missouri state
    court jury returned a verdict against Philip Morris and
    Brown & Williamson, and awarded $2.1 million in
    compensatory damages. The jury found Brown & Williamson
    to be 10% at fault, Philip Morris to be 40% at fault, and
    plaintiff to be 50% at fault. On December 11, 2003,
    defendants filed a motion for judgment notwithstanding the
    verdict, or, in the alternative, motion for a new trial.                                                                                                                                                                                                                                                                                                             
|
| |  | On November 24, 2003, a New Hampshire state
    court jury returned a verdict in favor of Philip Morris in
    Longden v. Philip Morris, Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Most recently, on December 18, 2003, a
    New York state court jury returned a verdict against
    Brown & Williamson in Frankson v.
    Brown & Williamson Tobacco Corp. The jury awarded
    $350,000 in compensatory damages. The jury found the plaintiff
    to be 50% at fault, thereby causing the compensatory damages
    award to be reduced to $175,000. On January 8, 2004, the
    jury awarded $20 million in punitive damages, of which
    $6 million was assigned to Brown & Williamson,
    $2 million to a predecessor company and $12 million to
    two trade organizations. Defendants post-trial motions are
    to be filed by January 29, 2004.

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

Individual Smoking and Health Cases

As of January 23, 2004, 1,499 individual
cases, including approximately 1,061 individual smoker cases
pending in West Virginia state court in a consolidated action,
were pending in the United States against RJR Tobacco. This
category of cases includes smoking and health cases alleging
personal injury brought by or on behalf of individual
plaintiffs, but does not include the Broin II cases
discussed below. A total of 1,491 of the individual pending
cases are brought by or on behalf of individual smokers or their
survivors, while the remaining seven are brought by or on behalf
of individuals or their survivors alleging personal injury as a
result of exposure to ETS.

Below is a description of the individual smoking
and health cases against RJR Tobacco that went to trial or were
decided or remained on appeal, since January 1, 2003.

On March 20, 2000, a California state court
jury found in favor of the plaintiff in Whiteley v.
Raybestos-Manhattan, Inc.The jury awarded the plaintiff
$1.72 million in compensatory damages and $20 million
in punitive damages. RJR Tobacco and Philip Morris were each
assigned $10 million of the punitive damages award. The
defendants appealed the final judgment to the California Court
of Appeal, First District, on May 30, 2000. Oral argument
occurred on January 21, 2004.

In Kenyon v. R. J. Reynolds Tobacco Co.,
an individual case in Florida, a jury awarded the plaintiff
$165,000 in compensatory damages, but no punitive damages, on
December 12, 2001. On May 30, 2003, Floridas
Second District Court of Appeal affirmed the final judgment
without an opinion. RJR Tobacco sought rehearing or a written
opinion, which was rejected on July 11, 2003. The court of
appeal entered its mandate on August 28, 2003. In Florida,
a supersedeas bond does not stay execution of a judgment once
the court of appeal enters its mandate in favor of a plaintiff.
Accordingly, RJR Tobacco deposited with the plaintiffs
counsel a check in the amount of the judgment plus accrued
interest ($196,000) to avoid any possible business disruption
during the remaining appeal. On September 5, 2003, RJR
Tobacco filed a petition with the Florida Supreme Court, asking
it to require the appeals court to issue a written opinion. That
petition remains pending. On November 12, 2003, RJR Tobacco
filed a petition for certiorari with the United States Supreme
Court.

On February 22, 2002, in Burton v. R. J.
Reynolds Tobacco Co., a federal district court jury in
Kansas found in favor of RJR Tobacco and Brown &
Williamson on product defect and conspiracy claims, but found
for the plaintiff on failure to warn, failure to test and
fraudulent concealment claims. The jury apportioned 99% of the
fault to RJR Tobacco and 1% to Brown & Williamson. It
awarded the plaintiff $198,400 in compensatory damages, and
determined that the plaintiff was entitled to punitive damages
against RJR Tobacco but not Brown & Williamson.
Brown & Williamson was voluntarily dismissed as a
defendant by the

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plaintiffs on June 10, 2002. On
June 21, 2002, the trial court awarded the plaintiff
$15 million in punitive damages. RJR Tobacco appealed to
the United States Court of Appeals for the Tenth Circuit. Oral
argument was heard on January 12, 2004.

In Figueroa-Cruz v. R. J. Reynolds Tobacco
Co., a federal district court jury in San Juan, Puerto
Rico, found in favor of one of two plaintiffs on
September 25, 2002. On October 9, 2002, however, the
trial judge granted RJR Tobaccos motion for judgment on
the pleadings. The plaintiffs appealed to the United States
Court of Appeals for the First Circuit. On October 28,
2003, the appeals court affirmed the trial courts
decision. Plaintiffs filed a petition for rehearing; however,
that petition was denied on December 12, 2003.

On February 7, 2003, a Florida state court
jury found in favor of RJR Tobacco and Philip Morris in
Lucier v. Phillip Morris, Inc., an individual smoker
case. Plaintiff appealed to the California Court of Appeal,
Third Appellate District, on May 9, 2003. On
December 4, 2003, the appellate court dismissed the appeal
because of the plaintiffs failure to file the initial
brief.

On February 28, 2003, a Florida federal
court jury found in favor of RJR Tobacco and Philip Morris
in Allen v. R. J. Reynolds Tobacco Co., an
individual smoker case. The plaintiff did not appeal.

On May 8, 2003, the Mississippi Supreme
Court, in Lane v. R. J. Reynolds Tobacco Co., ruled
that the Mississippi Product Liability Act does not allow
smoking and health cases based on products liability. RJR
Tobacco believes that the effect of the Lane ruling will
be to reduce the number, if not eliminate, smoking and health
cases in Mississippi.

On June 17, 2003, in Welch v.
Brown & Williamson Tobacco Corp., a Missouri state
court jury found in favor of RJR Tobacco and other cigarette
manufacturers. The plaintiffs new trial motion was denied
on September 18, 2003. The plaintiff filed a notice of
appeal to the Missouri Court of Appeals on September 23,
2003. No briefing schedule has been set.

On December 10, 2003, in Hall v. R. J.
Reynolds Tobacco Co., a state court jury in Florida returned
a verdict in favor of RJR Tobacco and Brown &
Williamson. The plaintiff filed a motion for a new trial on
December 19, 2003, which was denied on January 6, 2004.

Broin II Cases

As of January 23, 2004, approximately
2,737 lawsuits brought by individual flight attendants for
personal injury as a result of illness allegedly caused by
exposure to secondhand or environmental tobacco smoke in
airplane cabins, referred to as the Broin II cases,
were pending in Florida. In these lawsuits, filed pursuant to
the terms of the settlement of the Broin v. Philip
Morris, Inc.class action, discussed below under
 Class-Action Suits, each individual
flight attendant will be required to prove that he or she has a
disease and that the individuals exposure to secondhand
smoke in airplane cabins caused the disease. Under the terms of
the settlement of the original Broin case, punitive
damages are not available in the Broin II cases.

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

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Below is a description of the
Broin II cases against RJR Tobacco that went to
trial or were decided or remained on appeal, since
January 1, 2003.

In French v. Philip Morris, Inc., a
Florida state court jury found in favor of the plaintiff on
June 18, 2002, and awarded $5.5 million in
compensatory damages. On September 13, 2002, the trial
judge reduced the damages award to $500,000, but denied the
defendants remaining post-trial motions. The
defendants appeal of the trial courts final judgment
is pending in the Third District Court of Appeal of Florida.
Judge Kayes order in Jett v. Philip Morris,
Inc., referred to above, was applied, and the defendants are
appealing that order, as well as other matters. The appeal is in
the briefing phase.

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

In Tucker v. Philip Morris, Inc., a
Florida state court jury found in favor of the defendants,
including RJR Tobacco, on October 4, 2002. The
plaintiffs post-verdict motions were denied on
January 28, 2003. The plaintiff noticed an appeal to
Floridas Third District Court of Appeal on
February 28, 2003, but voluntarily dismissed the appeal on
May 23, 2003.

A Florida state court jury found in favor of RJR
Tobacco and other cigarette manufacturers on February 7,
2003, in Seal v. Philip Morris, Inc. On
February 14, 2003, the plaintiff filed a motion for a new
trial, which was denied on April 24, 2003.

In Mittan v. Philip Morris, Inc., on
July 16, 2003, the plaintiff accepted an $800 (eight
hundred dollars) offer of judgment tendered by RJR Tobacco,
Philip Morris, Brown & Williamson and Lorillard. RJR
Tobaccos share of the offer was $200.

In Routh v. Philip Morris, Inc., the trial
judge declared a mistrial on September 15, 2003. Retrial
began on September 23, 2003. The jury returned a verdict in
favor of the defendants, including RJR Tobacco, on
October 14, 2003. The plaintiff filed a motion for a new
trial on October 24, 2003; however, that motion was denied
on December 16, 2003. The plaintiff will not appeal.

Class-Action Suits

As of January 23, 2004, 18 class-action
cases were pending in the United States against RJR Tobacco, and
in some cases, RJR. In May 1996, in Castano v. American
Tobacco Co., the Fifth Circuit Court of Appeals overturned
the certification of a nationwide class of persons whose claims
related to alleged addiction to tobacco products. Since this
ruling by the Fifth Circuit, most class-action suits have sought
certification of statewide, rather than nationwide, classes.
Class-action suits based on claims similar to those asserted in
Castano are pending against RJR Tobacco, and in some
cases RJR, in state or federal courts in Alabama, California,
Florida, Illinois, Louisiana, Minnesota, Missouri,
New York, Oklahoma, Oregon, Utah and West Virginia.
Twenty-five virtually identical class-action complaints were
filed by one attorney in Nevada since July 2002. This same
attorney also filed class action complaints in Kentucky,
Massachusetts and Utah. As discussed below, a federal district
court judge recently denied class certification in all 25 of the
Nevada cases; a state court judge denied class certification in
the Kentucky case; the Massachusetts case was voluntarily
dismissed; and the Utah case remains pending.

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

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in the class certification discovery phase. Most
recently, in both the Louisiana and Minnesota actions,
Harper v. R. J. Reynolds Tobacco Co. and
Dahl v. R. J. Reynolds Tobacco Co., defendants
removed the cases to federal court. On December 17, 2003,
in Dahl, however, the case was remanded to state court.

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

Few smoker class-action complaints have been
certified or, if certified, have survived on appeal. Seventeen
federal courts that have considered the issue, including two
courts of appeals, and most state courts have rejected class
certification in smoking and health cases. Only one federal
district court has certified a smoker class action 
In re Simon (II) Litigation  which
was filed in the United States District Court for the Eastern
District of New York before Judge Weinstein. In
Simon (II), on September 19, 2002, Judge
Weinstein certified a nationwide mandatory, non-opt-out punitive
damages class. Defendants sought reconsideration of the
certification ruling, which was denied by Judge Weinstein on
October 25, 2002. On February 14, 2003, the United
States Court of Appeals for the Second Circuit granted the
defendants petition to review the class certification
decision. Oral argument was heard on November 20, 2003. On
February 10, 2003, in Sims v. Philip Morris,
Inc., the United States District Court for the District of
Columbia denied certification of a proposed nationwide class of
smokers who purchased cigarettes while underage. On
July 11, 2003, a federal district court judge in Nevada
denied class certification in five separate cases, brought by
the same attorney, which were consolidated for class
certification purposes. On October 7, 2003, the same
federal district court judge in Nevada denied class
certification in 20 additional cases brought by the same
attorney. On November 21, 2003, in Brown v. Philip
Morris Inc., the Circuit Court of Campbell County, Kentucky,
denied class certification; this case was voluntarily dismissed
on December 12, 2003. Most recently, on December 8,
2003, in Jackson v. Philip Morris Inc., a federal
district court judge in Utah dismissed the case due to
plaintiffs failure to prosecute.

Classes have been certified in several state
court class-action cases in which RJR Tobacco is a defendant. On
November 5, 1998, in Scott v. American Tobacco
Co., a Louisiana state appeals court affirmed the
certification of a medical monitoring and/or smoking cessation
class of Louisiana residents who were smokers on or before
May 24, 1996. On February 26, 1999, the Louisiana
Supreme Court denied the defendants petition for writ of
certiorari and/or review. Jury selection began on June 18,
2001. An initial jury was selected by July 16, 2001.
However, the defendants, including RJR Tobacco, raised multiple
challenges to the jury selection process. At various times, the
Louisiana Court of Appeals and/or the Louisiana Supreme Court
removed a number of jurors and alternate jurors that the trial
court had allowed to be seated. The jury selection process was
finally completed on September 23, 2002, and opening
statements occurred on January 21, 2003. On July 28,
2003, the jury returned a verdict in favor of the defendants,
including RJR Tobacco, on the plaintiffs claim for medical
monitoring and found that cigarettes were not defectively
designed. In addition, however, the jury made certain findings
against the defendants, including RJR Tobacco, on claims
relating to fraud, conspiracy, marketing to minors and smoking
cessation. With respect to these findings, this portion of the
trial did not determine liability as to any class member or
class representative. What primarily remains in the case is a
class-wide claim that the defendants, including RJR Tobacco, pay
for a program to help people stop smoking. The trial judge has
ordered that a phase two trial begin on March 29, 2004, to
address the scope and cost of a statewide smoking cessation
program. On October 23, 2003, the defendants, including RJR
Tobacco, filed a challenge to the trial judges phase two
trial order with the Louisiana Court of Appeals. The Court of
Appeals declined to accept the appeal on December 5, 2003.
On January 5, 2004, RJR Tobacco, Brown &
Williamson and Lorillard filed a writ seeking review by the
Louisiana Supreme Court.

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In Blankenship v. American Tobacco Co.,
the first tobacco-related medical monitoring class action to be
certified and to reach trial, the West Virginia state court jury
found in favor of RJR Tobacco and other cigarette manufacturers
on November 14, 2001. On July 18, 2002, the plaintiffs
petitioned the Supreme Court of West Virginia for leave to
appeal, which was granted on February 25, 2003. Oral
argument was heard on November 5, 2003.

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

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

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

On July 24, 2000, the defendants, including
RJR Tobacco, filed numerous post-verdict motions, including
motions for a new trial and to reduce the amount of the punitive
damages verdict. On November 6, 2000, the trial judge
denied the post-trial motions and entered judgment. On
November 7, 2000, RJR Tobacco posted an appeal bond in the
amount of $100 million, the maximum amount required,
pursuant to a Florida bond cap statute enacted on May 9,
2000, and intended to apply to the Engle case, and
initiated the appeals process. On May 21, 2003,
Floridas Third District Court of Appeal reversed the trial
courts final judgment and remanded the case to the Dade
County Circuit Court with instructions to decertify the class.
The appellate court denied the classs motion for rehearing
on September 22, 2003. On October 23, 2003, the
plaintiffs filed a notice asking the Florida Supreme Court to
review the case. Briefing on whether the Florida Supreme Court
should review the case is now complete. It is not known when the
Florida Supreme Court will issue a decision. Although RJR
Tobacco remains confident in its bases for appeal in this case,
RJR Tobacco cannot predict the final outcome of the appellate
process.

On May 7, 2001, three of the non-RJR Tobacco
defendants entered into agreements with the Engle class
to deposit an additional $1.86 billion into separate escrow
accounts to ensure that the stay of execution in effect pursuant
to the Florida bond cap statute will remain in effect as to
these three defendants throughout the appellate process,
regardless of the results of a challenge, if any, to the Florida
bond statute. Approximately $700 million of the total
amount deposited by these three defendants is non-refundable and
will go to the trial court to be distributed, regardless of the
result of the appeal. RJR Tobacco has not entered into a similar
agreement with the Engle class. Although RJR Tobacco
cannot predict the outcome of any possible challenges to the
Florida bond statute, RJR Tobacco remains confident of the
applicability and validity of the statute in the Engle
case.

RJR Tobacco has been named as a defendant in
several individual cases filed by members of the Engle
class. One such case (in which RJR Tobacco was dismissed prior
to trial), Lukacs v. Philip Morris, Inc., was tried
against Philip Morris and Brown & Williamson, and
resulted in a verdict for the plaintiffs on June 11, 2002.
The Florida state court jury awarded the plaintiffs a total of
$37.5 million in compensatory damages. On April 1,
2003, the Dade County Circuit Court granted in part the
defendants motion for remittitur and reduced the
jurys award to plaintiff Yolanda Lukacs (on the loss of
consortium claim) from $12.5 million to

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$0.125 million decreasing the total award to
$25.125 million. These plaintiffs agreed to stay execution
on the judgment pending the result of the Engle appeal.

On November 30, 2000, in Daniels v.
Philip Morris Cos., Inc., a San Diego Superior Court
judge reversed a prior ruling and, based on a California unfair
business practices statute, certified a class consisting of all
persons who, as California resident minors, smoked one or more
cigarettes in California between April 2, 1994 and
December 1, 1999. Trial was scheduled for October 18,
2002, but the court granted the defendants motions for
summary judgment on preemption and First Amendment grounds on
September 12, 2002, and dismissed the action. At a hearing
on October 21, 2002, the judge made final his original
ruling. The plaintiffs currently are appealing the dismissal to
the California Court of Appeal, Fourth Appellate District,
Division One. Appellants opening brief was filed on
July 30, 2003. Briefing is scheduled to be completed by
March 29, 2004.

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

On November 14, 2001, in Turner v.
R. J. Reynolds Tobacco Co., an Illinois state court judge
(Madison County) certified a class defined as [a]ll
persons who purchased defendants Doral Lights, Winston
Lights, Salem Lights and Camel Lights, in Illinois, for personal
consumption, between the first date that defendants sold Doral
Lights, Winston Lights, Salem Lights and Camel Lights through
the date the court certifies this suit as a class action ...
.. On June 6, 2003, RJR Tobacco filed a motion to stay
the case pending Philip Morriss appeal of the
Price v. Philip Morris case, which is discussed
below. On July 11, 2003, the judge denied the motion, and
RJR Tobacco appealed to the Illinois Fifth District Court of
Appeals. The Court of Appeals denied this motion on
October 17, 2003. On October 20, 2003, the trial judge
ordered that the case be stayed for 90 days, or pending the
result of the Price appeal, which is discussed below. The
order stated that a hearing would be held at the end of the
90 days to determine if the stay should be continued. On
November 5, 2003, the Illinois Supreme Court granted RJR
Tobaccos motion for a stay pending the courts final
appeal decision in Price v. Philip Morris.This case
currently includes both RJR and RJR Tobacco as defendants.

On December 31, 2003, in Collora v.
R. J. Reynolds Tobacco Co., a Missouri state court judge in
St. Louis certified a class defined as [a]ll persons
who purchased defendants Camel Lights, Camel Special
Lights, Salem Lights and Winston Lights cigarettes in Missouri
for personal consumption between the first date the defendants
placed their Camel Lights, Camel Special Lights, Salem Lights
and Winston Lights cigarettes into the stream of commerce
through the date of this Order. On January 14, 2004,
RJR and RJR Tobacco, the only named defendants, removed this
case to the United States District Court for the Eastern
District of Missouri.

A lights class-action case is pending
in the same jurisdiction in Illinois against Philip Morris.
Trial of the case against Philip Morris, Price v. Philip
Morris, Inc.(formerly known as Miles v. Philip
Morris, Inc.), began on January 21, 2003. On
March 21, 2003, the trial judge entered judgment against
Philip Morris in the amount of $7.1 billion in compensatory
damages and $3 billion in punitive damages to the State of
Illinois. Based on Illinois law, the bond required to stay
execution of the judgment was set initially at $12 billion.
Because of the difficulty of posting a bond of that magnitude,
Philip Morris pursued various avenues of relief from the
$12 billion bond requirement. On April 14, 2003, the
trial judge reduced the amount of bond. He ordered the bond to
be secured by $800 million, payable in four equal quarterly
installments beginning in

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September 2003, and a pre-existing
$6 billion long-term note to be placed in escrow pending
resolution of the case. The plaintiffs appealed the judges
decision to reduce the amount of the bond. On July 14,
2003, the appeals court ruled that the trial judge exceeded his
authority in reducing the bond and ordered the trial judge to
reinstate the original bond. On September 16, 2003, the
Illinois Supreme Court ordered that the reduced bond be
reinstated and agreed to hear Philip Morriss appeal
without need for intermediate appellate court review. The
Price case remains in the Illinois Supreme Court. In the
event RJR Tobacco tries and loses the Turner case, it
could face similar bonding difficulties depending upon the
amount of damages ordered, if any, which could have a material
adverse effect on RJR Tobaccos, and consequently
RJRs, results of operations, cash flows or financial
condition.

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

Governmental Health-Care Cost Recovery
Cases

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

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

In the settling jurisdictions, the MSA released
RJR Tobacco, its indemnitees and RJR from:



| |   |                                                                                                                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | all claims of the settling states and their
    respective political subdivisions and other recipients of state
    health-care funds, relating to past conduct arising out of the
    use, sale, distribution, manufacture, development, advertising,
    marketing or health effects of, the exposure to, or research,
    statements or warnings about, tobacco products; and

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| |   |                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | all monetary claims relating to future conduct
    arising out of the use of, or exposure to, tobacco products that
    have been manufactured in the ordinary course of business.

The cash payments made by RJR Tobacco under the
MSA and the other state settlement agreements during the years
2003, 2002 and 2001 were $1.8 billion, $2.5 billion
and $2.4 billion, respectively. RJR Tobacco records its
allocation of ongoing settlement charges in cost of products
sold as products are shipped. Set forth below is a table
depicting the unadjusted tobacco industry settlement payment
schedule under the MSA and the other state settlement agreements
and related information.

|                                           |                                         |                                                                              |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       | 
|------------------------------------------ | --------------------------------------- | ---------------------------------------------------------------------------- | ----- | ----- | ----- | ---- | ----- | ----- | ------ | ---- | ----- | ----- | ------ | ---- | ----- | ----- | ------ | ----- | ----- | ----- | ----- | -- | ----- | ----- | ----- | -- | ----- | ----- | ----- | -- | ----- | ----- | ----- | -- | ----- | ----- | ----- | 
|                                           |                                         |                                                                             
|                                           |                                         | Unadjusted Original Participating Manufacturers Settlement Payment Schedule
|                                           |                                         |                                                                             
|                                           |                                         | 2000                                                                         |       | 2001  |       | 2002 |       | 2003  |        | 2004 |       | 2005  |        | 2006 |       | 2007  |        | 2008+
|                                           |                                         |                                                                              |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |      
|                                           |                                         |                                                                             
|                                           |                                         | (Dollars in Millions)                                                       
|First Four States Settlements:(1)         |                                         |                                                                              |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|                                           | Mississippi Annual Payment              |                                                                              | $     | 85    |       |      | $     | 111   |        |      | $     | 111   |        |      | $     | 136   |        |       | $     | 136   |       |    | $     | 136   |       |    | $     | 136   |       |    | $     | 136   |       |    | $     | 136   |      
|                                           | Florida Annual Payment                  |                                                                              |       | 275   |       |      |       | 358   |        |      |       | 358   |        |      |       | 440   |        |       |       | 440   |       |    |       | 440   |       |    |       | 440   |       |    |       | 440   |       |    |       | 440   |      
|                                           | Texas Annual Payment                    |                                                                              |       | 363   |       |      |       | 471   |        |      |       | 471   |        |      |       | 580   |        |       |       | 580   |       |    |       | 580   |       |    |       | 580   |       |    |       | 580   |       |    |       | 580   |      
|                                           | Minnesota Annual Payment                |                                                                              |       | 128   |       |      |       | 166   |        |      |       | 166   |        |      |       | 204   |        |       |       | 204   |       |    |       | 204   |       |    |       | 204   |       |    |       | 204   |       |    |       | 204   |      
|                                           | Minnesota Initial Payment               |                                                                              |       | 243   |       |      |       | 243   |        |      |       | 243   |        |      |       | 122   |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|                                           | Most Favored Nations Agmt (MS, FL, TX)  |                                                                              |       | 1,215 |       |      |       | 1,215 |        |      |       | 1,215 |        |      |       | 609   |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|Remaining States Settlement:              |                                         |                                                                              |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|                                           | Initial Payments(1)                     |                                                                              |       | 2,472 |       |      |       | 2,546 |        |      |       | 2,623 |        |      |       | 2,701 |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|                                           | Annual Payments(1)                      |                                                                              |       | 3,940 |       |      |       | 4,378 |        |      |       | 5,691 |        |      |       | 5,691 |        |       |       | 7,004 |       |    |       | 7,004 |       |    |       | 7,004 |       |    |       | 7,004 |       |    |       | 7,126 |      
|                                           | Addl Annual Payments (through 2017)(1) |                                                                              |       |      |       |      |       |      |        |      |       |      |        |      |       |      |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       | 861   |      
|                                           | Base Foundation Funding (through 2008)  |                                                                              |       | 25    |       |      |       | 25    |        |      |       | 25    |        |      |       | 25    |        |       |       | 25    |       |    |       | 25    |       |    |       | 25    |       |    |       | 25    |       |    |       | 25    |      
|                                           | Additional Foundation Payments(2)       |                                                                              |       | 300   |       |      |       | 300   |        |      |       | 300   |        |      |       | 300   |        |       |       |      |       |    |       |      |       |    |       |      |       |    |       |      |       |    |       |      |      
|Growers Trust ($2952009 and 2010)(3)     |                                         |                                                                              | 280   |       |       |      | 400   |       |        |      | 500   |       |        |      | 500   |       |        |       | 500   |       |       |    | 500   |       |       |    | 500   |       |       |    | 500   |       |       |    | 500   |      
|Minnesota Blue Cross and Blue Shield       |                                         |                                                                              | 57    |       |       |      | 57    |       |        |      | 57    |       |        |      | 57    |       |        |       |      |       |       |    |      |       |       |    |      |       |       |    |      |       |       |    |      |      
|                                           |                                         |                                                                              |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|                                           |                                         | Total                                                                        |       | $     | 9,383 |      |       | $     | 10,270 |      |       | $     | 11,760 |      |       | $     | 11,365 |       |       | $     | 8,889 |    |       | $     | 8,889 |    |       | $     | 8,889 |    |       | $     | 8,889 |    |       | $     | 9,872 | 
|                                           |                                         |                                                                              |       |       |       |      |       |       |        |      |       |       |        |      |       |       |        |       |       |       |       |    |       |       |       |    |       |       |       |    |       |       |       |    |       |      
|RJR Tobaccos settlement expenses          |                                         | $                                                                            | 2,329 |       |       | $    | 2,584 |       |        | $    | 2,507 |       |        | $    | 1,925 |       |        |       |      |       |       |    |      |       |       |    |      |       |       |    |      |       |       |    |      |      
|RJR Tobaccos cash payments                |                                         | $                                                                            | 2,247 |       |       | $    | 2,393 |       |        | $    | 2,461 |       |        | $    | 1,812 |       |        |       |      |       |       |    |      |       |       |    |      |       |       |    |      |       |       |    |      |      
|RJR Tobaccos expected settlement expenses |                                         |                                                                              |      |       |       |      |      |       |        |      |      |       |        |      |      |       |        | >$    | 1,800 |       |       | >$ | 1,900 |       |       | >$ | 1,900 |       |       | >$ | 2,100 |       |       | >$ | 2,100 |      
|RJR Tobaccos expected cash payments       |                                         |                                                                              |      |       |       |      |      |       |        |      |      |       |        |      |      |       |        | >$    | 1,900 |       |       | >$ | 1,800 |       |       | >$ | 1,900 |       |       | >$ | 1,900 |       |       | >$ | 2,100 |      






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

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

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

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

In June 2001, the U.S. Attorney General
assembled a team of three DOJ lawyers to work on a possible
settlement of the federal lawsuit. The DOJ lawyers met with
representatives of the tobacco industry, including RJR Tobacco,
on July 18, 2001. No settlement was reached.

On May 23, 2003, Judge Kessler denied the
defendants first motion for partial summary judgment,
which sought legal preclusion of many aspects of the DOJs
lawsuit regarding advertising, marketing, promotion and warning
claims. The court simultaneously granted partial summary
judgment for the government on certain affirmative defenses. As
of July 16, 2003, the parties had completed briefing on the
defendants motion for partial reconsideration of the
May 23, 2003 order striking certain affirmative defenses,
or alternatively for certification for interlocutory appeal
pursuant to 28 U.S.C. § 1292(b).

Each side filed additional summary judgment
motions in the fall of 2003. The defendants as a group have now
filed nine summary judgment motions, with a request for
additional motions pending with the court. The government has
filed six summary judgment motions, including motions regarding
various affirmative defenses, including those affirmative
defenses addressing the standard for seeking disgorgement under
RICO. On January 23, 2004, the court granted the
governments motion for partial summary judgment on certain
of defendants equitable defenses, including waiver,
equitable estoppel, laches and unclean hands. Although the order
dismissed these particular affirmative defenses, it did not
address or limit the evidence that may be introduced regarding
the remaining RICO claims nor did it address the applicability
of the legal doctrines to issues related to equitable relief
should liability be established.

Trial is scheduled for September 13, 2004.

Local Government
Cases.Some local government entities
have filed lawsuits based largely on the same theories and
seeking the same relief as the state attorneys general cases.
Two such cases are pending against RJR Tobacco. On
August 8, 2001, in County of Cook v. Philip Morris,
Inc., the Circuit Court of Cook County, Illinois, granted
the defendants motion for judgment on the pleadings based
on remoteness grounds and dismissed the plaintiffs
complaint in its entirety. The plaintiffs appealed the dismissal
to the Illinois Appellate Court, First District, on
September 5, 2001. The defendants noticed a cross-appeal on
September 17, 2001, from the trial courts adverse
rulings on the defendants motions to dismiss on the
grounds of MSA release and lack of standing. Briefing has been
completed, although oral argument has not been scheduled. Most
recently, on November 14, 2003, plaintiff voluntarily
dismissed the complaint in St. Louis County v.
American Tobacco Co.

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

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District Court of Appeal. On June 10, 2003,
the Florida Supreme Court declined Venezuelas petition for
review. The court further indicated that it would not entertain
a motion for rehearing. In light of the Venezuela decision, on
August 25, 2003, the Circuit Court of Miami-Dade County,
Florida, granted the defendants motion for judgment on the
pleadings in two additional cases brought by foreign
sovereigns  Republic of Tajikistan v. Brooke
Group Ltd., Inc. and State of Tocantins, Brazil v.
Brooke Group Ltd., Inc. This most recent ruling led
22 other foreign nations to voluntarily dismiss their cases.

Of the four international cases currently pending
in the United States, one is pending in state court and three
are pending in federal court. Two of the three federal court
cases are pending before the Judicial Panel on Multi-District
Litigation in the United States District Court for the District
of Columbia. Twenty other cases are pending outside the United
States, two in Israel, three in Canada, and 15 in Puerto Rico.
Other foreign governments and entities have stated that they are
considering filing such actions in the United States.

On November 12, 1998, the Canadian Province
of British Columbia brought a case in British Columbia
Provincial Court (federally appointed), similar to the state
attorneys general cases discussed above, against RJR Tobacco and
certain other Canadian and U.S. tobacco companies and their
parent companies, including RJR. This lawsuit depended entirely
on legislation enacted in British Columbia that was separately
challenged by various Canadian tobacco companies. An agreement
was reached with the government in British Columbia to litigate
the separate constitutional challenges prior to the health-care
cost recovery action. On February 21, 2000, the British
Columbia Supreme Court declared the Cost Recovery Act
unconstitutional and dismissed the action. This decision was not
appealed by the government. On January 24, 2001, the
Canadian Province of British Columbia enacted a second and
revised statute and brought a second action in the same court. A
trial of the constitutionality of the second statute and a claim
that the second action be dismissed was heard from
November 4 through November 29, 2002. On June 5,
2003, the trial court ruled in favor of the defendants, again
finding that the legislation was unconstitutional. The Province
appealed this ruling. The appeal was heard before the British
Columbia Court of Appeal at a five-day hearing that commenced on
November 24, 2003. Judgment was reserved. Although it could
be announced at any time, a decision is expected to come down
some time between mid-February and mid-March 2004.

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

Other Health-Care Cost Recovery and Aggregated
Claims Cases

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

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

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

As of January 23, 2004, there were no
pending lawsuits by union trust funds against cigarette
manufacturers and others.

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Insurance-Related
Cases.As of January 23, 2004,
one insurance-related case was pending against RJR Tobacco.

On June 6, 2001, in Blue Cross and Blue
Shield of New Jersey, Inc. v. Philip Morris, Inc., a
federal court jury in Brooklyn returned a verdict in favor of
RJR Tobacco and other tobacco defendants on common law fraud and
civil RICO claims, but found for the plaintiff, Empire Blue
Cross and Blue Shield, on a claim under a New York state
deceptive business practices statute. Empire pursued its claims
against the defendants on behalf of itself directly, as well as
on behalf of its insureds under a theory of subrogation. The
jury verdict on the direct claim was approximately
$17.8 million, and the verdict on the subrogated claim was
approximately $11.8 million. RJR Tobaccos portion of
these amounts is $6.6 million and $4.4 million,
respectively. The New York statute under which Empire
recovered does not provide for punitive damages, but does allow
for recovery of reasonable attorneys fees. On
February 28, 2002, Judge Weinstein awarded plaintiffs
counsel approximately $38 million in attorneys fees.
On July 2, 2002, Judge Weinstein denied the
defendants renewed motion to dismiss. He also refused to
transfer the claims of non-New York plans to their
respective states, and continued the stay of those claims, as
well as all remaining claims of Blue Cross Blue Shield plans,
until final resolution of the Empire Blue Cross case. The
defendants, including RJR Tobacco, appealed to the United States
Court of Appeals for the Second Circuit. On September 16,
2003, the Second Circuit:



| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | reversed the judgment for Empire on its
    subrogation claim, and                                                              
|
| |  | reserved ruling on Empires direct claim
    pending resolution by the New York Court of Appeals of two
    certified questions:



| |   |                                                                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Are claims by a third party payer of health care
    costs seeking to recover costs of services provided to
    subscribers as a result of those subscribers being harmed by a
    defendants or defendants violation of N.Y. Gen. Bus.
    Law § 349 too remote to permit suit under that statute?                                                        
|
| |  | If such an action is not too remote to permit
    suit, is individualized proof of harm to subscribers required
    when a third party payer of health care costs seeks to recover
    costs of services provided to subscribers as a result of those
    subscribers being harmed by a defendants or
    defendants violation of N.Y. Gen. Bus. Law § 349?

