Reynolds American Inc.s2.q4cdn.com/.../Reynolds-Q2-2015-Form-10-Q.pdf · Reynolds Tobacco Company on July 30, 2004, with such combination referred to as the B&W business combination

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2015

OR

For the transition period from to

Commission file number: 1-32258

Reynolds American Inc. (Exact name of registrant as specified in its charter)

401 North Main Street Winston-Salem, NC 27101

(Address of principal executive offices) (Zip Code)

(336) 741-2000 (Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed from last report)

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 � No �

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes � No �

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes � No �

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: 714,550,703 shares of common stock, par value $.0001 per share, as of July 6, 2015.

� QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

� TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

North Carolina 20-0546644 (State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification Number)

Large accelerated filer � Accelerated filer �

Non-accelerated filer � (Do not check if a smaller reporting company) Smaller reporting company �

INDEX

2

Page Part I – Financial Information

Item 1. Financial Statements 3

Condensed Consolidated Statements of Income (Unaudited) – Three and Six Months Ended June 30, 2015 and 2014

3

Condensed Consolidated Statements of Comprehensive Income (Unaudited) – Three and Six Months Ended June 30, 2015 and 2014

4

Condensed Consolidated Statements of Cash Flows (Unaudited) –Six Months Ended June 30, 2015 and 2014

5

Condensed Consolidated Balance Sheets – June 30, 2015 (Unaudited) and December 31, 2014 6

Notes to Condensed Consolidated Financial Statements (Unaudited) 7

1 Business and Summary of Significant Accounting Policies 7

2 Merger, Divestiture and BAT Share Purchase 10

3 Fair Value 13

4 Intangible Assets 16

5 Restructuring 17

6 Income Per Share 18

7 Inventories 18

8 Income Taxes 18

9 Borrowing Arrangements 19

10 Long-Term Debt 20

11 Commitments and Contingencies 23

12 Shareholders’ Equity 68

13 Stock Plans 70

14 Segment Information 71

15 Related Party Transactions 72

16 RAI Guaranteed, Unsecured Notes — Condensed Consolidating Financial Statements 73

17 RJR Tobacco Guaranteed, Unsecured Notes — Condensed Consolidating Financial Statements 83

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 92

Item 3. Quantitative and Qualitative Disclosures about Market Risk 115

Item 4. Controls and Procedures 115

Part II – Other Information

Item 1. Legal Proceedings 116

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 116

Item 5. Other Information 116

Item 6. Exhibits 117

Signatures 119

Part I — F inancial Information

Item 1. Financial Statements

REYNOLDS AMERICAN INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Millions, Except Per Share Amounts) (Unaudited)

(1) Excludes excise taxes of $987 million and $927 million for the three months ended June 30, 2015 and 2014, respectively; and $1,827 million and $1,773 million for the six months ended June 30, 2015 and 2014, respectively.

See Notes to Condensed Consolidated Financial Statements (Unaudited)

3

For the Three Months Ended June 30,

For the Six Months Ended June 30,

2015 2014 2015 2014

Net sales (1) $ 2,349 $ 2,071 $ 4,324 $ 3,920 Net sales, related party 54 91 136 177

Net sales 2,403 2,162 4,460 4,097 Costs and expenses:

Cost of products sold (1) 1,084 959 1,934 1,889 Selling, general and administrative expenses 451 364 962 777 Gain on Divestiture (3,499 ) — (3,499 ) — Amortization expense 3 3 6 5

Operating income 4,364 836 5,057 1,426 Interest and debt expense 105 62 196 121 Interest income — (1 ) (1 ) (2 ) Other (income) expense, net 20 — 3 1

Income from continuing operations before income taxes 4,239 775 4,859 1,306 Provision for income taxes 2,311 283 2,542 476

Income from continuing operations 1,928 492 2,317 830 Income from discontinued operations, net of tax — — — 25

Net income $ 1,928 $ 492 $ 2,317 $ 855

Basic income per share: Income from continuing operations $ 3.39 $ 0.92 $ 4.21 $ 1.55 Income from discontinued operations — — — 0.05 Net income $ 3.39 $ 0.92 $ 4.21 $ 1.60

Diluted income per share: Income from continuing operations $ 3.38 $ 0.92 $ 4.20 $ 1.55 Income from discontinued operations — — — 0.04 Net income $ 3.38 $ 0.92 $ 4.20 $ 1.59

Dividends declared per share $ 0.67 $ 0.67 $ 1.34 $ 1.34

REYNOLDS AMERICAN INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in Millions)

(Unaudited)


4

For the Three Months

Ended June 30, 2015 2014

Net income $ 1,928 $ 492 Other comprehensive income (loss), net of tax:

Retirement benefits, net of tax (benefit) expense (2015 — $(12); 2014 — $4) (20 ) 6 Unrealized gain on long-term investments, net of tax — 1 Amortization of realized loss on hedging instruments, net of tax 1 1 Cumulative translation adjustment and other, net of tax (benefit) expense (2015 — $2; 2014 — $(1)) 10 (3 )

Comprehensive income $ 1,919 $ 497

For the Six Months

Ended June 30, 2015 2014

Net income $ 2,317 $ 855 Other comprehensive income (loss), net of tax:

Retirement benefits, net of tax (benefit) expense (2015 — $(16)) (26 ) — Unrealized gain on long-term investments, net of tax expense (2014 — $1) — 2 Amortization of realized loss on hedging instruments, net of tax 1 1 Cumulative translation adjustment and other, net of tax (benefit) expense (2015 — $(10); 2014 — $(1)) (17 ) (2 )

Comprehensive income $ 2,275 $ 856


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Millions)

(Unaudited)


5

For the Six Months

Ended June 30, 2015 2014

Cash flows from (used in) operating activities: Net income $ 2,317 $ 855

Income from discontinued operations, net of tax — (25 ) Adjustments to reconcile to net cash flows from (used in) continuing operating activities:

Depreciation and amortization 56 51 Deferred income tax expense (benefit) (381 ) 15 Pension and postretirement (63 ) (63 ) Tobacco settlement (590 ) (480 ) Other, net (891 ) (98 ) Net cash flows from operating activities 448 255

Cash flows from (used in) investing activities: Capital expenditures (64 ) (123 ) Acquisition, net of cash acquired (17,219 ) — Proceeds from Divestiture 7,056 — Proceeds from termination of joint venture — 35 Other, net 1 (24 )

Net cash flows used in investing activities (10,226 ) (112 ) Cash flows from (used in) financing activities:

Dividends paid on common stock (712 ) (699 ) Repurchase of common stock (40 ) (440 ) Proceeds from BAT Share Purchase 4,673 — Issuance of long-term debt 8,975 — Debt issuance costs and financing fees (64 ) — Principal borrowings under revolving credit facility 1,400 1,000 Repayments under revolving credit facility (1,400 ) (200 ) Excess tax benefit on stock-based compensation plans 15 10

Net cash flows from (used in) financing activities 12,847 (329 ) Effect of exchange rate changes on cash and cash equivalents (22 ) (1 ) Net change in cash and cash equivalents 3,047 (187 ) Cash and cash equivalents at beginning of period 966 1,500 Cash and cash equivalents at end of period $ 4,013 $ 1,313

Income taxes paid, net of refunds $ 645 $ 499 Interest paid $ 159 $ 125 Fair value of equity consideration issued in the Merger $ 7,555 $ —


CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in Millions)


6

June 30,

2015 December 31,

2014 (Unaudited)

Assets Current assets:

Cash and cash equivalents $ 4,013 $ 966 Short-term investments 347 — Accounts receivable 145 116 Accounts receivable, related party 31 41 Other receivables 18 12 Inventories 1,677 1,281 Deferred income taxes, net 935 703 Other current assets 285 204

Total current assets 7,451 3,323 Property, plant and equipment, net of accumulated depreciation (2015 — $1,621; 2014 — $1,627) 1,298 1,203 Trademarks and other intangible assets, net of accumulated amortization 28,301 2,421 Goodwill 17,019 8,016 Other assets and deferred charges 489 233 $ 54,558 $ 15,196

Liabilities and shareholders’ equity Current liabilities:

Accounts payable $ 178 $ 142 Tobacco settlement accruals 1,982 1,819 Due to related party 7 1 Deferred revenue, related party 15 32 Current maturities of long-term debt 450 450 Income taxes payable 2,125 — Dividends payable on common stock 356 356 Other current liabilities 1,329 744

Total current liabilities 6,442 3,544 Long-term debt (less current maturities) 17,550 4,633 Deferred income taxes, net 9,813 383 Long-term retirement benefits (less current portion) 2,239 1,997 Other noncurrent liabilities 188 117 Commitments and contingencies: Shareholders’ equity:

Common stock (shares issued: 2015 — 714,550,703; 2014 — 531,283,513) — — Paid-in capital 18,447 6,200 Retained earnings (accumulated deficit) 285 (1,314 ) Accumulated other comprehensive loss (406 ) (364 )

Total shareholders’ equity 18,326 4,522 $ 54,558 $ 15,196

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1 — Business and Summary of Significant Accounting Policies

Overview

The condensed consolidated financial statements (unaudited) include the accounts of Reynolds American Inc., referred to as RAI, and its wholly owned subsidiaries. RAI’s wholly owned operating subsidiaries include R. J. Reynolds Tobacco Company; American Snuff Company, LLC, referred to as American Snuff Co.; Santa Fe Natural Tobacco Company, Inc., referred to as SFNTC; R. J. Reynolds Vapor Company, referred to as RJR Vapor; Niconovum USA, Inc; Niconovum AB; SFR Tobacco International GmbH, referred to as SFRTI, and various foreign subsidiaries affiliated with SFRTI.

RAI was incorporated as a holding company in the State of North Carolina in 2004, and its common stock is listed on the New York Stock Exchange, referred to as NYSE, under the symbol “RAI.” RAI was created to facilitate the business combination of the U.S. business of Brown & Williamson Holdings, Inc., referred to as B&W, an indirect wholly owned subsidiary of British American Tobacco p.l.c., referred to as BAT, with R. J. Reynolds Tobacco Company on July 30, 2004, with such combination referred to as the B&W business combination.

References to RJR Tobacco prior to July 30, 2004, relate to R. J. Reynolds Tobacco Company, a New Jersey corporation and a wholly owned subsidiary of R.J. Reynolds Tobacco Holdings, Inc., referred to as RJR. References to RJR Tobacco on and subsequent to July 30, 2004, relate to the combined U.S. assets, liabilities and operations of B&W and R. J. Reynolds Tobacco Company, a North Carolina corporation.

On June 12, 2015, RAI acquired Lorillard, Inc., referred to as Lorillard, in a cash and stock transaction, referred to as the Merger, pursuant to which a wholly owned subsidiary of RAI, referred to as Merger Sub, merged with and into Lorillard, with Lorillard surviving as a wholly owned subsidiary of RAI, all in accordance with an agreement and plan of merger, dated July 15, 2014, among RAI, Merger Sub and Lorillard, referred to as the Merger Agreement.

Also on June 12, 2015, a wholly owned subsidiary, referred to as Imperial Sub, of Imperial Tobacco Group, PLC, referred to as Imperial, acquired for approximately $7.1 billion certain assets (1) owned by RAI subsidiaries or affiliates relating to the cigarette brands WINSTON, KOOL and SALEM, and (2) owned by Lorillard subsidiaries or affiliates related to the cigarette brand MAVERICK and the “e-vapor” brand blu (including SKYCIG), as well as Lorillard’s owned and leased real property, and certain transferred employees, together with associated liabilities, all in accordance with (x) an asset purchase agreement, dated July 15, 2014, as amended, referred to as the Asset Purchase Agreement, among RAI and Imperial Sub, and for certain provisions of the Asset Purchase Agreement and as guarantor of certain obligations of Imperial Sub, Imperial, and (y) a transfer agreement, dated July 15, 2014, referred to as the Transfer Agreement, between Lorillard and Imperial Sub. The transactions pursuant to the Asset Purchase Agreement and Transfer Agreement are collectively referred to as the Divestiture.

In addition, on June 12, 2015, shortly after the completion of the Merger, Lorillard Tobacco Company, LLC, a wholly owned subsidiary of Lorillard, referred to as Lorillard Tobacco, merged with and into RJR Tobacco, with RJR Tobacco continuing as the surviving entity, referred to as the Lorillard Tobacco Merger. The statements of financial position and results of operations contained in the condensed consolidated financial statements (unaudited) reflect the results of the Merger and Divestiture and related transactions. For additional information on the Merger and Divestiture, and related transactions, see note 2.

RAI’ s reportable operating segments are RJR Tobacco, American Snuff and Santa Fe. The RJR Tobacco segment consists principally of the primary operations of R. J. Reynolds Tobacco Company. The American Snuff segment consists of the primary operations of American Snuff Co. The Santa Fe segment consists of the domestic operations of SFNTC. Included in All Other, among other RAI subsidiaries, are RJR Vapor, Niconovum USA, Inc., Niconovum AB, SFRTI and various foreign subsidiaries affiliated with SFRTI. The segments were identified based on how RAI’s chief operating decision maker allocates resources and assesses performance. Certain of RAI’s operating subsidiaries have entered into intercompany agreements for products or services with other subsidiaries. As a result, certain activities of an operating subsidiary may be included in a different segment of RAI.

RAI’s operating subsidiaries primarily conduct their businesses in the United States.

Basis of Presentation

The accompanying interim condensed consolidated financial statements (unaudited) have been prepared in accordance with accounting principles generally accepted in the United States of America, referred to as GAAP, for interim financial information and,

7

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)

in management’s opinion, contain all adjustments, consisting only of normal recurring items, necessary for a fair presentation of the results for the periods presented. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. All material intercompany balances have been eliminated. For interim reporting purposes, certain costs and expenses are charged to operations in proportion to the estimated total annual amount expected to be incurred primari ly based on sales volumes. The results for the interim period ended June 30, 2015, are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.

The condensed consolidated financial statements (unaudited) should be read in conjunction with the consolidated financial statements and related footnotes, which appear in RAI’s Annual Report on Form 10-K for the year ended December 31, 2014. Certain reclassifications were made to conform prior years’ financial statements to the current presentation. Certain amounts presented in note 11 are rounded in the aggregate and may not sum from the individually presented components. All dollar amounts, other than per share amounts, are presented in millions, except for amounts set forth in note 11 and as otherwise noted.

Cost of Products Sold

Cost of products sold includes the expenses for the Master Settlement Agreement, referred to as the MSA, and other settlement agreements with the States of Mississippi, Florida, Texas and Minnesota, which together with the MSA are collectively referred to as the State Settlement Agreements; the user fees charged by the U.S. Food and Drug Administration, referred to as the FDA; and the federal tobacco quota assessment that expired in 2014. These expenses were as follows:

In 2012, RJR Tobacco, Lorillard Tobacco and certain other participating manufacturers, referred to as the PMs, including SFNTC, entered into a term sheet, referred to as the Term Sheet, with 17 states, the District of Columbia and Puerto Rico to settle certain claims related to the MSA non-participating manufacturer adjustment, referred to as the NPM Adjustment. The Term Sheet resolves claims related to volume years from 2003 through 2012 and puts in place a revised method to determine future adjustments from 2013 forward as to jurisdictions that join the agreement. On March 12, 2013, a single, nationwide arbitration panel of three former federal judges, referred to as the Arbitration Panel, hearing the dispute related to the 2003 NPM Adjustment (and related matters) issued an order, referred to as the Order, authorizing the implementation of the Term Sheet. In addition, after the Order, one additional state signed the Term Sheet on April 12, 2013; and, two additional states signed the Term Sheet on May 24, 2013. The Term Sheet is binding on all signatories.

Based on the jurisdictions bound by the Term Sheet through December 31, 2013, RJR Tobacco and SFNTC, collectively, will receive credits, currently estimated to total approximately $1.1 billion, with respect to their NPM Adjustment claims for the period from 2003 through 2012. These credits will be applied against annual payments under the MSA over a five-year period, which commenced with the April 2013 MSA payment. As a result of the Lorillard Tobacco Merger, RJR Tobacco will receive approximately $22 million of additional credits, attributable to Lorillard Tobacco, which will be applied against annual payments in 2016 and 2017.

In June 2014, two additional states agreed to settle the NPM Adjustment disputes on similar terms as set forth in the Term Sheet, except for certain provisions related to the determination of credits to be received by the PMs. RJR Tobacco and SFNTC, collectively, will receive credits, currently estimated to total approximately $170 million, with respect to their NPM Adjustment claims from 2003 through 2012. The credits related to these two states will be applied against annual payments under the MSA over a five-year period, which effectively commenced with the April 2014 MSA payment. As a result, expenses for the MSA were reduced by approximately $34 million for the three and six months ended June 30, 2014. As a result of the Lorillard Tobacco Merger, RJR Tobacco will receive approximately $5 million of additional credits, attributable to Lorillard Tobacco, which will be applied against annual payments over the next three years.

As a result of meeting the performance requirements associated with the Term Sheet, RJR Tobacco and Santa Fe, collectively, recognized credits of $69 million and $91 million for the three months ended June 30, 2015 and 2014, respectively, and $135 million and $154 million for the six months ended June 30, 2015 and 2014, respectively. RJR Tobacco expects to recognize additional credits through 2017, and Santa Fe expects to recognize additional credits through 2016.

8


Ended June 30, For the Six Months

Ended June 30, 2015 2014 2015 2014

State Settlement Agreements $ 571 $ 456 $ 965 $ 912 FDA user fees 38 33 73 67 Federal tobacco quota buyout — 51 — 106


On September 11, 2013, the Arbitration Panel ruled six states had not diligently enforced their qualifying statutes in 2003 related to the NPM Adjustment. Based on the status of the various challenges filed by the non-diligent states to certain rulings of the Arbitration Panel related to the 2003 NPM Adjustment claim, as of June 30, 2015, two of the non-diligent states are no longer challenging the findings of non-diligence entered against th em by the Arbitration Panel. As a result, a certain portion of the NPM Adjustment claim for 2003 from these two states is now certain and can be estimated. Consequently, RJR Tobacco and Santa Fe, collectively, recognized $70 million as a reduction of cost of products sold for the six months ended June 30, 2015.

For additional information related to the NPM Adjustment settlement and the 2003 NPM Adjustment claim, see “—Litigation Affecting the Cigarette Industry —State Settlement Agreements—Enforcement and Validity; Adjustments” in note 11.

Pension and Postretirement

Pension and postretirement benefits require balance sheet recognition of the net asset or liability for the overfunded or underfunded status of defined benefit pension and other postretirement benefit plans, on a plan-by-plan basis, and recognition of changes in the funded status in the year in which the changes occur.

Actuarial gains or losses are changes in the amount of either the benefit obligation or the fair value of plan assets resulting from experience different from that assumed or from changes in assumptions. Differences between actual results and actuarial assumptions are accumulated and recognized in the year in which they occur as a mark-to-market adjustment, referred to as an MTM adjustment, to the extent such net gains and losses are in excess of 10% of the greater of the fair value of plan assets or benefit obligations, referred to as the corridor. Actuarial gains and losses outside the corridor are generally recognized annually as of December 31, or when a plan is remeasured during an interim period.

Prior service costs of pension benefits, 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, or average remaining life expectancies for inactive employees if most of the plan obligations are due to inactive employees. Prior service costs of postretirement benefits, which are changes in benefit obligations due to plan amendments, are amortized on a straight-line basis over the expected service period to full eligibility age for active employees, or average remaining life expectancies for inactive employees if most of the plan obligations are due to inactive employees.

The components of the pension benefits and the postretirement benefits are set forth below:

RAI disclosed in its financial statements for the year ended December 31, 2014, that it expects to contribute $109 million to its pension plans in 2015, of which $5 million was contributed during the first six months of 2015.

Fair Value Measurement

RAI determines the fair value of assets and liabilities, if any, using a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity, and the reporting entity’s own assumptions about market participant assumptions based on the best information available in the circumstances.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, essentially an exit price.

9



Ended June 30, Postretirement Postretirement Pension Benefits Benefits Pension Benefits Benefits 2015 2014 2015 2014 2015 2014 2015 2014

Service cost $ 7 $ 6 $ — $ — $ 13 $ 11 $ 1 $ 1 Interest cost 67 67 12 13 131 133 24 27 Expected return on plan assets (90 ) (91 ) (3 ) (3 ) (178 ) (181 ) (6 ) (6 ) Amortization of prior service cost (credit) — 1 (10 ) (10 ) 1 2 (21 ) (21 )

Total benefit cost (credit) $ (16 ) $ (17 ) $ (1 ) $ — $ (33 ) $ (35 ) $ (2 ) $ 1


The levels of the fair value hierarchy are:

Level 1: inputs are quoted prices, unadjusted, in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2: inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. A Level 2 input must be observable for substantially the full term of the asset or liability.

Level 3: inputs are unobservable and reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability.

RAI evaluates its investments for possible impairment based on current economic conditions, credit loss experience and other criteria on a quarterly basis. The evaluation of investments for impairment requires significant judgments, including:

If there is a decline in a security’s net realizable value that is other-than-temporary and it is not likely to be sold before recovery, the decline is separated into the amount of impairment related to credit loss and the amount of impairment related to all other factors. The decline related to the credit loss is recognized in earnings, while the decline related to all other factors is recognized in accumulated other comprehensive loss.

Recently Issued Accounting Pronouncements

In January 2015, the Financial Accounting Standards Board, referred to as the FASB, issued amended guidance which simplifies income statement presentation by eliminating the concept of extraordinary items. Previously, events or transactions that were both unusual in nature and infrequent in occurrence for a business entity were considered to be extraordinary items and required separate presentation, net of tax, after income from continuing operations. The guidance does not change the requirement to disclose items which are unusual in nature or infrequent in occurrence as a component of continuing operations or in the footnotes. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015. Early adoption is permitted if it is applied from the beginning of the fiscal year of adoption. The adoption of the amended guidance is not expected to have a material impact on RAI’s results of operations, cash flows or financial position.

In February 2015, the FASB issued amendments to the consolidation standard that reduce the number of consolidation models. The amended standard changes the way reporting entities examine partnerships and similar entities, evaluate service providers and decision makers as they relate to a variable interest entity, referred to as a VIE, and examine how related party interests in a VIE can affect the consolidation of that VIE. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015. Early adoption is permitted. RAI is evaluating the effect that this guidance will have on its consolidated financial statements.

In April 2015, the FASB issued amended guidance to simplify the presentation of debt issuance costs. The current guidance requires debt issuance costs to be reported on the balance sheet as an asset and amortized as interest expense. The amended guidance requires debt issuance costs be presented as a direct reduction of the debt liability it is associated with similar to the way debt discounts are presented. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015. The standard requires retrospective application for all prior periods presented. Early adoption is permitted. The adoption of the amended guidance is not expected to have a material impact on RAI’s results of operations, cash flows or financial position.

In April 2015, the FASB issued new guidance for determining if an arrangement for cloud services includes a license of software. This new guidance does not change the accounting standard for cloud service providers, but does base the criteria for determining if a license of software is part of the arrangement based on the existing guidance. If a license of software is present in the arrangement, the fee associated with the license portion will be capitalized when the criteria for capitalization of internal-use software are met. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015. Early adoption is permitted. RAI is evaluating the effect that this guidance will have on its consolidated financial statements.

Note 2 — Merger, Divestiture and BAT Share Purchase Merger

10

● the identification of potentially impaired securities;

● the determination of their estimated fair value;

● the assessment of whether any decline in estimated fair value is other-than-temporary; and

● the likelihood of selling before recovery.


On June 12, 2015, the Merger was completed, with Merger Sub merging with and into Lorillard and Lorillard surviving as a wholly owned subsidiary of RAI. Pursuant to the Merger Agreement, each share of outstanding Lorillard common stock (other than treasur y shares held by Lorillard and any shares of Lorillard common stock owned by any Lorillard subsidiary, RAI or Merger Sub) was converted into the right to receive (1) 0.2909 of a share of RAI common stock plus (2) $50.50 in cash (the foregoing collectively referred to as the Merger Consideration). RAI issued 104,706,847 shares of RAI common stock at a price of $72.15 per share to Lorillard shareholders in the Merger.

As a part of the Merger, RAI acquired the premium cigarette brand, NEWPORT, which is the top selling menthol and second largest selling cigarette brand overall in the United States. In addition to NEWPORT, RAI acquired three additional brand families marketed under the KENT, TRUE and OLD GOLD brand names.

In accordance with FASB Accounting Standards Codification 805, Business Combinations , referred to as ASC 805, the Merger has been accounted for using the acquisition method of accounting with RAI considered the acquirer of Lorillard. RAI recorded assets acquired, including identifiable intangible assets, and liabilities assumed, from Lorillard at their respective fair values at the date of completion of the Merger. Any excess of the purchase price over the net fair value of such assets and liabilities will be recorded as goodwill.

The table below presents the purchase price along with a preliminary allocation of the purchase price to the assets acquired and liabilities assumed in the Merger.

Purchase Price

Preliminary Allocation of Purchase Price

The allocation of the purchase price reflected in the accompanying financial statements is preliminary and based upon estimates and assumptions that are subject to change within the measurement period (up to one year from the closing date of the Merger

11

Fair value of RAI common stock issued $ 7,555 Cash paid to Lorillard shareholders at $50.50 per share 18,205 Cash paid for Lorillard stock options and stock appreciation rights 73

Purchase price $ 25,833

Assets Cash and cash equivalents $ 1,059 Short-term investments 347 Accounts and other receivables 45 Inventories 583 Income tax receivable 114 Other current assets 1,361 Property, plant and equipment 94 Trademarks and other intangible assets 26,242 Goodwill 10,852 Other assets and deferred charges 210 Liabilities Tobacco settlement accruals 753 Other current liabilities 507 Long-term debt (less current maturities) 3,951 Deferred income taxes, net 9,536 Long-term retirement benefits 263 Other noncurrent liabilities 64

Preliminary allocation of purchase price $ 25,833


pursuant to ASC 805). The measurement period remains open pending the completion of valuation procedures related to acquired assets and assumed liabilities. Goodwill generated from the acquisition is primarily attributable to the establishment of deferred tax liabilities associated with the trademarks acquired and the expe cted synergies from future growth, and is allocated to the reporting unit that is expected to benefit from these synergies. The $10,852 million allocated to goodwill represents the excess of the preliminary allocation of the purchase price over the fair v alue of assets acquired and liabilities assumed, which amount has been allocated to the RJR Tobacco segment, and will be non-deductible for tax purposes.

The results of operations of the acquired Lorillard brands are included in RAI’s condensed consolidated statements of income from the date of acquisition and include $197 million of total net sales for the three and six months ended June 30, 2015, and are included in the RJR Tobacco segment’s financial results. There was no material impact to net income for the three and six months ended June 30, 2015.

Divestiture

On June 12, 2015, the Divestiture was completed, and Imperial Sub acquired the cigarette brands WINSTON, KOOL and SALEM, previously owned by RAI subsidiaries and included in the RJR Tobacco segment, as well as the cigarette brand MAVERICK and the “e-vapor” brand blu (including SKYCIG), previously owned by Lorillard subsidiaries, and other assets and certain liabilities, including inventory, fixed assets and employee benefit plans, for an aggregate purchase price of approximately $7.1 billion. A summary of the pre-tax preliminary gain is as follows:

BAT Share Purchase and Other

In connection with the Merger and Divestiture, on July 15, 2014, RAI, BAT, and for limited purposes only, B&W, entered into a subscription and support agreement, referred to as the Subscription Agreement, pursuant to which BAT agreed to subscribe for and purchase, directly or indirectly through one or more of its wholly owned subsidiaries, simultaneously with the completion of the Merger and at a price of approximately $4.7 billion in the aggregate, shares of RAI common stock such that BAT, directly or indirectly through its affiliates, would maintain its approximately 42% beneficial ownership in RAI (the foregoing purchase is referred to as the BAT Share Purchase).

On June 12, 2015, concurrently with the completion of the Merger and Divestiture and pursuant to the Subscription Agreement, BAT indirectly (through a wholly owned subsidiary) purchased 77,680,259 shares of RAI common stock for approximately $4.7 billion, which was sufficient for BAT and its subsidiaries collectively to maintain their approximately 42% beneficial ownership in RAI. Upon completion of the transactions on June 12, 2015, BAT and its subsidiaries collectively owned 301,014,278 shares, or approximately 42%, of RAI’s outstanding common stock.

RAI financed the cash portion of the Merger Consideration and related fees and expenses with (1) the net proceeds from a public offering of $9 billion aggregate principal amount of newly issued RAI senior notes, (2) the proceeds from the Divestiture, (3) the proceeds from the BAT Share Purchase and (4) available cash. Transaction related costs of $39 million and $54 million, for the three and six months ended June 30, 2015, respectively, were expensed as incurred and included in selling, general and administrative expenses in RAI’s condensed consolidated statements of income (unaudited).

Pro forma financial information (unaudited)

The following unaudited pro forma consolidated financial information presents the combined results of operations of RAI and Lorillard as if the Merger and Divestiture had occurred at the beginning of the earliest period presented and includes non-recurring pro forma adjustments that were directly attributable to the Merger and Divestiture. Pro forma net income includes adjustments for acquisition-related costs. Pro forma net income per share includes the impact of the issuance of RAI common stock in the BAT Share Purchase and as part of the Merger Consideration.

12

Purchase price $ 7,056 Net assets and liabilities divested (1,708 ) Goodwill associated with divested RJR Tobacco brands (1,849 )

Gain on Divestiture $ 3,499


The unaudited pro forma results do not reflect cost savings or synergies from operating efficiencies or the effect of the incremental costs incurred in the Merger or Divestiture. Accordingly, these unaudited pro forma results are presented for informational purposes only and are not necessarily indicative of what the actual results of operations of the combined company would have been if the Merger and Divestiture had occurred at the beginning of the periods presented, nor are they indicative of future results of operations. Note 3 — Fair Value

Fair Value of Financial Assets and Liabilities

Financial assets and liabilities carried at fair value were as follows:

There were no transfers between the levels for the six months ended June 30, 2015, or in the year ended December 31, 2014.

RAI’s short-term and long-term investments include corporate debt securities, U.S. Government agency obligations, commercial paper and international government obligations. The fair value of these investments, classified as Level 2, utilized quoted prices for identical assets in less active markets or quoted prices for similar assets in active markets. The fair value of the interest rate swaps, classified as Level 2, utilized a market approach model using the notional amount of the interest rate swaps and observable inputs of time to maturity and market interest rates.

RAI has investments in auction rate securities linked to corporate credit risk, investments in auction rate securities related to financial insurance companies, an investment in a mortgage-backed security and an investment in a marketable equity security. The unrealized gains and losses, net of tax, were included in accumulated other comprehensive loss in RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2015, and consolidated balance sheet as of December 31, 2014. The funds associated with the auction rate securities will not be accessible until a successful auction occurs or a buyer is found.

13

For the Three Months Ended June 30,

For the Six Months Ended June 30,

2015 2014 2015 2014

Net sales $ 3,102 $ 2,884 $ 5,871 $ 5,439 Net income 680 597 1,218 1,065

Net income per share: Basic income per share:

Net income $ 0.95 $ 0.83 $ 1.70 $ 1.48 Diluted income per share:

Net income $ 0.95 $ 0.83 $ 1.70 $ 1.48

June 30, 2015 December 31, 2104 Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total

Cash and cash equivalents: Cash equivalents $ 3,859 $ — $ — $ 3,859 $ 883 $ — $ — $ 883

Short-term investments: Corporate debt securities — 210 — 210 — — — — U.S. Governmental agency obligations — 71 — 71 — — — — Commercial paper — 27 — 27 — — — — International governmental obligations — 39 — 39 — — — —

Other assets and deferred charges: Corporate debt securities — 104 — 104 — — — — U.S. Governmental agency obligations — 28 — 28 — — — — Auction rate securities — — 79 79 — — 79 79 Mortgage-backed security — — 11 11 — — 12 12 Marketable equity security 2 — — 2 2 — — 2 Interest rate swaps — 59 — 59 — — — —


In determining if the difference between amort ized cost and estimated fair value of the auction rate securities or the mortgage-backed security was deemed either temporarily or other-than-temporarily impaired, RAI evaluated each type of long-term investment using a set of criteria, including decline i n value, duration of the decline, period until anticipated recovery, nature of investment, probability of recovery, financial condition and near-term prospects of the issuer, RAI’s intent and ability to retain the investment, attributes of the decline in v alue, status with rating agencies, status of principal and interest payments and any other issues related to the underlying securities. To assess credit losses, RAI uses historical default rates, debt ratings, credit default swap spreads and recovery rates . RAI has the intent and ability to hold these investments for a period of time sufficient to allow for the recovery in market value.

All of the fair values of the auction rate securities, classified as Level 3, are linked to the longer-term credit risk of a diverse range of corporations, including, but not limited to, manufacturing, financial and insurance sectors. The fair value was determined by utilizing an income approach model, which was based upon the weighted average present value of future cash payments, given the probability of certain events occurring within the market. RAI considers the market for its auction rate securities to be inactive. The income approach model utilized observable inputs, including the London interbank offered rate, referred to as LIBOR, based interest rate curves, corporate credit spreads and corporate ratings/market valuations. Additionally, unobservable factors incorporated into the model included default probability assumptions based on historical migration tables, various default recovery rates and how these factors changed as ratings on the underlying collateral migrated from one level to another. As related to the unobservable factors, substantial changes, relative to historical trends, of the levels of corporate defaults or default recovery rates would impact the fair value measurement of these securities. Maturity dates for the auction rate securities begin in 2017.

The fair value for the mortgage-backed security, classified as Level 3, utilized a market approach and was based upon the calculation of an overall weighted average valuation, derived from the actual, or modeled, market pricing of the specific collateral. The market approach utilized actual pricing inputs when observable and modeled pricing, based upon changes in observable market pricing, when unobservable. Substantial changes in the observable market pricing would directly impact the unobservable pricing and the fair value measurement of this security. RAI has deemed the market for its mortgage-backed security to be inactive. The maturity of the mortgage-backed security has been extended to March 2016, with the annual option to extend an additional year. Given the underlying collateral and RAI’s intent to continue to extend this security, it is classified as a noncurrent asset.

RAI determined the change in the fair value of the investment in a marketable equity security using quoted market prices as of June 30, 2015.

Financial assets classified as Level 3 investments were as follows:

14

June 30, 2015 December 31, 2014

Cost

Gross Unrealized

Loss (1) Estimated Fair Value Cost

Gross Unrealized

Loss (1) Estimated Fair Value

Auction rate securities $ 99 $ (20 ) $ 79 $ 99 $ (20 ) $ 79 Mortgage-backed security 17 (6 ) 11 18 (6 ) 12 $ 116 $ (26 ) $ 90 $ 117 $ (26 ) $ 91

(1) Unrealized losses, net of tax, are reported in accumulated other comprehensive loss in RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2015, and consolidated balance sheet as of December 31, 2014.


The changes in the Level 3 investments during the six months ended June 30, 2015, were as follows:

Fair Value of Debt

The estimated fair value of RAI’s outstanding debt, in the aggregate, was $18.3 billion and $5.4 billion, with an effective average annual interest rate of approximately 4.5%, as of June 30, 2015, and December 31, 2014, respectively. The fair values are based on available market quotes, credit spreads and discounted cash flows, as appropriate.

Interest Rate Management

From time to time, RAI and RJR have used interest rate swaps to manage interest rate risk on a portion of their respective debt obligations.

In 2009, RAI and RJR entered into offsetting floating to fixed interest rate swap agreements in the notional amount of $1.5 billion with maturity dates ranging from June 1, 2012 to June 15, 2017. The floating to fixed interest rate swap agreements were entered into with the same financial institution that held a notional amount of $1.5 billion of fixed to floating interest rate swaps.

In September 2011, RAI and RJR terminated the original and offsetting interest rate swap agreements, each with a notional amount of $1.5 billion, and received a total of $186 million cash in exchange for foregoing the future cash inflows associated with these swaps. These actions did not change the effective fixed rate of interest associated with the underlying debt.

In September 2013, RAI called for the redemption of, among other RAI notes, the $775 million outstanding principal amount of 7.625% notes due in 2016. Approximately $450 million of this outstanding principal amount was included in the interest rate swap agreements described above. As a result of this action and the maturity of debt in June 2012, RAI had $700 million of previously swapped outstanding fixed rate debt with an effective rate of interest of approximately 3.8%, as of June 30, 2015, and December 31, 2014.

In May 2012, RAI entered into forward starting interest rate contracts with an aggregate notional amount of $1 billion. RAI designated those derivatives as cash flow hedges of a future debt issuance, and they were determined to be highly effective at inception. The forward starting interest rate contracts mitigated RAI’s exposure to changes in the benchmark interest rate from the date of inception until the date of the forecasted transaction. On October 31, 2012, RAI completed the sale of $2.55 billion in aggregate principal amount of senior notes, consisting of $450 million of 1.05% senior notes due October 30, 2015, $1.1 billion of 3.25% senior notes due November 1, 2022, and $1 billion of 4.75% senior notes due November 1, 2042. The forward starting interest rate contracts were terminated, and $23 million in associated losses were settled with cash payments to the counterparties. The effective portion of the losses are recorded in accumulated other comprehensive loss in RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2015, and consolidated balance sheet as of December 31, 2014, and will be amortized over the life of the related debt.

The amortization of derivative instruments impacted the condensed consolidated statements of income (unaudited) as follows:

On June 12, 2015, RJR Tobacco assumed the fixed to floating interest rate swap agreements that Lorillard Tobacco held on its 8.125% notes due in 2019. Under the agreement, RJR Tobacco receives interest based on a fixed rate of 8.125% and pays interest

15

Auction Rate Securities

Cost

Gross Unrealized Gain (Loss)

Estimated Fair Value

Balance as of January 1, 2015 $ 99 $ (20 ) $ 79 Balance as of June 30, 2015 $ 99 $ (20 ) $ 79

Mortgage-Backed Security

Cost

Gross Unrealized Gain (Loss)

Estimated Fair Value

Balance as of January 1, 2015 $ 18 $ (6 ) $ 12 Redemptions (1 ) — (1 )

Balance as of June 30, 2015 $ 17 $ (6 ) $ 11



Ended June 30, 2015 2014 2015 2014

Interest and debt expense $ (4 ) $ (4 ) $ (8 ) $ (8 )


based on a floating one-month LIBOR rate plus a spread of 4.625%. The variable rate was 4.812% as of June 30, 2015. The agreements expire in June 2019. The interest rate swap agreements qualify for hedge accounting and were d esignated as fair value hedges at the date of the Merger. Under the swap agreements, RJR Tobacco receives a fixed rate settlement and pays a variable rate settlement with the difference recorded in interest expense. The difference reduced interest expense by $1 million for the three and six months ended June 30, 2015, respectively. As of June 30, 2015, the fair value hedges were highly effective, with an immaterial gain representing the ineffective portion, that was recorded in other (income) expense, net in the condensed consolidated statements of income (unaudited) for the three and six months ended June 30, 2015. See note 10 for additional information relating to fair value hedges. Note 4 — Intangible Assets

The changes in the carrying amounts of goodwill by segment were as follows:

The carrying amounts and changes therein of trademarks and other intangible assets by segment were as follows:

16

RJR

Tobacco American

Snuff Santa Fe All Other Consolidated

Goodwill $ 9,065 $ 2,501 $ 197 $ 44 $ 11,807 Accumulated impairment charges (3,763 ) (28 ) — — (3,791 ) Net goodwill balance as of December 31, 2014 5,302 2,473 197 44 $ 8,016

2015 Activity

Merger goodwill 10,852 — — — 10,852 Divested goodwill (1,849 ) — — — (1,849 )

9,003 — — — 9,003 Net goodwill balance as of June 30, 2015 $ 14,305 $ 2,473 $ 197 $ 44 $ 17,019

RJR Tobacco American

Snuff Santa Fe All Other Consolidated Trademarks Other Trademarks Trademarks Other Trademarks Other

Indefinite-lived: Balance as of December 31, 2014 $ 977 $ 99 $ 1,136 $ 155 $ 4 $ 2,268 $ 103

Trademarks acquired in Merger 26,000 — — — — 26,000 — Trademarks divested (344 ) — — — — (344 ) — Other intangibles divested — (12 ) — — — — (12 ) 25,656 (12 ) — — — 25,656 (12 )

Balance as of June 30, 2015 $ 26,633 $ 87 $ 1,136 $ 155 $ 4 $ 27,924 $ 91

Finite-lived: Balance as of December 31, 2014 $ 12 $ 31 $ 7 $ — $ — $ 19 $ 31

Trademarks acquired in Merger 9 — — — — 9 — Customer list acquired in Merger — 233 — — — — 233 Amortization (2 ) (4 ) — — — (2 ) (4 ) 7 229 — — — 7 229

Balance as of June 30, 2015 $ 19 $ 260 $ 7 $ — $ — $ 26 $ 260


Acquisition-related intangible a ssets include finite-lived trademarks and acquired customer relationships, which are being amortized using the straight-line method over their estimated useful lives, of 5 and 20 years, respectively. In addition, the acquisition-related intangible assets i nclude an indefinite-lived trademark, which is not amortized. Acquisition-related intangible assets are included in the RJR Tobacco segment. Amortization for the three and six months ended June 30, 2015, was $1 million.

As part of the Divestiture, RJR Tobacco divested to Imperial Sub the rights to sell WINSTON and SALEM in U.S. overseas military and U.S. duty-free markets.

Details of finite-lived intangible assets were as follows:

The estimated remaining amortization associated with finite-lived intangible assets is expected to be expensed as follows:

Note 5 — Restructuring

In 2012, RAI announced that it and its subsidiaries, RJR Tobacco and RAI Services Company, had completed a business analysis designed to identify resources to reinvest in their businesses. As a result of this initiative, the total U.S. workforce of RAI and its subsidiaries will decline by a net of approximately 10% upon the completion of the restructuring by the end of 2015. Cash payments related to the restructuring will be substantially complete by the end of 2016.

As of June 30, 2015, $129 million had been utilized to date. Accordingly, in the condensed consolidated balance sheet (unaudited) as of June 30, 2015, $18 million was included in other current liabilities and $2 million was included in other noncurrent liabilities.

The changes in the restructuring liability were as follows:

17

June 30, 2015 December 31, 2014

Gross Accumulated Amortization Net Gross

Accumulated Amortization Net

Customer lists $ 233 $ (1 ) $ 232 $ — $ — $ — Contract manufacturing agreements 151 (137 ) 14 151 (135 ) 16 Trademarks 123 (97 ) 26 114 (95 ) 19 Other intangibles 15 (1 ) 14 15 — 15 $ 522 $ (236 ) $ 286 $ 280 $ (230 ) $ 50

Year Amount

Remainder of 2015 $ 11 2016 22 2017 22 2018 21 2019 15 Thereafter 195

$ 286

Employee Severance and

Benefits

Balance as of December 31, 2013 $ 57 Utilized in 2014 (17 )

Balance as of December 31, 2014 40 Utilized in 2015 (20 )

Balance as of June 30, 2015 $ 20

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) N ote 6 — Income Per Share

The components of the calculation of income per share were as follows:

Note 7 — Inventories

The major components of inventories were as follows:

RJR Tobacco performs its annual LIFO inventory valuation at December 31. Interim periods represent an estimate of the expected annual valuation. Note 8 — Income Taxes

The provision for income taxes from continuing operations was as follows:

The effective tax rate for the three and six months ended June 30, 2015, as compared with the same prior-year period, was unfavorably impacted by an increase in tax attributable to nondeductible acquisition costs, nondeductible goodwill in the amount of $1,849 million associated with the Divestiture and an increase in uncertain tax positions , partially offset by a decrease in tax attributable to the release of a valuation allowance in the amount of $37 million and a reduction in state income taxes. The effective tax rate for the three and six months ended June 30, 2014, was favorably impacted by a decrease in uncertain tax positions related to a federal audit settlement.

The effective tax rate for each period differed from the federal statutory rate of 35% due to the domestic manufacturing deduction of the American Jobs Creation Act of 2004, state income taxes and certain nondeductible items.

The audit of the 2010 and 2011 tax years by the Internal Revenue Service was closed on February 27, 2014. A tax benefit of $25 million attributable to a decrease in uncertain tax positions was recorded in discontinued operations for the six months ended June 30, 2014.

18



Ended June 30, 2015 2014 2015 2014

Income from continuing operations $ 1,928 $ 492 $ 2,317 $ 830 Income from discontinued operations — — — 25 Net income $ 1,928 $ 492 $ 2,317 $ 855

Basic weighted average shares, in thousands 568,177 533,311 549,852 535,037 Effect of dilutive potential shares: Restricted stock units 1,527 1,454 1,748 1,787 Diluted weighted average shares, in thousands 569,704 534,765 551,600 536,824

June 30, 2015 December 31, 2014

Leaf tobacco $ 1,312 $ 1,125 Other raw materials 110 90 Work in process 80 72 Finished products 313 171 Other 39 27 Total 1,854 1,485 LIFO allowance (177 ) (204 ) $ 1,677 $ 1,281

For the Three Months For the Six Months Ended June 30, Ended June 30, 2015 2014 2015 2014

Provision for income taxes from continuing operations $ 2,311 $ 283 $ 2,542 $ 476 Effective tax rate 54.5 % 36.5 % 52.3 % 36.4 %

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) Note 9 — Borrowing Arrangements

Credit Agreement In December 2014, RAI entered into a credit agreement, referred to as the Credit Agreement, with a syndicate of lenders, providing for a five-year,

$2 billion senior unsecured revolving credit facility, which may be increased to $2.35 billion at the discretion of the lenders upon the request of RAI. The Credit Agreement replaced RAI’s four-year, $1.35 billion senior unsecured revolving credit facility dated October 8, 2013.

Subject to certain conditions, RAI is able to use the revolving credit facility under the Credit Agreement for borrowings and issuances of letters of

credit at its option, subject to a $300 million sublimit on the aggregate amount of letters of credit. Issuances of letters of credit reduce availability under such revolving credit facility.

The Credit Agreement contains restrictive covenants that, among other things:

The Credit Agreement contains two financial covenants – a consolidated leverage ratio covenant and a consolidated interest coverage ratio

covenant. Under the Credit Agreement, the consolidated leverage ratio may not exceed:

The Credit Agreement provides that the consolidated interest coverage ratio for any Reference Period ending on the last day of a fiscal quarter may not be less than 4.00 to 1.00.

The maturity date of the Credit Agreement is December 18, 2019 (which date may be extended, subject to certain terms and conditions, with the agreement of the requisite lenders, in two separate one-year increments). The Credit Agreement contains customary events of default, including upon a change in control (as defined therein), which could result in the acceleration of all amounts and cancellation of all commitments outstanding under the Credit Agreement.

The lenders’ obligations under the Credit Agreement to fund borrowings are subject to the accuracy of RAI’ s representations and warranties and the

absence of any default, provided, however, that the accuracy of RAI’s representation as to the absence of any material adverse effect (as defined in the Credit Agreement) is not a condition to borrowing for the purpose of refinancing maturing commercial paper.

Under the terms of the Credit Agreement, RAI is required to pay a facility fee of between 0.100% and 0.275%, based generally on the ratings of

RAI’s senior, unsecured, long-term indebtedness, per annum on the lender commitments in respect of the revolving credit facility thereunder.

Borrowings under the Credit Agreement bear interest, at the option of RAI, at a rate equal to an applicable margin based generally on the ratings of RAI’s senior, unsecured, long-term indebtedness, plus:

19

• limit the ability of RAI and its subsidiaries to (1) pay dividends and repurchase stock, (2) engage in transactions with affiliates, (3) create liens and (4) engage in sale-leaseback transactions involving a Principal Property, as defined in the Credit Agreement;

• limit the ability of RAI and its Material Subsidiaries, as defined in the Credit Agreement, to sell or dispose of all or substantially all of their assets and engage in specified mergers or consolidations; and

• limit the amount of debt that may be incurred by non-guarantor subsidiaries.

• 3.00 to 1.00 as of the last day of any period of four consecutive fiscal quarters, referred to as a Reference Period, ending prior to the closing of the Merger;

• 4.50 to 1.00 for the Reference Periods ending on the last day of the fiscal quarter in which the Merger closes and on the last day of the next two succeeding fiscal quarters;

• 4.25 to 1.00 for the Reference Periods ending on the last day of the next three succeeding quarters;

• 3.75 to 1.00 for the Reference Periods ending on the last day of the next three succeeding quarters; and

• 3.50 to 1.00 thereafter.


Overdue principal outstanding under the revolving credit facility under the Credit Agreement bears interest at a rate equal to the rate then in effect

with respect to such borrowings, plus 2.0% per annum. Any amount besides principal that becomes overdue bears interest at a rate equal to 2.0% per annum in excess of the rate of interest applicable to base rate loans.

Certain of RAI’s subsidiaries, including its Material Subsidiaries, have guaranteed, on an unsecured basis, RAI’s obligations under the Credit

Agreement. In the first six months of 2015, RAI borrowed and repaid $1.4 billion under the Credit Agreement at an average interest rate of 1.37%. As of June

30, 2015, there were no borrowings, and $8 million of letters of credit outstanding under the Credit Agreement.

Bridge Facility

In September 2014, RAI entered into a bridge credit agreement, referred to as the Bridge Facility, with a syndicate of lenders, providing for a 364-day senior unsecured term loan in the aggregate principal amount of up to $9 billion. The Bridge Facility was available for the purpose of financing a portion of the Merger Consideration. As described below in note 10, RAI issued notes, in lieu of borrowing any funds under the Bridge Facility, to finance part of the cash portion of the Merger Consideration. By its terms, the Bridge Facility terminated on June 12, 2015. Amortization and fees related to the Bridge Facility were $17 million and $48 million for the three and six months ended June 30, 2015, respectively, and were included in interest and debt expense.

Note 10 — Long-Term Debt

New Notes

On June 12, 2015, RAI completed an underwritten public offering of $9.0 billion aggregate principal amount of its senior notes, consisting of $1.25 billion aggregate principal amount of 2.30% Senior Notes due 2018, $1.25 billion aggregate principal amount of 3.25% Senior Notes due 2020, $1.0 billion aggregate principal amount of 4.00% Senior Notes due 2022, $2.5 billion aggregate principal amount of 4.45% Senior Notes due 2025, $750 million aggregate principal amount of 5.70% Senior Notes due 2035 and $2.25 billion aggregate principal amount of 5.85% Senior Notes due 2045. The foregoing RAI notes are collectively referred to as the New Notes. The proceeds from the offering of the New Notes were used to fund part of the cash portion of the Merger Consideration, the unpaid fees and expenses incurred in connection with the Merger and related transactions contemplated by the Merger Agreement, and the payment of certain Lorillard equity awards and certain change of control payments, also as contemplated by the Merger Agreement.

The New Notes are unsecured, and are fully and unconditionally guaranteed on a senior unsecured basis by certain of RAI’s subsidiaries, including its material domestic subsidiaries, which are the same guarantors that guarantee its other outstanding senior notes and its Credit Agreement. Any guarantor that is released from its guarantee under the Credit Agreement, or any replacement or refinancing thereof, also will be released automatically from its guarantee of the New Notes and RAI’s other outstanding notes. RAI may redeem the New Notes in whole or in part at any time at the applicable redemption price. If RAI experiences specific kinds of changes of control, accompanied by a certain credit ratings downgrade of any series of New Notes, RAI must offer to repurchase such series.

Lorillard Tobacco Notes

Immediately prior to the Merger, Lorillard Tobacco had outstanding an aggregate of $3.5 billion in principal amount of senior unsecured notes in seven series, referred to as the Lorillard Tobacco Notes, all of which were guaranteed by Lorillard. In connection with the Lorillard Tobacco Merger, RJR Tobacco assumed Lorillard Tobacco’s obligations under the Lorillard Tobacco Notes and the indenture governing the Lorillard Tobacco Notes, referred to as the Lorillard Tobacco Indenture, and RJR assumed Lorillard’s obligations as guarantor under the Lorillard Tobacco Notes and the Lorillard Tobacco Indenture.

20

• the alternate base rate, which is the higher of (1) the federal funds effective rate from time to time plus 0.5%, (2) the prime rate and (3) the reserve adjusted eurodollar rate for a one month interest period plus 1%; or

• the eurodollar rate, which is the reserve adjusted rate at which eurodollar deposits for one, two, three or six months are offered in the interbank eurodollar market.


RAI’s long-term debt, net of discounts and including adjustments associated with interest rate swaps of $38 million and $48 mill ion as of June 30, 2015 and December 31, 2014, respectively, is below. RJR Tobacco’s long-term debt, including adjustments associated with interest rate swaps of $59 million and adjustments to fair value of $392 million as of June 30, 2015, is below.

__________________ * The interest rate payable on these notes generally is subject to adjustment from time to time (as detailed in the form of these notes) based upon the credit rating assigned to these notes, provided that in no event will (1) the interest rate for these notes be reduced below 8.125% or (2) the total increase in the interest rate on these notes exceed 2.0% above 8.125%.

As of June 30, 2015, the maturities of RAI and RJR Tobacco’s notes, net of discounts, were as follows:

Exchange Offers and Consent Solicitations

On June 11, 2015, RAI commenced (1) private offers to exchange, referred to as the Exchange Offers, any and all (to the extent held by eligible holders) of the Lorillard Tobacco Notes for a series of new RAI senior notes, referred to as the Exchange Notes, having the same interest payment and maturity dates and interest rate provisions as the corresponding series of Lorillard Tobacco

21

June 30, 2015 December 31, 2014

RAI 2.30% notes due 2018 $ 1,250 $ — 3.25% notes due 2020 1,250 — 3.25% notes due 2022 1,099 1,099 4.00% notes due 2022 999 — 4.45% notes due 2025 2,492 — 4.75% notes due 2042 992 992 4.85% notes due 2023 550 550 5.70% notes due 2035 747 — 5.85% notes due 2045 2,238 — 6.15% notes due 2043 547 547 6.75% notes due 2017 738 747 7.25% notes due 2037 448 448 7.75% notes due 2018 249 250 Total RAI long-term debt $ 13,599 $ 4,633 RJR Tobacco 2.300% notes due 2017 $ 505 $ — 3.500% notes due 2016 511 — 3.750% notes due 2023 486 — 6.875% notes due 2020 870 — 7.000% notes due 2041 299 — 8.125% notes due 2019* 954 — 8.125% notes due 2040 326 — Total RJR Tobacco long-term debt $ 3,951 $ — Total long-term debt (less current maturities) $ 17,550 $ 4,633 Current maturities of long-term debt 450 450 $ 18,000 $ 5,083

Year RAI RJR Tobacco Total

2015 $ 450 $ — 450 2016 — 500 500 2017 700 500 1,200 2018 1,500 — 1,500 2019 — 750 750 2020 1,250 750 2,000 2022 and thereafter 10,111 1,000 11,111 $ 14,011 $ 3,500 $ 17,511


Notes, and (2) related consent solicitations, referred to as the Consent S olicitations, of the eligible holders of each series of Lorillard Tobacco Notes to amend the Lorillard Tobacco Indenture, with such amendments referred to as the Indenture Amendments.