On October 30, 2003, the New York Court
of Appeals agreed to review the two certified questions. The
tobacco defendants, including RJR Tobacco, filed their
initial brief on January 22, 2004.

In Group Health Plan, Inc. v. Philip
Morris, Inc. and Medica v. Philip Morris, Inc.,
a federal district judge in Minnesota dismissed all claims,
except a state antitrust claim and a state conspiracy claim. The
federal court certified to the Minnesota Supreme Court the
question whether these two claims could be pursued under
Minnesota law by Group Health Plan. On January 11, 2001,
the Minnesota Supreme Court ruled that the plaintiff could
pursue these claims. Certain defendants, including
RJR Tobacco, filed motions for summary judgment based on
the statutes of limitation and causation, injury and damages. On
January 31, 2002, summary judgment was granted in favor of
certain defendants, including RJR Tobacco. Plaintiffs
appealed to the United States Court of Appeals for the Eighth
Circuit. Argument occurred on May 15, 2003. On
September 16, 2003, the United States Court of Appeals for
the Eighth Circuit upheld the dismissal of the damages claims,
but remanded the cases to the trial court to consider whether
injunctive relief is available. Shortly after the appeals court
ruling, the plaintiffs decided to dismiss the respective cases,
and, on October 21, 2003, the judge entered an order
dismissing the cases with prejudice.

Native American
Tribes.Two Native American Tribe
cases remain pending against RJR Tobacco. On January 25,
2002, in Navajo Nation v. Philip Morris, Inc., the
District Court of Navajo Nation granted the defendants
motion to dismiss conspiracy, deceptive acts and restraint of
trade claims. The court refused to dismiss the plaintiffs
product liability claim. In response, the plaintiffs filed a
motion to alter, amend and/or clarify the January 25, 2002
order. No decision has been made by the court. One other Native
American tribe case remains pending before a tribal court in
South Dakota.

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Hospitals.As of
January 23, 2004, two cases brought by hospitals were
pending against RJR Tobacco, City of St. Louis v.
American Tobacco Co., Inc., pending in the Circuit Court of
the City of St. Louis, Missouri, and County of
McHenry v. Philip Morris, Inc., pending in the Circuit
Court of Cook County, Illinois. In May 2000, in A.O. Fox
Memorial Hospital v. American Tobacco Co., Inc.,
pending in state court in Nassau County, New York, a group
of approximately 175 hospitals filed suit against the tobacco
industry seeking at least $3.6 billion for costs expended
to treat smoking-related illnesses. On December 14, 2001,
the defendants motion to dismiss was granted. The
Appellate Division of the Supreme Court, Second Judicial
Department affirmed the trial courts dismissal on
February 10, 2003. In March 2003, the plaintiffs asked the
Court of Appeals of New York, the highest state appellate
court, for permission to appeal; their petition was denied on
May 13, 2003.

Taxpayers.On
October 2, 2003, in Mason v. American Tobacco
Co., the United States Court of Appeals for the Second
Circuit affirmed the United States District Court for the
Eastern District of New Yorks ruling that granted the
defendants motion to dismiss and denied the
plaintiffs motion for class certification. On
October 16, 2003, the plaintiffs filed a motion for
rehearing by the entire Court of Appeals. That motion was denied
on December 8, 2003.

MSA-Enforcement and Validity

As of January 23, 2004, two cases were
pending against RJR Tobacco concerning the enforcement and
validity of the MSA.

The litigation challenging the validity of the
MSA, including claims that the MSA violates antitrust laws, has
not been successful. On February 12, 2003, in Forces
Action Project, LLC v. California, a case in which a
smokers rights organization challenged the propriety of
the MSA on antitrust grounds, the United States Court of Appeals
for the Ninth Circuit affirmed the United States District Court
for the Northern District of Californias January 5,
2000 order that granted defendants motion to dismiss. On
January 6, 2004, in Freedom Holdings, Inc. v.
Spitzer, the United States Court of Appeals for the Second
Circuit reversed the dismissal of a complaint asserting an
antitrust challenge to legislation adopted by New York
State in furtherance of the MSA and remanded the case for
further proceedings.

Arizona, California, New York and Washington
have alleged that the posting of signage advertising
RJR Tobaccos former brand-name sponsorship of the
NASCAR Winston Cup Series violates a provision of the MSA
governing the times during which such signs may be posted. On
February 1, 2002, a New York court ruled in favor of
RJR Tobacco. On April 10, 2003, the New York
Court of Appeals Appellate Division, First Department, of the
New York Supreme Court affirmed this ruling. On
September 2, 2003, the New York Court of Appeals
denied the States petition for review. On
November 27, 2001, the trial court in California ruled
against RJR Tobacco. On March 27, 2003, the California
Court of Appeal affirmed the trial courts ruling against
RJR Tobacco. On June 25, 2003, the California Supreme
Court denied RJR Tobaccos petition for review. On
November 16, 2001, the Arizona trial court ruled against
RJR Tobacco. On September 9, 2003, the Arizona Court
of Appeals affirmed the trial courts ruling. The
Washington matter was rendered moot and was dismissed.
RJR Tobacco ended its sponsorship of the NASCAR Winston Cup
Series at the end of the 2003 season, so it will not pursue any
further appeals of these cases.

The State of Ohio alleged that
RJR Tobaccos purchase of advertising space on
matchbooks distributed by an independent third party violates a
provision of the MSA governing brand-name merchandise. On
April 25, 2002, the Franklin County Common Pleas Court
ruled in favor of RJR Tobacco. The state appealed the
decision to the Ohio Court of Appeals, Tenth Appellate District,
which, on March 31, 2003, reversed the trial courts
decision. RJR Tobacco appealed to the Ohio Supreme Court,
which accepted RJR Tobaccos petition on
September 10, 2003. Briefing is ongoing and a date for oral
argument has not been set.

Finally, the State of California alleged, in the
context of the placement of print advertising, that
RJR Tobacco is in violation of the prohibition in the MSA
against taking any action, directly or indirectly, to
target youth. In a decision issued on July 12, 2002,
the trial judge found that although youth may not have

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been directly targeted ... RJR indirectly
targeted youth, thereby violating the MSA. In addition,
the judge issued a $20 million fine. RJR Tobacco
appealed this ruling to the California Court of Appeal, Fourth
Appellate District. Oral argument was heard on December 9,
2003, and a decision is pending.

Asbestos Contribution Cases

As of January 23, 2004, seven lawsuits were
pending against RJR Tobacco in which asbestos companies and/or
asbestos-related trust funds allege that they
overpaid claims brought against them to the extent
that tobacco use, not asbestos exposure, was the cause of the
alleged personal injuries for which they paid compensation. On
May 24, 2001, a Mississippi state court judge dismissed all
such claims by Owens-Corning in Estate of Ezell
Thomas v. RJR Tobacco Co. Owens-Corning appealed the
dismissal to the Mississippi Supreme Court on August 15,
2001. Oral argument was heard on October 1, 2003. A
decision is pending. A similar case, H.K. Porter Co.,
Inc. v. American Tobacco Co., was pending in the United
States District Court for the Eastern District of New York
before Judge Weinstein. However, on July 26, 2001, the
parties stipulated to a dismissal of the action. In
Fibreboard Corp. v. R. J. Reynolds Tobacco
Co., a case pending in state court in California,
Owens-Corning and Fibreboard asserted the same claims as those
asserted in the Mississippi case. Motions to dismiss those
claims have been held in abeyance pending the final
determination of the Mississippi case.

Antitrust Cases

A number of tobacco wholesalers, as well as
indirect purchasers, have sued U.S. cigarette
manufacturers, including RJR Tobacco, and its parent
company, RJR, in federal and state courts, alleging that
cigarette manufacturers combined and conspired to set the price
of cigarettes, in violation of antitrust statutes and various
state unfair business practices statutes. In these cases, the
plaintiffs ask the court to certify the lawsuits as class
actions on behalf of other persons who purchased cigarettes
directly from one or more of the defendants. The federal cases
against RJR Tobacco were consolidated and sent by the Judicial
Panel on Multi-District Litigation for pretrial proceedings in
the United States District Court for the Northern District of
Georgia. The court certified a class of direct purchasers on
January 27, 2001. The court granted the defendants
motion for summary judgment in the consolidated federal cases on
July 11, 2002, and the United States Court of Appeals for
the Eleventh Circuit affirmed that decision on
September 22, 2003. As of January 23, 2004, all state
court cases on behalf of indirect purchasers have been
dismissed, except for two which are pending in Kansas and New
Mexico. The Kansas court granted class certification on
November 15, 2001, while the New Mexico court granted class
certification on April 11, 2003, and certified that
decision for interlocutory appeal on June 24, 2003.

On July 30, 1999, Cigarettes Cheaper!, a
retailer, filed an antitrust counterclaim against
RJR Tobacco in a gray market trademark suit originally
brought by RJR Tobacco in the United States District Court
for the Northern District of Illinois. Cigarettes Cheaper!
alleges that it was denied promotional resources in violation of
the Robinson-Patman Act. The District Court declined to dismiss
the counterclaim. On January 23, 2001, the court granted
Cigarettes Cheaper!s motion to amend its counterclaim to
include a violation of Section 1 of the Sherman Antitrust
Act, claiming that RJR Tobacco conspired with other
retailers to deny promotions to Cigarettes Cheaper!, an
allegation that RJR Tobacco denies. On March 21, 2001,
RJR Tobaccos motion to add a trademark dilution claim
against Cigarettes Cheaper! was granted. On June 28, 2001,
the court granted RJR Tobaccos motion to strike with
prejudice several of Cigarettes Cheaper!s affirmative
defenses. These defenses related to:



| |   |                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------
| |  | alleged misrepresentations caused by the
    packaging of cigarettes manufactured by RJR Tobacco for
    export;
|
| |  | RJR Tobaccos No Bull
    advertising campaign for its Winston cigarettes;                                    
|
| |  | antitrust trademark misuse;                                                                                     

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| |   |                         
| | - | ------------------------
| |  | nominative fair use; and
|
| |  | the first sale doctrine.

On June 25, 2003, the court granted RJR
Tobaccos motion for summary judgment on Cigarettes
Cheaper!s counterclaim alleging an illegal conspiracy
under the Sherman Antitrust Act, but denied the motion with
respect to the counterclaims alleging price discrimination under
the Robinson-Patman Act. Trial on RJR Tobaccos
trademark claims and the remaining antitrust counterclaims began
on January 12, 2004. The court declared a mistrial on
January 13, 2004 because of inappropriate opening
statements by Cigarettes Cheaper!s counsel. The court has
not set a new trial date.

On February 16, 2000, a class-action
complaint, Deloach v. Philip Morris Cos., Inc., was
filed against RJR Tobacco, other cigarette manufacturers
and others, in the United States District Court for the District
of Columbia on behalf of a putative class of all tobacco growers
and tobacco allotment holders. The plaintiffs assert that the
defendants, Philip Morris, Inc., RJR Tobacco,
Brown & Williamson Tobacco Corp. and Lorillard Tobacco
Co., engaged in bid-rigging of American burley and flue-cured
tobacco auctions beginning at least by 1996 and continuing to
present. The defendants actions are alleged to have held
the auction prices of tobacco at artificially low prices
resulting in damage to tobacco growers and allotment holders. In
addition, the plaintiffs allege that the defendants have engaged
in a conspiracy to force the elimination or destruction of the
federal governments tobacco quota and price support
program through an alleged illegal group boycott. On
October 9, 2000, the defendants filed a motion to dismiss
the second amended complaint and a motion to transfer venue to
the United States District Court for the Middle District of
North Carolina. On November 30, 2000, the court granted the
motion to transfer the case. On December 20, 2000, the
plaintiffs moved to amend the complaint to add the leaf-buying
companies Dimon, Universal Leaf and Standard Commercial as the
defendants, and the motion was allowed. The plaintiffs
motion to certify the class was granted on April 3, 2002.
On April 16, 2002, RJR Tobacco and the other
defendants petitioned the United States Court of Appeals for the
Fourth Circuit to review the class certification ruling. On
June 12, 2002, the Fourth Circuit declined to review the
class certification ruling, and on July 8, 2002, the court
denied a petition for rehearing. In May 2003, the plaintiffs and
all defendants but RJR Tobacco entered into a class-wide
settlement which was approved by Judge Osteen on October 1,
2003. The case continues against RJR Tobacco. Discovery has
now been completed and dispositive motions have been filed by
RJR Tobacco, but not yet argued. Trial has been set for
April 19, 2004.

On December 4, 2002, in Leslie H. Dial
Ent., Inc. v. R. J. Reynolds Tobacco Co., Leslie H.
Dial Enterprises, Inc. sued RJR Tobacco, Wal-Mart Stores,
Inc. and Sams Club in the United States District Court for
the District of South Carolina. The suit alleges that RJR
Tobacco violated the Robinson-Patman Act by refusing to
allow Dial, the operator of four small grocery stores, to
participate in RJR Tobacco promotional programs and by not
making RJR Tobacco promotional programs available to Dial
on terms proportionately equal to those offered other retailers.
The suit also alleges that RJR Tobacco conspired with
Wal-Mart Stores and Sams Club to reduce competition in the
sale of cigarettes in violation of Section 1 of the Sherman
Antitrust Act and South Carolina civil conspiracy law. In
addition, the complaint charges that RJR Tobacco has
violated the South Carolina Unfair Trade Practices Act allegedly
by denying promotional services and facilities to Dial that were
offered to other retailers. The suit seeks unspecified damages.
The plaintiff has requested a bench trial. RJR Tobacco has
answered the complaint and asserted a number of defenses. On
September 3, 2003, the court granted the plaintiffs
motion to file an amended complaint, which named Sams
East, Inc. as a defendant. Discovery is currently underway and,
with the exception of expert discovery, must be completed by
March 31, 2004. Trial is scheduled for November 1,
2004.

On January 31, 2003, in Smith Wholesale
Co., Inc. v. R. J. Reynolds Tobacco Co.,
Smith Wholesale Company, Inc. sued RJR Tobacco under the
federal antitrust laws in the United States District Court for
the Eastern District of Tennessee in connection with
RJR Tobaccos termination of Smiths
RJR Tobacco distribution agreement consistent with its
terms. That same day, Smith moved for an order to prevent
RJR Tobacco from terminating Smiths agreement. The
court granted Smiths motion on February 7, 2003,

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STATEMENTS  (Continued)


and required RJR Tobacco to reinstate
Smiths contract. Prior to the courts order that day,
RJR Tobacco terminated its distribution agreement with Rice
Wholesale Company, Inc. consistent with the terms of the
distribution agreement. On February 18, 2003, Smith moved
to amend its complaint to add Rice as a plaintiff and allege
similar claims on behalf of Rice, a motion the court immediately
granted, and Rice filed a motion for a preliminary injunction to
prevent RJR Tobacco from terminating it. The court granted
Rices motion on March 4, 2003. RJR Tobacco appealed
the courts February 7 order on February 11,
2003, and its March 4 order on March 6, 2003. On
April 1, 2003, the United States Court of Appeals for the
Sixth Circuit granted RJR Tobaccos motion to
consolidate the appeals and expedite oral argument. The parties
have completed briefing the appeal and had oral argument on
September 12, 2003. No decision on the appeal has been
issued to date. In the meantime, on June 10, 2003, nine
other wholesalers joined the lawsuit, and ten of the 11
plaintiffs filed another motion for a preliminary injunction,
this time asking the federal district court to enjoin RJR from
implementing amendments to its distribution agreements that were
scheduled to become effective on June 30, 2003. A hearing
on this motion was held on July 24, 2003, and the district
court issued an order granting the motion on August 6,
2003. (Prior to issuing its decision, the district court granted
the State of Tennessees motion to intervene as a plaintiff
on July 3, 2003, and the State of Mississippis motion
to intervene as a plaintiff on July 14, 2003.) RJR Tobacco
appealed to the United States Court of Appeals for the Sixth
Circuit on August 8, 2003. Briefing is complete. Oral
argument has not been scheduled. On September 24, 2003, the
district court granted RJR Tobaccos emergency motion for a
stay of the August 6, 2003 order, pending
RJR Tobaccos appeal. Plaintiffs subsequently filed a
fourth amended complaint to add nine new plaintiffs, bringing
the total of private plaintiffs to 20. Fact discovery is
scheduled to close on August 13, 2004, with expert
discovery to be completed by September 15, 2004. Trial is
set to begin on November 30, 2004.

Other Litigation and Developments

On December 10, 2003, the Attorney General
of Vermont issued a civil subpoena to RJR Tobacco,
asserting that he had reason to believe that
R. J. Reynolds Tobacco Company ha[d] engaged in unfair
and deceptive acts and practices ... by publishing false or
misleading claims about its product, Eclipse brand cigarettes,
by failing to disclose material facts and/or by otherwise
engaging in deceptive or unfair practices in marketing and
selling Eclipse brand cigarettes. The Vermont Attorney
General indicated that his office was working
cooperatively with the offices of the attorneys general of
California, Connecticut, Maine and New York ....
At this time, no lawsuit or enforcement action relating to
ECLIPSE has been filed against RJR Tobacco in any of these five
states. RJR Tobacco has obtained an extension of time for filing
its response to the subpoena.

On July 3, 2003, the Securities and Exchange
Commission, referred to as the SEC, issued a subpoena to RJR
pursuant to a formal order of investigation of potential
violations of the securities laws. The subpoena, and discussions
to date with the SEC staff, focus on whether the disclosure of
specific amounts of certain expenses of RJR should have been
quantified separately rather than aggregated with other expense
items. RJR is endeavoring to cooperate with the SEC in a way
that protects its rights. On August 14, 2003, the SEC
filed, in the United States District Court for the District of
Columbia, an Application for an order to show cause and an order
requiring obedience to subpoena duces tecum. On August 29,
2003, RJR filed, in the same court, a motion for a protective
order and its opposition to the SECs application for an
order to show cause. As of October 11, 2003, both the
SECs application and RJRs motion for a protective
order have been fully briefed and are pending before the court.
Oral argument on these matters was heard on January 8,
2004. RJR is unable to predict the outcome of this investigation.

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

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RJR Tobacco is aware of a grand jury
investigation in North Carolina that is related to the cigarette
business of certain of its former affiliates. In connection with
this investigation, RJR Tobacco responded to document
subpoenas dated July 7, 1999 and June 1, 2000,
respectively. On January 20, 2004, RJR and RJR Tobacco
were informed by the government that the investigation is now
closed.

On December 22, 1998, Northern Brands
International, Inc., referred to as Northern Brands, entered
into a plea agreement with the U.S. Attorney for the
Northern District of New York. Northern Brands is a
now-inactive RJR subsidiary that was part of the business of
R. J. Reynolds International B.V., a former
Netherlands subsidiary of RJR Tobacco, which was managed by
a former affiliate, RJR-MacDonald, Inc., referred to as RJR-MI.
On May 12, 1999, RJR-MI was sold to Japan Tobacco Inc. and
subsequently changed its name to JT-MacDonald, Corp. Northern
Brands was charged with aiding and abetting certain customers
who brought merchandise into the United States by means of
false and fraudulent practices .... It is understood
that, at all relevant times over the past several years,
JT-MacDonald, Corp., Japan Tobaccos international
operating company in Canada, cooperated with an investigation
conducted by the Royal Canadian Mounted Police, referred to as
RCMP, relating to the same events that gave rise to
the Northern Brands investigation. On or about February 27,
2003, the RCMP filed criminal charges against and served
summonses on JT-MacDonald, Corp., Northern Brands,
R.J. Reynolds Tobacco International, Inc., referred to as
RJR-TI, R. J. Reynolds Tobacco Co. (Puerto Rico),
referred to as RJR-PR, and eight individuals associated with
RJR-MI and/or RJR-TI during the period January 1, 1991
through December 31, 1996. The charges filed are for
alleged fraud and conspiracy to defraud Canada and the Provinces
of Ontario and Quebec in connection with the purchase, sale,
export, import and/or re-export of cigarettes and/or fine cut
tobacco. Although the international business was sold, RJR
and RJR Tobacco retained certain liabilities relating to
the Northern Brands guilty plea and the RCMPs
investigation of the activities that led to the plea. In October
2003, Northern Brands, RJR-TI and RJR-PR filed an application
challenging both the propriety of the service of the summons on
each of them as well as the jurisdiction of the Canadian court
over each of them. A hearing on the application was held in
December 2003 and the decision of the court is still pending,
but is likely to be announced in early 2004.

On September 18, 2003, RJR,
RJR Tobacco, RJR-TI, RJR-PR, and Northern Brands were
served with a statement of claim filed by the Attorney General
of Canada in the Superior Court of Justice, Ontario, Canada.
Also named as defendants are Japan Tobacco, Inc. and a number of
its affiliates. The statement of claim seeks to recover under
various legal theories taxes and duties allegedly not paid as a
result of cigarette smuggling and related activities. The
Attorney General is seeking to recover $1.5 billion in
compensatory damages and $50 million in punitive damages,
as well as equitable and other forms of relief.

Over the past few years, several civil lawsuits
have been filed against RJR Tobacco and its affiliates, along
with other cigarette manufacturers, by the European Community
and the following ten member states: Belgium, Finland, France,
Greece, Germany, Italy, Luxembourg, the Netherlands, Portugal
and Spain; as well as by Ecuador, Belize and Honduras. These
suits contend that RJR Tobacco and other tobacco companies in
the United States may be held responsible variously under the
federal RICO statute, the common law and other legal theories
for taxes and duties allegedly unpaid as a result of cigarette
smuggling. Each of these actions, which are discussed below,
seeks compensatory, punitive and treble damages.

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

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


with the United States Court of Appeals for the
Second Circuit. On January 14, 2004, the Second Circuit
affirmed the dismissal of the case.

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

On December 20, 2000, October 15, 2001,
and January 9, 2003, applications for annulment were filed
in the Court of First Instance in Luxembourg challenging the
competency of the European Community to bring each of the
foregoing actions and seeking an annulment of the decision to
bring each of the actions, respectively. On January 15,
2003, the Court of First Instance entered a judgment denying the
admissibility of the first two applications, principally on the
grounds that the filing of the first two complaints did not
impose binding legal effects on the applicants. On
March 21, 2003, RJR and its affiliates appealed that
judgment to the Court of Justice of the European Communities.
The application for annulment filed in connection with the third
action is still pending before the Court of First Instance. On
September 18, 2003, however, the Court of First Instance
stayed the proceedings in the third action, pending resolution
of the appeals from the January 15, 2003 judgment denying
the admissibility of the first two applications.

RJR Tobacco and other defendants filed
motions to dismiss the civil RICO actions seeking to recover
taxes and revenues allegedly lost as a result of cigarette
smuggling and related activities brought by Ecuador, Belize and
Honduras in the United States District Court for the Southern
District of Florida. These motions were granted on
February 26, 2002, and the plaintiffs filed a notice of
appeal with the United States Court of Appeals for the Eleventh
Circuit on March 26, 2002. On August 14, 2003, the
Eleventh Circuit announced its decision affirming the dismissal
of the cases. On January 12, 2004, the Supreme Court of the
United States announced that it had declined to review the
decision of the Eleventh Circuit.

RJR Tobacco has been served in two
reparations actions brought by descendants of slaves. Plaintiffs
in these actions claim that defendants, including
RJR Tobacco, profited from the use of slave labor. These
two actions have been transferred to Judge Norgle in the
Northern District of Illinois by the Judicial Panel on
Multi-District Litigation for coordinated or consolidated
pretrial proceedings with other reparation actions. Seven
additional cases were originally filed in California, Illinois
and New York. RJR Tobacco is a named defendant in only
one of these additional cases, but it has not been served. The
action in which RJR Tobacco is named but has not been
served was conditionally transferred to the Northern District of
Illinois on January 7, 2003, but the plaintiffs contested
that transfer, and the Judicial Panel on Multi-District
Litigation has not yet issued a final ruling on the transfer.
The plaintiffs filed a consolidated complaint on June 17,
2003. On July 18, 2003, the defendants moved to dismiss
plaintiffs complaint. That motion was granted on
January 26, 2004. The plaintiffs might seek to file an
amended complaint or appeal the dismissal to the United States
Court of Appeals for the Seventh Circuit.

On June 8, 2001, the Attorney General of the
State of California filed a lawsuit against RJR Tobacco in
California state court alleging that RJR Tobacco violated
California state law by distributing free cigarettes and free
coupons for discounts on cigarettes on public
grounds, even though the promotions occurred within an
adult-only facility at a race track and certain
festivals. RJR Tobacco answered the complaint on July 19,
2001, asserting that its promotions complied with all laws,
including California state law and that this

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


California state law is preempted by the Federal
Cigarette Labeling and Advertising Act. On March 29, 2002,
the court ruled that RJR Tobaccos distribution of free
cigarettes violated the law, but the distribution of free
coupons for discounts on cigarettes did not. On April 29,
2002, the judge assessed a civil fine against RJR Tobacco
of $14.8 million. On October 30, 2003, the California
Court of Appeal, Second Appellate District, affirmed the trial
courts decision. On December 8, 2003, RJR Tobacco
filed its petition for review with the California Supreme Court.

On May 23, 2001, Star Scientific, Inc.,
referred to as Star, filed a patent infringement action against
RJR Tobacco in the United States District Court for the
District of Maryland. The suit alleges infringement of
U.S. Patent No. 6,202,649 entitled Method of
Treating Tobacco to Reduce Nitrosamine Content, and Products
Produced Thereby. On July 30, 2002, Star filed
another infringement action against RJR Tobacco in the
United States District Court for the District of Maryland
alleging infringement of a related patent, U.S. Patent
No. 6,425,401 also entitled Method of Treating
Tobacco to Reduce Nitrosamine Content, and Products Produced
Thereby. RJR Tobacco has filed counterclaims seeking
a declaration that the claims of the two Star patents in dispute
are invalid, unenforceable and not infringed by
RJR Tobacco. The Maryland court consolidated the two cases.
No trial date has been set. Both sides have filed motions for
summary judgment. On August 28, 2003, the court held a
hearing on the pending motions, and heard oral arguments. On
September 15, 2003, the court appointed a special master to
issue a report and recommendation on certain of the pending
motions by December 15, 2003. On December 4, 2003, the
special master issued a report and recommendation regarding
Stars motion for claim construction and summary judgment
on definiteness. On December 23, 2003, the special master
issued a report and recommendation regarding
RJR Tobaccos motion for summary judgment that RJR
Tobacco has not infringed the patents in the case.
RJR Tobacco anticipates that the special master will issue
reports and recommendations on the remaining four motions
assigned to him, all of which are summary judgment motions filed
by RJR Tobacco, in the near future. The order of reference
to the special master includes a briefing schedule so that both
sides have an opportunity to submit objections to each of the
special masters reports and recommendations.



---

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

Unfavorable judgments awarding compensatory
damages, punitive damages and/or fines have been returned
against RJR Tobacco in the Engle class-action case,
which was reversed by the intermediate appellate court on
May 21, 2003, a small number of individual smoking and
health cases, a Broin II flight attendant ETS case,
an insurance-related action, an MSA enforcement action and a
California state law enforcement action. Although
RJR Tobacco believes that it has numerous bases for
successful appeals in these cases, and both RJR Tobacco and
RJR believe they have a number of valid defenses to all actions,
and intend to defend all actions vigorously, it is possible that
there could be further adverse developments in these cases, and
that additional cases could be decided unfavorably against RJR
Tobacco or its affiliates or indemnitees. Determinations of
liability or adverse rulings in such cases or in similar cases
involving other cigarette manufacturers as defendants, even if
such judgments are not final, could materially adversely affect
the litigation against RJR Tobacco or its affiliates or
indemnitees, and could encourage the commencement of additional
tobacco-related litigation. In addition, a number of political,
legislative, regulatory and other developments relating to the
tobacco industry and cigarette smoking have received wide media
attention. These developments may negatively affect the outcomes
of tobacco-related legal actions and encourage the commencement
of additional similar litigation.

Although it is impossible to predict the outcome
of such events on pending litigation and the rate new lawsuits
are filed against RJR Tobacco and RJR, a significant increase in
litigation and/or in adverse outcomes for tobacco defendants
could have a material adverse effect on either or both of these
entities.

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Moreover, notwithstanding the quality of defenses
available to it and its affiliates in litigation matters, it is
possible that RJRs results of operations, cash flows or
financial condition could be materially adversely affected by
the ultimate outcome of certain pending litigation matters.

ERISA Litigation

On May 13, 2002, in Tatum v. The R.J.R.
Pension Investment Committee of the R. J. Reynolds Tobacco
Company Capital Investment Plan, pending in the United
States District Court for the Middle District of North Carolina,
an employee of RJR Tobacco filed a class-action suit
alleging that the defendants, RJR, RJR Tobacco, the RJR Employee
Benefits Committee and the RJR Pension Investment Committee,
violated the Employee Retirement Income Security Act of 1974,
referred to as ERISA. The actions about which the plaintiff
complains stem from a decision made in 1999 by RJR Nabisco
Holdings Corp., subsequently renamed Nabisco Group Holdings
Corp., to spin off RJR, thereby separating NGHs tobacco
business and food business. As part of the spin-off, the
401(k) plan for the previously related entities had to be
divided into two separate plans for the now separate tobacco and
food businesses. The plaintiff contends that the defendants
violated ERISA by not overriding an amendment to
RJRs 401(k) plan requiring that, prior to
February 1, 2000, the stock funds of the companies involved
in the food business  NGH and Nabisco Holdings
Corp.  be eliminated as investment options from
RJRs 401(k) plan. In his complaint, the plaintiff
requests, among other things, that the court issue an order
requiring the defendants to pay as damages to the RJR 401(k)
plan an amount equal to the subsequent appreciation that was
purportedly lost as a result of the liquidation of the NGH and
Nabisco Holdings Corp. funds. On July 29, 2002, defendants
filed a motion to dismiss, which the court granted on
December 10, 2003. On January 7, 2004, the plaintiff
appealed to the United States Court of Appeals for the Fourth
Circuit.

Environmental Matters

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

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

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

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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

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

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

RJR Tobacco is a named defendant in a lawsuit
related to an existing superfund site in North Carolina,
United States v. AAF-McQuay, Inc., which was filed
in United States District Court for the Western District of
North Carolina on August 12, 2002. The
Jadco-Hughes superfund site near Belmont, North
Carolina, is land on which a solvent reclamation and disposal
business was owned and operated in the 1970s. It was placed on
the National Priorities List in 1986. RJR Tobacco, through its
former packaging division (now a wholly owned subsidiary known
as RJR Packaging, LLC), as a member of a group of 24 previously
identified PRPs, executed a waiver of service of summons in this
matter. A joint motion of plaintiff and all defendants for an
extension of the stay of all proceedings and for an extension of
time for all defendants to file answers or responses to the
complaint was again granted on November 12, 2003. EPA filed
the action as a result of the expiration of a then-existing
tolling agreement that could not be timely renewed. The PRP
group had requested information from the EPA regarding various
EPA costs related to the Jadco-Hughes site. The parties are
cooperating to seek a resolution of this matter. The aggregate
exposure for the Jadco-Hughes site for all PRPs is presently
approximately $9.2 million. Currently, RJR Tobaccos
apportionment among the PRPs of the costs associated with the
remediation of the sites is approximately 32%.

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

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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

In connection with the sale of the international
tobacco business to Japan Tobacco Inc. on May 12, 1999, RJR
and RJR Tobacco agreed to indemnify Japan Tobacco against



| |   |                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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,    
|
| |  | any liabilities, costs and expenses that Japan
    Tobacco or any of its affiliates, including the acquired
    entities, may incur after the sale in respect of any of
    RJRs or RJR Tobaccos employee benefit and welfare
    plans, and
|
| |  | any liabilities, costs and expenses incurred by
    Japan Tobacco or any of its affiliates arising out of certain
    activities of Northern Brands.                                                                                          

Although it is impossible to predict the outcome
of the Northern Brands litigation or the amount of liabilities,
costs and expenses, a significant adverse outcome regarding any
of these items could have an adverse effect on either or both of
RJR and RJR Tobacco.

As long as RJRs unsecured, unsubordinated
debt rating remains 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 with cash or
securities.

Guarantees

RJRs guarantees include 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 $108 million and
$130 million as of December 31, 2003 and 2002,
respectively.

RJR Tobacco has entered, and continues to enter,
into agreements to indemnify certain distributors and retailers
from liability and related defense costs arising out of the
lawful sale or distribution of RJR Tobaccos products.
RJR Tobacco and other cigarette manufacturers enter into
these agreements on a rotating basis when a distributor or
retailer is named in a lawsuit that also names them as
defendants. RJR Tobacco believes that the indemnifications
do not expose it to any significant incremental liability that
it may have by virtue of its having manufactured those products.
The term of an indemnification is dependent upon the resolution
of the related case, or dismissal of the distributor or retailer
from the case. The costs of such indemnifications have been, and
are expected to be, insignificant and as a result, the fair
value of such indemnifications is considered to be immaterial.
For further information related to these guarantees, including
probability, and estimates of loss, see
 Accounting for Tobacco-Related Litigation
Contingencies above.

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 14  Financial
Instruments

Interest Rate Arrangements

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

During 2002, RJR entered into interest rate swap
agreements to modify the interest characteristics of $1.25
billion, a portion of its publicly registered notes, with fixed
rates of 6.5% to 7.75%, due in 2006 to 2012, so that the
interest payable effectively becomes variable. As a result, as
of December 31, 2003, the average interest rate on
RJRs $1.7 billion long-term debt was 4.31%. The interest
rate swaps notional amounts and termination dates match
those of the outstanding registered notes. As of
December 31, 2003, these fair value hedges were perfectly
effective, resulting in no recognized net gain or loss. The
unrealized gain of the hedges resulting from the change in the
hedges fair value from inception to December 31,
2003, was $88 million, included in other assets and
deferred charges, and is equal to the increase in the fair value
of the hedged long-term debt.

These interest rate swap agreements are
guaranteed and secured by RJRs material subsidiaries,
including RJR Tobacco and Santa Fe.

As long as RJRs unsecured, unsubordinated
debt rating remains 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 with cash or
securities. In addition, because RJR and the guarantors have
pledged their assets to secure their obligations under
RJRs revolving credit facility, as amended and restated,
such pledge also has secured their obligations under these
interest rate swap agreements.

Foreign Currency Arrangements

During 2003, RJR Tobacco settled forward currency
exchange contracts to purchase 4 million euros, which
hedged unrecognized firm commitments for the purchase of
equipment. The $1 million effective unrealized gain is
included in accumulated other comprehensive income and will be
recognized as the underlying equipment cost is recognized in
earnings, generally over its depreciable life. The ineffective
portion of the hedge was insignificant and was recorded as a
foreign exchange gain in other expense.

At December 31, 2003, R. J. Reynolds
International Business Group, Inc. held forward currency
exchange contracts for a net purchase of 1.9 million
British pounds, for the payment of service agreement
obligations, with maturities that average less than
12 months. The insignificant net increase in the fair value
of the effective portion of the foreign currency cash flow
hedges resulted in an unrealized gain, and was recorded in
accumulated other comprehensive income in the accompanying
consolidated balance sheet. The ineffective portion of the
hedges was insignificant and was recorded as a foreign exchange
gain in other (income) expense during the periods presented.

See notes 7 and 12 to consolidated financial
statements for additional disclosures of fair value for
short-term investments and long-term debt.

Credit Risk

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

Note 15  Stockholders
Equity

RJRs authorized capital stock at
December 31, 2003 consisted of 50 million shares of
preferred stock, par value $.01 per share, and
290 million shares of common stock, par value $.01 per
share. The preferred

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


stock, none of which is issued or outstanding,
ranks senior to common stock as to dividends and liquidation
preferences. From the third quarter of 1999 through the second
quarter of 2001, RJRs board of directors declared a
quarterly cash dividend of $0.775 per common share, or
$3.10 on an annualized basis. Beginning with the third quarter
of 2001, the board of directors declared a quarterly cash
dividend of $0.875 per common share, or $3.50 on an
annualized basis, an increase of 12.9%. Beginning with the
second quarter of 2002, the board of directors declared a
quarterly cash dividend of $0.95 per common share, or $3.80
on an annualized basis, an increase of 8.6%.

The following tables summarize stock repurchases
from November 1999 to December 31, 2003. These repurchases
were 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. In April 2003, to increase
financial flexibility, RJR suspended repurchases under its $1.0
billion repurchase program authorized by the board of directors
in February 2002 and does not intend to reinstate this program
in the foreseeable future.

RJR continues to purchase stock through a program
designed to repurchase shares related to tax liability
concerning certain option exercises and restricted stock vesting
under its 1999 Long Term Incentive Plan. Shares held by RJR
through repurchase programs shown in the following table, in
addition to shares forfeited pursuant to employee stock plans,
are included in treasury stock in RJRs consolidated
balance sheets.

|                          |                   |        |           |               |  |   |    |    | 
|------------------------- | ----------------- | ------ | --------- | ------------- |  | - | -- | -- | 
|Repurchases  2003        |                   | Shares |           | Cost         
|                          |                   |        |           |              
|                          |                   |        |           | (In millions)
|$1 billion authorization  |                   |        | 1,441,460 |               |  | $ | 60 |   
|1999 LTIP tax withholding |                   |        | 348,414   |               |  |   | 15 |   
|                          |                   |        |           |               |  |   |    |   
|                          | Total during 2003 |        |           | 1,789,874     |  |   | $  | 75 | 
|                          |                   |        |           |               |  |   |    |   

|                                     |  |                                      |            |        |            |      |       |   |     | 
|------------------------------------ |  | ------------------------------------ | ---------- | ------ | ---------- | ---- | ----- | - | --- | 
|Cumulative                           |  | Period Completed                     |            | Shares |            | Cost
|                                     |  |                                      |            |        |            |     
|Programs completed                   |  | November 1999 to February 2002       |            |        | 21,570,739 |      |       | $ | 875 | 
|$1 billion approved February 6, 2002 |  | Remaining Authorization$530 million |            |        | 9,187,160  |      |       |   | 470 | 
|1999 LTIP tax withholding            |  | Ongoing                              |            |        | 467,488    |      |       |   | 21  | 
|                                     |  |                                      |            |        |            |      |       |   |     | 
|Total as of December 31, 2003        |  |                                      | 31,225,387 |        |            | $    | 1,366 |  
|                                     |  |                                      |            |        |            |      |       |  



|          |            
|--------- | -----------
|Note 16  | Stock Plans

As of December 31, 2003, RJR had two stock
plans, the Amended and Restated Equity Incentive Award Plan for
Directors, referred to as the EIAP, and the 1999 Long Term
Incentive Plan, referred to as the 1999 LTIP.

The EIAP currently provides for (1) grants
of stock options and deferred stock units to outside directors
upon becoming a director and (2) grants of deferred units
on a quarterly and annual basis thereafter. Directors may elect
to receive shares of common stock in lieu of their annual grant
of deferred stock units. A maximum of 500,000 shares of
common stock may be issued under this plan, of which
336,122 shares were available for grant as of
December 31, 2003. Options granted upon becoming a director
may be exercised between six months and ten years at a price
that is the market value of the stock on the grant date.
Effective in April 2000, the EIAP was amended to provide for
quarterly grants of deferred stock units in lieu of annual
grants of stock options. The annual stock option grants awarded
prior to the amendment of the EIAP in April 2000 each fully
vested in 2002 and are exercisable for ten years from the date
of grant. Deferred stock units granted under the EIAP have a
value equal to, and bear dividend equivalents at the same rate
as, one share of RJRs common stock at date of grant, and
have no voting rights. The dividends are paid as additional
units in an amount equal to the number of common shares that
could be purchased with the dividends on the date of payment. As
soon as practicable following his or her last year of service on
the board, the director is paid in cash for the units granted
quarterly and in common stock for the units granted annually,
unless the director elects to receive cash

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


for the annual grants. Cash payments are based on
the average closing price of RJRs common stock during
December of the year preceding payment.

The 1999 LTIP provides for grants of incentive
stock options, other stock options, stock appreciation rights,
restricted stock, performance units and performance shares to
key employees. The total number of shares of common stock
authorized for grant under the 1999 LTIP is
8,000,000 shares, plus 5,772,814 shares issuable under
the NGH Long Term Incentive Plan awards that, in connection with
the spin-off, were converted into 5,456,114 RJR options and
316,700 shares of restricted common stock under the 1999
LTIP. Of this authorization, 4,526,941 shares were
available for grant as of December 31, 2003.

The spin-off did not change the values of the
option grants, ratios of exercise price to market value, vesting
provisions or exercise periods. The five-year vesting provisions
of the restricted shares was identical for those held by
continuing employees of RJR and its subsidiaries and lapsed on
those held by employees of the sold international tobacco
business and NGH. Restrictions lapsed on the remaining shares in
2003 and the unamortized portion of the grant in
stockholders equity was fully amortized in 2003.
Compensation expense related to the restricted shares held by
continuing employees of RJR and its subsidiaries was
insignificant in each of 2003, 2002 and 2001.

In 1999, RJR granted 777,000 shares of
restricted stock in tandem with 3,108,000 options, included in
the following option table, to eligible employees under the 1999
LTIP. On each vesting date, each eligible employee will receive
the portion of the tandem award with the highest value, the
vesting shares of RJR common stock or tandem stock options,
unless he or she has previously made an affirmative election
otherwise. Generally, these shares may not be disposed of, or
transferred while restricted during the three- to five-year
vesting period. Of these restrictions, 126,250 will lapse in
2004, unless the shares are forfeited. Since the date of grant,
591,374 shares have been forfeited and restrictions have
lapsed on 59,376 shares. The market price of the stock on
the grant date was charged to stockholders equity as
unearned compensation and was amortized on a straight-line basis
over the vesting periods through September 2000. Since the
fourth quarter of 2000, it has been more probable that holders
will forfeit the restricted stock grant at vesting and elect to
exercise the related tandem options. Accordingly, amortization
of the unamortized equity to compensation expense was suspended.
During the 2003 vesting process, holders of certain of these
vesting shares elected stock. The unamortized equity portion of
these shares resulted in a $1 million charge to
compensation expense. The unamortized portion of the remaining
shares vesting in 2003 and forfeited for options was eliminated,
and the previously recognized compensation expense was credited
to paid-in capital. During 2003, compensation expense was
$2 million, including the amortization expense on vesting
shares, dividends paid on unvested restricted shares and the
reversal of previous compensation expense that resulted from the
forfeiture of unvested restricted shares. During 2002,
compensation expense was $1 million, including the
dividends paid on unvested restricted shares and the reversal of
previous compensation expense that resulted from the forfeiture
of unvested restricted shares. During 2001, a reversal of
previous compensation expense of $1 million resulted from
the forfeiture of unvested restricted shares. The unamortized
portion remaining in stockholders equity at
December 31, 2003 was $3 million.

In 2000, RJR granted 673,898 shares of
restricted stock at $17.03 to eligible employees under the 1999
LTIP. Generally, these shares may not be disposed of or
transferred during the three-year vesting period. Since the date
of grant, 82,715 shares were forfeited, and restrictions on
the remaining shares lapsed in February 2003. Because the actual
number of shares granted was based on certain performance
factors, this grant was accounted for as a variable grant and,
accordingly, the fair value was charged to stockholders
equity as unearned compensation and was amortized over the
three-year vesting period. Including amortization of performance
shares and dividends on forfeited shares, the unamortized
portion of the grant in stockholders equity was fully
amortized in 2003, resulting in compensation expense of
$1 million in 2003, a credit of $3 million in 2002 and
an expense of $17 million in 2001.

In 2001, RJR granted 304,590 shares of
restricted stock at $52.96 to eligible employees under the 1999
LTIP. Generally, these shares may not be disposed of or
transferred during the three-year vesting period.

123



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


These restrictions will lapse in 2004, unless the
related shares are forfeited. Because the actual number of
shares granted may increase or decrease based on certain
performance factors, this grant is accounted for as a variable
grant and, accordingly, the fair value is being charged to
stockholders equity as unearned compensation and is being
amortized over the three-year vesting period. Since the date of
the grant, 25,348 restricted shares have been forfeited and
restrictions on 39,879 shares lapsed. During 2003, 2002 and
2001, including amortization of expected performance shares and
dividends on forfeited shares, compensation expense was
$7 million, $1 million and $6 million,
respectively. The unamortized portion remaining in
stockholders equity at December 31, 2003 was
insignificant.

In 2002, RJR granted 334,766 shares of
restricted stock at $53.49 to eligible employees under the 1999
LTIP. Generally, these shares may not be disposed of or
transferred during the three-year vesting period. These
restrictions will lapse in 2005, unless the related shares are
forfeited. Because the actual number of shares granted may
increase or decrease based on certain performance factors, this
grant is accounted for as a variable grant and, accordingly, the
fair value is being charged to stockholders equity as
unearned compensation and is being amortized over the three-year
vesting period. Since the date of the grant, 30,792 restricted
shares were forfeited and restrictions on 16,155 shares
lapsed. During 2003 and 2002, including amortization of expected
performance shares and dividends on forfeited shares,
compensation expense was $6 million and $2 million,
respectively. The unamortized portion remaining in
stockholders equity at December 31, 2003 was
$7 million.

In 2003, RJR granted 401,314 shares of
restricted stock at $35.52 to eligible employees under the 1999
LTIP. Generally, these shares may not be disposed of or
transferred during the three-year vesting period. These
restrictions will lapse in 2006, unless the related shares are
forfeited. The actual number of shares granted is fixed, and
will not increase or decrease based on performance factors. The
market price of the stock on the grant date was charged to
stockholders equity as unearned compensation and is being
amortized using the straight-line method over the three-year
vesting period. Since the date of the grant, 128 restricted
shares have been forfeited. Including dividends on forfeited
shares, compensation expense was $2 million in 2003 and the
unamortized portion remaining in stockholders equity at
December 31, 2003 was $12 million.

In the EIAP and the 1999 LTIP, for various price
ranges, the weighted average characteristics of stock options
outstanding and exercisable at December 31, 2003 were:

|                     |  |                     |           |                     |  |          |     |        |  |          |       |  |  |  |           |  |  |   |       | 
|-------------------- |  | ------------------- | --------- | ------------------- |  | -------- | --- | ------ |  | -------- | ----- |  |  |  | --------- |  |  | - | ----- | 
|                     |  |                     |           |                    
|                     |  | Options Outstanding |           | Exercisable Options
|                     |  |                     |           |                    
|                     |  |                     |           | Average             |  | Weighted |     |        |  | Weighted
|                     |  |                     |           | Remaining           |  | Average  |     |        |  | Average 
|                     |  |                     |           | Contractual         |  | Exercise |     |        |  | Exercise
|Exercise Price Range |  | Shares              |           | Life (Years)        |  | Price    |     | Shares |  | Price   
|                     |  |                     |           |                     |  |          |     |        |  |         
|$23.32  $33.71      |  |                     | 1,960,092 |                     |  |          | 5.3 |        |  | $        | 29.11 |  |  |  | 1,455,092 |  |  | $ | 29.02 | 
|36.24   48.33       |  |                     | 25,321    |                     |  |          | 5.8 |        |  |          | 40.14 |  |  |  | 15,321    |  |  |   | 42.18 | 
|69.79   69.79       |  |                     | 10,000    |                     |  |          | 8.4 |        |  |          | 69.79 |  |  |  | 10,000    |  |  |   | 69.79 | 

124



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The changes in RJRs stock options during
2003, 2002 and 2001 were:

|                                         |  |         |           |          |  |         |       |          |  |         |            |          |  |   |       |  |  |  |            |   |  |   |       | 
|---------------------------------------- |  | ------- | --------- | -------- |  | ------- | ----- | -------- |  | ------- | ---------- | -------- |  | - | ----- |  |  |  | ---------- | - |  | - | ----- | 
|                                         |  |         |           |          |  |        
|                                         |  | 2003    |           | 2002     |  | 2001   
|                                         |  |         |           |          |  |        
|                                         |  |         |           | Weighted |  |         |       | Weighted |  |         |            | Weighted
|                                         |  |         |           | Average  |  |         |       | Average  |  |         |            | Average 
|                                         |  |         |           | Exercise |  |         |       | Exercise |  |         |            | Exercise
|                                         |  | Options |           | Price    |  | Options |       | Price    |  | Options |            | Price   
|                                         |  |         |           |          |  |         |       |          |  |         |            |         
|Options outstanding at beginning of year |  |         | 2,876,252 |          |  | $       | 29.31 |          |  |         | 4,393,776  |          |  | $ | 29.01 |  |  |  | 6,096,570  |   |  | $ | 28.76 | 
|Options granted                          |  |         | 10,000    |          |  |         | 37.03 |          |  |         | 10,000     |          |  |   | 69.79 |  |  |  |           |   |  |   |      | 
|Options forfeited                        |  |         | (277,443  | )        |  |         | 30.88 |          |  |         | (160,735   | )        |  |   | 29.14 |  |  |  | (220,000   | ) |  |   | 27.50 | 
|Options exercised                        |  |         | (613,396  | )        |  |         | 28.28 |          |  |         | (1,366,789 | )        |  |   | 28.65 |  |  |  | (1,482,794 | ) |  |   | 28.23 | 
|                                         |  |         |           |          |  |         |       |          |  |         |            |          |  |   |       |  |  |  |            |   |  |   |       | 
|Options outstanding at end of year       |  |         | 1,995,413 |          |  |         | 29.45 |          |  |         | 2,876,252  |          |  |   | 29.31 |  |  |  | 4,393,776  |   |  |   | 29.01 | 
|                                         |  |         |           |          |  |         |       |          |  |         |            |          |  |   |       |  |  |  |            |   |  |   |       | 
|Exercisable at end of year               |  |         | 1,480,413 |          |  |         | 29.43 |          |  |         | 1,738,252  |          |  |   | 29.42 |  |  |  | 1,713,866  |   |  |   | 28.76 | 
|                                         |  |         |           |          |  |         |       |          |  |         |            |          |  |   |       |  |  |  |            |   |  |   |       | 

Equity compensation plan information is as
follows:

|                                                                  |       |                      |           |                    |  |                         |       |       |  |  |           |           | 
|----------------------------------------------------------------- | ----- | -------------------- | --------- | ------------------ |  | ----------------------- | ----- | ----- |  |  | --------- | --------- | 
|                                                                  |       |                      |           |                    |  | Number of Securities   
|                                                                  |       |                      |           |                    |  | Remaining Available for
|                                                                  |       | Number of Securities |           | Weighted-Average   |  | Future Issuance under  
|                                                                  |       | to be Issued Upon    |           | Exercise Prices of |  | Equity Compensation    
|                                                                  |       | Exercise of          |           | Outstanding        |  | Plans (Excluding       
|                                                                  |       | Outstanding Options, |           | Options, Warrants  |  | Securities Reflected in
|Plan Category                                                     |       | Warrants and Rights  |           | and Rights         |  | Column (a))            
|                                                                  |       |                      |           |                    |  |                        
|                                                                  |       | (a)                  |           | (b)                |  | (c)                    
|Equity Compensation Plans Approved by Security
    Holders        |       |                      | 1,917,013 |                    |  | $                       | 29.12 |       |  |  | 4,526,941 |          
|Equity Compensation Plans Not Approved by
    Security Holders(1) |       |                      | 78,400    |                    |  |                         | 37.56 |       |  |  | 336,122   |          
|                                                                  |       |                      |           |                    |  |                         |       |       |  |  |           |          
|                                                                  | Total |                      |           | 1,995,413          |  |                         |       | 29.45 |  |  |           | 4,863,063 | 
|                                                                  |       |                      |           |                    |  |                         |       |       |  |  |           |          






|    |                                                                                                                                                                                                     
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The EIAP is the only equity compensation plan not
    approved by RJRs public stockholders. The EIAP was
    approved by RJRs sole shareholder, NGH, prior to
    RJRs spin-off on June 15, 1999.

RJR adopted the prospective method of transition
of SFAS No. 148 effective January 1, 2003.
Accordingly, all compensation costs related to employee stock
plans that were granted prior to January 1, 2003, will
continue to be recognized using the intrinsic value-based method
under the provisions of APB No. 25, Accounting for
Stock Issued to Employees, and related Interpretations.
However, any compensation costs related to grants or
modifications of existing grants subsequent to January 1,
2003 will be recognized under the fair value method of
SFAS No. 123, as amended. All compensation costs
related to employee stock plans for all grant dates will be
disclosed under the provisions of SFAS No. 123, as
amended. No compensation expense has been recognized for stock
options granted, as all options granted had an exercise price
equal to the market value of the underlying common stock on the
date of grant.

125



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 17  Retirement
Benefits

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

|                                                                      |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |      |  
|--------------------------------------------------------------------- | ---------------------------------------------- | ---------------- | - | -------------- | - | ---- | - | ----- | - |  | - | ---- | - |  | - | ---- | -
|                                                                      |                                                |                  |   |                |   |     
|                                                                      |                                                |                  |   | Postretirement
|                                                                      |                                                | Pension Benefits |   | Benefits      
|                                                                      |                                                |                  |   |               
|                                                                      |                                                | 2003             |   | 2002           |   | 2003 |   | 2002 
|                                                                      |                                                |                  |   |                |   |      |   |      
|Change in benefit obligation:                                         |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Obligation at beginning of year                |                  | $ | 2,848          |   |      | $ | 2,529 |   |  | $ | 919  |   |  | $ | 740  |  
|                                                                      | Service cost                                   |                  |   | 40             |   |      |   | 38    |   |  |   | 6    |   |  |   | 6    |  
|                                                                      | Interest cost                                  |                  |   | 181            |   |      |   | 181   |   |  |   | 53   |   |  |   | 60   |  
|                                                                      | Actuarial loss                                 |                  |   | 109            |   |      |   | 264   |   |  |   | 49   |   |  |   | 177  |  
|                                                                      | Plan amendments                                |                  |   | 6              |   |      |   | 5     |   |  |   | (155 | ) |  |   |     |  
|                                                                      | Benefits paid                                  |                  |   | (204           | ) |      |   | (194  | ) |  |   | (63  | ) |  |   | (71  | )
|                                                                      | Settlements                                    |                  |   | (5             | ) |      |   | (11   | ) |  |   |     |   |  |   |     |  
|                                                                      | Special termination benefits                   |                  |   | 71             |   |      |   | 34    |   |  |   |     |   |  |   |     |  
|                                                                      | Curtailment                                    |                  |   | 10             |   |      |   | 2     |   |  |   | 5    |   |  |   | 7    |  
|                                                                      |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Obligation at end of year                      |                  | $ | 3,056          |   |      | $ | 2,848 |   |  | $ | 814  |   |  | $ | 919  |  
|                                                                      |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|Change in plan assets:                                                |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Fair value of plan assets at beginning of year |                  | $ | 1,915          |   |      | $ | 2,160 |   |  | $ |     |   |  | $ |     |  
|                                                                      | Actual return on plan assets                   |                  |   | 488            |   |      |   | (240  | ) |  |   |     |   |  |   |     |  
|                                                                      | Employer contributions                         |                  |   | 112            |   |      |   | 200   |   |  |   | 63   |   |  |   | 71   |  
|                                                                      | Benefits paid                                  |                  |   | (204           | ) |      |   | (194  | ) |  |   | (63  | ) |  |   | (71  | )
|                                                                      | Settlements                                    |                  |   | (5             | ) |      |   | (11   | ) |  |   |     |   |  |   |     |  
|                                                                      |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Fair value of plan assets at end of year       |                  | $ | 2,306          |   |      | $ | 1,915 |   |  | $ |     |   |  | $ |     |  
|                                                                      |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|Funded status:                                                        |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Funded status                                  |                  | $ | (750           | ) |      | $ | (933  | ) |  | $ | (814 | ) |  | $ | (919 | )
|                                                                      | Unrecognized transition asset                  |                  |   |               |   |      |   |      |   |  |   | (3   | ) |  |   | (9   | )
|                                                                      | Unrecognized prior service cost                |                  |   | 17             |   |      |   | 15    |   |  |   | (133 | ) |  |   |     |  
|                                                                      | Unrecognized net actuarial loss                |                  |   | 851            |   |      |   | 1,097 |   |  |   | 351  |   |  |   | 330  |  
|                                                                      |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Net amount recognized                          |                  | $ | 118            |   |      | $ | 179   |   |  | $ | (599 | ) |  | $ | (598 | )
|                                                                      |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|Amounts recognized in the consolidated balance
    sheets consist of: |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Accrued benefit  current liability            |                  | $ | (116           | ) |      | $ | (100  | ) |  | $ | (58  | ) |  | $ | (82  | )
|                                                                      | Accrued benefit  long-term liability          |                  |   | (493           | ) |      |   | (660  | ) |  |   | (541 | ) |  |   | (516 | )
|                                                                      | Intangible asset                               |                  |   | 17             |   |      |   | 16    |   |  |   |     |   |  |   |     |  
|                                                                      | Accumulated other comprehensive income         |                  |   | 710            |   |      |   | 923   |   |  |   |     |   |  |   |     |  
|                                                                      |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     
|                                                                      | Net amount recognized                          |                  | $ | 118            |   |      | $ | 179   |   |  | $ | (599 | ) |  | $ | (598 | )
|                                                                      |                                                |                  |   |                |   |      |   |       |   |  |   |      |   |  |   |     

Weighted-average assumptions used to determine
benefit obligations at December 31:

|                              |  |      |       |      |  |  |       | 
|----------------------------- |  | ---- | ----- | ---- |  |  | ----- | 
|                              |  | 2003 |       | 2002
|                              |  |      |       |     
|Discount rate                 |  |      | 6.15% |      |  |  | 6.40% | 
|Rate of compensation increase |  |      | 5.00% |      |  |  | 5.00% | 

The measurement date used for all plans was
December 31, 2003.

As of December 31, 2003, all of the pension
plans experienced accumulated benefit obligations in excess of
plan assets, for which the projected benefit obligation,
accumulated benefit obligation and fair value of plan

126



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


assets were $3,056 million,
$2,913 million and $2,306 million, respectively. As of
December 31, 2002, all of the pension plans experienced
accumulated benefit obligations in excess of plan assets, for
which the projected benefit obligation, accumulated benefit
obligation and fair value of plan assets were
$2,848 million, $2,673 million and
$1,915 million, respectively.

|                                           |                                    |                             |   |                |     |      |   |      |    |      |   |      |    |   |   |     |    |  |   |    |    |  |   |    |    | 
|------------------------------------------ | ---------------------------------- | --------------------------- | - | -------------- | --- | ---- | - | ---- | -- | ---- | - | ---- | -- | - | - | --- | -- |  | - | -- | -- |  | - | -- | -- | 
|                                           |                                    |                             |   |                |     |      |   |     
|                                           |                                    |                             |   | Postretirement
|                                           |                                    | Pension Benefits            |   | Benefits      
|                                           |                                    |                             |   |               
|                                           |                                    | 2003                        |   | 2002           |     | 2001 |   | 2003 |    | 2002 |   | 2001
|                                           |                                    |                             |   |                |     |      |   |      |    |      |   |     
|Components of total benefit cost (income): |                                    |                             |   |                |     |      |   |      |    |      |   |      |    |   |   |     |    |  |   |    |    |  |   |   
|                                           | Service cost                       |                             | $ | 40             |     |      | $ | 38   |    |      | $ | 35   |    |   | $ | 6   |    |  | $ | 6  |    |  | $ | 6  |   
|                                           | Interest cost                      |                             |   | 181            |     |      |   | 181  |    |      |   | 179  |    |   |   | 53  |    |  |   | 60 |    |  |   | 54 |   
|                                           | Expected return on plan assets     |                             |   | (187           | )   |      |   | (222 | )  |      |   | (220 | )  |   |   |    |    |  |   |   |    |  |   |   |   
|                                           | Amortization of transition asset   |                             |   |               |     |      |   |     |    |      |   |     |    |   |   | (6  | )  |  |   | (6 | )  |  |   | (6 | ) 
|                                           | Amortization of prior service cost |                             |   | 1              |     |      |   | (2   | )  |      |   | (3   | )  |   |   | (10 | )  |  |   |   |    |  |   |   |   
|                                           | Amortization of net loss (gain)    |                             |   | 51             |     |      |   | 4    |    |      |   | 2    |    |   |   | 27  |    |  |   | 16 |    |  |   | 9  |   
|                                           |                                    |                             |   |                |     |      |   |      |    |      |   |      |    |   |   |     |    |  |   |    |    |  |   |   
|                                           | Net periodic benefit cost (income) |                             |   | 86             |     |      |   | (1   | )  |      |   | (7   | )  |   |   | 70  |    |  |   | 76 |    |  |   | 63 |   
|                                           | Curtailment/special benefits       |                             |   | 87             |     |      |   | 37   |    |      |   |     |    |   |   | (6  | )  |  |   | 7  |    |  |   |   |   
|                                           | Settlements                        |                             |   |               |     |      |   | 3    |    |      |   | 4    |    |   |   |    |    |  |   |   |    |  |   |   |   
|                                           |                                    |                             |   |                |     |      |   |      |    |      |   |      |    |   |   |     |    |  |   |    |    |  |   |   
|                                           |                                    | Total benefit cost (income) |   | $              | 173 |      |   | $    | 39 |      |   | $    | (3 | ) |   | $   | 64 |  |   | $  | 83 |  |   | $  | 63 | 
|                                           |                                    |                             |   |                |     |      |   |      |    |      |   |      |    |   |   |     |    |  |   |    |    |  |   |   

Weighted-average assumptions used to determine
net periodic benefit cost for years ended December 31:

|                                         |  |      |                |      |  |      |       |  |  |  |       | 
|---------------------------------------- |  | ---- | -------------- | ---- |  | ---- | ----- |  |  |  | ----- | 
|                                         |  | 2003 |                | 2002 |  | 2001
|                                         |  |      |                |      |  |     
|Discount rate                            |  |      | 6.40%/6.50%(1) |      |  |      | 7.40% |  |  |  | 7.50% | 
|Expected long-term return on plan assets |  |      | 9.00%          |      |  |      | 9.50% |  |  |  | 9.50% | 
|Rate of compensation increase            |  |      | 5.00%          |      |  |      | 5.00% |  |  |  | 5.00% | 






|    |                                                                                                                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | A discount rate of 6.40% was used for the period
    from January 1, 2003 to August 31, 2003, and adjusted
    to a discount rate of 6.50% for the period from August 31,
    2003 to December 31, 2003 to reflect the impact of the 2003
    restructuring plan.

The overall expected long-term rate of return on
assets assumption is based on: (1) the target asset
allocation for plan assets, (2) long-term capital markets
forecasts for asset classes employed, and (3) active
management excess return expectations to the extent asset
classes are actively managed.

SFAS No. 87 permits the delayed recognition
of pension fund gains and losses in ratable periods of up to
five years. RJR uses a five-year period wherein pension fund
gains and losses are reflected in the pension calculation at 20%
per year, beginning the year after the gains or losses occur.
Recent stock market increases have partially offset prior year
declines, which in turn resulted in a reduction of additional
minimum pension liabilities through a benefit of
$213 million, $137 million after tax, to other
comprehensive income in 2003. Prior service costs are amortized
on a straight-line basis over the average remaining service
period of employees expected to receive benefits under the plan.

In connection with the 2003 and 2002
restructuring plans, curtailment and special termination
benefits costs were $87 million and $37 million for
pension benefits, respectively, and $(6) million and
$7 million for postretirement benefits, respectively.

Plan assets are invested using a combination of
active and passive investment strategies. Active strategies
employ multiple investment management firms. Managers within
each asset class cover a range of investment styles and
approaches and are combined in a way that controls for
capitalization, style biases (equity investments), and interest
rate bets (fixed income investments) against related benchmark
indices, while focusing primarily on issue selection as a means
to add value. Risk is controlled through diversification among
asset classes, managers, styles and securities. Risk is further
controlled both at the manager and asset class level by
assigning excess return and tracking error targets. Investment
managers are monitored to evaluate performance against these
benchmark indices and targets.

127



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Allowable investment types include
U.S. equity, non-U.S. equity, fixed income and hedge
funds. The U.S. equity fund is composed of common stocks of
large, medium and small companies, which are predominantly
U.S. based. The non-U.S. equity fund includes equity
securities issued by companies domiciled outside the U.S. and in
depository receipts, which represent ownership of securities of
non-U.S. companies. The fixed income fund includes fixed
income securities issued or guaranteed by the
U.S. government, and to a lesser extent by
non-U.S. governments, or by their respective agencies and
instrumentalities, mortgage backed securities, including
collateralized mortgage obligations; corporate debt obligations
and dollar-denominated obligations issued in the United States
by non-U.S. banks and corporations (Yankee bonds). Up to
25% of the fixed income assets can be in debt securities that
are below investment grade. The hedge funds invest as a limited
partner in portfolios of primarily public securities, including
equities and fixed income.

Futures are used to equitize cash held by
investment managers in order to approach fully invested
portfolio positions. Otherwise, a small number of investment
managers employ limited use of derivatives, including futures
contracts, options on futures and interest rate swaps in place
of direct investment in securities to gain efficient exposure to
markets. Derivatives are not used to leverage portfolios.

The target asset allocation is 45%
U.S. equity investments, 20% non-U.S. equity
investments, 25% fixed income investments and 10% hedge fund
investments, with a rebalancing range of approximately plus or
minus 5% around the target asset allocations.

RJRs pension plans weighted-average asset
allocations at December 31, 2003, and 2002, by asset
category were as follows:

|                           |       |                |     |      |  |  |     |      | 
|-------------------------- | ----- | -------------- | --- | ---- |  |  | --- | ---- | 
|                           |       |               
|                           |       | Plan Assets at
|                           |       | December 31   
|                           |       |               
|                           |       | 2003           |     | 2002
|                           |       |                |     |     
|Asset Category             |       |                |     |      |  |  |     |     
|U.S. Equity securities     |       |                | 46% |      |  |  | 42% |     
|Non U.S. Equity securities |       |                | 22% |      |  |  | 18% |     
|Debt securities            |       |                | 21% |      |  |  | 26% |     
|Hedge funds                |       |                | 9%  |      |  |  | 12% |     
|Other                      |       |                | 2%  |      |  |  | 2%  |     
|                           |       |                |     |      |  |  |     |     
|                           | Total |                |     | 100% |  |  |     | 100% | 
|                           |       |                |     |      |  |  |     |     

For 2003 measurement purposes, a 9.5% annual rate
of increase in the pre-65 per capita cost of covered health
care was used for the HMO plan. The rate was assumed to decrease
to 9.0% for 2004 and then to decrease to an ultimate rate of
5.0% in 2013 and beyond. The 2003 annual rate of increase for
post-65 per capita cost of covered care for the HMO plan
was 12.5%, 11.5% for 2004, then decreasing to an ultimate rate
of 5.0% in 2013 and beyond. Additionally, for the indemnity
plan, a 10.0% annual rate of increase in the pre-65 per
capita cost of covered health care was used for 2003. The rate
was assumed to decrease to 9.5% for 2004, then decrease to a
rate of 5.5% in 2013 and beyond. The annual rate of increase for
post-65 per capita cost of covered care for the indemnity
plan was 13.0% for 2003. The rate was assumed to decrease to
12.0% for 2004, then decreasing to an ultimate rate of 5.5% in
2013 and beyond.

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

|                                                            |  |              |    |              |  |   |     |  
|----------------------------------------------------------- |  | ------------ | -- | ------------ |  | - | --- | -
|                                                            |  | 1-Percentage |    | 1-Percentage
|                                                            |  | Point        |    | Point       
|                                                            |  | Increase     |    | Decrease    
|                                                            |  |              |    |             
|Effect on Total of Service and Interest Cost
    Components |  | $            | 2  |              |  | $ | (2  | )
|Effect on Benefit Obligation                                |  |              | 34 |              |  |   | (30 | )

128



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


RJR expects to contribute $116 million to
its pension plans and $58 million to its post-retirement
plan during 2004.

Estimated future benefits payments:

|          |  |          |       |                |  |   |     | 
|--------- |  | -------- | ----- | -------------- |  | - | --- | 
|          |  | Pension  |       | Postretirement
|Year      |  | Benefits |       | Benefits      
|          |  |          |       |               
|2004      |  | $        | 219   |                |  | $ | 58  | 
|2005      |  |          | 326   | (1)            |  |   | 64  | 
|2006      |  |          | 262   |                |  |   | 66  | 
|2007      |  |          | 229   |                |  |   | 66  | 
|2008      |  |          | 223   |                |  |   | 66  | 
|2009-2013 |  |          | 1,107 |                |  |   | 323 | 






|    |                                                                                                                                                                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The increased pension benefits payments in 2005
    include the assumption that a larger than normal portion of the
    employees downsized during the 2003 restructuring will request a
    lump sum payment of their retirement benefits at the end of
    their severance period.