The Exchange Offers and Consent Solicitations expired on July 10, 2015, referred to as the Expiration Date. Eligible holders who validly tendered, and did not validly withdraw, their Lorillard Tobacco Notes in the Exchange Offers (and thereby gave, and did not validly revoke, their consents to the Indenture Amendments) received, upon settlement of the Exchange Offers and Consent Solicitations on July 15, 2015, Exchange Notes in the same principal amount as the Lorillard Tobacco Notes tendered therefor plus a consent payment of $2.50 per $1,000 principal amount of Lorillard Tobacco Notes tendered. The following table sets forth, as of the Expiration Date, the principal amounts of each series of Lorillard Tobacco Notes that (1) had been validly tendered and not validly withdrawn (and consents thereby validly given and not validly revoked) and (2) were not tendered in the Exchange Offers:

RJR Tobacco remains the principal obligor of the Lorillard Tobacco Notes that were not tendered in the Exchange Offers, and currently RAI and RJR are the guarantors of such notes. The Exchange Notes are the principal obligations of RAI and are guaranteed by the same guarantors as RAI’s other outstanding senior notes, including the New Notes. Unlike RAI’s outstanding senior notes, including the New Notes and Exchange Notes, the Lorillard Tobacco Notes (with a limited exception for the 3.75% Lorillard Tobacco Notes due 2023) are not redeemable at the option of the issuer prior to maturity. The Exchange Notes were issued in a private offering exempt from, or not subject to, the registration requirements of the federal securities laws. RAI entered into a registration rights agreement, however, upon the settlement of the Exchange Offers, pursuant to which RAI has agreed, among other things, to offer to exchange the Exchange Notes for materially identical notes which have been registered under the Securities Act of 1933. Upon certain defaults under the registration rights agreement, additional interest will accrue on the Exchange Notes.

In addition, RAI received the requisite number of consents to adopt the Indenture Amendments, which became operative on the July 15, 2015, settlement date, with respect to each of the seven series of Lorillard Tobacco Notes. The Indenture Amendments:

On June 12, 2015, RJR Tobacco assumed the interest rate swap agreements associated with the 8.125% Lorillard Tobacco Notes due in 2019. The interest rate swap agreements qualify for hedge accounting and were designated as fair value hedges at the date of the Merger. Under the swap agreements, RJR Tobacco receives a fixed rate settlement and pays a variable rate settlement with the difference recorded in interest expense.

For derivatives designated as fair value hedges, which relate entirely to hedges of long-term debt, changes in the fair value of the derivatives are recorded in other assets or other liabilities with an offsetting adjustment to the carrying amount of the hedged debt. Any temporary differences in the change in the fair value of the derivatives relative to the change in the fair value of the hedged debt are recorded in other (income) expense, net. At June 30, 2015, the adjusted carrying amount of the hedged debt was $954 million, and the amount included in other assets and deferred charges included in the condensed consolidated balance sheet (unaudited) was $59 million.

22

Series of Lorillard Tobacco Notes

Principal Amount of Lorillard Tobacco Notes Outstanding Prior to Exchange

Offers

Principal Amount of Lorillard Tobacco Notes Tendered in Exchange Offers

Principal Amount of Lorillard Tobacco

Notes Not Tendered in Exchange Offers

2.300% notes due 2017 $ 500 $ 447 $ 53 3.500% notes due 2016 500 415 85 3.750% notes due 2023 500 474 26 6.875% notes due 2020 750 641 109 7.000% notes due 2041 250 240 10 8.125% notes due 2019 750 669 81 8.125% notes due 2040 250 237 13 $ 3,500 $ 3,123 $ 377

• eliminated substantially all of the restrictive covenants and a bankruptcy event of default for the issuer and the guarantor of the Lorillard Tobacco Notes under the Lorillard Tobacco Indenture;

• eliminated the requirement under the Lorillard Tobacco Indenture that the guarantor of the Lorillard Tobacco Notes continue to provide holders of the Lorillard Tobacco Notes with financial statements and other financial information similar to that provided in periodic reports under the Securities Exchange Act of 1934 when it is not subject to such reporting requirements; and

• relieved the issuer of the Lorillard Tobacco Notes of the requirement (if any) under the Lorillard Tobacco Indenture that the issuer offer to repurchase the Lorillard Tobacco Notes upon certain change of control events combined with certain credit ratings events to the extent such change of control events relate to, arise out of or are undertaken in connection with the Merger or the Lorillard Tobacco Merger.


See note 2 for additional information on the Merger and note 3 for additional information on interest rate management. Note 11 — Commitments and Contingencies

Tobacco Litigation — General

Introduction

Various legal proceedings or claims, including litigation claiming that cancer and other diseases, as well as addiction, have resulted from the use of, or exposure to, RAI’s operating subsidiaries’ products, are pending or may be instituted against RJR Tobacco (including as successor by merger of Lorillard Tobacco, as detailed below), American Snuff Co. or their affiliates, including RAI, RJR, Lorillard or indemnitees, including B&W. These pending legal proceedings include claims relating to cigarette products manufactured by RJR Tobacco, Lorillard Tobacco or certain of their affiliates or indemnitees, as well as claims relating to smokeless tobacco products manufactured by American Snuff Co. A discussion of the legal proceedings relating to cigarette products is set forth below under the heading “— Litigation Affecting the Cigarette Industry.” All of the references under that heading to tobacco-related litigation, smoking and health litigation and other similar references are references to legal proceedings relating to cigarette products and are not references to legal proceedings involving smokeless tobacco products, and case numbers under that heading include only cases involving cigarette products. The legal proceedings relating to the smokeless tobacco products manufactured by American Snuff Co. are discussed separately under the heading “— Smokeless Tobacco Litigation” below.

In connection with the B&W business combination, RJR Tobacco has agreed to indemnify B&W and its affiliates, including its indirect parent,

BAT, against certain liabilities, costs and expenses incurred by B&W or its affiliates arising out of the U.S. cigarette and tobacco business of B&W. As a result of this indemnity, RJR Tobacco has assumed the defense of pending B&W-specific tobacco-related litigation, has paid the judgments and costs related to certain pre-business combination tobacco-related litigation of B&W, and has posted bonds on behalf of B&W, where necessary, in connection with cases decided since the B&W business combination. In connection with the Merger and Divestiture, as applicable, RAI and RJR Tobacco undertook certain indemnification obligations. See “— Other Contingencies – Imperial Sub Indemnity” and “— Other Contingencies –Loews Indemnity” below.

On June 12, 2015, Lorillard Tobacco was merged with and into RJR Tobacco, with RJR Tobacco as the surviving entity and Lorillard Tobacco

ceasing to exist. As a consequence of the Lorillard Tobacco Merger, RJR Tobacco succeeded to Lorillard Tobacco’s liabilities, and RJR Tobacco assumed the defense of pending Lorillard Tobacco litigation and will be responsible for paying judgments, paying costs, and posting bonds relating to Lorillard Tobacco’s litigation. Although Lorillard Tobacco no longer exists as a result of the Lorillard Tobacco Merger, it will remain as a named party in cases pending on the date of the Lorillard Tobacco Merger until courts grant motions to substitute RJR Tobacco for Lorillard Tobacco or the claims are dismissed. Certain Terms and Phrases

Certain terms and phrases used in this disclosure may require some explanation. The term “judgment” or “final judgment” refers 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. In most cases, 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 limits set by court or statute.

The term “per curiam” refers to an opinion entered by a court. In most cases, it is used to indicate that the opinion entered is a brief announcement

of the court’s decision and is not accompanied by a written opinion.

The term “settlement” refers to certain types of cases in which cigarette manufacturers, including RJR Tobacco, B&W and Lorillard Tobacco, have agreed to resolve disputes with certain plaintiffs without resolving the case through trial. The principal terms of certain settlements entered into by RJR Tobacco, B&W and Lorillard Tobacco are explained below under “— Accounting for Tobacco-Related Litigation Contingencies.”

23

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) Theories of Recovery

The plaintiffs seek recovery on a variety of legal theories, including negligence, strict liability in tort, design defect, failure to warn, fraud, misrepresentation, unfair trade practices, conspiracy, medical monitoring and violations of state and federal antitrust laws. In certain of these cases, the plaintiffs claim that cigarette smoking exacerbated injuries caused by exposure to asbestos or, in the case of certain claims asserted against Lorillard Tobacco, that they were injured by exposure to asbestos-containing filters used in one cigarette brand for roughly four years before 1957.

The plaintiffs seek various forms of relief, including compensatory and, where available, punitive damages, treble or 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 alleged damages often are not determinable from a complaint, and the law governing the pleading and calculation of damages varies from 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, Lorillard Tobacco, American Snuff Co. and their affiliates and indemnitees include, where applicable and otherwise appropriate, preemption by the Federal Cigarette Labeling and Advertising Act of some or all claims arising after 1969, or by the Comprehensive Smokeless Tobacco Health Education Act for claims arising after 1986, 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. RAI, RJR and Lorillard have asserted additional defenses, including jurisdictional defenses, in many of the cases in which they are named. Accounting for Tobacco-Related Litigation Contingencies

In accordance with GAAP, RAI and its subsidiaries, including RJR Tobacco, American Snuff Co. and SFNTC, as applicable, record any loss concerning litigation at such time as an unfavorable outcome becomes probable and the amount can be reasonably estimated on an individual case-by-case basis. For the reasons set forth below, RAI’s management continues to conclude that the loss of any particular pending smoking and health tobacco litigation claim against RJR Tobacco, Lorillard Tobacco or their affiliates or indemnitees, or the loss of any particular claim concerning the use of smokeless tobacco products against American Snuff Co., when viewed on an individual basis, is not probable, except for the Engle Progeny cases noted below.

RJR Tobacco and its affiliates believe that they have valid defenses to the smoking and health tobacco litigation claims against them, as well as

valid bases for appeal of adverse verdicts against them. RAI, Lorillard, RJR Tobacco, Lorillard Tobacco and their affiliates and indemnitees have, through their counsel, filed pleadings and memoranda in pending smoking and health tobacco litigation that set forth and discuss a number of grounds and defenses that they and their counsel believe have a valid basis in law and fact. With the exception of the Engle Progeny cases described below, RJR Tobacco, Lorillard Tobacco and their affiliates and indemnitees 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, including Engle Progeny cases, continue to be dismissed at or before trial. Based on their experience in smoking and health tobacco litigation and the strength of the defenses available to them in such litigation, RJR Tobacco and its affiliates believe that their successful defense of smoking and health tobacco litigation in the past will continue in the future.

RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2015 contains accruals for the following Engle Progeny cases: Hiott , Starr-Blundell , Clayton , Ward , Hallgren , Cohen , Sikes , Thibault , Buonomo , Mrozek and Tullo ; as well as payments for attorneys’ fees and statutory interest for Koballa , Webb , and Brown , the judgments of which were paid in 2014. Other accruals include an amount for the estimated costs of the corrective communications in the U.S. Department of Justice case and RJR Tobacco’s and Lorillard Tobacco’s share of the proposed federal Engle Progeny settlement. Also, RJR Tobacco paid the amount agreed to by RJR Tobacco and the State of Mississippi to resolve claims that were brought, could have been brought, or could be brought against RJR Tobacco, B&W or Lorillard in the enforcement actions filed in the Mississippi Chancery Court. As other cases proceed through the appellate process, RAI will evaluate the need for further accruals on an individual case-by-case basis if an unfavorable outcome becomes probable and the amount can be reasonably estimated.

It is the policy of RJR Tobacco and its affiliates to defend tobacco-related litigation claims vigorously; generally, RJR Tobacco and its affiliates and indemnitees do not settle such claims. However, RJR Tobacco and its affiliates may enter into settlement discussions in some cases, if they believe it is in their best interests to do so. Exceptions to this general approach include actions taken pursuant to “offer of judgment” statutes, as described below in “ — Litigation Affecting the Cigarette Industry—Overview,” and Filter Cases, as described below in “— Litigation Affecting the Cigarette Industry—Filter Cases,” as well as other historical examples discussed below.

24


With respect to smoking and health tobacco litigation claims, the only significant settlements reached by RJR Tobacco and B&W involved:

The circumstances surrounding the State Settlement Agreements and the funding of a trust fund to benefit the tobacco growers are readily

distinguishable from the current categories of smoking and health cases involving RJR Tobacco, Lorillard Tobacco or their affiliates and indemnitees. The claims underlying the State Settlement Agreements were brought on behalf of the states to recover funds paid for health care and medical and other assistance to state citizens suffering from diseases and conditions allegedly related to tobacco use. The 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 State Settlement Agreements, and a table depicting the related payment schedule, is set forth below under “— Litigation Affecting the Cigarette Industry — Health-Care Cost Recovery Cases.”

The states were a unique set of plaintiffs and are not involved in any of the smoking and health cases remaining against RJR Tobacco, Lorillard Tobacco or their affiliates and indemnitees. Although RJR Tobacco, Lorillard Tobacco and certain of their affiliates and indemnitees continue to be defendants in health-care cost recovery cases similar in theory to the state cases but involving other plaintiffs, such as Native American tribes and foreign governments, the vast majority of such cases have been dismissed on legal grounds. RJR Tobacco and its affiliates, including RAI, believe that the same legal principles that have resulted in dismissal of health-care cost recovery cases either at the trial court level or on appeal should compel dismissal of the similar pending cases.

As with claims that were resolved by the State Settlement Agreements, the other cases settled by RJR Tobacco can be distinguished from existing

cases pending against RJR Tobacco, Lorillard Tobacco and their affiliates and indemnitees. The original Broin case, discussed below under “— Litigation Affecting the Cigarette Industry — Broin II Cases,” was settled in the middle of trial during negotiations concerning a possible nation-wide settlement of claims similar to those underlying the State Settlement Agreements.

The federal Engle Progeny cases likewise presented exceptional circumstances not present in the state Engle Progeny cases or elsewhere. All of the

federal Engle Progeny cases subject to the proposed settlement were pending in the same court, coordinated by the same judge, and involved the same sets of plaintiffs’ lawyers. Moreover, RJR Tobacco settled only after the docket was reduced by approximately 90%. A discussion of the Engle Progeny cases and the settlement of the federal Engle Progeny cases is set forth below under “— Litigation Affecting the Cigarette Industry – Engle and Engle Progeny Cases.”

In 2010, RJR Tobacco entered into a comprehensive agreement with the Canadian federal, provincial and territorial governments, which resolved

all civil claims related to the movement of contraband tobacco products in Canada during the period 1985 through 1999 that the Canadian governments could assert against RJR Tobacco and its affiliates. These claims were separate from any smoking and health tobacco litigation.

Also, in 2004, RJR Tobacco and B&W separately settled the antitrust case DeLoach v. Philip Morris Cos., Inc., which was brought by a unique

class of plaintiffs: a class of all tobacco growers and tobacco allotment holders. The plaintiffs asserted that the defendants conspired to fix the price of tobacco leaf and to destroy the federal government’s tobacco quota and price support program. Despite legal defenses they believed to be valid, RJR Tobacco and B&W separately settled this case to avoid a long and contentious trial with the tobacco growers. The DeLoach case and the antitrust case previously pending against RJR Tobacco and B&W involve different types of plaintiffs and different theories of recovery under the antitrust laws than the smoking and health cases pending against RJR Tobacco, Lorillard Tobacco and their affiliates and indemnitees.

Finally, as discussed under “— Litigation Affecting the Cigarette Industry — State Settlement Agreements—Enforcement and Validity;

Adjustments,” RJR Tobacco, B&W and Lorillard Tobacco each has settled certain cases brought by states concerning the enforcement of State Settlement Agreements. Despite legal defenses believed to be valid, these cases were settled to avoid further contentious litigation with the states involved. These enforcement actions involve alleged breaches of State Settlement Agreements

25

• the State Settlement Agreements and the funding by various tobacco companies of a $5.2 billion trust fund contemplated by the MSA to benefit tobacco growers;

• the original Broin flight attendant case discussed below under “— Litigation Affecting the Cigarette Industry — Broin II Cases,” and

• most of the Engle Progeny cases pending in federal court, after the initial docket of over 4,000 such cases was reduced to approximately 400 cases.

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) based on specific actions taken by particular defendants. Accordingly, any future enforcement actions involving State Settlement Agreements will be reviewed by RJR Tobacco on the merits and should not be affected by the settlement of prior enforcemen t cases.

American Snuff Co. also believes that it has valid defenses to the smokeless tobacco products litigation against it. American Snuff Co. asserted and

will continue to assert some or all of these defenses in each case at the time and in the manner deemed appropriate by American Snuff Co. and its counsel. No verdict or judgment has been returned or entered against American Snuff Co. on any claim for personal injuries allegedly resulting from the use of smokeless tobacco products. American Snuff Co. intends to defend vigorously all smokeless tobacco litigation claims asserted against it. No liability for pending smokeless tobacco litigation was recorded in RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2015. Cautionary Statement

Even though RAI’s management continues to conclude that the loss of particular pending smoking and health tobacco litigation claims against RJR Tobacco, Lorillard Tobacco or their affiliates or indemnitees, or the loss of any particular case concerning the use of smokeless tobacco against American Snuff Co., when viewed on an individual case-by-case basis, is not probable or estimable (except for the Engle Progeny cases described below), the possibility of material losses related to such litigation is more than remote. Litigation is subject to many uncertainties, and generally, it is not possible to predict the outcome of any particular litigation pending against RJR Tobacco, Lorillard Tobacco, American Snuff Co. or their affiliates or indemnitees, or to reasonably estimate the amount or range of any possible loss.

Although RJR Tobacco believes that it has valid bases for appeals of adverse verdicts in its pending cases, and RJR Tobacco, Lorillard and RAI believe they have valid defenses to all actions, and intend to defend them vigorously as described above, it is possible that there could be further adverse developments in pending cases, and that additional cases could be decided unfavorably against RAI, RJR Tobacco, Lorillard, Lorillard Tobacco or their 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 have a material adverse effect on the litigation against RJR Tobacco, Lorillard Tobacco or their affiliates or indemnitees and could encourage the commencement of additional tobacco-related litigation. RJR Tobacco and its affiliates also may enter into settlement discussions in some cases, if they believe it is in their best interests to do so. 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 or its affiliates or indemnitees, a significant increase in litigation or in adverse outcomes for tobacco defendants, or difficulties in obtaining the bonding required to stay execution of judgments on appeal, could have a material adverse effect on any or all of these entities. Moreover, notwithstanding the quality of defenses available to RJR Tobacco, Lorillard Tobacco and their affiliates and indemnitees in litigation matters, it is possible that RAI’s results of operations, cash flows or financial position could be materially adversely affected by the ultimate outcome of certain pending litigation matters against RJR Tobacco, Lorillard Tobacco or their affiliates or indemnitees.

Similarly, smokeless tobacco litigation is subject to many uncertainties. Notwithstanding the quality of defenses available to American Snuff Co., it is possible that RAI’s results of operations, cash flows or financial position could be materially adversely affected by the ultimate outcome of certain pending litigation matters against American Snuff Co. Litigation Affecting the Cigarette Industry Overview

Introduction. In connection with the B&W business combination, RJR Tobacco agreed to indemnify B&W and its affiliates against, among other things, certain litigation liabilities, costs and expenses incurred by B&W or its affiliates arising out of the U.S. cigarette and tobacco business of B&W. As a result of the Lorillard Tobacco Merger, Lorillard Tobacco was merged into RJR Tobacco with RJR Tobacco the surviving entity, Lorillard Tobacco ceasing to exist, and RJR Tobacco succeeding to Lorillard Tobacco’s liabilities, including Lorillard Tobacco’s litigation liabilities, costs and expenses. Accordingly, the cases discussed below include cases brought against RJR Tobacco, Lorillard Tobacco and their affiliates and indemnitees, including RAI, RJR, B&W and Lorillard.

During the second quarter of 2015, 26 tobacco-related cases, including two Engle Progeny cases, were served against RJR Tobacco, Lorillard

Tobacco (before the Lorillard Tobacco Merger), or RJR Tobacco’s affiliates or indemnitees. On June 30, 2015, there were 262 cases pending against RJR Tobacco, Lorillard Tobacco or their affiliates or indemnitees: 245 in the United States and 17 in

26

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) Canada, as compared with 170 total cases on June 30, 2014. The U.S. case number does not include the approximately 567 individual smoker cases pending in West Virginia state court as a consolidated action, 3,58 1 Engle Progeny cases, involving approximately 4,591 individual plaintiffs, and 2,545 Broin II cases (as hereinafter defined), pending in the United States against RJR Tobacco, Lorillard Tobacco or their affiliates or indemnitees. Of the U.S. cases pendin g on June 30, 2015, 17 are pending in federal court, 227 in state court and 1 in tribal court, primarily in the following states: Illinois (39 cases); Maryland (36 cases); Florida (30 cases); New York (21 cases); Missouri (19 cases); Delaware (16 cases); a nd California (11 cases).

The following table lists the categories of the U.S. tobacco-related cases pending against RJR Tobacco, Lorillard Tobacco or their affiliates or indemnitees as of June 30, 2015, compared with the number of cases pending against RJR Tobacco or its affiliates or indemnitees as of March 31, 2015, as reported in RAI’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2015, filed with the SEC on April 20, 2015, and a cross-reference to the discussion of each case type.

The following cases against RJR Tobacco, B&W and Lorillard Tobacco have attracted significant attention: the Florida state court class-action case,

Engle v. R. J. Reynolds Tobacco Co . and the related Engle Progeny cases; and the case brought by the U.S. Department of Justice under the federal Racketeer Influenced and Corrupt Organizations Act, referred to as RICO.

In 2000, a jury in Engle v. Liggett Group , a class action brought against the major U.S. cigarette manufacturers by Florida smokers allegedly harmed by their addiction to nicotine, rendered a $145 billion punitive damages verdict in favor of the class. In 2006, the Florida Supreme Court set aside that award, prospectively decertified the class, and preserved several of the Engle jury findings for use in subsequent individual actions to be filed within one year of its decision. The preserved findings include jury determinations that smoking causes various diseases, that nicotine is addictive, and that each defendant sold cigarettes that were defective and unreasonably dangerous, committed unspecified acts of negligence and individually and jointly concealed unspecified information about the health risks of smoking.

In the wake of Engle , thousands of individual progeny actions were filed in federal and state courts in Florida against the major tobacco companies,

including RJR Tobacco, B&W, Lorillard Tobacco and Philip Morris USA Inc. Such actions are commonly referred to as “ Engle Progeny” cases. As of June 30, 2015, 442 Engle Progeny cases were pending in federal court, and 3,138 of them were pending in state court. These cases include approximately 4,590 plaintiffs. In addition, as of June 30, 2015, RJR Tobacco was aware of 11 additional Engle Progeny cases that had been filed but not served. One hundred eighteen Engle Progeny cases have been tried in Florida state and federal courts since the beginning of 2012, and numerous state court trials are scheduled for 2015. The number of pending cases fluctuates for a variety of reasons, including voluntary and involuntary dismissals. Voluntary dismissals include cases in which a plaintiff accepts an “offer of judgment,” referred to in Florida statutes as “proposals for settlement,” from RJR Tobacco, Lorillard Tobacco and/or RJR Tobacco’s affiliates. An offer of judgment, if rejected by the plaintiff, preserves RJR

27

Case Type

RJR Tobacco’s U.S. Case Numbers as of June 30, 2015***

Change in Number of Cases Since

March 31, 2015 Increase/(Decrease)

Page Reference

Individual Smoking and Health 112 12 33 West Virginia IPIC (Number of Plaintiffs)* 1 (approx. 567) No change 35

Engle Progeny (Number of Plaintiffs)** 3,580 (approx.

4,590) (58) (91) 35 Broin II 2,545 (10) 47 Class Action 21 1 48 Filter Cases 67 67 51 Health-Care Cost Recovery 2 No change 51

State Settlement Agreements—Enforcement and Validity; Adjustments 28 No change 57

Other Litigation and Developments 14 3 62

* Includes as one case the approximately 567 cases pending as a consolidated action In Re: Tobacco Litigation Individual Personal Injury Cases , sometimes referred to as West Virginia IPIC cases, described below. The West Virginia IPIC cases have been separated from the Individual Smoking and Health cases for reporting purposes.

** The Engle Progeny cases have been separated from the Individual Smoking and Health cases for reporting purposes. The number of cases does not reflect the impact of the proposed federal Engle Progeny settlement.

*** RJR Tobacco's case number increased as a result of the Lorillard Tobacco Merger as follows: Individual Smoking and Health - 6; Class Action - 1; West Virginia IPIC - 3; Engle Progeny - 10; Filter Cases - 67.

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) Tobacco and Lorillard Tobacco’s right to recover attorneys’ fees under Florida law in the event of a verdict favorable to RJR Tobacco or Lorillard Tobacco. Such offers are sometimes made through court-ordered mediations.

During the first quarter of 2015, RJR Tobacco and Lorillard Tobacco, together with Philip Morris USA Inc., tentatively settled virtually all of the

Engle Progeny cases then pending against them in federal district court. The total amount of the settlement was $100 million divided as follows: RJR Tobacco - $42.5 million; Philip Morris USA Inc. - $42.5 million; and Lorillard Tobacco - $15 million. The settlement covers more than 400 federal progeny cases but does not cover 13 federal progeny cases previously tried to verdict and currently pending on post-trial motions or appeal; approximately two federal progeny cases pending as of June 30, 2015 involving pro se plaintiffs unrepresented by counsel; and two federal progeny cases filed by different lawyers from the ones who negotiated the settlement for the plaintiffs. In March 2015, RJR Tobacco and Lorillard Tobacco paid their share of the settlement to an escrow account now under RJR Tobacco’s control for disbursements and has reflected this balance as restricted cash in other current assets with a corresponding balance in other current liabilities in RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2015.

At the beginning of the Engle Progeny litigation, a central issue was the proper use of the preserved Engle findings. RJR Tobacco has argued that

use of the Engle findings to establish individual elements of progeny claims (such as defect, negligence and concealment) is a violation of federal due process. In 2013, however, both the Florida Supreme Court and the U.S. Court of Appeals for the Eleventh Circuit, referred to as the Eleventh Circuit, rejected that argument. In addition to this global due process argument, RJR Tobacco and Lorillard Tobacco raise many other factual and legal defenses as appropriate in each case. These defenses may include, among other things, arguing that the plaintiff is not a proper member of the Engle class, that the plaintiff did not rely on any statements by any tobacco company, that the trial was conducted unfairly, that some or all claims are preempted or barred by applicable statutes of limitation, or that any injury was caused by the smoker’s own conduct. In Hess v. Philip Morris USA Inc . and Russo v. Philip Morris USA Inc ., decided on April 2, 2015, the Florida Supreme Court held that, in Engle Progeny cases, the defendants cannot raise a statute of repose defense to claims for concealment or conspiracy. The defendants in each of these cases filed a motion for rehearing on April 17, 2015. On April 8, 2015, in Graham v. R. J. Reynolds Tobacco Co ., the Eleventh Circuit held that federal law impliedly preempts use of the preserved Engle findings to establish claims for strict liability or negligence. On April 28, 2015, the plaintiff in Graham filed a motion for rehearing en banc . A decision is pending.

Thirty-four Engle Progeny cases that were tried have become final through June 30, 2015. These cases resulted in aggregate payments by RJR

Tobacco or Lorillard Tobacco of $276.4 million ($212.3 million for compensatory and punitive damages and $64.1 million for attorneys’ fees and statutory interest). During the second quarter of 2015, payments were made for attorneys’ fees and statutory interest in Koballa , Webb and Brown , the judgments of which were paid in 2014. Based on RJR Tobacco’s evaluation, accruals for compensatory and punitive damages and attorneys’ fees and statutory interest for Hiott, Starr-Blundell, Clayton, Ward, Hallgren, Cohen, Sikes, Thibault, Buonomo, Mrozek and Tullo were recorded in RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2015. The following chart reflects the details related to Hiott, Starr-Blundell, Clayton, Cohen, Buonomo, Hallgren, Sikes, and Thibault :

28


The following chart reflects verdicts in all other individual Engle Progeny cases, pending as of June 30, 2015, in which a verdict has been returned

against RJR Tobacco, B&W or Lorillard Tobacco, or all three, and has not been set aside on appeal. No liability for any of these cases has been recorded in RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2015. This chart does not include the mistrials or verdicts returned in favor of RJR Tobacco, B&W or Lorillard Tobacco, or all three.

29

Plaintiff Case Name

RJR Tobacco

Allocation of Fault

Lorillard Tobacco Allocation of

Fault

Compensatory Damages

(as adjusted) (1) Punitive Damages Appeal Status

Hiott 40% — $ 730,000 $ — Notice to invoke jurisdiction of Florida Supreme Court pending

Starr-Blundell 10% — 50,000 — Notice to invoke jurisdiction of Florida Supreme Court pending; stayed pending resolution of Soffer v. R. J. Reynolds Tobacco Co.

Clayton 10% — 60,000 — Pending – First DCA Cohen 33.3% — 3,330,000 10,000,000 Remanded for partial new trial;

notice to invoke jurisdiction of Florida Supreme Court pending

Buonomo 77.5% — 4,060,000 25,000,000 Remanded for new trial; notice to invoke jurisdiction of Florida Supreme Court pending; appeal of reinstated punitive damages award pending in Fourth DCA

Hallgren 25% — 500,000 750,000 Notice to invoke jurisdiction of Florida Supreme Court pending; stayed pending resolution of Soffer v. R. J. Reynolds Tobacco Co.

Sikes 51% — 3,520,000 2,000,000 Notice to invoke jurisdiction of Florida Supreme Court pending

Thibault 70% — 1,750,000 1,275,000 First DCA affirmed the judgment, per curiam; notice to invoke the discretionary jurisdiction of Florida Supreme Court pending

Totals $ 14,000,000 $ 39,025,000

(1) Compensatory damages are adjusted to reflect the reduction that may be required by the allocation of fault. Punitive damages are not adjusted and reflect the amount of the final judgment(s) signed by the trial court judge(s). The amounts listed above do not include attorneys’ fees or statutory interest.


30

Plaintiff Case Name

RJR Tobacco Allocation of

Fault

Lorillard Tobacco Allocation of

Fault

Compensatory Damages

(as adjusted) (1) Punitive Damages Appeal Status

Putney 30% — — — Reversed and remanded for further proceedings; notice to invoke jurisdiction of Florida Supreme Court pending

Andy Allen 24% — 2,475,000 7,756,000 Reversed and remanded for new trial; new trial completed on November 26, 2014; final judgment has not been entered

Jewett 20% 10% — — Reversed and remanded for new trial; new trial has not been scheduled

Soffer 40% — 2,000,000 — Pending – Florida Supreme Court Ciccone 30% — 1,000,000 — Pending – Florida Supreme Court Calloway 27% 18% 16,100,000 (2) 29,850,000 Pending – Fourth DCA Hancock 5% — 700 — Fourth DCA affirmed, per curiam James Smith 55% — 600,000 (2) 20,000 Pending – Eleventh Circuit Ballard 55% — 5,000,000 — Notice to invoke jurisdiction of

Florida Supreme Court pending Evers 60% 9% 2,036,000 — Punitive damages of $12.4 million

set aside by trial court; pending – Second DCA

Schoeff 75% — 7,875,000 30,000,000 Pending – Fourth DCA Marotta 58% — 3,480,000 — Pending – Fourth DCA Searcy 30% — 1,000,000 (2) 1,670,000 Pending – Eleventh Circuit Earl Graham 20% — 550,000 — Eleventh Circuit held that federal

law impliedly preempts claims for strict liability and negligence based on the defect and negligence findings from Engle

Skolnick 30% — — — Fourth DCA set aside judgment and ordered a partial new trial

Grossman 75% — 15,350,000 (2) 22,500,000 Pending – Fourth DCA Gafney 33% 33% 3,828,000 — Pending – Fourth DCA Cheeley 50% — 1,500,000 2,000,000 Pending – Fourth DCA Goveia 35% — 297,500 2,250,000 Fifth DCA affirmed per curiam Bowden 30% — 1,500,000 — Pending – First DCA Burkhart 25% 10% 3,500,000 (2) 1,750,000 Pending – Eleventh Circuit Bakst 75% — 4,504,000 14,000,000 Pending – Fourth DCA Robinson 70.5% — 16,900,000 16,900,000 Pending – First DCA Harris 15% 10% 1,223,500 (2) — Post-trial motions are pending (3) Wilcox 70% — 4,900,000 8,500,000 Pending – Third DCA Irimi 14.5% 14.5% — — Defendants' motion for new trial

granted; pending - Fourth DCA Hubbird 50% — 3,000,000 (2) 25,000,000 Pending – Third DCA Lourie 3% 7% 137,000 — Pending – Second DCA


(4) At this time, it is unknown if comparative fault will apply to the final judgment.

As of June 30, 2015, judgments in favor of the Engle Progeny plaintiffs have been entered and remain outstanding against RJR Tobacco or Lorillard Tobacco in the amount of $158,553,640 in compensatory damages (as adjusted) and in the amount of $204,817,000 in punitive damages, for a total of $363,370,640. All of these verdicts are at various stages in the appellate process. RJR Tobacco continues to believe that RJR Tobacco and Lorillard Tobacco have valid defenses in these cases, including case-specific issues beyond the due process issue discussed above. It is the policy of RJR Tobacco and its affiliates to vigorously defend, as described in more detail above in “Accounting for Tobacco-Related Litigation Contingencies,”smoking and health claims, including all Engle Progeny cases.

Should RJR Tobacco or Lorillard Tobacco not prevail in any particular individual Engle Progeny case or determine that in any individual Engle

Progeny case an unfavorable outcome has become probable and the amount can be reasonably estimated, a loss would be recognized, which could have a material adverse effect on earnings and cash flows of RAI in a particular quarter or year. This position on loss recognition for Engle Progeny cases as of June 30, 2015, is consistent with RAI’s and RJR Tobacco’s historic position on loss recognition for other smoking and health litigation. It is also the policy of RJR Tobacco to record any loss concerning litigation at such time as an unfavorable outcome becomes probable and the amount can be reasonably estimated on an individual case-by-case basis.

In the U.S. Department of Justice case, brought in 1999 in the U.S. District Court for the District of Columbia, the government sought, among other

forms of relief, the disgorgement of profits pursuant to the civil provisions of RICO. The U.S. Court of Appeals for the District of Columbia ruled in 2005 that disgorgement is not an available remedy in the case. The bench trial ended in June 2005, and the court, in August 2006, issued its ruling, among other things, finding certain defendants, including RJR Tobacco and B&W, liable for the RICO claims, imposing no direct financial penalties on the defendants, but ordering the defendants to make certain “corrective communications” in a variety of media and enjoining the defendants from using certain brand descriptors. Both sides appealed to the U.S. Court of Appeals for the District of Columbia, referred to as the D.C. Circuit. In May 2009, the U.S Court of Appeals largely affirmed the findings against the tobacco company defendants and remanded the case to the trial court for further proceedings. The U.S. Supreme Court denied the parties’ petitions for writ of certiorari in June 2010. In June 2014, the district court

31

Kerrivan 31% — 6,046,660 (2) 9,600,000 Post-trial motions are pending (3) Taylor 58% — 4,116,000 (2) 521,000 Pending – First DCA Schleider 70% — 14,700,000 (2) — Pending – Third DCA Perrotto 20% 6% 1,063,000 — Post-trial motions are pending (3) Ellen Gray 50% — 3,000,000 — Post-trial motions are pending (3) Sowers 50% — 2,130,000 — Post-trial motions are pending (3) Zamboni 30% — 102,000 — Final judgment has not been

entered Pollari 42.5% — 5,000,000 (2) 1,500,000 Post-trial motions are pending (3) Gore 23% — 1,000,000 — Final judgment has not been

entered Ryan 65% — 21,500,000 25,000,000 Post-trial motions are pending (3) Hardin 13% — 100,880 — Post-trial motions are pending (3) McCoy 25% 20% 1,038,400 (4) 6,000,000 Final judgment has not been

entered Totals $ 158,553,640 $ 204,817,000

(1) Unless otherwise noted, compensatory damages in these cases are adjusted to reflect the jury’s allocation of comparative fault. Punitive damages are not so adjusted. The amounts listed above do not include attorneys’ fees or statutory interest that may apply to the judgments.

(2) The court did not apply comparative fault in the final judgment. (3) Should the pending post-trial motions be denied, RJR Tobacco will likely file a notice of appeal with the appropriate appellate court.

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) issued an implementation order for the corrective-statements remedy. That order stays implementation until the exhaustion of the defendants’ appeal challenging the legality of the corrective statements. On May 22, 2015, the D.C. Circuit issued an opinion on the legality of the corrective statements, affirming them in part and reversing them in part. Additional remand proceedings remain ongoing.

For a detailed description of these cases, see “— Engle and Engle Progeny Cases” and “— Health-Care Cost Recovery Cases — U.S. Department of Justice Case” below.

In November 1998, the major U.S. cigarette manufacturers, including RJR Tobacco, B&W and Lorillard Tobacco, entered into the MSA with 46

U.S. states, Washington, D.C. and certain U.S. territories and possessions. These cigarette manufacturers previously settled four other cases, brought on behalf of Mississippi, Florida, Texas and Minnesota, by separate agreements with each state. These State Settlement Agreements:

Payments under the State Settlement Agreements are subject to various adjustments for, among other things, the volume of cigarettes sold, relevant

market share and inflation. See “— Health-Care Cost Recovery Cases — State Settlement Agreements” below for a detailed discussion of the State Settlement Agreements, including RAI’s operating subsidiaries’ monetary obligations under these agreements. RJR Tobacco records the allocation of settlement charges as products are shipped.

Scheduled Trials. Trial schedules are subject to change, and many cases are dismissed before trial. It is likely that RJR Tobacco, Lorillard Tobacco and other cigarette manufacturers will have an increased number of tobacco-related trials in 2015. There are 33 cases, exclusive of Engle Progeny cases, scheduled for trial as of June 30, 2015 through June 30, 2016, for RJR Tobacco, Lorillard Tobacco or their affiliates and indemnitees: 2 non-smoking and health cases, one class action, four individual smoking and health cases and 26 filter cases. There are approximately 85 Engle Progeny cases against RJR Tobacco B&W and/or Lorillard Tobacco set for trial through June 30, 2016, but it is not known how many of these cases will actually be tried.

Trial Results. From January 1, 2012 through June 30, 2015, 123 smoking and health, Engle Progeny and health-care cost recovery cases in which RJR Tobacco, B&W and/or Lorillard Tobacco were defendants were tried, including 10 trials for cases where mistrials were declared in the original proceedings. Verdicts in favor of RJR Tobacco, B&W and Lorillard Tobacco and, in some cases, RJR Tobacco, B&W, Lorillard Tobacco and/or other defendants, were returned in 59 cases, including 18 mistrials, tried in Florida (58) and West Virginia (1). Verdicts in favor of the plaintiffs were returned in 57 cases tried in Florida, one in New York, and one in California. Three cases in Florida were dismissed during trial, but one of those cases continued against Lorillard Tobacco and resulted in a plaintiff verdict. One case in Florida was a retrial only as to the amount of damages. In another case in Florida, the jury entered a partial verdict that did not include compensatory or punitive damages, and post-trial motions are pending.

In the second quarter of 2015, five Engle Progeny cases in which RJR Tobacco and/or Lorillard Tobacco was a defendant were tried:

32

• 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 future payment obligations in perpetuity on RJR Tobacco, B&W and other major U.S. cigarette manufacturers; and

• placed significant restrictions on their ability to market and sell cigarettes and smokeless tobacco products.

• In Ryan v. R. J. Reynolds Tobacco Co ., the court declared a mistrial due to the opinion being issued by the Florida Supreme Court in Hess v. Philip Morris USA Inc. In the subsequent retrial, the jury returned a verdict in favor of the plaintiff, found the plaintiff 35% at fault and RJR Tobacco 65% at fault, and awarded $21.5 million in compensatory damages and $25 million in punitive damages.

• In Russo v. Philip Morris USA Inc. , the jury returned a verdict in favor of the defendants, including RJR Tobacco.

• In Dupre v. Philip Morris USA Inc. , the court declared a mistrial based on a surprise change in testimony of a witness.

• In Ethel Gray v. R. J. Reynolds Tobacco Co. , the jury returned a verdict in favor of RJR Tobacco.


In addition, since the end of the second quarter of 2015, a decision was entered in the following Engle Progeny case:

For a detailed description of the above-described cases, see “— Engle and Engle Progeny Cases” below.

In the second quarter of 2015, one non- Engle Progeny individual smoking and health case in which RJR Tobacco, B&W or Lorillard Tobacco was

a defendant was tried:

The following chart reflects the verdicts in the non- Engle Progeny smoking and health cases, health-care cost recovery cases or Filter Cases that

have been tried and remain pending as of June 30, 2015, in which verdicts have been returned against RJR Tobacco, B&W or Lorillard Tobacco, or all three. For information on the verdicts in the Engle Progeny cases that have been tried and remain pending as of June 30, 2015, in which verdicts have been returned against RJR Tobacco, Lorillard Tobacco or B&W, or all three, see the Engle Progeny cases chart above. For information on the post-trial status of individual smoking and health cases, the governmental health-care cost recovery case and the Filter Cases, see “— Individual Smoking and Health Cases,” “—Health-Care Cost Recovery Cases – U.S. Department of Justice Case,” and “— Filter Cases,” respectively, below:

Individual Smoking and Health Cases

As of June 30, 2015, 112 individual cases were pending in the United States against RJR Tobacco, B&W (as RJR Tobacco’s indemnitee), Lorillard Tobacco or all three. 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, Engle Progeny or West Virginia IPIC cases discussed below. A total of 110 of the individual cases are brought by or on behalf of individual smokers or their survivors, while the remaining two

33

• In Hardin v. R. J. Reynolds Tobacco Co. , the jury returned a verdict in favor of the plaintiff, found the decedent 87% at fault and RJR Tobacco 13% at fault, and awarded $776,000 in compensatory damages. Punitive damages were not awarded.

• In McCoy v. R. J. Reynolds Tobacco Co. , the jury returned a verdict in favor of the plaintiff, found the decedent 35% at fault, RJR Tobacco 25% at fault, Lorillard Tobacco 20% at fault and the remaining defendant 20% at fault, and awarded $1.5 million in compensatory damages and $_3 million in punitive damages against each defendant.

• In Larkin v. R. J. Reynolds Tobacco Co. , the jury returned a verdict in favor of the plaintiff, found the decedent 38% at fault, RJR Tobacco 62% at fault, and awarded approximately $4.96 million in compensatory damages and $8.5 million in punitive damages.

Date of Verdict Case Name/Type Jurisdiction Verdict

August 17, 2006 United States v. Philip Morris USA, Inc. [Governmental Health-Care Cost Recovery]

U.S. District Court, District of Columbia (Washington, DC)

RJR Tobacco, B&W and Lorillard Tobacco were found liable for civil RICO claims; were enjoined from using certain brand descriptors and from making certain misrepresentations; and were ordered to make corrective communications on five subjects, including smoking and health and addiction, to reimburse the U.S. Department of Justice appropriate costs associated with the lawsuit, and to maintain document web sites.

May 26, 2010 Izzarelli v. R. J. Reynolds Tobacco Co. [Individual]

U.S. District Court, District of Connecticut, (Bridgeport, CT)

$13.9 million in compensatory damages; 58% of fault assigned to RJR Tobacco, which reduced the award to $8.08 million against RJR Tobacco; $3.97 million in punitive damages.

September 13, 2013 DeLisle v. A. W. Chesterton Co. [Filter]

Circuit Court, Broward County, (Ft. Lauderdale, FL)

$8 million in compensatory damages; 44% of fault assigned to Lorillard Tobacco.

July 30, 2014

Major v. Lorillard Tobacco Co. [Individual]

Superior Court, Los Angeles County, (Los Angeles, CA)

$17.74 million in compensatory damages; 17% of fault assigned to Lorillard Tobacco.

July 8, 2015

Larkin v. R. J. Reynolds Tobacco Co. [Individual]

Circuit Court, Miami-Dade County, (Miami, FL)

$4.96 million in compensatory damages; 62% of fault assigned to RJR Tobacco; $8.5 million in punitive damages.

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) cases are brought by or on behalf of individuals or their survivors alleging personal in jury as a result of exposure to environmental tobacco smoke, referred to as ETS.

Below is a description of the non- Engle Progeny individual smoking and health cases against RJR Tobacco, B&W or Lorillard Tobacco, or all three, which went to trial or were decided during the period from January 1, 2015 to June 30, 2015, or remained on appeal as of June 30, 2015.

On May 26, 2010, the jury returned a verdict in favor of the plaintiff in Izzarelli v. R. J. Reynolds Tobacco Co ., a case filed in December 1999 in

the U.S. District Court for the District of Connecticut. The plaintiff sought to recover damages for personal injuries allegedly sustained as a result of unsafe and unreasonably dangerous cigarette products and for economic losses she sustained as a result of supposed unfair trade practices. The district court granted summary judgment to RJR Tobacco on the plaintiff’s claim for unfair trade practices. After a trial on the negligence and strict liability claims, the jury returned a verdict finding RJR Tobacco to be 58% at fault and the plaintiff to be 42% at fault, awarding $13.76 million in compensatory damages and finding the plaintiff to be entitled to punitive damages. In December 2010, the district court awarded the plaintiff $3.97 million in punitive damages. Final judgment was entered in December 2010, in the amount of $11.95 million. The district court granted the plaintiff’s motion for offer of judgment interest, and awarded the plaintiff $15.8 million for the period of December 6, 1999 up to and including December 5, 2010, and approximately $4,000 per day thereafter until an amended judgment was entered. The amended judgment was entered in the amount of approximately $28.1 million in March 2011. In September 2011, RJR Tobacco filed a notice of appeal in the U.S. Court of Appeals for the Second Circuit, referred to as the Second Circuit, and the plaintiff thereafter cross appealed with respect to the punitive damages award. In September 2013, the Second Circuit certified the following question to the Connecticut Supreme Court: “Does Comment i to section 402A of the Restatement (Second) of Torts preclude a suit premised on strict products liability against a cigarette manufacturer based on evidence that the defendant purposefully manufactured cigarettes to increase daily consumption without regard to the resultant increase in exposure to carcinogens, but in the absence of evidence of any adulteration or contamination?” Subsequently, the plaintiff moved in the Second Circuit to amend the certification order to add a second question to the Connecticut Supreme Court: “Does Comment i to section 402A of the Restatement (Second) of Torts preclude a claim under the [Connecticut Products Liability Act] against a cigarette manufacturer for negligence (in the design of its cigarette products)?” The Second Circuit denied the plaintiff’s motion to amend. The Connecticut Supreme Court accepted the certified question and overruled the plaintiff’s objection that sought to amend the certification order to add the same additional question that the plaintiff had proposed to the Second Circuit. Oral argument in the Connecticut Supreme Court occurred on April 22, 2015. A decision is pending. The Second Circuit has retained jurisdiction over the parties’ appeals and will decide the case after the Connecticut Supreme Court has completed its proceedings.

On June 19, 2013, in Whitney v. R. J. Reynolds Tobacco Co. , the jury returned a verdict in favor of the defendants, including RJR Tobacco. The

case was filed in January 2011, in the Circuit Court, Alachua County, Florida. The plaintiff alleged that as a result of using the defendants’ products, she suffers from lung cancer and emphysema. Final judgment was entered in July 2013. The plaintiff filed a notice of appeal to the First DCA in August 2013. On December 5, 2014, the First DCA reversed the trial court’s directed verdict in favor of the defendants on the plaintiff’s design defect claims, affirmed on all other issues, and remanded the case for a new trial. The defendants’ motion for panel rehearing, rehearing en banc , or certification to the Florida Supreme Court was denied on February 26, 2015. The new trial is scheduled for February 1, 2016.

On July 30, 2014, in Major v. Lorillard Tobacco Co. , a case filed in November 2011, in the Superior Court, Los Angeles County, California, the

jury returned a verdict in favor of the plaintiff, found the plaintiff 50% at fault, Lorillard Tobacco 17% at fault, and RJR Tobacco and another manufacturer collectively 33% at fault. RJR Tobacco and the other manufacturer were dismissed prior to trial. The jury awarded approximately $17.74 million in compensatory damages. The plaintiffs alleged that as a result of the use of the defendants’ products and exposure to asbestos, the decedent, William Major, suffered from lung cancer. In August 2014, an initial final judgment was entered against Lorillard Tobacco in the amount of approximately $3.9 million. In November 2014, Lorillard Tobacco filed a notice of appeal to the California District Court of Appeal and posted a supersedeas bond in the amount of approximately $9 million. The plaintiff filed a notice of cross appeal in December 2014. On July 1, 2015, the trial court entered an amended final judgment in the amount of approximately $3.78 million in compensatory damages, approximately $135,000 in costs, approximately $1.9 million in prejudgment interest, and post-judgment interest from August 25, 2014 in the amount of approximately $1,100 per day. Briefing is underway.

On July 8, 2015, in Larkin v. R. J. Reynolds Tobacco Co. , a case filed in January 2002, in the Circuit Court, Miami-Dade County, Florida, the jury

returned a verdict in favor of the plaintiff, found the decedent, Carole Larkin, 38% at fault, RJR Tobacco 62% at fault, and awarded approximately $4.96 million in compensatory damages and $8.5 million in punitive damages. The plaintiff alleged that as a result of using the defendant’s products, the decedent suffered from mouth and lung cancer. Final judgment was entered in the amount of approximately $13.46 million on July 15, 2015. Post-trial motions are pending.

34

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) West Virginia IPIC

In re: Tobacco Litigation Individual Personal Injury Cases began in 1999, in West Virginia state court, as a series of roughly 1,200 individual plaintiff cases making claims with respect to cigarettes manufactured by Philip Morris, Lorillard Tobacco, RJR Tobacco, B&W and The American Tobacco Company . The cases were consolidated for a Phase I trial on various defense conduct issues, to be followed in Phase II by individual trials of any claims left standing. Over the years, approximately 600 individual plaintiff claims were dismissed for failure to comply with the case management order, leaving 567 individual cases pending as of April 2013. On April 15, 2013, the Phase I jury trial began and ended with a virtually complete defense verdict on May 15, 2013. The jury found that cigarettes were not defectively designed, were not defective due to a failure to warn prior to July 1, 1969, that defendants were not negligent, did not breach warranties and did not engage in conduct which would warrant punitive damages. The only claim remaining after the verdict was the jury’s finding that all ventilated filter cigarettes manufactured and sold between 1964 and July 1, 1969 were defective for a failure to instruct. In November 2014, the West Virginia Supreme Court affirmed the verdict, issuing an opinion without oral argument. In January 2015, the plaintiffs’ petition for rehearing was denied. On June 8, 2015, the plaintiffs’ petition for writ of certiorari to the U.S. Supreme Court was denied. Also on June 8, 2015, the trial court ruled in favor of the defendants’ contention that there are only 30 plaintiffs remaining who arguably claim to have smoked a ventilated filter cigarette during the relevant period. In addition to the foregoing claims, various plaintiffs in 1999 and 2000 asserted claims against retailers and distributors. Those claims were severed and stayed pending the outcome of Phase I. Also, 41 plaintiffs asserted smokeless tobacco claims against various smokeless manufacturers including American Snuff Co. Those claims were severed from IPIC in 2001, and the plaintiffs took no action to prosecute the claims. They have recently sought to activate those claims. The defendants will assert various defenses to all of these claims, including that all of the additional claims were either covered by the Phase I verdict or abandoned.

Engle and Engle Progeny Cases

Trial began in July 1998 in Engle v. R. J. Reynolds Tobacco Co., a class action filed in Circuit Court, Miami-Dade County, Florida. The Engle class consisted of Florida citizens and residents, and their survivors, who suffer from or have died from diseases or medical conditions caused by an addiction to smoking. The action was brought against the major U.S. cigarette manufacturers, including RJR Tobacco, B&W and Lorillard Tobacco. In July 1999, the Engle jury found against RJR Tobacco, B&W, Lorillard Tobacco and the other defendants in the initial phase of the trial, which addressed alleged common issues related to the defendants’ conduct, general causation, the addictiveness of cigarettes, and potential entitlement to punitive damages.

On July 14, 2000, in the second phase of the trial, the jury returned a punitive damages verdict in favor of the class of approximately $145 billion, including verdicts of $36.3 billion against RJR Tobacco, $17.6 billion against B&W, and $16.3 billion against Lorillard Tobacco.

On appeal, the Florida Supreme Court prospectively decertified the class, and it set aside the punitive damages award as both premature and excessive. However, the court preserved a number of findings from Phase I of the trial, including findings that cigarettes can cause certain diseases, that nicotine is addictive, and that defendants placed defective cigarettes on the market, breached duties of care, and concealed health-related information about cigarettes. The court authorized former class members to file individual lawsuits within one year, and it stated that the preserved findings would have res judicata effect in those actions.

In the wake of the Florida Supreme Court ruling, thousands of individuals filed separate lawsuits seeking to benefit from the Engle findings. As of June 30, 2015, RJR Tobacco and/or Lorillard Tobacco were defendants in 3,581 Engle Progeny cases in both state and federal courts in Florida. These cases include approximately 4,591 plaintiffs. Many of these cases are in active discovery or nearing trial. During the first quarter of 2015, however, RJR Tobacco and Lorillard Tobacco, together with Philip Morris USA Inc., tentatively settled virtually all of the Engle Progeny cases then pending against them in federal district court. The total amount of the settlement was $100 million divided as follows: RJR Tobacco - $42.5 million; Philip Morris USA Inc. - $42.5 million; and Lorillard Tobacco - $15 million. The settlement covers more than 400 federal progeny cases but does not cover 13 federal progeny cases previously tried to verdict and currently pending on post-trial motions or appeal; approximately two federal progeny cases pending as of June 30, 2015 involving pro se plaintiffs unrepresented by counsel; and two federal progeny cases filed by different lawyers from the ones who negotiated the settlement for the plaintiffs. In March 2015, RJR Tobacco and Lorillard Tobacco paid their shares of the settlement to escrow accounts under RJR Tobacco’s control for disbursements and has reflected this balance as restricted cash in other current assets with a corresponding balance in other current liabilities in RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2015.

At the beginning of the Engle Progeny litigation, a central issue was the proper use of the preserved Engle findings. RJR Tobacco has argued that use of the Engle findings to establish individual elements of progeny claims (such as defect, negligence and concealment) is a violation of federal due process. In 2013, however, both the Florida Supreme Court and the Eleventh Circuit

35

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) rejected that argument. RJR Tobacco continues to press various other factual and legal defenses as appropriate in each case, including defenses based on express and implied preemption.

In June 2009, Florida amended its existing bond cap statute by adding a $200 million bond cap that applied to all Engle Progeny cases in the

aggregate. In May 2011, Florida removed the provision that would have allowed it to expire on December 31, 2012. The bond cap for any given individual Engle Progeny case varies depending on the number of judgments in effect at a given time, but never exceeds $5 million per case. The legislation, which became effective in June 2009 and 2011, applies to judgments entered after the original 2009 effective date.

Below is a description of the Engle Progeny cases against RJR Tobacco, B&W or Lorillard Tobacco, or all three that went to trial or were decided

during the period from January 1, 2015 to June 30, 2015, or remained on appeal as of June 30, 2015.

On February 25, 2010, in Grossman v. R. J. Reynolds Tobacco Co ., a case filed in December 2007, in the Circuit Court, Broward County, Florida, the court declared a mistrial due to the jury’s inability to reach a decision. The plaintiff alleged that as a result of an addiction to cigarettes, the decedent, Laura Grossman, developed lung cancer and died. The plaintiff sought damages in excess of $15,000 and all taxable costs and interest. Retrial began in March 2010. In April 2010, the jury returned a verdict in favor of the plaintiff in Phase I, and in Phase II awarded $1.9 million in compensatory damages and no punitive damages. The jury also found RJR Tobacco to be 25% at fault, the decedent to be 70% at fault and the decedent’s spouse to be 5% at fault. Final judgment was entered in June 2010, in the amount of $483,682. RJR Tobacco filed a notice of appeal to the Fourth DCA, and posted a supersedeas bond in the amount of approximately $484,000. The plaintiff filed a notice of cross appeal. In June 2012, the Fourth DCA entered an opinion that affirmed the trial court’s judgment, but remanded the case for a new trial on all Phase II issues. In October 2012, RJR Tobacco filed a notice to invoke the discretionary jurisdiction of the Florida Supreme Court. In February 2014, the Florida Supreme Court declined to accept jurisdiction of the appeal of the original verdict. Retrial began on July 11, 2013. On July 31, 2013, the jury returned a verdict in favor of the plaintiff, found the decedent to be 25% at fault and RJR Tobacco to be 75% at fault, and awarded $15.35 million in compensatory damages and $22.5 million in punitive damages. Final judgment was entered in August 2013 and did not include a reduction for comparative fault. RJR Tobacco filed a notice of appeal to the Fourth DCA and the plaintiff filed a notice of cross appeal in October 2013. RJR Tobacco’s original bond was returned, and RJR Tobacco posted a new bond in the amount of $5 million. Briefing is underway.