On December 8, 2003, President Bush signed
into law the Medicare Prescription Drug, Improvement and
Modernization Act of 2003, referred to as the Act. The Act
expanded Medicare to include, for the first time, coverage for
prescription drugs. RJR sponsors retiree medical programs, which
include coverage for prescription drugs. RJR has elected to
defer financial recognition of this legislation until the FASB
issues final accounting guidance. When issued, that final
guidance could require RJR to change previously reported
information. This deferral election is permitted under FASB
Staff Position FAS 106-1, Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003.

RJR and its subsidiaries sponsor a qualified
defined contribution plan, and following a participants
contribution, match 50% based on a maximum of 6% of a
participants compensation for participants hired prior to
January 1, 2004. For participants hired after
December 31, 2003, RJR will match 100% based on a maximum
of 6% of a participants compensation. The expense related
to this plan was $12 million in each of 2003, 2002 and 2001.

Note 18  Segment
Information

RJR has one reportable operating segment, RJR
Tobacco, which is the second largest cigarette manufacturer in
the United States. RJR Tobaccos largest selling cigarette
brands, CAMEL, WINSTON, SALEM and DORAL, were four of the top
ten best-selling brands of cigarettes in the United States in
2003. Those brands, and its other brands, including VANTAGE,
MORE and NOW, are manufactured in a variety of styles and
marketed in the United States to meet a range of adult smoker
preferences.

The disclosures classified as All Other include
the total assets and results of operations of Santa Fe,
which was acquired by RJR on January 16, 2002.
Santa Fe manufactures and markets cigarettes and other
tobacco products under the NATURAL AMERICAN SPIRIT brand.
Santa Fe currently markets its products primarily in the
United States, and 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, is initially
marketing its products in France, Spain, the Canary Islands and
Italy, and in 2003, expanded into Andorra and Belgium. Its
products are manufactured in Austria. As a part of the
transaction, RJR Tobacco is licensing REYNOLDS, a new
American-blend brand, to the joint venture. The investment is
accounted for using the equity method. Segment disclosures
related to the joint venture are included in the classification
All Other.

129



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Segment Data:

|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |        |        |    
|----------------------------------------------------------------------------------- | ---------------------------------------------------------------- | ------------------------------------ | - | ------ | ------ | ---- | - | ------ | ------ | - | - | ------ | ------ | ---
|                                                                                    |                                                                  | 2003                                 |   | 2002   |        | 2001
|                                                                                    |                                                                  |                                      |   |        |        |     
|Net sales:                                                                          |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    | RJR Tobacco                                                      |                                      | $ | 5,024  |        |      | $ | 6,026  |        |   | $ | 6,195  |       
|                                                                                    | All Other                                                        |                                      |   | 243    |        |      |   | 185    |        |   |   | 74     |       
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    |                                                                  | Consolidated net sales               |   | $      | 5,267  |      |   | $      | 6,211  |   |   | $      | 6,269  |    
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|Operating income:                                                                   |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    | RJR Tobacco                                                      |                                      | $ | (3,852 | )      |      | $ | 733    |        |   | $ | 926    |       
|                                                                                    | All Other                                                        |                                      |   | 77     |        |      |   | 73     |        |   |   | 25     |       
|                                                                                    | Corporate expense                                                |                                      |   | (66    | )      |      |   | (27    | )      |   |   | (33    | )     
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    |                                                                  | Consolidated operating income (loss) |   | $      | (3,841 | )    |   | $      | 779    |   |   | $      | 918    |    
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|Assets:                                                                             |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    | RJR Tobacco                                                      |                                      | $ | 7,498  |        |      | $ | 11,968 |        |   | $ | 13,233 |       
|                                                                                    | All Other                                                        |                                      |   | 800    |        |      |   | 693    |        |   |   | 269    |       
|                                                                                    | Corporate                                                        |                                      |   | 1,379  |        |      |   | 1,990  |        |   |   | 1,620  |       
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    |                                                                  | Consolidated assets                  |   | $      | 9,677  |      |   | $      | 14,651 |   |   | $      | 15,122 |    
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|Capital expenditures:                                                               |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    | RJR Tobacco                                                      |                                      | $ | 60     |        |      | $ | 94     |        |   | $ | 69     |       
|                                                                                    | All Other                                                        |                                      |   | 10     |        |      |   | 17     |        |   |   | 5      |       
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    |                                                                  | Consolidated capital expenditures    |   | $      | 70     |      |   | $      | 111    |   |   | $      | 74     |    
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|Depreciation expense:                                                               |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    | RJR Tobacco                                                      |                                      | $ | 147    |        |      | $ | 180    |        |   | $ | 126    | (1)   
|                                                                                    | All Other                                                        |                                      |   | 4      |        |      |   | 4      |        |   |   | 3      |       
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    |                                                                  | Consolidated depreciation expense    |   | $      | 151    |      |   | $      | 184    |   |   | $      | 129    | (1)
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|Reconciliation to income (loss) from continuing
    operations before income taxes: |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    | Operating income (loss)                                          |                                      | $ | (3,841 | )      |      | $ | 779    |        |   | $ | 918    |       
|                                                                                    |                                                                  | Interest and debt expense            |   |        | 111    |      |   |        | 147    |   |   |        | 150    |    
|                                                                                    |                                                                  | Interest income                      |   |        | (29    | )    |   |        | (62    | ) |   |        | (137   | )  
|                                                                                    |                                                                  | Other (income) expense               |   |        | (5     | )    |   |        | 11     |   |   |        | 13     |    
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       
|                                                                                    | Income (loss) from continuing operations before
    income taxes |                                      | $ | (3,918 | )      |      | $ | 683    |        |   | $ | 892    |       
|                                                                                    |                                                                  |                                      |   |        |        |      |   |        |        |   |   |       






|    |                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes $362 million amortization related to
    goodwill and trademarks, no longer amortized upon
    RJR Tobaccos adoption of SFAS No. 142 on
    January 1, 2002.

For further information related to restructuring
and asset impairment charges, see note 4 to consolidated
financial statements. For further information related to
goodwill and trademark impairment, see note 1 to
consolidated financial statements.

Sales made by RJR Tobacco to McLane Company,
Inc., a distributor to, and former affiliate of, Wal-Mart
Stores, Inc., comprised 31%, 26% and 27% of RJRs
consolidated revenue in 2003, 2002 and 2001, respectively. No
other customer accounted for 10% or more of RJRs revenue
during those years.

130



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 19  Quarterly
Results of Operations (Unaudited)

|                                                                |                                                                 |       |       |        |   |       |       |        |  |   |        |        |   |   |       |       |  
|--------------------------------------------------------------- | --------------------------------------------------------------- | ----- | ----- | ------ | - | ----- | ----- | ------ |  | - | ------ | ------ | - | - | ----- | ----- | -
|                                                                |                                                                 | First |       | Second |   | Third |       | Fourth
|                                                                |                                                                 |       |       |        |   |       |       |       
|2003                                                            |                                                                 |       |       |        |   |       |       |        |  |   |        |        |   |   |       |      
|Net sales                                                       |                                                                 | $     | 1,218 |        |   | $     | 1,431 |        |  | $ | 1,384  |        |   | $ | 1,234 |      
|Gross profit                                                    |                                                                 |       | 469   |        |   |       | 576   |        |  |   | 570    |        |   |   | 434   |      
|Net income (loss) from continuing operations                    |                                                                 |       | 71    |        |   |       | 70    |        |  |   | (3,451 | )      |   |   | (379  | )    
|Discontinued operations, net of income taxes                    |                                                                 |       |      |        |   |       |      |        |  |   |       |        |   |   | 122   |      
|Extraordinary item, net of income taxes                         |                                                                 |       |      |        |   |       |      |        |  |   |       |        |   |   | 121   |      
|Net income (loss)                                               |                                                                 |       | 71    |        |   |       | 70    |        |  |   | (3,451 | )      |   |   | (136  | )    
|Per share data (1):                                             |                                                                 |       |       |        |   |       |       |        |  |   |        |        |   |   |       |      
|Basic:                                                          |                                                                 |       |       |        |   |       |       |        |  |   |        |        |   |   |       |      
|                                                                | Net income (loss) from continuing operations                    |       |       | 0.84   |   |       |       | 0.84   |  |   |        | (41.31 | ) |   |       | (4.53 | )
|                                                                | Discontinued operations, net of income taxes                    |       |       |       |   |       |       |       |  |   |        |       |   |   |       | 1.46  |  
|                                                                | Extraordinary item, net of income taxes                         |       |       |       |   |       |       |       |  |   |        |       |   |   |       | 1.45  |  
|                                                                | Net income (loss)                                               |       |       | 0.84   |   |       |       | 0.84   |  |   |        | (41.31 | ) |   |       | (1.62 | )
|Diluted:                                                        |                                                                 |       |       |        |   |       |       |        |  |   |        |        |   |   |       |      
|                                                                | Net income (loss) from continuing operations                    |       |       | 0.84   |   |       |       | 0.83   |  |   |        | (41.31 | ) |   |       | (4.53 | )
|                                                                | Discontinued operations, net of income taxes                    |       |       |       |   |       |       |       |  |   |        |       |   |   |       | 1.46  |  
|                                                                | Extraordinary item, net of income taxes                         |       |       |       |   |       |       |       |  |   |        |       |   |   |       | 1.45  |  
|                                                                | Net income (loss)                                               |       |       | 0.84   |   |       |       | 0.83   |  |   |        | (41.31 | ) |   |       | (1.62 | )
|2002                                                            |                                                                 |       |       |        |   |       |       |        |  |   |        |        |   |   |       |      
|Net sales                                                       |                                                                 | $     | 1,515 |        |   | $     | 1,705 |        |  | $ | 1,585  |        |   | $ | 1,406 |      
|Gross profit                                                    |                                                                 |       | 633   |        |   |       | 729   |        |  |   | 600    |        |   |   | 517   |      
|Income (loss) from continuing operations                        |                                                                 |       | 167   |        |   |       | 211   |        |  |   | 139    |        |   |   | (99   | )    
|Discontinued operations, net of income taxes                    |                                                                 |       |      |        |   |       |      |        |  |   |       |        |   |   | 40    |      
|Cumulative effect of accounting change, net of
    income taxes |                                                                 |       | (502  | )      |   |       |      |        |  |   |       |        |   |   |      |      
|Net income (loss)                                               |                                                                 |       | (335  | )      |   |       | 211   |        |  |   | 139    |        |   |   | (59   | )    
|Per share data (1):                                             |                                                                 |       |       |        |   |       |       |        |  |   |        |        |   |   |       |      
|Basic:                                                          |                                                                 |       |       |        |   |       |       |        |  |   |        |        |   |   |       |      
|                                                                | Income (loss) from continuing operations                        |       |       | 1.83   |   |       |       | 2.35   |  |   |        | 1.58   |   |   |       | (1.16 | )
|                                                                | Discontinued operations, net of income taxes                    |       |       |       |   |       |       |       |  |   |        |       |   |   |       | 0.47  |  
|                                                                | Cumulative effect of accounting change, net of
    income taxes |       |       | (5.49  | ) |       |       |       |  |   |        |       |   |   |       |      |  
|                                                                | Net income (loss)                                               |       |       | (3.66  | ) |       |       | 2.35   |  |   |        | 1.58   |   |   |       | (0.69 | )
|Diluted:                                                        |                                                                 |       |       |        |   |       |       |        |  |   |        |        |   |   |       |      
|                                                                | Income (loss) from continuing operations                        |       |       | 1.79   |   |       |       | 2.29   |  |   |        | 1.56   |   |   |       | (1.16 | )
|                                                                | Discontinued operations, net of income taxes                    |       |       |       |   |       |       |       |  |   |        |       |   |   |       | 0.47  |  
|                                                                | Cumulative effect of accounting change, net of
    income taxes |       |       | (5.37  | ) |       |       |       |  |   |        |       |   |   |       |      |  
|                                                                | Net income (loss)                                               |       |       | (3.58  | ) |       |       | 2.29   |  |   |        | 1.56   |   |   |       | (0.69 | )






|    |                                                                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Income per share is computed independently for
    each of the periods presented. The sum of the income per share
    amounts for the quarters may not equal the total for the year.

Note 20  Condensed
Consolidating Financial Statements

Separate financial statements and other
disclosures have not been presented concerning the guarantors,
because such information is not believed to be material to
holders of RJRs $1.45 billion guaranteed, secured
notes. The guarantors are direct or indirect, wholly owned
subsidiaries of RJR, and have fully and unconditionally
guaranteed these notes. Because the guarantees are full and
unconditional and joint and several, the following condensed
consolidating financial statements include: the accounts and
activities of RJR, the issuer of the debt securities; RJR
Tobacco, RJR Acquisition Corp., Santa Fe and RJRs
other material subsidiaries, the guarantors; other subsidiaries
of RJR and RJR Tobacco that are not guarantors; and elimination
adjustments.

131



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##### Table of Contents



Condensed Consolidating Statements of
Income

(Dollars in Millions) (Unaudited)


|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |        |  
|---------------------------------------------------------------- | ---------------------------------------------------------------- | ------ | ------ | ---------- | - | -------------- | ----- | ------------ | - | ------------ | ---- | ---- | - | - | ------ | ------ | - | - | ----- | ------ | -
|                                                                 |                                                                  | Issuer |        | Guarantors |   | Non-Guarantors |       | Eliminations |   | Consolidated
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |             
|For the Year Ended December 31,
    2003                         |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|Net sales                                                        |                                                                  | $      |       |            |   | $              | 5,267 |              |   | $            | 58   |      |   | $ | (58    | )      |   | $ | 5,267 |       
|Cost of products sold                                            |                                                                  |        |       |            |   |                | 3,263 |              |   |              | 13   |      |   |   | (58    | )      |   |   | 3,218 |       
|Selling, general and administrative expenses                     |                                                                  |        | 41     |            |   |                | 1,250 |              |   |              | 36   |      |   |   |       |        |   |   | 1,327 |       
|Fixture impairment                                               |                                                                  |        |       |            |   |                | 106   |              |   |              |     |      |   |   |       |        |   |   | 106   |       
|Restructuring and asset impairment charges                       |                                                                  |        | 24     |            |   |                | 344   |              |   |              |     |      |   |   |       |        |   |   | 368   |       
|Goodwill and trademark impairment charge                         |                                                                  |        |       |            |   |                | 4,089 |              |   |              |     |      |   |   |       |        |   |   | 4,089 |       
|Interest and debt expense                                        |                                                                  |        | 102    |            |   |                | 9     |              |   |              |     |      |   |   |       |        |   |   | 111   |       
|Interest income                                                  |                                                                  |        | (7     | )          |   |                | (22   | )            |   |              |     |      |   |   |       |        |   |   | (29   | )     
|Intercompany interest (income) expense                           |                                                                  |        | (9     | )          |   |                | 9     |              |   |              |     |      |   |   |       |        |   |   |      |       
|Intercompany dividend                                            |                                                                  |        | (168   | )          |   |                | (22   | )            |   |              |     |      |   |   | 190    |        |   |   |      |       
|Other expense (income), net                                      |                                                                  |        | (18    | )          |   |                | 7     |              |   |              | 6    |      |   |   |       |        |   |   | (5    | )     
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|                                                                 | Income (loss) from continuing operations
    before income taxes |        |        | 35         |   |                |       | (3,766       | ) |              |      | 3    |   |   |        | (190   | ) |   |       | (3,918 | )
|Provision for (benefit from) income taxes                        |                                                                  |        | (203   | )          |   |                | (23   | )            |   |              | (3   | )    |   |   |       |        |   |   | (229  | )     
|Gain (loss) from discontinued operations                         |                                                                  |        | 106    |            |   |                | 16    |              |   |              |     |      |   |   |       |        |   |   | 122   |       
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|                                                                 | Income (loss) from continuing
    operations                     |        |        | 344        |   |                |       | (3,727       | ) |              |      | 6    |   |   |        | (190   | ) |   |       | (3,567 | )
|Extraordinary item                                               |                                                                  |        |       |            |   |                | 121   |              |   |              |     |      |   |   |       |        |   |   | 121   |       
|Equity income (loss) from subsidiaries                           |                                                                  |        | (3,601 | )          |   |                | 15    |              |   |              | 14   |      |   |   | 3,572  |        |   |   |      |       
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|                                                                 | Net income (loss)                                                |        | $      | (3,257     | ) |                | $     | (3,591       | ) |              | $    | 20   |   |   | $      | 3,382  |   |   | $     | (3,446 | )
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|For the Year Ended December 31,
    2002                         |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|Net sales                                                        |                                                                  | $      |       |            |   | $              | 6,098 |              |   | $            | 170  |      |   | $ | (57    | )      |   | $ | 6,211 |       
|Cost of products sold                                            |                                                                  |        |       |            |   |                | 3,740 |              |   |              | 49   |      |   |   | (57    | )      |   |   | 3,732 |       
|Selling, general and administrative expenses                     |                                                                  |        | 25     |            |   |                | 1,667 |              |   |              | (229 | )    |   |   |       |        |   |   | 1,463 |       
|Restructuring and asset impairment charges                       |                                                                  |        | 2      |            |   |                | 221   |              |   |              | 1    |      |   |   |       |        |   |   | 224   |       
|Trademark impairment charge                                      |                                                                  |        |       |            |   |                |      |              |   |              | 13   |      |   |   |       |        |   |   | 13    |       
|Interest and debt expense                                        |                                                                  |        | 136    |            |   |                | 11    |              |   |              |     |      |   |   |       |        |   |   | 147   |       
|Interest income                                                  |                                                                  |        | (11    | )          |   |                | (49   | )            |   |              | (2   | )    |   |   |       |        |   |   | (62   | )     
|Intercompany interest (income) expense                           |                                                                  |        | (19    | )          |   |                | 155   |              |   |              | (136 | )    |   |   |       |        |   |   |      |       
|Intercompany dividend                                            |                                                                  |        | (1,098 | )          |   |                | (644  | )            |   |              |     |      |   |   | 1,742  |        |   |   |      |       
|Other expense (income), net                                      |                                                                  |        | (3     | )          |   |                | 13    |              |   |              | 1    |      |   |   |       |        |   |   | 11    |       
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|                                                                 | Income from continuing operations before
    income taxes        |        |        | 968        |   |                |       | 984          |   |              |      | 473  |   |   |        | (1,742 | ) |   |       | 683    |  
|Provision for (benefit from) income taxes                        |                                                                  |        | (71    | )          |   |                | 143   |              |   |              | 193  |      |   |   |       |        |   |   | 265   |       
|Equity income (loss) from subsidiaries                           |                                                                  |        | 660    |            |   |                | (286  | )            |   |              | 8    |      |   |   | (382   | )      |   |   |      |       
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|                                                                 | Income from continuing operations                                |        |        | 1,699      |   |                |       | 555          |   |              |      | 288  |   |   |        | (2,124 | ) |   |       | 418    |  
|Gain on sale of discontinued businesses, net of
    income taxes |                                                                  |        |       |            |   |                | 40    |              |   |              |     |      |   |   |       |        |   |   | 40    |       
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|                                                                 | Income before cumulative effect of accounting
    change         |        |        | 1,699      |   |                |       | 595          |   |              |      | 288  |   |   |        | (2,124 | ) |   |       | 458    |  
|Cumulative effect of accounting change, net of
    income taxes  |                                                                  |        |       |            |   |                | 37    |              |   |              | (539 | )    |   |   |       |        |   |   | (502  | )     
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|                                                                 | Net income (loss)                                                |        | $      | 1,699      |   |                | $     | 632          |   |              | $    | (251 | ) |   | $      | (2,124 | ) |   | $     | (44    | )
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|For the Year Ended December 31,
    2001                         |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|Net sales                                                        |                                                                  | $      |       |            |   | $              | 6,269 |              |   | $            | 50   |      |   | $ | (50    | )      |   | $ | 6,269 |       
|Cost of products sold                                            |                                                                  |        |       |            |   |                | 3,607 |              |   |              | 3    |      |   |   | (50    | )      |   |   | 3,560 |       
|Selling, general and administrative expenses                     |                                                                  |        | 32     |            |   |                | 1,749 |              |   |              | (352 | )    |   |   |       |        |   |   | 1,429 |       
|Amortization of trademarks and goodwill                          |                                                                  |        |       |            |   |                | 260   |              |   |              | 102  |      |   |   |       |        |   |   | 362   |       
|Interest and debt expense                                        |                                                                  |        | 138    |            |   |                | 12    |              |   |              |     |      |   |   |       |        |   |   | 150   |       
|Interest income                                                  |                                                                  |        | (4     | )          |   |                | (129  | )            |   |              | (4   | )    |   |   |       |        |   |   | (137  | )     
|Intercompany interest (income) expense                           |                                                                  |        | (10    | )          |   |                | 274   |              |   |              | (264 | )    |   |   |       |        |   |   |      |       
|Intercompany dividend                                            |                                                                  |        | (1,632 | )          |   |                | (698  | )            |   |              |     |      |   |   | 2,330  |        |   |   |      |       
|Other expense (income), net                                      |                                                                  |        | (3     | )          |   |                | 16    |              |   |              |     |      |   |   |       |        |   |   | 13    |       
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|                                                                 | Income from continuing operations before
    income taxes        |        |        | 1,479      |   |                |       | 1,178        |   |              |      | 565  |   |   |        | (2,330 | ) |   |       | 892    |  
|Provision for (benefit from) income taxes                        |                                                                  |        | (51    | )          |   |                | 300   |              |   |              | 199  |      |   |   |       |        |   |   | 448   |       
|Equity income (loss) from subsidiaries                           |                                                                  |        | 1,235  |            |   |                | 357   |              |   |              |     |      |   |   | (1,592 | )      |   |   |      |       
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|                                                                 | Income from continuing operations                                |        |        | 2,765      |   |                |       | 1,235        |   |              |      | 366  |   |   |        | (3,922 | ) |   |       | 444    |  
|Loss on sale of discontinued businesses, net of
    income taxes |                                                                  |        |       |            |   |                |      |              |   |              | (9   | )    |   |   |       |        |   |   | (9    | )     
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       
|                                                                 | Net income                                                       |        | $      | 2,765      |   |                | $     | 1,235        |   |              | $    | 357  |   |   | $      | (3,922 | ) |   | $     | 435    |  
|                                                                 |                                                                  |        |        |            |   |                |       |              |   |              |      |      |   |   |        |        |   |   |       |       

132



---



##### Table of Contents



Condensed Consolidating Statements of Cash
Flows

(Dollars in Millions) (Unaudited)


|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |      |        |  
|----------------------------------------------- | ---------------------------------------- | -------------------------------------------------- | ----- | ---------- | ---- | -------------- | ----- | ------------ | ------ | ------------ | --- | ---- | ---- | - | ------ | ----- | ----- | - | ----- | ---- | ------ | -
|                                                |                                          | Issuer                                             |       | Guarantors |      | Non-Guarantors |       | Eliminations |        | Consolidated
|                                                |                                          |                                                    |       |            |      |                |       |              |        |             
|For the Year Ended December 31,
    2003        |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash flows from (used in) operating activities  |                                          | $                                                  | 453   |            |      | $              | 1,202 |              |        | $            | 24  |      |      | $ | (1,098 | )     |       | $ | 581   |     
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash flows from (used in) investing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                | Purchases of short-term investments      |                                                    |       | (3         | )    |                |       | (1           | )      |              |     |     |      |   |        |      |       |   |       | (4   | )     
|                                                | Proceeds from short-term investments     |                                                    |       | 400        |      |                |       | 92           |        |              |     |     |      |   |        |      |       |   |       | 492  |       
|                                                | Capital expenditures                     |                                                    |       |           |      |                |       | (69          | )      |              |     | (1   | )    |   |        |      |       |   |       | (70  | )     
|                                                | Acquisition, net of cash acquired        |                                                    |       |           |      |                |       | (9           | )      |              |     |     |      |   |        |      |       |   |       | (9   | )     
|                                                | Net proceeds from sale of business       |                                                    |       |           |      |                |       | 6            |        |              |     |     |      |   |        |      |       |   |       | 6    |       
|                                                | Increase in equity investments           |                                                    |       |           |      |                |       |             |        |              |     | (36  | )    |   |        |      |       |   |       | (36  | )     
|                                                | Proceeds from liquidation of trusts      |                                                    |       |           |      |                |       | 99           |        |              |     |     |      |   |        |      |       |   |       | 99   |       
|                                                | Other, net                               |                                                    |       |           |      |                |       | 2            |        |              |     |     |      |   |        |      |       |   |       | 2    |       
|                                                | Intercompany notes receivable            |                                                    |       | (26        | )    |                |       | 272          |        |              |     |     |      |   |        | (246  | )     |   |       |     |       
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                |                                          | Net cash flows from (used in) investing activities |       |            | 371  |                |       |              | 392    |              |     |      | (37  | ) |        |       | (246  | ) |       |      | 480    |  
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash flows from (used in) financing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                | Repurchase of common stock               |                                                    |       | (75        | )    |                |       |             |        |              |     |     |      |   |        |      |       |   |       | (75  | )     
|                                                | Dividends paid on common stock           |                                                    |       | (323       | )    |                |       | (1,093       | )      |              |     |     |      |   |        | 1,093 |       |   |       | (323 | )     
|                                                | Repayments of long-term debt             |                                                    |       | (643       | )    |                |       | (98          | )      |              |     |     |      |   |        |      |       |   |       | (741 | )     
|                                                | Proceeds from exercise of stock options  |                                                    |       | 17         |      |                |       |             |        |              |     |     |      |   |        |      |       |   |       | 17   |       
|                                                | Intercompany notes payables              |                                                    |       | 123        |      |                |       | (411         | )      |              |     | 37   |      |   |        | 251   |       |   |       |     |       
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                |                                          | Net cash flows from (used in) financing activities |       |            | (901 | )              |       |              | (1,602 | )            |     |      | 37   |   |        |       | 1,344 |   |       |      | (1,122 | )
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Net change in cash and cash equivalents         |                                          |                                                    | (77   | )          |      |                | (8    | )            |        |              | 24  |      |      |   |       |       |       |   | (61   | )   
|Cash and cash equivalents at beginning of year  |                                          |                                                    | 463   |            |      |                | 1,112 |              |        |              | 9   |      |      |   |       |       |       |   | 1,584 |     
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash and cash equivalents at end of year        |                                          | $                                                  | 386   |            |      | $              | 1,104 |              |        | $            | 33  |      |      | $ |       |       |       | $ | 1,523 |     
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|For the Year Ended December 31,
    2002        |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash flows from operating activities            |                                          | $                                                  | 824   |            |      | $              | 710   |              |        | $            | 721 |      |      | $ | (1,766 | )     |       | $ | 489   |     
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash flows from (used in) investing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                | Purchases of short-term investments      |                                                    |       | (504       | )    |                |       | (4           | )      |              |     |     |      |   |        |      |       |   |       | (508 | )     
|                                                | Proceeds from short-term investments     |                                                    |       |           |      |                |       | 120          |        |              |     |     |      |   |        |      |       |   |       | 120  |       
|                                                | Capital expenditures                     |                                                    |       |           |      |                |       | (98          | )      |              |     | (13  | )    |   |        |      |       |   |       | (111 | )     
|                                                | Acquisition, net of cash acquired        |                                                    |       | (339       | )    |                |       |             |        |              |     |     |      |   |        |      |       |   |       | (339 | )     
|                                                | Other, net                               |                                                    |       |           |      |                |       | 18           |        |              |     |     |      |   |        |      |       |   |       | 18   |       
|                                                | Intercompany notes receivable            |                                                    |       | 214        |      |                |       | 160          |        |              |     | (386 | )    |   |        | 12    |       |   |       |     |       
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                |                                          | Net cash flows from (used in) investing activities |       |            | (629 | )              |       |              | 196    |              |     |      | (399 | ) |        |       | 12    |   |       |      | (820   | )
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash flows from (used in) financing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                | Repurchase of common stock               |                                                    |       | (511       | )    |                |       |             |        |              |     |     |      |   |        |      |       |   |       | (511 | )     
|                                                | Dividends paid on common stock           |                                                    |       | (335       | )    |                |       | (1,098       | )      |              |     | (644 | )    |   |        | 1,742 |       |   |       | (335 | )     
|                                                | Repayments of long-term debt             |                                                    |       | (43        | )    |                |       |             |        |              |     |     |      |   |        |      |       |   |       | (43  | )     
|                                                | Proceeds from issuance of long-term debt |                                                    |       | 745        |      |                |       |             |        |              |     |     |      |   |        |      |       |   |       | 745  |       
|                                                | Proceeds from exercise of stock options  |                                                    |       | 39         |      |                |       |             |        |              |     |     |      |   |        |      |       |   |       | 39   |       
|                                                | Intercompany notes payables              |                                                    |       | 188        |      |                |       | (536         | )      |              |     | 336  |      |   |        | 12    |       |   |       |     |       
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                |                                          | Net cash flows from (used in) financing activities |       |            | 83   |                |       |              | (1,634 | )            |     |      | (308 | ) |        |       | 1,754 |   |       |      | (105   | )
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Net change in cash and cash equivalents         |                                          |                                                    | 278   |            |      |                | (728  | )            |        |              | 14  |      |      |   |       |       |       |   | (436  | )   
|Cash and cash equivalents at beginning of year  |                                          |                                                    | 185   |            |      |                | 1,734 |              |        |              | 101 |      |      |   |       |       |       |   | 2,020 |     
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash and cash equivalents at end of year        |                                          | $                                                  | 463   |            |      | $              | 1,006 |              |        | $            | 115 |      |      | $ |       |       |       | $ | 1,584 |     
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|For the Year Ended December 31,
    2001        |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash flows from operating activities            |                                          | $                                                  | 1,003 |            |      | $              | 895   |              |        | $            | 420 |      |      | $ | (1,692 | )     |       | $ | 626   |     
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash flows from (used in) investing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                | Purchases of short-term investments      |                                                    |       |           |      |                |       | (207         | )      |              |     |     |      |   |        |      |       |   |       | (207 | )     
|                                                | Intercompany notes receivable            |                                                    |       | (5         | )    |                |       | (9           | )      |              |     | 281  |      |   |        | (267  | )     |   |       |     |       
|                                                | Other, net                               |                                                    |       |           |      |                |       | (85          | )      |              |     | (15  | )    |   |        |      |       |   |       | (100 | )     
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                |                                          | Net cash flows from (used in) investing activities |       |            | (5   | )              |       |              | (301   | )            |     |      | 266  |   |        |       | (267  | ) |       |      | (307   | )
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash flows from (used in) financing activities: |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                | Repurchase of common stock               |                                                    |       | (494       | )    |                |       |             |        |              |     |     |      |   |        |      |       |   |       | (494 | )     
|                                                | Dividends paid on common stock           |                                                    |       | (320       | )    |                |       | (994         | )      |              |     | (698 | )    |   |        | 1,692 |       |   |       | (320 | )     
|                                                | Repayments of long-term debt             |                                                    |       | (73        | )    |                |       |             |        |              |     |     |      |   |        |      |       |   |       | (73  | )     
|                                                | Proceeds from exercise of stock options  |                                                    |       | 45         |      |                |       |             |        |              |     |     |      |   |        |      |       |   |       | 45   |       
|                                                | Intercompany notes payables              |                                                    |       | 15         |      |                |       | (290         | )      |              |     | 8    |      |   |        | 267   |       |   |       |     |       
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|                                                |                                          | Net cash flows used in financing activities        |       |            | (827 | )              |       |              | (1,284 | )            |     |      | (690 | ) |        |       | 1,959 |   |       |      | (842   | )
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Net change in cash and cash equivalents         |                                          |                                                    | 171   |            |      |                | (690  | )            |        |              | (4  | )    |      |   |       |       |       |   | (523  | )   
|Cash and cash equivalents at beginning of year  |                                          |                                                    | 14    |            |      |                | 2,424 |              |        |              | 105 |      |      |   |       |       |       |   | 2,543 |     
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     
|Cash and cash equivalents at end of year        |                                          | $                                                  | 185   |            |      | $              | 1,734 |              |        | $            | 101 |      |      | $ |       |       |       | $ | 2,020 |     
|                                                |                                          |                                                    |       |            |      |                |       |              |        |              |     |      |      |   |        |       |       |   |       |     

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Condensed Consolidating Balance
Sheets

(Dollars in Millions)


(Unaudited)


|                                            |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |        | 
|------------------------------------------- | ------------------------------------------ | ------ | ----- | ---------- |  | -------------- | ----- | ------------ |  | ------------ | ----- | ----- |  | - | ------- | ------- | - | - | ----- | ------ | 
|                                            |                                            | Issuer |       | Guarantors |  | Non-Guarantors |       | Eliminations |  | Consolidated
|                                            |                                            |        |       |            |  |                |       |              |  |             
|December 31, 2003                           |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|Assets                                      |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|Cash and cash equivalents                   |                                            | $      | 386   |            |  | $              | 1,104 |              |  | $            | 33    |       |  | $ |        |         |   | $ | 1,523 |       
|Short-term investments                      |                                            |        | 107   |            |  |                |      |              |  |              |      |       |  |   |        |         |   |   | 107   |       
|Assets held for sale                        |                                            |        |      |            |  |                | 84    |              |  |              |      |       |  |   |        |         |   |   | 84    |       
|Other current assets                        |                                            |        | 60    |            |  |                | 1,913 |              |  |              | 7     |       |  |   | (363    | )       |   |   | 1,617 |       
|Trademarks, net                             |                                            |        |      |            |  |                | 1,759 |              |  |              |      |       |  |   |        |         |   |   | 1,759 |       
|Goodwill, net                               |                                            |        |      |            |  |                | 3,292 |              |  |              |      |       |  |   |        |         |   |   | 3,292 |       
|Intercompany notes receivable               |                                            |        | 386   |            |  |                | 3,320 |              |  |              | 13    |       |  |   | (3,719  | )       |   |   |      |       
|Investment in subsidiaries                  |                                            |        | 4,798 |            |  |                | 44    |              |  |              | 19    |       |  |   | (4,861  | )       |   |   |      |       
|Other noncurrent assets                     |                                            |        | 143   |            |  |                | 1,098 |              |  |              | 58    |       |  |   | (4      | )       |   |   | 1,295 |       
|                                            |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|                                            | Total assets                               |        | $     | 5,880      |  |                | $     | 12,614       |  |              | $     | 130   |  |   | $       | (8,947  | ) |   | $     | 9,677  | 
|                                            |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|Liabilities and stockholders
    equity    |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|Liabilities related to assets held for sale |                                            | $      |      |            |  | $              | 10    |              |  | $            |      |       |  | $ |        |         |   | $ | 10    |       
|Tobacco settlement and related accruals     |                                            |        |      |            |  |                | 1,629 |              |  |              |      |       |  |   |        |         |   |   | 1,629 |       
|Other current liabilities                   |                                            |        | 545   |            |  |                | 1,027 |              |  |              | 17    |       |  |   | (363    | )       |   |   | 1,226 |       
|Intercompany notes payable                  |                                            |        | 381   |            |  |                | 3,287 |              |  |              | 51    |       |  |   | (3,719  | )       |   |   |      |       
|Long-term debt (less current maturities)    |                                            |        | 1,671 |            |  |                |      |              |  |              |      |       |  |   |        |         |   |   | 1,671 |       
|Other noncurrent liabilities                |                                            |        | 226   |            |  |                | 1,850 |              |  |              | 12    |       |  |   | (4      | )       |   |   | 2,084 |       
|Stockholders equity                        |                                            |        | 3,057 |            |  |                | 4,811 |              |  |              | 50    |       |  |   | (4,861  | )       |   |   | 3,057 |       
|                                            |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|                                            | Total liabilities and stockholders equity |        | $     | 5,880      |  |                | $     | 12,614       |  |              | $     | 130   |  |   | $       | (8,947  | ) |   | $     | 9,677  | 
|                                            |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|December 31, 2002                           |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|Assets                                      |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|Cash and cash equivalents                   |                                            | $      | 463   |            |  | $              | 1,006 |              |  | $            | 115   |       |  | $ |        |         |   | $ | 1,584 |       
|Short-term investments                      |                                            |        | 504   |            |  |                | 91    |              |  |              |      |       |  |   |        |         |   |   | 595   |       
|Assets held for sale                        |                                            |        |      |            |  |                | 76    |              |  |              | 2     |       |  |   |        |         |   |   | 78    |       
|Other current assets                        |                                            |        | 80    |            |  |                | 2,043 |              |  |              | 70    |       |  |   | (458    | )       |   |   | 1,735 |       
|Trademarks, net                             |                                            |        |      |            |  |                |      |              |  |              | 2,085 |       |  |   |        |         |   |   | 2,085 |       
|Goodwill, net                               |                                            |        |      |            |  |                | 6,875 |              |  |              | 215   |       |  |   |        |         |   |   | 7,090 |       
|Intercompany notes receivable               |                                            |        | 360   |            |  |                | 174   |              |  |              | 3,436 |       |  |   | (3,970  | )       |   |   |      |       
|Investment in subsidiaries                  |                                            |        | 8,705 |            |  |                | 4,834 |              |  |              | 8     |       |  |   | (13,547 | )       |   |   |      |       
|Other noncurrent assets                     |                                            |        | 188   |            |  |                | 1,258 |              |  |              | 38    |       |  |   |        |         |   |   | 1,484 |       
|                                            |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|                                            | Total assets                               |        | $     | 10,300     |  |                | $     | 16,357       |  |              | $     | 5,969 |  |   | $       | (17,975 | ) |   | $     | 14,651 | 
|                                            |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|Liabilities and stockholders
    equity    |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|Liabilities related to assets held for sale |                                            | $      |      |            |  | $              | 8     |              |  | $            |      |       |  | $ |        |         |   | $ | 8     |       
|Tobacco settlement and related accruals     |                                            |        |      |            |  |                | 1,536 |              |  |              | 7     |       |  |   |        |         |   |   | 1,543 |       
|Other current liabilities                   |                                            |        | 1,233 |            |  |                | 1,079 |              |  |              | 22    |       |  |   | (458    | )       |   |   | 1,876 |       
|Intercompany notes payable                  |                                            |        | 257   |            |  |                | 3,369 |              |  |              | 344   |       |  |   | (3,970  | )       |   |   |      |       
|Long-term debt (less current maturities)    |                                            |        | 1,755 |            |  |                |      |              |  |              |      |       |  |   |        |         |   |   | 1,755 |       
|Other noncurrent liabilities                |                                            |        | 339   |            |  |                | 1,669 |              |  |              | 745   |       |  |   |        |         |   |   | 2,753 |       
|Stockholders equity                        |                                            |        | 6,716 |            |  |                | 8,696 |              |  |              | 4,851 |       |  |   | (13,547 | )       |   |   | 6,716 |       
|                                            |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       
|                                            | Total liabilities and stockholders equity |        | $     | 10,300     |  |                | $     | 16,357       |  |              | $     | 5,969 |  |   | $       | (17,975 | ) |   | $     | 14,651 | 
|                                            |                                            |        |       |            |  |                |       |              |  |              |       |       |  |   |         |         |   |   |       |       

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

None.






|         |                        
|-------- | -----------------------
|Item 9a. | Controls and Procedures



|    |                                                                                                                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | RJRs chief executive officer and chief
    financial officer have concluded that RJRs disclosure
    controls and procedures were effective as of the end of the
    period covered by this report, based on their evaluation of
    these controls and procedures.
|   
|(b) | There have been no significant changes in
    RJRs internal controls that could significantly affect
    these controls subsequent to the date of their evaluation.                                                                                                 




PART III






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

Directors

RJRs Board of Directors is divided into
three classes serving staggered terms of three years. The
Class I directors have a term ending on the date of the
2006 annual meeting, the Class II directors have a term
ending on the date of the 2004 annual meeting, and the
Class III directors have a term ending on the date of the
2005 annual meeting. Pursuant to RJRs Certificate of
Incorporation, each class is to consist, as nearly as may
reasonably be possible, of one-third of the total number of
directors constituting the Board of Directors. Currently, each
of Class I and Class III is composed of three
directors, and Class II is composed of four directors.

Biographies of the Class I directors
(terms expiring in 2006)

|             |  |                              |  |        
|------------ |  | ---------------------------- |  | -------
|Mary K. Bush |  | Director since July 28, 1999 |  | Age: 55

Ms. Bush has been President of Bush
International, a provider of advice on financial strategies and
business development to commercial, industrial and financial
companies, since its founding in 1991. Bush International also
advises governments, internationally, on financial market
matters. Prior to establishing Bush International, Ms. Bush
held several positions in financial institutions and served two
presidents of the United States as Alternate Executive Director
of the International Monetary Fund and Managing Director of the
Federal Housing Finance Board, the oversight body for the
Federal Home Loan Banks. Ms. Bush also is a member of the
boards of directors of Mortgage Guaranty Insurance Corporation,
Brady Corporation and Millennium Chemicals, Inc., a trustee of
the Pioneer Funds and a member of the Advisory Board of
Washington Mutual Investors Fund.

|                   |  |                              |  |        
|------------------ |  | ---------------------------- |  | -------
|John T. Chain, Jr. |  | Director since June 14, 1999 |  | Age: 69

General (Retired) Chain has been the Chairman of
Thomas Group, Inc., an international management consulting firm,
since May 1998 and has been a member of the board of directors
of Thomas Group, Inc. since May 1995. He served as the President
of Quarterdeck Equity Partners, Inc., an investor in the
aerospace industry, from January 1996 to January 2003. He also
served as Special Assistant to the Chairman of Burlington
Northern Santa Fe Corporation, a major U.S. freight railroad,
from November 1995 to March 1996, and as an Executive Vice
President of Burlington Northern from 1991 to November 1995. For
more than five years prior to that time, he served as a General
(Commander-in-Chief, the Strategic Air Command) in the United
States Air Force. General Chain is a member of the boards of
directors of ConAgra Foods, Inc., Northrup Grumman Corporation,
Kemper Insurance and Thomas Group, Inc. He also was a member of
the board of directors of RJR Nabisco, Inc. (now known as RJR)
from 1994 until June 14, 1999, and he was a member of the
board of directors of Nabisco Group Holdings Corp., the former
parent of RJR, from 1994 to December 2000.

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|                  |  |                              |  |        
|----------------- |  | ---------------------------- |  | -------
|Thomas C. Wajnert |  | Director since June 14, 1999 |  | Age: 60

Mr. Wajnert has been Managing Director of
Fairview Advisors, LLC, a merchant bank, since January 2002. He
was Chairman and Chief Executive Officer of SEISMIQ, Inc., a
provider of advanced technology to the commercial finance and
leasing industry, from its founding in April 2000 until December
2001. Mr. Wajnert also has been the Chairman of, and a
significant investor in, EPIX Holdings, Inc., a professional
employer organization, since March 1998, where he also served as
Chief Executive Officer from March 1998 to April 1999.
Previously, Mr. Wajnert was Chairman of the board of
directors from January 1992 until December 1997, and Chief
Executive Officer from November 1984 until December 1997, of
AT&T Capital Corporation, a commercial finance and leasing
company. He was self-employed from December 1997 to March 1998.
Mr. Wajnert serves on the board of directors of JLG
Industries, Inc.

Biographies of the Class II directors
(terms expiring in 2004)

|                  |  |                              |  |        
|----------------- |  | ---------------------------- |  | -------
|A.D. Frazier, Jr. |  | Director since June 14, 1999 |  | Age: 59

Mr. Frazier has been President and Chief
Operating Officer and a member of the board of directors of
Caremark Rx, Inc., a publicly traded pharmacy benefit management
company, since August 2002. He served as Chief Executive Officer
of the Chicago Stock Exchange from March 2001 until August 2001,
and as Chairman of the Board and Chief Executive Officer of the
Chicago Stock Exchange from September 2001 to August 2002. Prior
to joining the Chicago Stock Exchange, Mr. Frazier was a
Global Partner and member of the Board of Directors of AMVESCAP
PLC, a quoted worldwide fund manager and the parent company of
INVESCO, Inc., from November 1996 to March 2001. He served as
President and Chief Executive Officer of INVESCO, Inc., an
investment manager, from April 1997 to December 2000. From March
1991 until November 1996, Mr. Frazier was Chief Operating
Officer of the Atlanta Committee for the Olympic Games.
Mr. Frazier is a member of the boards of directors of
Caremark Rx, Inc. and Apache Corporation.

|                   |  |                             |  |        
|------------------ |  | --------------------------- |  | -------
|E.V. (Rick) Goings |  | Director since June 5, 2002 |  | Age: 58

Mr. Goings has been Chairman and Chief
Executive Officer of Tupperware Corporation, a worldwide
direct-selling consumer products company, since October 1997,
and served as its President and Chief Operating Officer from
November 1992 until October 1997. Prior to joining Tupperware,
Mr. Goings served at Avon Products Inc., a leading direct
seller of beauty and related products, from 1985 to November
1992, where he held a number of senior management positions: in
Europe as President of Avon Germany, in the Pacific Rim as Group
Vice President and Senior Operating Officer, and ultimately in
the United States as President of Avon USA. Mr. Goings is a
member of the boards of directors of Tupperware Corporation,
Circuit City Stores, Inc., Rollins College and Sun Trust Bank,
Central Florida, N.A., and is the former National Chairman, and
current Vice Chairman, of the Board of Governors for the Boys
and Girls Clubs of America.

|            |  |                              |  |        
|----------- |  | ---------------------------- |  | -------
|Nana Mensah |  | Director since June 14, 1999 |  | Age: 51

Mr. Mensah has been the Chief Operating
Officer-Domestic of Churchs Chicken, a division of AFC
Enterprises, Inc. and one of the worlds largest
quick-service restaurant chains, since August 2003.
Mr. Mensah was President, U.S. Tax Services of H&R
Block Inc., a tax, mortgage and financial services company, from
January 2003 until March 2003. He also was the Chairman and
Chief Executive Officer of XPORTS, Inc., a privately held
company that exports agricultural products, pharmaceuticals and
construction materials to foreign markets, from April 2003 until
July 2003 and from October 2000 until December 2002, and was a
management consultant from October 1999 to September 2000.
Previously, Mr. Mensah served as President and Chief
Operating Officer of Long John Silvers Restaurants, Inc.,
the worlds largest chain of seafood quick-service
restaurants, from 1997 until it was sold under his auspices in
October 1999. From 1994 until 1997, he served as Senior Vice
President, Operations and Concept Development of PepsiCo
Restaurants International, the international holding company, at
that time, for KFC, Pizza Hut and Taco Bell. Mr. Mensah is
the Co-Chair on the Board of Advisors of the College of Human
Environmental Sciences for the University of Kentucky, and is a
Distinguished Fellow at Georgetown College in Kentucky. He also
is a member of the Board of Trustees of the Lexington
Philharmonic Society and Gods Pantry.

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|                              |  |                             |  |        
|----------------------------- |  | --------------------------- |  | -------
|Robert S. (Steve) Miller, Jr. |  | Director since July 1, 2003 |  | Age: 62

Mr. Miller has been non-executive Chairman
of the Board of Federal-Mogul, Inc., an auto parts supplier,
since January 2004. Previously, he served in a number of
corporate restructuring situations. Mr. Miller was Chairman
and Chief Executive Officer of Bethlehem Steel Corporation, a
global steel manufacturer, from September 2001 until January
2004, and served as Chairman of Federal-Mogul from September
2000 until October 2001 and as chief executive officer from
September 2000 until January 2001. From February 2000 until
September 2000, Mr. Miller served as special advisor to
Aetna, Inc., a health insurer, and from November 1999 until
February 2000, he served as President and a director of Reliance
Group Holdings, Inc., a property and casualty insurance company.
Mr. Miller served as President and Chief Executive Officer
of Waste Management, Inc., a waste transporter, from August 1999
until November 1999 and as non-executive Chairman of the Board
of Waste Management from July 1998 until May 1999.
Mr. Miller currently is a member of the Board of Directors
of Federal-Mogul, Inc., United Air Lines, Inc., Pope &
Talbot, Inc., Symantec Corp. and Waste Management, Inc.

Biographies of the Class III directors
(terms expiring in 2005)

|              |  |                              |  |        
|------------- |  | ---------------------------- |  | -------
|Denise Ilitch |  | Director since June 14, 1999 |  | Age: 48

Ms. Ilitch has been the President of Ilitch
Holdings, Inc., a privately held company that oversees the
management and operations of Little Caesar Enterprises, the
Detroit Tigers baseball team, the Detroit Red Wings hockey team,
Olympia Entertainment, Blue Line Distributing, Little Caesars
Pizza Kit Fundraising Program, Champion Foods, Olympia
Development and Uptown Entertainment, since June 2000.
Previously, Ms. Ilitch served as Executive Vice President
for Ilitch Holdings, Inc., and since 1997, has been the Vice
Chairwoman of Little Caesar Enterprises, Inc., one of the top
international pizza chains with restaurants on five continents,
where she has been part of the senior management team for nearly
25 years. She also is the President of Olympia Development,
where she directs development efforts in downtown Detroit.
Ms. Ilitch serves on the board of directors for the Atanas
Ilitch Osteosarcoma Foundation and Ilitch Charities for
Children. She is a Detroit Red Wings Alternate Governor for the
National Hockey League and is a representative of ownership of
the Detroit Tigers and member of Major League Baseball. In 2003,
Michigan Governor Jennifer Granholm appointed Ms. Ilitch to
a four-year post as a Board member of the Michigan Economic
Growth Authority (MEGA).

|                    |  |                              |  |        
|------------------- |  | ---------------------------- |  | -------
|Andrew J. Schindler |  | Director since June 14, 1999 |  | Age: 59

Mr. Schindler has served as Chief Executive
Officer of RJR Tobacco since 1995 and as President and Chief
Executive Officer of RJR since June 1999. He has served as a
director of RJR Tobacco since 1989, and as Chairman of the Board
of RJR and RJR Tobacco since July 1999. Mr. Schindler
joined RJR in 1974. He became Senior Vice President 
Operations of RJR Tobacco in 1989 and was elected Executive Vice
President  Operations of RJR Tobacco in 1991.
Mr. Schindler served as Chief Operating Officer of RJR
Tobacco from 1994 until 1995 and as its President from 1994
until January 2002. He is a member of the board of trustees of
Wake Forest University, and the boards of directors of the
R. J. Reynolds Foundation, Winston-Salem Business,
Inc. and !dealliance (formerly the North Carolina Emerging
Technology Alliance). Mr. Schindler also is Chairman of the
Winston-Salem Alliance.

|                  |  |                              |  |        
|----------------- |  | ---------------------------- |  | -------
|Joseph P. Viviano |  | Director since June 14, 1999 |  | Age: 65

Mr. Viviano served as the Vice Chairman of
Hershey Foods Corporation, a chocolate and confectionery
manufacturer, from January 1999 until his retirement in April
2000. Previously, Mr. Viviano had been President and Chief
Operating Officer of Hershey Foods Corporation from 1994 through
1998. He is a member of the boards of directors of Chesapeake
Corporation, Huffy Corporation, Harsco Corporation and RPM,
Incorporated.

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##### Table of Contents






Executive Officers and Certain Significant
Employees

The executive officers and certain significant
employees are:

Andrew J. Schindler.Mr. Schindler, 59, has served as Chief Executive Officer of
RJR Tobacco since 1995 and as President and Chief Executive
Officer of RJR since June 1999. Mr. Schindler has served as
Director of RJR Tobacco since 1989, and as Chairman of the
Board of RJR and RJR Tobacco since July 1999. Mr. Schindler
joined RJR in 1974. He became Senior Vice President 
Operations of RJ Tobacco in 1989 and was elected Executive
Vice President  Operations of RJR Tobacco in 1991.
Mr. Schindler served as Chief Operating Officer of
RJR Tobacco from 1994 until 1995 and as its President from
1994 until January 2002. Previously, he achieved the rank of
captain in the U.S. Army, where he held command and staff
positions in the United States and Vietnam. Mr. Schindler
currently serves as Chairman of the Winston-Salem Alliance. He
is a member of the Board of Trustees of Wake Forest University
and the boards of directors of Winston-Salem Business, Inc.
and !dealliance (formerly the North Carolina Emerging Technology
Alliance).

Thomas R. Adams.Mr. Adams, 53, has been Senior Vice President and
Controller of RJR and RJR Tobacco since June 1999. From
1985 until 1999, he was Partner at the accounting firm of
Deloitte & Touche LLP. Mr. Adams is a member of
the board of directors of Technology Concepts &
Design, Inc., an affiliate of RJR. He is a member of the
Old Hickory Council of the Boy Scouts of America.

Lynn J. Beasley.In
January 2002, Ms. Beasley, 46, was promoted to President
and Chief Operating Officer of RJR Tobacco, after serving
as Executive Vice President  Marketing since 1997,
and has been Director of RJR Tobacco since March 2000.
Ms. Beasley joined RJR Tobacco in 1982 as a marketing
assistant. After holding a number of positions at RJR Tobacco,
she became Senior Vice President of the WINSTON/CAMEL business
unit in 1993. From 1995 until 1997, she was Senior Vice
President of brand marketing for WINSTON, CAMEL and SALEM.
Ms. Beasley is a member of the board of directors of The
Scotts Company. Ms. Beasley is a member of the board of
trustees of Senior Services, the board of directors of
Tanglewood Park Foundation, and the Winston-Salem State
University Business Advisory Council for the School of Business
and Economics.

Charles A. Blixt.Mr. Blixt, 52, has been Executive Vice President and
General Counsel of RJR Tobacco since 1998 and Executive Vice
President, General Counsel and Assistant Secretary of RJR since
June 1999. He was Senior Vice President and General Counsel of
RJR Tobacco from 1995 until 1998. Mr. Blixt served as
Director of RJR Tobacco from 1995 until March 2000. He
joined RJR Tobacco as Associate Counsel 
Litigation in 1985. Mr. Blixt is a member of the board of
directors of Technology Concepts & Design, Inc. and
Targacept, Inc., both of which are affiliates of RJR. He also
serves on the board of trustees of Salem College and Academy and
the Board of Visitors of Wake Forest University School of Law.

Frances V.
Creighton.In January 2004,
Ms. Creighton, 52, was promoted to Executive Vice
President  Marketing at RJR Tobacco. She was
previously Senior Vice President  Marketing during
2002 and 2003, after serving as Vice President of
RJR Tobaccos Camel business unit since 1997. She
joined RJR Tobacco in 1981 as a marketing research analyst.
Through a series of promotions, she became senior marketing
manager in 1990 and marketing director in 1994.
Ms. Creighton serves as Secretary of the board of directors
of the local chapter of the American Red Cross and is a member
of the board of directors for the United Way of Forsyth County.

McDara P.
Folan, III.Mr. Folan, 45,
joined RJR in June 1999 as Vice President, Deputy General
Counsel and Secretary. He also was Vice President, Deputy
General Counsel and Secretary of RJR Tobacco from June 1999
to March 2000, and currently serves as Assistant Secretary of
RJR Tobacco. From 1992 until 1999, Mr. Folan served as Vice
President, Secretary and General Counsel for Allen Telecom Inc.,
a manufacturer and distributor of wireless communications
equipment, in Cleveland, Ohio. Mr. Folan serves on the City
of Winston-Salem/Forsyth County Planning Board, the board of
directors of the Piedmont Triad Chapter of the Juvenile Diabetes
Research Foundation and the Advisory Board for Brenner
Childrens Hospital.

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L. Joe Inman.In July 2002, Mr. Inman, 53, was promoted to Executive Vice
President  Operations of RJR Tobacco after serving as
Vice President  Manufacturing for eight years.
Joining RJR Tobacco in 1969, he began as an employee in the
manufacturing department. Mr. Inman held a number of
positions in production and research and development before
becoming Director  Brands for Research and
Development in 1992. He was named Director 
Manufacturing the following year and was promoted to Vice
President  Manufacturing in 1994.

Ann A. Johnston.In
January 2002, Ms. Johnston, 50, was promoted to Executive
Vice President  Human Resources of RJR and of
RJR Tobacco after serving as Vice President 
Human Resources of RJR Tobacco since 1998. She joined
RJR Tobacco in 1988 as a compensation manager, and was
promoted to personnel manager in 1989 and to director of
compensation/benefits/HRIS in 1993. Ms. Johnston also
serves as Chairman of the board of directors for Allegacy
Federal Credit Union, is a member of the Alumni Council for the
Babcock Graduate School of Management of Wake Forest University,
and serves on the boards of directors of the Winston-Salem
Symphony and the Winston-Salem Industries for the Blind.

Lynn L. Lane.In
June 1999, Ms. Lane, 52, rejoined RJR as Senior Vice
President and Treasurer and was named Senior Vice President and
Treasurer of RJR Tobacco. She joined RJR in 1973 and was
promoted to Vice President and Assistant Treasurer of RJR in
1991. In 1995, she was named Vice President and Treasurer of
R.J. Reynolds Tobacco Worldwide. From 1996 until 1999,
Ms. Lane was Vice President  Treasurer and
Investor Relations of Burlington Industries, a manufacturer and
distributor of fabrics and other textile products. She also
serves on the board of directors of the R. J. Reynolds
Foundation, the board of trustees of Greensboro College and is
the Chair of the East Carolina University Foundation Board.

James V. Maguire.In
July 1999, Mr. Maguire, 52, was promoted to Executive Vice
President  Sales of RJR Tobacco, after serving as
Senior Vice President  Sales of RJR Tobacco since
1994, and has been Director of RJR Tobacco since March 2000. He
joined RJR Tobacco in 1973 as a sales representative, and after
holding a number of positions at RJR Tobacco and RJR, he
became Vice President of Sales and Marketing Development of RJR
Tobacco in 1993.

Dianne M. Neal.Ms. Neal, 44, has been Executive Vice President and Chief
Financial Officer of RJR since July 2003, after serving as Vice
President  Investor Relations of RJR since 1999.
Ms. Neal joined RJR Tobacco in 1988 and held a number of
financial management positions within various RJR Tobacco
business units. In 1997, she was promoted to Vice President and
Controller. She is a member of the board of Southern Community
Bank and Trust and the Business Advisory Board of UNCGs
Bryan School of Business and Economics.

Tommy J. Payne.Mr. Payne, 47, assumed his current positions as Executive
Vice President  External Relations of RJR Tobacco and
of RJR in July 1999, after serving as Senior Vice
President  External Relations of RJR Tobacco
since 1998 and of RJR since June 1999. He joined RJR in 1988 and
was promoted to Director of Federal Government Affairs in 1995.
From 1995 until 1998, he was Vice President  Federal
Government Affairs of RJR Tobacco in Washington, D.C.
Mr. Payne serves on the boards of trustees of Winston-Salem
State University and the Southeast Center for Contemporary Art,
the North Carolina Community Colleges Foundation Board of
Advisors and the board of directors of the
R. J. Reynolds Foundation.

Richard M. Sanders.In connection with RJRs acquisition of Santa Fe
Natural Tobacco Company, Inc., in January 2002,
Mr. Sanders, 50, was named President and Chief Executive
Officer of Santa Fe. From December 1999 until January 2002,
he served as Senior Vice President  Marketing of
RJR Tobacco while continuing his role as
President  Sports Marketing Enterprises, a division
of RJR Tobacco. Mr. Sanders joined RJR Tobacco in
Marketing in 1977 and has held several positions during his
career, including Vice President  Advertising and
Brand Management, Vice President  Marketing and Sales
Operations and Area Vice President  Sales. He is
Chairman of the board of directors of the Natural American
Spirit Foundation and serves on the board of directors of
Santa Fe Economic Development, Inc. and Minnesota
Resources.

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David E. Townsend.In October 2000, Dr. Townsend, 56, was promoted to
Executive Vice President  Research and Development of
RJR Tobacco after serving as Vice President of the Research
and Development Product Development and Assessment Group of
RJR Tobacco since 1997. He joined RJR Tobacco in 1977
and, after holding a number of positions at RJR Tobacco,
was promoted to Senior Principal Scientist of RJR Tobacco
in 1995, and to Director of Product Development and Assessment
of RJR Tobacco in 1996.

Committees of the Board of
Directors

The business and affairs of RJR are managed under
the direction of its Board of Directors. The standing committees
of the Board are the Audit Committee, the Compensation Committee
and the Corporate Governance and Nominating Committee. All of
the standing committees of the Board are composed of
non-management directors, who are independent, as
that term is defined by the SEC and NYSE listing standards. See
 Determination of Independence of
Directors below, for a discussion of the standards adopted
by RJRs Board of Directors to assist it in its
determination of director independence.

The current members of the Audit Committee are
Thomas C. Wajnert (Chair), A.D. Frazier, Denise Ilitch, Nana
Mensah and Robert S. (Steve) Miller, Jr. RJRs
Board of Directors has determined that Mr. Wajnert meets
the definition of an audit committee financial expert, as set
forth in Item 401(h)(2) of Regulation S-K, and that
Mr. Wajnert is independent, as that term is
defined by the SEC and NYSE listing standards.

The current members of the Compensation Committee
are Joseph P. Viviano (Chair), Mary K. Bush, General John T.
Chain, Jr. and E.V. (Rick) Goings.

The current members of the Corporate Governance
and Nominating Committee are General John T. Chain, Jr. (Chair),
Mary K. Bush, A.D. Frazier, Jr., Joseph P. Viviano and
Thomas C. Wajnert.

Copies of the charters of the Audit Committee,
the Compensation Committee and the Corporate Governance and
Nominating Committee, as well as RJRs Standards of
Business Conduct and Current Board of Directors Practices on
Certain Corporate Governance Issues, can be found in the
Inside RJRTH section of the www.RJRHoldings.com web
site, under Corporate Governance, or can be
requested, free of charge, by writing to the Office of the
Secretary, R.J. Reynolds Tobacco Holdings, Inc., P.O. Box
2866, Winston-Salem, North Carolina 27102-2866.

RJRs Current Board of Directors Practices
on Certain Corporate Governance Issues provides that each Board
meeting agenda shall include time for an executive session with
only non-employee directors present. When only non-employee
directors are meeting, the director whose committee chairmanship
makes him or her most appropriate to lead a discussion of the
subject matter at hand presides. Otherwise, the Chair of the
Corporate Governance and Nominating Committee presides.
Stockholders may communicate directly with the non-management
directors as a group by writing to the Chair of the Corporate
Governance and Nominating Committee, R.J. Reynolds Tobacco
Holdings, Inc., P.O. Box 2866, Winston-Salem, North
Carolina 27102-2866.

Determination of Independence of
Directors

The NYSE listing standards require that all
listed companies have a majority of independent directors. For a
director to be independent under the NYSE listing
standards, the board of directors of a listed company must
affirmatively determine that the director has no material
relationship with the company, or its subsidiaries or
affiliates, either directly or as a partner, shareholder or
officer of an organization that has a relationship with the
company or its subsidiaries or affiliates. In accordance with
the NYSE listing standards, RJRs Board of Directors has
adopted the following standards to assist it in its
determination of director independence:



| |   |                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A director who is an employee, or whose immediate
    family member is an executive officer, of RJR, or its
    subsidiaries or affiliates, is not independent until three years
    after the end of such employment relationship.

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A director who receives, or whose immediate
    family member receives, more than $100,000 per year in direct
    compensation from RJR, or its subsidiaries or affiliates, other
    than director and committee fees and pension or other forms of
    deferred compensation for prior service (provided such
    compensation is not contingent in any way on continued service),
    is not independent until three years after he or she ceases to
    receive more than $100,000 per year in such compensation.
|
| |  | A director who is affiliated with or employed by,
    or whose immediate family member is affiliated with or employed
    in a professional capacity by, a present or former internal or
    external auditor of RJR is not independent until three years
    after the end of the affiliation or the employment or auditing
    relationship.                                                                                                                                                                       
|
| |  | A director who is employed, or whose immediate
    family member is employed, as an executive officer of another
    company where any of RJRs, or its subsidiaries or
    affiliates, present executives serve on that
    companys compensation committee is not independent until
    three years after the end of such service or the employment
    relationship.                                                                                                                                           
|
| |  | A director who is an executive officer or an
    employee, or whose immediate family member is an executive
    officer, of a company that makes payments to, or receives
    payments from, RJR, or its subsidiaries or affiliates, for
    property or services in an amount which, in any single fiscal
    year, exceeds the greater of $1 million, or 2 percent
    of such other companys consolidated gross revenues, is not
    independent until three years after falling below such threshold.           

These standards are contained in RJRs
Current Board of Directors Practices on Certain Corporate
Governance Issues, which can be found in the Inside
RJRTH section of the www.RJRHoldings.com web site,
under Corporate Governance, or can be requested free
of charge, by writing to the Office of the Secretary,
R.J. Reynolds Tobacco Holdings, Inc., P. O. Box 2866,
Winston-Salem, North Carolina 27102-2966.

The Board of Directors has determined that the
following directors meet RJRs standards of independence
described above: Mary K. Bush, General John T. Chain, Jr., A. D.
Frazier, Jr., E. V. (Rick) Goings, Denise Ilitch, Nana Mensah,
Robert S. (Steve) Miller, Jr., Joseph P. Viviano and Thomas C.
Wajnert.

Compliance with Section 16(a) of the
Exchange Act

Section 16(a) of the Securities Exchange Act
of 1934 requires RJRs directors and executive officers and
persons who own more than 10% of RJRs common stock,
referred to as reporting persons, to file initial statements of
beneficial ownership, on Form 3, and statements of changes
in beneficial ownership, on Forms 4 or 5, of RJR common stock
with the SEC and the NYSE. These reporting persons are required
by SEC regulation to furnish RJR with copies of all Forms 3, 4
and 5 they file with the SEC and the NYSE.

Based solely on RJRs review of the copies
of the forms that it has received, and on written
representations from certain reporting persons that no
additional forms were required, RJR believes that all of its
reporting persons complied with these filing requirements for
transactions that occurred during 2003.

Code of Ethics

RJR has adopted a code of ethics, its
Standards of Business Conduct, which applies to all
directors, officers and employees of RJR and its subsidiaries,
including RJRs chief executive officer, chief financial
officer and controller. The Standards of Business Conductcan be found in the Inside RJRTH section of the
www.RJRHoldings.com web site, under Corporate
Governance, or can be requested free of charge by writing
to the Office of the Secretary, R.J. Reynolds Tobacco Holdings,
Inc., P. O. Box 2866, Winston-Salem, North Carolina 27102-2866.

Any amendment to, or waiver from, a provision of
the Standards of Business Conductthat applies to
RJRs chief executive officer, chief financial officer or
controller, or persons performing similar functions for RJR,
will be disclosed on the www.RJRHoldings.com web site
within five business days following the date of the amendment or
waiver.

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Item 11. Executive Compensation

Director Compensation

RJR provides the following compensation to its
outside directors for their service as directors:

Annual Retainers and Fees



| |   |                                                                                                                                                                                                                                                                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Each outside director receives an annual retainer
    of $50,000. In addition, the committee chairs receive the
    following annual retainers: Audit Committee, $5,000;
    Compensation Committee, $7,500; and Corporate Governance and
    Nominating Committee, $5,000.                                                                                                    
|
| |  | Outside directors receive the following
    attendance fees for each Board or committee meeting attended,
    including designated days during which the Board or a committee
    of the Board conducts RJRs business: Board of Directors,
    $1,250; Audit Committee, $1,500; Compensation Committee, $1,350;
    and Corporate Governance and Nominating Committee, $1,250.
|
| |  | RJR also reimburses directors for actual expenses
    incurred in connection with attendance at Board and committee
    meetings, including transportation and lodging expenses.                                                                                                                                                                                               

Deferred Compensation Plan

Under the Deferred Compensation Plan for
Directors of RJR, outside directors may defer payment of their
compensation for services as Board or committee members until
termination of service as a director or until a selected year in
the future. Participating directors may elect to direct RJR to
credit deferred amounts in 25% increments to a cash account, a
stock account or a combination of both. The Plan provides that
amounts deferred to the cash account earn interest at the prime
rate as set by Morgan Guaranty Trust Company of New York, and
amounts deferred to the stock account mirror the performance of,
and receive dividend equivalents based on, RJR common stock.
Participating directors are entitled to receive cash
distribution of the balance in their accounts in full on the
deferral date or in up to ten annual installments commencing on
the deferral date.

Equity Awards

Upon becoming a director, each outside director
receives under the Equity Incentive Award Plan for Directors of
RJR and Subsidiaries, referred to as the EIAP, an option to
purchase 10,000 shares of RJR common stock. The options have an
exercise price equal to the fair market value of RJR common
stock on the date of grant. The options are not exercisable for
six months following the date of grant, but thereafter are
exercisable for 10 years from the date of grant. Under this
provision of the EIAP, Mr. Miller received a stock option
to purchase 10,000 shares of RJR common stock at an exercise
price of $37.03 upon his election to the Board on July 1,
2003.