On March 10, 2010, in Cohen v. R. J. Reynolds Tobacco Co ., a case filed in May 2007, in the Circuit Court, Broward County, Florida, a jury

returned a verdict in favor of the plaintiff. The plaintiff alleged that the decedent, Nathan Cohen, developed lung cancer as a result of using the defendants’ products, and sought in excess of $15,000 compensatory damages and unspecified punitive damages. On March 24, 2010, the jury awarded the plaintiff $10 million in compensatory damages, and found the decedent to be 33.3% at fault, RJR Tobacco to be 33.3% at fault and the remaining defendant to be 33.3% at fault. The jury also awarded $20 million in punitive damages, of which $10 million was assigned to RJR Tobacco. In July 2010, the court entered final judgment against RJR Tobacco in the amount of $3.33 million in compensatory damages and $10 million in punitive damages. The court entered an amended judgment in September 2010 to include interest from the date of the verdict. RJR Tobacco filed a notice of appeal to the Fourth DCA and posted a supersedeas bond in the amount of $2.5 million. In September 2012, the Fourth DCA affirmed the liability finding and the compensatory damages award, but reversed the finding of entitlement to punitive damages, and remanded the case for a retrial limited to the issue of liability for concealment and conspiracy. The defendants and the plaintiff filed separate notices to invoke the discretionary jurisdiction of the Florida Supreme Court in January 2013. In February 2014, the Florida Supreme Court, on its own motion, consolidated the petitions for review filed by the plaintiff and RJR Tobacco and stayed the petitions pending disposition by the court of Hess v. Philip Morris USA Inc. , which dealt with the application of the statute of repose as an affirmative defense to claims of fraudulent concealment and conspiracy to commit fraudulent concealment. On April 2, 2015, in Hess , the Florida Supreme Court held that, in Engle Progeny cases, the defendants cannot raise a statute of repose defense to claims for concealment or conspiracy. A decision on the notice to invoke the discretionary jurisdiction of the Florida Supreme Court remains pending.

On April 26, 2010, in Putney v. R. J. Reynolds Tobacco Co ., a case filed in December 2007 in the Circuit Court, Broward County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, Margot Putney, to be 35% at fault, RJR Tobacco to be 30% at fault and the remaining defendants collectively to be 35% at fault, and awarded $15.1 million in compensatory damages and $2.5 million in punitive damages each against RJR Tobacco and the remaining defendants. The plaintiff alleged that the decedent suffered from nicotine addiction and lung cancer as a result of using the defendants’ products and sought an unspecified amount of compensatory and punitive damages. In August 2010, final judgment was entered against RJR Tobacco in the amount of $4.5 million in compensatory damages, and $2.5 million in punitive damages. RJR Tobacco filed a notice of appeal and the plaintiff filed a notice of cross appeal. In December 2010, the court entered an amended final judgment to provide that interest would run from April 26, 2010. The defendants filed a joint notice of appeal to the Fourth DCA of the amended final judgment, and RJR Tobacco posted a supersedeas bond in the amount of approximately $2.4 million. In June 2013, the Fourth DCA held that the court erred in denying the defendants’motion for remittitur of the compensatory damages for loss of consortium and in striking the defendants’ statute of repose affirmative defenses. As a result, the verdict was reversed, and the case was remanded for further proceedings. The plaintiff’s motion

36

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) for rehearing, w ritten opinion on one issue, or certification of conflict to the Florida Supreme Court was denied in August 2013. The defendants and the plaintiff filed separate notices to invoke the discretionary jurisdiction of the Florida Supreme Court in September 20 13. In December 2013, the Florida Supreme Court consolidated the petitions for review filed by the plaintiff and the defendants and stayed the petitions pending disposition of Hess v. Philip Morris USA Inc. , described above. On April 2, 2015, in Hess , th e Florida Supreme Court held that, in Engle Progeny cases, the defendants cannot raise a statute of repose defense to claims for concealment or conspiracy. A decision on the notice to invoke the discretionary jurisdiction of the Florida Supreme Court rema ins pending.

On May 20, 2010, in Buonomo v. R. J. Reynolds Tobacco Co ., a case filed in October 2007, in the Circuit Court, Broward County, Florida, a jury

returned a verdict in favor of the plaintiff, found RJR Tobacco to be 77.5% at fault and the decedent, Matthew Buonomo, to be 22.5% at fault, and awarded $5.2 million in compensatory damages and $25 million in punitive damages. The plaintiff alleged that the decedent was addicted to cigarettes and, as a result, developed one or more smoking-related medical conditions and/or diseases and sought an unspecified amount of compensatory and punitive damages. Post-trial motions were denied, but the court, in accordance with the Florida statutory limitation on punitive damage awards, ordered the punitive damage award of $25 million be reduced to $15.7 million – three times the compensatory damages award of $5.2 million. In August 2010, the court entered final judgment in the amount of $4.06 million in compensatory damages and $15.7 million in punitive damages. RJR Tobacco filed a notice of appeal to the Fourth DCA and posted a supersedeas bond in the amount of $5 million. The plaintiff also filed a notice of appeal. In September 2013, the Fourth DCA affirmed the final judgment and damages award to the plaintiff on strict liability and negligence and held that the trial court was not bound to hold punitive damages at three times compensatory damages. However, the court reversed the judgment entered for the plaintiff on the claims for fraudulent concealment and conspiracy to commit fraud by concealment due to the erroneous striking of RJR Tobacco’s statute of repose defense. As a result, the punitive damages award was set aside and remanded for a new trial. In December 2013, the Fourth DCA denied RJR Tobacco’s motion for rehearing. In January 2014, RJR Tobacco and the plaintiff filed notices to invoke the discretionary jurisdiction of the Florida Supreme Court. In June 2014, the Florida Supreme Court stayed the petitions for review pending disposition by the court of Hess v. Philip Morris USA Inc., described above. On April 2, 2015, in Hess , the Florida Supreme Court held that, in Engle Progeny cases, the defendants cannot raise a statute of repose defense to claims for concealment or conspiracy. A decision on the notice to invoke the discretionary jurisdiction of the Florida Supreme Court remains pending. The trial court determined in October 2014 that the original $25 million punitive damages award was not excessive and would be reinstated if the plaintiff prevails on the repose issue. An amended final judgment was entered in April 2015 against RJR Tobacco in the amount of approximately $29.1 million. RJR Tobacco filed a notice of appeal to the Fourth DCA in May 2015. Briefing is underway.

On October 15, 2010, in Frazier v. Philip Morris USA Inc ., now known as Russo v. Philip Morris USA Inc. , a case filed in December 2007 in the

Circuit Court, Miami-Dade County, Florida, a jury returned a verdict in favor of the defendants. The plaintiff alleged that as a result of smoking defendants’, including RJR Tobacco’s, products she developed chronic obstructive pulmonary disease, and sought in excess of $15,000 in compensatory damages and unspecified punitive damages. Final judgment was entered in February 2011. The plaintiff filed a notice of appeal to the Third DCA, and the defendants filed a notice of cross appeal. In April 2012, the Third DCA reversed the trial court’s judgment, directed entry of judgment in the plaintiff’s favor and ordered a new trial. In July 2012, the defendants filed a notice to invoke the discretionary jurisdiction of the Florida Supreme Court. The Florida Supreme Court accepted jurisdiction of the case in September 2013. Oral argument in the Florida Supreme Court occurred on April 30, 2014. The new trial began on October 14, 2014, but on October 22, 2014, the court declared a mistrial because of the inability to seat a jury. On April 2, 2015, the Florida Supreme Court approved the decision of the Third DCA. Following its decision in Hess , the Florida Supreme Court held that the statute of repose is unavailable as a defense to concealment and conspiracy claims in Engle Progeny cases. The defendants filed a motion for rehearing on April 17, 2015. A decision is pending. Retrial began on April 6, 2015. On April 23, 2015, the jury returned a verdict in favor of the defendants, including RJR Tobacco. Final judgment was entered in May 2015. In June 2015, the plaintiff filed a notice of appeal to the Third DCA, and the defendants filed a notice of cross appeal. Briefing is underway.

On April 26, 2011, in Andy Allen v. R. J. Reynolds Tobacco Co ., a case filed in September 2007, in the Circuit Court, Duval County, Florida, a jury

returned a verdict in favor of the plaintiff, found RJR Tobacco to be 45% at fault, the decedent, Patricia Allen, to be 40% at fault and the remaining defendant to be 15% at fault, and awarded $6 million in compensatory damages and $17 million in punitive damages against each defendant. The plaintiff alleged that as a result of smoking the defendants’ products, the decedent developed chronic obstructive pulmonary disease, and sought in excess of $15,000 in compensatory damages. Final judgment was entered against RJR Tobacco in the amount of $19.7 million in May 2011. In October 2011, the trial court entered a remittitur of the punitive damages to $8.1 million and denied all other post-trial motions. The defendants filed a joint notice of appeal, RJR Tobacco posted a supersedeas bond in the amount of $3.75 million, and the plaintiff filed a notice of cross appeal in November 2011. In May 2013, the First DCA reversed the trial court’s judgment and remanded the case for a new trial. As a result, RJR Tobacco’s bond was returned. In August 2013, the plaintiff filed a notice to invoke the discretionary jurisdiction of the Florida Supreme Court. In February 2014, the Florida Supreme Court declined to accept jurisdiction. The new trial began on November 1, 2014, and on November 26, 2014, the jury returned a verdict in favor of the plaintiff, found the decedent to be 70% at fault, RJR Tobacco to be 24%

37

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) at fault and the remaining defendant to be 6% at fault, and awarded $3.1 million in compensatory damages and approximately $7.8 million in punitive damages against each defendant. Post-trial motions are pending. Final judgment has not been entered.

On June 16, 2011, in Soffer v. R. J. Reynolds Tobacco Co ., a case filed in December 2007, in the Circuit Court, Alachua County, Florida, a jury

returned a verdict in favor of the plaintiff, found RJR Tobacco to be 40% at fault, the decedent, Maurice Soffer, to be 60% at fault, and awarded $5 million in compensatory damages and no punitive damages. The plaintiff alleged that the decedent was addicted to cigarettes and, as a result, developed lung cancer and other smoking-related conditions and/or diseases, and sought in excess of $15,000 in compensatory damages. Final judgment was entered against RJR Tobacco in the amount of $2 million. The plaintiff filed a notice of appeal to the First DCA in July 2011. RJR Tobacco filed a notice of cross appeal and posted a supersedeas bond in the amount of $2 million. In October 2012, the First DCA affirmed the trial court’s ruling in full. On the direct appeal, the court held that only intentional torts could support a punitive damages claim and held that Engle Progeny plaintiffs may not seek punitive damages for negligence or strict liability because the original Engle class did not seek punitive damages for those claims. The First DCA certified the question to the Florida Supreme Court as one of great public importance. On the cross appeal, the court rejected RJR Tobacco’s arguments about the use of the Engle findings and the statute of limitations. RJR Tobacco filed a motion for rehearing or for certification to the Florida Supreme Court, and the plaintiff filed a motion for rehearing or rehearing en banc . In January 2013, the First DCA granted rehearing on RJR Tobacco’s cross appeal to clarify that the trial court’s application of Engle findings did not violate RJR Tobacco’s due process rights. Otherwise, rehearing, rehearing en banc and certification were denied. RJR Tobacco and the plaintiff both filed notices to invoke the discretionary jurisdiction of the Florida Supreme Court. In February 2014, the Florida Supreme Court declined to accept jurisdiction of RJR Tobacco’s petition for review and accepted the plaintiff’s petition for review of the First DCA’s decision. Oral argument occurred on December 4, 2014. A decision is pending.

On July 15, 2011, in Ciccone v. R. J. Reynolds Tobacco Co ., a case filed in August 2004, in the Circuit Court, Broward County, Florida, a jury

returned a verdict finding the plaintiff is a member of the Engle class. The plaintiff alleged that as a result of the use of the defendant’s tobacco products, the decedent, George Ciccone, suffered from nicotine addiction and one or more smoking-related diseases and/or medical conditions, and sought an unspecified amount of compensatory and punitive damages. On July 21, 2011, the jury awarded approximately $3.2 million in compensatory damages and $50,000 in punitive damages. The jury found the decedent to be 70% at fault and RJR Tobacco to be 30% at fault. Final judgment was entered in September 2011, and RJR Tobacco filed a notice of appeal to the Fourth DCA. RJR Tobacco posted a supersedeas bond in the amount of approximately $1 million on October 17, 2011. In August 2013, the Fourth DCA affirmed the judgment of the trial court, but reversed the punitive damages award and remanded the case to the trial court for entry of a final judgment that eliminates the punitive damages award. RJR Tobacco’s motion for rehearing or rehearing en banc was denied in November 2013. The Florida Supreme Court accepted jurisdiction of the case in June 2014. Oral argument occurred on December 4, 2014. A decision is pending.

On January 24, 2012, in Hallgren v. R. J. Reynolds Tobacco Co., a case filed in April 2007, in the Circuit Court, Highlands County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, Claire Hallgren, to be 50% at fault, RJR Tobacco to be 25% at fault, and the remaining defendant to be 25% at fault, and awarded $2 million in compensatory damages and $750,000 in punitive damages against each defendant. The plaintiff alleged that the decedent was addicted to the defendants’ products, and as a result, suffered from lung cancer, and sought in excess of $15,000 in compensatory damages and unspecified punitive damages. In March 2012, the court entered final judgment in the amount of approximately $1 million for which RJR Tobacco and the other defendant are jointly and severally liable; and $750,000 in punitive damages against each defendant. The defendants filed a joint notice of appeal to the Second DCA, and RJR Tobacco posted a supersedeas bond in the amount of approximately $1.3 million in May 2012. The plaintiff filed a notice of cross appeal. In October 2013, the Second DCA affirmed the trial court’s ruling that punitive damages can be awarded for negligence and strict liability claims as well as for the intentional tort claims brought under Engle . The court certified a conflict with the First DCA’s decision in Soffer and the Fourth DCA’s decision in Ciccone . The court also certified the following question to be of great public importance – “Are members of the Engle class who pursue individual damages actions in accordance with the decision in Engle v. Liggett Group, Inc. , entitled to pursue punitive damages under claims for strict liability and negligence?” In November 2013, the defendants filed a notice to invoke the discretionary jurisdiction of the Florida Supreme Court. In June 2014, the Florida Supreme Court stayed the petition pending disposition of Russo v. Philip Morris USA Inc., described above, and in April 2015, stayed the petition pending disposition of Soffer v. R. J. Reynolds Tobacco Co., described above.

On February 29, 2012, in Marotta v. R. J. Reynolds Tobacco Co ., a case filed in December 2007, in the Circuit Court, Broward County, Florida,

the court declared a mistrial during jury prequalification. The plaintiff alleged that the decedent, Phil Marotta, was addicted to cigarettes and, as a result, suffered from lung cancer. The plaintiff sought compensatory damages in excess of $75,000, including compensatory and punitive damages, costs and pre-judgment interest. Retrial began on March 7, 2013. On March 20, 2013, a jury returned a verdict in favor of the plaintiff, found the decedent to be 42% at fault and RJR Tobacco to be 58% at fault, and awarded $6 million in compensatory damages and no punitive damages. Final judgment was entered against RJR Tobacco in the amount of $3.48 million, and RJR Tobacco filed a notice of appeal to the Fourth DCA in April 2013. The plaintiff filed a notice of cross appeal in May 2013. Briefing is complete. Oral argument has not been scheduled.

38


On May 17, 2012, in Calloway v. R. J. Reynolds Tobacco Co., a case filed in December 2007, in the Circuit Court, Broward County, Florida, a jury returned a verdict in favor of the plaintiff, found the decedent, Johnnie Calloway, to be 20.5% at fault, RJR Tobacco to be 27% at fault, Lorillard Tobacco to be 18% at f ault, and the remaining defendants collectively to be 34.5% at fault, and awarded $20.5 million in compensatory damages and $17.25 million in punitive damages against RJR Tobacco, $12.6 million in punitive damages against Lorillard Tobacco, and $25 million collectively against the remaining defendants. The plaintiff alleged that as a result of using the defendants’ products, the decedent became addicted and developed smoking-related diseases and/or conditions. The plaintiff sought an unspecified amount of compensatory and punitive damages, including costs and interest. In its ruling on the post-trial motions, the court determined that the jury’s apportionment of comparative fault did not apply to the compensatory damages award. Final judgment was entered in August 2012. In September 2012, the defendants filed a notice of appeal to the Fourth DCA, RJR Tobacco posted a supersedeas bond in the amount of $1.5 million, and Lorillard Tobacco posted a supersedeas bond in the amount of $1.25 million. The plaint iff filed a notice of cross appeal. Oral argument occurred on June 16, 2015. A decision is pending.

On August 1, 2012, in Hiott v. R. J. Reynolds Tobacco Co ., a case filed in January 2008, in the Circuit Court, Duval County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, Kenneth Hiott, to be 60% at fault and RJR Tobacco to be 40% at fault, and awarded $1.83 million in compensatory damages and no punitive damages. The plaintiff alleged that as a result of using the defendant’s product, the decedent suffered from addiction and smoking-related diseases and/or conditions. The plaintiff sought an unspecified amount of compensatory and punitive damages. In November 2012, final judgment was entered against RJR Tobacco in the amount of $730,000 in compensatory damages. RJR Tobacco filed a notice of appeal to the First DCA and posted a supersedeas bond in the amount of $730,000 in December 2012. In January 2014, the First DCA affirmed the trial court’s decision. RJR Tobacco filed a notice to invoke the discretionary jurisdiction of the Florida Supreme Court in January 2014. In June 2014, the Florida Supreme Court stayed the petition pending the court’s disposition of Hess v. Philip Morris USA Inc. , described above. On April 2, 2015, in Hess , the Florida Supreme Court held that, in Engle Progeny cases, the defendants cannot raise a statute of repose defense to claims for concealment or conspiracy. A decision on the notice to invoke the discretionary jurisdiction of the Florida Supreme Court remains pending.

On August 10, 2012, in Hancock v. Philip Morris USA, Inc ., a case filed in January 2008, in the Circuit Court, Miami-Dade County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, Edna Siwieck, to be 90% at fault, RJR Tobacco to be 5% at fault and the remaining defendant to be 5% at fault. However, the jury did not award compensatory damages and found that the plaintiff was not entitled to punitive damages. The court determined that the jury verdict was inconsistent due to the parties previously stipulating to $110,200 in medical expenses, which is subject to the allocation of fault. The defendants agreed to an additur for that amount. The plaintiff alleged that as a result of using the defendants’products, the decedent suffered from chronic obstructive pulmonary disease. The plaintiff sought an unspecified amount of compensatory and punitive damages, costs and interest. Final judgment was entered against RJR Tobacco in the amount of $705 in October 2012. The stipulated amount was reduced by the defendants’ motion to reduce economic damages by collateral sources. The plaintiff filed a notice of appeal to the Fourth DCA, and the defendants filed a notice of cross appeal in November 2012. On April 2, 2015, the Fourth DCA affirmed the final judgment of the trial court, per curiam. In May 2015, the plaintiff filed a motion for rehearing and for written opinion and rehearing en banc . The Fourth DCA denied that motion on June 25, 2015. At this time, it is unknown if the plaintiff will seek further review.

On September 19, 2012, in Baker v. R. J. Reynolds Tobacco Co ., a case filed in November 2007, in the Circuit Court, Palm Beach County, Florida,

a jury returned a verdict in favor of the defendant, RJR Tobacco. The plaintiff alleged that as a result of using the defendant’s products, the decedent, Elmer Baker, suffered from lung cancer. The plaintiff sought compensatory damages in excess of $15,000, costs and interest. Final judgment was entered in January 2013, in favor of RJR Tobacco. The plaintiff filed a notice of appeal to the Fourth DCA, and RJR Tobacco filed a notice of cross appeal in February 2013. On February 18, 2015, the Fourth DCA affirmed the final judgment in favor of RJR Tobacco. The plaintiff did not seek further review.

On September 20, 2012, in Sikes v. R. J. Reynolds Tobacco Co ., a case filed in December 2007, in the Circuit Court, Duval County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, Jimmie Sikes, to be 49% at fault and RJR Tobacco to be 51% at fault, and awarded $4.1 million in compensatory damages and $2 million in punitive damages. The plaintiff alleged that as a result of using the defendant’s product, the decedent suffered from chronic obstructive pulmonary disease, and sought in excess of $15,000 of compensatory damages. Final judgment was entered against RJR Tobacco in the amount of $6.1 million on June 3, 2013. On June 25, 2013, the court entered a corrected final judgment against RJR Tobacco in the amount of $5.5 million and vacated the June 3, 2013 final judgment. RJR Tobacco filed a notice of appeal to the First DCA, and posted a supersedeas bond in the amount of $5 million in July 2013. In July 2014, the First DCA affirmed the trial court’s decision, per curiam, but following the Hiott case, certified a conflict to the Florida Supreme Court with Hess v. Philip Morris USA Inc. , with both cases being described above. In August 2014, RJR Tobacco filed a notice to invoke the discretionary jurisdiction of the Florida Supreme Court. The Florida Supreme Court stayed the case pending disposition of Hess v. Philip Morris USA Inc . On April 2, 2015, in Hess , the Florida Supreme Court held that, in Engle Progeny cases, the defendants cannot raise a statute of repose defense to claims for concealment or conspiracy. A decision on the notice to invoke the discretionary jurisdiction of the Florida Supreme Court remains pending.

39


On October 17, 2012, in James Smith v. R. J. Reynolds Tobacco Co ., a case filed in August 2007, in the U.S. District Court for the Middle District

of Florida, a jury returned a verdict in favor of the plaintiff, found the decedent, Wanette Smith, to be 45% at fault and RJR Tobacco to be 55% at fault, and awarded $600,000 in compensatory damages and $20,000 in punitive damages. The plaintiff alleged that as a result of using the defendant’s products, the decedent suffered from lung cancer and chronic obstructive pulmonary disease. The plaintiff sought an unspecified amount of compensatory and punitive damages, costs and interest. Final judgment was entered against RJR Tobacco in the amount of $620,000. RJR Tobacco filed a notice of appeal to the Eleventh Circuit and posted a supersedeas bond in the amount of approximately $620,000 in September 2013. Oral argument occurred on October 17, 2014. A decision is pending.

On October 19, 2012, in Ballard v. R. J. Reynolds Tobacco Co ., a case filed in September 2007, in the Circuit Court, Miami-Dade County, Florida, a jury returned a verdict in favor of the plaintiff, found the plaintiff to be 45% at fault and RJR Tobacco to be 55% at fault, and awarded $8.55 million in compensatory damages. Punitive damages were not at issue. The plaintiff alleged that as a result of using the defendant’s products, he suffers from bladder cancer and emphysema, and sought an unspecified amount of compensatory and punitive damages. The court entered final judgment against RJR Tobacco in the amount of $4.7 million in October 2012, and in August 2013, the court entered an amended final judgment against RJR Tobacco in the amount of $5 million. RJR Tobacco filed a notice of appeal to the Third DCA and posted a supersedeas bond in the amount of $5 million in October 2013. In March 2015, the Third DCA affirmed the amended final judgment. RJR Tobacco’s motion for rehearing and rehearing en banc was denied on April 30, 2015. On May 29, 2015, RJR Tobacco filed a notice to invoke the discretionary jurisdiction of the Florida Supreme Court. A decision is pending.

On February 11, 2013, in Evers v. R. J. Reynolds Tobacco Co. , a case filed in November 2007, in the Circuit Court, Hillsborough County, Florida,

a jury returned a verdict in favor of the plaintiff, found the decedent, Jacqueline Loyd, to be 31% at fault, RJR Tobacco to be 60% at fault and Lorillard Tobacco to be 9% at fault, and awarded $3.23 million in compensatory damages and $12.36 million in punitive damages against RJR Tobacco only. The plaintiff alleged that as a result of using the defendants’ products, the decedent became addicted and suffered from smoking-related diseases and/or conditions, and sought an unspecified amount of damages. In March 2013, the court granted the defendants’ post-trial motions for directed verdict on fraudulent concealment, conspiracy and punitive damages. As a result, the $12.36 million punitive damages award was set aside. The plaintiff’ s motion to reconsider directed verdict as to concealment, conspiracy and punitive damages was denied in April 2013. Final judgment was entered in the amount of $1.77 million against RJR Tobacco and approximately $266,000 against Lorillard Tobacco. The plaintiff filed a notice of appeal to the Second DCA, the defendants filed a notice of cross appeal, RJR Tobacco posted a supersedeas bond in the amount of $1.77 million and Lorillard Tobacco posted a supersedeas bond in the amount of approximately $266,000 in May 2013. Oral argument occurred on December 3, 2014. A decision is pending.

On February 13, 2013, in Schoeff v. R. J. Reynolds Tobacco Co ., a case filed in November 2007, in the Circuit Court, Broward County, Florida, a

jury returned a verdict in favor of the plaintiff, found the decedent, James Schoeff, to be 25% at fault, RJR Tobacco to be 75% at fault, and awarded $10.5 million in compensatory damages and $30 million in punitive damages. The plaintiff alleged that as a result of using the defendant’s products, the decedent suffered from addiction and one or more smoking-related diseases and/or conditions, including lung cancer, and sought in excess of $15,000 in damages. In April 2013, final judgment was entered against RJR Tobacco in the amount of $7.88 million in compensatory damages and $30 million in punitive damages. RJR Tobacco filed a notice of appeal to the Fourth DCA, and the plaintiff filed a notice of cross appeal in May 2013. Oral argument occurred on May 19, 2015. A decision is pending.

On April 1, 2013, in Searcy v. R. J. Reynolds Tobacco Co ., a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of the plaintiff, found the decedent, Carol LaSard, to be 40% at fault, RJR Tobacco to be 30% at fault and the remaining defendant to be 30% at fault, and awarded $6 million in compensatory damages and $10 million in punitive damages against each defendant. The plaintiff alleged that as a result of using the defendants’ products, the decedent suffered from lung cancer, and sought an unspecified amount of compensatory and punitive damages. Final judgment was entered against RJR Tobacco in the amount of $6 million in compensatory damages and $10 million in punitive damages. In September 2013, the trial court granted the defendants’ motion for a new trial, or in the alternative, reduction or remittitur of the damages awarded to the extent it sought remittitur of the damages. The compensatory damage award was remitted to $1 million, and the punitive damage award was remitted to $1.67 million against each defendant. The remaining post-trial motions were denied. The plaintiff’s motion to reconsider the trial court’s order granting in part the defendants’ motion for remittitur of the damages award was denied in October 2013. The plaintiff filed a notice of acceptance of remittitur in November 2013, and the court issued an amended final judgment. The defendants filed a joint notice of appeal to the Eleventh Circuit, and RJR Tobacco posted a supersedeas bond in the amount of approximately $2.2 million in November 2013. Oral argument occurred on October 17, 2014. A decision is pending.

On May 2, 2013, in David Cohen v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Palm Beach County, Florida, a jury returned a verdict in favor of the plaintiff, found the decedent, Helen Cohen, to be 40% at fault, RJR Tobacco

40


to be 30% at fault, Lorillard Tobacco to be 20% at fault and the remaining defendant to be 10% at fault, and awarded $2.06 million in compensatory damages. The plaintiff alleged that as a result of using the defendants’ products, the decedent became addicted and suffered from one or more smoking-related diseases and/or conditions, and sought in excess of $15,000 in compensatory damages and unspecified punitive damages. Final jud gment was entered against RJR Tobacco in the amount of $617,000 and against Lorillard Tobacco in the amount of approximately $411,000 in May 2013. In July 2013, the court granted the defendants’ motion for a new trial due to the plaintiff’s improper argum ents during closing. The new trial date has not been scheduled. The plaintiff filed a notice of appeal to the Fourth DCA, and the defendants filed a notice of cross appeal. Briefing is underway.

On May 22, 2013, in John Campbell v. R. J. Reynolds Tobacco Co. , a case pending in Polk County, Florida, a jury returned a verdict in favor of the

defendants, including RJR Tobacco. The plaintiff alleged that as a result of smoking the defendants’ products, the decedent, Judy Campbell, became addicted to smoking cigarettes and suffered from unspecified smoking-related conditions and/or diseases, and sought an unspecified amount of damages. The plaintiff’s motion for a new trial was denied and the court entered final judgment in July 2013. The plaintiff filed a notice of appeal to the Second DCA, and the defendants filed a notice of cross appeal in August 2013. Oral argument occurred on May 12, 2015. On May 20, 2015, the Second DCA affirmed the final judgment of the trial court, per curiam. The plaintiff did not seek further review.

On May 23, 2013, in Earl Graham v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of the plaintiff, found the decedent, Faye Graham, to be 70% at fault, RJR Tobacco to be 20% at fault and the remaining defendant to be 10% at fault, and awarded $2.75 million in compensatory damages. The plaintiff alleged that as a result of smoking the defendants’ products, the decedent became addicted to smoking cigarettes which resulted in her death, and sought an unspecified amount of damages. Final judgment was entered against RJR Tobacco in the amount of $550,000 in May 2013. The defendants filed a joint notice of appeal to the Eleventh Circuit, and RJR Tobacco posted a supersedeas bond in the amount of approximately $556,000 in October 2013. On April 8, 2015, the Eleventh Circuit reversed and ordered entry of judgment for RJR Tobacco. The Eleventh Circuit held that federal law impliedly preempts claims for strict liability and negligence based on the defect and negligence findings from Engle . The plaintiff filed a motion for rehearing en banc or panel rehearing on April 28, 2015. A decision is pending.

On June 4, 2013, in Starr-Blundell v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Duval County, Florida, a

jury returned a verdict in favor of the plaintiff, found the decedent, Lucy Mae Starr, to be 80% at fault, RJR Tobacco to be 10% at fault and the remaining defendant to be 10% at fault, and awarded $500,000 in compensatory damages. The plaintiff alleged that as a result of smoking the defendants’ products, the decedent suffered from lung cancer and other smoking relating diseases and/or conditions, and sought in excess of $15,000 in damages. The court entered final judgment in the amount of $50,000 against each defendant in November 2013. The plaintiff filed a notice of appeal to the First DCA, and the defendants filed a notice of cross appeal in December 2013. RJR Tobacco posted a supersedeas bond in the amount of $50,000 in December 2013. On May 29, 2015, the First DCA affirmed the final judgment of the trial court, per curiam. On June 29, 2015, the plaintiff filed a notice to invoke the discretionary jurisdiction of the Florida Supreme Court. On July 7, 2015, the Florida Supreme Court stayed the petition pending disposition of Soffer v. R. J. Reynolds Tobacco Co. , described above.

On June 14, 2013, in Skolnick v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Palm Beach County, Florida, a

jury returned a verdict in favor of the plaintiff, found the decedent, Leo Skolnick, to be 40% at fault, RJR Tobacco to be 30% at fault and the remaining defendant to be 30% at fault, and awarded $2.56 million in compensatory damages. The plaintiff alleged that as a result of using the defendants’ products, the decedent suffered from lung cancer, and sought in excess of $15,000 in compensatory damages and unspecified punitive damages. The court entered final judgment against RJR Tobacco in the amount of $766,500 in July 2013. The defendants filed a joint notice of appeal to the Fourth DCA, and the plaintiff filed a notice of cross appeal in December 2013. RJR Tobacco posted a supersedeas bond in the amount of $767,000 in March 2014. On July 15, 2015, the Fourth DCA set aside the judgment and ordered a partial new trial. The court held that the strict liability and negligence claims, on which the plaintiff had prevailed, were barred by a prior settlement entered into by the plaintiff in a separate action. However, the court also held that the plaintiff’s concealment and conspiracy claims, on which the defendants had prevailed, must be re-tried due to an erroneous jury instruction on the statute of repose.

On June 19, 2013, in Thibault v. R. J. Reynolds Tobacco Co. , a case pending in the Circuit Court, Escambia County, Florida, a jury returned a

verdict in favor of the plaintiff, found the decedent, Evelyn Thibault, to be 30% at fault and RJR Tobacco to be 70% at fault, and awarded $1.75 million in compensatory damages and $1.28 million in punitive damages. The plaintiff alleged that as a result of using the defendant’s products, the decedent suffered from chronic obstructive pulmonary disease, and sought an unspecified amount of compensatory and punitive damages. The court determined that comparative fault did not apply to reduce the amount of the verdict. In June 2013, the court entered final judgment against RJR Tobacco in the amount of $3.03 million. RJR Tobacco filed a notice of appeal to the First DCA in August 2013. RJR Tobacco posted a supersedeas bond in the amount of $3.03 million in September 2013. On October 13, 2014, the First DCA affirmed the trial court’s judgment, per curiam. The First DCA also certified a conflict to the Florida Supreme Court with Hess v. Philip Morris USA, Inc. , described above. On October 22, 2014, RJR Tobacco

41

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) filed a notice to invoke the discretionary jurisdict ion of the Florida Supreme Court. The Florida Supreme Court stayed the case pending disposition of Hess v. Philip Morris USA Inc . On April 2, 2015, in Hess , the Florida Supreme Court held that, in Engle Progeny cases, the defendants cannot raise a statut e of repose defense to claims for concealment or conspiracy. A decision on the notice to invoke the discretionary jurisdiction of the Florida Supreme Court is pending.

On September 20, 2013, in Gafney v. R. J. Reynolds Tobacco Co. , a case pending in Palm Beach County, Florida, a jury returned a verdict in favor

of the plaintiff, found the decedent, Frank Gafney, to be 34% at fault, RJR Tobacco to be 33% at fault and Lorillard Tobacco to be 33% at fault, and awarded $5.8 million in compensatory damages. Punitive damages were not awarded. The plaintiff alleged that as a result of smoking the defendants’products, the decedent developed chronic obstructive pulmonary disease, and sought in excess of $15,000 in compensatory damages. Final judgment was entered against RJR Tobacco in the amount of $1.9 million and Lorillard Tobacco in the amount of $1.9 million in September 2013. The defendants filed a joint notice of appeal to the Fourth DCA, and RJR Tobacco and Lorillard Tobacco each posted supersedeas bonds in the amount of $1.9 million in November 2013. The plaintiff filed a notice of cross appeal. Briefing is complete. Oral argument has not been scheduled.

On January 27, 2014, in Harford v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of the plaintiff, found the plaintiff to be 82% at fault and RJR Tobacco to be 18% at fault, and awarded $330,000 in compensatory damages. The plaintiff alleged that as a result of his use of the defendant’s products, he suffers from addiction and lung cancer, and sought an unspecified amount of compensatory and punitive damages. The court granted the plaintiff’ s motion for a new trial on compensatory damages in October 2014. This case has been tentatively resolved as part of the federal Engle Progeny settlement.

On January 31, 2014, in Cheeley v. R. J. Reynolds Tobacco Co. , a case filed in November 2007, in the Circuit Court, Broward County, Florida, a

jury returned a verdict in favor of the plaintiff, found the decedent, Georgia Cheeley, to be 50% at fault and RJR Tobacco to be 50% at fault, and awarded $3 million in compensatory damages and $2 million in punitive damages. The plaintiff alleged that as a result of smoking the defendant’s products, the decedent suffered from one or more smoking-related conditions or diseases, and sought in excess of $15,000 in compensatory damages. The court entered final judgment against RJR Tobacco in the amount of $1.5 million in compensatory damages and $2 million in punitive damages. RJR Tobacco filed a notice of appeal to the Fourth DCA and posted a supersedeas bond in the amount of $3.5 million in April 2014. The plaintiff filed a notice of cross appeal in May 2014. Briefing is underway.

On February 3, 2014, in Deshaies v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of RJR Tobacco. The plaintiff alleged that as a result of smoking the defendant’s products, he suffers from one or more smoking-related conditions or diseases, and sought an unspecified amount of compensatory and punitive damages. Final judgment was entered in February 2014. The plaintiff filed a notice of appeal to the Eleventh Circuit on February 11, 2015. Briefing is underway.

On February 18, 2014, in Goveia v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the Circuit Court, Orange County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, Mary Goveia, to be 30% at fault, RJR Tobacco to be 35% at fault, and the remaining defendant to be 35% at fault, and awarded $850,000 in compensatory damages and $2.25 million in punitive damages against each defendant. The plaintiff alleged that as a result of smoking the defendants’ products, the decedent became addicted and suffered from one or more smoking-related diseases and/or conditions, and sought an unspecified amount of compensatory and punitive damages. Final judgment was entered in the amount of $297,500 in compensatory damages and $2.25 million in punitive damages against each defendant in April 2014. The defendants filed a joint notice of appeal to the Fifth DCA, and RJR Tobacco posted a supersedeas bond in the amount of $2.5 million in April 2014. The Fifth DCA affirmed the trial court’s judgment, per curiam, on June 30, 2015. On July 15, 2015, the defendants filed a motion for a citation or, in the alternative, to extend the rehearing deadline and stay the issuance of the mandate. The Fifth DCA denied the motion on August 3, 2015.

On February 27, 2014, in Banks v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Broward County, Florida, a

jury returned a verdict in favor of the defendants, including RJR Tobacco. The plaintiff alleged that as a result of using the defendants’ products, the decedent, George Banks, developed one or more smoking-related diseases and/or conditions, and sought in excess of $15,000 in compensatory damages. The plaintiff’s motion for a new trial was denied, and the court entered final judgment in favor of RJR Tobacco and the other defendant in May 2014. The plaintiff filed a notice of appeal to the Fourth DCA, and the defendants filed a notice of cross appeal in June 2014. Briefing is underway.

On March 17, 2014, in Clayton v. R. J. Reynolds Tobacco Co. , a case filed in November 2007, in the Circuit Court, Duval County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, David Clayton, to be 90% at fault and RJR Tobacco to be 10% at fault, and awarded $600,000 in compensatory damages. Punitive damages were not awarded. The plaintiff alleged that as a result of smoking the defendant’s products, the decedent suffered from bodily injury and died, and sought an unspecified amount of damages. In July 2014, final judgment was entered against RJR Tobacco in the amount of $60,000 in compensatory damages,

42

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) together with $163,469 in taxable costs, for a total of $223,469. RJR Tobacco filed a notice of appeal to the First DCA in August 2014. RJR Tobacco posted a supersedeas bond in the amount of approximately $223,000, and the plaintiff filed a notice of cross appeal in September 2014. Briefing is complete. Ora l argument has not been scheduled.

On March 26, 2014, in Bowden v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the Circuit Court, Duval County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, William Bowden, to be 40% at fault, RJR Tobacco to be 30% at fault and the remaining defendant to be 30% at fault, and awarded $5 million in compensatory damages. Punitive damages were not awarded. The plaintiff alleged that as a result of smoking the defendants’ products, the decedent suffered from unspecified injuries which resulted in his death, and sought an unspecified amount of compensatory and punitive damages. Final judgment was entered against each defendant in the amount of $1.5 million in compensatory damages in March 2014. Post-trial motions were denied in May 2014. The defendants filed a joint notice of appeal to the First DCA, the plaintiff filed a notice of cross appeal and RJR Tobacco posted a supersedeas bond in the amount of $1.5 million in June 2014. Briefing is complete. Oral argument has not been scheduled.

On April 29, 2014, in Dupre v. Philip Morris USA Inc. , a case filed in December 2007, in the Circuit Court, Manatee County, Florida, the court

declared a mistrial because the jury was unable to reach a unanimous verdict. The plaintiff alleged that the decedent, Richard Dupre, was addicted to cigarettes manufactured by the defendant, and as a result, developed one or more smoking-related diseases and/or conditions. The plaintiff is seeking compensatory and punitive damages, costs and interest. Retrial began on April 27, 2015. On May 5, 2015, the court again declared a mistrial based on a surprise change in testimony of a witness. Retrial is scheduled for March 28, 2016.

On May 16, 2014, in Burkhart v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of the plaintiff, found the plaintiff to be 50% at fault, RJR Tobacco to be 25% at fault, Lorillard Tobacco to be 10% at fault and the remaining defendant to be 15% at fault, and awarded $5 million in compensatory damages and $1.25 million in punitive damages against RJR Tobacco, $500,000 in punitive damages against Lorillard Tobacco and $750,000 in punitive damages against the remaining defendant. The plaintiff alleged that she became addicted to smoking cigarettes manufactured by the defendants and suffers from one or more smoking-related diseases and/or conditions. The plaintiff sought an unspecified amount of compensatory and punitive damages, costs and interest. Final judgment was entered in June 2014, and did not include a reduction for comparative fault. In September 2014, the court denied the defendants’ post-trial motions. The defendants filed a joint notice of appeal to the Eleventh Circuit on October 10, 2014. Briefing is complete. Oral argument is tentatively scheduled for September 29, 2015.

On May 19, 2014, in Starbuck v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, the court declared a mistrial because the jury was unable to reach a unanimous verdict. The plaintiff alleged that he suffers from addiction and one or more smoking-related diseases and/or conditions. The plaintiff is seeking an unspecified amount of compensatory damages. Retrial began on December 1, 2014, and on December 16, 2014, the jury returned a verdict in favor of the defendants, including RJR Tobacco. Final judgment was entered in February 2015. In May 2015, the plaintiff’s motion for a new trial was granted on the grounds that the jury’s verdict on “addiction” was against the greater weight of the evidence. The new trial has not been scheduled.

On June 23, 2014, in Bakst v. R. J. Reynolds Tobacco Co. , now known as Odom v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in

the Circuit Court, Palm Beach County, Florida, a jury returned a verdict in favor of the plaintiff, found the decedent, Juanita Thurston, to be 25% at fault and RJR Tobacco to be 75% at fault, and awarded $6 million in compensatory damages plus $4,209 for funeral expenses and $14 million in punitive damages. The plaintiff alleged that as a result of using the defendant’s products, the decedent suffered from nicotine addiction and one or more smoking-related diseases and/or conditions, including lung cancer. The plaintiff sought in excess of $15,000 in compensatory damages, punitive damages, recoverable costs and interest. RJR Tobacco’s post-trial motions were denied, and final judgment was entered against RJR Tobacco in the amount of $4.5 million in compensatory damages and $14 million in punitive damages. RJR Tobacco filed a notice of appeal to the Fourth DCA and posted a supersedeas bond in the amount of $5 million in October 2014. Briefing is underway.

On July 17, 2014, in Robinson v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the Circuit Court, Escambia County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, Michael Johnson, Sr., to be 29.5% at fault and RJR Tobacco to be 70.5% at fault, and awarded $16.9 million in compensatory damages and determined that the plaintiff was entitled to punitive damages. On July 18, 2014, the jury awarded $23.6 billion in punitive damages. The plaintiff alleged that as a result of using the defendant’s products, the decedent suffered from lung cancer. The plaintiff sought an unspecified amount of damages, costs and interest. The court entered partial judgment on compensatory damages against RJR Tobacco in the amount of $16.9 million in July 2014. On January 27, 2015, the court denied the defendant’s post-trial motions, but granted the defendant’s motion for remittitur of the punitive damages award. The punitive damages award was remitted to approximately $16.9 million. In February 2015, RJR Tobacco filed an objection to the remitted award of punitive damages and a demand for a new trial on damages. The court granted a

43

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) new trial on the amount o f punitive damages only. The new trial on punitive damages, which was scheduled for June 29, 2015, has been stayed. RJR Tobacco filed a notice of appeal to the First DCA of the partial judgment of compensatory damages and of the order granting a new tria l on the amount of punitive damages only, and posted a supersedeas bond in the amount of $5 million. Briefing on the merits is expected to begin later this year after the First DCA resolves a threshold issue regarding the scope of the appeal.

On July 31, 2014, in Harris v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of the plaintiff. The jury allocated fault: (1) for the survival claim as follows: decedent – 60%, RJR Tobacco – 15%, Lorillard – 10%, and the remaining defendant – 15%, and (2) for the wrongful death claim as follows: decedent – 70%, RJR Tobacco – 10%, Lorillard – 10%, and the remaining defendant – 10%. The jury awarded $400,000 in compensatory damages for wrongful death and $1.3 million in compensatory damages for the survival claim. The jury declined to award punitive damages. The plaintiff alleged that as a result of smoking cigarettes manufactured by the defendants, the decedent, Gerald Harris, became addicted and suffered from unspecified smoking-related diseases and/or conditions. The plaintiff sought an unspecified amount of compensatory damages, costs and interest. Final judgment was entered in December 2014. Post-trial motions are pending. In April 2015, the court stayed all post-trial proceedings pending resolution of any petition for en banc consideration and rehearing in Graham v. R. J. Reynolds Tobacco Co. , discussed above.

On August 27, 2014, in Gore v. R. J. Reynolds Tobacco Co ., a case filed in January 2008, in the Circuit Court, Indian River County, Florida, the

court declared a mistrial because the jury returned a potentially inconsistent verdict. The jury found for the plaintiff on liability, but awarded no compensatory damages and determined that the plaintiff was entitled to punitive damages. The plaintiff alleged that as a result of using the defendants’ products, the decedent, Gloria Gore, suffered from addiction and one or more smoking-related diseases and/or conditions. The plaintiff sought an unspecified amount of damages. Retrial began on March 9, 2015. On March 26, 2015, the jury returned a verdict in favor of the plaintiff, found the decedent 54% at fault, RJR Tobacco 23% at fault and the remaining defendant 23% at fault, and awarded $2 million in compensatory damages. Punitive damages were not awarded. Post-trial motions are pending.

On August 28, 2014, in Wilcox v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the Circuit Court, Miami-Dade County, Florida, a

jury returned a verdict in favor of the plaintiff, found the decedent, Cleston Wilcox, to be 30% at fault and RJR Tobacco to be 70% at fault, and awarded $7 million in compensatory damages and $8.5 million in punitive damages. The plaintiff alleged that as a result of using the defendant’s products, the decedent suffered from addiction and one or more smoking-related diseases and/or conditions. The plaintiff sought in excess of $15,000, taxable costs and interest. Final judgment was entered in September 2014 against RJR Tobacco in the amount of $4.9 million in compensatory damages and $8.5 million in punitive damages. Post-trial motions were denied on January 16, 2015. RJR Tobacco filed a notice of appeal to the Third DCA and posted a supersedeas bond in the amount of $5 million in February 2015. Briefing is underway.

On August 28, 2014, in Irimi v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Broward County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, Dale Moyer, to be 70% at fault, RJR Tobacco to be 14.5% at fault, Lorillard Tobacco to be 14.5% at fault and the remaining defendant to be 1% at fault, and awarded approximately $3.1 million in compensatory damages. The jury did not find entitlement to punitive damages. The plaintiff alleged that as a result of using the defendants’ products, the decedent suffered from one or more smoking-related illnesses or diseases. The plaintiff sought an unspecified amount of compensatory damages. Final judgment was entered against each of RJR Tobacco and Lorillard Tobacco in the amount of approximately $453,000 and against the remaining defendant in the amount of approximately $31,000. On January 29, 2015, the court granted the defendants’ motion for a new trial. The new trial has not been scheduled. The plaintiff filed a notice of appeal to the Fourth DCA in February 2015, and the defendants filed a notice of cross appeal in March 2015. Briefing is underway.

On August 29, 2014, in Hubbird v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the Circuit Court, Miami-Dade County, Florida, a

jury returned a verdict in favor of the plaintiff, found the decedent, David Ellsworth, to be 50% at fault and RJR Tobacco to be 50% at fault, and awarded $3 million in compensatory damages and $25 million in punitive damages. The plaintiff alleged that as a result of using the defendant’s products, the decedent suffered from smoking-related diseases and/or conditions. The plaintiff sought an unspecified amount of damages. Final judgment was entered against RJR Tobacco in the amount of $28 million. RJR Tobacco filed a notice of appeal to the Third DCA and posted a supersedeas bond in the amount of $5 million in December 2014. Briefing is underway.

On September 5, 2014, in Baum v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the Circuit Court, Miami-Dade County, Florida, a

jury returned a verdict in favor of the defendants, including RJR Tobacco. The plaintiff alleged that as a result of using the defendants’ products, the decedent, Paul Baum, suffered from one or more smoking-related diseases and/or conditions. The plaintiff sought an unspecified amount of compensatory damages, costs and interest. The plaintiff’ s motion for a new trial was denied in November 2014. In December 2014, the plaintiffs filed a notice of appeal to the Third DCA. The defendants filed a notice of cross appeal in January 2015. Briefing is underway.

44


On September 26, 2014, in Morse v. Philip Morris USA, Inc. , a case filed in January 2008, in the Circuit Court, Brevard County, Florida, the court declared a mistrial because of improper testimony by the plaintiff’s addiction witness. The plaintiff alleged that as a result of using the defendant’s products, the de cedent, Jay Morse, suffered from one or more smoking-related diseases and/or conditions. The plaintiff sought an unspecified amount of damages, costs and interest. Retrial is scheduled for February 1, 2016.

On October 10, 2014, in Lourie v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Hillsborough County, Florida,

a jury returned a verdict in favor of the plaintiff, found the decedent, Barbara Lourie, to be 63% at fault, RJR Tobacco to be 3% at fault, Lorillard Tobacco to be 7% at fault and the remaining defendant to be 27% at fault, and awarded approximately $1.37 million in compensatory damages. Punitive damages were not awarded. The plaintiff alleged that as a result of using the defendants’ products, the decedent suffered from addiction and one or more smoking-related diseases and/or conditions. The plaintiff sought an unspecified amount of compensatory and punitive damages, costs and interest. Post-trial motions were denied, final judgment was entered, and the defendants filed a joint notice of appeal to the Second DCA in November 2014. RJR Tobacco posted a supersedeas bond in the amount of approximately $41,000, and Lorillard Tobacco posted a supersedeas bond in the amount of $96,000. Briefing is underway.

On October 22, 2014, in Kerrivan v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of the plaintiff, found the plaintiff to be 19% at fault, RJR Tobacco to be 31% at fault and the remaining defendant to be 50% at fault, and awarded $15.8 million in compensatory damages, and $9.6 million in punitive damages against RJR Tobacco and $15.7 million against the remaining defendant. The plaintiff alleged that as a result of using the defendants’ products, the plaintiff developed one or more smoking-related diseases and/or conditions. The plaintiff sought an unspecified amount of compensatory damages, punitive damages, costs and interest. Final judgment was entered in November 2014. RJR Tobacco filed its post-trial motions on December 11, 2014. In May 2015, the trial court deferred briefing and directed the parties to notify the court when the mandate has issued in Graham v. R. J. Reynolds Tobacco Co. or Searcy v. R. J. Reynolds Tobacco Co ., described above.

On November 5, 2014, in Bishop v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Orange County, Florida, a

jury returned a verdict in favor of the defendants, including RJR Tobacco. The plaintiff alleged that as a result of using the defendants’ products, the decedent, Robert Ramsay, suffered from one or more smoking-related diseases and/or conditions. Final judgment was entered in November 2014. The plaintiff’s motion for a new trial was denied in December 2014. In January 2015, the plaintiff filed a notice of appeal, and the defendants filed a notice of cross appeal to the Fifth DCA. Briefing is underway.

On November 7, 2014, in Taylor v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Duval County, Florida, a jury

returned a verdict in favor of the plaintiff, found the plaintiff to be 42% at fault and RJR Tobacco to be 58% at fault, and awarded approximately $4.5 million in compensatory damages and approximately $521,000 in punitive damages. The plaintiff alleged that as a result of using the defendant’s products, she suffers from chronic obstructive pulmonary disease and peripheral vascular disease. The plaintiff sought in excess of $15,000 in compensatory damages. Post-trial motions were denied, and final judgment was entered in the amount of approximately $4.64 million against RJR Tobacco. RJR Tobacco filed a notice of appeal to the First DCA and posted a supersedeas bond in the amount of approximately $4.64 million in December 2014. Briefing is underway.

On November 18, 2014, in Schleider v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the Circuit Court, Miami-Dade County,

Florida, a jury returned a verdict in favor of the plaintiff, found the decedent, Andrew Schleider, to be 30% at fault and RJR Tobacco to be 70% at fault, and awarded $21 million in compensatory damages. The plaintiff alleged that as a result of the use of the defendant’s products, the decedent suffered from lung cancer and one or more smoking-related diseases and/or conditions. The plaintiff sought in excess of $15,000 plus taxable costs and interest. In June 2015, post-trial motions were denied, and final judgment was entered against RJR Tobacco in the amount of $14.7 million. RJR Tobacco filed a notice of appeal to the Third DCA on July 16, 2015. Briefing is underway.

On November 21, 2014, in Perrotto v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Palm Beach County, Florida, a jury returned a verdict in favor of the plaintiff, found the decedent, Nicholas Perrotto, to be 49% at fault, RJR Tobacco to be 20% at fault, Lorillard Tobacco to be 6% at fault and the remaining defendant to be 25% at fault, and awarded approximately $4.1 million in compensatory damages, but refused to award punitive damages. The plaintiff alleged that as the result of the use of the defendants’ products, the decedent suffered from one or more smoking-related diseases and/or conditions. The plaintiff sought in excess of $15,000, taxable costs and recoverable interest. Final judgment was entered against RJR Tobacco in the amount of approximately $818,000 and against Lorillard Tobacco in the amount of approximately $245,000, and in December 2014, the plaintiff and the defendants filed motions for a new trial. Decisions are pending.

On December 19, 2014, in Haliburton v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the Circuit Court, Palm Beach County,

Florida, a jury returned a verdict in favor of RJR Tobacco. The plaintiff alleged that as the result of the use of the defendant’s products, the decedent, Andrew Haliburton, suffered from one or more smoking-related diseases and/or conditions. The plaintiff

45

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) sought an unspecified amount of compensatory and punitive damages, costs and interest. The court denied the plaintiff’s post-trial motions in March 2015. Final judgment was entered in favor of RJR Tobacc o on April 14, 2015. In May 2015, the plaintiff filed a notice of appeal to the Fourth DCA, and RJR Tobacco filed a notice of cross appeal. Briefing is underway.

On January 29, 2015, in Ellen Gray v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of the plaintiff, found the decedent, Henry Gray, to be 50% at fault and RJR Tobacco to be 50% at fault, and awarded $6 million in compensatory damages. Punitive damages were not awarded. The plaintiff alleged that as a result of the use of the defendant’s products, the decedent suffered from lung cancer, chronic obstructive pulmonary disease and other smoking-related diseases and/or conditions. The plaintiff sought an unspecified amount of compensatory and punitive damages, costs and interest. Final judgment was entered against RJR Tobacco in the amount of $3 million in February 2015. Post-trial motions are pending. On June 10, 2015, the court granted RJR Tobacco’s motion to stay the case pending resolution of the petition for en banc consideration in Graham v. R. J. Reynolds Tobacco Co. , described above.

On February 10, 2015, in Hecht v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of RJR Tobacco. The plaintiff alleged that as a result of the use of the defendant’s products, he suffers from chronic obstructive pulmonary disease and coronary heart disease. The plaintiff sought an unspecified amount of compensatory and punitive damages, costs and interest. Final judgment has not been entered.