On the date of his or her election to the Board
of Directors and on the date of each annual meeting of
stockholders thereafter, under the EIAP, each outside director
also receives a grant of 1,000 deferred common stock units,
unless the director elects to receive instead 1,000 shares of
RJR common stock. In addition, under the EIAP, each eligible
director receives a quarterly grant of deferred common stock
units on the last day of each calendar quarter, determined by
the following formula: $10,000 divided by the average closing
price of a share of RJR common stock for each business day
during the last month of such calendar quarter. If a director
has served for less than the entire quarter, the number of units
is pro-rated.

The deferred common stock units bear dividends at
the same rate as RJR common stock, but the dividends are paid in
the form of additional deferred common stock units. The deferred
common stock units have no voting rights. A director will
receive payment of his or her deferred common stock units as
soon as practicable following his or her last year of service on
the Board of Directors. At the election of the director, the
payment of annual grants may be made in cash or in RJR common
stock. Distribution of the deferred common stock units received
in connection with a quarterly award will be made only in cash.
Distributions

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may be made in one lump sum or in up to 10 annual
installments. Cash payments generally are based on the average
closing price of RJR common stock during December of the year
preceding payment.


RJR does not compensate any director who is an
employee of RJR or any of its subsidiaries in his or her
capacity as a director.

Other Benefits

RJR offers outside directors life insurance
having a death benefit up to $100,000, a matching grants program
and supplemental insurance programs, and reimburses outside
directors for the fees and expenses incurred by them in
connection with their attendance at seminars or training courses
related to their role as directors of a public company.

Compensation Committee Interlocks and
Insider Participation

The Compensation Committee consists of
Ms. Bush, General Chain and Messrs. Goings and Viviano.
During 2003, there were no Compensation Committee interlocks or
insider participation.

Compensation Committee Report on Executive
Compensation

Pursuant to the proxy rules adopted by the SEC
designed to enhance disclosure of public companies
policies toward executive compensation, the Compensation
Committee of RJRs Board of Directors submits the following
report:

This report is submitted to the stockholders by
the Compensation Committee (the Committee) of the
Board of Directors and reflects the executive compensation
policies and practices of RJR and its subsidiaries during 2003.
The Committee is responsible for executive compensation and
oversees the administration of RJRs executive compensation
programs and plans. The Committee reports regularly to the Board
of Directors, and the Board is periodically asked to approve or
ratify Committee actions. During 2003, the Committee consisted
of directors who were not employees of the Company or any of its
subsidiaries, and who, therefore, were not eligible to
participate in any of the Companys executive compensation
programs or plans.

Executive Compensation Principles and
Policies

In determining the amounts, composition and terms
and conditions of the compensation for executive officers of RJR
in 2003, the Committee was guided by two principles:
(1) compensation opportunities must enable RJR to attract
and retain individuals with the high caliber of talent and
skills critical to RJRs success and (2) a substantial
portion of each executive officers compensation must be
tied to quantifiable measures of RJRs financial
performance and/or stock price performance. These principles are
reflected in the actions discussed below relating to salaries,
annual incentives and long-term incentives.

As noted in Compensation Committee reports in
prior years, the federal tax code limits the ability of publicly
traded companies to secure an income tax deduction for
compensation paid to highly compensated individuals. Although
the Committee has taken, and intends to continue taking, actions
to limit the impact of this law, the Committee believes that the
tax deduction is only one of several considerations in setting
compensation and that the tax deduction limitations should not
be permitted to compromise RJRs ability to design and
maintain executive compensation arrangements that will attract
and retain the executive talent required to compete
successfully. Accordingly, achieving the desired flexibility in
the design and delivery of compensation may occasionally result
in some compensation that is not deductible for federal income
tax purposes.

Major Compensation Components

The compensation program for executive officers
is composed of base salary, annual and long-term
performance-based incentive compensation, and benefits. In
determining appropriate compensation plans and levels, the
Committee relies on outside consultants who report directly to
the Committee and who provide survey and other data regarding
compensation practices of companies that are representative of
the size and

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type of company with which RJR competes in the
marketplace for executive talent. This is generally a broader
and more diverse group of companies than used for the peer
company index in the performance graph mandated by the
Securities and Exchange Commission, which appears on page xx of
this report. The base salary and targeted incentive compensation
levels of comparator companies are among several factors the
Committee considers in determining appropriate base salary and
targeted incentive compensation levels of executive officers of
RJR, as described below.


Annual Compensation

The annual compensation for each of the named
executive officers is composed of salary and an annual targeted
bonus opportunity. In general, executive officers salaries
are targeted to reflect the median of competitive practices, as
reflected in survey data used by the Committee for comparison
purposes. Annual compensation levels (salaries plus an annual
target bonus opportunity) are generally set between the 50th and
75th percentile of the compensation practices of comparator
companies. A senior executive will receive an increase in salary
and/or annual target bonus opportunity only when performance
warrants, or the Committee determines that either a change in
the individuals responsibilities or in competitive or
market conditions warrant such an action. Ms. Beasley,
Ms. Neal and Messrs. Schindler, Blixt, Maguire and
Bogan each received base salary increases during 2003 based on
performance, job responsibilities and comparisons of survey data.

The annual bonus amounts shown in the Summary
Compensation Table for the named executive officers were based
on ratings of RJRs financial performance, market share
performance and achievement of cost savings targets during 2003.
The measure of financial performance was net income. For 2003,
the Companys performance under the annual bonus program
provided a maximum bonus opportunity of 150% of the target bonus
opportunity.

Long-term Compensation

The Committee utilizes a mix of various forms of
stock-based and multi-year incentive opportunities to motivate
executives to maintain a longer-term perspective.

In 2003, long-term grants were made in the form
of restricted stock and performance units. The initial dollar
value of each recipients total grant, which was
competitively determined, was split into two parts. Fifty
percent of the initial grant value was converted into restricted
shares of the Companys common stock after the value of
dividends projected to be paid over three years was considered.
The other 50% of the total initial grant value was converted
into performance units, with each performance unit having a
stated value of $1.00. The restriction period for the shares of
restricted stock is three years, and the performance period for
the performance units is three years. Both awards vest after
three years if the Company pays to its stockholders a dividend
of at least $0.95 per share per quarter for each of the 12
quarters of the restriction/performance period (the
threshold performance requirement), unless the Board
of Directors approves vesting of all or part of the grant when a
lower dividend is paid for one or more quarters during the
restriction/performance period. Otherwise, the grants do not
vest and are forfeited. At the end of the
restriction/performance period, if the threshold performance
requirement is met, the original number of performance units
will be multiplied by the average of the total weighted annual
bonus program scores for each year of the three-year
restriction/performance period to determine the final award
levels. (See footnote 5 to the Summary Compensation Table
and the Long-Term Incentive Plans  Awards in Last
Fiscal Year table for a more detailed description of the
restricted stock and performance units referred to here.)

Chief Executive Officers
Compensation

Mr. Schindlers compensation for 2003
was based on his performance, competitive market data and the
Companys financial performance, market share performance
and achievement of cost savings targets.

Effective March 1, 2003, the Committee
approved an increase in Mr. Schindlers annual base salary
from $1,050,000 to $1,081,500, based on the above-mentioned
factors and survey data of comparison companies. The Committee
approved a bonus of $1,285,000 for Mr. Schindler for 2003,
based on ratings for the

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Companys financial performance, market
share performance and achievement of cost savings targets under
the annual bonus plan.


Under the long-term compensation structure
described above, Mr. Schindler was awarded a 2003 grant
that had an initial grant value of $4,326,000. This initial
grant value was converted to 46,100 shares of restricted stock
(based on a $35.52 per share closing market price on the
July 31, 2003 grant date and projected dividends based on
$0.95 per share per quarter for each of 2003, 2004 and 2005) and
2,163,000 performance units.

In connection with the spinoff of RJR by Nabisco
Group Holdings Corp. on June 14, 1999, and as an incentive
to retain Mr. Schindlers services as an employee of
RJR after the spinoff, Mr. Schindler was granted a special
retention bonus of $3,600,000 under a cash retention program
established in 1998. This special retention grant vested 50% at
the end of three years and 25% after four years and will vest
the final 25% after five years. The first 50% payment was funded
on June 15, 1999, in a special trust established for the
purpose of holding retention bonus funds until they become
payable, and was paid on June 15, 2002. The 25% payment to
be paid at the end of the fourth year was funded through the
trust on June 15, 2000, and was paid on June 14, 2003.
The final 25% payment to be paid at the end of the fifth year
was funded through the trust on June 15, 2001. According to
the provisions of the program and the trust, unpaid payments may
partially vest if Mr. Schindler is involuntarily terminated
under certain circumstances.

Summary

The Committee believes that the executive
compensation program must continually provide compensation
potential of such significance that individuals of exceptional
talent and skills are motivated to join and remain with RJR and
to perform in an exceptional manner. By ensuring that such
persons are managing RJRs operations, the long-term
interests of stockholders will be best served. The actions taken
by the Committee during 2003 were consistent with this focus and
the principles outlined above.



| |                          
| | -------------------------
| | Respectfully submitted,  
|
| | Joseph P. Viviano (Chair)
| | Mary K. Bush             
| | John T. Chain, Jr.       
| | E.V. (Rick) Goings       

Executive Compensation

The following describes the components of the
total compensation of the Chief Executive Officer and the four
other most highly compensated executive officers, as defined by
the rules of the SEC, of RJR at the end of the last completed
fiscal year. In addition, pursuant to the rules adopted by the
SEC concerning the disclosure of executive compensation,
information regarding the compensation paid to Richard H. Bogan,
RJRs former Executive Vice President and Chief Financial
Officer whose active employment with RJR terminated on June 30,
2003, also is provided.

The long-term compensation shown in the Summary
Compensation Table and discussed elsewhere in this report was
granted under the R.J. Reynolds Tobacco Holdings, Inc. 1999 Long
Term Incentive Plan. The 1999 LTIP provides for various types of
awards, such as restricted stock, stock options and performance
units. This report also describes the future compensation that
the named executive officers may receive under RJRs
retirement plans and, following termination of employment under
various circumstances, under individual agreements.

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Summary Compensation Table

The following table shows the annual and
long-term compensation paid or accrued by RJR and its
subsidiaries to its Chief Executive Officer and its other four
most highly compensated executive officers for the years ending
December 31, 2003, 2002 and 2001. In addition, pursuant to
the rules adopted by the SEC concerning the disclosure of
executive compensation, information regarding the compensation
paid to Richard H. Bogan, RJRs former Executive Vice
President and Chief Financial Officer whose active employment
with RJR terminated on June 30, 2003, also is provided.
RJRs Chief Executive Officer, its four other most highly
compensated executive officers and Mr. Bogan are referred
to collectively in this report as the named executive
officers.

Summary Compensation Table

|                            |                                     |      |      |                     |  |                        |           |              |  |        |           |           |     |              |        |        |  |  |           |           |     |  |           |         |  |  |           |           | 
|--------------------------- | ----------------------------------- | ---- | ---- | ------------------- |  | ---------------------- | --------- | ------------ |  | ------ | --------- | --------- | --- | ------------ | ------ | ------ |  |  | --------- | --------- | --- |  | --------- | ------- |  |  | --------- | --------- | 
|                            |                                     |      |      |                     |  |                        |           |              |  |        |           |          
|                            |                                     |      |      |                     |  | Long-Term Compensation |           |             
|                            |                                     |      |      | Annual Compensation |  |                        |           |             
|                            |                                     |      |      |                     |  | Restricted             |           | Long-Term    |  |       
|                            |                                     |      |      | Aggregate           |  |                        |           | Other Annual |  | Stock  |           | Incentive |     | All Other   
|                            |                                     |      |      | Base Salary         |  |                        |           | Compensation |  | Awards |           | Payouts   |     | Compensation
|Name and Principal Position |                                     | Year |      | ($)                 |  | Bonus ($)              |           | ($)(3)       |  | ($)(4) |           | ($)       |     | ($)(8)      
|                            |                                     |      |      |                     |  |                        |           |              |  |        |           |           |     |             
|Andrew J. Schindler         |                                     |      | 2003 |                     |  |                        | 1,076,250 |              |  |        | 1,285,000 |           |     |              | 82,954 |        |  |  | 1,637,472 | (5)       |     |  | 1,678,600 |         |  |  | 4,541,637 |          
|                            | Chairman of the Board, President    |      |      | 2002                |  |                        |           | 1,041,667    |  |        |           | 250,000   |     |              |        | 80,938 |  |  |           | 1,731,043 | (6) |  |           | 714,000 |  |  |           | 1,865,690 | 
|                            | and Chief Executive Officer         |      |      | 2001                |  |                        |           | 983,333      |  |        |           | 1,148,000 |     |              |        | 78,732 |  |  |           | 1,701,231 | (7) |  |           | 753,797 |  |  |           | 2,588,000 | 
|Lynn J. Beasley             |                                     |      | 2003 |                     |  |                        | 758,333   |              |  |        | 778,000   |           |     |              | 66,044 |        |  |  | 874,360   | (5)       |     |  | 755,370   |         |  |  | 168,183   |          
|                            | President and Chief Operating       |      |      | 2002                |  |                        |           | 700,000      |  |        |           | 142,000   |     |              |        | 65,092 |  |  |           | 865,522   | (6) |  |           | 321,300 |  |  |           | 97,097    | 
|                            | Officer, RJR Tobacco                |      |      | 2001                |  |                        |           | 495,833      |  |        |           | 431,000   |     |              |        | 64,109 |  |  |           | 688,985   | (7) |  |           | 337,149 |  |  |           | 1,206,725 | 
|Charles A. Blixt            |                                     |      | 2003 |                     |  |                        | 527,917   |              |  |        | 473,000   |           |     |              | 65,735 |        |  |  | 613,182   | (5)       |     |  | 755,030   |         |  |  | 311,914   |          
|                            | Executive Vice President, General   |      |      | 2002                |  |                        |           | 512,500      |  |        |           | 92,000    |     |              |        | 65,227 |  |  |           | 667,716   | (6) |  |           | 303,450 |  |  |           | 28,305    | 
|                            | Counsel and Assistant Secretary     |      |      | 2001                |  |                        |           | 495,833      |  |        |           | 431,000   |     |              |        | 64,350 |  |  |           | 688,985   | (7) |  |           | 321,512 |  |  |           | 1,244,725 | 
|James V. Maguire            |                                     |      | 2003 |                     |  |                        | 361,183   |              |  |        | 280,000   |           |     |              | 57,414 |        |  |  | 343,443   | (5)       |     |  | 420,330   |         |  |  | 144,788   |          
|                            | Executive Vice President  Sales,   |      |      | 2002                |  |                        |           | 350,583      |  |        |           | 55,000    |     |              |        | 81,211 |  |  |           | 370,953   | (6) |  |           | 214,200 |  |  |           | 91,922    | 
|                            | RJR Tobacco                         |      |      | 2001                |  |                        |           | 339,167      |  |        |           | 255,000   |     |              |        | 57,189 |  |  |           | 382,776   | (7) |  |           | 229,926 |  |  |           | 1,066,465 | 
|Dianne M. Neal(1)           |                                     |      | 2003 |                     |  |                        | 308,150   |              |  |        | 356,000   |           |     |              | 45,562 |        |  |  | 454,230   | (5)       |     |  | 88,243    |         |  |  | 9,905     |          
|                            | Executive Vice President and        |      |      | 2002                |  |                        |           | 208,333      |  |        |           | 22,000    |     |              |        | 28,490 |  |  |           | 86,547    | (6) |  |           | 58,191  |  |  |           | 9,340     | 
|                            | Chief Financial Officer             |      |      | 2001                |  |                        |           | 198,500      |  |        |           | 103,000   |     |              |        | 24,918 |  |  |           | 80,113    | (7) |  |           | 66,423  |  |  |           | 319,377   | 
|Richard H. Bogan            |                                     |      | 2003 |                     |  |                        | 426,667   |              |  |        | 357,667   |           |     |              | 64,673 |        |  |  |          |           |     |  |          |         |  |  | 118,540   |          
|                            | Former Executive Vice President and |      |      | 2002                |  |                        |           | 222,826      |  |        |           | 295,000   | (2) |              |        | 56,788 |  |  |           | 618,237   | (6) |  |           |        |  |  |           | 6,685     | 
|                            | Chief Financial Officer             |      |      |                     |  |                        |           |              |  |        |           |           |     |              |        |        |  |  |           |           |     |  |           |         |  |  |           |           | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Ms. Neal was promoted to Executive Vice
    President and Chief Financial Officer on July 1, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|(2) | This amount includes a $250,000
    sign-on bonus.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|(3) | The amounts shown in the table include amounts
    attributed to the named executive officers participation
    in the executive perquisite program of RJR and its subsidiaries,
    which provided them with supplemental insurance, a leased
    automobile and an annual allowance in the following amounts
    during 2003: Mr. Schindler  $54,750; Ms. Beasley
     $47,500; Mr. Blixt  $47,500; Mr. Maguire
     $40,000; Ms. Neal - $32,500; and
    Mr. Bogan  $47,500.                                                                                                                                                                        
|(4) | The values of restricted shares of RJR common
    stock held by each of the named executive officers as of
    December 31, 2003, based on the closing price of RJR common
    stock on that date of $58.15, are as follows: Mr. Schindler
    (110,591 shares with a value of $6,430,867), Ms. Beasley
    (53,809 shares with a value of $3,128,993), Mr. Blixt
    (42,758 shares with a value of $2,486,378), Mr. Maguire
    (23,833 shares with a value of $1,385,889) and Ms. Neal
    (15,919 shares with a value of $925,690). Dividends are paid on
    the restricted shares of RJR common stock to the same extent as
    for unrestricted shares.
|(5) | These restricted shares of RJR common stock were
    awarded under the 1999 LTIP, and are scheduled to vest on
    July 31, 2006. For these restricted shares to vest, RJR
    must pay to its stockholders a dividend per share of RJR common
    stock of at least $0.95 in each fiscal quarter during the period
    from July 31, 2003 through December 31, 2005, unless
    the Board of Directors specifically approves the vesting of the
    grant when a lower dividend is paid to stockholders for one or
    more quarters during the performance period.                                                                                          

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | These restricted shares will vest pro rata upon
    the named executive officers termination of employment
    without cause, as such term is defined in the restricted stock
    agreement, or retirement, and all of these restricted shares
    will be fully vested upon the named executive officers
    death or permanent disability, or a change of control of RJR, as
    such term is defined in the restricted stock agreement. Upon the
    named executive officers voluntary termination of
    employment or termination of employment for cause, the named
    executive officer will forfeit all of his or her awarded shares
    of RJR common stock still subject to the restrictions.

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(6) | These restricted shares of RJR common stock were
    awarded under the 1999 LTIP, and are scheduled to vest on the
    later of July 26, 2005, or the date the Annual Incentive
    Award Plan score for 2004 is determined. For these restricted
    shares to vest, RJR must pay to its stockholders a dividend per
    share of RJR common stock of at least $0.95 in each fiscal
    quarter during the period from July 26, 2002 through
    December 31, 2004, unless the Board of Directors
    specifically approves the vesting of the grant when a lower
    dividend is paid to stockholders for one or more quarters during
    the performance period, referred to in the restricted stock
    agreement as the threshold performance requirement.
    On the vesting date, if the threshold performance requirement
    has been met, the original number of restricted shares will be
    multiplied by the average of the total weighted AIAP percentage
    scores for the financial and market share components of the AIAP
    for each of 2002, 2003 and 2004, resulting in a revised number
    of shares. If the revised number is greater than the original
    number of restricted shares, all of the restricted shares will
    vest, and RJR will issue an additional number of unrestricted
    shares of RJR common stock to the named executive officer equal
    to the difference between the revised number and the original
    number. If the revised number is less than the original number,
    the named executive officer, other than Mr. Bogan, will
    forfeit the number of shares equal to the difference between the
    original number of restricted shares and the revised number, and
    the remaining restricted shares will vest.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | These restricted shares will vest pro rata upon
    the named executive officers termination of employment
    without cause, as such term is defined in the restricted stock
    agreement, or retirement, and all of these restricted shares
    will be fully vested upon the named executive officers
    death or permanent disability, or a change of control of RJR, as
    such term is defined in the restricted stock agreement. Upon the
    named executive officers voluntary termination of
    employment or termination of employment for cause, the named
    executive officer will forfeit all of his or her awarded shares
    of RJR common stock still subject to the restrictions. Pursuant
    to the terms of his restricted stock agreement,
    Mr. Bogans restricted shares vested pro rata upon the
    termination of his active employment with RJR on June 30,
    2003.

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(7) | These restricted shares of RJR common stock were
    awarded under the 1999 LTIP, and vested on January 31,
    2004. For these restricted shares to vest, RJR was required to
    pay to its stockholders a dividend per share of RJR common stock
    of at least $0.775 per quarter for each of the 12 quarters from
    January 1, 2001 through December 31, 2003, referred to
    in the restricted stock agreement as the threshold
    performance requirement. On January 31, 2004, since
    the threshold performance requirement had been met, the original
    number of restricted shares was multiplied by 85.8%, the average
    of the total weighted AIAP percentage scores for the financial
    and market share components of the AIAP for each of 2001, 2002
    and 2003, resulting in a revised number of shares. Since the
    revised number was less than the original number, on the vesting
    date, the named executive officers forfeited 14.2% of the
    original number of restricted shares awarded to them, and the
    remaining shares vested.
|(8) | The amounts shown in the table reflect the
    following RJR contributions made on behalf of the named
    executive officers and Mr. Bogan under RJRs qualified
    and non-qualified defined contribution plans during 2003:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

|              |  |                           |       |                      |  |   |        | 
|------------- |  | ------------------------- | ----- | -------------------- |  | - | ------ | 
|              |  | RJR Matching Contribution |       | RJR Contribution    
|Name          |  | (qualified plan)          |       | (non-qualified plan)
|              |  |                           |       |                     
|Mr. Schindler |  | $                         | 6,000 |                      |  | $ | 33,788 | 
|Ms. Beasley   |  |                           | 6,000 |                      |  |   | 21,010 | 
|Mr. Blixt     |  |                           | 6,000 |                      |  |   | 12,598 | 
|Mr. Maguire   |  |                           | 5,226 |                      |  |   | 6,484  | 
|Ms. Neal      |  |                           | 6,000 |                      |  |   | 3,905  | 
|Mr. Bogan     |  |                           | 3,000 |                      |  |   | 6,005  | 

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In addition, in 2003, (1) Mr. Schindler
    received 25% of his special retention award of $3,600,000
    ($900,000) under the Retention Incentive Program, as described
    in the Compensation Committee Report, and in
     Agreements with Executive Officers,
    (2) Mr. Bogan received a retention bonus, prorated
    through the date of the termination of his active employment
    with RJR on June 30, 2003, of $109,535 and (3) the
    following named executive officers were paid the following
    non-qualified pension benefits from a retention trust, pursuant
    to the funding of retirement benefits program, as described
    under  Funding of Retirement Benefits:
    Mr. Schindler  $3,601,849,
    Ms. Beasley  $141,173,
    Mr. Blixt  $293,316 and
    Mr. Maguire  $133,078.

Long-Term Incentive Compensation

RJR maintains the 1999 LTIP to provide executives
with long-term performance-based incentive compensation. RJR has
issued stock options, restricted stock and other
performance-based awards under the 1999 LTIP to the named
executive officers and to other key employees. The following
table provides information relating to the exercise of employee
stock options by the named executive officers during fiscal year
2003 and the number and value of shares of RJR common stock
subject to stock options held by the named executive officers as
of December 31, 2003.

Aggregated Option/ SAR Exercises in Last
Fiscal Year and Fiscal Year-End Option Values

|                    |  |                 |        |             |  |                        |         |                           |  |             |         |               |  |  |        |  |  |  |            |  |  |  |           | 
|------------------- |  | --------------- | ------ | ----------- |  | ---------------------- | ------- | ------------------------- |  | ----------- | ------- | ------------- |  |  | ------ |  |  |  | ---------- |  |  |  | --------- | 
|                    |  |                 |        |             |  |                        |         |                           |  |            
|                    |  |                 |        |             |  | Number of Securities   |         |                          
|                    |  |                 |        |             |  | Underlying Unexercised |         | Value of Unexercised     
|                    |  |                 |        |             |  | Options/SARs at Fiscal |         | In-the-Money Options/SARs
|                    |  |                 |        |             |  | Year-End(#)(1)         |         | at Fiscal Year-End($)(2) 
|                    |  | Shares Acquired |        | Value       |  |                        |         |                          
|Name                |  | on Exercise(#)  |        | Realized($) |  | Exercisable            |         | Unexercisable             |  | Exercisable |         | Unexercisable
|                    |  |                 |        |             |  |                        |         |                           |  |             |         |              
|Andrew J. Schindler |  |                 |       | (3)         |  |                        |        |                           |  |             | 380,997 |               |  |  | 85,000 |  |  |  | 10,265,984 |  |  |  | 2,185,563 | 
|Lynn J. Beasley     |  |                 | 7,759  |             |  |                        | 215,670 |                           |  |             |        |               |  |  | 35,000 |  |  |  |           |  |  |  | 899,938   | 
|                    |  |                 | 4,916  |             |  |                        | 112,056 |                           |  |             |         |               |  |  |        |  |  |  |            |  |  |  |           | 
|Charles A. Blixt    |  |                 | 9,004  |             |  |                        | 260,702 |                           |  |             | 35,000  |               |  |  | 35,000 |  |  |  | 899,938    |  |  |  | 899,938   | 
|                    |  |                 | 7,762  |             |  |                        | 165,674 |                           |  |             |         |               |  |  |        |  |  |  |            |  |  |  |           | 
|                    |  |                 | 35,000 |             |  |                        | 861,438 |                           |  |             |         |               |  |  |        |  |  |  |            |  |  |  |           | 
|James V. Maguire    |  |                 |       | (3)         |  |                        |        |                           |  |             | 8,279   |               |  |  | 35,000 |  |  |  | 202,374    |  |  |  | 899,938   | 
|Dianne M. Neal      |  |                 | 1,054  |             |  |                        | 34,892  |                           |  |             | 12,000  |               |  |  | 12,000 |  |  |  | 367,800    |  |  |  | 367,800   | 
|                    |  |                 | 2,846  |             |  |                        | 72,158  |                           |  |             |         |               |  |  |        |  |  |  |            |  |  |  |           | 
|                    |  |                 | 12,000 |             |  |                        | 382,200 |                           |  |             |         |               |  |  |        |  |  |  |            |  |  |  |           | 
|Richard H. Bogan    |  |                 |       | (4)         |  |                        |        |                           |  |             |        |               |  |  |       |  |  |  |           |  |  |  |          | 



---



|    |                                                                                                                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The unexercisable RJR stock options are grants of
    RJR stock options made in tandem with grants of restricted
    shares of RJR common stock on June 15, 1999 and
    July 28, 1999.                                                                
|(2) | The dollar values of the RJR stock options are
    calculated by determining the difference between the fair market
    value of the shares of RJR common stock underlying the options
    and the exercise price of such options at December 31, 2003.
|(3) | Messrs. Schindler and Maguire did not
    exercise any RJR stock options during 2003.                                                                                                                                                                  
|(4) | Mr. Bogan was not granted any RJR stock
    options.                                                                                                                                                                                                   

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The regular annual 2003 long-term incentive
grants for all of the named executive officers were made in the
form of restricted shares of RJR common stock, as described in
footnote (5) to the Summary Compensation Table, and
performance units, the value of which is based on the financial
and market share performance of RJR and its subsidiaries over a
three-year period. The following table identifies the
performance units that were granted to the named executive
officers on July 31, 2003, and the threshold, target and
maximum values of the performance units upon their maturation.

Long-Term Incentive Plans  Awards
in Last Fiscal Year

|                    |  |  |           |           |  |                                |          |              |  |           |   |  |  |  |           |  |  |  |           | 
|------------------- |  |  | --------- | --------- |  | ------------------------------ | -------- | ------------ |  | --------- | - |  |  |  | --------- |  |  |  | --------- | 
|                    |  |  |           |           |  |                               
|                    |  |  |           |           |  | Estimated Future Payouts Under
|                    |  |  |           |           |  | Non-Stock Price-Based Plans(1)
|                    |  |  |           |           |  |                               
|                    |  |  |           | Number of |  | Performance                    |          |             
|                    |  |  |           | Shares,   |  | Or Other                       |          |             
|                    |  |  |           | Units Or  |  | Period Until                   |          |             
|                    |  |  |           | Other     |  | Maturation                     |          |             
|Name                |  |  |           | Rights(#) |  | Or Payout                      |          | Threshold($) |  | Target($)
|                    |  |  |           |           |  |                                |          |              |  |          
|Andrew J. Schindler |  |  | 2,163,000 |           |  |                                | 12/31/05 |              |  |           | 0 |  |  |  | 2,163,000 |  |  |  | 3,244,500 | 
|Lynn J. Beasley     |  |  | 1,155,000 |           |  |                                | 12/31/05 |              |  |           | 0 |  |  |  | 1,155,000 |  |  |  | 1,732,500 | 
|Charles A. Blixt    |  |  | 810,000   |           |  |                                | 12/31/05 |              |  |           | 0 |  |  |  | 810,000   |  |  |  | 1,215,000 | 
|James V. Maguire    |  |  | 453,650   |           |  |                                | 12/31/05 |              |  |           | 0 |  |  |  | 453,650   |  |  |  | 680,475   | 
|Dianne M. Neal      |  |  | 600,000   |           |  |                                | 12/31/05 |              |  |           | 0 |  |  |  | 600,000   |  |  |  | 900,000   | 
|Richard H. Bogan    |  |  |          |           |  |                                |         |              |  |           |  |  |  |  |          |  |  |  |          | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The performance units have a three-year
    performance period, consisting of RJRs fiscal years 2003,
    2004 and 2005. At the end of the performance period, the
    performance units will be valued and paid, if they vest, or
    cancelled, if they do not vest. For the performance units to
    vest, RJR must pay to its stockholders a dividend per share of
    RJR common stock of at least $0.95 in each fiscal quarter during
    the period from July 31, 2003 through December 31,
    2005, unless the Board of Directors specifically approves the
    vesting of the performance units when a lower dividend is paid
    to stockholders for one or more quarters during the performance
    period, referred to in the performance units agreement as the
    threshold performance requirement. At the end of the
    vesting period, if the threshold performance requirement has
    been met, the value of each performance unit will be multiplied
    by the average of the total weighted AIAP scores for each of
    2003, 2004 and 2005. Payment of performance units will be made
    only in cash.

In the event of a named executive officers
death, permanent disability, retirement or termination of
employment without cause, as such term is defined in the
performance units agreement, or a change of control of RJR, as
such term is defined in the performance units agreement, prior
to December 31, 2005, the number of performance units which
will vest, if not previously cancelled due to RJRs failure
to meet the threshold performance requirement, will be equal to
the product of (a) the original number of performance units
granted to the named executive officer, and (b) a fraction,
the numerator of which will be the number of whole or partial
months between January 1, 2003 and the date of the named
executive officers death, permanent disability, retirement
or termination of employment without cause or change of control,
and the denominator of which will be 36. Except in the event of
a change of control of RJR, the value of a performance unit will
equal $1. In the event of a change of control of RJR, the value
of each performance unit will be equal to the greater of
(i) $1, or (ii) $1 multiplied by the average of the
total weighted AIAP scores for each of the years 2003, 2004 and
2005 completed prior to the change of control. Upon a named
executive officers voluntary termination of employment or
termination of employment for cause prior to December 31,
2005, all of his or her performance units will be cancelled.

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##### Table of Contents



Retirement Plans

The named executive officers participate in
noncontributory defined benefit retirement plans maintained by
RJR. Messrs. Schindler and Bogan also participate in the
R. J. Reynolds Supplemental Executive Retirement Plan,
referred to as the SERP. Benefits under the SERP are payable
only after a participants retirement at a specified
retirement age or earlier retirement or termination in various
circumstances.

The following table shows the estimated annual
benefits payable to Messrs. Schindler and Bogan upon
retirement under the SERP, as described in the preceding
paragraph. The retirement benefits shown are computed before
being offset for Social Security and are based upon retirement
at age 60 and the payment of a single-life annuity.

Estimated Annual Retirement Benefits

|                              |  |                     |  |   |           | 
|----------------------------- |  | ------------------- |  | - | --------- | 
|                              |  | Years of Service(1)
|Average Final Compensation(1) |  | 20 or More         
|                              |  |                    
|$                             |  | 800,000             |  | $ | 400,000   | 
|                              |  | 900,000             |  |   | 450,000   | 
|                              |  | 1,000,000           |  |   | 500,000   | 
|                              |  | 1,100,000           |  |   | 550,000   | 
|                              |  | 1,200,000           |  |   | 600,000   | 
|                              |  | 1,300,000           |  |   | 650,000   | 
|                              |  | 1,400,000           |  |   | 700,000   | 
|                              |  | 1,500,000           |  |   | 750,000   | 
|                              |  | 1,600,000           |  |   | 800,000   | 
|                              |  | 1,700,000           |  |   | 850,000   | 
|                              |  | 1,800,000           |  |   | 900,000   | 
|                              |  | 1,900,000           |  |   | 950,000   | 
|                              |  | 2,000,000           |  |   | 1,000,000 | 
|                              |  | 2,100,000           |  |   | 1,050,000 | 
|                              |  | 2,200,000           |  |   | 1,100,000 | 
|                              |  | 2,300,000           |  |   | 1,150,000 | 
|                              |  | 2,400,000           |  |   | 1,200,000 | 
|                              |  | 2,500,000           |  |   | 1,250,000 | 
|                              |  | 2,600,000           |  |   | 1,300,000 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | For purposes of determining retirement benefits
    under this table, Average Final Compensation
    consists of the annualized sum of base salary, bonus in the year
    earned and pre-tax contributions to plans maintained under
    Sections 401(k) and 125 of the Internal Revenue Code, and
    is determined by considering the 36 consecutive months that
    yield the highest average compensation during the
    participants last 60 months of service.
    Mr. Schindlers Average Final Compensation as of
    December 31, 2003 was $2,123,842, and he is expected to
    have more than 20 years of credited service at age 60.

Mr. Bogans Average Final Compensation
as of December 31, 2003, was $831,484, and his Average
Final Compensation as of June 30, 2006,
Mr. Bogans official Separation Date under
his June 6, 2003 Severance Agreement with RJR described
under  Richard H. Bogan Severance
Agreement, is expected to be approximately $912,166. On
his Separation Date, Mr. Bogan will be entitled to an early
retirement benefit under the plan and, pursuant to the terms of
his Severance Agreement and a Letter Agreement dated
June 12, 2002, will be credited with an additional
12 years of service under the plan. Accordingly, the annual
single life annuity payable to Mr. Bogan on his Separation
Date is expected to be approximately $311,749, reducing to
$303,346 at age 62.