On February 11, 2015, in Lennox v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of RJR Tobacco. The plaintiff alleged that as a result of using the defendant’s products, she developed chronic obstructive pulmonary disease. The plaintiff sought an unspecified amount of compensatory damages, costs and interest. Punitive damages were not sought. Final judgment was entered in favor of RJR Tobacco on April 6, 2015. The plaintiff filed a motion for a new trial in April 2015, which was denied on June 19, 2015. The defendants agreed to waive their motion for fees and costs if the plaintiff agreed not to appeal. The plaintiff agreed to the proposal on July 7, 2015.

On February 11, 2015, in Sowers v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of the plaintiff, found the decedent, Charles Sowers, to be 50% at fault and RJR Tobacco to be 50% at fault, and awarded $4.25 million in compensatory damages. Punitive damages were not awarded. The plaintiff alleged that as a result of using the defendant’s products, the decedent suffered from lung cancer and chronic obstructive pulmonary disease. The plaintiff sought an unspecified amount of compensatory and punitive damages, costs and interest. Final judgment was entered against RJR Tobacco in the amount of approximately $2.13 million on February 12, 2015. Post-trial motions are pending. On April 17, 2015, the court stayed post-trial proceedings until resolution of the petition for en banc consideration in Graham v. R. J. Reynolds Tobacco Co. , described above.

On February 19, 2015, in McMannis v. R. J. Reynolds Tobacco Co. , a case filed in November 2007, in the Circuit Court, Charlotte County, Florida,

a jury returned a verdict in favor of the defendants, including RJR Tobacco. The plaintiff alleged that as the result of using the defendants’ products, the decedent, Barbara McMannis, suffered from lung cancer and other smoking-related diseases or conditions. The plaintiff sought an unspecified amount of compensatory and punitive damages, costs and interest. In May 2015, the plaintiff’s motion for a new trial was denied, and final judgment was entered. The defendants agreed to waive their motion for fees and costs if the plaintiff agreed not to appeal. The plaintiff agreed to the proposal on June 3, 2015.

On February 24, 2015, in Caprio v. R. J. Reynolds Tobacco Co ., a jury advised the court that it could not reach a unanimous verdict. The court

directed the jury to complete the verdict form on those individual verdict questions where there was unanimous agreement. The jury did not reach unanimous agreement on all questions and completed only part of the verdict form. The defendants moved for a mistrial, and the plaintiff moved for entry of a partial verdict. The Court requested post-trial briefing. In May 2015, the court advised that it accepted the questions answered by the jurors as a partial verdict. The court also denied the defendants’ post-trial motions. A new trial will be held on the remaining issues, including comparative fault allocation. The defendants filed a notice of appeal to the Fourth DCA on May 26, 2015. The plaintiff filed a motion to dismiss the appeal on June 16, 2015. A decision is pending.

On February 26, 2015, in Zamboni v. R. J. Reynolds Tobacco Co. , a case filed in January 2008, in the U.S. District Court for the Middle District of

Florida, a jury returned a verdict in favor of the plaintiff, found the decedent, Robert Hoover, to be 60% at fault, RJR Tobacco to be 30% at fault and the remaining defendant to be 10% at fault, and awarded $340,000 in compensatory damages. Punitive damages were not awarded. The plaintiff alleged that as a result of the use of the defendants’ products, the decedent suffered from cerebrovascular disease, coronary heart disease and lung cancer. The plaintiff sought an unspecified amount of compensatory and punitive damages, costs and interest. Post-trial motions are pending. The court stayed the case pending resolution of the petition for rehearing or rehearing en banc and any rehearing in Graham v. R. J. Reynolds Tobacco Co. , discussed above.

46


On March 18, 201 5, in Dion v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Sarasota County, Florida, the court declared a mistrial due to the jury’s inability to reach a unanimous verdict. The plaintiff alleged that as a result of usin g the defendant’s products, the decedent, Marion Dion, suffered from one or more smoking-related diseases or conditions. The plaintiff seeks in excess of $15,000 in compensatory and punitive damages, costs and interest. Retrial is scheduled for April 25, 2016.

On March 25, 2015, in Pollari v. R. J. Reynolds Tobacco Co. , a case filed in May 2007, in the Circuit Court, Broward County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, Paul Pollari, to be 15% at fault, RJR Tobacco to be 42.5% at fault and the remaining defendant to be 42.5% at fault, and awarded $10 million in compensatory damages and $1.5 million in punitive damages against each defendant. The plaintiff alleged that as a result of using the defendants’ products, the decedent suffered from lung cancer. The plaintiff sought an unspecified amount of compensatory and punitive damages, costs and interest. Final judgment was entered against the defendants in the amount of $10 million in compensatory damages and $1.5 million in punitive damages against each defendant. Post-trial motions are pending.

On April 2, 2015, in Ryan v. R. J. Reynolds Tobacco Co. , a case filed in August 2007, in the Circuit Court, Broward County, Florida, the court

declared a mistrial due to the opinion being issued by the Florida Supreme Court in Hess v. Philip Morris USA Inc . The plaintiff alleges that as a result of using the defendants’ products, he developed chronic obstructive pulmonary disease. The plaintiff sought an unspecified amount of compensatory and punitive damages, costs and interest. Retrial began on April 8, 2015. On April 17, 2015, the jury returned a verdict in favor of the plaintiff, found the plaintiff to be 35% at fault and RJR Tobacco to be 65% at fault and awarded $21.5 million in compensatory damages and $25 million in punitive damages. In May 2015, RJR Tobacco filed its post-trial motions, and final judgment was entered against RJR Tobacco in the amount of $21.5 million in compensatory damages and $25 million in punitive damages. Post-trial motions are pending and a hearing on the motions is scheduled for September 15, 2015.

On May 21, 2015, in Ethel Gray v. R. J. Reynolds Tobacco Co. , a case pending in Escambia County, Florida, a jury returned a verdict in favor of

RJR Tobacco. The plaintiff alleged that as a result of using the defendant’s products, the decedent, Willie Gray, suffered from peripheral vascular disease and chronic obstructive pulmonary disease. The plaintiff sought an unspecified amount of damages, costs and interest. Final judgment has not been entered.

On June 18, 2015, in Hardin v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Miami-Dade County, Florida, a

jury returned a verdict in favor of the plaintiff, found the decedent, Thomas Hardin, to be 87% at fault and RJR Tobacco to be 13% at fault, and awarded $776,000 in compensatory damages. Punitive damages were not awarded. The plaintiff alleged that as a result of using the defendant’s products, the decedent suffered from one or more smoking-related diseases or conditions. Final judgment was entered against RJR Tobacco in the amount of $100,880 in June 2015. Post-trial motions are pending.

On July 13, 2015, in McCoy v. R. J. Reynolds Tobacco Co. , a case filed in December 2007, in the Circuit Court, Broward County, Florida, a jury

returned a verdict in favor of the plaintiff, found the decedent, Glodine McCoy, 35% at fault, RJR Tobacco 25% at fault, Lorillard Tobacco 20% at fault and the remaining defendant 20% at fault, and awarded $1.5 million in compensatory damages. The jury also awarded $3 million in punitive damages against each defendant. The plaintiff alleged that as a result of using the defendants’ products, the decedent suffered from lung cancer and other smoking-related diseases and/or conditions. The plaintiff sought compensatory damages in excess of $15,000, punitive damages, recoverable costs and interest.

Broin II Cases

RJR Tobacco, B&W and other cigarette manufacturer defendants settled Broin v. Philip Morris, Inc. in October 1997. This case had been brought in Florida state court on behalf of flight attendants alleged to have suffered from diseases or ailments caused by exposure to ETS 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; B&W’s portion of these payments was approximately $57 million. The settlement agreement bars class members from bringing aggregate claims or obtaining punitive 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 airplane cabins, referred to as “specific causation,” the individual plaintiff will have the burden of proof. On September 7, 1999, the Florida Supreme Court approved the settlement. The Broin II cases arose out of the settlement of this case.

On October 5, 2000, the Broin court 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.

47

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) 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 ETS in airplane cabins, that is, specific causation.

As of June 30, 2015, there were 2,545 Broin II lawsuits pending in Florida. There have been no Broin II trials since 2007.

Class-Action Suits

Overview. As of June 30, 2015, nine class-action cases, excluding the shareholder cases described below, were pending in the United States against RJR Tobacco, Lorillard Tobacco or their affiliates or indemnitees. These class actions seek recovery for personal injuries allegedly caused by cigarette smoking or, in some cases, for economic damages allegedly incurred by cigarette or e-cigarette purchasers.

In 1996, the Fifth Circuit Court of Appeals in Castano v. American Tobacco Co. overturned the certification of a nation-wide 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 state-wide, rather than nation-wide, classes. Class-action suits based on claims similar to those asserted in Castano or claims that class members are at a greater risk of injury or injured by the use of tobacco or exposure to ETS are pending against RJR Tobacco, Lorillard Tobacco, or their affiliates or indemnitees in state or federal courts in California, Illinois, Louisiana, Missouri, and West Virginia. All pending class-action cases are discussed below.

The pending class actions against RJR Tobacco or its affiliates or indemnitees include four cases alleging that the use of the term “lights”constitutes unfair and deceptive trade practices under state law or violates the federal RICO statute. Such suits are pending in state or federal courts in Illinois and Missouri and are discussed below under “— ‘Lights’ Cases.”

Finally, certain third-party payers have filed health-care cost recovery actions in the form of class actions. These cases are discussed below under “— Health-Care Cost Recovery Cases.”

Few smoker class-action complaints have been certified or, if certified, have survived on appeal. Eighteen federal courts, including two courts of appeals, and most state courts that have considered the issue have rejected class certification in such cases. Apart from the Castano case discussed above, only two smoker class actions have been certified by a federal court — In re Simon (II) Litigation, and Schwab [McLaughlin] v. Philip Morris USA, Inc. , both of which were filed in the U.S. District Court for the Eastern District of New York and ultimately decertified.

California Class Actions. Sateriale v. R. J. Reynolds Tobacco Co. , is a class action filed in November 2009 in the U.S. District Court for the Central District of California relating to the termination of a series of promotions by RJR Tobacco’s Camel brand from 1991 to 2007 known as “Camel Cash.” The plaintiffs originally brought the case on behalf of a putative class of all persons who tried unsuccessfully to redeem Camel Cash certificates from October 1, 1991 through March 31, 2007, or who held Camel Cash certificates as of March 31, 2007. The plaintiffs alleged that RJR Tobacco failed to have any rewards available during the final promotional period. The plaintiffs alleged claims based on the California Unfair Competition Law, the California Consumer Legal Remedies Law, breach of contract and promissory estoppel, and the plaintiffs sought injunctive relief, actual damages, costs and expenses. In January 2010, RJR Tobacco filed a motion to dismiss. In February 2010, the plaintiffs filed an amended complaint. In the amended complaint, the proposed class definition changed to a class consisting of all persons who reside in the U.S. and tried unsuccessfully to redeem Camel Cash certificates, also referred to as C-Notes, from October 1, 2006 to March 31, 2007. The plaintiffs also proposed a California subclass consisting of persons in California meeting the same criteria. In May 2010, RJR Tobacco’s motion to dismiss the amended complaint for lack of subject matter jurisdiction and, alternatively, for failure to state a claim was granted with leave to amend. The plaintiffs filed a second amended complaint. In July 2010, RJR Tobacco’s motion to dismiss the second amended complaint was granted with leave to amend. The plaintiffs filed a third amended complaint, and RJR Tobacco filed a motion to dismiss in September 2010. In December 2010, the district court granted RJR Tobacco’s motion to dismiss with prejudice and entered final judgment. In January 2011, the plaintiffs filed a notice of appeal. In July 2012, the U.S. Court of Appeals for the Ninth Circuit, referred to as the Ninth Circuit, affirmed the dismissal of the plaintiffs’ claims under the California Unfair Competition Law and the California Consumer Legal Remedies Acts and reversed the dismissal of the plaintiffs’ claims for promissory estoppel and breach of contract. In October 2012, the Ninth Circuit denied RJR Tobacco’s motion for rehearing or rehearing en banc . RJR Tobacco filed its answer to the plaintiffs’ third amended complaint in December 2012. Following the completion of discovery in June 2014, RJR Tobacco filed a motion for summary judgment, and the plaintiffs filed a motion for class certification. On December 19, 2014, the district court denied RJR Tobacco’s motion for summary judgment, declined to certify a national class, found that the plaintiffs’ promissory estoppel claim could not be tried on a class basis, and, on the plaintiffs’ breach of contract claim, certified a class of “all persons in California who, as adult smokers, were assigned registration numbers by RJR Tobacco, collected C-Notes, and held C-Notes as of October 1, 2006.” In January 2015, RJR Tobacco filed motions for reconsideration of the district court’s order on class certification and summary judgment. On April 8, 2015, the district court denied both of RJR Tobacco’s motions for reconsideration. On April 22, 2015, RJR Tobacco filed a petition with the Ninth Circuit for leave to appeal the district court’s order granting class certification. A decision is pending. In May 2015, the court denied the plaintiffs’ motion to add residents of New York, South Dakota and Iowa into the certified class. On June 17, 2015, the court denied RJR Tobacco’s motion to certify an interlocutory appeal of the

48

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) district court’s denial of RJR Tobacco’s motion for summary judgment. On July 8, 2015, RJR Tobacco’s motion for leave to reopen discovery was granted. Trial is schedul ed to begin on November 3, 2015.

In Diek v. Lorillard Tobacco Company, a putative class action filed in April 2015, in the Superior Court of California, Orange County, the plaintiff

brought a case against Lorillard Tobacco and two affiliated entities on behalf of a putative class of purchasers of one or more blu brand e-cigarettes, including e-juices, components thereof, cartridges or accessories sold by the defendants. The plaintiff alleges that certain advertising, marketing and packaging materials for blu brand e-cigarettes made deceptive claims and omitted material information. The plaintiff seeks injunctive relief under California Civil Code §1,750 et seq ., injunctive and equitable relief under California Business & Professions Code §17,200 et seq ., injunctive relief and damages under California Business and Professions Code §17,500 et seq ., and damages for purported breaches of express warranty. On June 18, 2015, pursuant to the terms of the Asset Purchase Agreement, RAI tendered the defense of this action to, and sought indemnification for this action from, Imperial Sub. On June 26, 2015, the defendants removed the action to the U.S. District Court for the Central District of California.

“Lights” Cases. As noted above, “lights” class-action cases are pending against RJR Tobacco or B&W in Illinois (2) and Missouri (2). The classes in these cases generally seek to recover $50,000 to $75,000 per class member for compensatory and punitive damages, injunctive and other forms of relief, and attorneys’ fees and costs from RJR Tobacco and/or B&W. In general, the plaintiffs allege that RJR Tobacco or B&W made false and misleading claims that “lights” cigarettes were lower in tar and nicotine and/or were less hazardous or less mutagenic than other cigarettes. The cases typically are filed pursuant to state consumer protection and related statutes.

Many of these “lights” cases were stayed pending review of the Good v. Altria Group, Inc . case by the U.S. Supreme Court. In that “lights” class-action case against Altria Group, Inc. and Philip Morris USA, the U.S. Supreme Court decided that these claims are not preempted by the Federal Cigarette Labeling and Advertising Act or by the Federal Trade Commission’s, referred to as FTC, historic regulation of the industry. Since this decision in December 2008, a number of the stayed cases have become active again.

The seminal “lights” class-action case involves RJR Tobacco’s competitor, Philip Morris, Inc. Trial began in Price v. Philip Morris, Inc . in January 2003. In March 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. Based on Illinois law, the bond required to stay execution of the judgment was set initially at $12 billion. Philip Morris pursued various avenues of relief from the $12 billion bond requirement. On December 15, 2005, the Illinois Supreme Court reversed the lower court’s decision and sent the case back to the trial court with instructions to dismiss the case. On December 5, 2006, the trial court granted the defendant’s motion to dismiss and for entry of final judgment. The case was dismissed with prejudice the same day. In December 2008, the plaintiffs filed a petition for relief from judgment, stating that the U.S. Supreme Court’s decision in Good v. Altria Group, Inc . rejected the basis for the reversal. The trial court granted the defendant’s motion to dismiss the plaintiffs’ petition for relief from judgment in February 2009. In March 2009, the plaintiffs filed a notice of appeal to the Illinois Appellate Court, Fifth Judicial District, requesting a reversal of the February 2009 order and remand to the circuit court. On February 24, 2011, the appellate court entered an order, concluding that the two-year time limit for filing a petition for relief from a final judgment began to run when the trial court dismissed the plaintiffs’ lawsuit on December 18, 2006. The appellate court therefore found that the petition was timely, reversed the order of the trial court, and remanded the case for further proceedings. Philip Morris filed a petition for leave to appeal to the Illinois Supreme Court. On September 28, 2011, the Illinois Supreme Court denied Philip Morris’s petition for leave to appeal and returned the case to the trial court for further proceedings. In December 2012, the trial court denied the plaintiffs’ petition for relief from the judgment. The plaintiffs filed a notice of appeal to the Illinois Appellate Court, Fifth Judicial District. In April 2014, the appellate court reinstated the 2003 verdict. In May 2014, Philip Morris filed a petition for leave to appeal to the Illinois Supreme Court and a motion for supervisory order. Philip Morris has requested the Illinois Supreme Court to direct the Fifth Judicial District to vacate its April 2014 judgment and to order the Fifth Judicial District to affirm the trial court’s denial of the plaintiff’s petition for relief from the judgment, or in the alternative, grant its petition for leave to appeal. On September 24, 2014, the Illinois Supreme Court agreed to hear Philip Morris’s appeal. Oral argument occurred on May 19, 2015. A decision is pending.

In Turner v. R. J. Reynolds Tobacco Co., a case filed in February 2000, in Circuit Court, Madison County, Illinois, a judge certified a class in November 2001. In June 2003, RJR Tobacco filed a motion to stay the case pending Philip Morris’s appeal of the Price v. Philip Morris, Inc. case mentioned above, which the judge denied in July 2003. In October 2003, the Illinois Fifth District Court of Appeals denied RJR Tobacco’s emergency stay/supremacy order request. In November 2003, the Illinois Supreme Court granted RJR Tobacco’s motion for a stay pending the court’s final appeal decision in Price. On October 11, 2007, the Illinois Fifth District Court of Appeals dismissed RJR Tobacco’s appeal of the court’s denial of its emergency stay/supremacy order request and remanded the case to the Circuit Court. A status conference is scheduled for August 19, 2015.

In Howard v. Brown & Williamson Tobacco Corp., another case filed in February 2000 in Circuit Court, Madison County, Illinois, a judge certified a class in December 2001. In June 2003, the trial judge issued an order staying all proceedings pending resolution of the Price v. Philip Morris, Inc. case mentioned above. The plaintiffs appealed this stay order to the Illinois Fifth District Court of Appeals, which affirmed the Circuit Court’s stay order in August 2005. There is currently no activity in the case.

49


A “lights” class-action case is pending against each of RJR Tobacco and B&W in Missouri. In Collora v. R. J. Reynolds Tobacco Co., a case filed

in May 2000 in Circuit Court, St. Louis County, Missouri, a judge in St. Louis certified a class in December 2003. In April 2007, the court granted the plaintiffs’ motion to reassign Collora and the following cases to a single general division: Craft v. Philip Morris Companies, Inc. and Black v. Brown & Williamson Tobacco Corp., discussed below. In April 2008, the court stayed the case pending U.S. Supreme Court review in Good v. Altria Group, Inc . A nominal trial date of January 10, 2011 was scheduled, but it did not proceed at that time. A status conference is scheduled for February 22, 2016.

Finally, in Black v. Brown & Williamson Tobacco Corp., a case filed in November 2000 in Circuit Court, City of St. Louis, Missouri, B&W removed the case to the U.S. District Court for the Eastern District of Missouri. The plaintiffs filed a motion to remand, which was granted in March 2006. In April 2008, the court stayed the case pending U.S. Supreme Court review in Good v. Altria Group, Inc. A nominal trial date of January 10, 2011, was scheduled, but it did not proceed at that time. A status conference is scheduled for February 22, 2016.

In the event RJR Tobacco and its affiliates or indemnitees lose one or more of the pending “lights” class-action suits, RJR Tobacco, depending

upon the amount of any damages ordered, could face difficulties in its ability to pay the judgment or obtain any bond required to stay execution of the judgment which could have a material adverse effect on RJR Tobacco’s, and consequently RAI’s, results of operations, cash flows or financial position.

Other Class Actions. In Young v. American Tobacco Co., Inc., a case filed in November 1997 in Circuit Court, Orleans Parish, Louisiana, the plaintiffs brought an ETS class action against U.S. cigarette manufacturers, including RJR Tobacco and B&W, and parent companies of U.S. cigarette manufacturers, including RJR, on behalf of all residents of Louisiana who, though not themselves cigarette smokers, have been exposed to secondhand smoke from cigarettes which were manufactured by the defendants, and who allegedly suffered injury as a result of that exposure. The plaintiffs seek to recover an unspecified amount of compensatory and punitive damages. In March 2013, the court entered an order staying the case, including all discovery, pending the implementation of the smoking cessation program ordered by the court in Scott v. The American Tobacco Co .

In Parsons v. A C & S, Inc., a case filed in February 1998 in Circuit Court, Ohio County, West Virginia, the plaintiff sued asbestos manufacturers, U.S. cigarette manufacturers, including RJR Tobacco, B&W, Lorillard Tobacco, and parent companies of U.S. cigarette manufacturers, including RJR and Lorillard, seeking to recover $1 million in compensatory and punitive damages individually and an unspecified amount for the class in both compensatory and punitive damages. The class was brought on behalf of persons who allegedly have personal injury claims arising from their exposure to respirable asbestos fibers and cigarette smoke. The plaintiffs allege that Mrs. Parsons’ use of tobacco products and exposure to asbestos products caused her to develop lung cancer and to become addicted to tobacco. In December 2000, three defendants, Nitral Liquidators, Inc., Desseaux Corporation of North America and Armstrong World Industries, filed bankruptcy petitions in the U.S. Bankruptcy Court for the District of Delaware, In re Armstrong World Industries, Inc. Pursuant to section 362(a) of the Bankruptcy Code, Parsons is automatically stayed with respect to all defendants who filed for bankruptcy. The case remained pending against the other defendants, including RJR Tobacco and Lorillard Tobacco, but it has long been dormant.

Finally, in Jones v. American Tobacco Co., Inc., a case filed in December 1998 in Circuit Court, Jackson County, Missouri, the defendants removed the case to the U.S. District Court for the Western District of Missouri in February 1999. The action was brought against the major U.S. cigarette manufacturers, including RJR Tobacco, B&W, Lorillard Tobacco, and parent companies of U.S. cigarette manufacturers, including RJR and Lorillard, by tobacco product users and purchasers on behalf of all similarly situated Missouri consumers. The plaintiffs allege that their use of the defendants’tobacco products has caused them to become addicted to nicotine. The plaintiffs seek to recover an unspecified amount of compensatory and punitive damages. The case was remanded to the Circuit Court in February 1999. There is currently no activity in this case.

50

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) Filter Cases

Claims have been brought against Lorillard Tobacco and Lorillard by individuals who seek damages resulting from their alleged exposure to asbestos fibers that were incorporated into filter material used in one brand of cigarettes manufactured by a predecessor to Lorillard Tobacco for a limited period of time ending more than 50 years ago. As of June 30, 2015, Lorillard Tobacco and/or Lorillard was a defendant in 67 Filter Cases. Since January 1, 2012, Lorillard Tobacco has paid, or has reached agreement to pay, a total of approximately $49.3 million in settlements to finally resolve 178 claims asserted in Filter Cases.

Pursuant to the terms of a 1952 agreement between P. Lorillard Company and H&V Specialties Co., Inc. (the manufacturer of the filter material),

Lorillard Tobacco is required to indemnify Hollingsworth & Vose for legal fees, expenses, judgments and resolutions in cases and claims alleging injury from finished products sold by P. Lorillard Company that contained the filter material.

On September 13, 2013, the jury in DeLisle v. A. W. Chesterton Company , a case tried in the Circuit Court for the 17 th Judicial Circuit, Broward

County, Florida, found in favor of the plaintiffs as to their claims for negligence and strict liability, and awarded $8 million. Lorillard Tobacco is responsible for 44%, or $3.52 million. Judgment was entered on November 6, 2013. Lorillard Tobacco filed its notice of appeal on November 18, 2013. Briefing is underway. Health-Care Cost Recovery Cases

Health-care cost recovery cases have been brought by a variety of plaintiffs. Other than certain governmental 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.

As of June 30, 2015, two health-care cost recovery cases were pending in the United States against RJR Tobacco, B&W, Lorillard Tobacco, or all three, as discussed below after the discussion of the State Settlement Agreements. A limited number of claimants have filed suit against RJR Tobacco, one of its affiliates, and other tobacco industry defendants to recover funds for health care, medical and other assistance paid by foreign provincial governments in treating their citizens. For additional information on these cases, see “— International Cases” below.

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, B&W and Lorillard Tobacco. This case was brought on behalf of the state to recover state funds paid for health care 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, B&W, Lorillard Tobacco and other U.S. cigarette manufacturers based on similar theories. The cigarette manufacturer defendants, including RJR Tobacco, B&W and Lorillard Tobacco, settled the first four of these cases scheduled for trial — Mississippi, Florida, Texas and Minnesota — by separate agreements with each such state.

On November 23, 1998, the major U.S. cigarette manufacturers, including RJR Tobacco, B&W and Lorillard Tobacco, entered into the Master

Settlement Agreement with attorneys general representing the remaining 46 states, the District of Columbia, Puerto Rico, Guam, the Virgin Islands, American Samoa and the Northern Marianas. Effective on November 12, 1999, the MSA settled all the health-care cost recovery actions brought by, or on behalf of, the settling jurisdictions and released various additional present and future claims.

In the settling jurisdictions, the MSA released RJR Tobacco, B&W, Lorillard Tobacco, and their affiliates and indemnitees, including RAI and Lorillard, from:

51

• 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 of the settling states and their respective political subdivisions and other recipients of state health-care funds, 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.


Set forth below is the unadjusted tobacco industry settlement payment schedule for 2013 and beyond:

RAI’ s operating subsidiaries expenses and payments under the State Settlement Agreements for 2013 and 2014, and the projected expenses and payments for 2015 and beyond, which include the impact of the Merger, are set forth below (2) .

The State Settlement Agreements also contain provisions restricting the marketing of tobacco products. Among these provisions are restrictions or

prohibitions on the use of cartoon characters, brand-name sponsorships, apparel and other merchandise, outdoor and transit advertising, payments for product placement, free sampling and lobbying. Furthermore, the State Settlement Agreements required the dissolution of three industry-sponsored research and trade organizations.

The State Settlement Agreements have materially adversely affected RJR Tobacco’s shipment volumes. RAI believes that these settlement obligations may materially adversely affect the results of operations, cash flows or financial position of RAI 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 value categories, RJR Tobacco’s share of the domestic premium and value cigarette categories, and the effect of any resulting cost advantage of manufacturers not subject to the State Settlement Agreements.

U.S. Department of Justice Case. On September 22, 1999, in United States v. Philip Morris USA Inc., the U.S. Department of Justice brought an

action against RJR Tobacco, B&W, Lorillard Tobacco and other tobacco companies in the U.S. District Court for the District of Columbia. The government initially sought to recover federal funds expended by the federal government in providing health care to smokers who developed diseases and injuries alleged to be smoking-related, based on several federal statutes. In addition, the government sought, pursuant to the civil provisions of RICO, disgorgement of profits the government contends were earned as a consequence of a RICO racketeering “enterprise.” In September 2000, the district court dismissed the government’s claims asserted under the Medical Care Recovery Act as well as those under the Medicare Secondary Payer provisions of the Social Security Act, but did not dismiss the RICO claims. In February 2005, the D.C. Circuit ruled that disgorgement is not an available remedy in this case. The government’s petition for writ of certiorari with the U.S. Supreme Court was denied in October 2005. The non-jury, bench trial began in September 2004, and closing arguments concluded in June 2005.

On August 17, 2006, the district court found certain defendants, including RJR Tobacco, B&W and Lorillard Tobacco had violated RICO, but did not impose any direct financial penalties. The district court instead enjoined RJR Tobacco, Lorillard Tobacco and the defendants from committing future racketeering acts, participating in certain trade organizations, making misrepresentations concerning smoking and health and youth marketing, and using certain brand descriptors such as “low tar,” “light,” “ultra light,” “mild” and “natural.” The district court also ordered RJR Tobacco, Lorillard Tobacco and the other defendants to issue “corrective communications” on five subjects, including smoking and health and addiction, and to comply with further undertakings, including maintaining web sites of historical corporate documents and disseminating certain marketing information on a confidential basis to the

52

2013 2014 2015 and thereafter

First Four States’ Settlements: (1) Mississippi Annual Payment $ 136 $ 136 $ 136 Florida Annual Payment 440 440 440 Texas Annual Payment 580 580 580 Minnesota Annual Payment 204 204 204 Remaining Jurisdictions’ Settlement: Annual Payments (1) 8,004 8,004 8,004 Total $ 9,364 $ 9,364 $ 9,364

(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. For further information, see “— State Settlement Agreements — Enforcement and Validity; Adjustments” below.

2013 2014 2015 2016 2017 2018 and thereafter

Settlement expenses $ 1,819 $ 1,917 — Settlement cash payments $ 2,582 $ 1,985 — Projected settlement expenses $>2,400 $>2,900 $>3,200 $>3,200 Projected settlement cash payments $>2,100 $>3,100 $>2,900 $>3,200

(2) Amounts beginning in 2013 reflect the impact of the Term Sheet described below under “— State Settlement Agreements – Enforcement and Validity; Adjustments – Partial Settlement of Certain NPM Adjustment Claims.”

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) government. In addition, the district court place d restrictions on the defendants’ ability to dispose of certain assets for use in the United States, unless the transferee agrees to abide by the terms of the district court’s order, and ordered certain defendants to reimburse the U.S. Department of Justic e its taxable costs incurred in connection with the case.

Certain defendants, including RJR Tobacco and Lorillard Tobacco, filed notices of appeal to the D.C. Circuit in September 2006. The government filed its notice of appeal in October 2006. In addition, the defendants, including RJR Tobacco and Lorillard Tobacco, filed joint motions asking the district court to clarify and to stay its order pending the defendants’ appeal. On September 28, 2006, the district court denied the defendants’ motion to stay. On September 29, 2006, the defendants, including RJR Tobacco and Lorillard Tobacco, filed a motion asking the D.C. Circuit to stay the district court’s order pending the defendants’ appeal. The D.C. Circuit granted the motion in October 2006.

In November 2006, the D.C. Circuit stayed the appeals pending the district court’s ruling on the defendants’ motion for clarification. The defendants’ motion was granted in part and denied in part. The defendants’ motion as to the meaning and applicability of the general injunctive relief of the August 2006 order was denied. The request for clarification as to the scope of the provisions in the order prohibiting the use of descriptors and requiring corrective statements at retail point of sale was granted. The district court also ruled that the provisions prohibiting the use of express or implied health messages or descriptors do apply to the actions of the defendants taken outside of the United States.

In May 2009, the D.C. Circuit largely affirmed the finding of liability against the tobacco defendants and remanded to the trial court for dismissal of the trade organizations. The D.C. Circuit also largely affirmed the remedial order, including the denial of additional remedies, but vacated the order and remanded for further proceedings as to the following four discrete issues:

RJR Tobacco, Lorillard Tobacco and the other defendants, as well as the Department of Justice, filed petitions for writ of certiorari to the U.S.

Supreme Court in February 2010. In June 2010, the U.S. Supreme Court denied the parties’ petitions for writ of certiorari. Post-remand proceedings are underway to determine the extent to which the original order will be implemented. On December 22, 2010, the

district court dismissed B&W from the litigation. On March 3, 2011, the defendants filed a motion for vacatur, in which they moved to vacate the district court’s injunctions and factual findings and dismiss the case in its entirety. The court denied the motion on June 1, 2011. The defendants filed a notice of appeal. In addition, the parties to the lawsuit entered into an agreement concerning certain technical obligations regarding their public websites. Pursuant to this agreement, RJR Tobacco agreed to deposit $3.125 million, and Lorillard Tobacco agreed to deposit $650,000, over three years into the registry of the district court. Those deposits are now complete. In July 2012, the D.C. Circuit affirmed the district court’s denial of the defendants’ motion to vacate the injunctions. In November 2012, the trial court entered an order wherein the court determined the language to be included in the text of the corrective statements and directed the parties to engage in discussions with the Special Master to implement them. The defendants filed a notice of appeal of that order on January 25, 2013. In February 2013, the D.C. Circuit granted the defendants’ motion to hold the case in abeyance pending the District Court’s resolution of corrective-statement implementation issues. The mediation process on implementation issues has concluded, and the district court entered an implementation order on June 2, 2014. The order stays implementation pending exhaustion of appeals on the corrective-statements remedy. On June 25, 2014, the defendants filed a notice of appeal from the implementation order. On August 8, 2014, the D.C. Circuit consolidated the appeal from the implementation order with the appeal previously held in abeyance from the district court order dictating the language of the corrective statements. Oral argument before the D.C. Circuit was held on February 23, 2015. On May 22, 2015, the D.C. Circuit issued its opinion on the court-ordered corrective statements. The D.C. Circuit reversed part of the corrective statements, affirmed other parts and remanded the case to the District Court for further proceedings. On June 8, 2015, the district court entered an order authorizing the transfer of certain cigarette brands and businesses to Imperial Sub and subjecting Imperial Sub and two of its affiliates—Commonwealth Brands, Inc. and Commonwealth-Altadis, Inc.—to the jurisdiction of the district court in this case. Under Paragraph 20 of Order #1015, the district court’s authorization was required prior to the transfer of the brands from RJR Tobacco and Lorillard Tobacco to Imperial Sub. On June 30, 2015, the district court held a status conference to discuss briefing and scheduling of future submissions in light of the D.C.

53

• the issue of the extent of B&W’s control over tobacco operations was remanded for further fact finding and clarification;

• the remedial order was vacated to the extent that it binds all defendants’ subsidiaries and was remanded to the district court for determination as to whether inclusion of the subsidiaries and which of the subsidiaries satisfy Rule 65(d) of the Federal Rules of Civil Procedure;

• the D.C. Circuit held that the provision found in paragraph four of the injunction, concerning the use of any express or implied health message or health descriptor for any cigarette brand, should not be read to govern overseas sales. The issue was remanded to the district court with instructions to reformulate it so as to exempt foreign activities that have no substantial, direct and foreseeable domestic effects; and

• the remedial order was vacated regarding “point of sale” displays and remanded for the district court to evaluate and make due provisions for the rights of innocent persons, either by abandoning this part of the remedial order or re-crafting a new version reflecting the rights of third parties.

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) Circuit’s decision on the corrective statement issue. On July 7, 2015, the U.S. Department of Justice filed a motion for rehea ring with the D.C. Circuit. In light of the corrective-statements implementation order, $20 million has been accrued for the estimated costs of the corrective communications and is included in the condensed consolidated balance sheet (unaudited) as of Jun e 30, 2015.

Native American Tribe Case. As of June 30, 2015, one Native American tribe case was pending before a tribal court against RJR Tobacco, B&W

and Lorillard Tobacco, Crow Creek Sioux Tribe v. American Tobacco Co. , a case filed in September 1997 in Tribal Court, Crow Creek Sioux, South Dakota. The plaintiffs seek to recover actual and punitive damages, restitution, funding of a clinical cessation program, funding of a corrective public education program, and disgorgement of unjust profits from sales to minors. The plaintiffs claim that the defendants are liable under the following theories: unlawful marketing and targeting of minors, contributing to the delinquency of minors, unfair and deceptive acts or practices, unreasonable restraint of trade and unfair method of competition, negligence, negligence per se, conspiracy and restitution of unjust enrichment. The case is dormant.

International Cases. Ten health care reimbursement cases have been filed against RJR Tobacco, its affiliates, or B&W outside the United States,

by each of the Canadian provinces. In these actions, foreign governments are seeking to recover for health care, medical and other assistance paid and to be paid in treating their citizens for tobacco-related disease. No such actions are pending in the United States. Pursuant to the terms of the 1999 sale of RJR Tobacco’s international tobacco business, RJR Tobacco has tendered the defense of these actions to Japan Tobacco Inc., referred to as JTI. Subject to a reservation of rights, JTI has assumed the defense of RJR Tobacco and its current or former affiliates in these actions.

54

• British Columbia - In 1997, British Columbia enacted a statute, subsequently amended, which created a civil cause of action for the government to recover the costs of health-care benefits incurred for insured populations of British Columbia residents resulting from tobacco-related disease. An action brought on behalf of the Province of British Columbia pursuant to the statute against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and certain of its affiliates, was dismissed in February 2000 when the British Columbia Supreme Court ruled that the legislation was unconstitutional and set aside service ex juris against the foreign defendants for that reason. British Columbia then enacted a revised statute, pursuant to which an action was filed in January 2001 against many of the same defendants, including RJR Tobacco and one of its affiliates, in Supreme Court, British Columbia. In that action, the British Columbia government seeks to recover the present value of its total expenditures for health-care benefits provided for insured persons resulting from tobacco-related disease or the risk of tobacco-related disease caused by alleged breaches of duty by the manufacturers, the present value of its estimated total expenditures for health-care benefits that reasonably could be expected to be provided for those insured persons resulting from tobacco-related disease or the risk of tobacco-related disease in the future, court ordered interest, and costs, or in the alternative, special or increased costs. The government alleges that the defendants are liable under the British Columbia statute by reason of their “tobacco related wrongs,”which are alleged to include: selling defective products, failure to warn, sale of cigarettes to children and adolescents, strict liability, deceit and misrepresentation, violation of trade practice and competition acts, concerted action, and joint liability. A jurisdictional challenge brought by RJR Tobacco and its affiliate was dismissed. RJR Tobacco and its affiliate filed statements of defense in January 2007. Pretrial discovery is ongoing.

• New Brunswick - In March 2008, a case was filed on behalf of Her Majesty the Queen in Right of the Province of New Brunswick, Canada, against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, in the Trial Division in the Court of Queen’s Bench of New Brunswick. The claim is brought pursuant to New Brunswick legislation enacted in 2008, which legislation is substantially similar to the revised British Columbia statute described above. In this action, the New Brunswick government seeks to recover essentially the same types of damages that are being sought in the British Columbia action described above based on analogous theories of liability. RJR Tobacco and its affiliate filed statements of defense in March 2010. Pretrial discovery is ongoing.

• Ontario - In September 2009, a case was filed on behalf of the Province of Ontario, Canada, against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, in the Ontario Superior Court of Justice. The claim is brought pursuant to Ontario legislation enacted in 2009, which legislation is substantially similar to the revised British Columbia statute described above. In this action, the Ontario government seeks to recover essentially the same types of damages that are being sought in the British Columbia and New Brunswick actions described above based on analogous theories of liability, although the government also asserted claims based on the illegal importation of cigarettes, which claims were deleted in an amended statement of claim filed in August 2010. A jurisdictional challenge brought by RJR Tobacco and its affiliate was dismissed. Preliminary motions are pending.

• Newfoundland and Labrador - In February 2011, a case was filed on behalf of the Province of Newfoundland and Labrador, Canada against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, in the General Trial Division of the Supreme Court of Newfoundland and Labrador. The claim is brought pursuant to legislation passed in Newfoundland in 2001 and proclaimed in February 2011, which legislation is substantially similar to the revised British Columbia statute described above. In this action, the Newfoundland government seeks to recover essentially the same types of damages that are being sought in the British Columbia and other provincial actions described above based on


The following seven putative Canadian class actions were filed against various Canadian and non-Canadian tobacco-related entities, including RJR

Tobacco and one of its affiliates, in courts in the Provinces of Alberta, British Columbia, Manitoba, Nova

55

analogous theories of liability. A jurisdictional challenge brought by RJR Tobacco and its affiliate was dismissed. Preliminary motions are pending.

• Manitoba - In May 2012, a case was filed on behalf of the Province of Manitoba, Canada, against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, in the Court of Queen’s Bench, Winnipeg Judicial Centre, Manitoba. The claim is brought pursuant to legislation assented to in 2006 and proclaimed in 2012, which legislation is substantially similar to the revised British Columbia statute described above. In this action, the Manitoba government seeks to recover essentially the same types of damages that are being sought in the British Columbia and other provincial actions described above based on analogous theories of liability. A jurisdictional challenge brought by RJR Tobacco and its affiliate was dismissed. RJR Tobacco and its affiliate filed statements of defense in September 2014.

• Quebec - In June 2012, a case was filed on behalf of the Province of Quebec, Canada, against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, in the Superior Court of the Province of Quebec, District of Montreal. The claim is brought pursuant to legislation enacted in Quebec in 2009, which legislation is substantially similar to the revised British Columbia statute described above. In this action, the Quebec government seeks to recover essentially the same types of damages that are being sought in the British Columbia and other provincial actions described above based on analogous theories of liability. RJR Tobacco and its affiliate have brought a motion challenging the jurisdiction of the Quebec court, which was dismissed. RJR Tobacco and its affiliate filed defenses in December 2014. Pretrial discovery is ongoing. Separately, in August 2009, certain Canadian manufacturers filed a constitutional challenge to the Quebec statute, which was dismissed. Argument in the appeal of that decision proceeded on June 18, 2015. Judgment was reserved.

• Saskatchewan - In June 2012, a case was filed on behalf of the Province of Saskatchewan, Canada, against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, in the Court of Queen’s Bench, Judicial Centre of Saskatoon, Saskatchewan. The claim is brought pursuant to legislation assented to in 2007 and proclaimed in 2012, which legislation is substantially similar to the revised British Columbia statute described above. In this action, the Saskatchewan government seeks to recover essentially the same types of damages that are being sought in the British Columbia and other provincial actions described above based on analogous theories of liability. A jurisdictional challenge brought by RJR Tobacco and its affiliate was dismissed. RJR Tobacco and its affiliate filed statements of defense in February 2015.

• Alberta - In June 2012, a case was filed on behalf of the Province of Alberta, Canada, against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, in the Court of Queen’s Bench of Alberta Judicial Centre, Calgary, Alberta. The claim is brought pursuant to legislation assented to in 2009 and proclaimed in 2012, which legislation is substantially similar to the revised British Columbia statute described above. In this action, the Alberta government seeks to recover essentially the same types of damages that are being sought in the British Columbia and other provincial actions described above based on analogous theories of liability. A jurisdictional challenge brought by RJR Tobacco and its affiliate was dismissed. Preliminary motions are pending.

• Prince Edward Island - In September 2012, a case was filed on behalf of the Province of Prince Edward Island, Canada, against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, in the Supreme Court of Prince Edward Island (General Section), Charlottetown, Prince Edward Island. The claim is brought pursuant to legislation assented to in 2009 and proclaimed in 2012, which legislation is substantially similar to the revised British Columbia statute described above. In this action, the Prince Edward Island government seeks to recover essentially the same types of damages that are being sought in the British Columbia and other provincial actions described above based on analogous theories of liability. A jurisdictional challenge brought by RJR Tobacco and its affiliate was dismissed. RJR Tobacco and its affiliate filed statements of defense in February 2015.

• Nova Scotia – In January 2015, a case was filed on behalf of the Province of Nova Scotia, Canada, against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, in the Supreme Court of Nova Scotia, Halifax, Nova Scotia. The claim is brought pursuant to legislation assented to in 2005 and proclaimed in 2014, which legislation is substantially similar to the revised British Columbia statute described above. In this action, the Nova Scotia government seeks to recover essentially the same types of damages that are being sought in the British Columbia and other provincial actions described above based on analogous theories of liability. RJR Tobacco and its affiliate filed statements of defense in July 2015.

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) Scotia, Ontario and Saskatchewan, although the plaintiffs’ counsel have been a ctively pursuing only Bourassa , the action pending in British Columbia, at this time:

56

• In Kunka v. Canadian Tobacco Manufacturers’ Council, a case filed in June 2009 in the Court of Queen’s Bench of Manitoba against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, the plaintiff, an individual smoker, alleging her own addiction and chronic obstructive pulmonary disease, severe asthma and lung disease resulting from the use of tobacco products, is seeking compensatory and unspecified punitive damages on behalf of a proposed class comprised of all individuals, including their estates, and their dependents and family members, who purchased or smoked cigarettes manufactured by the defendants, as well as restitution of profits and reimbursement of government expenditure for health-care benefits allegedly caused by the use of tobacco products.

• In Dorion v. Canadian Tobacco Manufacturers’ Council, a case filed in June 2009, in the Court of Queen’s Bench of Alberta against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, the plaintiff, an individual smoker, alleging her own addiction and chronic bronchitis resulting from the use of tobacco products, is seeking compensatory and unspecified punitive damages on behalf of a proposed class comprised of all individuals, including their estates, dependents and family members, who purchased or smoked cigarettes designed, manufactured, marketed or distributed by the defendants, as well as restitution of profits and reimbursement of government expenditure for health-care benefits allegedly caused by the use of tobacco products.

• In Semple v. Canadian Tobacco Manufacturers’ Council, a case filed in June 2009 in the Supreme Court of Nova Scotia against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, the plaintiff, an individual smoker, alleging his own addiction and chronic obstructive pulmonary disease resulting from the use of tobacco products, is seeking compensatory and unspecified punitive damages on behalf of a proposed class comprised of all individuals, including their estates, dependents and family members, who purchased or smoked cigarettes designed, manufactured, marketed or distributed by the defendants for the period from January 1, 1954, to the expiry of the opt-out period as set by the court, as well as restitution of profits and reimbursement of government expenditure for health-care costs allegedly caused by the use of tobacco products.

• In Adams v. Canadian Tobacco Manufacturers’ Council, a case filed in July 2009 in the Court of Queen’s Bench for Saskatchewan against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, the plaintiff, an individual smoker, alleging her own addiction and chronic obstructive pulmonary disease resulting from the use of tobacco products, is seeking compensatory and unspecified punitive damages on behalf of a proposed class comprised of all individuals who were alive on July 10, 2009, and who have suffered, or who currently suffer, from chronic obstructive pulmonary disease, emphysema, heart disease or cancer, after having smoked a minimum of 25,000 cigarettes designed, manufactured, imported, marketed or distributed by the defendants, as well as disgorgement of revenues earned by the defendants. RJR Tobacco and its affiliate have brought a motion challenging the jurisdiction of the Saskatchewan court.

• In Bourassa v. Imperial Tobacco Canada Limited, a case filed in June 2010 in the Supreme Court of British Columbia against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, the plaintiff, the heir to a deceased smoker, alleging that the deceased was addicted to and suffered emphysema resulting from the use of tobacco products, is seeking compensatory and unspecified punitive damages on behalf of a proposed class comprised of all individuals, including their estates, who were alive on June 12, 2007, and who have suffered, or who currently suffer from chronic respiratory diseases, after having smoked a minimum of 25,000 cigarettes designed, manufactured, imported, marketed, or distributed by the defendants, as well as disgorgement of revenues earned by the defendants from January 1, 1954, to the date the claim was filed. RJR Tobacco and its affiliate have filed a challenge to the jurisdiction of the British Columbia court. The plaintiff filed a motion for certification in April 2012, and filed affidavits in support in August 2013. An amended claim was filed in December 2014.

• In McDermid v. Imperial Tobacco Canada Limited, a case filed in June 2010 in the Supreme Court of British Columbia against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, the plaintiff, an individual smoker, alleging his own addiction and heart disease resulting from the use of tobacco products, is seeking compensatory and unspecified punitive damages on behalf of a proposed class comprised of all individuals, including their estates, who were alive on June 12, 2007, and who have suffered, or who currently suffer from heart disease, after having smoked a minimum of 25,000 cigarettes designed, manufactured, imported, marketed, or distributed by the defendants, as well as disgorgement of revenues earned by the defendants from January 1, 1954, to the date the claim was filed. RJR Tobacco and its affiliate have filed a challenge to the jurisdiction of the British Columbia court.

• In Jacklin v. Canadian Tobacco Manufacturers’ Council , a case filed in June 2012 in the Ontario Superior Court of Justice against Canadian and non-Canadian tobacco-related entities, including RJR Tobacco and one of its affiliates, the plaintiff, an individual smoker, alleging her own addiction and chronic obstructive pulmonary disease resulting from the use of tobacco products, is seeking compensatory and unspecified punitive damages on behalf of a proposed class comprised of all


In each of these seven cases, the plaintiffs allege fraud, fraudulent concealment, breach of warranty, breach of warranty of merchantability and of

fitness for a particular purpose, failure to warn, design defects, negligence, breach of a “special duty” to children and adolescents, conspiracy, concert of action, unjust enrichment, market share liability, joint liability, and violations of various trade practices and competition statutes. Pursuant to the terms of the 1999 sale of RJR Tobacco’s international tobacco business, RJR Tobacco has tendered the defense of these seven actions to JTI. Subject to a reservation of rights, JTI has assumed the defense of RJR Tobacco and its current or former affiliates in these actions.

State Settlement Agreements—Enforcement and Validity; Adjustments

As of June 30, 2015, there were 28 cases concerning the enforcement, validity or interpretation of the State Settlement Agreements in which RJR Tobacco, B&W or Lorillard Tobacco is a party. This number includes those cases, discussed below, relating to disputed payments under the State Settlement Agreements.

In April 2005, the Mississippi Attorney General notified B&W of its intent to seek approximately $3.9 million in additional payments under the Mississippi Settlement Agreement. The Mississippi Attorney General asserts that B&W failed to report in its net operating profit or its shipments, cigarettes manufactured by B&W under contract for Star Tobacco or its parent, Star Scientific, Inc. B&W advised the State that it did not owe the State any money. In August 2005, the Mississippi Attorney General filed in the Chancery Court of Jackson County, Mississippi, a Notice of Violation, Motion to Enforce Settlement Agreement, and Request for an Accounting by Defendant Brown & Williamson Holdings, Inc., formerly known as Brown & Williamson Tobacco Corporation. In this filing, Mississippi estimated that its damages exceeded $5.0 million. On August 24, 2011, the court entered an order finding in favor of the State on the Star contract manufacturing issue, and that the total amount of the underpayment from B&W was approximately $3.8 million and that interest on the underpayment was approximately $4.3 million. The court also appointed a Special Master to undertake an accounting of the benefit received by B&W for failure to include its profits from Star contract manufacturing in its net operating profits reported to the State. A report from the Special Master on the benefit received by B&W was issued on April 30, 2014. A hearing on the Special Master’s Report and Recommendation was held before the court on July 2, 2014. On September 24, 2014, the court entered an order confirming its earlier rulings and ordered B&W to pay compensatory damages (including interest) to the State in the total sum of approximately $10.8 million.

In February 2010, the Mississippi Attorney General filed a motion alleging that RJR Tobacco had improperly failed to report shipments of certain

categories of cigarette volumes, and for certain years had improperly reported its net operating profit. As a result, the State alleged that settlement payments to it were improperly reduced. RJR Tobacco disputed these allegations. Hearings on these issues were held on January 24-25, 2012, and May 9, 2012. On May 15, 2012, the court entered an order finding in favor of RJR Tobacco on the claim related to RJR Tobacco’s reported net operating profits in the year used as a baseline for future calculations of the State’s net operating profits payment. The State had sought $3.8 million in damages for this issue, with an additional $2.7 million in interest. On June 19, 2012, the court entered an order finding in favor of the State on the remaining issues, holding that the total amount of the underpayment was approximately $3.3 million and that interest on the underpayment was also approximately $3.3 million, though the court also held that this amount should be offset by additional payments previously made by Lorillard Tobacco on some of these issues. The court further ordered RJR Tobacco to perform an accounting of its profits and shipments from 1999-2011. On July 10, 2012, RJR Tobacco filed a petition with the Mississippi Supreme Court requesting leave to immediately appeal the court’s ordered accounting and its entry of judgment for the State without first conducting an evidentiary hearing. On August 15, 2012, the request was denied. An independent accountant acceptable to both the State and RJR Tobacco was identified and retained. On August 8, 2013, the final report of the independent accountant was filed with the court. The report generally found that RJR Tobacco’s accounting and reporting of information in connection with settlement payment calculations was correct. In some respects, the report expressly disagreed with findings made earlier by the trial court. On December 13, 2013, the State of Mississippi filed its report as to additional damages due from RJR Tobacco, challenging in various respects the findings set forth in the final report of the independent accountant and seeking various changes to the damages calculations. Also on December 13, 2013, RJR Tobacco filed a motion to finalize remaining damages of third round issues, and/or reconsider, the June 19, 2012 order requesting that the court implement the findings of the independent accountant in a final order on the damage issues and/or to revisit its earlier rulings “in light of the findings and determinations in the independent accountant’s report.” A hearing on these motions was held on July 2, 2014. On September 24, 2014, the court entered an order confirming its earlier rulings and ordered RJR Tobacco to pay compensatory damages (including interest) to the State in the total sum of approximately $8.0 million.

Finally, in connection with the actions brought against RJR Tobacco and B&W, the court awarded the State attorneys’ fees and expenses in an amount to be determined. On May 1, 2013, a hearing on attorneys’ fees and expenses was held before the Special Master appointed by the court. On November 19, 2013, the Special Master issued a report and recommendations on application for

57

individuals, includ ing their estates, who were alive on June 12, 2007, and who have suffered, or who currently suffer from chronic obstructive pulmonary disease, heart disease, or cancer, after having smoked a minimum of 25,000 cigarettes designed, manufactured, imported, ma rketed, or distributed by the defendants, as well as restitution of profits, and reimbursement of government expenditure for health-care benefits allegedly caused by the use of tobacco products.

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) award of costs and attorneys’ fees. The Special Master ruled that attorneys’ fees are to be paid with respect to the settlement payment claims against B&W and RJR Tobacco at 25% of “total amounts” awarded to the State of Mississi ppi by the court in its August 24, 2011 ruling. On December 13, 2013, the State of Mississippi filed a statement seeking various clarifications of the Special Master’s ruling. Also on December 13, 2013, B&W and RJR Tobacco filed their objections to the r uling. A hearing on these issues was held on July 2, 2014. On September 24, 2014, the court entered an order confirming its earlier rulings and ordered RJR Tobacco and B&W to pay attorneys’ fees in the total sum of approximately $4.9 million.

On June 16, 2015, the State of Mississippi and RJR Tobacco entered into an agreement with respect to certain claims for years 1999 through 2014

against RJR Tobacco, B&W and Lorillard Tobacco, referred to as the 2015 Settlement Agreement. The 2015 Settlement Agreement resolved with finality all claims that were brought, could have been brought, or could be brought against RJR Tobacco, B&W or Lorillard Tobacco in the enforcement actions filed by the State in the Mississippi Chancery Court. The 2015 Settlement Agreement required RJR Tobacco to pay approximately $15 million in resolution of the State’s claims and approximately $4 million in resolution of the award of attorneys’ fees and costs entered by the Mississippi Chancery Court in its order of October 6, 2014. The 2015 Settlement Agreement contains no admission or concession of any liability or any wrongdoing whatsoever on the part of RJR Tobacco, B&W or Lorillard Tobacco relating to the claims release pursuant to the 2015 Settlement Agreement. On June 18, 2015, the court entered an agreed judgment of dismissal upon the joint motion filed by the State of Mississippi, RJR Tobacco and B&W that dismissed with prejudice all pending motions and claims in the case, including but not limited to, the State’s Notices of Violation and Motions to Enforce Settlement Agreement filed on August 2005 and February 2010.

In May 2006, the State of Florida filed a motion, in the Circuit Court of the Fifteenth Judicial Circuit, in and for Palm Beach County, Florida, to

enforce the Florida Settlement Agreement, for an Accounting by Brown & Williamson Holdings, Inc., and for an Order of Contempt, raising substantially the same issues as raised by the Mississippi Attorney General and seeking approximately $12.4 million in additional payments under the Florida Settlement Agreement, as well as $17.0 million in interest payments. This matter is currently in the discovery phase.

NPM Adjustment Claims. The MSA includes an adjustment that potentially reduces the annual payment obligations of RJR Tobacco and the other

PMs. Certain requirements, collectively referred to as the Adjustment Requirements, must be satisfied before the NPM Adjustment for a given year is available:

When the Adjustment Requirements are satisfied, the MSA provides that the NPM Adjustment applies to reduce the annual payment obligation of

the PMs. However, an individual settling state may avoid its share of the NPM Adjustment if it had in place and diligently enforced during the entirety of the relevant year a “Qualifying Statute” that imposes escrow obligations on NPMs that are comparable to what the NPMs would have owed if they had joined the MSA. In such event, the state’s share of the NPM Adjustment is reallocated to other settling states, if any, that did not have in place and diligently enforce a Qualifying Statute.

NPM Adjustment Claim for 2003. For 2003, the Adjustment Requirements were satisfied. As a result, in April 2006, RJR Tobacco placed approximately $647 million, and Lorillard Tobacco placed approximately $114 million, of its MSA payment into a disputed payments account, in accordance with a procedure established by the MSA. Such amounts represented RJR Tobacco’s and Lorillard Tobacco’s shares of the 2003 NPM Adjustment as calculated by the Independent Auditor. In March 2007, the Independent Auditor issued revised calculations that reduced RJR Tobacco’s and Lorillard Tobacco’s share of the NPM Adjustment for 2003 to approximately $615 million and $109 million, respectively. As a result, in April 2007, RJR Tobacco and Lorillard Tobacco instructed the Independent Auditor to release to the settling states approximately $32 million and $5 million, respectively, from the disputed payments account.

Following RJR Tobacco’s payment of a portion of its 2006 MSA payment into the disputed payments account, 37 of the settling states filed legal proceedings in their respective MSA courts seeking declaratory orders that they diligently enforced their Qualifying Statutes during 2003 and/or orders compelling RJR Tobacco and the other PMs that placed money in the disputed payments account to pay the disputed amounts to the settling states. In response, RJR Tobacco and other PMs, pursuant to the MSA’s arbitration provisions, moved to compel arbitration of the parties’ dispute concerning the 2003 NPM Adjustment, including the states’ diligent enforcement claims, before an arbitration panel consisting of three retired federal court judges. The settling states opposed these motions, arguing, among other things, that the issue of diligent enforcement must be resolved by MSA courts in each of the 52 settling states and territories.

58

• an Independent Auditor must determine that the PMs have experienced a market share loss beyond a triggering threshold to those manufacturers that do not participate in the MSA, such non-participating manufacturers referred to as NPMs; and

• in a binding arbitration proceeding, a firm of independent economic consultants must find that the disadvantages of the MSA were a significant factor contributing to the loss. This finding is known as a significant factor determination.


Forty-seven of the 48 courts that addressed the question whether the dispute concerning the 2003 NPM Adjustment is arbitrable ruled that arbitration is required under the MSA. The Montana Supreme Court ruled that the State of Montana did not agree to arbitrate the question of whether it diligently enforced a Qualifying Statute. Subsequently, Montana and the PMs reached an agreement whereby the PMs agreed not to contest Montana’s claim that it diligently enforced the Qualifying Statute during 2003.

In January 2009, RJR Tobacco and certain other PMs entered into an Agreement Regarding Arbitration, referred to as the Arbitration Agreement, with 45 of the MSA settling states (representing approximately 90% of the allocable share of the settling states) pursuant to which those states agreed to participate in a multistate arbitration of issues related to the 2003 NPM Adjustment. Under the Arbitration Agreement, the signing states had their ultimate liability, if any, with respect to the 2003 NPM Adjustment reduced by 20%, and RJR Tobacco and the other PMs that placed their share of the disputed 2005 NPM Adjustment (discussed below) into the disputed payments account, without releasing or waiving any claims, authorized the release of those funds to the settling states.

The arbitration panel contemplated by the MSA and the Arbitration Agreement, referred to as the Arbitration Panel, was selected, and proceedings before the panel with respect to the 2003 NPM Adjustment claim began in July 2010. Following the completion of document and deposition discovery, on November 3, 2011, RJR Tobacco and the other PMs advised the Arbitration Panel that they were not contesting the “diligent enforcement” of 12 states and the four U.S. territories with a combined allocable share of less than 14%. The “diligent enforcement” of the remaining 33 settling states, the District of Columbia and Puerto Rico was contested and became the subject of further proceedings. A common issues hearing was held in April 2012, and state specific evidentiary hearings with respect to the contested states were initiated.

As a result of the partial settlement of certain NPM Adjustment claims, as described in more detail below, as well as the earlier decisions not to

contest the diligent enforcement of 13 states, two of which are participants in the partial settlement, and the four U.S. territories, only 15 contested settling states required state specific diligent enforcement rulings. State specific evidentiary hearings were completed as of the end of May 2013.

On September 11, 2013, the Arbitration Panel issued rulings with respect to the 15 remaining contested states. The Arbitration Panel ruled that six

states (representing approximately 14.68% allocable share) – Indiana, Kentucky, Maryland, Missouri, New Mexico and Pennsylvania – had not diligently enforced their Qualifying Statutes in 2003. As a result of these rulings, it was expected that each of RJR Tobacco and Lorillard Tobacco was entitled to the maximum remaining amount with respect to its 2003 NPM Adjustment claim – approximately $266 million and $47 million, respectively, plus interest and earnings. All six states that were found “non-diligent” by the Arbitration Panel filed motions to vacate and/or modify the diligent enforcement rulings on the 2003 NPM Adjustment claim. To date, only the state courts in Pennsylvania and Missouri have entered orders affecting the settlement payment calculations. Both courts modified the judgment reduction method that had been adopted by the Arbitration Panel, the effect of which was to reduce RJR Tobacco’s and Lorillard Tobacco’s recovery from these two states by a total of $75 million and $13 million, respectively. Similar motions filed by Maryland were denied by its state court. The orders in Pennsylvania and Missouri have been appealed by RJR Tobacco and the other PMs. On April 10, 2015, the intermediate appellate court in Pennsylvania upheld the trial court ruling modifying the judgment reduction method adopted by the Arbitration Panel. RJR Tobacco is appealing that ruling. Maryland is appealing the rulings on its motions.

Separately, two of the states found to be “non-diligent,” Kentucky and Indiana, subsequently joined the partial settlement of certain NPM

Adjustment claims, as described in more detail below. As a result, RJR Tobacco now estimates that the maximum remaining amount of its claim and Lorillard Tobacco’s claim with respect to the 2003 NPM Adjustment claim is $197 million and $35 million, respectively, plus interest and earnings, and before reduction for the impact of the Pennsylvania and Missouri court orders.

In light of its joining the partial settlement, Indiana participated in a joint motion to stay indefinitely further proceedings on the motions it had filed

to vacate the settlement and to modify the adverse diligent enforcement ruling against it. Similarly, Kentucky has joined in a stipulation by the parties filed with the court there to stay further proceedings on its motions, but that stipulation has not yet been signed by the court.

During the first quarter of 2015, RJR Tobacco reviewed the status of the various challenges filed by the non-diligent states to certain rulings of the

Arbitration Panel. Two of the non-diligent states, Pennsylvania and Missouri, are no longer challenging the findings of non-diligence entered against them by the Arbitration Panel. As a result, notwithstanding the orders entered by the trial courts in those two states that modified the judgment reduction method adopted by the Arbitration Panel to account for the partial settlement of certain NPM Adjustment claims and RJR Tobacco’s pending appeals of those rulings, a certain portion of the potential recovery from these two states is now certain and can be estimated. Consequently, RJR Tobacco recognized $70 million as a reduction of cost of products sold in RAI’s condensed consolidated statement of income (unaudited) for the six months ended June 30, 2015. Until such time as the various remaining state motions challenging the rulings of the Arbitration Panel have been resolved, including any necessary appeals, uncertainty exists as to the timing, process and amount of RJR Tobacco’s ultimate recovery with

59

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) respect to its remaining share of the 2003 NPM Adjustment claim. Due to the uncertainty over the final resolution of these additional challenges impacting the remaining amount of RJR Tobac co’s 2003 NPM Adjustment claim, no additional amounts resulting from the rulings of the Arbitration Panel for the remaining four non-diligent states have been recognized in RAI’s condensed consolidated financial statements (unaudited) as of June 30, 2015.

NPM Adjustment Claims for 2004-2013. From 2006 to 2008, proceedings (including significant factor arbitrations before an independent

economic consulting firm) were initiated with respect to the NPM Adjustment for 2004, 2005 and 2006. Ultimately, the Adjustment Requirements were satisfied with respect to each of these NPM Adjustments.

In June 2009, RJR Tobacco, certain other PMs and the settling states entered into an agreement with respect to the 2007, 2008 and 2009 significant factor determinations. This agreement provided that the settling states would not contest that the disadvantages of the MSA were “a significant factor contributing to” the market share loss experienced by the PMs in those years. The stipulation pertaining to each of the three years covered by the agreement became effective in February of the year a final determination by the firm of independent economic consultants would otherwise have been expected (2010, 2011 and 2012, respectively), if the issue had been arbitrated on the merits. RJR Tobacco and the PMs paid a total amount of $5 million into the States’ Antitrust/Consumer Protection Tobacco Enforcement Fund established under Section VIII(c) of the MSA for each year covered by that agreement, with RJR Tobacco paying approximately 47% of such amounts. On January 9, 2012, a new agreement with respect to significant factor determinations pertaining to 2010, 2011 and 2012 was entered into on terms essentially identical to the earlier agreement.

On May 19, 2015, a new agreement with respect to significant factor determinations pertaining to 2013 and 2014 was entered into on similar terms

to the two earlier agreements, although the amount of the payment by RJR Tobacco and the other PMs for each year covered by the agreement was reduced from $5 million to $3.5 million. RJR Tobacco’s and Lorillard Tobacco’s shares of the payment pertaining to 2013 remained at approximately 47%, or $1.63 million, and approximately 20%, or $0.70 million, respectively.

Based on the payment calculations of the Independent Auditor and the agreement described above regarding the 2007, 2008 and 2009 significant

factor determinations, the Adjustment Requirements have been satisfied with respect to the NPM Adjustments for 2007, 2008 and 2009. In addition, based on the payment calculations of the Independent Auditor and the agreement described above regarding the 2010, 2011 and 2012 significant factor determinations, the Adjustment Requirements have been satisfied with respect to the NPM Adjustment for 2010, 2011 and 2012.

The approximate maximum principal amounts of RJR Tobacco’s and Lorillard Tobacco’s shares of the disputed NPM Adjustments for the years

2004 through 2012, as currently calculated by the Independent Auditor, are as follows (the amounts shown below do not include the interest or earnings thereon to which RJR Tobacco and Lorillard Tobacco believe they would be entitled under the MSA and do not reflect any reduction as a result of the Term Sheet described below):

In addition to the NPM Adjustment claims described above, RJR Tobacco and Lorillard Tobacco have filed dispute notices with respect to their

annual MSA payments relating to the NPM Adjustments potentially applicable to 2013 and 2014. The amount at issue for those two years is approximately $888 million and $185 million in the aggregate for RJR Tobacco and Lorillard Tobacco, respectively.

Preliminary discussions are currently underway with the jurisdictions that have not joined the Term Sheet for the partial settlement of certain NPM

Adjustment claims, described below, to initiate arbitration proceedings with respect to the 2004 NPM Adjustment.

Due to the uncertainty over the final resolution of the 2004-2013 NPM Adjustment claims asserted by RJR Tobacco, no assurances can be made related to the amounts, if any, that will be realized or any amounts (including interest) that will be owed, except as described below related to the partial settlement of certain NPM Adjustment claims.

Partial Settlement of Certain NPM Adjustment Claims. On November 14, 2012, RJR Tobacco, certain other PMs and certain settling states entered

into a Term Sheet that set forth terms on which accrued and potential NPM Adjustment claims for 2003 through 2014 could be resolved. The Term Sheet also set forth a restructured NPM Adjustment process to be applied on a going-forward

60

Year for which NPM Adjustment calculated 2004 2005 2006 2007 2008 2009 2010 2011 2012 Year in which deduction for NPM Adjustment was taken 2007 2008 2009 2010 2011 2012 2013 2014 2015 RJR Tobacco’s approximate share of disputed NPM Adjustment (millions) $ 562 $ 445 $ 419 $ 435 $ 468 $ 472 $ 470 $ 422 $ 429 Lorillard Tobacco’s approximate share of disputed NPM Adjustment (millions) $ 111 $ 76 $ 73 $ 83 $ 104 $ 107 $ 119 $ 88 $ 97

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) basis, starting with the 2013 volume year. The Term Sheet was provided to all of the MSA settling states for their review and consideration. A total of 17 states, the District of Columbia and Puerto Rico, together representing just under 42% allocable share, joined the proposed settlement. RJR Tobacco and the other PMs indicated that they were prepared to go forward with the proposed settlement with that level of jurisdictional participation.

The Term Sheet provided that the Arbitration Panel in place to deal with the 2003 NPM Adjustment (and other NPM Adjustment-related matters)

must review the proposed settlement and enter an appropriate order to confirm for the Independent Auditor that it should implement, as necessary, the terms of the settlement agreement.

On March 12, 2013, the Arbitration Panel entered a Stipulated Partial Settlement and Award, referred to as the Award, reflecting the financial

terms of the Term Sheet. On March 29, 2013, the Independent Auditor issued a notice indicating that it intended to implement the financial provisions of the Term Sheet, and also issued various revised payment calculations pertaining to payment years 2009 through 2012 and final calculations pertaining to payment year 2013 that reflected implementation of the financial provisions of the Term Sheet.

On April 12, 2013, Oklahoma joined the Term Sheet, bringing to 20 the total number of jurisdictions that have joined the settlement, representing

approximately 43% allocable share, and the Independent Auditor issued revised payment calculations reflecting the financial impact of Oklahoma’s decision to join the settlement. Subsequently, on May 24, 2013, Connecticut and South Carolina also joined the Term Sheet bringing to 22 the total number of jurisdictions that have joined the settlement, representing approximately 46% allocable share. Efforts by two states, Colorado and Ohio, to obtain injunctions to prevent implementation of the Award were unsuccessful.

On June 10, 2014, Kentucky, and on June 26, 2014, Indiana, joined the Term Sheet, bringing to 24 the total number of jurisdictions that have

joined the settlement, representing approximately 49.87% allocable share. These states, both of which were among the states found “non-diligent” by the Arbitration Panel, joined the Term Sheet on financial terms more favorable to the industry than those received by the original signatory states.

As of June 30, 2015, six non-settling states have motions pending, in their respective MSA courts, to vacate and/or modify the Award. The

motions filed by Idaho and Colorado have been denied. For additional information related to the Term Sheet and the Award, see “— Cost of Products Sold” in note 1.

Other NPM Matters. Separately, on August 19, 2011, Idaho sent a letter on behalf of itself and 31 other states, stating their intent to initiate arbitration with respect to whether amounts used to measure the domestic cigarette market and to calculate PM payment obligations under the MSA should be the adjusted gross or the net number of cigarettes on which federal excise tax (including arbitrios de cigarillos) is paid. The parties also agreed to arbitrate the Independent Auditor’s calculation of the volume adjustment with respect to the treatment of “roll your own,” referred to as RYO, tobacco. On January 21, 2013, the panel ruled that adjusted gross figures should be used in payment calculations and that, in the calculation of the volume adjustment, the Independent Auditor should use 0.0325 ounces of RYO tobacco to be the equivalent of one cigarette. Antitrust Case

A number of tobacco wholesalers and consumers have sued U.S. cigarette manufacturers, including RJR Tobacco and B&W, 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 asked the court to certify the lawsuits as class actions on behalf of other persons who purchased cigarettes directly or indirectly from one or more of the defendants. As of June 30, 2015, all of the federal and state court cases on behalf of indirect purchasers had been dismissed.

In Smith v. Philip Morris Cos., Inc., a case filed in February 2000, and pending in District Court, Seward County, Kansas, the court granted class certification in November 2001, in an action brought against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, and the parent companies of the major U.S. cigarette manufacturers, including RJR, seeking to recover an unspecified amount in actual and punitive damages. The plaintiffs allege that the defendants participated in a conspiracy to fix or maintain the price of cigarettes sold in the United States. In an opinion dated March 23, 2012, the court granted summary judgment in favor of RJR Tobacco and B&W on the plaintiffs’ claims. On July 18, 2014, the Court of Appeals of the State of Kansas affirmed the grant of summary judgment. On August 18, 2014, the plaintiffs filed a petition for review with the Supreme Court of the State of Kansas. On June 29, 2015, the court denied the petition for review.

61

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) Other Litigation and Developments

JTI Claims for Indemnification . By purchase agreement dated March 9, 1999, amended and restated as of May 11, 1999, referred to as the 1999 Purchase Agreement, RJR and RJR Tobacco sold the international tobacco business to JTI. Under the 1999 Purchase Agreement, RJR and RJR Tobacco retained certain liabilities relating to the international tobacco business sold to JTI. Under its reading of the indemnification provisions of the 1999 Purchase Agreement, JTI has requested indemnification for damages allegedly arising out of these retained liabilities. As previously reported, a number of the indemnification claims between the parties relating to the activities of Northern Brands in Canada have been resolved. The other matters for which JTI has requested indemnification for damages under the indemnification provisions of the 1999 Purchase Agreement are described below:

Although RJR and RJR Tobacco recognize that, under certain circumstances, they may have these and other unresolved indemnification obligations to JTI under the 1999 Purchase Agreement, RJR and RJR Tobacco disagree with JTI as to (1) what circumstances relating to any such matters may give rise to indemnification obligations by RJR and RJR Tobacco, and (2) the nature and extent of any such obligation. RJR and RJR Tobacco have conveyed their position to JTI, and the parties have agreed to resolve their differences at a later time.

European Community. On October 30, 2002, the European Community and ten of its member states filed a complaint in the U.S. District Court for

the Eastern District of New York against RJR, RJR Tobacco and several currently and formerly related companies. The complaint contains many of the same or similar allegations found in an earlier complaint, now dismissed, filed in August 2001 and also alleges that the defendants, together with certain identified and unidentified persons, engaged in money laundering and other conduct violating civil RICO and a variety of common laws. The complaint also alleges that the defendants manufactured cigarettes that were eventually sold in Iraq in violation of U.S. sanctions. The plaintiffs seek compensatory, punitive and treble damages among other types of relief. This matter had been stayed and largely inactive until November 24, 2009, when, with the court’s permission, the European Community and member states filed and served a second amended complaint. The second amended complaint added 16 member states as plaintiffs and RAI, RJR Tobacco and R. J. Reynolds Global Products Inc., referred to as GPI, as defendants. The allegations contained in the second amended complaint are in most respects either identical or similar to those found in the prior complaint, but now add new allegations primarily regarding the activities of RAI, RJR Tobacco and GPI following the B&W business combination. Pursuant to a stipulation and order, the defendants filed a motion to dismiss the plaintiffs’ second amended complaint on February 15, 2010. Ruling on part of the defendants’ motion to dismiss, on March 8, 2011, the district court dismissed the plaintiffs’ RICO claims, and reserved decision as to dismissal of the plaintiffs’ state-law claims. Thereafter, on May 13, 2011, the district court granted the remaining portion of the defendants’ motion and dismissed the plaintiffs’ state-law claims based on the court’s lack of subject matter jurisdiction. On May 16, 2011, the clerk of court entered a judgment dismissing the action in its entirety. On June 10, 2011, the plaintiffs filed a notice of appeal with the Second Circuit, appealing from the May 16, 2011, judgment, as well as the March 8, 2011, and May 13, 2011, orders that respectively resulted in the dismissal of their RICO and state-law claims. Oral argument occurred on February 24, 2012.

62

• In a letter dated March 31, 2006, counsel for JTI stated that JTI would be seeking indemnification under the 1999 Purchase Agreement for any damages it may incur or may have incurred arising out of a Southern District of New York grand jury investigation, a now-terminated Eastern District of North Carolina grand jury investigation, and various actions filed by the European Community and others in the U.S. District Court for the Eastern District of New York, referred to as the EDNY, against RJR Tobacco and certain of its affiliates on November 3, 2000, August 6, 2001, and (as discussed in greater detail below) October 30, 2002, and against JTI on January 11, 2002.

• JTI also has sought indemnification relating to a Statement of Claim filed on April 23, 2010, against JTI Macdonald Corp., referred to as JTI-MC, by the Ontario Flue-Cured Tobacco Growers’ Marketing Board, referred to as the Board, Andy J. Jacko, Brian Baswick, Ron Kichler, and Aprad Dobrenty, proceeding on their own behalf and on behalf of a putative class of Ontario tobacco producers that sold tobacco to JTI-MC during the period between January 1, 1986, and December 31, 1996, referred to as the Class Period, through the Board pursuant to certain agreements. The Statement of Claim seeks recovery for damages allegedly incurred by the class representatives and the putative class for tobacco sales during the Class Period made at the contract price for duty free or export cigarettes with respect to cigarettes that, rather than being sold duty free or for export, purportedly were sold in Canada, which allegedly breached one or more of a series of contracts dated between June 4, 1986, and July 3, 1996. A motion to dismiss on the basis of statute of limitations was denied. An application requesting leave to appeal that decision was granted in April 2015. The appeal is pending.

• Finally, JTI has advised RJR and RJR Tobacco of its view that, under the terms of the 1999 Purchase Agreement, RJR and RJR Tobacco are liable for a roughly $1.85 million judgment entered in 1998, plus interest and costs, in an action filed in Brazil by Lutz Hanneman, a former employee of a former RJR Tobacco subsidiary. RJR and RJR Tobacco deny that they are liable for this judgment under the terms of the 1999 Purchase Agreement.


On April 23, 2014, a three judge pane l of the Second Circuit issued a decision on the appeal, and on April 29, 2014, a corrected decision was issued. The Second Circuit concluded that: (1) as pled, the RICO claims are within the scope of the RICO statute, and (2) the federal court does have subject matter jurisdiction over the state-law claims. Accordingly, the three judge panel of the Second Circuit decided that the judgment of the district court should be vacated, and the case remanded to the district court for further proceedings. On May 7, 2014, the defendants filed in the Second Circuit a petition for panel rehearing, or rehearing en banc , regarding the plaintiffs’ RICO claims. On August 20, 2014, the three judge panel denied panel rehearing and issued an amended opinion that holds tha t a civil RICO cause of action extends to extraterritorial injuries. The amended opinion adheres to the three judge panel’s April 23, 2014 ruling that the judgment of the district court should be vacated, and the case remanded to the district court for fu rther proceedings. On April 13, 2015, the Second Circuit denied rehearing en banc . On July 27, 2015, the defendants filed a petition for writ of certiorari asking the U.S. Supreme Court to review the Second Circuit’s decision to reinstate the RICO claims , and the district court has stayed further proceedings pending the disposition of that petition.

FDA Litigation. On February 25, 2011, RJR Tobacco, Lorillard and Lorillard Tobacco jointly filed a lawsuit, Lorillard, Inc. v. U.S. Food and Drug Administration , in the U.S. District Court for the District of Columbia, challenging the composition of TPSAC which had been established by the FDA under the Family Smoking Prevention and Tobacco Control Act, referred to as the FDA Tobacco Act. The complaint alleges that certain members of the TPSAC and certain members of its Constituents Subcommittee have financial and appearance conflicts of interest that are disqualifying under federal ethics law and regulations, and that the TPSAC is not “fairly balanced,” as required by the Federal Advisory Committee Act, referred to as FACA. In March 2011, the plaintiffs filed an amended complaint, which added an additional claim, based on a nonpublic meeting of members of the TPSAC, in violation of the FACA. The court granted the plaintiffs’ unopposed motion to file a second amended complaint adding a count addressing the FDA’s refusal to produce all documents generated by the TPSAC and its subcommittee in preparation of the menthol report. On August 1, 2012, the court denied the FDA’s motion to dismiss. The FDA filed its answer to the complaint on October 12, 2012. The parties participated in a status conference on April 22, 2013, with Lorillard and RJR Tobacco filing an amended complaint the same day. Briefing for summary judgment motions was completed on September 20, 2013. On July 21, 2014, the court granted the plaintiffs’ summary judgment motions finding that three members of the TPSAC Committee had impermissible conflicts of interest. As relief, the court ordered the FDA to reconstitute the committee in conformance with the law and enjoined the agency from using or relying on the TPSAC’s 2011 Menthol Report. On September 18, 2014, the FDA appealed the decision to the D.C. Circuit. Briefing on the appeal was completed in June 2015. A decision is pending.

On April 14, 2015, RJR Tobacco, American Snuff Co., SFNTC, Philip Morris USA Inc., U.S. Smokeless Tobacco Company LLC, and Lorillard

Tobacco jointly filed a lawsuit in the U.S. District Court for the District of Columbia challenging the FDA’s March 4, 2015 “guidance” document, “Guidance for Industry: Demonstrating the Substantial Equivalence of a New Tobacco Product: Responses to Frequently Asked Questions.” The FDA’s guidance attempts to require the FDA’s prior approval for all changes to the label of a tobacco product that would render the product “distinct”and a “new tobacco product,” even though there is no change to the product itself. Similarly, the FDA’s guidance claims that prior approval would also be required for changes in the quantity of products sold within a package. The complaint alleges that the FDA’s guidance: is contrary to and exceeds the FDA’s authority under the Federal Food, Drug, and Cosmetic Act (“FDCA”); violates First Amendment rights because it restricts and chills protected commercial speech about tobacco products; and was issued under the guise of “guidance” to avoid the notice-and-comment rulemaking requirements of the Administrative Procedure Act and the FDCA and subsequent judicial review. The plaintiffs have requested that the court prevent the FDA from enforcing the guidance. On April 3, 2015, RAI Services Company, on behalf of RAI’s above-mentioned operating companies, also filed comments with the FDA, explaining the reasons why the companies disagree with the guidance. On May 29, 2015, the FDA issued an interim enforcement policy pertaining to the above-mentioned guidance whereby the FDA agreed not to take any enforcement actions pertaining to products whose only change consisted of a change to the label or a change in product quantity while the agency considers whether to revise the guidance. On June 2, 2015, the plaintiffs voluntarily dismissed the lawsuit without prejudice.

For a detailed description of the FDA Tobacco Act, see “— Governmental Activity” in “Management’s Discussion and Analysis of Financial

Condition and Results of Operations,” in Part I, Item 2.

Smokeless Tobacco Litigation In 1999, when the IPIC litigation was first filed, the named defendants included manufacturers of smokeless products, including Conwood Company, LLC (now known as American Snuff Company, LLC) and others. When the IPIC plaintiffs filed discovery responses in IPIC listing the products they used, 41 of them listed a smokeless product among the products they used. It appears that only six of those 41 may have a claim against American Snuff because only six listed a brand owned by American Snuff (Levi Garrett). Seven plaintiffs listed using Beechnut smokeless at a time when that brand was manufactured by Lorillard Tobacco (now manufactured by National Tobacco Company). On December 3, 2001, the IPIC court severed all smokeless claims and all smokeless defendants from IPIC. There was no order staying the case during IPIC. In the ensuing 15 years, the plaintiffs in the severed cases did nothing to pursue the cases. Recently, during hearings in 2015 in the IPIC litigation, plaintiffs’ counsel has suggested that he

63

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) intends to move forward with the severed smokeless claims. The defendants will object to any effort to activate these cases due to the fact that the plaintiffs took no action for the last 15 years.

Tobacco Buyout Legislation

In 2004, legislation was passed eliminating the U.S. Government’s tobacco production controls and price support program. The buyout of tobacco quota holders provided for in the Fair and Equitable Tobacco Reform Act, referred to as FETRA, was funded by a direct quarterly assessment on every tobacco product manufacturer and importer, on a market-share basis measured on volume to which federal excise tax was applied. The aggregate cost of the buyout to the industry was approximately $9.9 billion, including approximately $9.6 billion payable to quota tobacco holders and growers through industry assessments over ten years, into 2014, and approximately $290 million for the liquidation of quota tobacco stock. The FETRA assessment expired in September 2014.

RAI’s operating subsidiaries recorded the FETRA assessment on a quarterly basis as cost of goods sold. RAI’s operating subsidiaries’ overall share of the buyout approximated $2.5 billion prior to the deduction of permitted offsets under the MSA. RAI’s operating subsidiaries’ expense under FETRA for the three months and six months ended June 30, 2014 was $51 million and $106 million, respectively. ERISA Litigation

In May 2002, in Tatum v. The R.J.R. Pension Investment Committee of the R. J. Reynolds Tobacco Company Capital Investment Plan , an employee of RJR Tobacco filed a class-action suit in the U.S. District Court for the Middle District of North Carolina, 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., referred to as NGH, 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 breached their fiduciary duties to participants of the RJR 401(k) plan when the defendants removed the stock funds of the companies involved in the food business, NGH and Nabisco Holdings Corp., referred to as Nabisco, as investment options from the RJR 401(k) plan approximately six months after the spin-off. The plaintiff asserts that a November 1999 amendment (the “1999 Amendment”) that eliminated the NGH and Nabisco funds from the RJR 401(k) plan on January 31, 2000, contained sufficient discretion for the defendants to have retained the NGH and Nabisco funds after January 31, 2000, and that the failure to exercise such discretion was a breach of fiduciary duty. In his complaint, the plaintiff requests, among other things, that the court require 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 funds.

In July 2002, the defendants filed a motion to dismiss, which the court granted in December 2003. In December 2004, the U.S. Court of Appeals for the Fourth Circuit reversed the dismissal of the complaint, holding that the 1999 Amendment did contain sufficient discretion for the defendants to have retained the NGH and Nabisco funds as of February 1, 2000, and remanded the case for further proceedings. The court granted the plaintiff leave to file an amended complaint and denied all pending motions as moot. In April 2007, the defendants moved to dismiss the amended complaint. The court granted the motion in part and denied it in part, dismissing all claims against the RJR Employee Benefits Committee and the RJR Pension Investment Committee. The remaining defendants, RJR and RJR Tobacco, filed their answer and affirmative defenses in June 2007. The plaintiff filed a motion for class certification, which the court granted in September 2008. The district court ordered mediation, but no resolution of the case was reached. In September 2008, each of the plaintiffs and the defendants filed motions for summary judgment, and in January 2009, the defendants filed a motion to decertify the class. A second mediation occurred in June 2009, but again no resolution of the case was reached. The district court overruled the motions for summary judgment and the motion to decertify the class.

A non-jury trial was held in January and February 2010. During closing arguments, the plaintiff argued for the first time that certain facts arising at

trial showed that the 1999 Amendment was not validly adopted, and then moved to amend his complaint to conform to this evidence at trial. On June 1, 2011, the court granted the plaintiff’s motion to amend his complaint and found that the 1999 Amendment was invalid.

The parties filed their findings of fact and conclusions of law on February 4, 2011. On February 25, 2013, the district court dismissed the case with

prejudice finding that a hypothetical prudent fiduciary could have made the same decision and thus the plan’s loss was not caused by the procedural prudence which the court found to have existed. On March 8, 2013, the plaintiffs filed a notice of appeal. On August 4, 2014, the Fourth Circuit Court of Appeals, referred to as Fourth Circuit, reversed, holding that the district court applied the wrong standard when it held that the defendants did not cause any loss to the plan, determined the test was whether a hypothetical prudent fiduciary would have made the same decision and remanded the case back to the district court to apply the

64

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) correct – would have – standard. On September 2, 2014, the Fourth Circuit denied the defendants’ request for rehearing en banc . The mandate from the Fourth Circuit was issued on October 1, 2014. On December 1, 2014, the d efendants filed a petition for writ of certiorari with the U.S. Supreme Court. On March 9, 2015, the U.S. Supreme Court invited the Solicitor General of the United States to express the views of the United States with respect to the defendants’ petition f or writ of certiorari. The Solicitor General filed his brief on May 26, 2015, recommending that the petition for writ of certiorari be denied. The defendants responded to the Solicitor General’s brief on June 9, 2015, and on June 29, 2015, the U.S. Supre me Court denied the defendants’ petition for writ of certiorari.

On November 19, 2014, the district court held a hearing and ordered briefing on various issues that remain pending on remand. The parties filed

briefs addressing (1) the application of the different prudence standard, –“the would have standard” – adopted by the Fourth Circuit and (2) the merits of the defendants’ affirmative defense related to releases executed by many class members and to the claims by class members who voluntarily sold their Nabisco shares while their accounts were frozen. The defendants also filed a renewed motion to decertify the class. The district court will address these pending motions in due course.

Environmental Matters

RAI 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 or facility 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 with third parties under the Comprehensive Environmental Response, Compensation and Liability Act with respect to several superfund sites. RAI and its subsidiaries are not aware of any current environmental matters that are expected to have a material adverse effect on the business, results of operations or financial position of RAI or its subsidiaries.

RAI and its operating subsidiaries believe that climate change is an environmental issue primarily driven by carbon dioxide emissions from the use of energy. RAI’s operating subsidiaries are working to reduce carbon dioxide emissions by minimizing the use of energy where cost effective, minimizing waste to landfills and increasing recycling. Climate change is not viewed by RAI’s operating subsidiaries as a significant direct economic risk to their businesses, but rather an indirect risk involving the potential for a longer-term general increase in the cost of doing business. Regulatory changes are difficult to predict, but the current regulatory risks to the business of RAI’s operating subsidiaries with respect to climate change are relatively low. Financial impacts will be driven more by the cost of natural gas and electricity. Efforts are made to anticipate the effect of increases in fuel costs directly impacting RAI’s operating subsidiaries by evaluating natural gas usage and market conditions. Occasionally forward contracts are purchased, limited to a two-year period, for natural gas. In addition, RAI’s operating subsidiaries are continually evaluating energy conservation measures and energy efficient equipment to mitigate impacts of increases in energy costs, and adopting or utilizing such measures and equipment where appropriate.

Regulations promulgated by the EPA and other governmental agencies under various statutes have resulted in, and likely will continue to result in,

substantial expenditures for pollution control, waste treatment or handling, facility modification and similar activities. RAI and its subsidiaries are engaged in a continuing program to comply with federal, state and local environmental laws and regulations, and dependent upon the probability of occurrence and reasonable estimation of cost, accrue or disclose any material liability. Although it is difficult to reasonably estimate the portion of capital expenditures or other costs attributable to compliance with environmental laws and regulations, RAI does not expect such expenditures or other costs to have a material adverse effect on the business, results of operations, cash flows or financial position of RAI or its subsidiaries. Shareholder Cases

Delaware. In the third quarter of 2014, Lorillard, the members of Lorillard’s board of directors, RAI and BAT were named as defendants in 11 putative class action lawsuits brought in the Delaware Court of Chancery by Lorillard shareholders challenging the proposed Merger, referred to as the Delaware Actions. The complaints generally allege, among other things, that the members of the Lorillard board of directors breached their fiduciary duties to Lorillard shareholders by authorizing the proposed (now completed) Merger. The complaints also allege that RAI and BAT aided and abetted the breaches of fiduciary duties allegedly committed by the members of the Lorillard board of directors. On November 25, 2014, the court granted a motion for consolidation of the lawsuits into a single action captioned In re Lorillard, Inc. Stockholders Litigation , and for appointment of lead plaintiffs and lead counsel. On December 11, 2014, the lead plaintiffs filed a motion for a preliminary injunction and a motion to expedite.

Although they believe that these lawsuits are without merit and that no further disclosure was required to supplement the Joint Proxy

Statement/Prospectus under applicable laws, to eliminate the burden, expense and uncertainties inherent in such litigation, on January 15, 2015, the defendants (other than BAT, which was not named in the amended complaint) entered into the Delaware

65

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) Memorandum of Understanding regarding the settlement of the Delaware Actions. The Delaware Memorandum of Understanding outlines the terms of the parties’ agreement in principle to settle and release all claims which were or could have been asserted in the Delaware Actions. In consideration for such settlement and release, the parties to the Delaware Actions agreed, among other things, that Lorill ard and RAI would make certain supplemental disclosures to the Joint Proxy Statement/Prospectus, which they did on January 20, 2015. The Delaware Memorandum of Understanding contemplates that the parties will negotiate in good faith to agree upon a stipul ation of settlement to be submitted to the court for approval as soon as practicable. The stipulation of settlement will be subject to customary conditions, including approval by the court, which will consider the fairness, reasonableness and adequacy of such settlement. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the court will approve the settlement even if the parties were to enter into such a stipulation. In such event, or if the transacti ons contemplated by the Merger Agreement are not consummated for any reason, the proposed settlement will be of no force and effect.

North Carolina. RAI, the members of the RAI board of directors and BAT have been named as defendants in a putative class action lawsuit

captioned Corwin v. British American Tobacco PLC , et al ., brought in North Carolina state court, referred to as the North Carolina Action, by a person identifying himself as a shareholder of RAI. The North Carolina Action was initiated on August 8, 2014, and an amended complaint was filed on November 7, 2014. The amended complaint generally alleges, among other things, that the members of the RAI board of directors breached their fiduciary duties to RAI shareholders by approving the BAT Share Purchase and the sharing of technology with BAT. The amended complaint also alleges that there were various conflicts of interest in the transaction, and that RAI aided and abetted the alleged breaches of fiduciary duties by its board of directors. The North Carolina Action seeks injunctive relief, damages and reimbursement of costs, among other remedies. On January 2, 2015, the plaintiff in the North Carolina Action filed a motion for a preliminary injunction seeking to enjoin temporarily the RAI shareholder meeting and votes scheduled for January 28, 2015. RAI and the RAI board of directors timely opposed that motion prior to a hearing that was scheduled to occur on January 16, 2015.

RAI believes that the North Carolina Action is without merit and that no further disclosure was necessary to supplement the Joint Proxy

Statement/Prospectus under applicable laws. However, to eliminate certain burdens, expenses and uncertainties, on January 17, 2015, RAI and the director defendants in the North Carolina Action entered into the North Carolina Memorandum of Understanding regarding the settlement of the disclosure claims asserted in that lawsuit. The North Carolina Memorandum of Understanding outlines the terms of the parties’ agreement in principle to settle and release the disclosure claims which were or could have been asserted in the North Carolina Action. In consideration of the partial settlement and release, RAI agreed to make certain supplemental disclosures to the Joint Proxy Statement/Prospectus, which it did on January 20, 2015. The North Carolina Memorandum of Understanding contemplates that the parties will negotiate in good faith to agree upon a stipulation of partial settlement to be submitted to the court for approval as soon as practicable. The stipulation of partial settlement will be subject to customary conditions, including approval by the court, which will consider the fairness, reasonableness and adequacy of the partial settlement. There can be no assurance that the parties will ultimately enter into a stipulation of partial settlement or that the court will approve the partial settlement even if the parties were to enter into such a stipulation. In that event, the proposed partial settlement will be null and void and of no force and effect. In addition, the partial settlement did not affect the consideration paid to Lorillard shareholders in connection with the Merger.

On August 4, 2015, the court issued an order granting defendants’ motions to dismiss all of the remaining non-disclosure claims.

Other Contingencies

JTI Indemnity . In connection with the sale of the international tobacco business to JTI, pursuant to the 1999 Purchase Agreement, RJR and RJR Tobacco agreed to indemnify JTI against:

As described above in “— Litigation Affecting the Cigarette Industry — Other Litigation and Developments — JTI Claims for Indemnification,”

RJR Tobacco has received claims for indemnification from JTI, and several of these have been resolved. Although RJR and RJR Tobacco recognize that, under certain circumstances, they may have other unresolved indemnification obligations to JTI under the 1999 Purchase Agreement, RJR and RJR Tobacco disagree what circumstances described in such claims give rise to any indemnification obligations by RJR and RJR Tobacco and the nature and extent of any such obligation. RJR and RJR Tobacco have conveyed their position to JTI, and the parties have agreed to resolve their differences at a later date.

66

• 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 JTI or any of its affiliates, including the acquired entities, may incur after the sale with respect to any of RJR’s or RJR Tobacco’s employee benefit and welfare plans; and

• any liabilities, costs and expenses incurred by JTI or any of its affiliates arising out of certain activities of Northern Brands.


Indemnification of Distributors and Retailers. RJR Tobacco, Lorillard Tobacco, SFNTC and American Snuff Co. have entered into agreements to indemnify certain distributors and retailers from liability and related defense costs arising out of the sale or distribution of their products. Additionally, SFNTC has entered into an agreement to indemnify a supplier from liability and related defense costs arising out of the sale or use of SFNTC’s products. The cost has been, and is expected to be, insign ificant. RJR Tobacco, SFNTC and American Snuff Co. believe that the indemnified claims are substantially similar in nature and extent to the claims that they are already exposed to by virtue of their having manufactured those products.

Imperial Sub Indemnity . In the Asset Purchase Agreement, RAI agreed to defend and indemnify, subject to certain conditions and limitations, Imperial Sub in connection with claims relating to the purchase or use of one or more of the WINSTON, KOOL, SALEM, or MAVERICK cigarettes brands on or before June 12, 2015, as well as in actions filed before June 13, 2023, relating to the purchase or use of one or more of the WINSTON, KOOL, SALEM, or MAVERICK cigarette brands. In the Asset Purchase Agreement, Imperial Sub agreed to defend and indemnify, subject to certain conditions and limitations, RAI and its affiliates in connection with claims relating to the purchase or use of blu brand e-cigarettes. Imperial Sub also agreed to defend and indemnify, subject to certain conditions and limitations, RAI and its affiliates in actions filed after June 12, 2023, relating to the purchase or use of one or more of the WINSTON, KOOL, SALEM, or MAVERICK cigarette brands after June 12, 2015.

Loews Indemnity . In 2008, Loews Corporation, referred to as Loews, entered into an agreement with Lorillard, Lorillard Tobacco, and certain of

their affiliates, which agreement is referred to as the Separation Agreement. In the Separation Agreement, Lorillard agreed to indemnify Loews and its officers, directors, employees and agents against all costs and expenses arising out of third party claims (including, without limitation, attorneys’ fees, interest, penalties and costs of investigation or preparation of defense), judgments, fines, losses, claims, damages, liabilities, taxes, demands, assessments, and amounts paid in settlement based on, arising out of or resulting from, among other things, Loews’s ownership of or the operation of Lorillard and its assets and properties, and its operation or conduct of its businesses at any time prior to or following the separation of Lorillard and Loews (including with respect to any product liability claims). Loews is a defendant in three pending product liability actions, each of which is a putative class action. Pursuant to the Separation Agreement, Lorillard is required to indemnify Loews for the amount of any losses and any legal or other fees with respect to such cases. Following the closing of the Merger, RJR Tobacco assumed Lorillard’s obligations under the Separation Agreement as was required under the Separation Agreement.

Except as otherwise noted above, RAI is not able to estimate the maximum potential amount of future payments, if any, related to these

indemnification obligations.

67

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) No te 12 — Shareholders’ Equity

68

Common Stock Paid-In Capital

Retained Earnings

(Accumulated Deficit)

Accumulated Other

Comprehensive Loss

Total Shareholders’

Equity

Balance as of December 31, 2014 $ — $ 6,200 $ (1,314 ) $ (364 ) $ 4,522 Net income — — 2,317 — 2,317 Retirement benefits, net of $16 million tax benefit — — — (26 ) (26 ) Amortization of realized loss on hedging instruments, net of tax — — — 1 1 Cumulative translation adjustment and other, net of $10 million tax benefit — — — (17 ) (17 ) Dividends - $1.34 per share — — (718 ) — (718 ) Issuance of additional shares as Merger Consideration — 7,555 — — 7,555 Issuance of additional shares for BAT Share Purchase — 4,673 — — 4,673 Common stock repurchased — (40 ) — — (40 ) Equity incentive award plan and stock-based compensation — 44 — — 44 Excess tax benefit on stock-based compensation plans — 15 — — 15 Balance as of June 30, 2015 $ — $ 18,447 $ 285 $ (406 ) $ 18,326

Common

Stock Paid-In Capital

Retained Earnings

(Accumulated Deficit)

Accumulated Other Comprehensive

Loss

Total Shareholders’

Equity

Balance as of December 31, 2013 $ — $ 6,571 $ (1,348 ) $ (56 ) $ 5,167 Net income — — 855 — 855 Unrealized gain on long-term investments, net of $1 million tax expense — — — 2 2 Amortization of realized loss on hedging instruments, net of tax — — — 1 1 Cumulative translation adjustment and other, net of $1 million tax benefit — — — (2 ) (2 ) Dividends - $1.34 per share — — (719 ) — (719 ) Common stock repurchased — (440 ) — — (440 ) Equity incentive award plan and stock-based compensation — 21 — — 21 Excess tax benefit on stock-based compensation plans — 10 — — 10 Balance as of June 30, 2014 $ — $ 6,162 $ (1,212 ) $ (55 ) $ 4,895


Accumulated Other Comprehensive Income (Loss)

The components of accumulated other comprehensive loss, net of tax, for the six months ended June 30, 2015, were as follows:

The components of accumulated other comprehensive loss, net of tax, for the six months ended June 30, 2014, were as follows:

Details about the reclassifications out of accumulated other comprehensive loss and the affected line items in the condensed consolidated statement of income (unaudited) for the three months ended June 30, were as follows:

69

Retirement

Benefits

Unrealized Gain (Loss) on Long-

Term Investments

Realized Loss on Hedging Instruments

Cumulative Translation

Adjustment and Other Total

Balance as of December 31, 2014 $ (294 ) $ (14 ) $ (12 ) $ (44 ) $ (364 ) Other comprehensive income (loss) before reclassifications (13 ) — — (17 ) (30 ) Amounts reclassified from accumulated other comprehensive income (loss) (13 ) — 1 — (12 ) Net current-period other comprehensive income (loss) (26 ) — 1 (17 ) (42 ) Balance as of June 30, 2015 $ (320 ) $ (14 ) $ (11 ) $ (61 ) $ (406 )

Retirement

Benefits

Unrealized Gain (Loss) on Long-

Term Investments

Realized Loss on Hedging

Instruments

Cumulative Translation Adjustment and Other Total

Balance as of December 31, 2013 $ (17 ) $ (16 ) $ (13 ) $ (10 ) $ (56 ) Other comprehensive income (loss) before reclassifications 12 2 — (2 ) 12 Amounts reclassified from accumulated other comprehensive income (loss) (12 ) — 1 — (11 ) Net current-period other comprehensive income (loss) — 2 1 (2 ) 1 Balance as of June 30, 2014 $ (17 ) $ (14 ) $ (12 ) $ (12 ) $ (55 )

Components Amounts Reclassified Affected Line Item

2015 2014

Defined benefit pension and postretirement plans: Amortization of prior service costs $ (6 ) $ (5 ) Cost of products sold

Amortization of prior service costs (4 ) (4 ) Selling, general and administrative expenses

(10 ) (9 ) Deferred taxes 3 3 Provision for income taxes

Net of tax $ (7 ) $ (6 ) Loss on hedging instruments:

Amortization of realized loss $ 1 $ 1 Interest and debt expense Deferred taxes — — Provision for income taxes

Net of tax $ 1 $ 1 Total reclassifications $ (6 ) $ (5 ) Net income


Details about the reclassifications out of accumulated other comprehensive loss and the affected line items in the condensed consolidated statement of income (unaudited) for the six months ended June 30, were as follows:

Stock Split

On July 27, 2015, RAI’s board of directors approved a two-for-one stock split of RAI’s common stock, in the form of a special 100 percent stock dividend, to be issued on August 31, 2015, to shareholders of record on August 17, 2015. Shareholders of record will receive one additional share of RAI common stock for each share owned. After the stock split, there will be approximately 1.4 billion shares outstanding of RAI common stock.

Share Repurchases and Other

Restricted stock units granted in March 2012 and May 2014 under the Amended and Restated 2009 Omnibus Incentive Compensation Plan, referred to as the Omnibus Plan, vested in March 2015 and May 2015, respectively, and were settled with the issuance of 1,377,554 shares of RAI common stock. In addition, during the first six months of 2015, at a cost of $40 million, RAI purchased 529,074 shares of RAI common stock that were forfeited and cancelled with respect to tax liabilities associated with restricted stock units vesting under the Omnibus Plan.

On February 5, 2015, and May 7, 2015, RAI’s board of directors declared a quarterly cash dividend of $0.67 per common share, or $2.68 on an annualized basis, to shareholders of record as of March 10, 2015 and June 10, 2015, respectively. Note 13 — Stock Plans

In February 2015, the board of directors of RAI approved a grant to key employees of RAI and its subsidiaries, effective March 2, 2015, of 693,090 nonvested restricted stock units under the Omnibus Plan. The restricted stock units generally will vest on March 2, 2018. Upon settlement, each grantee will receive a number of shares of RAI’s common stock equal to the product of the number of vested units and a percentage up to 150% based on the average RAI annual incentive award plan score over the three-year period ending December 31, 2017.

As an equity-based grant, compensation expense relating to the February 2015 grant under the Omnibus Plan will take into account the vesting period lapsed and will be calculated based on the per share closing price of RAI common stock on the date of grant, or $75.88. Following the vesting date, each grantee will receive a cash dividend equivalent payment equal to the aggregate amount of dividends per share paid on shares of RAI common stock during the performance period multiplied by the actual number of restricted stock units earned by the grantee. If RAI fails to pay its shareholders cumulative dividends of at least $8.04 per share for the three-year performance period ending December 31, 2017, then each award will be reduced by an amount equal to three times the percentage of the dividend underpayment, up to a maximum reduction of 50%.

In May 2015, the board of directors of RAI approved a grant to a key employee of RAI, effective May 7, 2015, of 108,652 nonvested restricted stock units under the Omnibus Plan. The restricted stock units generally will vest on May 7, 2016. Upon settlement, the grantee will receive a number of shares of RAI’s common stock equal to the product of the number of vested units and

70


2015 2014

Defined benefit pension and postretirement plans: Amortization of prior service costs $ (11 ) $ (10 ) Cost of products sold

Amortization of prior service costs (9 ) (9 ) Selling, general and administrative expenses

(20 ) (19 ) Deferred taxes 7 7 Provision for income taxes

Net of tax $ (13 ) $ (12 ) Net income Loss on hedging instruments:

Amortization of realized loss $ 1 $ 1 Interest and debt expense Deferred taxes — — Provision for income taxes

Net of tax $ 1 $ 1 Total reclassifications $ (12 ) $ (11 ) Net income

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) a percentage up to 200% based on the overall performance of RAI and its subsidiaries during the one-year performance period beginning May 1, 2015, and ending April 30, 2016, against RAI’s 2015 annual incentive award program metrics and other performance factors.

As an equity-based grant, compensation expense relating to the May 2015 grant under the Omnibus Plan will take into account the vesting period

lapsed and will be calculated based on the per share closing price of RAI common stock as of the end of each quarter, which was $74.66 as of June 30, 2015. Following the vesting date, the grantee will receive a cash dividend equivalent payment equal to the aggregate amount of dividends per share paid on shares of RAI common stock during the performance period multiplied by the actual number of restricted stock units earned by the grantee. If RAI fails to pay its shareholders cumulative dividends of at least $2.68 per share for the one-year performance period ending April 30, 2016, then the award will be reduced by an amount equal to three times the percentage of the dividend underpayment, up to a maximum reduction of 50%. Note 14 — Segment Information

RAI’ s reportable operating segments are RJR Tobacco, American Snuff and Santa Fe. The RJR Tobacco segment consists principally of the primary operations of R. J. Reynolds Tobacco Company, the second largest tobacco company in the United States. The American Snuff segment consists of the primary operations of American Snuff Co. The Santa Fe segment consists of the domestic operations of SFNTC. Included in All Other, among other RAI subsidiaries, are RJR Vapor, Niconovum USA, Inc., Niconovum AB, SFRTI and various foreign subsidiaries affiliated with SFRTI. The segments were identified based on how RAI’s chief operating decision maker allocates resources and assesses performance. Certain of RAI’s operating subsidiaries have entered into intercompany agreements for products or services with other subsidiaries. As a result, certain activities of an operating subsidiary may be included in a different segment of RAI.

RJR Tobacco is RAI’s largest reportable operating segment, and its brands include three of the best-selling cigarettes in the United States: NEWPORT, CAMEL and PALL MALL. These brands, and its other brands, including DORAL, MISTY, and CAPRI, are manufactured in a variety of styles and marketed in the United States. As part of its total tobacco strategy, RJR Tobacco offers a smoke-free tobacco product, CAMEL SNUS. RJR Tobacco manages contract manufacturing of cigarette and tobacco products through arrangements with BAT affiliates, and manages the export of tobacco products to certain U.S. territories, U.S. duty-free shops and U.S. overseas military bases. RJR Tobacco also manages the super-premium cigarette brands, DUNHILL and STATE EXPRESS 555, which are licensed from BAT.

American Snuff is the second largest smokeless tobacco products manufacturer in the United States. American Snuff’s primary brands include its largest selling moist snuff brands, GRIZZLY and KODIAK.

Santa Fe manufactures and markets super-premium cigarettes and other tobacco products under the NATURAL AMERICAN SPIRIT brand in the United States.

RJR Vapor is a manufacturer and marketer of digital vapor cigarettes under the VUSE brand name in the United States. Niconovum USA, Inc. and Niconovum AB are marketers of nicotine replacement therapy products in the United States and Sweden, respectively, under the ZONNIC brand name. SFRTI and various foreign subsidiaries affiliated with SFRTI distribute the NATURAL AMERICAN SPIRIT brand outside of the United States.

Intersegment revenues and items below the operating income line of the condensed consolidated statements of income (unaudited) are not presented by segment, since they are excluded from the measure of segment profitability reviewed by RAI’ s chief operating decision maker. Additionally, information about total assets by segment is not reviewed by RAI’s chief operating decision maker and therefore is not disclosed.

71


Segment Data:

Note 15 — Related Party Transactions

RAI and RAI’s operating subsidiaries engage in transactions with affiliates of BAT, which owns approximately 42% of RAI’s outstanding common stock. A summary of balances and transactions with such BAT affiliates is as follows:

Balances:

Significant transactions:

72



Ended June 30,

2015 2014 2015 2014

Net sales: RJR Tobacco $ 1,876 $ 1,736 $ 3,484 $ 3,299 American Snuff 218 195 419 379 Santa Fe 218 168 389 303 All Other 91 63 168 116

Consolidated net sales $ 2,403 $ 2,162 $ 4,460 $ 4,097

Operating income (loss): RJR Tobacco (1) $ 727 $ 726 $ 1,315 $ 1,208 American Snuff 130 110 248 212 Santa Fe 125 84 217 149 All Other (35 ) (49 ) (96 ) (88 ) Gain on Divestiture 3,499 — 3,499 — Corporate expense (82 ) (35 ) (126 ) (55 )

Consolidated operating income $ 4,364 $ 836 $ 5,057 $ 1,426

Reconciliation to income from continuing operations before income taxes:

Consolidated operating income (1) $ 4,364 $ 836 $ 5,057 $ 1,426 Interest and debt expense 105 62 196 121 Interest income — (1 ) (1 ) (2 ) Other (income) expense, net 20 — 3 1

Income from continuing operations before income taxes $ 4,239 $ 775 $ 4,859 $ 1,306

(1) The six months ended June 30, 2015, includes a $70 million reduction in cost of goods sold associated with the 2003 NPM Adjustment claim, see “— Cost of Products Sold” in note 1.