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RJR has determined the retirement benefits for
Ms. Beasley, Mr. Blixt and Ms. Neal by the
formula under a noncontributory defined benefit plan maintained
by RJR that has no Social Security offset. The following table
shows the estimated annual single life annuity payable at age 65
under the plan.

Estimated Annual Retirement Benefits

|                              |  |                     |         |    |  |            |         |  |  |   |         | 
|----------------------------- |  | ------------------- | ------- | -- |  | ---------- | ------- |  |  | - | ------- | 
|                              |  |                    
|                              |  | Years of Service(1)
|                              |  |                    
|Average Final Compensation(1) |  | 30                  |         | 35 |  | 40 or more
|                              |  |                     |         |    |  |           
|$ 300,000                     |  | $                   | 105,534 |    |  | $          | 113,552 |  |  | $ | 119,966 | 
|400,000                       |  |                     | 141,668 |    |  |            | 152,359 |  |  |   | 160,911 | 
|500,000                       |  |                     | 177,803 |    |  |            | 191,166 |  |  |   | 201,856 | 
|600,000                       |  |                     | 213,937 |    |  |            | 229,973 |  |  |   | 242,801 | 
|700,000                       |  |                     | 250,071 |    |  |            | 268,780 |  |  |   | 283,747 | 
|800,000                       |  |                     | 286,205 |    |  |            | 307,587 |  |  |   | 324,692 | 
|900,000                       |  |                     | 322,340 |    |  |            | 346,394 |  |  |   | 365,637 | 
|1,000,000                     |  |                     | 358,474 |    |  |            | 385,200 |  |  |   | 406,582 | 
|1,100,000                     |  |                     | 394,608 |    |  |            | 424,007 |  |  |   | 447,527 | 
|1,200,000                     |  |                     | 430,742 |    |  |            | 462,814 |  |  |   | 488,472 | 
|1,300,000                     |  |                     | 466,877 |    |  |            | 501,621 |  |  |   | 529,417 | 
|1,400,000                     |  |                     | 503,011 |    |  |            | 540,428 |  |  |   | 570,362 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | For purposes of determining retirement benefits
    under this table, Average Final Compensation
    consists of the annualized sum of base salary, bonus in the year
    earned and pre-tax contributions to plans maintained under
    Sections 401(k) and 125 of the Internal Revenue Code, and
    is determined by considering the 36 consecutive months that
    yield the highest average compensation during the
    participants last 60 months of service. Average Final
    Compensation as of December 31, 2003 was $1,101,722 for
    Ms. Beasley, $940,319 for Mr. Blixt and $398,661 for
    Ms. Neal. Estimated years of credited service, rounded to
    the nearest year, at age 65 is 40 years for
    Ms. Beasley, 32 years for Mr. Blixt and
    36 years for Ms. Neal.

RJR has determined the retirement benefits for
Mr. Maguire by the formula under a noncontributory defined
benefit plan maintained by RJR that is subject to a Social
Security offset. The following table shows the estimated annual
single life annuity payable at age 65 under the plan.

Estimated Annual Retirement Benefits

|                              |         |                     |         |         |  |            |         |         |  |   |         |         | 
|----------------------------- | ------- | ------------------- | ------- | ------- |  | ---------- | ------- | ------- |  | - | ------- | ------- | 
|                              |         |                    
|                              |         | Years of Service(1)
|                              |         |                    
|Average Final Compensation(1) |         | 30                  |         | 35      |  | 40 or more
|                              |         |                     |         |         |  |           
|$500,000                      |         | $                   | 257,632 |         |  | $          | 300,571 |         |  | $ | 343,509 |        
|                              | 600,000 |                     |         | 310,132 |  |            |         | 361,821 |  |   |         | 413,509 | 
|                              | 700,000 |                     |         | 362,632 |  |            |         | 423,071 |  |   |         | 483,509 | 
|                              | 800,000 |                     |         | 415,132 |  |            |         | 484,321 |  |   |         | 553,509 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | For purposes of determining retirement benefits
    under this table, Average Final Compensation
    consists of the annualized sum of base salary, bonus in the year
    earned and pre-tax contributions to plans maintained under
    Sections 401(k) and 125 of the Internal Revenue Code, and
    is determined by considering the 60 consecutive months that
    yield the highest average compensation during the
    participants last 120 months of service. Mr.
    Maguires Average Final Compensation as of
    December 31, 2003, was $577,166, and he is expected to have
    more than 40 years of credited service at age 65.

Funding of Retirement Benefits

In the summer of 2000, RJR offered to its current
and retired employees who had earned non-qualified pension
benefits a one-time opportunity to elect to have at least 75% of
their total earned qualified and non-qualified pension benefits
funded over a three-year period. Under this program, eligible
participants could elect

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to continue to have all of their non-qualified
pension benefit payments made in the form(s) and at the time(s)
specified under the current non-qualified pension plan
provisions. Alternatively, eligible participants could elect to
have a specified portion of their non-qualified pension benefits
funded, which for electing active employees will result in their
non-qualified pension benefits being paid at an earlier time
than required under current non-qualified pension plan
provisions. Under this program, participants who are active
employees will receive such benefits out of funds already set
aside in a retention trust established on May 13, 1998.
Participants who are already retirees will receive such benefits
directly from RJR. The remaining 25% of each participants
total earned pension benefits not funded under this program will
continue to be paid in the form(s) and at the time(s) specified
under the current non-qualified pension plan provisions.


With respect to participants who are active
employees and have elected the alternative funded payment
option, RJR calculated their funding levels based on the
qualified and non-qualified pension benefits they had earned as
of January 31, 2000. For those participants whose total
earned pension benefits funding level was less than 50% at that
time, an amount (paid in 2003) was designated in the trust to
increase their funding level to 50%. For those participants
whose total earned pension benefits funding level was less than
65% as of January 31, 2001, an additional amount (payable
in 2004) was designated in the trust to increase their funding
level to 65%. Finally, for those participants whose total earned
pension benefits funding level was less than 75% as of
January 31, 2002, an additional amount (payable in 2005)
was designated in the trust to increase their funding level to
75%. All of the designated amounts have been targeted to be
comparable on an after-tax basis to each participants
earned non-qualified pension benefits funded at that time. Under
this program, the following named executive officers were paid
the following amounts from the retention trust in 2003:
Mr. Schindler  $3,601,849,
Ms. Beasley  $141,173,
Mr. Blixt  $293,316 and
Mr. Maguire  $133,078.

In the event a participant who was an active
employee at the time of his or her election to participate in
the funding program voluntarily terminates his or her employment
(including retirement), the participant will forfeit any right
to any further payments from the trust, and such payments will
be paid directly by RJR. If a participants employment is
terminated because of his or her death or permanent disability,
the participant (or his or her estate) will receive all of his
or her remaining designated payments from the trust as soon as
practicable thereafter. If a participants employment is
involuntarily terminated, the participant may be entitled to
receive a pro rataportion of his or her remaining
payments from the trust, and the remainder of such payments will
be paid directly by RJR. However, if the termination without
cause occurs following a change of control of RJR, as such term
is defined in the trust document, the participant will receive
all of his or her remaining payments from the trust. Any earned
non-qualified pension benefits not provided from the trust will
continue to be paid in the form(s) and at the time(s) specified
under current non-qualified pension plan provisions.

Agreements with Executive Officers

In October 1988, RJR entered into an employment
agreement with Mr. Schindler, which was amended in December
1988, June 1999 and January 2002, and supplemented in October
1999, providing (as amended and supplemented) that if
Mr. Schindlers employment is terminated other than
for cause, he will be entitled to an amount equal to
three times his annual salary and target bonus, payable over
three years. In addition, he is entitled to receive
retirement credits, welfare benefits and other perquisites for
the same three-year period. Mr. Schindlers employment
agreement further provides that upon a change of
control, Mr. Schindler immediately will be paid in a
lump sum an amount equal to three times his annual salary
and target bonus (or last bonus, if higher), regardless of
whether his employment with RJR ends at that time or some later
date. Whenever Mr. Schindler retires from RJR, provided
that the retirement is after the date of a change of control, he
will be credited with three years of retirement credits, and the
value of his lump sum payment made upon the change of control
will be deemed to be the compensation received during the three
additional years of credited service.

Cause includes, generally, criminal
conduct, deliberate refusal to perform employment duties or
deliberate misconduct materially damaging to RJR. A change
of control includes specified acquisitions of 30% or more
of the combined voting power of RJR securities, various changes
in the composition of the RJR

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Board of Directors, selected mergers or
consolidations of RJR or the disposition of substantially all of
the assets of RJR.


If a parachute excise tax is imposed
on any payments to Mr. Schindler, Mr. Schindler will
be entitled to tax reimbursement payments. In addition, upon a
change of control, restrictions on restricted stock held by
Mr. Schindler will lapse and all his outstanding stock
options under the 1999 LTIP will vest and be converted into
stock options of equal value in the successor company. Upon
termination of employment following a change of control,
Mr. Schindlers annual incentive awards and
performance units also will vest pro rataand be paid in
a lump sum.

RJR has entered into severance agreements with
its other executive officers, including Ms. Beasley,
Messrs. Blixt and Maguire and Ms. Neal, which, in each
case, provide that if the executives employment is
involuntarily terminated other than for cause or if
the executive terminates his or her employment for good
reason, he or she will receive two years base salary plus
bonus, payable over three years, benefit continuation for three
years, and if in effect, coverage under the executive perquisite
plan for three years. Cause includes criminal
dishonesty, deliberate misconduct, and deliberate and continual
refusal to perform employment duties or to act in accordance
with instructions of the RJR Board of Directors. Good
reason includes a substantial reduction in the
executives responsibilities, a more than 20% reduction in
the executives salary and annual bonus opportunity and
relocation. Compensation continuance is based on the highest
annual rate of salary in effect during the 12 months
immediately before termination and the current target incentive
award opportunity for the calendar year in which employment
terminates.

RJR also has entered into change of control
agreements with its other executive officers, including
Ms. Beasley, Messrs. Blixt and Maguire and
Ms. Neal. These agreements provide that, if there is a
change of control of RJR, the executive is entitled to tax
reimbursement payments if a parachute excise tax is
imposed, reimbursement payments for legal and accounting fees as
a result of termination of employment, and severance if
termination of employment is by RJR without cause or by the
executive with good reason. Following a change of
control, good reason includes a material reduction
in the executives duties, position and reporting
relationship, a reduction in pay grade or bonus opportunity,
RJRs failure to continue in effect any compensation plan
in which the executive participated at the time of the change of
control, any action by RJR which directly or indirectly
materially reduces benefits under its retirement or savings plan
or fringe benefits, termination of employment without written
notice by RJR and relocation.

As described under  Retirement
Plans, Mr. Schindler participates in a Supplemental
Executive Retirement Plan. Under the SERP, in the event of a
change of control, as such term is defined in the
1999 LTIP, the SERP benefits of Mr. Schindler will be
funded in a rabbi trust. At the earlier of his normal
Retirement Age or other Retirement Date,
as such terms are defined in the SERP, Mr. Schindler will
receive an annuity purchased from the rabbi trust.

In connection with the spin-off of RJR by Nabisco
Group Holdings Corp. on June 14, 1999, Mr. Schindler
was granted a special retention award of $3,600,000 under the
Retention Incentive Program, as described in the Compensation
Committee Report. Mr. Schindlers special retention
grant vested 50% at the end of three years, vested an additional
25% after four years, and will vest the final 25% after
five years. The first 50% payment was paid from the trust
described above on June 15, 2002. An additional 25% payment
was paid from the trust on June 15, 2003. The final 25%
payment to be paid at the end of the fifth year was funded
through the trust on June 15, 2001.

According to the terms of the Retention Incentive
Program and related trust, the following rules apply if
Mr. Schindlers employment terminates prior to
June 15, 2004:



| |   |                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | If Mr. Schindler voluntarily terminates
    employment (including retirement) or if his employment is
    terminated for cause (as defined in his employment
    agreement), he will forfeit all rights to any unpaid payments.
|
| |  | If Mr. Schindlers employment is
    terminated because of his death or permanent disability, he (or
    his estate) will receive the entire amount of any unpaid
    payments.                                                  

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| |   |                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | If Mr. Schindlers employment is
    involuntarily terminated without cause prior to
    June 15, 2004, he will be paid $3,600,000 less the amount
    of any payments that he previously received from the trust.                        
|
| |  | If Mr. Schindlers employment is
    involuntarily terminated following a change of control, as
    defined in the 1999 LTIP, he will be paid $3,600,000 less the
    amount of any payments that he previously received from the
    trust.

Richard H. Bogan Severance Agreement

On June 30, 2003, Mr. Bogan terminated
his active employment with RJR, pursuant to the terms of a
Severance Agreement with RJR dated June 6, 2003, which is
referred to as the Severance Agreement. Under the Severance
Agreement, Mr. Bogan will receive Compensation
Continuance of $600,667 per year, payable monthly, plus
continuation of coverage under RJRs benefits programs, for
the three-year period ending June 30, 2006. Such
continuation of coverage will be subject to the terms,
provisions and conditions of RJRs benefits programs,
including RJRs right to amend, modify or terminate the
programs and will not include participation in the 1999 LTIP.
During the period of Compensation Continuance, if Mr. Bogan
becomes employed by an employer not affiliated with RJR, his
Compensation Continuance will continue and he will remain
eligible to participate in the R. J. Reynolds Capital Investment
Plan and the R. J. Reynolds Supplemental Executive Retirement
Plan. However, his other benefits will be appropriately
terminated, coordinated or offset to the extent provided for by
the other employer. If Mr. Bogan dies during the period of
Compensation Continuance, any Compensation Continuance that
would have been paid to him had he lived until June 30,
2006, his official Separation Date under the
Severance Agreement, will be paid in a lump sum to his estate.

In accordance with the terms of a letter
agreement dated June 12, 2002, entered into between
Mr. Bogan and RJR at the commencement of
Mr. Bogans employment with RJR, Mr. Bogan has
been credited with an additional 12 years of service for
purposes of his participation in RJRs Supplemental
Executive Retirement Plan. For further discussion of
Mr. Bogans retirement benefits, see
 Retirement Plans.

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Performance Graph

The following graph shows changes over the period
from June 15, 1999, the first day of regular way trading
after the spin-off distribution by Nabisco Group Holdings Corp.
of all of the outstanding shares of RJR common stock to the
stockholders of NGH, through December 31, 2003, in the
value of $100 invested in (1) RJR common stock;
(2) the Standard & Poors 500 Index; and
(3) the Standard & Poors Tobacco Index.

Comparison of Cumulative Total
Return

from June 15, 1999 to December 31,
2003* among RJR


Common Stock, S&P 500 Index and S&P
Tobacco Index


(CUMULATIVE TOTAL RETURN GRAPH)

|                  |  |         |        |          |  |          |        |          |  |          |        |          |  |  |        |  |  |  |        |  |  |  |        | 
|----------------- |  | ------- | ------ | -------- |  | -------- | ------ | -------- |  | -------- | ------ | -------- |  |  | ------ |  |  |  | ------ |  |  |  | ------ | 
|                  |  | 6/15/99 |        | 12/31/99 |  | 12/31/00 |        | 12/31/01 |  | 12/31/02 |        | 12/31/03
|                  |  |         |        |          |  |          |        |          |  |          |        |         
|RJR               |  |         | 100.00 |          |  |          | 57.94  |          |  |          | 179.17 |          |  |  | 219.25 |  |  |  | 175.53 |  |  |  | 266.27 | 
|S&P Tobacco Index |  |         | 100.00 |          |  |          | 63.69  |          |  |          | 124.03 |          |  |  | 136.59 |  |  |  | 127.31 |  |  |  | 179.85 | 
|S&P 500 Index     |  |         | 100.00 |          |  |          | 113.68 |          |  |          | 103.33 |          |  |  | 91.05  |  |  |  | 70.93  |  |  |  | 91.28  | 

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Item 12. Security Ownership of
Certain Beneficial Owners and Management

Securities Authorized for Issuance under
Equity Compensation Plans

For information regarding securities authorized
for issuance under equity compensation plans, see note 15
to consolidated financial statements.

Security Ownership of Certain Beneficial
Owners

RJR has been notified by the persons in the
following table that they are beneficial owners, as defined by
the rules of the SEC, of more than 5% of its common stock.
According to the Schedule 13G or 13G/ A filed by each owner
with the SEC, these shares were acquired in the ordinary course
of business, were not acquired for the purpose of, and do not
have the effect of, change or influence of control over RJR and
were not acquired in connection with, or as a party to, any
transaction having such purpose or effect.

|                                        |                          |                    |            |                        |  |  |      |   | 
|--------------------------------------- | ------------------------ | ------------------ | ---------- | ---------------------- |  |  | ---- | - | 
|                                        |                          | Number of Shares   |            | Percent of Outstanding
|Name and Address of Beneficial Owner    |                          | Beneficially Owned |            | Shares Owned(5)       
|                                        |                          |                    |            |                       
|Capital Research and Management Company |                          |                    | 11,043,270 | (1)                    |  |  | 13.0 | %
|                                        | 333 South Hope Street    |                    |            |                        |  |  |      |   | 
|                                        | Los Angeles, CA 90071    |                    |            |                        |  |  |      |   | 
|INVESCO North American Holdings, Inc.   |                          |                    | 9,352,040  | (2)                    |  |  | 11.0 | %
|                                        | 4350 South Monaco Street |                    |            |                        |  |  |      |   | 
|                                        | Denver, CO 80237         |                    |            |                        |  |  |      |   | 
|INVESCO Asset Management Limited        |                          |                    | 9,352,040  | (3)                    |  |  | 11.0 | %
|                                        | 30 Finsbury Square       |                    |            |                        |  |  |      |   | 
|                                        | London, England EC2A 1AG |                    |            |                        |  |  |      |   | 
|The Investment Company of America       |                          |                    | 4,461,666  | (4)                    |  |  | 5.2  | %
|                                        | 333 South Hope Street    |                    |            |                        |  |  |      |   | 
|                                        | Los Angeles, CA 90071    |                    |            |                        |  |  |      |   | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Capital Research and Management Company, acting
    as investment advisor to various investment companies, held no
    voting power and sole dispositive power over all of these
    shares, as of December 31, 2003, based on a
    Schedule 13G/ A filed jointly by Capital Research and
    Management Company and The Investment Company of America with
    the SEC on February 13, 2004. The Investment Company of
    America also claims beneficial ownership of 4,461,666 of these
    shares.                                                                                                                                                  
|(2) | INVESCO North American Holdings, Inc., a holding
    company many of whose subsidiaries act as investment advisor to
    various investment companies, and an affiliate of INVESCO Assets
    Management Limited, held voting power over 40,150 of these
    shares and shared dispositive power over all of these shares, as
    of December 31, 2003, based on a Schedule 13G filed
    jointly by INVESCO North American Holdings, Inc. and INVESCO
    Asset Management Limited with the SEC on February 17, 2004.
    Both INVESCO North American Holding, Inc. and INVESCO Asset
    Management Limited claim beneficial ownership of these shares.
|(3) | INVESCO Asset Management Limited, an investment
    adviser affiliated with INVESCO North American Holdings, Inc.,
    held shared voting power and shared dispositive power over all
    of these shares, as of December 31, 2003, based on a
    Schedule 13G filed jointly by INVESCO Asset Management
    Limited and INVESCO North American Holdings, Inc. with the SEC
    on February 17, 2004. INVESCO Asset Management Limited and
    INVESCO North American Holdings, Inc. claim beneficial ownership
    of these shares.                                                                                                                    
|(4) | The Investment Company of America, an investment
    company advised by Capital Research and Management Company, held
    sole voting power and no dispositive power over all of these
    shares, as of December 31, 2003, based on a
    Schedule 13G/ A filed jointly by The Investment Company of
    America and Capital Research and Management Company with the SEC
    on February 13, 2004. Capital Research and Management
    Company also claims beneficial ownership of these
    4,461,666 shares.                                                                                                                                         
|(5) | Based on 85,080,693 shares of RJR common stock
    outstanding (exclusive of 31,459,839 shares held in RJRs
    treasury) on February 6, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

156



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##### Table of Contents



Security Ownership of
Management

The following table indicates the number of
shares of RJR common stock beneficially owned as of
February 6, 2004, by each director, each executive officer
named in the Summary Compensation Table, and all directors and
executive officers as a group, based on information provided by
these individuals. In general, beneficial ownership
includes those shares a director or executive officer has the
power to vote, or the power to transfer, and stock options that
are exercisable currently or become exercisable within
60 days. Except as described in the footnotes to the table,
each person has sole investment and voting power over the shares
for which he or she is shown as beneficial owner.

|                                                                                       |  |                    |           |                 |  |  |     |  
|-------------------------------------------------------------------------------------- |  | ------------------ | --------- | --------------- |  |  | --- | -
|                                                                                       |  |                    |           | Percent of     
|                                                                                       |  | Number of Shares   |           | Outstanding    
|Name of Beneficial Owner                                                               |  | Beneficially Owned |           | Shares Owned(1)
|                                                                                       |  |                    |           |                
|Lynn J. Beasley                                                                        |  |                    | 73,845    | (3)             |  |  | *   |  
|Charles A. Blixt                                                                       |  |                    | 56,472    | (3)             |  |  | *   |  
|Richard H. Bogan                                                                       |  |                    | 1,980     | (3)             |  |  | *   |  
|Mary K. Bush                                                                           |  |                    | 4,600     | (2)(4)          |  |  | *   |  
|John T. Chain, Jr.                                                                     |  |                    | 4,399     | (2)(4)          |  |  | *   |  
|A. D. Frazier, Jr.                                                                     |  |                    | 18,557    | (2)(4)          |  |  | *   |  
|E. V. (Rick) Goings                                                                    |  |                    | 10,000    | (2)(4)          |  |  | *   |  
|Denise Ilitch                                                                          |  |                    | 12,800    | (2)(4)          |  |  | *   |  
|James V. Maguire                                                                       |  |                    | 49,056    | (2)(3)          |  |  | *   |  
|Nana Mensah                                                                            |  |                    | 5,450     | (2)(4)          |  |  | *   |  
|Robert S. Miller, Jr.                                                                  |  |                    | 11,000    | (2)(4)          |  |  | *   |  
|Dianne M. Neal                                                                         |  |                    | 32,059    | (2)(3)          |  |  | *   |  
|Andrew J. Schindler                                                                    |  |                    | 563,138   | (2)(3)          |  |  | *   |  
|Joseph P. Viviano                                                                      |  |                    | 11,400    | (2)(4)          |  |  | *   |  
|Thomas C. Wajnert                                                                      |  |                    | 21,400    | (2)(4)          |  |  | *   |  
|All directors and executive officers, including
    Mr. Bogan, as a group (21 persons) |  |                    | 1,044,612 | (2)(3)(4)       |  |  | 1.2 | %



---



|  |              
|- | -------------
|* | Less than 1%.



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | For purposes of computing the percentage of
    outstanding shares held by each person named in the table, any
    security that such person has the right to acquire within
    60 days is deemed to be held by such person, but is not
    deemed to be outstanding for the purpose of computing the
    percentage ownership of any other person.                                                                                                                                                                                                                                                                                                                                                                                                    
|(2) | The number of shares beneficially owned includes
    shares of RJR common stock not currently owned, but issuable
    upon exercise of stock options that are exercisable as of
    February 6, 2004, or become exercisable within 60 days
    thereafter, in the following amounts: (a) 3,600 shares for
    Ms. Bush; (b) 1,400 shares for each of General Chain
    and Mr. Mensah; (c) 11,400 shares for each of
    Ms. Ilitch and Messrs. Frazier and Wajnert; (d) 10,000
    shares for Messrs. Goings and Miller; (e) 8,279 shares
    for Mr. Maguire; (f) 12,000 for Ms. Neal;
    (g) 380,997 shares for Mr. Schindler; (h) 6,400
    shares for Mr. Viviano; and (i) 532,002 shares
    for all directors and executive officers as a group.
|(3) | The number of shares beneficially owned includes
    shares of RJR common stock granted under the R.J. Reynolds
    Tobacco Holdings, Inc. 1999 Long Term Incentive Plan that remain
    subject to certain restrictions as to continued employment and
    transfer as provided in the 1999 LTIP, in the following amounts:
    (a) 49,547 shares for Ms. Beasley; (b) 38,496
    shares for Mr. Blixt; (c) 25,354 shares for
    Mr. Maguire; (d) 17,406 shares for Ms. Neal;
    (e) 99,712 shares for Mr. Schindler; and
    (f) 305,704 shares for all directors and executive officers
    as a group.                                                                                                                                            
|(4) | The number of shares beneficially owned does not
    include the following deferred common stock units, which are RJR
    common stock equivalents received as equity incentives by the
    directors under the EIAP or credited to the directors under the
    Deferred Compensation Plan for Directors of RJR: (a) 9,090
    units for Ms. Bush; (b) 8,815 units for
    Mr. Frazier; (c) 3,804 units for Mr. Goings;
    (d) 10,157 units for each of Ms. Ilitch, General Chain
    and Mr. Wajnert; (e) 7,919 units for Mr. Mensah;
    (f) 1,490 units for Mr. Miller; and (g) 18,046
    units for Mr. Viviano.                                                                                                                                   

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Item 13. Certain Relationships and
Related Transactions

None.




Item 14. Principal Accounting Fees
and Services

Audit Committees Audit and Non-Audit
Services Pre-Approval Policy

Prior to April 29, 2003, the Audit
Committees policy was to pre-approve all non-audit
services performed by the independent auditors in excess of
$100,000. For non-audit services below this threshold,
management was required to consider the potential impact of
providing such services on the independent auditors
independence.

The Audit Committees current policy is to
pre-approve all audit and non-audit services performed by the
independent auditors to assure that the provision of these
services does not impair the independent auditors
independence. This policy is set forth in the Audit
Committees Audit and Non-Audit Services Pre-Approval
Policy, which was adopted by the Committee on April 29,
2003. The Audit and Non-Audit Services Pre-Approval Policy
describes the procedures and conditions pursuant to which
services proposed to be performed by the independent auditor may
be pre-approved by the Audit Committee, or its Chair pursuant to
delegated authority. The Policy provides that the Chair of the
Audit Committee may make pre-approval decisions for proposed
services that are not covered by specific reference in the
Policy and have not been previously pre-approved by the full
Committee. Under the Policy, the Chair is required to report any
such pre-approval decisions to the full Committee at its next
scheduled meeting.

The Audit Committee was in compliance with the
requirements of the Sarbanes-Oxley Act of 2002 regarding the
pre-approval of all audit and non-audit fees by the mandated
effective date of May 6, 2003. A copy of the Audit
Committees Audit and Non-Audit Services Pre-Approval
Policy is included as Exhibit 99.2 to this report and also
can be found in the Inside RJRTH section of the
www.RJRHoldings.com web site, under Corporate
Governance, or can be requested free of charge, by writing
to the Office of the Secretary, R. J. Reynolds Tobacco
Holdings, Inc., P.O. Box 2866, Winston-Salem, North
Carolina 27102-2866.

Fees of Independent Auditors

The following table shows the aggregate fees
billed to the Company by KPMG LLP for services rendered during
each of the fiscal years ended December 31, 2003 and 2002:

|                   |            |                |           |           |  |   |           |           | 
|------------------ | ---------- | -------------- | --------- | --------- |  | - | --------- | --------- | 
|                   |            |               
|                   |            | Amount of Fees
|                   |            |               
|                   |            | 2003           |           | 2002     
|                   |            |                |           |          
|Audit Fees         |            | $              | 2,615,022 |           |  | $ | 2,003,139 |          
|Audit-Related Fees |            |                | 957,415   |           |  |   | 228,500   |          
|Tax Fees           |            |                | 139,987   |           |  |   | 494,130   |          
|All Other Fees     |            |                |          |           |  |   | 83,649    |          
|                   |            |                |           |           |  |   |           |          
|                   | Total Fees |                | $         | 3,712,424 |  |   | $         | 2,809,418 | 

Audit Fees

Audit fees principally constitute fees billed for
professional services rendered by KPMG LLP for the audit of
RJRs financial statements for each of the fiscal years
ended December 31, 2003 and 2002, and the reviews of the
condensed financial statements included in RJRs Quarterly
Reports on Form 10-Q filed during the fiscal years ended
December 31, 2003 and 2002.

Audit-Related Fees

Audit-related fees constitute fees billed for
assurance and related services rendered by KPMG LLP that are
reasonably related to the performance of the audit or review of
RJRs financial statements, other than the services
reported above under Audit Fees, in each of the
fiscal years ended December 31, 2003 and 2002. In 2003,
audit-related fees principally consisted of fees for due
diligence assistance pertaining to acquisitions,

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assistance with compliance with Section 404
of the Sarbanes-Oxley Act of 2002, forensic audit assistance,
audits of the financial statements of certain employee benefits
and audits of certain subsidiaries of RJR. In 2002,
audit-related fees consisted principally of fees for audits of
the financial statements of certain employee benefits and audits
of certain subsidiaries of RJR. The Audit Committee pre-approved
94% of the audit-related fees in 2003, and 63% of the
audit-related fees in 2002. The Audit Committee pre-approved
100% of the audit-related fees subsequent to April 29, 2003.


Tax Fees

Tax fees constitute fees billed for professional
services rendered by KPMG for tax compliance, tax consulting and
tax planning in each of the fiscal years ended December 31,
2003 and 2002. In 2003, tax fees consisted principally of
assistance with tax audits related to the formerly disposed of
international business, tax compliance advice and miscellaneous
general tax consultations. In 2002, tax fees consisted
principally of fees for assistance with calculating LIFO
inventory for tax return purposes only, advice in connection
with establishing an international joint venture, identification
of state tax credit opportunities at Santa Fe Natural Tobacco
Company, Inc. for the periods prior to its acquisition,
assistance with tax audits related to the formerly disposed of
international business, tax compliance advice and miscellaneous
general tax consultations. The Audit Committee pre-approved 85%
of the tax fees in 2003, and 87% of the tax fees in 2002. The
Audit Committee pre-approved 100% of the tax fees subsequent to
April 29, 2003.

All Other Fees

All other fees constitute the aggregate fees
billed for products and services, other than the services
reported above under Audit Fees, Audit-Related
Fees and Tax Fees, provided by KPMG LLP in
each of the fiscal years ended December 31, 2003 and 2002.
In 2003, there were no other fees billed by KPMG LLP. In 2002,
all other fees consisted principally of fees for litigation
support assistance. The Audit Committee did not pre-approve any
of the all other fees in 2002.




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, 2003, 2002 and 2001.



| |  |                                                                                                                                       
| |  | --------------------------------------------------------------------------------------------------------------------------------------
| |  | Consolidated Statements of Cash Flows for the
    years ended December 31, 2003, 2002 and 2001.                                       
|
| |  | Consolidated Balance Sheets as of
    December 31, 2003 and 2002.                                                                     
|
| |  | Consolidated Statements of Stockholders
    Equity and Comprehensive Income for the years ended
    December 31, 2003, 2002 and 2001.



| |     |                                                                                                                                                                          
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (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 furnished a Current Report on Form 8-K,
    dated October 28, 2003, announcing earnings for the three
    months ended September 30, 2003.



| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | RJR filed a Current Report on Form 8-K,
    dated October 30, 2003, announcing a business combination
    agreement with Brown & Williamson Tobacco Corporation
    to combine the assets and operations of their respective U.S.
    tobacco businesses. In addition, RJR announced a stock purchase
    agreement with American Cigarette Company (Overseas) BV,
    Cigarette Manufacturers Supplies Inc. and Brown & Williamson
    Tobacco Corporation to acquire Lane Limited.