June 30, 2015 December 31, 2014

Accounts receivable, related party $ 31 $ 41 Due to related party 7 1 Deferred revenue, related party 15 32



Ended June 30,

2015 2014 2015 2014

Net sales $ 54 $ 91 $ 136 $ 177 Purchases 12 4 14 13 BAT Share Purchase 4,673 — 4,673 — RAI common stock purchases from B&W — 114 — 155


RJR Tobacco sells contract-manufactured cigarettes, tobacco leaf and processed tobacco to BAT affiliates. In December 2012, RJR Tobacco entered into an amendment to its contract manufacturing agreement with a BAT affiliate, which amendment, among other thi ngs, requires either party to provide three years’ notice to the other party to terminate the agreement without cause, with any such notice to be given no earlier than January 1, 2016. Net sales to BAT affiliates, primarily cigarettes, represented approxim ately 2% and 3% of RAI’s total net sales during the three and six months ended June 30, 2015, respectively. Net sales to BAT affiliates, primarily cigarettes, represented approximately 4% of RAI’s total net sales during the three and six months ended June 30, 2014.

RJR Tobacco recorded deferred sales revenue relating to leaf sold to BAT affiliates that had not been delivered as of the end of the respective quarter, given that RJR Tobacco has a legal right to bill the BAT affiliates. Leaf sales revenue to BAT affiliates is recognized when the product is shipped to the customer. RJR Tobacco recorded royalty income from the license of capsule technology to BAT affiliates which ended in 2014.

RAI’ s operating subsidiaries also purchase unprocessed leaf at market prices, and import cigarettes at prices not to exceed manufacturing costs plus 10%, from BAT affiliates.

On June 12, 2015, RAI and BAT completed the BAT Share Purchase in connection with the Merger and Divestiture. For additional information, see note 2. Note 16 — RAI Guaranteed, Unsecured Notes — Condensed Consolidating Financial Statements

The following condensed consolidating financial statements relate to the guaranties of RAI’s $14.1 billion unsecured notes. Certain of RAI’s direct, wholly owned subsidiaries and certain of its indirectly owned subsidiaries have fully and unconditionally, and jointly and severally, guaranteed these notes. The following condensed consolidating financial statements include: the accounts and activities of RAI, the parent issuer; RJR, RJR Tobacco, American Snuff Co., SFNTC and certain of RAI’s other subsidiaries, the Guarantors; other direct and indirect subsidiaries of RAI that are not Guarantors; and elimination adjustments.

73


Condensed Consolidating Statements of Income (Dollars in Millions)

74

Parent Issuer Guarantors

Non- Guarantors Eliminations Consolidated

For the Three Months Ended June 30, 2015 Net sales $ — $ 2,320 $ 82 $ (53 ) $ 2,349 Net sales, related party — 54 — — 54

Net sales — 2,374 82 (53 ) 2,403 Cost of products sold — 1,082 53 (51 ) 1,084 Selling, general and administrative expenses 43 348 60 — 451 (Gain) loss on Divestiture — (3,702 ) 203 — (3,499 ) Amortization expense — 3 — — 3

Operating income (loss) (43 ) 4,643 (234 ) (2 ) 4,364 Interest and debt expense 98 33 2 (28 ) 105 Interest income (28 ) — — 28 — Other (income) expense, net 14 (11 ) 7 10 20

Income (loss) from continuing operations before income taxes (127 ) 4,621 (243 ) (12 ) 4,239

Provision for (benefit from) income taxes (77 ) 2,391 (3 ) — 2,311 Equity income (loss) from subsidiaries 1,978 (207 ) — (1,771 ) —

Net income (loss) $ 1,928 $ 2,023 $ (240 ) $ (1,783 ) $ 1,928

For the Three Months Ended June 30, 2014 Net sales $ — $ 2,029 $ 54 $ (12 ) $ 2,071 Net sales, related party — 91 — — 91

Net sales — 2,120 54 (12 ) 2,162 Cost of products sold — 921 49 (11 ) 959 Selling, general and administrative expenses 17 287 60 — 364 Amortization expense — 3 — — 3

Operating income (loss) (17 ) 909 (55 ) (1 ) 836 Interest and debt expense 62 20 2 (22 ) 62 Interest income (22 ) — (1 ) 22 (1 ) Other (income) expense, net — (10 ) — 10 —

Income (loss) from continuing operations before income taxes (57 ) 899 (56 ) (11 ) 775

Provision for (benefit from) income taxes (20 ) 323 (20 ) — 283 Equity income (loss) from subsidiaries 529 3 — (532 ) —

Net income (loss) $ 492 $ 579 $ (36 ) $ (543 ) $ 492



75



For the Six Months Ended June 30, 2015 Net sales $ — $ 4,319 $ 150 $ (145 ) $ 4,324 Net sales, related party — 136 — — 136

Net sales — 4,455 150 (145 ) 4,460 Cost of products sold — 1,951 123 (140 ) 1,934 Selling, general and administrative expenses 62 773 127 — 962 (Gain) loss on Divestiture — (3,702 ) 203 — (3,499 ) Amortization expense — 6 — — 6

Operating income (loss) (62 ) 5,427 (303 ) (5 ) 5,057 Interest and debt expense 189 50 4 (47 ) 196 Interest income (47 ) (1 ) — 47 (1 ) Other (income) expense, net 15 (21 ) (12 ) 21 3


Provision for (benefit from) income taxes (104 ) 2,672 (26 ) — 2,542 Equity income (loss) from subsidiaries 2,432 (187 ) — (2,245 ) —

Net income (loss) $ 2,317 $ 2,540 $ (269 ) $ (2,271 ) $ 2,317

For the Six Months Ended June 30, 2014 Net sales $ — $ 3,843 $ 97 $ (20 ) $ 3,920 Net sales, related party — 177 — — 177

Net sales — 4,020 97 (20 ) 4,097 Cost of products sold — 1,826 82 (19 ) 1,889 Selling, general and administrative expenses 20 644 113 — 777 Amortization expense — 5 — — 5

Operating income (loss) (20 ) 1,545 (98 ) (1 ) 1,426 Interest and debt expense 121 43 3 (46 ) 121 Interest income (46 ) (1 ) (1 ) 46 (2 ) Other (income) expense, net 2 (21 ) (1 ) 21 1


Provision for (benefit from) income taxes (34 ) 546 (36 ) — 476 Equity income (loss) from subsidiaries 918 9 — (927 ) —

Income (loss) from continuing operations 855 987 (63 ) (949 ) 830 Income from discontinued operations — 25 — — 25

Net income (loss) $ 855 $ 1,012 $ (63 ) $ (949 ) $ 855


Condensed Consolidating Statements of Comprehensive Income (Dollars in Millions)

76



For the Three Months Ended June 30, 2015 Net income (loss) $ 1,928 $ 2,023 $ (240 ) $ (1,783 ) $ 1,928 Other comprehensive income (loss), net of tax:

Retirement benefits (20 ) (17 ) (1 ) 18 (20 ) Amortization of realized loss on hedging instruments 1 — — — 1 Cumulative translation adjustment and other 10 10 13 (23 ) 10 Comprehensive income (loss) $ 1,919 $ 2,016 $ (228 ) $ (1,788 ) $ 1,919

For the Three Months Ended June 30, 2014 Net income (loss) $ 492 $ 579 $ (36 ) $ (543 ) $ 492 Other comprehensive income (loss), net of tax:

Retirement benefits 6 7 — (7 ) 6 Unrealized gain on long-term investments 1 1 — (1 ) 1 Amortization of realized loss on hedging instruments 1 — — — 1 Cumulative translation adjustment and other (3 ) (2 ) (2 ) 4 (3 ) Comprehensive income (loss) $ 497 $ 585 $ (38 ) $ (547 ) $ 497

For the Six Months Ended June 30, 2015 Net income (loss) $ 2,317 $ 2,540 $ (269 ) $ (2,271 ) $ 2,317 Other comprehensive income (loss), net of tax:

Retirement benefits (26 ) (23 ) (1 ) 24 (26 ) Amortization of realized loss on hedging instruments 1 — — — 1 Cumulative translation adjustment and other (17 ) (17 ) (27 ) 44 (17 ) Comprehensive income (loss) $ 2,275 $ 2,500 $ (297 ) $ (2,203 ) $ 2,275

For the Six Months Ended June 30, 2014 Net income (loss) $ 855 $ 1,012 $ (63 ) $ (949 ) $ 855 Other comprehensive income (loss), net of tax:

Retirement benefits — 1 — (1 ) — Unrealized gain on long-term investments 2 2 — (2 ) 2 Amortization of realized loss on hedging instruments 1 — — — 1 Cumulative translation adjustment and other (2 ) (1 ) (2 ) 3 (2 ) Comprehensive income (loss) $ 856 $ 1,014 $ (65 ) $ (949 ) $ 856


Details about the reclassifications out of accumulated other comprehensive loss and the affected line items in the condensed consolidating sta tements of income (unaudited) for the three months ended June 30, 2015, were as follows:

Details about the reclassifications out of accumulated other comprehensive loss and the affected line items in the condensed consolidating statements of income (unaudited) for the three months ended June 30, 2014, were as follows:

77



Non-Guarantors Eliminations Consolidated

Defined benefit pension and postretirement plans:

Amortization of prior service costs $ — $ (6 ) $ — $ — $ (6 ) Cost of products sold

Amortization of prior service costs — (4 ) — — (4 ) Selling, general and administrative expenses

— (10 ) — — (10 ) Deferred taxes — 3 — — 3 Provision for income taxes

Defined benefit pension and postretirement plans (7 ) — — 7 — Equity income (loss) from subsidiaries

(7 ) (7 ) — 7 (7 ) Net income (loss) Loss on hedging instruments:

Amortization of realized loss 1 — — — 1 Interest and debt expense Deferred taxes — — — — — Provision for income taxes

Net of tax 1 — — — 1 Total reclassifications $ (6 ) $ (7 ) $ — $ 7 $ (6 ) Net income













Details about the reclassifications out of accumulated other comprehensive loss and the affected line items in t he condensed consolidating statements of income (unaudited) for the six months ended June 30, 2015, were as follows:

Details about the reclassifications out of accumulated other comprehensive loss and the affected line items in the condensed consolidating statements of income (unaudited) for the six months ended June 30, 2014, were as follows:

78
























Condensed Consolidating Statements of Cash Flows (Dollars in Millions)

79



For the Six Months Ended June 30, 2015 Cash flows from (used in) operating activities $ 125 $ 827 $ (4 ) $ (500 ) $ 448 Cash flows from (used in) investing activities:

Capital expenditures — (60 ) (3 ) (1 ) (64 ) Return of intercompany investments 185 — — (185 ) — Acquisition, net of cash acquired (18,278 ) 524 535 — (17,219 ) Proceeds from Divestiture 7,056 — — — 7,056 Other, net (710 ) 12 (1 ) 700 1 Net cash flows from (used in) investing activities (11,747 ) 476 531 514 (10,226 )

Cash flows from (used in) financing activities: Dividends paid on common stock (712 ) (479 ) — 479 (712 ) Repurchase of common stock (40 ) — — — (40 ) Proceeds from BAT Share Purchase 4,673 — — — 4,673 Issuance of long-term debt 8,975 — — — 8,975 Debt issuance costs and financing fees (64 ) — — — (64 ) Principal borrowings under revolving credit facility 1,400 — — — 1,400 Repayments under revolving credit facility (1,400 ) — — — (1,400 ) Excess tax benefit on stock-based compensation plans 15 — — — 15 Dividends paid on preferred stock (21 ) — — 21 — Distribution of equity — (185 ) — 185 — Other, net (11 ) 680 30 (699 ) — Net cash flows from (used in) financing activities 12,815 16 30 (14 ) 12,847

Effect of exchange rate changes on cash and cash equivalents — — (22 ) — (22 ) Net change in cash and cash equivalents 1,193 1,319 535 — 3,047 Cash and cash equivalents at beginning of period 102 469 395 — 966 Cash and cash equivalents at end of period $ 1,295 $ 1,788 $ 930 $ — $ 4,013



80



For the Six Months Ended June 30, 2014 Cash flows from (used in) operating activities $ 326 $ 635 $ (44 ) $ (662 ) $ 255 Cash flows from (used in) investing activities:

Capital expenditures — (41 ) (86 ) 4 (123 ) Proceeds from termination of joint venture — — 35 — 35 Contributions to intercompany investments (32 ) — — 32 — Other, net 143 41 (33 ) (175 ) (24 ) Net cash flows from (used in) investing activities 111 — (84 ) (139 ) (112 )

Cash flows from (used in) financing activities: Dividends paid on common stock (699 ) (637 ) — 637 (699 ) Repurchase of common stock (440 ) — — — (440 ) Principal borrowings under revolving credit facility 1,000 — — — 1,000 Repayments under revolving credit facility (200 ) — — — (200 ) Excess tax benefit on stock-based compensation 10 — — — 10 Dividends paid on preferred stock (21 ) — — 21 — Receipt of equity — — 32 (32 ) — Other, net (31 ) (320 ) 176 175 — Net cash flows from (used in) financing activities (381 ) (957 ) 208 801 (329 )

Effect of exchange rate changes on cash and cash equivalents — — (1 ) — (1 ) Net change in cash and cash equivalents 56 (322 ) 79 — (187 ) Cash and cash equivalents at beginning of period 444 696 360 — 1,500 Cash and cash equivalents at end of period $ 500 $ 374 $ 439 $ — $ 1,313


Condensed Consolidating Balance Sheets (Dollars in Millions)

81



June 30, 2015 Assets Cash and cash equivalents $ 1,295 $ 1,788 $ 930 $ — $ 4,013 Short-term investments — 347 — — 347 Accounts receivable — 84 61 — 145 Accounts receivable, related party — 31 — — 31 Other receivables 772 4,328 432 (5,514 ) 18 Inventories — 1,554 130 (7 ) 1,677 Deferred income taxes, net 4 921 10 — 935 Other current assets 7 275 3 — 285

Total current assets 2,078 9,328 1,566 (5,521 ) 7,451 Property, plant and equipment, net 3 1,263 32 — 1,298 Trademarks and other intangible assets, net — 2,289 26,012 — 28,301 Goodwill — 17,003 16 — 17,019 Long-term intercompany notes receivable 1,603 180 — (1,783 ) — Investment in subsidiaries 36,134 17,760 — (53,894 ) — Other assets and deferred charges 150 383 7 (51 ) 489

Total assets $ 39,968 $ 48,206 $ 27,633 $ (61,249 ) $ 54,558

Liabilities and shareholders’ equity Accounts payable $ 3 $ 146 $ 29 $ — $ 178 Tobacco settlement accruals — 1,982 — — 1,982 Due to related party — 3 4 — 7 Deferred revenue, related party — 15 — — 15 Current maturities of long-term debt 450 — — — 450 Income taxes payable 2,096 19 14 (4 ) 2,125 Dividends payable on common stock 356 — — — 356 Other current liabilities 4,871 1,922 50 (5,514 ) 1,329

Total current liabilities 7,776 4,087 97 (5,518 ) 6,442 Long-term intercompany notes payable 180 1,280 323 (1,783 ) — Long-term debt (less current maturities) 13,599 3,951 — — 17,550 Deferred income taxes, net — 195 9,664 (46 ) 9,813 Long-term retirement benefits (less current portion) 56 2,113 70 — 2,239 Other noncurrent liabilities 31 156 1 — 188 Shareholders’ equity 18,326 36,424 17,478 (53,902 ) 18,326

Total liabilities and shareholders’ equity $ 39,968 $ 48,206 $ 27,633 $ (61,249 ) $ 54,558



82



December 31, 2014 Assets Cash and cash equivalents $ 102 $ 469 $ 395 $ — $ 966 Accounts receivable — 74 42 — 116 Accounts receivable, related party — 41 — — 41 Other receivables 70 1,199 10 (1,267 ) 12 Inventories — 1,198 85 (2 ) 1,281 Deferred income taxes, net 5 688 10 — 703 Other current assets 50 151 1 2 204

Total current assets 227 3,820 543 (1,267 ) 3,323 Property, plant and equipment, net 3 1,170 30 — 1,203 Trademarks and other intangible assets, net — 2,417 4 — 2,421 Goodwill — 7,999 17 — 8,016 Long-term intercompany notes receivable 1,593 190 — (1,783 ) — Investment in subsidiaries 9,598 450 — (10,048 ) — Other assets and deferred charges 101 180 23 (71 ) 233

Total assets $ 11,522 $ 16,226 $ 617 $ (13,169 ) $ 15,196

Liabilities and shareholders’ equity Accounts payable $ 1 $ 128 $ 13 $ — $ 142 Tobacco settlement accruals — 1,819 — — 1,819 Due to related party — 1 — — 1 Deferred revenue, related party — 32 — — 32 Current maturities of long-term debt 450 — — — 450 Dividends payable on common stock 356 — — — 356 Other current liabilities 1,280 682 51 (1,269 ) 744

Total current liabilities 2,087 2,662 64 (1,269 ) 3,544 Long-term intercompany notes payable 190 1,300 293 (1,783 ) — Long-term debt (less current maturities) 4,633 — — — 4,633 Deferred income taxes, net — 450 — (67 ) 383 Long-term retirement benefits (less current portion) 57 1,930 10 — 1,997 Other noncurrent liabilities 33 83 1 — 117 Shareholders’ equity 4,522 9,801 249 (10,050 ) 4,522

Total liabilities and shareholders’ equity $ 11,522 $ 16,226 $ 617 $ (13,169 ) $ 15,196

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued) Note 17 — RJR Tobacco Guaranteed, Unsecured Notes — Condensed Consolidating Financial Statements

The following condensed consolidating financial statements relate to the guaranties of RJR Tobacco’s $3.5 billion unsecured notes, representing the Lorillard Tobacco Notes assumed by RJR Tobacco in connection with the Lorillard Tobacco Merger. RAI and RJR have fully and unconditionally, and jointly and severally, guaranteed these notes. The following condensed consolidating financial statements include: the accounts and activities of RAI, the Parent Guarantor; RJR Tobacco, the Issuer; RJR, a Guarantor; other direct and indirect subsidiaries of RAI that are not Guarantors; and elimination adjustments.


83

Parent

Guarantor Issuer Guarantor Non-

Guarantors Eliminations Consolidated

For the Three Months Ended June 30, 2015 Net sales $ — $ 1,875 $ — $ 524 $ (50 ) $ 2,349 Net sales, related party — 54 — — — 54

Net sales — 1,929 — 524 (50 ) 2,403 Cost of products sold — 953 — 180 (49 ) 1,084 Selling, general and administrative expenses 43 375 — 33 — 451 (Gain) loss on Divestiture — 1,891 — (5,390 ) — (3,499 ) Amortization expense — 2 — 1 — 3

Operating income (loss) (43 ) (1,292 ) — 5,700 (1 ) 4,364 Interest and debt expense 98 9 — 27 (29 ) 105 Interest income (28 ) — (1 ) — 29 — Other (income) expense, net 14 — (11 ) 6 11 20

Income (loss) from continuing operations before income taxes (127 ) (1,301 ) 12 5,667 (12 ) 4,239

Provision for (benefit from) income taxes (77 ) 313 — 2,075 — 2,311 Equity income (loss) from subsidiaries 1,978 3,449 1,864 — (7,291 ) —

Net income (loss) $ 1,928 $ 1,835 $ 1,876 $ 3,592 $ (7,303 ) $ 1,928

For the Three Months Ended June 30, 2014 Net sales $ — $ 1,657 $ — $ 424 $ (10 ) $ 2,071 Net sales, related party — 91 — — — 91

Net sales — 1,748 — 424 (10 ) 2,162 Cost of products sold — 806 — 163 (10 ) 959 Selling, general and administrative expenses 17 318 — 29 — 364 Amortization expense — 1 — 2 — 3

Operating income (loss) (17 ) 623 — 230 — 836 Interest and debt expense 62 6 — 16 (22 ) 62 Interest income (22 ) — — (1 ) 22 (1 ) Other (income) expense, net — — (10 ) (1 ) 11 —

Income (loss) from continuing operations before income taxes (57 ) 617 10 216 (11 ) 775

Provision for (benefit from) income taxes (20 ) 226 — 77 — 283 Equity income (loss) from subsidiaries 529 70 460 — (1,059 ) —

Income (loss) from continuing operations 492 461 470 139 (1,070 ) 492 Income from discontinued operations — — — — — —

Net income (loss) $ 492 $ 461 $ 470 $ 139 $ (1,070 ) $ 492



84

Parent



For the Six Months Ended June 30, 2015 Net sales $ — $ 3,496 $ — $ 958 $ (130 ) $ 4,324 Net sales, related party — 136 — — — 136

Net sales — 3,632 — 958 (130 ) 4,460 Cost of products sold — 1,711 — 349 (126 ) 1,934 Selling, general and administrative expenses 62 827 — 73 — 962 (Gain) loss on Divestiture — 1,891 — (5,390 ) — (3,499 ) Amortization expense — 3 — 3 — 6

Operating income (loss) (62 ) (800 ) — 5,923 (4 ) 5,057 Interest and debt expense 189 14 — 42 (49 ) 196 Interest income (47 ) (1 ) (2 ) — 49 (1 ) Other (income) expense, net 15 — (21 ) (12 ) 21 3

Income (loss) from continuing operations before income taxes (219 ) (813 ) 23 5,893 (25 ) 4,859

Provision for (benefit from) income taxes (104 ) 489 — 2,157 — 2,542 Equity income (loss) from subsidiaries 2,432 3,527 2,252 — (8,211 ) —

Net income (loss) $ 2,317 $ 2,225 $ 2,275 $ 3,736 $ (8,236 ) $ 2,317

For the Six Months Ended June 30, 2014 Net sales $ — $ 3,149 $ — $ 793 $ (22 ) $ 3,920 Net sales, related party — 177 — — — 177

Net sales — 3,326 — 793 (22 ) 4,097 Cost of products sold — 1,614 — 297 (22 ) 1,889 Selling, general and administrative expenses 20 697 2 58 — 777 Amortization expense — 2 — 3 — 5

Operating income (loss) (20 ) 1,013 (2 ) 435 — 1,426 Interest and debt expense 121 11 — 37 (48 ) 121 Interest income (46 ) (1 ) (2 ) (1 ) 48 (2 ) Other (income) expense, net 2 — (21 ) (1 ) 21 1

Income (loss) from continuing operations before income taxes (97 ) 1,003 21 400 (21 ) 1,306

Provision for (benefit from) income taxes (34 ) 368 — 142 — 476 Equity income (loss) from subsidiaries 918 134 797 — (1,849 ) —

Income (loss) from continuing operations 855 769 818 258 (1,870 ) 830 Income from discontinued operations — 25 — — — 25

Net income (loss) $ 855 $ 794 $ 818 $ 258 $ (1,870 ) $ 855


Condensed Consolidating Statements of Comprehensive Income (Dollars in Millions)

85

Parent



For the Three Months Ended June 30, 2015 Net income (loss) $ 1,928 $ 1,835 $ 1,876 $ 3,592 $ (7,303 ) $ 1,928 Other comprehensive income (loss), net of tax:

Retirement benefits (20 ) (13 ) (14 ) (5 ) 32 (20 ) Amortization of realized loss on hedging instruments 1 — — — — 1 Cumulative translation adjustment and other 10 10 10 10 (30 ) 10 Comprehensive income (loss) $ 1,919 $ 1,832 $ 1,872 $ 3,597 $ (7,301 ) $ 1,919

For the Three Months Ended June 30, 2014 Net income (loss) $ 492 $ 461 $ 470 $ 139 $ (1,070 ) $ 492 Other comprehensive income (loss), net of tax:

Retirement benefits 6 8 8 (1 ) (15 ) 6 Unrealized gain on long-term investments 1 1 1 — (2 ) 1 Amortization of realized loss on hedging instruments 1 — — — — 1 Cumulative translation adjustment and other (3 ) (2 ) (2 ) (2 ) 6 (3 ) Comprehensive income (loss) $ 497 $ 468 $ 477 $ 136 $ (1,081 ) $ 497

For the Six Months Ended June 30, 2015 Net income (loss) $ 2,317 $ 2,225 $ 2,275 $ 3,736 $ (8,236 ) $ 2,317 Other comprehensive income (loss), net of tax:

Retirement benefits (26 ) (18 ) (19 ) (5 ) 42 (26 ) Amortization of realized loss on hedging instruments 1 — — — — 1 Cumulative translation adjustment and other (17 ) (17 ) (16 ) (17 ) 50 (17 ) Comprehensive income (loss) $ 2,275 $ 2,190 $ 2,240 $ 3,714 $ (8,144 ) $ 2,275

For the Six Months Ended June 30, 2014 Net income (loss) $ 855 $ 794 $ 818 $ 258 $ (1,870 ) $ 855 Other comprehensive income (loss), net of tax:

Retirement benefits — 3 2 (1 ) (4 ) — Unrealized gain on long-term investments 2 2 2 — (4 ) 2 Amortization of realized loss on hedging instruments 1 — — — — 1 Cumulative translation adjustment and other (2 ) (1 ) (1 ) (1 ) 3 (2 ) Comprehensive income (loss) $ 856 $ 798 $ 821 $ 256 $ (1,875 ) $ 856




86


Parent




Amortization of prior service costs $ — $ (5 ) $ — $ (1 ) $ — $ (6 ) Cost of products sold

Amortization of prior service costs — (4 ) — — — (4 ) Selling, general and administrative expenses

— (9 ) — (1 ) — (10 ) Deferred taxes — 3 — — — 3 Provision for income taxes Defined benefit pension and postretirement plans (7 ) (1 ) (7 ) — 15 —

Equity income (loss) from subsidiaries

(7 ) (7 ) (7 ) (1 ) 15 (7 ) Net income (loss) Loss on hedging instruments:

Amortization of realized loss 1 — — — — 1 Interest and debt expense Deferred taxes — — — — — — Provision for income taxes

Net of tax 1 — — — — 1 Total reclassifications $ (6 ) $ (7 ) $ (7 ) $ (1 ) $ 15 $ (6 ) Net income


Parent




Amortization of prior service costs $ — $ (5 ) $ — $ — $ — $ (5 ) Cost of products sold


— (9 ) — — — (9 ) Deferred taxes — 3 — — — 3 Provision for income taxes Defined benefit pension and postretirement plans (6 ) — (6 ) — 12 —


(6 ) (6 ) (6 ) — 12 (6 ) Net income (loss) Loss on hedging instruments:


Net of tax 1 — — — — 1 Total reclassifications $ (5 ) $ (6 ) $ (6 ) $ — $ 12 $ (5 ) Net income


Details about the reclassifications out of accumulated oth er comprehensive loss and the affected line items in the condensed consolidating statements of income (unaudited) for the six months ended June 30, 2015, were as follows:

Details about the reclassifications out of accumulated other comprehensive loss and the affected line items in the condensed consolidating statements of income (unaudited) for the six months ended June 30, 2014, were as follows:

87


Parent




Amortization of prior service costs $ — $ (10 ) $ — $ (1 ) $ — $ (11 ) Cost of products sold


— (19 ) — (1 ) — (20 ) Deferred taxes — 7 — — — 7 Provision for income taxes Defined benefit pension and postretirement plans (13 ) (1 ) (13 ) — 27 —


(13 ) (13 ) (13 ) (1 ) 27 (13 ) Net income (loss) Loss on hedging instruments:


Net of tax 1 — — — — 1 Total reclassifications $ (12 ) $ (13 ) $ (13 ) $ (1 ) $ 27 $ (12 ) Net income


Parent




Amortization of prior service costs $ — $ (10 ) $ — $ — $ — $ (10 ) Cost of products sold


— (19 ) — — — (19 ) Deferred taxes — 7 — — — 7 Provision for income taxes Defined benefit pension and postretirement plans (12 ) — (12 ) — 24 —


(12 ) (12 ) (12 ) — 24 (12 ) Net income (loss) Loss on hedging instruments:


Net of tax 1 — — — — 1 Total reclassifications $ (11 ) $ (12 ) $ (12 ) $ — $ 24 $ (11 ) Net income



88

Parent



For the Six Months Ended June 30, 2015 Cash flows from (used in) operating activities $ 125 $ 700 $ 485 $ 208 $ (1,070 ) $ 448 Cash flows from (used in) investing activities:

Capital expenditures — (34 ) — (29 ) (1 ) (64 ) Return of intercompany investments 185 10 184 — (379 ) — Acquisition, net of cash acquired (18,278 ) 524 — 535 — (17,219 ) Proceeds from Divestiture 7,056 — — — — 7,056 Other, net (710 ) 1 8 11 691 1 Net cash flows from (used in) investing activities (11,747 ) 501 192 517 311 (10,226 )

Cash flows from (used in) financing activities: Dividends paid on common stock (712 ) (461 ) (479 ) (110 ) 1,050 (712 ) Repurchase of common stock (40 ) — — — — (40 ) Proceeds from BAT Share Purchase 4,673 — — — — 4,673 Issuance of long-term debt 8,975 — — — — 8,975 Debt issuance costs and financing fees (64 ) — — — — (64 ) Principal borrowings under revolving credit facility 1,400 — — — — 1,400 Repayments under revolving credit facility (1,400 ) — — — — (1,400 ) Excess tax benefit on stock-based compensation plans 15 — — — — 15 Dividends paid on preferred stock (21 ) — — — 21 — Distribution of equity — (184 ) (185 ) (10 ) 379 — Other, net (11 ) 700 — 2 (691 ) — Net cash flows from (used in) financing activities 12,815 55 (664 ) (118 ) 759 12,847

Effect of exchange rate changes on cash and cash equivalents — — — (22 ) — (22 ) Net change in cash and cash equivalents 1,193 1,256 13 585 — 3,047 Cash and cash equivalents at beginning of period 102 327 3 534 — 966 Cash and cash equivalents at end of period $ 1,295 $ 1,583 $ 16 $ 1,119 $ — $ 4,013


Condensed Consolidating Statements of Cash Flows

(Dollars in Millions)

89

Parent



For the Six Months Ended June 30, 2014 Cash flows from (used in) operating activities $ 326 $ 327 $ 607 $ 347 $ (1,352 ) $ 255 Cash flows from (used in) investing activities:

Capital expenditures — (23 ) — (104 ) 4 (123 ) Proceeds from termination of joint venture — — — 35 — 35 Contributions to intercompany investments (32 ) — — — 32 — Return of intercompany investments — 90 21 — (111 ) — Other, net 143 8 10 18 (203 ) (24 ) Net cash flows from (used in) investing activities 111 75 31 (51 ) (278 ) (112 )

Cash flows from (used in) financing activities: Dividends paid on common stock (699 ) (580 ) (637 ) (110 ) 1,327 (699 ) Repurchase of common stock (440 ) — — — — (440 ) Principal borrowings under revolving credit facility 1,000 — — — — 1,000 Repayments under revolving credit facility (200 ) — — — — (200 ) Excess tax benefit on stock-based compensation 10 — — — — 10 Dividends paid on preferred stock (21 ) — — — 21 — Receipt of equity — — — 32 (32 ) — Distribution of equity — (21 ) — (90 ) 111 — Other, net (31 ) (20 ) — (152 ) 203 — Net cash flows from (used in) financing activities (381 ) (621 ) (637 ) (320 ) 1,630 (329 )

Effect of exchange rate changes on cash and cash equivalents — — — (1 ) — (1 ) Net change in cash and cash equivalents 56 (219 ) 1 (25 ) — (187 ) Cash and cash equivalents at beginning of period 444 514 2 540 — 1,500 Cash and cash equivalents at end of period $ 500 $ 295 $ 3 $ 515 $ — $ 1,313



90

Parent



June 30, 2015 Assets Cash and cash equivalents $ 1,295 $ 1,583 $ 16 $ 1,119 $ — $ 4,013 Short-term investments — 347 — — — 347 Accounts receivable — 71 — 74 — 145 Accounts receivable, related party — 31 — — — 31 Other receivables 772 445 19 4,313 (5,531 ) 18 Inventories — 923 — 761 (7 ) 1,677 Deferred income taxes, net 4 842 1 88 — 935 Other current assets 7 233 — 45 285

Total current assets 2,078 4,475 36 6,400 (5,538 ) 7,451 Property, plant and equipment, net 3 850 — 445 — 1,298 Trademarks and other intangible assets, net — 347 — 27,954 — 28,301 Goodwill — 3,453 10,852 2,714 — 17,019 Long-term intercompany notes receivable 1,603 — 98 180 (1,881 ) — Investment in subsidiaries 36,134 22,039 22,437 — (80,610 ) — Other assets and deferred charges 150 1,046 18 7 (732 ) 489

Total assets $ 39,968 $ 32,210 $ 33,441 $ 37,700 $ (88,761 ) $ 54,558

Liabilities and shareholders’ equity Accounts payable $ 3 $ 126 $ — $ 49 $ — $ 178 Tobacco settlement accruals — 1,912 — 70 — 1,982 Due to related party — 3 — 4 — 7 Deferred revenue, related party — 15 — — — 15 Current maturities of long-term debt 450 — — — — 450 Income taxes payable 2,096 3 — 30 (4 ) 2,125 Dividends payable on common stock 356 — — — — 356 Other current liabilities 4,871 1,746 3 240 (5,531 ) 1,329

Total current liabilities 7,776 3,805 3 393 (5,535 ) 6,442 Long-term intercompany notes payable 180 — — 1,701 (1,881 ) — Long-term debt (less current maturities) 13,599 3,951 — — — 17,550 Deferred income taxes, net — 1 — 10,540 (728 ) 9,813 Long-term retirement benefits (less current portion) 56 1,992 29 162 — 2,239 Other noncurrent liabilities 31 151 2 4 — 188 Shareholders’ equity 18,326 22,310 33,407 24,900 (80,617 ) 18,326

Total liabilities and shareholders’ equity $ 39,968 $ 32,210 $ 33,441 $ 37,700 $ (88,761 ) $ 54,558



91

Parent



December 31, 2014 Assets Cash and cash equivalents $ 102 $ 327 $ 3 $ 534 $ — $ 966 Accounts receivable — 61 — 55 — 116 Accounts receivable, related party — 41 — — — 41 Other receivables 70 291 20 1,864 (2,233 ) 12 Inventories — 529 — 754 (2 ) 1,281 Deferred income taxes, net 5 611 1 86 — 703 Other current assets 50 118 — 34 2 204

Total current assets 227 1,978 24 3,327 (2,233 ) 3,323 Property, plant and equipment, net 3 765 — 435 — 1,203 Trademarks and other intangible assets, net — 130 — 2,291 — 2,421 Goodwill — 5,302 — 2,714 — 8,016 Long-term intercompany notes receivable 1,593 — 106 190 (1,889 ) — Investment in subsidiaries 9,598 3,060 6,941 — (19,599 ) — Other assets and deferred charges 101 731 18 18 (635 ) 233

Total assets $ 11,522 $ 11,966 $ 7,089 $ 8,975 $ (24,356 ) $ 15,196

Liabilities and shareholders’ equity Accounts payable $ 1 $ 110 $ — $ 31 $ — $ 142 Tobacco settlement accruals — 1,709 — 110 — 1,819 Due to related party — 1 — — — 1 Deferred revenue, related party — 32 — — — 32 Current maturities of long-term debt 450 — — — — 450 Dividends payable on common stock 356 — — — — 356 Other current liabilities 1,280 1,274 3 423 (2,236 ) 744

Total current liabilities 2,087 3,126 3 564 (2,236 ) 3,544 Long-term intercompany notes payable 190 — — 1,699 (1,889 ) — Long-term debt (less current maturities) 4,633 — — — — 4,633 Deferred income taxes, net — 1 — 1,013 (631 ) 383 Long-term retirement benefits (less current portion) 57 1,822 30 88 — 1,997 Other noncurrent liabilities 33 78 — 6 — 117 Shareholders’ equity 4,522 6,939 7,056 5,605 (19,600 ) 4,522

Total liabilities and shareholders’ equity $ 11,522 $ 11,966 $ 7,089 $ 8,975 $ (24,356 ) $ 15,196

I tem 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion and analysis of RAI’s business, initiatives, critical accounting estimates and its consolidated results of operations and financial position. Following the overview and discussion of business initiatives, the critical accounting estimates disclose certain accounting estimates that are material to RAI’s results of operations and financial position for the periods presented in this report. The discussion and analysis of RAI’s results of operations compares the second quarter of 2015 with the second quarter of 2014, and the first six months of 2015 with the first six months of 2014. The statements of financial position and results of operations contained in the condensed consolidated financial statements (unaudited) reflect the results of the Merger, Divestiture and related transactions. Disclosures related to liquidity and financial position complete management’s discussion and analysis. You should read this discussion and analysis of RAI’s consolidated financial position and results of operations in conjunction with the financial information included in the condensed consolidated financial statements (unaudited).

Overview and Business Initiatives

On June 12, 2015, RAI completed the Merger, Divestiture and BAT Share Purchase. For additional information on these transactions, see Merger, Divestiture and Related Transactions below.

RAI’ s reportable operating segments are RJR Tobacco, American Snuff and Santa Fe. The RJR Tobacco segment consists principally of the primary operations of R. J. Reynolds Tobacco Company, the second largest tobacco company in the United States. The American Snuff segment consists of the primary operations of American Snuff Co. The Santa Fe segment consists of the domestic operations of SFNTC. Included in All Other, among other RAI subsidiaries, are RJR Vapor, Niconovum USA, Inc., Niconovum AB, SFRTI and various foreign subsidiaries affiliated with SFRTI. The segments were identified based on how RAI’s chief operating decision maker allocates resources and assesses performance. Certain of RAI’s operating subsidiaries have entered into intercompany agreements for products or services with other subsidiaries. As a result, certain activities of an operating subsidiary may be included in a different segment of RAI.

As a result of shifts in consumer preferences, RAI’s strategy continues to focus on transforming tobacco to deliver sustainable earnings growth, strong cash flow and enhanced long-term shareholder value. This transformation strategy includes growing the core cigarette and moist-snuff businesses, focusing on innovation and engaging with adult tobacco consumers, while maintaining efficient and effective operations.

To achieve its strategy, RAI encourages the migration of adult smokers to smoke-free tobacco products and other products, which it believes aligns consumer preferences for new alternatives to traditional tobacco products in view of societal pressure to reduce smoking. RAI’s operating companies facilitate this migration through innovation, including the development of CAMEL SNUS, heat-not-burn cigarettes, digital vapor cigarettes and nicotine replacement therapy technologies. RAI remains committed to maintaining high standards of corporate governance and business conduct in a high performing culture.

RJR Tobacco is RAI’s largest reportable operating segment, and its brands include three of the best-selling cigarettes in the United States: NEWPORT, CAMEL and PALL MALL. These brands, and its other brands, including DORAL, MISTY, and CAPRI are manufactured in a variety of styles and marketed in the United States. As part of its total tobacco strategy, RJR Tobacco offers a smoke-free tobacco product, CAMEL SNUS. RJR Tobacco manages contract manufacturing of cigarettes and tobacco products through arrangements with BAT affiliates, and manages the export of tobacco products to certain U.S. territories, U.S. duty-free shops and U.S. overseas military bases. RJR Tobacco also manages the super-premium cigarette brands, DUNHILL and STATE EXPRESS 555, which are licensed from BAT.

American Snuff is the second largest smokeless tobacco products manufacturer in the United States. American Snuff’s primary brands include its largest selling moist snuff brands, GRIZZLY and KODIAK.

Santa Fe manufactures and markets super-premium cigarettes and other tobacco products under the NATURAL AMERICAN SPIRIT brand in the United States.

RJR Tobacco

RJR Tobacco primarily conducts business in the highly competitive U.S. cigarette market, which has a few large manufacturers and many smaller participants. The international rights to substantially all of RJR Tobacco’s brands were sold in 1999 to JTI, and no international rights were acquired in connection with the B&W business combination or the Merger. The U.S. cigarette market is a mature market in which overall adult consumer demand has declined since 1981, and is expected to continue to decline. Profitability of the U.S. cigarette industry and RJR Tobacco continues to be adversely impacted by decreases in consumption, increases in state

92

excise taxes and governmental regulations and restrictions, such as marketing limitations, product standards and ingredients legislation.

RJR Tobacco’s cigarette brand portfolio strategy is based upon three brand categories: growth, support and non-support. The growth brands now consist of two premium brands, NEWPORT and CAMEL, and the largest traditional value brand, PALL MALL. Although these three brands are managed for long-term market share and profit growth, NEWPORT and CAMEL will continue to receive the most significant equity support. The support brands include one premium brand, CAPRI, and two value brands, DORAL and MISTY, all of which receive limited marketing support. The non-support brands, consisting of all other brands, are managed to maximize near-term profitability. The key objectives of the portfolio strategy are designed to focus on the long-term market share growth of the growth brands while managing the support brands for long-term sustainability and profitability. Consistent with that strategy, RJR Tobacco continues to evaluate some of its non-core cigarette styles for potential elimination.

RJR Tobacco’s portfolio also includes CAMEL SNUS, a smoke-free, heat-treated tobacco product sold in individual pouches that provides convenient tobacco consumption.

Competition is based primarily on brand positioning, including price, product attributes and packaging, consumer loyalty, promotions, advertising and retail presence, as well as finding efficient and effective means of balancing market share and profit growth. Cigarette brands produced by the major manufacturers generally require competitive pricing, substantial marketing support, retail programs and other incentives to maintain or improve market position or to introduce a new brand or brand style. Competition among the major cigarette manufacturers continues to be highly competitive and includes product innovation and expansion into smoke-free tobacco categories.

RJR Tobacco is committed to building and maintaining a portfolio of profitable brands. RJR Tobacco’s marketing programs are designed to strengthen brand image, build brand awareness and loyalty, and switch adult smokers of competing brands to RJR Tobacco brands. In addition to building strong brand equity, RJR Tobacco’s marketing approach utilizes a retail pricing strategy, including discounting at retail, to defend certain brands’ shares of market against competitive pricing pressure. RJR Tobacco’s competitive pricing methods may include list price changes, discounting programs, such as retail and wholesale buydowns, periodic price reductions, off-invoice price reductions, dollar-off promotions and consumer coupons. Retail buydowns refer to payments made to the retailer to reduce the price that consumers pay at retail. Consumer coupons generally are distributed by a variety of methods, including in, or on, the pack and by direct mail.

American Snuff

American Snuff offers adult tobacco consumers a range of differentiated smokeless tobacco products, primarily moist snuff. The moist snuff category is divided into premium and price-value brands. The highly competitive moist snuff category has developed many of the characteristics of the larger cigarette market, including multiple pricing tiers, focused marketing programs and significant product innovation.

In contrast to the declining U.S. cigarette market, U.S. moist snuff shipments to retail grew approximately 3% in the first six months of 2015. Profit margins on moist snuff products are generally higher than on cigarette products. Moist snuff’s growth is partially attributable to cigarette smokers switching from cigarettes to smokeless tobacco products or using both.

American Snuff faces significant competition in the smokeless tobacco category. Similar to the cigarette market, competition is based primarily on brand positioning and price, as well as product attributes and packaging, consumer loyalty, promotions, advertising and retail presence.

Santa Fe

Santa Fe competes in the U.S. cigarette market with its NATURAL AMERICAN SPIRIT brand, which is the leading super-premium cigarette brand and is a top 10 best-selling cigarette brand. It is priced higher than most other competitive brands, and is differentiated from key competitors through its use of all natural, additive-free tobacco, including styles made with organic tobacco. Competition in the cigarette category is based primarily on brand positioning, including price, product attributes and packaging, consumer loyalty, promotions, advertising and retail presence.

All Other

RJR Vapor is the manufacturer and marketer of VUSE Digital Vapor Cigarette. The national expansion of VUSE began in 2014, and was completed in early 2015. VUSE is now the top-selling vapor product in convenience/gas stores, and its innovative digital technology is designed to deliver a consistent flavor and vapor experience.

93

Niconovum USA, Inc. was in lead markets in Iowa and Nebraska with ZONN IC, a nicotine replacement therapy gum, until September 2014, when it began its national expansion. ZONNIC is available in many retail outlets across the United States. Niconovum AB is a marketer of nicotine replacement therapy products in Sweden under t he ZONNIC brand name.

SFRTI and various foreign subsidiaries affiliated with SFRTI distribute the NATURAL AMERICAN SPIRIT brand outside the United States.

Merger, Divestiture and BAT Share Purchase

Overview

On July 15, 2014, RAI, Merger Sub and Lorillard entered into the Merger Agreement, pursuant to which RAI agreed to acquire Lorillard in a cash and stock transaction.

On July 15, 2014, RAI entered into the Asset Purchase Agreement and Lorillard entered into the Transfer Agreement, in each case with Imperial Sub and for certain provisions of the Asset Purchase Agreement and as guarantor of certain obligations of Imperial Sub, Imperial, pursuant to which Imperial Sub agreed to acquire certain assets and assume certain liabilities of certain affiliates of each of RAI and Lorillard.

Merger

On June 12, 2015, the Merger was completed, with Merger Sub merging with and into Lorillard and Lorillard surviving as a wholly owned subsidiary of RAI. Pursuant to the Merger Agreement, each share of Lorillard common stock (other than treasury shares held by Lorillard and any shares of Lorillard common stock owned by any Lorillard subsidiary, RAI or Merger Sub) was converted into the right to receive (1) 0.2909 of a share of RAI common stock plus (2) $50.50 in cash. RAI issued 104,706,847 shares of RAI common stock to Lorillard shareholders in the Merger.

As a part of the Merger, RAI acquired the premium cigarette brand, NEWPORT, which is the top selling menthol and second largest selling cigarette brand overall in the United States. In addition to NEWPORT, RAI acquired three additional brand families marketed under the KENT, TRUE and OLD GOLD brand names. With the addition of the NEWPORT brand, RAI's operating companies have brand portfolios that reflect diversification and strength across product categories and across geographies. It is expected that the transaction will provide RAI with additional resources to invest in innovation, R&D and its operating companies’ brands.

Divestiture

On June 12, 2015, the Divestiture was completed and Imperial Sub acquired the cigarette brands WINSTON, KOOL and SALEM, previously owned by RAI subsidiaries and included in the RJR Tobacco segment, as well as the cigarette brand MAVERICK and the “e-vapor” brand blu (including SKYCIG), previously owned by Lorillard subsidiaries, and other assets and certain liabilities, including inventory, fixed assets and employee benefit plans, for an aggregate purchase price of approximately $7.1 billion.

BAT Share Purchase and Other

Concurrently with the completion of the Merger and Divestiture and pursuant to the Subscription Agreement, BAT indirectly (through a wholly owned subsidiary) purchased 77,680,259 shares of RAI common stock for approximately $4.7 billion, which was sufficient for BAT and its subsidiaries collectively to maintain their approximately 42% beneficial ownership in RAI. Upon completion of the transactions on June 12, 2015, BAT and its subsidiaries collectively owned 301,014,278 shares, or approximately 42%, of RAI’s outstanding common stock.

RAI financed the cash portion of the Merger Consideration and related fees and expenses with (1) the net proceeds from a public offering of $9 billion aggregate principal amount of newly issued RAI senior notes, (2) the proceeds from the Divestiture, (3) the proceeds from the BAT Share Purchase and (4) available cash. Transaction related costs of $39 million and $54 million, for the three and six months ended June 30, 2015, respectively, were expensed as incurred and included in selling, general and administrative expenses in RAI’s condensed consolidated statements of income (unaudited).

Critical Accounting Estimates

GAAP requires estimates and assumptions to be made that affect the reported amounts in RAI’s condensed consolidated financial statements (unaudited) 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

94

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

Business Combination

RAI accounts for business combination transactions in accordance with ASC 805. RAI allocates the cost of an acquisition to the assets acquired and liabilities assumed based on their fair values as of the acquisition date. Any excess of the purchase price over the estimated fair value of net assets acquired is recorded as goodwill. Determining the fair value of these items requires management’s judgment and the utilization of independent valuation experts. These valuations involve the use of significant estimates and assumptions with respect to the timing and amounts of future cash flows, discount rates, market prices, and asset lives, among other items. The judgments made in the determination of the estimated fair value of the assets acquired and the liabilities assumed as well as the estimated useful life of each asset and the duration of each liability can materially impact the financial statements in periods after the acquisition, such as depreciation, amortization, or in certain situations, impairment charges. For further information related to accounting for the Merger and Divestiture, see note 2 to condensed consolidated financial statements (unaudited).

Litigation

RAI discloses information concerning litigation for which an unfavorable outcome is more than remote. RAI and its subsidiaries record their legal expenses and other litigation costs and related administrative costs as selling, general and administrative expenses as those costs are incurred. RAI and its subsidiaries will record any loss related to litigation at such time as an unfavorable outcome becomes probable and the amount can be reasonably estimated on an individual case-by-case basis. When the reasonable estimate is a range, the recorded loss will be the best estimate within the range. If no amount in the range is a better estimate than any other amount, the minimum amount of the range will be recorded.

RJR Tobacco, Lorillard Tobacco, American Snuff Co. or their affiliates, including RAI, and indemnitees, 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 have been returned in a number of tobacco-related cases and state enforcement actions.

RAI and its subsidiaries believe that they have valid bases for appeal of adverse verdicts in their pending cases and believe they have valid defenses to all actions and intend to defend all actions vigorously. RAI’s management continues to conclude that the loss of any particular smoking and health tobacco litigation claim against RJR Tobacco, Lorillard Tobacco or its affiliates or indemnitees, including B&W, or the loss of any particular claim concerning the use of smokeless tobacco products against American Snuff Co., when viewed on an individual case-by-case basis, is not probable or estimable, except for certain Engle Progeny cases described in “— Litigation Affecting the Cigarette Industry — Engle and Engle Progeny Cases” in note 11 to condensed consolidated financial statements (unaudited).

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, Lorillard Tobacco, American Snuff Co. or their affiliates, including RAI, and indemnitees. Any unfavorable outcome of such actions could have a material adverse effect on the consolidated results of operations, cash flows or financial position of RAI or its subsidiaries.

For further discussion of the litigation and legal proceedings pending against RAI or its affiliates or indemnitees, see note 11 to condensed consolidated financial statements (unaudited).

State Settlement Agreements

RJR Tobacco (itself, and as successor by merger to Lorillard Tobacco) and SFNTC are participants in the MSA, and RJR Tobacco (itself, and as successor by merger to Lorillard Tobacco) is a participant in the other state settlement agreements. Their obligations and the related expense charges under these 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 to RJR Tobacco and SFNTC under these agreements is recorded in cost of products sold as the products are shipped. Included in these adjustments is an NPM Adjustment that potentially reduces the annual payment obligation of RJR Tobacco, SFNTC and other PMs. Adjustments to these estimates are recorded in the period that the change becomes probable and the amount can be reasonably estimated. American Snuff Co. is not a participant in the State Settlement Agreements. For additional information related to historical and expected settlement expenses and payments under the State Settlement Agreements, see “— Litigation Affecting the Cigarette Industry — Health-Care Cost Recovery Cases — State Settlement Agreements” and “— State Settlement Agreements—Enforcement and Validity; Adjustments” in note 11 to condensed consolidated financial statements (unaudited).

95

Pensi on and Postretirement Benefits

RAI sponsors a number of non-contributory defined benefit pension plans covering most of the employees of RAI and certain of its subsidiaries, and also provides certain health and life insurance benefits for most of their retired employees and their dependents. These benefits are generally no longer provided to employees hired on or after January 1, 2004.

Because pension and other postretirement obligations ultimately will be settled in future periods, the determination of annual expense and liabilities is subject to estimates and assumptions. RAI reviews these assumptions annually based on historical experience and expected future trends or coincidental with a major event and modifies them as needed. Demographic assumptions such as termination of employment, mortality or retirement are reviewed periodically as expectations change.

Actuarial gains or losses are changes in the amount of either the benefit obligation or the fair value of plan assets resulting from experience different from that assumed or from changes in assumptions. RAI immediately recognizes actuarial gains and losses in its operating results in the year in which they occur, to the extent the gains and losses are outside the corridor. Actuarial gains and losses outside the corridor are recognized annually as of December 31, or when a plan is remeasured during an interim period, and are recorded as an MTM adjustment. Additionally, for the purpose of calculating the expected return on plan assets, RAI uses the actual fair value of plan assets.

Prior service costs of pension benefits, 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, or average remaining life expectancies for inactive employees if most of the plan obligations are due to inactive employees. Prior service costs of postretirement benefits, which are changes in benefit obligations due to plan amendments, are amortized on a straight-line basis over the expected service period to full eligibility age for active employees, or average remaining life expectancies for inactive employees if most of the plan obligations are due to inactive employees.

Intangible Assets

Intangible assets include goodwill, trademarks and other intangible assets. The determination of fair value involves considerable estimates and judgment. Goodwill, trademarks and other intangible assets with indefinite lives are tested annually for impairment in the fourth quarter.

For goodwill, the determination of fair value of a reporting unit involves, among other things, RAI’s market capitalization, and application of the income approach, which includes developing forecasts of future cash flows and determining an appropriate discount rate. If goodwill impairment is implied, the fair values of individual assets and liabilities, including unrecorded intangibles, must be determined. RAI believes it has based its goodwill impairment testing on reasonable estimates and assumptions, and during the annual testing, the estimated fair value of each of RAI’s reporting units was substantially in excess of its respective carrying value.

The methodology used to determine the fair value of trademarks includes assumptions with inherent uncertainty, including projected sales volumes and related projected revenues, long-term growth rates, royalty rates that a market participant might assume and judgments regarding the factors to develop an applied discount rate. The carrying value of intangible assets is at risk of impairment if future projected revenues or long-term growth rates are lower than those currently projected, or if factors used in the development of a discount rate result in the application of a higher discount rate.

Goodwill, trademarks and other intangible assets are tested more frequently if events and circumstances indicate that the asset might be impaired. The carrying value of these intangible assets could be impaired if a significant adverse change in the use, life, or brand strategy of the asset is determined, or if a significant adverse change in the legal and regulatory environment, business or competitive climate occurs that would adversely impact the asset. For information related to intangible assets, see note 4 to condensed consolidated financial statements (unaudited).

Fair Value Measurement

RAI determines fair value of assets and liabilities using a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity, and the reporting entity’s own assumptions about market participant assumptions based on the best information available in the circumstances.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, essentially an exit price. The levels of the fair value hierarchy are:

Level 1: inputs are quoted prices, unadjusted, in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

96

Level 2: inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. A Level 2 input must be observable for substantially the full term of the asset or liability.

Level 3: inputs are unobservable and reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability.

Income Taxes

Tax law requires certain items to be excluded or included in taxable income at different times than is required for book reporting purposes. These differences may be permanent or temporary in nature.

RAI determines its annual effective income tax rate based on forecasted pre-tax book income and forecasted permanent book and tax differences. The rate is established at the beginning of the year and is evaluated on a quarterly basis. Any changes to the forecasted information may cause the effective rate to be adjusted. Additional tax, interest and penalties associated with uncertain tax positions are recognized in tax expense on a quarterly basis.

To the extent that any book and tax differences are temporary in nature, that is, the book realization will occur in a different period than the tax realization, a deferred tax asset or liability is established. To the extent that a deferred tax asset is created, management evaluates RAI’s ability to realize this asset. RAI maintains a valuation allowance to reduce certain deferred tax assets to amounts that are more likely than not to be realized. This allowance is attributable to deferred tax assets established for capital loss carryforwards.

The financial statements reflect management’s best estimate of RAI’s current and deferred tax liabilities and assets. Future events, including, but not limited to, additional resolutions with taxing authorities could have an impact on RAI’s current estimate of tax liabilities, realization of tax assets and effective income tax rate.

Recently Issued Accounting Pronouncements

For information relating to recently issued accounting pronouncements, see note 1 to condensed consolidated financial statements (unaudited).