159



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| |     |                                                                                                                                                                   
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (c) | The following exhibits are filed as part of this
    report, Exhibit Numbers 10.27 through 10.72 are management
    contracts, compensatory plans or arrangements:

|        |   |    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------- | - | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |   |   
|Number  |   |   
|        |   |   
|        | 2 | .1 |  | Business Combination Agreement dated as of
    October 27, 2003, by and between R.J. Reynolds Tobacco
    Holdings, Inc. and Brown & Williamson Tobacco
    Corporation (incorporated by reference to Exhibit 99.2 to
    Registrants Form 8-K dated October 29, 2003).                                                                                                                                                                                                                      
|        | 2 | .2 |  | Amendment No. 1, dated as of January 9,
    2004, to Business Combination Agreement dated as of
    October 27, 2003, by and between R.J. Reynolds Tobacco
    Holdings, Inc. and Brown & Williamson Tobacco
    Corporation.                                                                                                                                                                                                                                                                 
|        | 2 | .3 |  | Lane Stock Purchase Agreement dated as of
    October 27, 2003, by and among R.J. Reynolds Tobacco
    Holdings, Inc., American Cigarette Company Overseas B.V.,
    Cigarette Manufacturers Supplies Inc. and Brown &
    Williamson Tobacco Corporation (incorporated by reference to
    Exhibit 99.3 to Registrants Form 8-K dated
    October 29, 2003).                                                                                                                                
|        | 2 | .4 |  | Amendment No. 1, dated as of January 9,
    2004, to Lane Stock Purchase Agreement dated as of
    October 27, 2003, by and among R.J. Reynolds Tobacco
    Holdings, Inc., American Cigarette Company Overseas B.V.,
    Cigarette Manufacturers Supplies Inc. and Brown &
    Williamson Tobacco Corporation.                                                                                                                                                                               
|        | 3 | .1 |  | Restated Certificate of Incorporation of
    R.J. Reynolds Tobacco Holdings, Inc. (incorporated by
    reference to Exhibit 3.1 to Registrants Form 8-K
    dated June 14, 1999).                                                                                                                                                                                                                                                                                                            
|        | 3 | .2 |  | Bylaws of R.J. Reynolds Tobacco Holdings,
    Inc., as amended and restated effective April 25, 2001
    (incorporated by reference to Exhibit 4.2 to
    Registrants Registration Statement on Form S-8 filed
    April 27, 2001).                                                                                                                                                                                                                                                          
|        | 4 | .1 |  | Rights Agreement dated as of May 18, 1999,
    between R.J. Reynolds Tobacco Holdings, Inc. and its rights
    agent (incorporated by reference to Exhibit 4.1 to
    Registrants Form 8-K dated June 14, 1999).                                                                                                                                                                                                                                                                             
|        | 4 | .2 |  | Amendment No. 1, dated as of August 9,
    2002, to the Rights Agreement dated as of May 17, 1999,
    between R.J. Reynolds Tobacco Holdings, Inc. and The Bank
    of New York, as rights agent (incorporated by reference to
    Exhibit 4.1 to Registrants Form 8-A/ A filed
    August 19, 2002).                                                                                                                                                                                       
|        | 4 | .3 |  | Amendment No. 2, dated as of
    December 18, 2002, to the Rights Agreement dated as of
    May 17, 1999, between R.J. Reynolds Tobacco Holdings,
    Inc. and The Bank of New York, as rights agent (incorporated by
    reference to Exhibit 4.1 to Registrants
    Form 8-A/ A filed December 20, 2002).                                                                                                                                                                                  
|        | 4 | .4 |  | Amendment No. 3, dated as of
    October 27, 2003, to the Rights Agreement, dated as of
    May 17, 1999, between R.J. Reynolds Tobacco Holdings,
    Inc. and The Bank of New York, as rights agent (incorporated by
    reference to Exhibit 4.1 to Registrants
    Form 8-A/ A filed October 28, 2003).                                                                                                                                                                                   
|        | 4 | .5 |  | Amended and Restated Indenture dated as of
    July 24, 1995, between RJR Nabisco, Inc. and The Bank
    of New York (incorporated by reference to Exhibit 4.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1995, filed August 8, 1995).                                                                                                                                                                                                              
|        | 4 | .6 |  | First Supplemental Indenture and Waiver dated as
    of April 27, 1999, between RJR Nabisco, Inc. and The
    Bank of New York, to the Amended and Restated Indenture dated as
    of July 24, 1995, between RJR Nabisco, Inc. and The Bank of
    New York, as successor trustee (incorporated by reference to
    Exhibit 10.3 to Registrants Form 8-A filed
    May 19, 1999).                                                                                                            
|        | 4 | .7 |  | Second Supplemental Indenture and Waiver dated as
    of April 27, 1999, between RJR Nabisco, Inc. and The
    Bank of New York, to the Amended and Restated Indenture dated as
    of May 18, 1992, between RJR Nabisco, Inc. and The
    Bank of New York, as successor trustee, as amended by the Form
    of First Supplemental Indenture and Waiver thereto dated as of
    June 2, 1995 (incorporated by reference to
    Exhibit 10.4 to Registrants Form 8-A filed
    May 19, 1999).
|        | 4 | .8 |  | Indenture dated as of May 15, 1999, among
    RJR Nabisco, Inc., R.J. Reynolds Tobacco Company and
    The Bank of New York, as trustee (incorporated by reference to
    Exhibit 10.2 to Registrants Form 8-A filed
    May 19, 1999).                                                                                                                                                                                                                                                      

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|        |    |     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|------- | -- | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |    
|Number  |    |    
|        |    |    
|        | 4  | .9  |  | First Supplemental Indenture dated as of
    December 12, 2000, among RJR Acquisition Corp.,
    R.J. Reynolds Tobacco Holdings, Inc., R.J. Reynolds
    Tobacco Company and The Bank of New York, as Trustee, to the
    Indenture dated as of May 15, 1999, among RJR Nabisco,
    Inc., R.J. Reynolds Tobacco Company and The Bank of New
    York, as Trustee (incorporated by reference to Exhibit 4.6
    to Registrants Annual Report on Form 10-K for the
    year ended December 31, 2000, filed March 1, 2001).                                                                                                                                                                           
|        | 4  | .10 |  | Second Supplemental Indenture dated as of
    June 30, 2003, among GMB, Inc., FSH, Inc.,
    R.J. Reynolds Tobacco Co., Santa Fe Natural Tobacco
    Company, Inc., RJR Packaging, LLC, R.J. Reynolds
    Tobacco Holdings, Inc., R.J. Reynolds Tobacco Company, RJR
    Acquisition Corp. and The Bank of New York, as Trustee, to the
    Indenture dated May 15, 1999, among RJR Nabisco, Inc.,
    R.J. Reynolds Tobacco Company and The Bank of New York, as
    Trustee (incorporated by reference to Exhibit 4.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2003, filed August 8, 2003).                                                            
|        | 4  | .11 |  | Form of Note for the 6 1/2% Note due 2007
    (incorporated by reference to Exhibit 4.1 to
    Registrants Form 8-K dated May 15, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|        | 4  | .12 |  | Form of Note for the 7 1/4% Note due 2012
    (incorporated by reference to Exhibit 4.2 to
    Registrants Form 8-K dated May 15, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|        | 4  | .13 |  | Indenture dated as of May 20, 2002, by and
    among R.J. Reynolds Tobacco Holdings, Inc.,
    R.J. Reynolds Tobacco Company, RJR Acquisition Corp.
    and The Bank of New York (incorporated by reference to
    Exhibit 4.3 to Registrants Form 8-K dated
    May 15, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                     
|        | 4  | .14 |  | First Supplemental Indenture dated as of
    June 30, 2003, among GMB, Inc., FSH, Inc.,
    R.J. Reynolds Tobacco Co., Santa Fe Natural Tobacco
    Company, Inc., RJR Packaging, LLC, R.J. Reynolds
    Tobacco Holdings, Inc., R.J. Reynolds Tobacco Company, RJR
    Acquisition Corp. and The Bank of New York, as Trustee, to the
    Indenture dated as of May 20, 2002, among
    R.J. Reynolds Tobacco Holdings, Inc., R.J. Reynolds
    Tobacco Company, RJR Acquisition Corp. and The Bank of New York,
    as Trustee (incorporated by reference to Exhibit 4.2 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2003, filed August 8, 2003).         
|        | 10 | .1  |  | Second Amended and Restated Credit Agreement
    dated as of May 10, 2002, among R.J. Reynolds Tobacco
    Holdings, Inc. and the lending institutions listed and to be
    listed from time to time on Annex I thereto (incorporated
    as Exhibit 10.1 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2002, filed
    August 1, 2002).                                                                                                                                                                                                                                                                                                                          
|        | 10 | .2  |  | First Amendment to the Credit Agreement dated as
    of January 17, 2003, among R.J. Reynolds Tobacco
    Holdings, Inc. and lending institutions party to the Credit
    Agreement (incorporated by reference to Exhibit 10.2 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2002, filed March 3, 2003).                                                                                                                                                                                                                                                                                                                                                        
|        | 10 | .3  |  | Second Amendment to the Credit Agreement dated as
    of September 25, 2003, among R.J. Reynolds Tobacco
    Holdings, Inc. and lending institutions party to the Credit
    Agreement (incorporated by reference to Exhibit 10.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2003, filed November 7,
    2003).                                                                                                                                                                                                                                                                                                                                       
|        | 10 | .4  |  | Third Amended and Restated Subsidiary Guaranty by
    R.J. Reynolds Tobacco Company and RJR Acquisition Corp. to
    the creditors defined therein, issued in connection with the
    Credit Agreement dated as of May 18, 1999 and amended and
    restated as of November 17, 2000 and further amended as of
    May 10, 2002, among R.J. Reynolds Tobacco Holdings,
    Inc. and the lending institutions listed and to be listed from
    time to time on Annex I thereto (incorporated by reference
    to Exhibit 10.3 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2002, filed
    March 3, 2003).                                                          
|        | 10 | .5  |  | Subsidiary Assumption Agreement dated as of
    June 30, 2003, made by GMB, Inc., FSH, Inc.,
    R.J. Reynolds Tobacco Co., Santa Fe Natural Tobacco
    Company, Inc. and RJR Packaging LLC, issued in connection with
    the Credit Agreement dated as of May 18, 1999 and amended
    and restated as of November 17, 2000 and further amended
    and restated as of May 10, 2002, among R.J. Reynolds
    Tobacco Holdings, Inc. and the lending institutions listed and
    to be listed from time to time on Annex I thereto (incorporated
    by reference to Exhibit 10.1 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2003, filed August 8, 2003).

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|        |    |     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------- | -- | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |    
|Number  |    |    
|        |    |    
|        | 10 | .6  |  | Security Agreement dated as of July 15,
    2003, among R.J. Reynolds Tobacco Holdings, Inc., various
    subsidiaries of R.J. Reynolds Tobacco Holdings, Inc. and
    JPMorgan Chase Bank, as Collateral Agent (incorporated by
    reference to Exhibit 10.2 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2003, filed August 8, 2003).                                                                                                                                                               
|        | 10 | .7  |  | Pledge Agreement dated as of July 15, 2003,
    among R.J. Reynolds Tobacco Holdings, Inc., various
    subsidiaries of R.J. Reynolds Tobacco Holdings, Inc. and
    JPMorgan Chase Bank, as Collateral Agent (incorporated by
    reference to Exhibit 10.3 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2003, filed August 8, 2003).                                                                                                                                                                 
|        | 10 | .8  |  | Deed of Trust, Security Agreement, Assignment of
    Leases, Rents and Profits, Financing Statement and Fixture
    Filing (Davie County) made by R.J. Reynolds Tobacco
    Company, as the Trustor, to The Fidelity Company, as Trustee,
    and JPMorgan Chase Bank, as Administrative Agent and Collateral
    Agent for various lending institutions, as the Beneficiary
    (incorporated by reference to Exhibit 10.4 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2003, filed August 8, 2003).  
|        | 10 | .9  |  | Deed of Trust, Security Agreement, Assignment of
    Leases, Rents and Profits, Financing Statement and Fixture
    Filing (Forsyth County) made by R.J. Reynolds Tobacco
    Company, as the Trustor, to The Fidelity Company, as Trustee,
    and JPMorgan Chase Bank, as Administrative Agent and Collateral
    Agent for various lending institutions, as the Beneficiary
    (incorporated by reference to Exhibit 10.5 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2003, filed August 8, 2003).
|        | 10 | .10 |  | Deed of Trust, Security Agreement, Assignment of
    Leases, Rents and Profits, Financing Statement and Fixture
    Filing (Stokes County) made by R.J. Reynolds Tobacco
    Company, as the Trustor, to The Fidelity Company, as Trustee,
    and JPMorgan Chase Bank, as Administrative Agent and Collateral
    Agent for various lending institutions, as the Beneficiary
    (incorporated by reference to Exhibit 10.6 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2003, filed August 8, 2003). 
|        | 10 | .11 |  | Guarantee dated as of May 18, 1999, by
    R.J. Reynolds Tobacco Company to the holders and to The
    Bank of New York, as trustee, issued in connection with the
    Indenture dated as of May 15, 1999, among RJR Nabisco,
    Inc., R.J. Reynolds Tobacco Company and The Bank of New
    York, as trustee (incorporated by reference to Exhibit 10.6
    to Registrants Form 8-A filed May 19, 1999).                                                                                                                                    
|        | 10 | .12 |  | Purchase Agreement dated as of March 9,
    1999, as amended and restated as of May 11, 1999, among
    R.J. Reynolds Tobacco Company, RJR Nabisco, Inc. and Japan
    Tobacco Inc. (incorporated by reference to Exhibit 2.1 to
    Registrants Form 8-K dated May 12, 1999).                                                                                                                                                                                                                                                                
|        | 10 | .13 |  | Tax Sharing Agreement dated as of June 14,
    1999, among RJR Nabisco Holdings Corp., R.J. Reynolds
    Tobacco Holdings, Inc., R.J. Reynolds Tobacco Company and
    Nabisco Holdings Corp. (incorporated by reference to
    Exhibit 10.1 to Registrants Form 8-K dated
    June 14, 1999).                                                                                                                                                                                                                                                
|        | 10 | .14 |  | Amendment to Tax Sharing Agreement dated
    June 25, 2000, among Nabisco Group Holdings Corp.,
    R.J. Reynolds Tobacco Holdings, Inc., Nabisco Holdings
    Corp. and R.J. Reynolds Tobacco Company (incorporated by
    reference to Exhibit 10.2 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2000, filed August 7, 2000).                                                                                                                                                                        
|        | 10 | .15 |  | Agreement dated as of May 20, 1999, among
    Pension Benefit Guaranty Corporation, RJR Nabisco Holdings Corp.
    and R.J. Reynolds Tobacco Company (incorporated by
    reference to Exhibit 10.16 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    1999, filed August 16, 1999).                                                                                                                                                                                                                        
|        | 10 | .16 |  | Amendment effective as of June 14, 1999, to
    the Agreement effective as of May 20, 1999, by and among
    the Pension Benefit Guaranty Corporation, R.J. Reynolds
    Tobacco Holdings, Inc. and R.J. Reynolds Tobacco Company
    (incorporated by reference to Exhibit 10.3 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2000, filed August 7, 2000).                                                                                                                                             
|        | 10 | .17 |  | Second Amendment effective as of January 7,
    2002, to the Agreement effective as of May 20, 1999, by and
    among the Pension Benefit Guaranty Corporation,
    R.J. Reynolds Tobacco Holdings, Inc. and R.J. Reynolds
    Tobacco Company (incorporated by reference to Exhibit 10.9
    to Registrants Annual Report on Form 10-K for the
    year ended December 31, 2001, filed February 28, 2002).                                                                                                                                   

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|        |    |     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|------- | -- | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |    
|Number  |    |    
|        |    |    
|        | 10 | .18 |  | Settlement Agreement dated August 25, 1997,
    between the State of Florida and settling defendants in The
    State of Florida v. American Tobacco Co. (incorporated by
    reference to Exhibit 2 to Registrants Form 8-K
    dated August 25, 1997).                                                                                                                                                                                                              
|        | 10 | .19 |  | Comprehensive Settlement Agreement and Release
    dated January 16, 1998, between the State of Texas and
    settling defendants in The State of Texas v. American
    Tobacco Co. (incorporated by reference to Exhibit 2 to
    Registrants Form 8-K dated January 16, 1998).                                                                                                                                                                                      
|        | 10 | .20 |  | Settlement Agreement and Release in re: The State
    of Minnesota v. Philip Morris, Inc., by and among the State
    of Minnesota, Blue Cross and Blue Shield of Minnesota and the
    various tobacco company defendants named therein, dated as of
    May 8, 1998 (incorporated by reference to Exhibit 99.1
    to Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 30, 1998, filed May 15, 1998).                                      
|        | 10 | .21 |  | Settlement Agreement and Stipulation for Entry of
    Consent Judgment in re: The State of Minnesota v. Philip
    Morris, Inc., by and among the State of Minnesota, Blue Cross
    and Blue Shield of Minnesota and the various tobacco company
    defendants named therein, dated as of May 8, 1998
    (incorporated by reference to Exhibit 99.2 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 30, 1998, filed May 15, 1998).
|        | 10 | .22 |  | Form of Consent Judgment by Judge Kenneth J.
    Fitzpatrick, Judge of District Court in re: The State of
    Minnesota v. Philip Morris, Inc. (incorporated by reference
    to Exhibit 99.3 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended March 30, 1998, filed
    May 15, 1998).                                                                                                                                                         
|        | 10 | .23 |  | Stipulation of Amendment to Settlement Agreement
    and for Entry of Agreed Order dated July 2, 1998, by and
    among the Mississippi Defendants, Mississippi and the
    Mississippi Counsel in connection with the Mississippi Action
    (incorporated by reference to Exhibit 99.2 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1998, filed August 14, 1998).                                                            
|        | 10 | .24 |  | Stipulation of Amendment to Settlement Agreement
    and for Entry of Consent Decree dated July 24, 1998, by and
    among the Texas Defendants, Texas and the Texas Counsel in
    connection with the Texas Action (incorporated by reference to
    Exhibit 99.4 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1998, filed
    August 14, 1998).                                                                                 
|        | 10 | .25 |  | Stipulation of Amendment to Settlement Agreement
    and for Entry of Consent Decree dated September 11, 1998,
    by and among the State of Florida and the tobacco companies
    named therein (incorporated by reference to Exhibit 99.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 1998, filed November 12,
    1998).                                                                                              
|        | 10 | .26 |  | Master Settlement Agreement (the MSA)
    dated November 23, 1998, between the Settling States named
    in the MSA and the Participating Manufacturers also named
    therein (incorporated by reference to Exhibit 4 to
    Registrants Form 8-K dated November 23, 1998).                                                                                                                                                                                        
|        | 10 | .27 |  | Amended and Restated Equity Incentive Award Plan
    for Directors of R.J. Reynolds Tobacco Holdings, Inc. and
    Subsidiaries (the EIAP) (incorporated by reference
    to Exhibit 10.1 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended March 31, 2000, filed
    May 9, 2000).                                                                                                                                                            
|        | 10 | .28 |  | Form of Deferred Stock Unit Agreement between
    R.J. Reynolds Tobacco Holdings, Inc. and the Director named
    therein, pursuant to the EIAP (incorporated by reference to
    Exhibit 10.9 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1999, filed
    August 16, 1999).                                                                                                                                                      
|        | 10 | .29 |  | Form of Stock Option Agreement (Initial) between
    R.J. Reynolds Tobacco Holdings, Inc. and the Director named
    therein, pursuant to the EIAP (incorporated by reference to
    Exhibit 10.10 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1999, filed
    August 16, 1999).                                                                                                                                                  
|        | 10 | .30 |  | Form of Stock Option Agreement (Annual) between
    R.J. Reynolds Tobacco Holdings, Inc. and the Director named
    therein, pursuant to the EIAP, dated as of June 15, 1999
    (incorporated by reference to Exhibit 10.11 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1999, filed August 16, 1999).                                                                                                                        

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|        |    |     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|------- | -- | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |    
|Number  |    |    
|        |    |    
|        | 10 | .31 |  | Deferred Compensation Plan for Directors between
    R.J. Reynolds Tobacco Holdings, Inc. (Effective
    June 14, 1999) (incorporated by reference to
    Exhibit 10.12 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1999, filed
    August 16, 1999).                                                                                                                                                                      
|        | 10 | .32 |  | R.J. Reynolds Tobacco Holdings, Inc. 1999
    Long Term Incentive Plan (incorporated by reference to
    Exhibit 10.2 to Registrants Form 8-K dated
    June 15, 1999).                                                                                                                                                                                                                                                                                        
|        | 10 | .33 |  | Amendments to the R.J. Reynolds Tobacco
    Holdings, Inc. 1999 Long Term Incentive Plan dated
    December 5, 2001 (incorporated by reference to
    Exhibit 10.26 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2001, filed
    February 28, 2002).                                                                                                                                                                          
|        | 10 | .34 |  | Amendment No. 2 to R.J. Reynolds
    Tobacco Holdings, Inc. 1999 Long Term Incentive Plan dated
    December 10, 2002 (incorporated by reference to
    Exhibit 10.27 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2002, filed
    March 3, 2003).                                                                                                                                                                            
|        | 10 | .35 |  | Form of 1999 Performance Appreciation Rights
    Agreement under R.J. Reynolds Tobacco Holdings, Inc. 1999
    Long Term Incentive Plan between R.J. Reynolds Tobacco
    Holdings, Inc. and the grantee named therein (incorporated by
    reference to Exhibit 10.1 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended
    September 30, 1999, filed November 12, 1999).                                                                 
|        | 10 | .36 |  | Form of Tandem Restricted Stock/ Stock Option
    Agreement dated June 15, 1999, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.2 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 1999, filed November 12,
    1999).                                                                                                                    
|        | 10 | .37 |  | Form of Tandem Restricted Stock/ Stock Option
    Agreement dated June 15, 1999, between R.J. Reynolds
    Tobacco Holdings, Inc. and Andrew J. Schindler (incorporated by
    reference to Exhibit 10.3 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended
    September 30, 1999, filed November 12, 1999).                                                                                                                              
|        | 10 | .38 |  | Amendment No. 1 to Tandem Restricted Stock/
    Stock Option Agreement Dated June 15, 1999, dated
    December 5, 2001 (incorporated by reference to
    Exhibit 10.30 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2001, filed
    February 28, 2002).                                                                                                                                                                       
|        | 10 | .39 |  | Form of Tandem Restricted Stock/ Stock Option
    Agreement dated July 28, 1999, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.4 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 1999, filed November 12,
    1999).                                                                                                                    
|        | 10 | .40 |  | Amendment No. 1 to Tandem Restricted Stock/
    Stock Option Agreement Dated July 28, 1999, dated
    December 5, 2001 (incorporated by reference to
    Exhibit 10.32 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2001, filed
    February 28, 2002).                                                                                                                                                                       
|        | 10 | .41 |  | Form of Amendment No. 2 to Tandem Restricted
    Stock/ Stock Option Agreement dated as of April 24, 2002,
    amending the Tandem Restricted Stock/ Stock Option Agreements
    dated June 15 and July 28, 1999, between
    R.J. Reynolds Tobacco Holdings, Inc. and the grantee named
    therein (incorporated by reference to Exhibit 10.3 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2002, filed August 6, 2002)
|        | 10 | .42 |  | Amendment No. 3 to Tandem Restricted Stock/
    Stock Option Agreements dated December 10, 2002, amending
    the Tandem Restricted Stock/ Stock Option Agreements dated
    June 15 and July 28, 1999 (incorporated by reference
    to Exhibit 10.35 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2002, filed
    March 3, 2003).                                                                                           
|        | 10 | .43 |  | Form of Restricted Stock Agreement dated
    January 31, 2001, between R.J. Reynolds Tobacco
    Holdings, Inc. and the grantee named therein (incorporated by
    reference to Exhibit 10.36 to Registrants Annual
    Report on Form 10-K for the year ended December 31,
    2000, filed March 1, 2001).                                                                                                                                                    
|        | 10 | .44 |  | Form of Performance Unit Agreement (three-year
    vesting) dated January 31, 2001, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.38 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2000, filed March 1, 2001).                                                                                                                               

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|        |    |     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|------- | -- | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |    
|Number  |    |    
|        |    |    
|        | 10 | .45 |  | Amendment No. 1 to Performance Unit
    Agreements dated December 5, 2001, amending the Performance
    Unit agreements dated February 2, 2000 and January 31,
    2001, between R.J. Reynolds Tobacco Holdings, Inc. and the
    grantee named therein (incorporated by reference to
    Exhibit 10.37 to Registrants Annual Report on
    Form 10-K for the year ended December 31, 2001, filed
    February 28, 2002).                          
|        | 10 | .46 |  | Form of Restricted Stock Agreement dated
    July 26, 2002, between R.J. Reynolds Tobacco Holdings,
    Inc. and the grantee named therein (incorporated by reference to
    Exhibit 10.5 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2002, filed
    August 6, 2002).                                                                                                                                         
|        | 10 | .47 |  | Form of Performance Unit Agreement (three-year
    vesting) dated July 26, 2002, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.4 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2002, filed August 6, 2002).                                                                                                                    
|        | 10 | .48 |  | Form of Amendment No. 1 to Restricted Stock
    Agreements dated as of December 10, 2002, amending the
    Restricted Stock Agreements dated February 2, 2000,
    January 31, 2001 and July 26, 2002, between
    R.J. Reynolds Tobacco Holdings, Inc. and the grantee named
    therein (incorporated by reference to Exhibit 10.43 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2002, filed March 3, 2003).
|        | 10 | .49 |  | Form of Performance Unit Agreement (one-year
    vesting) dated February 5, 2003, between R.J. Reynolds
    Holdings, Inc. and the grantee named therein (incorporated by
    reference to Exhibit 10.45 to Registrants Annual
    Report on Form 10-K for the year ended December 31,
    2002, filed March 3, 2003).                                                                                                                             
|        | 10 | .50 |  | Form of Restricted Stock Agreement dated
    July 31, 2003, between R.J. Reynolds Tobacco Holdings,
    Inc. and the grantee named therein (incorporated by reference to
    Exhibit 10.3 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 2003,
    filed November 7, 2003).                                                                                                                                  
|        | 10 | .51 |  | Form of Performance Unit Agreement (three-year
    vesting) dated July 31, 2003, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein
    (incorporated by reference to Exhibit 10.2 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2003, filed November 7,
    2003).                                                                                                         
|        | 10 | .52 |  | Form of Performance Unit Agreement (one-year
    vesting) dated February 4, 2004, between R.J. Reynolds
    Tobacco Holdings, Inc. and the grantee named therein.                                                                                                                                                                                                                                                                                   
|        | 10 | .53 |  | R.J. Reynolds Tobacco Holdings, Inc. Annual
    Incentive Award Plan, Effective January 1, 1987 and Amended
    and Restated Effective January 1, 2002 (incorporated by
    reference to Exhibit 10.38 to Registrants Annual
    Report on Form 10-K for the year ended December 31,
    2001, filed February 28, 2002).                                                                                                                           
|        | 10 | .54 |  | Amendment No. 1 dated June 4, 2003, to
    R.J. Reynolds Tobacco Holdings, Inc. Annual Incentive Award
    Plan, Effective January 1, 1987 and Amended and Restated
    Effective January 1, 2002.                                                                                                                                                                                                                                                  
|        | 10 | .55 |  | Excess Benefit Master Trust Agreement, as amended
    and restated as of October 12, 1988, by and between RJR
    Nabisco, Inc. and Wachovia Bank and Trust Company, N.A.
    (incorporated by reference to Exhibit 10.21 to
    Registrants Registration Statement on Form S-4 of RJR
    Holdings Corp. and RJR Holdings Group, Inc., Registration
    No. 33-27894, filed April 5, 1989, as amended).                                           
|        | 10 | .56 |  | Amendment No. 1 to Excess Benefit Master
    Trust Agreement, dated January 27, 1989, by and between RJR
    Nabisco, Inc. and Wachovia Bank and Trust Company, N.A.
    (incorporated by reference to Exhibit 10(h)(ii) to
    Registrants Annual Report on Form 10-K for the fiscal
    year ended December 31, 1988, filed March 9, 1989).                                                                                                      
|        | 10 | .57 |  | Second Amendment to Excess Benefit Master Trust
    Agreement, dated as of October 3, 2003, by and between
    R.J. Reynolds Tobacco Company, as successor to RJR Nabisco,
    Inc., and Wachovia Bank, N.A.                                                                                                                                                                                                                                        
|        | 10 | .58 |  | R.J. Reynolds Supplemental Executive
    Retirement Plan, as amended and restated on January 1, 2004.                                                                                                                                                                                                                                                                                                                                               
|        | 10 | .59 |  | Retention Trust Agreement dated May 13,
    1998, by and between RJR Nabisco, Inc. and Wachovia Bank, N.A.
    (incorporated by reference to Registrants Quarterly Report
    on Form 10-Q for the quarter ended June 30, 1998,
    filed August 14, 1998).                                                                                                                                                                                        

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|        |    |     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|------- | -- | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |    
|Number  |    |    
|        |    |    
|        | 10 | .60 |  | Form of Employment Agreement dated as of
    October 31, 1988, by and between RJR Nabisco, Inc. and
    Andrew J. Schindler (incorporated by reference to
    Exhibit 10 to Registrants Schedule 14D-9 filed
    on November 8, 1988).                                                                                                                                                                                                                                                                         
|        | 10 | .61 |  | Form of Special Addendum dated December 20,
    1988, to the Employment Agreement dated as of October 31,
    1988, between RJR Nabisco, Inc. and Andrew J. Schindler
    (incorporated by reference to Exhibit 10(d)(i) to
    Registrants Annual Report on Form 10-K for the fiscal
    year ended December 31, 1988, filed March 8, 1989).                                                                                                                                                                  
|        | 10 | .62 |  | Amendment dated June 7, 1999, to the
    Employment Agreement dated as of October 31, 1988, and
    previously amended as of December 20, 1988, between
    RJR Nabisco, Inc. and Andrew J. Schindler (incorporated by
    reference to Exhibit 10.8 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended
    September 30, 1999, filed November 12, 1999).                                                                                                                                  
|        | 10 | .63 |  | Amendment dated January 4, 2002, to the
    Employment Agreement dated as of October 31, 1988, and
    previously amended as of December 20, 1988 and June 7,
    1999, between R.J. Reynolds Tobacco Holdings, Inc.
    (formerly known as RJR Nabisco, Inc.) and Andrew J. Schindler
    (incorporated by reference to Exhibit 10.52 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2001, filed February 28, 2002).                                                       
|        | 10 | .64 |  | Change of Control Letter Agreement dated
    October 25, 1999, by and among R.J. Reynolds Tobacco
    Holdings, Inc. and Andrew J. Schindler (incorporated by
    reference to Exhibit 10.53 to Registrants Annual
    Report on Form 10-K for the year ended December 31,
    2001, filed February 28, 2002).                                                                                                                                                                                                 
|        | 10 | .65 |  | Participation Agreement, RJR Nabisco, Inc.
    Supplemental Executive Retirement Plan (now known as the
    R.J. Reynolds Supplemental Executive Retirement Plan), for
    Andrew J. Schindler dated December 28, 1995 (incorporated
    by reference to Exhibit 10.45 to Registrants Annual
    Report on Form 10-K for the fiscal year ended
    December 31, 1995, filed February 22, 1996).                                                                                                                
|        | 10 | .66 |  | Amendment dated October 25, 1999, to the
    Participation Agreement, RJR Nabisco, Inc. Supplemental
    Executive Retirement Plan (now known as the R.J. Reynolds
    Supplemental Executive Retirement Plan), for Andrew J. Schindler
    dated December 28, 1995, between R.J. Reynolds Tobacco
    Holdings, Inc. and Andrew J. Schindler (incorporated by
    reference to Exhibit 10.55 to Registrants Annual
    Report on Form 10-K for the year ended December 31,
    2001, filed February 28, 2002).
|        | 10 | .67 |  | Cash Retention Grant Letter Agreement dated
    August 17, 1999, between R.J. Reynolds Tobacco
    Holdings, Inc. and Andrew J. Schindler (incorporated by
    reference to Exhibit 10.9 to Registrants Quarterly
    Report on Form 10-Q for the quarter ended
    September 30, 1999, filed November 12, 1999).                                                                                                                                                                                              
|        | 10 | .68 |  | Offer of Employment Letter dated June 12,
    2002, by R.J. Reynolds Tobacco Holdings, Inc. to Richard H.
    Bogan, accepted by Mr. Bogan on June 18, 2002
    (incorporated by reference to Exhibit 10.1 to
    Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2002, filed November 1,
    2002).                                                                                                                                                                         
|        | 10 | .69 |  | Severance Agreement dated June 6, 2003, by
    and between R.J. Reynolds Tobacco Holdings, Inc. and
    Richard H. Bogan (incorporated by reference to Exhibit 10.7
    to Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2003, filed August 8, 2003).                                                                                                                                                                                                                           
|        | 10 | .70 |  | Form of Change of Control Letter Agreement
    between R.J. Reynolds Tobacco Holdings, Inc. and the
    executive officer named therein (incorporated by reference to
    Exhibit 10.5 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                                                                                                                                                                                                
|        | 10 | .71 |  | Form of Special Severance Benefits Letter
    Agreement between R.J. Reynolds Tobacco Company and the
    executive officer named therein (incorporated by reference to
    Exhibit 10.6 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                                                                                                                                                                                              
|        | 10 | .72 |  | Form of Amendment to Special Severance Benefits
    Letter Agreement between R.J. Reynolds Tobacco Company and
    the executive officer named therein (incorporated by reference
    to Exhibit 10.7 to Registrants Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1999,
    filed November 12, 1999).                                                                                                                                                                                 

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|        |    |    |  |                                                                                                                                                                                                                                                                                                    
|------- | -- | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |   
|Number  |    |   
|        |    |   
|        | 12 | .1 |  | Computation of Ratio of Earnings to Combined
    Fixed Charges and Preferred Stock Dividends/ Deficiency in the
    Coverage of Combined Fixed Charges and Preferred Stock Dividends
    by Earnings Before Fixed Charges for each of the five years
    within the period ended December 31, 2003.
|        | 21 | .1 |  | Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                    
|        | 23 | .1 |  | Consent of Independent Auditors.                                                                                                                                                                                                                                                                   
|        | 31 | .1 |  | Certification of Chief Executive Officer relating
    to RJRs Annual Report on Form 10-K for the period
    ended December 31, 2003.                                                                                                                                                              
|        | 31 | .2 |  | Certification of Chief Financial Officer relating
    to RJRs Annual Report on Form 10-K for the period
    ended December 31, 2003.                                                                                                                                                              
|        | 32 | .1 |  | Certification of Chief Executive Officer and
    Chief Financial Officer relating to RJRs Annual Report on
    Form 10-K for the period ended December 31, 2003,
    pursuant to Section 18 U.S.C. §1350, adopted pursuant
    to Section 906 of the Sarbanes-Oxley Act of 2002.                  
|        | 99 | .1 |  | Expanded Litigation Disclosure.                                                                                                                                                                                                                                                                    
|        | 99 | .2 |  | Audit Committees Audit and Non-Audit
    Services Pre-Approval Policy.                                                                                                                                                                                                                            

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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

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

|                                               |  |                                                                                                              |  |               |  | 
|---------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------ |  | ------------- |  | 
|                                               |  |                                                                                                              |  |              
|Signature                                      |  | Title                                                                                                        |  | Date         
|                                               |  |                                                                                                              |  |              
|                                              
|/s/ ANDREW J. SCHINDLERAndrew J. Schindler     |  | Chairman of the Board, President,
    Chief Executive Officer and Director
    (principal executive officer) |  | March 5, 2004
|                                              
|/s/ DIANNE M. NEALDianne M. Neal               |  | Executive Vice President and
    Chief Financial Officer
    (principal financial officer)                   |  | March 5, 2004
|                                              
|/s/ THOMAS R. ADAMSThomas R. Adams             |  | Senior Vice President and Controller
    (principal accounting officer)                                      |  | March 5, 2004
|                                              
|/s/ MARY K. BUSHMary K. Bush                   |  | Director                                                                                                     |  | March 5, 2004
|                                              
|/s/ JOHN T. CHAIN, JR.John T. Chain, Jr.       |  | Director                                                                                                     |  | March 5, 2004
|                                              
|/s/ A.D. FRAZIER, JR.A.D. Frazier, Jr.         |  | Director                                                                                                     |  | March 5, 2004
|                                              
|/s/ E.V. GOINGSE.V. Goings                     |  | Director                                                                                                     |  | March 5, 2004
|                                              
|/s/ DENISE ILITCHDenise Ilitch                 |  | Director                                                                                                     |  | March 5, 2004
|                                              
|/s/ NANA MENSAHNana Mensah                     |  | Director                                                                                                     |  | March 5, 2004
|                                              
|/s/ ROBERT S. MILLER, JR.Robert S. Miller, Jr. |  | Director                                                                                                     |  | March 5, 2004
|                                              
|/s/ JOSEPH P. VIVIANOJoseph P. Viviano         |  | Director                                                                                                     |  | March 5, 2004
|                                              
|/s/ THOMAS C. WAJNERTThomas C. Wajnert         |  | Director                                                                                                     |  | March 5, 2004

168