Results of Operations

The results of operations below reflect the Merger and Divestiture that occurred on June 12, 2015. As a result, for 2015, RJR Tobacco’s net sales and operating income include results of operations for the WINSTON, KOOL and SALEM brands only for the period of January 1, 2015 through June 12, 2015, and include results of operations for the NEWPORT, KENT, OLD GOLD and TRUE brands only for the period from June 12, 2015 through June 30, 2015.

97

For the Three Months Ended June 30, For the Six Months Ended June 30,

2015 2014 % Change 2015 2014 % Change

Net sales (1) : RJR Tobacco $ 1,876 $ 1,736 8.1 % $ 3,484 $ 3,299 5.6 % American Snuff 218 195 11.8 % 419 379 10.6 % Santa Fe 218 168 29.8 % 389 303 28.4 % All Other 91 63 44.4 % 168 116 44.8 %

Net sales 2,403 2,162 11.1 % 4,460 4,097 8.9 % Cost of products sold (1)(2) 1,084 959 13.0 % 1,934 1,889 2.4 % Selling, general and administrative expenses 451 364 23.9 % 962 777 23.8 % Gain on Divestiture (3,499 ) — NM (3) (3,499 ) — NM (3) Amortization expense 3 3 — 6 5 20.0 % Operating income (loss):

RJR Tobacco 727 726 0.1 % 1,315 1,208 8.9 % American Snuff 130 110 18.2 % 248 212 17.0 % Santa Fe 125 84 48.8 % 217 149 45.6 % All Other (35 ) (49 ) (28.6 )% (96 ) (88 ) 9.1 % Gain on Divestiture 3,499 — NM (3) 3,499 — NM (3) Corporate expense (82 ) (35 ) NM (3) (126 ) (55 ) NM (3)

Operating income $ 4,364 $ 836 NM (3) $ 5,057 $ 1,426 NM (3)

In the following discussion, the amounts presented in the operating companies’ shipment volume and share tables are rounded on an individual basis and, accordingly, may not sum in the aggregate. Percentages are calculated on unrounded numbers.

RJR Tobacco

Net Sales

The acquisition of the NEWPORT, KENT, OLD GOLD and TRUE brands occurred on June 12, 2015, and consequently, the RAI consolidated statements of income for 2015 include the results of operations for these brands only from June 12, 2015 through June 30, 2015. The divestiture of the WINSTON, KOOL and SALEM brands occurred on June 12, 2015, and consequently, the RAI consolidated statements of income for 2015 include the results of operations for these brands only for the period from January 1, 2015 through June 12, 2015.

Domestic cigarette shipment volume, in billions of units for RJR Tobacco and the industry, was as follows:

98

(1) Excludes excise taxes of:



Ended June 30,

2015 2014 2015 2014

RJR Tobacco $ 820 $ 787 $ 1,522 $ 1,506 American Snuff 14 13 27 26 Santa Fe 68 54 121 98 All Other 85 73 157 143 $ 987 $ 927 $ 1,827 $ 1,773

(2) See below for further information related to the State Settlement Agreements, FDA user fees and federal tobacco quota buyout included in cost of products sold.

(3)

Percentage of change not meaningful.


2015 2014 %

Change 2015 2014 %

Change

RJR Tobacco: Growth brands:

NEWPORT 1.4 — NM (2) 1.4 — NM (2) CAMEL 5.4 5.2 3.5 % 10.3 10.2 1.7 % PALL MALL 5.2 5.3 (2.2 )% 9.9 10.1 (1.6 )%

12.0 10.5 14.3 % 21.7 20.3 7.2 % Other 4.3 5.1 (16.3 )% 8.5 9.7 (11.6 )% Total RJR Tobacco domestic cigarette shipment volume 16.3 15.6 4.4 % 30.2 29.9 1.1 %

Total premium 10.0 9.1 10.0 % 18.2 17.4 4.2 % Total value 6.3 6.5 (3.4 )% 12.1 12.5 (3.2 )%

Premium/total mix 61.3 % 58.2 % 60.1 % 58.3 % Industry (1) :

Premium 49.8 48.6 2.6 % 94.0 92.1 2.1 % Value 19.0 19.0 (0.1 )% 36.1 36.5 (1.0 )%

Total industry domestic cigarette shipment volume 68.8 67.5 1.9 % 130.1 128.6 1.2 % Premium/total mix 72.4 % 71.9 % 72.2 % 71.6 %

(1)

Based on information from Management Science Associates, Inc., referred to as MSAi.

(2)

Percentage of change not meaningful.

RJR Tobacco’s net sales are dependent upon its cigarette shipment volume in a declining market, premium versus value-brand mix and list pricing, offset by promotional spending, trade incentives and federal excise taxes.

RJR Tobacco’s net sales for the three months ended June 30, 2015, increased compared with the prior-year quarter, primarily due to higher volume and favorable product mix of $103 million and higher net pricing of $73 million, partially offset by $36 million attributable to contract manufacturing and leaf sales. RJR Tobacco’s net sales for the six months ended June 30, 2015, increased compared with the prior-year six months, primarily due to higher net pricing of $172 million and higher volume of $60 million, partially offset by $44 million attributable to contract manufacturing and leaf sales.

Market Share

Market share information is included for RJR Tobacco to provide enhanced analysis of its brand performance. For brands that were acquired in the Merger, share information is displayed as if the brands were part of the portfolio for all time periods shown. Brands that were part of the Divestiture have been removed for all presented time periods. Accordingly, these pro forma results are presented for informational purposes only and are not necessarily indicative of what the actual results of operations of the combined company would have been if the Merger and Divestiture had occurred at the beginning of the periods presented, nor are they indicative of future results of operations.

The shares of RJR Tobacco’s cigarette brands as a percentage of total share of U.S. cigarette shipments to retail, referred to as STR data, based on information submitted by wholesale locations and processed and managed by MSAi (1) , were as follows:

The retail share of market of NEWPORT, at 13.2 share points, was up 0.4 share points compared with the prior-year quarter in the highly competitive U.S. cigarette category. NEWPORT’s cigarette market share continued to be favorably impacted by its strength in the menthol category.

The retail share of market of CAMEL, at 8.2 share points, was flat compared with the prior-year quarter in the highly competitive U.S. cigarette category. CAMEL’s cigarette market share continued to be favorably impacted by its innovative capsule technology offered in CAMEL Crush and CAMEL menthol styles. CAMEL Crush styles provide adult smokers the choice of switching from non-menthol to menthol. CAMEL menthol styles allow adult smokers to choose the level of menthol flavor on demand. CAMEL SNUS, a smoke-free tobacco product, continues to lead the U.S. snus category with a market share of approximately 80%. CAMEL White was introduced in 21 western states beginning in late March and is available in mellow and menthol styles.

PALL MALL, a product that offers a high quality, longer-lasting cigarette at a value price, continues to attract interest from adult tobacco consumers. PALL MALL’s second-quarter market share of 7.8% was down 0.3 share points compared with the prior-year quarter due to continued competitive pressure.

99

For the Three Months Ended

June 30,

2015 March 31,

2015 Share Point

Change June 30,

2014 Share Point

Change

Growth brands: NEWPORT 13.2 % 13.3 % (0.1 ) 12.8 % 0.4 CAMEL 8.2 % 8.2 % — 8.1 % — PALL MALL 7.8 % 7.9 % (0.1 ) 8.1 % (0.3 )

Total growth brands 29.2 % 29.4 % (0.2 ) 29.1 % 0.2 Other 2.6 % 2.8 % (0.2 ) 2.9 % (0.3 )

Total RJR Tobacco domestic cigarette share of retail shipments 31.8 % 32.2 % (0.4 ) 31.9 % (0.1 )

(1) Beginning with this Quarterly Report on Form 10-Q, RJR Tobacco is reporting market share information based on STR data, instead of information based on a sampling of retail cigarette sales, referred to as retail scan data. Management believes that STR data more accurately reflects marketplace performance across all channels of trade. All share information has been restated to reflect STR data. You should not rely on the STR data reported by MSAi as being a precise measurement of actual market share as the shipments to retail do not reflect actual consumer sales and do not track all volume and trade channels. Accordingly, the STR data for RJR Tobacco and its brands may overstate or understate their actual market share. Moreover, you should be aware that in a product market experiencing overall declining consumption, a particular product can experience increasing market share relative to competing products, yet still be subject to declining consumption volumes.

The comb ined share of market of RJR Tobacco’s growth brands during the second quarter of 2015 was stable compared with the same period in 2014. RJR Tobacco’s total cigarette market share was down slightly from the prior-year quarter, primarily driven by decreases in the company’s support and non-support brands, consistent with its strategy of focusing on growth brands.

Operating Income

RJR Tobacco’s operating income for the three-month period ended June 30, 2015, was favorably impacted by higher cigarette pricing, higher volume, the expiration in 2014 of the federal tobacco quota buyout and product mix, partially offset by inventory valuation costs associated with the Merger.

RJR Tobacco’s operating income for the six-month period ended June 30, 2015, was favorably impacted by higher cigarette pricing, higher volume, the expiration of the federal tobacco quota buyout in 2014 and the 2003 NPM Adjustment claim, partially offset by expenses associated with Engle Progeny litigation and other litigation and inventory valuation costs associated with the Merger .

RJR Tobacco’s expenses under the State Settlement Agreements, FDA user fees and federal tobacco quota buyout included in cost of products sold were:

Expenses under the State Settlement Agreements are expected to be approximately $2.3 billion in 2015, subject to adjustment for changes in volume and other factors. Pursuant to the Term Sheet, RJR Tobacco will receive credits with respect to its NPM Adjustment claims for the period from 2003 through 2012. These credits will be applied against annual payments under the MSA over a five-year period, which commenced with the April 2013 payment.

In June 2014, two additional states agreed to settle the NPM Adjustment disputes on similar terms as set forth in the Term Sheet, except for certain provisions related to the determination of credits to be received by the PMs. The credits related to these two states will be applied against annual payments under the MSA over a five-year period, which effectively commenced with the April 2014 MSA payment. As a result, expenses for the MSA were reduced by approximately $34 million for the three and six months ended June 30, 2014.

As a result of meeting the performance requirements associated with the Term Sheet, RJR Tobacco recognized credits of $68 million and $90 million for the three months ended June 30, 2015 and 2014, respectively; and $133 million and $152 million for the six months ended June 30, 2015 and 2014, respectively. RJR Tobacco expects to recognize additional credits through 2017.

On September 11, 2013, the Arbitration Panel ruled six states had not diligently enforced their qualifying statutes in 2003 related to the NPM Adjustment. Based on the status of the various challenges filed by the non-diligent states to certain rulings of the Arbitration Panel related to the 2003 NPM Adjustment claim, as of June 30, 2015, two of the non-diligent states are no longer challenging the findings of non-diligence entered against them by the Arbitration Panel. As a result, a certain portion of the NPM Adjustment claim for 2003 from these two states is now certain and can be estimated. Consequently, RJR Tobacco recognized $70 million as a reduction of cost of products sold for the six months ended June 30, 2015.

For additional information, see “— Cost of Products Sold” in note 1 and “— Litigation Affecting the Cigarette Industry — Health-Care Cost Recovery Cases — State Settlement Agreements” and “— State Settlement Agreements—Enforcement and Validity; Adjustments” in note 11 to condensed consolidated financial statements (unaudited).

Expenses for FDA user fees are expected to be approximately $160 million to $170 million in 2015. For additional information, see “—Governmental Activity” below.

Selling, general and administrative expenses include the costs of litigating and administering product liability claims, as well as other legal expenses. RJR Tobacco’s product liability defense costs were $43 million and $47 million for the three months ended June 30, 2015 and 2014, respectively, and $93 million and $93 million for the six months ended June 30, 2015 and 2014, respectively.

100



Ended June 30,

2015 2014 2015 2014


“Product liability” cases gen erally include the following types of smoking and health related cases:

“Product liability defense costs” include the following items:

Numerous factors affect 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, that is, with active discovery and motions practice. See “— Litigation Affecting the Cigarette Industry — Overview” in note 11 to condensed consolidated financial statements (unaudited) for detailed information regarding the number and type of cases pending, and “— Litigation Affecting the Cigarette Industry — Overview — Scheduled Trials” in note 11 to condensed consolidated financial statements (unaudited) for detailed information regarding the number and nature of cases in trial and scheduled for trial through June 30, 2016.

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 RJR Tobacco’s pending cases, including the number of cases in trial and scheduled for trial, particularly with respect to Engle Progeny cases, RJR Tobacco’s product liability defense costs continue to remain at a high level. See “— Litigation Affecting the Cigarette Industry — Engle and Engle Progeny Cases” in note 11 to condensed consolidated financial statements (unaudited) for additional information.

In addition, it is possible that other 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 consolidated results of operations, cash flows or financial position of RAI 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.

American Snuff

Net Sales

The moist snuff shipment volume, in millions of cans, for American Snuff was as follows:

101

● Individual Smoking and Health;

● West Virginia IPIC ;

● Engle Progeny;

● Broin II ;

● Class Actions;

● Filter Cases; and

● Health-Care Cost Recovery Claims.

● direct and indirect compensation, fees and related costs, and expenses for internal legal and related administrative staff administering the defense of product liability claims;

● fees and cost reimbursements paid to outside attorneys;

● direct and indirect payments to third party vendors for litigation support activities; and

● expert witness costs and fees.


2015 2014 %

Change 2015 2014 %

Change

GRIZZLY 117.2 109.4 7.1 % 224.3 215.8 3.9 % Other 11.3 11.8 (4.1 )% 21.7 22.3 (2.4 )%

Total American Snuff moist snuff shipment volume 128.5 121.2 6.0 % 246.0 238.1 3.3 %

American Snuff’s net sales for the three-month period ended June 30, 2015, increased compared with the same prior-year period primarily due to higher net pricing and higher moist snuff volume. American Snuff’s net sales for the six-month period ended June 30, 2015, increased compared with the same prior-year period primarily due to higher net pricing and higher moist snuff volume.

Market Share

Moist snuff has been the key driver to American Snuff’ s overall growth and profitability within the U.S. smokeless tobacco market. Moist snuff accounted for approximately 90% of American Snuff’s revenue for the three and six months ended June 30, 2015, compared with approximately 89% for the three and six months ended June 30, 2014. U.S. moist snuff industry retail shipment volume grew by approximately 3% in the second quarter of 2015 compared with the same period in 2014.

The shares of American Snuff’s moist snuff brands as a percentage of total share of U.S. moist snuff STR data according to MSAi (1) , were as follows:

GRIZZLY, the leading U.S. moist snuff brand, was up 1.3 share points in the second quarter of 2015, compared with the second quarter of 2014, led by growth in wintergreen styles and pouch offerings. In 2014, American Snuff expanded the distribution of GRIZZLY Wide Cut Wintergreen nationwide. The wider cut offers adult smokeless tobacco consumers a long-lasting wintergreen flavor and easy packing. To complement GRIZZLY’s range of product offerings and extend its market-leading position in wintergreen, the brand began expanding the GRIZZLY Dark Wintergreen style in early 2015. This style offers a differentiated and bolder wintergreen flavor, and is made from 100% American tobacco grown in Kentucky and Tennessee.

Operating Income

American Snuff’s operating income for the three-month period ended June 30, 2015, increased as compared with the prior-year period primarily due to higher net pricing and volume. American Snuff’s operating income for the six-month period ended June 30, 2015, increased as compared with the prior-year period primarily due to higher net pricing and volume.

Santa Fe

Net Sales

Domestic cigarette shipment volume, in billions of units for Santa Fe, was as follows:

Santa Fe’s net sales for the three- and six-month periods ended June 30, 2015, increased compared with the prior-year period, primarily due to higher volume and net pricing.

102


June 30,

2015 March 31,

2015 Share

Point Change June 30,

2014 Share

Point Change

GRIZZLY 31.1 % 30.2 % 0.9 29.8 % 1.3 Other 2.8 % 2.8 % — 3.0 % (0.2 )

Total American Snuff moist snuff share of retail shipments 33.8 % 33.0 % 0.8 32.8 % 1.1

(1) Beginning with this Quarterly Report on Form 10-Q, American Snuff is reporting market share information based on STR data, instead of information based on a sampling of retail moist snuff sales, referred to as retail scan data. Management believes that STR data more accurately reflects marketplace performance across all channels of trade. All share information has been restated to reflect STR data. You should not rely on the STR data reported by MSAi as being a precise measurement of actual market share as the shipments to retail do not reflect actual consumer sales and do not track all volume and trade channels. Accordingly, the STR data for American Snuff and its brands may overstate or understate their actual market share.


2015 2014 %

Change 2015 2014 %

Change

NATURAL AMERICAN SPIRIT 1.3 1.0 25.1 % 2.3 1.8 24.3 %

Market Share

The shares of Santa Fe’s NATURAL AMERICAN SPIRIT brand as a percentage of total share of U.S. cigarette STR data from MSAi (1) , were as follows:

Operating Income

Santa Fe’s operating income for the three- and six-month period ended June 30, 2015, increased as compared with the prior-year period primarily due to higher volume, net pricing and the expiration of the federal tobacco quota buyout in 2014.

Santa Fe’s expenses under the State Settlement Agreements, FDA user fees and federal tobacco quota buyout included in cost of products sold were:

Expenses under the MSA are expected to be approximately $130 million to $140 million in 2015, subject to adjustment for changes in volume and other factors. Pursuant to the Term Sheet, SFNTC will receive credits with respect to its NPM Adjustment claims for the period from 2003 through 2012. These credits will be applied against annual payments under the MSA over a four-year period, which commenced with the April 2013 payment.

In June 2014, two additional states agreed to settle the NPM Adjustment disputes on similar terms as set forth in the Term Sheet, except for certain provisions related to the determination of credits to be received by the PMs. SFNTC will receive credits, currently estimated to total approximately $1 million, with respect to its NPM Adjustment claims from 2003 through 2012. The credits related to these two states will be applied against annual payments under the MSA over a four-year period, which effectively commenced with the April 2014 MSA payment.

As a result of meeting the performance requirements associated with the Term Sheet, Santa Fe recognized credits of $1 million for each of the three months ended June 30, 2015 and 2014; and $2 million for each of the six months ended June 30, 2015 and 2014. Santa Fe expects to recognize additional credits through 2016.

For additional information, see “— Cost of Products Sold” in note 1 and “— Litigation Affecting the Cigarette Industry — Health-Care Cost Recovery Cases — State Settlement Agreements” and “— State Settlement Agreements—Enforcement and Validity; Adjustments” in note 11 to condensed consolidated financial statements (unaudited).

103


June 30,

2015 March 31,

2015 Share

Point Change June 30,

2014 Share

Point Change

NATURAL AMERICAN SPIRIT 1.8 % 1.7 % 0.1 1.5 % 0.3

(1) Beginning with this Quarterly Report on Form 10-Q, Santa Fe is reporting market share information based on STR data, instead of information based on a sampling of retail cigarette sales, referred to as retail scan data. Management believes that STR data more accurately reflects marketplace performance across all channels of trade. All share information has been restated to reflect STR data. You should not rely on the STR data reported by MSAi as being a precise measurement of actual market share as the shipments to retail do not reflect actual consumer sales and do not track all volume and trade channels. Accordingly, the STR data for Santa Fe and its brands may overstate or understate their actual market share. Moreover, you should be aware that in a product market experiencing overall declining consumption, a particular product can experience increasing market share relative to competing products, yet still be subject to declining consumption volumes.



Ended June 30,

2015 2014 2015 2014


All Other

RJR Vapor is the manufacturer and marketer of VUSE Digital Vapor Cigarette. The national expansion of VUSE began in 2014, and was completed in early 2015. VUSE is now the top-selling vapor product in convenience/gas stores, and its innovative digital technology is designed to deliver a consistent flavor and vapor experience.

Niconovum USA, Inc. was in lead markets in Iowa and Nebraska with ZONNIC, a nicotine replacement therapy gum, until September 2014, when it began its national expansion. ZONNIC is available in many retail outlets across the United States. Niconovum AB is a marketer of nicotine replacement therapy products in Sweden under the ZONNIC brand name.

SFRTI and various foreign subsidiaries affiliated with SFRTI distribute the NATURAL AMERICAN SPIRIT brand outside of the United States.

Gain on Divestiture

The gain is a result of the Divestiture of WINSTON, KOOL and SALEM, previously owned by RAI subsidiaries, as well as the cigarette brand MAVERICK and the “e-vapor” brand blu (including SKYCIG), previously owned by Lorillard subsidiaries, and other assets and certain liabilities. See note 2 for additional information on the Divestiture.

Corporate Expense

Corporate operating costs and expenses increased for the three and six months ended June 30, 2015, compared with the same period in 2014, primarily due to approximately $39 million and $54 million of transaction related costs associated with the Merger and Divestiture for the three and six months ended June 30, 2015, respectively.

RAI Consolidated

Interest and debt expense was $105 million and $196 million for the three and six months ended June 30, 2015, respectively, compared with $62 million and $121 million for the three and six months ended June 30, 2014, respectively. The change is primarily due to costs associated with the New Notes, issued to fund part of the Merger Consideration, and the Lorillard Tobacco Notes, assumed in connection with the Lorillard Tobacco Merger, as well as amortization of the fees incurred for the Bridge Facility that was not used to finance any part of the Merger Consideration. By its terms, the Bridge Facility terminated on June 12, 2015 and all associated fees have been fully amortized as of June 30, 2015.

Provision for income taxes was $2,311 million, for an effective rate of 54.5%, for the three months ended June 30, 2015, compared with $283 million, for an effective rate of 36.5%, for the three months ended June 30, 2014. The provision for income taxes was $2,542 million, for an effective tax rate of 52.3%, for the six months ended June 30, 2015, compared with $476 million, for an effective rate of 36.4%, for the six months ended June 30, 2014. The effective tax rate for the three and six months ended June 30, 2015, as compared with the same prior-year period, was unfavorably impacted by an increase in tax attributable to nondeductible acquisition costs, nondeductible goodwill in the amount of $1,849 million associated with the Divestiture and an increase in uncertain tax positions , partially offset by a decrease in tax attributable to the release of a valuation allowance in the amount of $37 million and a reduction in state income taxes. The effective tax rate for the three and six months ended June 30, 2014, was favorably impacted by a decrease in uncertain tax positions related to a federal audit settlement.

The effective tax rate for each period differed from the federal statutory rate of 35% due to the domestic manufacturing deduction of the American Jobs Creation Act of 2004, state income taxes and certain nondeductible items.

Income from discontinued operations, net of tax was $25 million for the six months ended June 30, 2014. The audit of the 2010 and 2011 tax years by the Internal Revenue Service was closed on February 27, 2014. A tax benefit of $25 million attributable to a decrease in uncertain tax positions was recorded in discontinued operations.

Liquidity and Financial Condition

Liquidity

The principal sources of liquidity for RAI’s operating subsidiaries’ businesses and operating needs are internally generated funds from their operations and intercompany loans and advances. The principal sources of liquidity for RAI, in turn, are proceeds from issuances of debt securities and the Credit Agreement described below under “— Borrowing Arrangements,” as well as intercompany dividends and distributions. Cash flows from operating activities are believed to be sufficient for the foreseeable future to enable the

104

operating subsidiaries to meet their obligations under the State Settlement Agreements, to fund their capital expenditures and to make payments to RAI that, when combined with RAI’s cash balances, proceeds from any financings and loans under the Credit Agreement, will enable RAI to make its required debt-service payments and to pay dividends to its shareholders.

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, accelerated declines in consumption, particularly from increases in regulation or excise taxes, or adverse impacts from financial markets, cannot be predicted. RAI also cannot predict its cash requirements or those of its subsidiaries related to any future settlements or judgments, including cash required to be held in escrow or to bond any appeals, if necessary, and RAI makes no assurance that it or its subsidiaries will be able to meet all of those requirements.

RAI’ s operating companies monitor the liquidity of key suppliers and customers, and where liquidity concerns are identified, appropriate contingency or response plans are developed. During 2015, no business interruptions have occurred due to key supplier liquidity, and no liquidity issues were identified involving significant suppliers or customers.

RAI’ s excess cash may be invested in money market funds, commercial paper, corporate debt securities, U.S. treasuries, U.S. and international government agencies and time deposits in major institutions to minimize risk. At present, RAI primarily invests cash in U.S. treasuries, corporate debt securities and U.S. government agencies.

As of June 30, 2015, RAI held investments primarily in auction rate securities and a mortgage-backed security totaling $90 million. Adverse changes in financial markets caused the auction rate securities and the mortgage-backed security to revalue lower than carrying value and become less liquid. The auction rate securities and mortgage-backed security will not become liquid until a successful auction occurs or a buyer is found. RAI intends, and has the ability, to hold these auction rate securities and mortgage-backed security for a period of time sufficient to allow for sale, redemption or anticipated recovery in fair value. For additional information on these investments, see note 3 to condensed consolidated financial statements (unaudited).

Cash Flows

Net cash flows from operating activities were $448 million in the first six months of 2015, compared with $255 million in the first six months of 2014. This change was driven primarily by higher net pricing and the expiration of the federal tobacco quota buyout in 2014, partially offset by the litigation payment related to the proposed federal Engle Progeny settlement in 2015.

Net cash flows used in investing activities were $10.2 billion in the first six months of 2015, compared with $112 million in the first six months of 2014. This change was primarily due to the Merger and Divestiture.

Net cash flows from financing activities were $12.8 billion in the first six months of 2015, compared with $329 million used in the first six months of 2014. This change was primarily due to the issuance of long-term debt to finance part of the Merger Consideration and proceeds from the issuance of common stock in the BAT Share Purchase.

Borrowing Arrangements and Long-Term Debt

RAI Notes

As of June 30, 2015, the principal amount of RAI’s outstanding notes was $14.1 billion, with maturity dates ranging from 2015 to 2045. RAI, at its option, may redeem any or all of its outstanding notes, in whole or in part at any time, subject to the payment of a make-whole premium. RAI’s outstanding notes include $9.0 billion aggregate principal amount of RAI senior notes that were issued on June 12, 2015, to fund part of the cash portion of the Merger Consideration. Interest on the notes is payable semi-annually. At June 30, 2015, RAI had $450 million of current maturities of long-term debt. See note 10 to the condensed consolidated financial statements (unaudited) for additional information.

105

RJR Tobacco Notes

As of June 30, 2015, the principal amount of RJR Tobacco’s outstanding notes was $3.5 billion, with maturity dates ranging from 2016 to 2041. Such notes represent the Lorillard Tobacco Notes, originally issued by Lorillard Tobacco, as to which RJR Tobacco became the principal obligor in connection with the closing of the Lorillard Tobacco Merger. The Lorillard Tobacco Notes were the subject of the Exchange Offers described below. Effective as of June 30, 2015, RAI and RJR were the guarantors of the Lorillard Tobacco Notes. Interest on the notes is payable semi-annually. See note 10 to the condensed consolidated financial statements (unaudited) for additional information relating to the RJR Tobacco Notes and see Part II, Item 5 for information relating to the RAI guaranty.

Exchange Offers

On June 11, 2015, RAI commenced offers to exchange any and all (to the extent held by eligible holders) of the $3.5 billion aggregate principal amount of the outstanding Lorillard Tobacco Notes for RAI senior notes. RAI completed the Exchange Offers on July 15, 2015. Approximately $3.1 billion, representing 89%, of the Lorillard Tobacco Notes were exchanged for RAI senior notes. The unexchanged $377 million aggregate principal amount of Lorillard Tobacco Notes will remain the principal obligations of RJR Tobacco. See note 10 to the condensed consolidated financial statements (unaudited) for additional information.

Credit Agreement

On December 18, 2014, RAI entered into the Credit Agreement with a syndicate of lenders, providing for a five-year $2 billion senior unsecured revolving credit facility, which may be increased to $2.35 billion at the discretion of the lenders upon the request of RAI. This agreement replaced RAI’s four-year $1.35 billion senior unsecured revolving credit facility dated October 8, 2013. Certain of RAI’s subsidiaries, including its Material Subsidiaries, as such term is defined in the Credit Agreement, have guaranteed, on an unsecured basis, RAI’s obligations under the Credit Agreement.

During the first six months of 2015, RAI borrowed and repaid $1.4 billion under the Credit Agreement at an average interest rate of 1.37% and used the proceeds for general corporate purposes of RAI and its subsidiaries, including making payments under the MSA and dividend payments. As of June 30, 2015, there were $8 million of letters of credit outstanding and no outstanding borrowings under the Credit Agreement.

Bridge Facility

On June 12, 2015, the Bridge Facility, in accordance with its terms, terminated.

Other

The lowering of RAI’s credit ratings, or concerns over such a lowering, could have an adverse impact on RAI’s ability to access the debt markets and could increase borrowing costs.

RAI and its affiliates were in compliance with all covenants and restrictions imposed by RAI’s indebtedness at June 30, 2015.

For additional information on the Borrowing Arrangements and Long-term Debt, see note 9 and note 10, respectively, to condensed consolidated financial statements (unaudited).

Stock Split

On July 27, 2015, RAI’s board of directors approved a two-for-one stock split of RAI’s common stock, in the form of a special 100 percent stock dividend, to be issued on August 31, 2015, to shareholders of record on August 17, 2015. Shareholders of record will receive one additional share of RAI common stock for each share owned. After the stock split, there will be approximately 1.4 billion shares outstanding of RAI common stock.

Dividends

On February 5, 2015 and May 7, 2015, RAI’s board of directors declared a quarterly cash dividend of $0.67 per common share. The dividends were paid on April 1, 2015 and July 1, 2015, to shareholders of record as of March 10, 2015 and June 10, 2015, respectively.

106

On July 27, 2015, RAI’s board of directors declared a quarterly cash dividend of $0.36 per common share, on a post-split basis. The dividend will be paid on October 1, 2015, to shareholders of record as of September 10, 2015.

On an annualized basis, the dividend rate is $1.44 per common share, on a post-split basis. The dividend reflects RAI’s current policy of paying dividends to the holders of RAI’s common stock in an aggregate amount that is approximately 75% of RAI’s annual consolidated net income.

Share Repurchases

During the first six months of 2015, at a cost of $40 million, RAI purchased 529,074 shares of RAI common stock that were forfeited and cancelled with respect to tax liabilities associated with restricted stock units vesting under the Omnibus Plan.

Share Issuance

On June 12, 2015, RAI issued 104,706,847 shares of common stock to Lorillard shareholders in the Merger as part of the Merger Consideration. In addition, BAT indirectly, through a wholly owned subsidiary, purchased 77,680,259 shares of RAI common stock for approximately $4.7 billion in the BAT Share Purchase, thereby maintaining the collective beneficial ownership of BAT and its subsidiaries in RAI at approximately 42%.

Capital Expenditures

RAI’ s operating subsidiaries recorded cash capital expenditures of $64 million and $123 million for the first six months of 2015 and 2014, respectively. RAI’s operating subsidiaries plan to spend an additional $170 million to $180 million for capital expenditures during the remainder of 2015, which includes ongoing investments to support production and distribution of VUSE and capital spending related to the Merger. Capital expenditures are funded primarily by cash flows from operations. RAI’s operating subsidiaries’ capital expenditure programs are expected to continue at a level sufficient to support their strategic and operating needs. There were no material long-term commitments for capital expenditures as of June 30, 2015.

Retirement Benefits

RAI disclosed in its financial statements for the year ended December 31, 2014, that it expects to contribute $109 million to its pension plans in 2015, of which $5 million was contributed during the first six months of 2015.

Litigation and Settlements

RJR Tobacco, Lorillard Tobacco, American Snuff Co., or their affiliates, including RAI, RJR and Lorillard or indemnitees, including B&W, 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. For further discussion of specific cases, see note 11 to condensed consolidated financial statements (unaudited). Unfavorable judgments have been returned in a number of tobacco-related cases and state enforcement actions. As of June 30, 2015, RJR Tobacco had paid approximately $124 million since January 1, 2013, related to unfavorable smoking and health litigation judgments.

RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2015 contains accruals for the following Engle Progeny cases: Hiott , Starr-Blundell , Clayton , Ward , Hallgren , Cohen , Sikes , Thibault , Buonomo , Mrozek and Tullo ; as well as payments for attorneys’ fees and statutory interest for Koballa , Webb , and Brown , the judgments of which were paid in 2014. Other accruals include an amount for the estimated costs of the corrective communications in the U.S. Department of Justice case and RJR Tobacco’s and Lorillard Tobacco’s share of the proposed federal Engle Progeny settlement. Also, RJR Tobacco paid the amount agreed to by RJR Tobacco and the State of Mississippi to resolve claims that were brought, could have been brought, or could be brought against RJR Tobacco, B&W or Lorillard Tobacco in the enforcement actions filed in the Mississippi Chancery Court. For additional information related to litigation, see note 11 to condensed consolidated financial statements (unaudited).

Litigation is subject to many uncertainties, and generally it is not possible to predict the outcome of the litigation pending against RJR Tobacco, Lorillard Tobacco, American Snuff Co., or their affiliates or indemnitees, or to reasonably estimate the amount or range of any possible loss, except for the cases noted above. Moreover, notwithstanding the quality of defenses available to RJR Tobacco, Lorillard Tobacco, and their affiliates and indemnitees in tobacco-related litigation matters, it is possible that RAI’s consolidated results of operations, cash flows or financial position could be materially adversely affected by the ultimate outcome of certain pending or future litigation matters or difficulties in obtaining the bonds required to stay execution of judgments on appeal.

107

In 1998, RJR Tobacco, Lorillard Tobacco, B&W and the other major U.S. cigarette manufacturers entered into the MSA with attorneys general representing most U.S. states, territories and possessions. The State Settlement Agreements impose a perpetual stream of future payment obligations on RJR Tobacco and the other major U.S. cigarette manufacturers, and place significant restrictions on their ability to market and sell cigarettes in the future. For additional information related to historical and expected settlement expenses and payments under the State Settlement Agreements, see “— Litigation Affecting the Cigarette Industry —State Settlement Agreements—Enforcement and Validity; Adjustments” in note 11 to condensed consolidated financial statements (unaudited). The State Settlement Agreements have materially adversely affected RJR Tobacco’s shipment volumes. RAI believes that these settlement obligations may materially adversely affect the results of operations, cash flows or financial position of RAI and RJR Tobacco in future periods.

RJR Tobacco and certain of the other PMs under the MSA are currently involved in arbitration with certain of the settling states with respect to the NPM adjustment, for the market year 2003. RJR Tobacco and Lorillard Tobacco disputed a total of $5.6 billion and $1.2 billion, respectively, for the years 2003 through 2014. This amount does not include interest or earnings and does not reflect any reduction as a result of the Term Sheet described below.

In 2012, RJR Tobacco, Lorillard Tobacco certain other PMs, including SFNTC, and certain settling states entered into a Term Sheet that sets forth the terms on which accrued and potential NPM Adjustment claims for 2003 through 2012 could be resolved. The Term Sheet also sets forth a restructured NPM Adjustment process to be applied on a going-forward basis, starting with the 2013 volume year.

Based on the jurisdictions bound by the Term Sheet through December 31, 2013, RJR Tobacco and SFNTC, collectively, will receive credits, currently estimated to total approximately $1.1 billion, with respect to their NPM Adjustment claims for the period from 2003 to 2012. These credits will be applied against annual payments under the MSA over a five-year period, which commenced with the April 2013 MSA payment. As a result of the Lorillard Tobacco Merger, RJR Tobacco will receive approximately $22 million of additional credits, attributable to Lorillard Tobacco, which will be applied against annual payments in 2016 and 2017.

In June 2014, two additional states agreed to settle the NPM Adjustment disputes on similar terms as set forth in the Term Sheet, except for certain provisions related to the determination of credits to be received by the PMs. RJR Tobacco and SFNTC, collectively, will receive credits, currently estimated to total approximately $170 million, with respect to their NPM Adjustment claims from 2003 through 2012. The credits related to these two states will be applied against annual payments under the MSA over a five-year period, which effectively commenced with the April 2014 MSA payment. As a result of the Lorillard Tobacco Merger, RJR Tobacco will receive approximately $5 million of additional credits, attributable to Lorillard Tobacco, which will be applied against annual payments over the next three years

On September 11, 2013, the Arbitration Panel ruled six states had not diligently enforced their qualifying statutes in 2003 related to the NPM Adjustment. Based on the status of the various challenges filed by the non-diligent states to certain rulings of the Arbitration Panel related to the 2003 NPM Adjustment claim, as of June 30, 2015, two of the non-diligent states are no longer challenging the findings of non-diligence entered against them by the Arbitration Panel. As a result, a certain portion of the NPM Adjustment claim for 2003 from these two states is now certain and can be estimated. Consequently, RJR Tobacco and Santa Fe, collectively, recognized $70 million as a reduction of cost of products sold for the six months ended June 30, 2015.

For additional information related to this litigation and its potential resolution, see “— Cost of Products Sold” in note 1 and “— Litigation Affecting the Cigarette Industry — State Settlement Agreements—Enforcement and Validity; Adjustments”, in note 11 to condensed consolidated financial statements (unaudited).

Governmental Activity

The marketing, sale, taxation and use of tobacco products 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:

108

● significantly increase their taxes on all tobacco products;

● restrict displays, advertising and sampling of tobacco products;

● raise the minimum age to possess or purchase tobacco products;

● restrict or ban the use of menthol in cigarettes or prohibit mint or wintergreen as a flavor in smokeless tobacco products and vapor products;

● require the disclosure of ingredients used in the manufacture of tobacco products;

Together with manufacturers’ price increases in recent years and substantial increases in state and federal taxes on tobacco products, and the granting to the FDA of broad authority over the manufacture, sale, marketing and packaging of tobacco products, these developments have had and will likely continue to have an adverse effect on the sale of tobacco products. Products that are alternatives to traditional tobacco products also have become subject to increasing regulation. For example, in addition to the anticipated regulation by the FDA of e-cigarettes, as described below, various states have adopted, or are considering adoption of, taxes on e-cigarettes as well as restrictions on the promotion and distribution of e-cigarettes.

Cigarettes and other tobacco products are subject to substantial taxes in the United States. As a result of a 2009 law which increased taxes on cigarettes and other tobacco products:

Currently, there is no federal tax on vapor products, such as e-cigarettes.

On March 4, 2014, President Obama released a budget in which he proposed increasing the federal excise tax: on a pack of cigarettes from $1.01 to $1.95; for snuff from $1.51 per pound to $2.93 per pound; and for chewing tobacco from $0.5033 per pound to $0.98 per pound. These proposed tax increases would fund a new initiative for pre-kindergarten education for lower-income children. While the proposal was not acted upon by Congress during 2014, RAI’s management believes that such tax increases would have an adverse impact on the sale of tobacco products by RAI’s operating companies and could have a material adverse effect on the results of operations, cash flows or financial position of RAI, including impairment of the value of its operating subsidiaries’ trademarks.

The 2009 federal excise tax increase on tobacco products increased taxes on ready-made cigarettes, such as those made by RJR Tobacco and SFNTC, at a much higher rate than taxes on loose tobacco. As a result of that tax disparity, the number of retailers selling loose tobacco and operating roll-your-own machines, allowing consumers to convert the loose tobacco into finished cigarettes, greatly increased following the 2009 federal tax hike on tobacco products. On July 6, 2012, President Obama signed into law a provision classifying retailers which operate roll-your-own machines as cigarette manufacturers, and thus requiring those retailers to pay the same tax rate as other cigarette manufacturers. As of June 30, 2015, 26 states also had passed legislation classifying retailers operating roll-your-own machines as cigarette manufacturers.

All states and the District of Columbia currently impose cigarette excise taxes at levels ranging from $0.17 per pack in Missouri to $4.35 per pack in New York. As of December 31, 2014 and June 30, 2015, the weighted average state cigarette excise tax per pack, calculated on a 12-month rolling average basis, was approximately $1.29. Certain city and county governments, such as New York, Philadelphia and Chicago, also impose substantial excise taxes on cigarettes sold in those jurisdictions. During the first half of 2015, 27 states proposed legislation to increase cigarette excise taxes, with legislation being enacted in 7 states, failing in 15 states and remaining pending, as of June 30, 2015, in 5 states.

Six states now require NPMs to pay a fee on each pack of cigarettes sold in their respective states, ranging from $0.25 per pack in Alaska to $0.55 per pack in Texas.

The Texas NPM fee has been challenged by a coalition of small tobacco manufacturers. This group asserts that the Texas fee violates the Texas Constitution’s “Equal and Uniform” Clause, as well as the Equal Protection and Due Process Clauses of the U.S. Constitution. On November 15, 2013, a state trial court in Texas declared the NPM fee unconstitutional and enjoined the state from “assessing, collecting, and enforcing” the fee. The State of Texas appealed the court’s order. In doing so, enforcement of the trial court’s order, including the injunction, is suspended. The coalition filed a motion for a “hardship exemption” from payment of the fee during the pendency of the state’s appeal. The coalition’s motion was denied on February 12, 2014, with the trial court concluding that it lacked jurisdiction to consider the motion on the merits in light of the state’s appeal of the court’s earlier ruling. Oral argument on the state’s appeal took place before the Court of Appeals for the Third District on July 16, 2014. On August 15, 2014, the three-judge panel unanimously affirmed the ruling. The State of Texas filed its petition for review with the Texas Supreme Court on October 29, 2014. On December 5, 2014, the Texas Supreme Court requested the coalition of small manufacturers to file a response to the petition for review. The response was filed on February 4, 2015. On March 13, 2015, the Texas Supreme Court requested full merits briefing on the appeal and that briefing is now underway.

Forty-nine states and the District of Columbia also subject smokeless tobacco products to excise taxes. The Commonwealth of Pennsylvania is considering such a tax during its 2015 legislative session, but no decision has been reached. As of June 30, 2015:

109

● require the disclosure of ni cotine yield information for cigarettes;

● impose restrictions on smoking and vaping in public and private areas; and

● restrict the sale of tobacco products directly to consumers or other unlicensed recipients, including by mail or over the Internet.

● the federal excise tax per pack of 20 cigarettes is $1.01; and

● the federal excise tax rate for chewing tobacco is $0.5033 per pound, and for snuff is $1.51 per pound.

During the first half of 2015, 23 states proposed legislation to increase excise taxes on smokeless tobacco products, with legislation being enacted in one state, failing in 12 states and remaining pending, as of June 30, 2015, in 10 states.

As of June 30, 2015, four states had enacted a tax on vapor products, such as e-cigarettes, including Minnesota, which taxes vapor products at the same rate as it taxes smokeless tobacco products, and North Carolina, which taxes vapor products at the rate of $0.05 per fluid milliliter. Further, during the first half of 2015, 29 states proposed taxes on vapor products, including, in some cases, implementing a tax on a per fluid milliliter basis, taxing vapor products on the same basis as “other tobacco products” and, in other cases, taxing vapor products at a rate equivalent to cigarette excise taxes. During the first half of 2015, two of those states enacted taxes on vapor products: Kansas (which will tax such products at a rate of $0.20 per fluid milliliter, effective July 1, 2016) and Louisiana (which will tax such products at a rate of $0.05 per fluid milliliter, effective August 1, 2015). In the remaining states that during the first six months of 2015 had proposed taxes on vapor products, such legislation failed in 20 states and, as of June 30, 2015, remained pending in seven states.

In 2009, President Obama signed into law the FDA Tobacco Act, which grants the FDA broad authority over the manufacture, sale, marketing and packaging of tobacco products. Pursuant to the FDA Tobacco Act:

110

● 26 states taxed moist snuff on an ad valorem basis, at rates ranging from 5% in South Carolina to 210% in Massachusetts;

● 21 states and the District of Columbia had weight-based taxes on moist snuff, ranging from $0.02 for cans weighing between 5 / 8 of an ounce and 1 5 / 8 ounces in Alabama to $2.02 per ounce in Maine; and

● Two states imposed a unit tax on moist snuff: Kentucky with a tax of $0.19 per unit, and Washington, with a tax of $2.526 per unit for units weighing 1.2 ounces or less and a proportionate amount above that weight. In addition, Minnesota imposed a tax on moist snuff at a rate equal to the greater of (1) 95% of the wholesale price and (2) generally, the tax equal to the rate imposed on a pack of 20 cigarettes.

● charitable distributions of tobacco products are prohibited;

● statements that would lead consumers to believe that a tobacco product is approved, endorsed, or deemed safe by the FDA are prohibited;

● pre-market approval by the FDA is required for claims made with respect to reduced risk or reduced exposure products;

● the marketing of tobacco products in conjunction with any other class of product regulated by the FDA is prohibited;

● tobacco manufacturers are banned from selling cigarettes with characterizing flavors (other than menthol, which under the FDA Tobacco Act is specifically exempt as a characterizing flavor, but the impact of which on public health will be studied as discussed below);

● all manufacturers are required to register with the FDA their domestic manufacturing facilities as well as all cigarette and smokeless tobacco products sold in the United States;

● the FDA reissued regulations addressing advertising and marketing restrictions that were originally promulgated in 1996 (including, among other restrictions, prohibitions on: the sale of cigarettes and smokeless tobacco products to persons under the age of 18; the sale of packages of cigarettes with less than 20 cigarettes; the distribution of free samples of cigarettes; and brand name sponsorship of any athletic, musical or other social/cultural events);

● manufacturers were required to produce health-related documents generated from and after June 22, 2009 through December 31, 2009 (the FDA has interpreted the FDA Tobacco Act as establishing an ongoing requirement to submit health-related documents; however, the FDA has not yet established a timetable for further production);

● manufacturers are required to make by-brand ingredient submissions, place different and larger warnings on packaging and advertising for smokeless tobacco products and eliminate the use of descriptors on tobacco products, such as “ low-tar” and “ lights” ;

● the FDA issued a final regulation for the imposition of larger, graphic health warnings on cigarette packaging and advertising, which was scheduled to take effect September 22, 2012, but the FDA is currently enjoined from enforcing such regulation;

● as described in greater detail below, new or modified products introduced in the market after February 15, 2007 are subject to certain FDA clearance requirements;

● the FDA announced that it would inspect every domestic establishment that manufactured cigarettes, cigarette tobacco, roll-your-own tobacco or smokeless tobacco products once in a two-year cycle, beginning October 1, 2011; and

● in April 2012, the FDA issued draft guidance on: (1) the reporting of harmful and potentially harmful constituents in tobacco products and tobacco smoke pursuant to Section 904(a)(3) of the FDA Tobacco Act, and (2) preparing and submitting applications for modified risk tobacco products pursuant to Section 911 of the FDA Tobacco Act.

On a going forward basis, various provisions under the FDA Tobacco Act and regulations to be issued under the FDA Tobacco Act will become effective and will:

The U.S. Congress did limit the FDA’s authority in two areas, prohibiting it from:

In 2009, a “Center for Tobacco Products,” referred to as the CTP, was established within the FDA, funded through quarterly user fees that will be assessed against tobacco product manufacturers and importers based on market share. The total amount of user fees to be collected over the first ten years will be approximately $5.4 billion.

Within the CTP, a Tobacco Products Scientific Advisory Committee, referred to as the TPSAC, was established on March 22, 2010, to provide advice, information and recommendations with respect to the safety, dependence or health issues related to tobacco products. The TPSAC is scheduled to meet periodically to address matters brought to it by the Center as well as those required of it by the Act, including:

At a meeting held on March 18, 2011, the TPSAC presented its final report on the use of menthol, which concluded that removal of menthol cigarettes from the marketplace would benefit public health in the United States. On July 24, 2013, the FDA issued a report detailing its own preliminary scientific evaluation of public health issues related to the use of menthol in cigarettes, including a determination that there is likely a public health impact of menthol in cigarettes. The FDA’s report found that the weight of the evidence supports the conclusion that menthol in cigarettes is associated with:

The report found that menthol in cigarettes is not associated with:

The FDA concurrently published in the Federal Register an Advance Notice of Proposed Rulemaking, referred to as the ANPRM, to obtain information related to the potential regulation of menthol in cigarettes. The ANPRM sought comments from interested stakeholders on the FDA’s preliminary evaluation, as well as any data, research or other information on various topics, including, but not limited to:

111

● require manufacturers to test ingredients and constituents identified by the FDA and disclose this information to the public;

● prohibit use of tobacco containing a pesticide chemical residue at a level greater than allowed under Federal law;

● establish “good manufacturing practices” to be followed at tobacco manufacturing facilities;

● authorize the FDA to place more severe restrictions on the advertising, marketing and sale of tobacco products;

● permit inconsistent state regulation of labeling and advertising and eliminate the existing federal preemption of such regulation;

● authorize the FDA to require the reduction of nicotine and the reduction or elimination of other constituents; and

● grant the FDA the regulatory authority to impose broad additional restrictions.

● banning all tobacco products; and

● requiring the reduction of nicotine yields of a tobacco product to zero.

● a recommendation on modified risk applications;

● a recommendation as to whether there is a threshold level below which nicotine yields do not produce dependence;

● a report on the impact of the use of menthol in cigarettes on the public health; and

● a report on the impact of dissolvable tobacco products on the public health.

● increased initiation among youth and young adults;

● reduced success in smoking cessation; and

● increased dependence.

● increased smoke toxicity;

● increased levels of biomarkers of exposure; or

● increased disease risk.

● potential product standards for menthol and the potential period for compliance with such standards;

● potential restrictions on the sale and/or distribution of menthol products; and

In November 2013, RAI’s operating companies submitted comments on the ANPRM. The FDA will evaluate all comments it has received from interested stakeholders in response to the ANPRM, as the agency considers whether to require additional standards or restrictions with respect to menthol cigarettes. The FDA Tobacco Act does not require the FDA to adopt any such standards or restrictions. Any rule that the FDA may propose will be subject to a 60-day comment period, and may only become effective at least one year after the rule’s adoption.

On February 25, 2011, RJR Tobacco, Lorillard, Inc. and Lorillard Tobacco Company jointly filed in the U.S. District Court for the District of Columbia a lawsuit, Lorillard, Inc. v. U.S. Food and Drug Administration , challenging the composition of the TPSAC. On July 21, 2014, the District Court granted, in part, the plaintiffs’ motion for summary judgment, ordering the FDA to reconstitute the TPSAC and barring the agency from relying on the March 2011 TPSAC report on menthol. For additional information concerning this case, see “— Litigation Affecting the Cigarette Industry —Other Litigation and Developments — FDA Litigation” in note 11 to condensed consolidated financial statements (unaudited).

At a meeting on March 1, 2012, the TPSAC presented to the FDA its final report and recommendations with respect to dissolvable tobacco products. The FDA will consider the report and recommendations and determine what future action, if any, is warranted with respect to dissolvable tobacco products. There is no timeline or statutory requirement for the FDA to act on the TPSAC’s recommendations.

On April 25, 2014, the FDA issued a proposed deeming regulation that would extend the agency’s authority under the FDA Tobacco Act to other tobacco products not currently regulated by the agency, such as e-cigarettes, cigars, pipe tobacco and hookah. The deeming regulation, as proposed, would, among other things:

The proposed deeming regulation was open for public comment from all interested parties through August 8, 2014. RAI’s operating companies submitted comments on the proposed rule. The FDA will evaluate all comments it has received from the various stakeholders in preparation for issuance of a final rule, expected in 2015.

On April 14, 2015, RJR Tobacco, American Snuff Co., SFNTC and other tobacco companies jointly filed a lawsuit in the U.S. District Court for the District of Columbia, challenging the FDA’s March 4, 2015, “guidance” document regarding demonstrating substantial equivalence of a new tobacco product. For additional information concerning this case, see “— Litigation Affecting the Cigarette Industry — Other Litigation and Developments — FDA Litigation” in note 11 to condensed consolidated financial statements (unaudited).

It is likely that the FDA Tobacco Act could result in a decrease in cigarette and smokeless tobacco product sales in the United States, including sales of RJR Tobacco’s, American Snuff Co.’s and SFNTC’s brands, that, together with increased costs incurred by RAI’s operating companies arising from the FDA Tobacco Act, could have a material adverse effect on RAI’s financial condition, results of operations and cash flows. RAI’s strategy of focusing on innovation to help transform the tobacco industry is dependent on its operating companies’ ability to introduce new products into the market. For a manufacturer to launch a new product or modify an existing one after March 22, 2011, the FDA Tobacco Act requires a manufacturer to file one of three types of product applications (a new product application, a substantial equivalence application or a substantial equivalence exemption application) with the CTP, depending on the type and level of change being sought. In all cases, however, the manufacturer may not market the new or modified product in the United States until the CTP issues a marketing order, allowing the product to be marketed. Similarly, a manufacturer that introduced a new tobacco product or modified a tobacco product between February 15, 2007 and March 22, 2011, had to file a substantial equivalence report with the CTP, demonstrating either (1) that the new or modified product had the same characteristics as a product commercially available as of February 15, 2007, referred to as a predicate product, or (2) if the new or modified product had different characteristics than the predicate product, that it did not raise different questions of public health. A product subject to such report is referred to as a provisional product. A manufacturer may continue to market a provisional product unless and until the CTP issues an order that the provisional product is not substantially equivalent, in which case the FDA could then require the manufacturer

112

● evidence regarding illicit trade in menthol cigarettes (including the public health impact thereof) should the use of menthol in cigarettes be restricted or banned.

● establish minimum age and identification restrictions to prevent underage sales;

● require specific health warnings;

● require registration with the FDA and reporting of product and ingredient listings;

● prohibit distribution of free samples of the newly deemed products;

● prohibit most vending machine sales; and

● require FDA review to market new tobacco products introduced after the proposed grandfathered date of February 15, 2007.

to remove the provisional product from the market. While the FDA Tobacco Act has now been in effect six years and the review of substantial equivalence reports has been in progress for nearly five years, uncertai nty remains as to the timing of the review and the requirements for clearance. These uncertainties, in conjunction with the clearance requirement itself, could further adversely impact the ability of RAI’s operating companies to innovate in the future wh ich, in turn, could have an adverse impact on the results of operations, cash flows and financial position of RAI and its operating companies.

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, SFNTC or the cigarette industry in general, but any new legislation or regulations could have an adverse effect on RJR Tobacco, SFNTC or the cigarette industry in general. Similarly, it is not possible to determine what additional federal, state or local legislation or regulations relating to smokeless tobacco products will be enacted or to predict the effect of new regulations on American Snuff Co. or smokeless tobacco products in general, but any new legislation or regulations could have an adverse effect on American Snuff Co. or smokeless tobacco products in general.

Other Contingencies

For information relating to other contingencies of RAI, RJR, RJR Tobacco, American Snuff Co. and SFNTC, see “— Other Contingencies” in note 11 to condensed consolidated financial statements (unaudited).

Off-Balance Sheet Arrangements

RAI has no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on its financial position, results of operations, liquidity, capital expenditures or capital resources.

Cautionary Information Regarding Forward-Looking St atements

Statements included in this report 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. When used in this document and in documents incorporated by reference, forward-looking statements include, without limitation, statements regarding financial forecasts or projections, and RAI’s and its subsidiaries’ expectations, beliefs, intentions or future strategies that may be signified by the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “objective,” “outlook,”“plan,” “project,” “possible,” “potential,” “should” and similar expressions. These statements regarding future events or the future performance or results of RAI and its subsidiaries inherently are subject to a variety of risks, contingencies and other uncertainties that could cause actual results, performance or achievements to differ materially from those described in or implied by the forward-looking statements. These risks, contingencies and other uncertainties include:

113

● the information appearing under the caption “Risk Factors” included in RAI’s most recent annual report on Form 10-K and in any updates to the risk factors in any quarterly or other report RAI files subsequently to such annual report;

● the substantial and increasing taxation and regulation of tobacco products, including the regulation of tobacco products by the FDA;

● the effect of adverse governmental developments on RAI’s subsidiaries’ sales of products that contain menthol, including the possibility that the FDA will issue regulations prohibiting menthol, or restricting the use of menthol, in cigarettes;

● the possibility that the FDA will require the reduction of nicotine levels or the reduction or elimination of other constituents in cigarettes;

● the possibility that the FDA will issue regulations extending the FDA’s authority over tobacco products to e-cigarettes, subjecting e-cigarettes to restrictions on, among other things, the manufacturing, marketing and sale of such products;

● decreased sales resulting from the future issuance of “corrective communications,” required by the order in the U.S. Department of Justice case on five subjects, including smoking and health, and addiction;

● various legal actions, proceedings and claims relating to the sale, distribution, manufacture, development, advertising, marketing and claimed health effects of tobacco products that are pending or may be instituted against RAI or its subsidiaries;

● the possibility that reports from the U.S. Surgeon General regarding the negative health consequences associated with cigarette smoking and second-hand smoke may result in additional litigation and/or regulation;

● the possibility of being required to pay various adverse judgments in the Engle Progeny cases and/or other litigation;

● the substantial payment obligations with respect to cigarette sales, and the substantial limitations on the advertising and marketing of cigarettes (and of RJR Tobacco’s smoke-free tobacco products) under the State Settlement Agreements;

114

● the possibility that the Arbitration Panel’s Award reflecting the partial resolution of the NPM Adjustment disputes will be vacated or otherwise modified ;

● the possibility that the Arbitration Panel’s Final Award with respect to certain of the states found to be non-diligent in connection with the 2003 NPM Adjustment will be vacated or otherwise modified;

● the continuing decline in volume in the U.S. cigarette industry and RAI’s and its subsidiaries’ dependence on the U.S. cigarette industry and premium and super-premium brands;

● concentration of a material amount of sales with a limited number of customers and potential loss of these customers;

● competition from other manufacturers, including those resulting from industry consolidations or any new entrants in the marketplace;

● increased promotional activities by competitors, including manufacturers of deep-discount cigarette brands;

● the success or failure of new product innovations, including the digital vapor cigarette, VUSE;

● the success or failure of acquisitions or dispositions, which RAI or its subsidiaries may engage in from time to time, including the Merger and the Divestiture;

● the responsiveness of both the trade and consumers to new products, marketing strategies and promotional programs;

● the reliance on outside suppliers to manage certain non-core business processes;

● the reliance on a limited number of suppliers for certain raw materials;

● the cost of tobacco leaf, and other raw materials and commodities used in products;

● the passage of new federal or state legislation or regulations;

● the effect of market conditions on interest rate risk, foreign currency exchange rate risk and the return on corporate cash, or adverse changes in liquidity in the financial markets;

● the impairment of goodwill and other intangible assets, including trademarks;

● the effect of market conditions on the performance of pension assets or any adverse effects of any new legislation or regulations changing pension and postretirement benefits accounting or required pension funding levels;

● the substantial amount of RAI debt, including the additional debt incurred and assumed in connection with the Merger;

● the possibility of decreases in the credit ratings assigned to RAI, and to the senior unsecured long-term debt of RAI;

● the possibility of changes in RAI’s historical dividend policy;

● the restrictive covenants imposed under RAI’s debt agreements;

● the possibility of natural or man-made disasters or other disruptions, including disruptions in information technology systems or security breaches, that may adversely affect manufacturing or other operations and other facilities or data;

● the loss of key personnel or difficulties recruiting and retaining qualified personnel;

● the inability to adequately protect intellectual property rights;

● the significant ownership interest in RAI of BAT and its subsidiaries, collectively RAI’s largest beneficial owner, and their rights under the governance agreement among the companies;

● the potential consequences due to the expiration of the standstill provisions of the governance agreement, and the expiration of RAI’s shareholder rights plan, on July 30, 2014;

● a termination of the governance agreement or certain of its provisions in accordance with its terms, including the limitations on B&W’s representation on the RAI board of directors and its committees;

● the potential for increased competition between RAI and BAT and their respective subsidiaries due to the expiration of the non-competition agreement between RAI and BAT on July 30, 2014; and

● additional risks, contingencies and uncertainties associated with the Merger and Divestiture that could result in an adverse effect on the results of operations, cash flows and financial position of RAI and its subsidiaries and/or the failure to realize any anticipated benefits of the Merger and Divestiture to RAI shareholders, including:

o the effect of the Merger and Divestiture on the ability to maintain business relationships, and on operating results and businesses generally;

Due to these risks, contingencies and other uncertainties, 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, RAI is not required to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk represents the risk of loss that may impact the consolidated results of operations, cash flows and financial position due to adverse changes in financial market prices and rates. RAI and its subsidiaries are exposed to interest rate risk directly related to their normal investing and funding activities. In addition, RAI and its subsidiaries have immaterial exposure to foreign currency exchange rate risk related primarily to purchases or foreign operations denominated in euros, British pounds, Canadian dollars, Swiss francs, Swedish krona, Chinese renminbi and Japanese yen. RAI and its subsidiaries have established policies and procedures to manage their exposure to market risks.

The table below provides information, as of June 30, 2015, about RAI’s financial instruments that are sensitive to changes in interest rates. The table presents notional amounts and weighted average interest rates by contractual maturity dates for the years ending December 31:

RAI’ s exposure to foreign currency transactions was not material to its results of operations for the six months ended June 30, 2015, but may become material in future periods in relation to activity associated with RAI’s international operations. RAI currently has no hedges for its exposure to foreign currency. Item 4. Controls and Procedures

115

o the reliance of RJR Tobacco on Imperial Sub to manufacture Newport on RJR Tobacco’s behalf for a period of time after the Merger and Divestiture ;

o RAI’s obligations to indemnify Imperial Sub for specified matters and to retain certain liabilities related to the transferred assets;

o the failure to realize projected synergies and other benefits from the Merger and Divestiture; and

o the incurrence of significant post-transaction related costs in connection with the Merger and Divestiture.

2015 2016 2017 2018 2019 Thereafter Total Fair

Value (1) Investments:

Variable-rate $ 3,859 $ 11 $ 72 $ — $ — $ — $ 3,942 $ 3,942 Average interest rate 0.1 % 0.5 % 2.4 % — — — 0.1 % — Fixed-rate $ 203 $ 218 $ 54 $ 4 $ — $ 7 $ 486 $ 486 Average interest rate (2) 1.4 % 1.4 % 1.3 % 1.1 % — 4.7 % 1.5 % —

Debt: Variable-rate (3) $ — $ — $ — $ — $ 750 $ — $ 750 $ 888 Average interest rate — — — — 4.8 % — 4.8 % — Fixed-rate $ 450 $ 500 $ 1,200 $ 1,500 $ — $ 13,150 $ 16,800 $ 17,378 Average interest rate (2) 1.1 % 3.5 % 4.9 % 3.2 % — 5.0 % 4.6 % —

(1) Fair values are based on current market rates available or on rates available for instruments with similar terms and maturities and quoted fair values.

(2) Based upon coupon interest rates for fixed-rate instruments. (3) Fixed to floating rate swaps acquired in the Merger.

(a) RAI’s chief executive officer and chief financial officer have concluded that RAI’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 changes in RAI’s internal controls over financial reporting that occurred during the first six months of 2015 that have materially affected, or are reasonably likely to materially affect, RAI’s internal controls over financial reporting.

PA RT II-Other Information

Item 1. Legal Proceedings

For a discussion of the litigation and legal proceedings pending against RJR Tobacco, Lorillard Tobacco, American Snuff Co. or their affiliates, including RAI or RJR, or indemnitees, including B&W, see note 11 to condensed consolidated financial statements (unaudited) and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates — Litigation” included in Part I, Item 2. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

RAI conducts its business through its subsidiaries and is dependent on the earnings and cash flows of its subsidiaries to satisfy its obligations and other cash needs. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Financial Condition” in Part I, Item 2. RAI does not believe that the provisions of its Credit Agreement and notes (and the associated guarantees of the foregoing) will impair its payment of quarterly dividends. Item 5. Other Information

(a) RAI reports here the following information pursuant to Items 1.01, 2.03 and 3.03 of Form 8-K in lieu of filing a Form 8-K reporting such information.

Pursuant to (1) the Eighth Supplemental Indenture, dated August 6, 2015, referred to as the Eighth Supplemental Indenture, among RAI, RJR Tobacco, RJR and The Bank of New York Mellon Trust Company, N.A., referred to as the Trustee, to the Lorillard Tobacco Indenture, and (2) a Guarantee Agreement, dated August 6, 2015, of RAI, referred to as the RAI Guarantee, on August 6, 2015, RAI fully and unconditionally guaranteed, effective as of June 30, 2015, the obligations of the principal obligor (RJR Tobacco) with respect to the following series of Lorillard Tobacco Notes:

116

Series of Lorillard Tobacco Notes Current Outstanding Principal

Amount (1)

2.300% notes due 2017 $ 53 3.500% notes due 2016 85 3.750% notes due 2023 26 6.875% notes due 2020 109 7.000% notes due 2041 10 8.125% notes due 2019 81 8.125% notes due 2040 13

Total: $ 377

As a result of the Lorillard Tobacco Merger, RJR Tobacco became the new principal obligor with respect to the Lorillard Tobacco Notes, and RJR succeeded to Lorillard as the guarantor of the Lorillard Tobacco Notes. RJR remains a guarantor of the Lorillard Tobacco Notes following RAI’s guarantee of such notes.

The Trustee or its affiliates have engaged in, and may in the future engage in, commercial or investment banking, corporate trust or other commercial dealings in the ordinary course of business with RAI or its affiliates. They have received, or may in the future receive, customary fees and commissions for these transactions. Without limitation, the Trustee is the trustee under RAI’s indenture, and its affiliate is a lender under the Credit Agreement. The RAI Guarantee and Eighth Supplemental Indenture are filed as Exhibit 4.11 and Exhibit 4.12, respectively, to this Quarterly Report and are incorporated herein by reference. This summary of the provisions of each of the RAI Guarantee and Eighth Supplemental Indenture is qualified in its entirety by reference to the filed RAI Guarantee and Eighth Supplemental Indenture. Item 6. Exhibits

117

(1) Represents the principal amount of each series of the Lorillard Tobacco Notes not tendered in the Exchange Offers. For more information related to the Exchange Offers, see note 10 to condensed consolidated financial statements (unaudited).

Exhibit Number Description 2.1

Amendment No. 1 to Asset Purchase Agreement, dated May 26, 2015, by and between Reynolds American Inc. and ITG Brands, LLC (formerly known as Lignum-2, L.L.C.) and Imperial Tobacco Group PLC (incorporated by reference to Exhibit 2.3 to Reynolds American Inc.’s Form 8-K dated May 28, 2015).

4.1

Indenture, dated June 23, 2009, among Lorillard Tobacco Company, Lorillard, Inc. and The Bank of New York Mellon Trust Company, N.A., as Trustee (incorporated by reference to Exhibit 4.1 to Lorillard, Inc.’s Form 8-K dated June 18, 2009).

4.2

First Supplemental Indenture, dated June 23, 2009, among Lorillard Tobacco Company, Lorillard, Inc. and The Bank of New York Mellon Trust Company, N.A., as Trustee (incorporated by reference to Exhibit 4.2 to Lorillard, Inc.’ s Form 8-K dated June 18, 2009).

4.3

Second Supplemental Indenture, dated April 12, 2010, among Lorillard Tobacco Company, Lorillard, Inc. and The Bank of New York Mellon Trust Company, N.A., as Trustee (incorporated by reference to Exhibit 4.2 to Lorillard Inc.’s Form 8-K dated April 7, 2010).

4.4

Third Supplemental Indenture, dated August 4, 2011, among Lorillard Tobacco Company, Lorillard, Inc. and The Bank of New York Mellon Trust Company, N.A. as Trustee (incorporated by reference to Exhibit 4.2 to Lorillard Inc.’ s Form 8-K dated August 1, 2011).

4.5

Fourth Supplemental Indenture, dated August 21, 2012, among Lorillard Tobacco Company, Lorillard, Inc. and The Bank of New York Mellon Trust Company, N.A. as Trustee (incorporated by reference to Exhibit 4.2 to Lorillard Inc.’ s Form 8-K dated August 16, 2012).

4.6

Fifth Supplemental Indenture, dated May 20, 2013, among Lorillard Tobacco Company, Lorillard, Inc. and The Bank of New York Mellon Trust Company, N.A. as Trustee (incorporated by reference to Exhibit 4.2 to Lorillard Inc.’s Form 8-K dated May 15, 2013).

4.7

Sixth Supplemental Indenture, dated June 12, 2015, among R. J. Reynolds Tobacco Company, Lorillard Tobacco Company, LLC, R.J. Reynolds Tobacco Holdings, Inc., Lorillard, Inc. and The Bank of New York Mellon Trust Company, N.A., as Trustee (incorporated by reference to Exhibit 4.7 to Reynolds American Inc.’s Form 8-K dated June 12, 2015).

4.8

Underwriting Agreement, dated June 9, 2015, by and among Reynolds American Inc., as issuer, Reynolds American Inc.’s subsidiaries that are guaranteeing the New Notes and Citigroup Global Markets Inc. and J.P. Morgan Securities LLC, for themselves and as representatives of the several other underwriters named therein (incorporated by reference to Exhibit 1.1 to Reynolds American Inc.’s Form 8-K dated June 12, 2015).

4.9 Guarantee Agreement of R.J. Reynolds Tobacco Holdings, Inc., dated June 12, 2015, for the Senior Notes of Lorillard Tobacco Company, LLC (incorporated by reference to Exhibit 4.15 to Reynold American Inc.’ s Form 8-K dated June 12, 2015).

4.10

Seventh Supplemental Indenture, dated June 25, 2015, to Indenture dated June 23, 2009 (incorporated by reference to Exhibit 4.1 to Reynolds American Inc.’s Form 8-K dated June 29, 2015).

118

Exhibit Number Description 4.11

Guarantee Agreement of Reynolds American Inc., dated August 6, 2015, for the Senior Notes of R. J. Reynolds Tobacco Company (as successor obligor to Lorillard Tobacco Company, LLC (formerly known as Lorillard Tobacco Company)).

4.12

Eighth Supplemental Indenture, dated August 6, 2015, to Indenture dated June 23, 2009.

4.13

In accordance with Item 601(b)(4)(iii) of Regulation S-K, Reynolds American Inc. agrees to furnish to the SEC, upon request, a copy of each instrument that defines the rights of holders of such long-term debt not filed or incorporated by reference as an exhibit to this Quarterly Report on Form 10-Q.

10.1

Performance Share Agreement (one-year vesting), dated May 7, 2015, between Reynolds American Inc. and Susan M. Cameron.

10.2 Amendment No.1, entered into as of June 12, 2015, to the Reynolds American Inc. Executive Severance Plan (Amended and Restated Effective December 1, 2012).

10.3

Amendment No. 1 to Subscription and Support Agreement dated May 28, 2015, among British American Tobacco p.l.c., Reynolds American Inc. and for limited purposes Brown & Williamson Holding Inc. (incorporated by reference to Exhibit 10.2 to Reynolds American Inc.’s Form 8-K dated May 28, 2015).

10.4*

Reciprocal Manufacturing Agreement, dated June 12, 2015, by and between R. J. Reynolds Tobacco Company and ITG Brands, LLC (f/k/a Lignum-2, LLC).

31.1 Certification of Chief Executive Officer relating to RAI’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015.

31.2 Certification of Chief Financial Officer relating to RAI’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015.

32.1** Certification of Chief Executive Officer and Chief Financial Officer relating to RAI’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, pursuant to Section 18 U.S.C. §1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS XBRL instance document

101.SCH XBRL taxonomy extension schema

101.CAL XBRL taxonomy extension calculation linkbase

101.DEF

XBRL taxonomy extension definition linkbase document

101.LAB XBRL taxonomy extension label linkbase

101.PRE XBRL taxonomy extension presentation linkbase

* Portions of this exhibit have been omitted and filed separately with the Securities and Exchange Commission as part of an application for confidential treatment pursuant to the Exchange Act.

** Exhibit is being furnished and shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subjected to the liabilities of that Section. This exhibit shall not be incorporated by reference into any registration statement or other document pursuant to the Securities Act of 1933, as amended, except as shall be expressly set forth by specific reference in such a filing.

SIGNATURES

Pursuant to the requirements 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.

119

REYNOLDS AMERICAN INC. (Registrant)

Dated: August 6, 2015 /s/ Andrew D. Gilchrist Andrew D. Gilchrist Executive Vice President and Chief Financial Officer (principal financial officer)

Exhibit 4.11 GUARANTEE AGREEMENT

GUARANTEE, entered into August 6, 2015 and effective as of June 30, 2015 (as amended from time to time, this “Guarantee ”), made by Reynolds American Inc., a North Carolina corporation (the “ Guarantor ”), in favor of The Bank of New York Mellon Trust Company, N.A., as trustee (“ Trustee ”) for the registered holders (the “ Holders ”) of the series of Notes set forth below (collectively, the “ Debt Securities ”) of R. J. Reynolds Tobacco Company, a North Carolina corporation (as successor to Lorillard Tobacco Company, LLC (f/k/a Lorillard Tobacco Company), a Delaware limited liability company) (the “ Issuer ”):

WITNESSETH: SECTION 1. Guarantee . (a) The Guarantor hereby unconditionally guarantees, jointly and severally, the punctual

payment when due, whether at stated maturity, by acceleration or otherwise, of the principal of, premium, if any, and interest on the Debt Securities (the “ Obligations ”), according to the terms of the Debt Securities and as more fully described in the Indenture (as amended, modified or otherwise supplemented from time to time, the “ Indenture ”), dated June 23, 2009 among the Issuer, the Guarantor and the Trustee, and any other amounts payable by the Issuer under the Indenture.

(b) It is the intention of the Guarantor that this Guarantee not constitute a fraudulent transfer or conveyance for purposes of Bankruptcy Law, the Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act or any similar federal or state law to the extent applicable to this Guarantee. To effectuate the foregoing intention, the amount guaranteed by the Guarantor under this Guarantee shall be limited to the maximum amount as will, after giving effect to such maximum amount and all other contingent and fixed liabilities of the Guarantor that are relevant under such laws, result in the Obligations of the Guarantor under this Guarantee not constituting a fraudulent transfer or conveyance. For purposes hereof, “Bankruptcy Law ” means Title 11, U.S. Code, or any similar federal or state law for the relief of debtors.

SECTION 2. Guarantee Absolute . The Guarantor guarantees that the Obligations will be paid strictly in accordance with the terms of the Indenture, regardless of any law, regulation or order now or hereafter in effect in any jurisdiction affecting any of such terms or the rights of Holders of the Debt Securities with respect thereto. The liability of the Guarantor under this Guarantee shall be absolute and unconditional irrespective of:

• 8.125% Senior Notes due June 23, 2019 • 6.875% Senior Notes due 2020 • 8.125% Senior Notes due 2040 • 3.500% Senior Notes due 2016 • 7.000% Senior Notes due 2041 • 2.300% Senior Notes due 2017 • 3.750% Senior Notes due 2023

SECTION 3. Ranking . The Guarantor covenants and agrees that its obligation to make payments of the Obligations hereunder constitutes an unsecured obligation of the Guarantor ranking (a) pari passu with all existing and future senior indebtedness of the Guarantor and (b) senior in right of payment to all existing and future subordinated indebtedness of the Guarantor.

SECTION 4. Waiver; Subrogation . (a) The Guarantor hereby waives promptness, diligence, notice of acceptance and any other notice with respect to this Guarantee and any requirement that the Trustee, or the Holders of any Debt Securities protect, secure, perfect or insure any security interest or lien or any property subject thereto or exhaust any right or take any action against the Issuer or any other Person or any collateral.

(b) The Guarantor hereby irrevocably waives any claims or other rights that it may now or hereafter acquire against the Issuer that arise from the existence, payment, performance or enforcement of the Guarantor’s obligations under this Guarantee or the Indenture, including, without limitation, any right of subrogation, reimbursement, exoneration, contribution or indemnification and any right to participate in any claim or remedy of the Trustee, or the Holders of any Debt Securities against the Issuer or any collateral, whether or not such claim, remedy or right arises in equity or under contract, statute or common law, including, without limitation, the right to take or receive from the Issuer, directly or indirectly, in cash or other property or by set-off or in any other manner, payment or security on account of such claim, remedy or right. If any amount shall be paid to the Guarantor in violation of the preceding sentence at any time prior to the cash payment in full of the Obligations and all other amounts payable under this Guarantee, such amount shall be held in trust for the benefit of the Trustee and the Holders of any Debt Securities and shall forthwith be paid to the Trustee, to be credited and applied to the Obligations and all other amounts payable under this Guarantee, whether matured or unmatured, in accordance with the terms of the Indenture and this Guarantee, or be held as collateral for any Obligations or other amounts payable under this Guarantee thereafter arising.

SECTION 5. No Waiver; Remedies . No failure on the part of the Trustee or any Holder of the Debt Securities to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof; nor shall any single or partial exercise of any right hereunder preclude any

2 " ""

(a) any lack of validity, enforceability or genuineness of any provision of the Indenture, the Debt Securities or any other agreement or instrument relating thereto;

(b) any change in the time, manner or place of payment of, or in any other term of, all or any of the Obligations, or any other amendment or waiver of or any consent to departure from the Indenture;

(c) any exchange, release or non-perfection of any collateral, or any release or amendment or waiver of or consent to departure from any other guarantee, for all or any of the Obligations; or

(d) any other circumstance that might otherwise constitute a defense available to, or a discharge of, the Issuer or a guarantor.

other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law.

SECTION 6. Continuing Guarantee; Transfer of Interest . This Guarantee is a continuing guarantee and shall (a) remain in full force and effect until the earliest to occur of (i) the date, if any, on which the Guarantor shall consolidate with or merge into the Issuer or any successor thereto, (ii) the date, if any, on which the Issuer or any successor thereto shall consolidate with or merge into the Guarantor, and (iii) payment in full of the Obligations, (b) be binding upon the Guarantor, its successors and assigns, and (c) inure to the benefit of and be enforceable by any Holder of Debt Securities, the Trustee, and by their respective successors, transferees, and assigns.

SECTION 7. Reinstatement . This Guarantee shall continue to be effective or be reinstated, as the case may be, if at any time any payment of any of the Obligations is rescinded or must otherwise be returned by any Holder of the Debt Securities or the Trustee upon the insolvency, bankruptcy or reorganization of the Issuer or otherwise, all as though such payment had not been made.

SECTION 8. Amendment . The Guarantor may amend this Guarantee at any time for any purpose without the consent of the Trustee or any Holder of the Debt Securities; provided, however, that if such amendment adversely affects (a) the rights of the Trustee or (b) any Holder of the Debt Securities, the prior written consent of the Trustee (in the case of (b), acting at the written direction of the Holders of more than 50% in aggregate principal amount of Debt Securities) shall be required.

SECTION 9. Governing Law . This Guarantee shall be governed by, and construed in accordance with the laws of the State of New York.

( signature page follows )

3 " ""

IN WITNESS WHEREOF, the Guarantor has caused this Guarantee to be duly executed and delivered by its officer thereunto duly authorized.

REYNOLDS AMERICAN INC. By: /s/ Daniel A. Fawley

Name: Daniel A. Fawley Title: Senior Vice President and Treasurer

Signature Page to Guarantee Agreement of Reynolds American Inc. with respect to Notes Issued Under Indenture dated June 23, 2009

" ""

Exhibit 4.12

R. J. REYNOLDS TOBACCO COMPANY

(as successor to Lorillard Tobacco Company, LLC (f/k/a Lorillard Tobacco Company)) as Issuer

R.J. REYNOLDS TOBACCO HOLDINGS, INC.

(as successor to Lorillard, LLC (f/k/a Lorillard, Inc.))


each, as a Guarantor

THE BANK OF NEW YORK MELLON TRUST COMPANY, N.A.,

as Trustee

EIGHTH SUPPLEMENTAL INDENTURE

Dated August 6, 2015

to Indenture dated June 23, 2009

Exhibit 4.12

THIS EIGHTH SUPPLEMENTAL INDENTURE (the “ Eighth Supplemental Indenture ”) is made the 6 th day of August , 2015, among R. J. REYNOLDS TOBACCO COMPANY, a North Carolina corporation (the “ I ssuer ”), R.J. REYNOLDS TOBACCO HOLDINGS, INC., a Delaware corporation (the “ Existing Guarantor ”), REYNOLDS AMERICAN INC. , a North Carolina corporation and the direct or indirect parent company of the Issuer and the Existing Guarantor ( the “ New Guarantor ” , and together with the Existing Guarantor, the “ Guarantors ” ) , and THE BANK OF NEW YORK MELLON TRUST COMPANY, N.A., a national banking association, as Trustee (the “ Trustee ”).

RECITALS

WHEREAS, the Existing Guarantor, the Issuer and the Trustee are parties to an Indenture, dated June 23, 2009, with the Trustee (the “ Original Indenture ”, and as amended, supplemented or otherwise modified on or prior to the date hereof, the “ Indenture ”) (all capitalized terms used in this Eighth Supplemental Indenture and not otherwise defined herein have the meanings assigned to such terms in the Indenture);

WHEREAS, the New Guarantor has determined that it is desirable and would be a direct benefit to the New Guarantor for it, along with the Issuer and the Existing Guarantor, to execute and deliver to the Trustee a supplemental indenture pursuant to which the New Guarantor will unconditionally guarantee, on a joint and several basis with the Existing Guarantor, the due and punctual payment of the principal of (and premium, if any) and interest, if any (including all additional amounts, if any, payable pursuant to Section 515 of the Indenture), on all the Securities and the performance of every covenant of the Existing Guarantor with respect to such Guarantee to be performed or observed, other than with respect to Section 704 of the Indenture;

WHEREAS, pursuant to Section 901(12) of the Indenture, the Issuer, the Existing Guarantor (in the case of Guaranteed Securities) and the Trustee are permitted to execute and deliver this Eighth Supplemental Indenture to amend the Indenture, without the consent of any Holders of Securities, to, among other things, make any provisions with respect to matters arising under the Indenture, provided such action shall not adversely affect the interests of the Holders of Securities of any particular series in any material respect;

WHEREAS, the entry into this Eighth Supplemental Indenture by the parties hereto is in all respects authorized by the provisions of the Indenture; and

WHEREAS, all conditions necessary to authorize the execution and delivery of this Eighth Supplemental Indenture and to make it a valid and binding obligation of the Issuer and the Guarantors have been done or performed.

NOW, THEREFORE, THIS EIGHTH SUPPLEMENTAL INDENTURE WITNESSETH:

For and in consideration of the foregoing premises, it is mutually covenanted and agreed as follows:

Section 1 . Amendment to Section 101 . The definition of the term “Guarantor” set forth in Section 101 of the Indenture (in the case of each outstanding series of Notes, as amended with

1

Exhibit 4.12

respect to such series pursuant to the corresponding Issuance Supplemental Indenture) is hereby deleted and replaced in its entirety with the following:

“Guarantor” means the Person named as the “Guarantor” in the first paragraph of this instrument, and any Person who agrees to become a guarantor in a supplemental indenture to this instrument (except, in the case of such additional guarantors, for purposes of Section 704, the obligations of which section shall only apply to the Person named as the “Guarantor” in the first paragraph of this instrument and their successors), (i) until released pursuant to the provisions of this Indenture or (ii) until a successor Person shall have become such pursuant to the applicable provisions of this Indenture, and thereafter “Guarantor” shall mean that successor Person until released pursuant to the provisions of this Indenture.

Section 2 . Agreement to be Bound . The New Guarantor hereby becomes a party to the Indenture as a Guarantor, and will have all the rights and be subject to all of the obligations and agreements of a Guarantor under the Indenture, other than for purposes of Section 704 of the Indenture, the obligations of which section shall only apply to the Existing Guarantor.

Section 3 . Guarantee . The New Guarantor hereby fully, unconditionally and irrevocably guarantees, on a joint and several basis with the Existing Guarantor, the due and punctual payment of the principal of (and premium, if any) and interest, if any (including all additional amounts, if any, payable pursuant to Section 515 of the Indenture), on all the Securities and the performance of every covenant of the Existing Guarantor with respect to the Guarantee and the Indenture to be performed or observed, other than with respect to Section 704 of the Indenture, subject in each case to the terms of the Indenture and the guarantee agreement referred to in Section 4 below.

Section 4 . Guarantee Agreement . To further evidence the New Guarantor’s guarantee of the Securities, the New Guarantor shall execute and deliver to the Trustee a guarantee agreement substantially in the form attached hereto as Exhibit A .

Section 5 . Securities . Each Global Security representing the Notes, with effect on and from the date hereof and subject to becoming operative as provided herein, shall be deemed supplemented, modified and amended in such manner as necessary to make the terms of such Global Security consistent with the terms of the Indenture after giving effect to the amendments set forth in Section 1 hereof.

Section 6 . Trustee . The recitals and statements in this Eighth Supplemental Indenture are made by the Issuer and the Guarantors only and not by the Trustee, and the Trustee makes no representation as to the validity or sufficiency of this Eighth Supplemental Indenture (other than with respect to the due authorization, execution and delivery of this Eighth Supplemental Indenture by the Trustee). All of the provisions contained in the Indenture in respect of the rights, privileges, immunities, powers and duties of the Trustee shall be applicable in respect of each series of the Notes and of this Eighth Supplemental Indenture as fully and with like effect as if set forth herein in full.

Section 7 . Ratification of Indenture; Eighth Supplemental Indenture Part of Indenture . As amended and supplemented hereby, the Indenture is in all respects ratified and confirmed, and

2

Exhibit 4.12

the Original Indenture , as supplemented prior to the date hereof, and this Eighth Supplemental Indenture shall be read, taken and construed as one and the same instrument and all references to “ Securities ” in the Original Indenture shall be deemed to refer also to the Notes unless the context otherwise provides.

Section 8 . Governing Law . This Eighth Supplemental Indenture shall be governed by, and construed in accordance with, the laws of the State of New York.

Section 9 . Conflicts . In the event of a conflict between the terms and conditions of the Original Indenture, as supplemented prior to the date hereof, and the terms and conditions of this Eighth Supplemental Indenture, then the terms and conditions of this Eighth Supplemental Indenture shall prevail; provided that if and to the extent that any provision of this Eighth Supplemental Indenture limits, qualifies or conflicts with another provision which is required to be included herein or in the Indenture by the Trust Indenture Act, such required provision shall control.

Section 10 . Successors . All covenants and agreements in this Eighth Supplemental Indenture by the parties shall bind their respective successors and assigns, whether so expressed or not.

Section 11 . Severability . In case any provision in this Eighth Supplemental Indenture shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired hereby.

Section 12 . Third Parties . Nothing in this Eighth Supplemental Indenture, expressed or implied, shall give to any Person, other than the parties hereto and their successors under the Indenture, any benefit or any legal or equitable right, remedy or claim under this Eighth Supplemental Indenture.

Section 13 . Counterparts . This Eighth Supplemental Indenture may be simultaneously executed in several counterparts, each of which shall be deemed to be an original, and such counterparts shall together constitute but one and the same instrument.

Section 14 . Headings . The headings of the sections in this Eighth Supplemental Indenture are for convenience of reference only and shall not be deemed to alter or affect the meaning or interpretation of any provisions hereof.

Section 15 . Effectiveness; Operativeness . This Eighth Supplemental Indenture shall become effective upon the due execution and delivery of this Eighth Supplemental Indenture by the Issuer, the Guarantors and the Trustee.


3

Exhibit 4.12

IN WITNESS WHEREOF, the parties hereto have caused this Eighth Supplemental Indenture dated August 6 , 2015 to be duly executed.

R. J. REYNOLDS TOBACCO COMPANY, By: /s/ Daniel A. Fawley

Name: Daniel A. Fawley Title: Treasurer

R.J. REYNOLDS TOBACCO HOLDINGS, INC., By: /s/ Daniel A. Fawley


REYNOLDS AMERICAN INC. By: /s/ Daniel A. Fawley


Signature Page to Eighth Supplemental Indenture to Indenture dated June 23, 2009

" ""

Exhibit 4.12

THE BANK OF NEW YORK MELLON TRUST COMPANY, N.A., Trustee By: /s/ Richard Tarnas

Name: Richard Tarnas Title: Vice President

Signature Page to Eighth Supplemental Indenture to Indenture dated June 23, 2009

" ""

Exhibit 4.12

EXHIBIT A

FORM OF GUARANTEE AGREEMENT

" ""

US2008 7372383 5 GUARANTEE AGREEMENT

GUARANTEE, entered into August __, 2015 and effective as of June 30, 2015 (as amended from time to time, this “ Guarantee ”), made by Reynolds American Inc., a North Carolina corporation (the “ Guarantor ”), in favor of The Bank of New York Mellon Trust Company, N.A., as trustee (“ Trustee ”) for the registered holders (the “ Holders ”) of the series of Notes set forth below (collectively, the “ Debt Securities ”) of R. J. Reynolds Tobacco Company, a North Carolina corporation (as successor to Lorillard Tobacco Company, LLC (f/k/a Lorillard Tobacco Company), a Delaware limited liability company) (the “ Issuer ”):

WITNESSETH: SECTION 1. Guarantee . (a) The Guarantor hereby unconditionally guarantees, jointly and severally, the punctual

payment when due, whether at stated maturity, by acceleration or otherwise, of the principal of, premium, if any, and interest on the Debt Securities (the “ Obligations ”), according to the terms of the Debt Securities and as more fully described in the Indenture (as amended, modified or otherwise supplemented from time to time, the “ Indenture ”), dated June 23, 2009 among the Issuer, the Guarantor and the Trustee, and any other amounts payable by the Issuer under the Indenture.

(b) It is the intention of the Guarantor that this Guarantee not constitute a fraudulent transfer or conveyance for purposes of Bankruptcy Law, the Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act or any similar federal or state law to the extent applicable to this Guarantee. To effectuate the foregoing intention, the amount guaranteed by the Guarantor under this Guarantee shall be limited to the maximum amount as will, after giving effect to such maximum amount and all other contingent and fixed liabilities of the Guarantor that are relevant under such laws, result in the Obligations of the Guarantor under this Guarantee not constituting a fraudulent transfer or conveyance. For purposes hereof, “Bankruptcy Law ” means Title 11, U.S. Code, or any similar federal or state law for the relief of debtors.

SECTION 2. Guarantee Absolute . The Guarantor guarantees that the Obligations will be paid strictly in accordance with the terms of the Indenture, regardless of any law, regulation or order now or hereafter in effect in any jurisdiction affecting any of such terms or the rights of Holders of the Debt Securities with respect thereto. The liability of the Guarantor under this Guarantee shall be absolute and unconditional irrespective of:

1 " ""

• 8.125% Senior Notes due June 23, 2019 • 6.875% Senior Notes due 2020 • 8.125% Senior Notes due 2040 • 3.500% Senior Notes due 2016 • 7.000% Senior Notes due 2041 • 2.300% Senior Notes due 2017 • 3.750% Senior Notes due 2023

SECTION 3. Ranking . The Guarantor covenants and agrees that its obligation to make payments of the Obligations hereunder constitutes an unsecured obligation of the Guarantor ranking (a) pari passu with all existing and future senior indebtedness of the Guarantor and (b) senior in right of payment to all existing and future subordinated indebtedness of the Guarantor.

SECTION 4. Waiver; Subrogation . (a) The Guarantor hereby waives promptness, diligence, notice of acceptance and any other notice with respect to this Guarantee and any requirement that the Trustee, or the Holders of any Debt Securities protect, secure, perfect or insure any security interest or lien or any property subject thereto or exhaust any right or take any action against the Issuer or any other Person or any collateral.

(b) The Guarantor hereby irrevocably waives any claims or other rights that it may now or hereafter acquire against the Issuer that arise from the existence, payment, performance or enforcement of the Guarantor’s obligations under this Guarantee or the Indenture, including, without limitation, any right of subrogation, reimbursement, exoneration, contribution or indemnification and any right to participate in any claim or remedy of the Trustee, or the Holders of any Debt Securities against the Issuer or any collateral, whether or not such claim, remedy or right arises in equity or under contract, statute or common law, including, without limitation, the right to take or receive from the Issuer, directly or indirectly, in cash or other property or by set-off or in any other manner, payment or security on account of such claim, remedy or right. If any amount shall be paid to the Guarantor in violation of the preceding sentence at any time prior to the cash payment in full of the Obligations and all other amounts payable under this Guarantee, such amount shall be held in trust for the benefit of the Trustee and the Holders of any Debt Securities and shall forthwith be paid to the Trustee, to be credited and applied to the Obligations and all other amounts payable under this Guarantee, whether matured or unmatured, in accordance with the terms of the Indenture and this Guarantee, or be held as collateral for any Obligations or other amounts payable under this Guarantee thereafter arising.

SECTION 5. No Waiver; Remedies . No failure on the part of the Trustee or any Holder of the Debt Securities to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof; nor shall any single or partial exercise of any right hereunder preclude any

2 " ""

(a) any lack of validity, enforceability or genuineness of any provision of the Indenture, the Debt Securities or any other agreement or instrument relating thereto;

(b) any change in the time, manner or place of payment of, or in any other term of, all or any of the Obligations, or any other amendment or waiver of or any consent to departure from the Indenture;

(c) any exchange, release or non-perfection of any collateral, or any release or amendment or waiver of or consent to departure from any other guarantee, for all or any of the Obligations; or

(d) any other circumstance that might otherwise constitute a defense available to, or a discharge of, the Issuer or a guarantor.

other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law.

SECTION 6. Continuing Guarantee; Transfer of Interest . This Guarantee is a continuing guarantee and shall (a) remain in full force and effect until the earliest to occur of (i) the date, if any, on which the Guarantor shall consolidate with or merge into the Issuer or any successor thereto, (ii) the date, if any, on which the Issuer or any successor thereto shall consolidate with or merge into the Guarantor, and (iii) payment in full of the Obligations, (b) be binding upon the Guarantor, its successors and assigns, and (c) inure to the benefit of and be enforceable by any Holder of Debt Securities, the Trustee, and by their respective successors, transferees, and assigns.

SECTION 7. Reinstatement . This Guarantee shall continue to be effective or be reinstated, as the case may be, if at any time any payment of any of the Obligations is rescinded or must otherwise be returned by any Holder of the Debt Securities or the Trustee upon the insolvency, bankruptcy or reorganization of the Issuer or otherwise, all as though such payment had not been made.

SECTION 8. Amendment . The Guarantor may amend this Guarantee at any time for any purpose without the consent of the Trustee or any Holder of the Debt Securities; provided, however, that if such amendment adversely affects (a) the rights of the Trustee or (b) any Holder of the Debt Securities, the prior written consent of the Trustee (in the case of (b), acting at the written direction of the Holders of more than 50% in aggregate principal amount of Debt Securities) shall be required.

SECTION 9. Governing Law . This Guarantee shall be governed by, and construed in accordance with the laws of the State of New York.


3 " ""

IN WITNESS WHEREOF, the Guarantor has caused this Guarantee to be duly executed and delivered by its officer

thereunto duly authorized.

REYNOLDS AMERICAN INC. By:


Signature Page to Guarantee Agreement of Reynolds American Inc. with respect to Notes Issued Under Indenture dated June 23, 2009

" ""

Exhibit 10.1

REYNOLDS AMERICAN INC. LONG-TERM INCENTIVE PROGRAM

_________________________________________

PERFORMANCE SHARE AGREEMENT ________________________________________

DATE OF GRANT: May 7, 2015

1. Grant . Pursuant to the provisions of the Reynolds American Inc. Amended and Restated 2009 Omnibus Incentive Compensation Plan (the “Plan”), Reynolds American Inc. (the “Company”) on the date set forth above, has granted to

SUSAN M. CAMERON (the “Grantee”),

subject to the terms and conditions which follow and the terms and conditions of the Plan, an initial grant (the “Target Number”) of

108,652 Performance Shares.

A copy of the Plan has been provided to the Grantee and is made part of this Performance Share Agreement (this “Agreement”) with the same force and effect as if set forth in this Agreement itself. All capitalized terms used in this Agreement shall have the meaning set forth in the Plan, unless otherwise defined in this Agreement.

2. Value . Each Performance Share shall be equal in value to one share of common stock, par value $0.0001 per share, of the Company or any security or other consideration into which such share may be changed by reason of any transaction or event of the type referred to in Section 11 of the Plan (each, a “Share”).

3. Scoring . (a) Subject to the terms and conditions of this Agreement, the Performance Shares shall have a one-year performance period, consisting of the twelve-month period beginning May 1, 2015 and ending April 30, 2016 (the “Performance Period”), after which the number of Performance Shares earned (the “Earned Number”) will be determined as provided below, and when vested, will be paid in Shares.

(b) If the Company fails to pay to its shareholders cumulative dividends of at least $2.68 per Share (the “Dividend Threshold”) for the Performance Period (which shall include the dividend paid on each of July 1, 2015, October 1, 2015, January 2, 2016 and April 1, 2016), then the Target Number shall be reduced by an amount equal to three times the percentage of the dividend underpayment for the Performance Period, up to a maximum Target Number reduction of 50% (the “Revised Target Number”).

(c) At the end of the Performance Period, after determining if the Dividend Threshold has been met, the

Earned Number shall be determined by multiplying the Target Number, or Revised Target Number if the Dividend Threshold has not been met, by the achievement score for the Performance Period (the “LTI Achievement Score”) determined by the

Committee guided by its consideration of the overall performance of RAI and its operating companies during the Performance Period against the 2015 annual incentive award program metrics, the Grantee’s prog ress on her succession planning goals, and such other performance factors as the Committee chooses to consider; provided , however , that such percentage shall in no event be greater than 200%; and provided , further , that the value of the Earned Number of Pe rformance Shares that vest as provided in Section 4 of this Agreement, and are paid as provided in Section 5 of this Agreement, shall not exceed any maximum limits set by the Board of Directors pursuant to its resolutions adopted on May 7, 2015, or otherwi se contained in the Plan.

(d) Notwithstanding anything in Section 3 of this Agreement to the contrary, in the event of a Change of Control prior to the end of the Performance Period, the Earned Number shall be equal to the product of (i) the Target Number and (ii) the LTI Achievement Score determined by the Committee for the portion of the Performance Period prior to the Change of Control (the “Change of Control Earned Number”).

4. Vesting . (a) Subject to the terms and conditions of this Agreement, the Earned Number of Performance Shares shall vest on May 7, 2016 (the “Normal Vesting Date”) if the Grantee remains employed by the Company or a subsidiary of the Company on such date.

(b) Notwithstanding anything in Section 4(a) of this Agreement to the contrary, in the event of the Grantee’s involuntary Termination of Employment where the Grantee is eligible for and accepts severance benefits under a Company-sponsored severance plan or agreement with the Company (with eligibility for severance benefits to be determined in the sole discretion of the Company), prior to the end of the Performance Period, the number of Performance Shares that will vest on the Normal Vesting Date shall be equal to the product of (x) the Earned Number and (y) a fraction, the numerator of which shall be the number of days between the Date of Grant and the date of the Grantee’s involuntary Termination of Employment, and the denominator of which shall be the number of days between the Date of Grant and the Normal Vesting Date, and the remaining Performance Shares will be forfeited and cancelled on the Normal Vesting Date.

(c) Notwithstanding anything in Section 4(a) of this Agreement to the contrary, in the event of (i) the Grantee’s death while an active employee of the Company or a subsidiary of the Company or (ii) the Grantee’s Permanent Disability (as such term is defined in the Company’s Long-Term Disability Plan), in either case, prior to the end of the Performance Period, the number of Performance Shares that will vest on the date of the Grantee’s death or Permanent Disability, as applicable, shall be equal to the product of (x) the Target Number and (y) a fraction, the numerator of which shall be the number of days between the Date of Grant and the date of the Grantee’s death or Permanent Disability, as applicable, and the denominator of which shall be the number of days between the Date of Grant and the Normal Vesting Date, and the remaining Performance Shares will be forfeited and cancelled on the date of the Grantee’s death or Permanent Disability, as applicable.

(d) Notwithstanding anything in Section 4(a) of this Agreement to the contrary, in the event of a Change of Control prior to the end of the Performance Period, the number of Performance Shares that will vest on the date of such Change of Control shall be equal to the product of (i) the higher of (x) the Target Number and (y) the Change of Control Earned Number, and (ii) a fraction, the numerator of which shall be the number of days between the

2

Dat e of Grant and the date of the Change of Control, and the denominator of which shall be the number of days between the Date of Grant and the Normal Vesting Date, and the remaining Performance Shares will be forfeited and cancelled on the date of such Chang e of Control.

(e) Notwithstanding anything in Section 4 of this Agreement to the contrary, in the event of the Grantee’s (i) voluntary Termination of Employment, (ii) involuntary Termination of Employment where the Grantee is not eligible for severance benefits under a Company-sponsored severance plan or agreement with the Company (including, without limitation, a Termination of Employment for Cause, as such term is defined in the relevant severance plan or agreement) or (iii) involuntary Termination of Employment where the Grantee is eligible for but does not accept the severance benefits under the relevant Company-sponsored severance plan or agreement with the Company, in each case, prior to the end of the Performance Period, the Performance Shares shall be immediately forfeited and cancelled.

5. Payment . (a) Payment of vested Performance Shares shall be made only in Shares. At the Company’s sole discretion, such Shares may be issued in certificated or book-entry form.

(b) Except as set forth in Section 5(c) of this Agreement, no payment of vested Performance Shares shall be made to the Grantee prior to the end of the Performance Period. Except as otherwise provided by this Agreement, payment of vested Performance Shares shall be made as soon as practicable following the Normal Vesting Date, and in any event no later than March 15, 2017.

(c) In the event of a Change of Control, the Grantee’s death while an active employee of the Company or a subsidiary of the Company or the Grantee’s Permanent Disability, in each case prior to the end of the Performance Period, the payment of vested Performance Shares shall be paid as soon as practicable after such event occurs, and in any case no later than March 15 after the end of the year in which such event occurs.

(d) In the event of the death of the Grantee while the Grantee is an active employee of the Company or a subsidiary of the Company, any payment to which the Grantee is entitled under this Agreement shall be made to the beneficiary de signated by the Grantee to receive the proceeds of any noncontributory group life insurance coverage provided for the Grantee by the Company or a subsidiary of the Company (such life insurance coverage, “Group Life Insurance Coverage,” and such beneficiary, a “Designated Beneficiary”). If no designation of beneficiary has been made by the Grantee under the Group Life Insurance Coverage, distribution upon the Grantee’s death shall be made in accordance with the provisions of the Group Life Insurance Coverage.

(e) In the event of the death of the Grantee while the Grantee is no longer an active employee of the Company or a subsidiary of the Company, but at a time while the Grantee continues to have Group Life Insurance Coverage, any payment to which the Grantee is entitled under this Agreement shall be made to the Designated Beneficiary. If no designation of beneficiary has been made by the Grantee under the Group Life Insurance Coverage, distribution shall be made in accordance with the provisions of the Group Life Insurance Coverage. In the event of the death of the Grantee while the Grantee is no longer an active employee of the Company or a subsidiary of the Company, and at a time while the Grantee no longer has Group Life Insurance Coverage, distribution shall be made to the Grantee’s estate.

3

(f) For purposes of Sections 5(d) and 5(e), (i) if the Designated Beneficiary predeceases the Grantee,

distribution shall be made in accordance with the provisions of the Group Life Insurance Coverage, and (ii) if the Designated Beneficiary survives the Grantee but dies before payment is made, distribution shall be made to the Designated Beneficiary’s estate.

6. Termination of Employment . For purposes of this Agreement, the term “Termination of Employment” shall mean termination from active employment with the Company or a subsidiary of the Company; it does not mean the termination of pay and benefits at the end of a period of salary continuation (or other form of severance pay or pay in lieu of salary).

7. Dividend Equivalent Payment . At the time of the payment of the vested Performance Shares, the Grantee shall receive a cash dividend equivalent payment in an amount equal to the product of (a) the Earned Number and (b) the aggregate amount of dividends per share declared and paid to the Company’s shareholders on Shares during the period from the Date of Grant through the date of the payment of the Performance Shares, without interest (the “Actual Dividends Paid”); provided, however, that in the event of the Grantee’s death while an active employee of the Company or a subsidiary of the Company or Permanent Disability or in the event of a Change of Control, the amount of the dividend equivalent payment to the Grantee shall be equal to the product of (i) the Target Number (in the case of death or Permanent Disability) or the Change of Control Earned Number (in the case of a Change of Control), and (ii) the Actual Dividends Paid. Notwithstanding anything in Section 7 of this Agreement to the contrary, to the extent the payment of the vested Performance Shares occurs after both the date a dividend has been declared by the Company and the record date for such dividend, but prior to the dividend payment date related thereto, the amount of the Actual Dividend Paid also shall include such dividend. In the case of a dividend payment to be paid in property, the dividend payment shall be deemed to be the fair market value of the property at the time of distribution of the dividend payment to the Grantee, as determined by the Committee.

8. Rights as a Shareholder . The Grantee shall not be, nor have any of the rights or privileges of, a shareholder of the Company with respect to the Performance Shares unless and until, and to the extent, the Performance Shares vest and Shares have been paid to the Grantee in accordance with Section 5 of this Agreement.

9. Transferability . Other than as specifically provided in this Agreement with regard to the death of the Grantee, this Agreement and any benefit provided or accruing hereunder shall not be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance or charge; and any attempt to do so shall be void. No such benefit shall, prior to receipt thereof by the Grantee, be in any manner liable for or subject to the debts, contracts, liabilities, engagements or torts of the Grantee.

10. No Right to Employment . Neither the execution and delivery of this Agreement nor the granting of the Performance Shares evidenced by this Agreement shall constitute any agreement or understanding, express or implied, on the part of the Company or its subsidiaries to employ the Grantee for any specific period or in any specific capacity or shall prevent the Company or its subsidiaries from terminating the Grantee’s employment at any time with or without cause.

4

11. Application of Laws . The granting of Performance Shares under this Agreement shall be subject to all

applicable laws, rules and regulations and to such approvals of any governmental agencies as may be required.

12. Notices . Any notices required to be given hereunder to the Company shall be addressed to the Corporate Secretary, Reynolds American Inc., Post Office Box 2990, Winston-Salem, NC 27102-2990, and any notice required to be given hereunder to the Grantee shall be sent to the Grantee’s address as shown on the records of the Company.

13. Taxes . Any taxes required by federal, state or local laws to be withheld by the Company in respect of the grant of Performance Shares or payment of vested Performance Shares hereunder shall be paid to the Company by the Grantee by the time such taxes are required to be paid or deposited by the Company. The Grantee hereby authorizes the necessary withholding of Performance Shares by the Company to satisfy the minimum statutory tax withholding amount prior to delivery of the vested Performance Shares.

14. Administration and Interpretation . In consideration of the grant of Performance Shares hereunder, the Grantee specifically agrees that the Committee shall have the power to interpret the Plan and this Agreement and to adopt such rules for the administration, interpretation and application of the Plan and Agreement as are consistent therewith and to interpret or revoke any such rules. All actions taken and all interpretations and determinations made by the Committee shall be final, conclusive, and binding upon the Grantee, the Company and all other interested persons. No member of the Committee shall be personally liable for any action, determination or interpretation made in good faith with respect to the Plan or this Agreement. The Committee may delegate its interpretive authority as permitted by the provisions of the Plan.

15. Compliance with Section 409A of the Code . This Agreement is intended to comply with Section 409A of the Internal Revenue Code of 1986, as amended, and shall be construed and interpreted in accordance with such intent.

16. Amendment . This Agreement is subject to the Plan, a copy of which has been provided to the Grantee. The Board of Directors and the Committee, as applicable, may amend the Plan, and the Committee may amend this Agreement, at any time in any way, except that, other than as otherwise provided by the Plan, any amendment of the Plan or this Agreement that would impair the Grantee’s rights under this Agreement may not be made without the Grantee’s written consent.

17. Litigation Assistance and Non-Disclosure of Confidential Information . (a) In addition to any other obligations of the Grantee under law or any other agreement with any Related Company, in consideration of the grant of Performance Shares hereunder, the Grantee specifically agrees that the Grantee:

(i) if requested by the Company, will personally provide reasonable assistance and cooperation to the Related Companies in activities related to the prosecution or defense of any pending or future lawsuits or claims involving any Related Company;

5

(ii) will promptly notify the Company’s General Counsel, in writing, upon receipt of any requests from anyone other than an employee or agent of one of the Related Companies for information regarding any Related Company which could reasonably be construed as being proprietary, non-public or confidential, or if the Grantee becomes aware of any potential claim or proposed litigation against any Related Company;

(iii) will refrain from providing any information related to any claim or potential litigation against any Related Company to any person who is not a representative of the C ompany without the Company’s prior written permission, unless required to provide information pursuant to legal process; and

(iv) will not engage in any activity detrimental to the interests of any Related Company, including an act of dishonesty, mo ral turpitude or other misconduct that has or could have a detrimental impact on the business or reputation of any Related Company.

(b) In further consideration of the grant of Performance Shares hereunder, the Grantee specifically agrees that, if required by law to provide sworn testimony regarding any matter related to any Related Company: the Grantee will consult with and have Company designated legal counsel present for such testimony (with the Company being responsible for the costs of such designated counsel); the Grantee will cooperate with the Company’s attorneys to assist their efforts, especially on matters the Grantee has been privy to, holding all privileged attorney-client matters in strictest confidence; and if the Grantee desires legal counsel to represent and protect her interests (in addition to the Company’s designated legal counsel provided under this Section 17(b)), the Company will reimburse the Grantee for any reasonable legal expenses (including, but not limited to, the reasonable costs of the Grantee’s counsel) and other reasonable and necessary out-of-pocket expenses the Grantee may incur in relation to such testimony.

(c) The Grantee acknowledges that, given the position(s) that the Grantee has had with one or more of the Related Companies, the Grantee has had access to and has acquired Confidential Information, and will continue to have access to and acquire Confidential Information. The Grantee further acknowledges that the Related Companies have a legitimate and significant business interest in preventing the unauthorized disclosure of the Confidential Information. Accordingly, the Grantee shall not, without the prior written consent of the Company (which consent may be granted only by the Company’s General Counsel), use, divulge, disclose or make accessible to any other person, firm, partnership, corporation or other entity, for any reason or purpose whatsoever, any Confidential Information, except when required to do so by a court of competent jurisdiction or any Governmental Authority, in any case, with jurisdiction to order the Grantee to divulge, disclose or make accessible such information. If the Grantee becomes compelled to disclose any Confidential Information in the circumstances described in the preceding sentence, the Grantee shall: promptly provide the Company’s General Counsel with written notice thereof, so as to permit the Company to seek a protective order or other appropriate remedy, and the Grantee shall cooperate with the Company in the Company’s efforts in connection therewith; and disclose only that portion of the Confidential Information that the Grantee is advised by her counsel (which counsel will be reasonably acceptable to the Company and the reasonable costs and expenses of which will be borne by the Company) the Grantee is legally required to disclose and shall use reasonable efforts to have such disclosed Confidential Information accorded confidential treatment.

6

18. Noncompetition and Other Prohibited Activities. (a) In addition to any other o bligations of the Grantee under law or any other agreement with the Company or any of its subsidiaries, in consideration of the grant of Performance Shares hereunder, the Grantee, during the continuation of her employment by any Related Company and during the one-year period commencing upon her Termination of Employment for any reason (or, if the Grantee is receiving benefits under a severance plan or agreement, the period of time set forth in the non-competition agreement entered into by the Grantee in con nection with the receipt of such severance benefits), will not, directly or indirectly:

(i) be employed, or retained as an independent contractor, or otherwise provide advisory or consulting services (in each case, whether compensated or not compens ated), in a sales-related capacity, marketing role, strategic planning role, financial role, or in a product research and development role for any Competitive Business;

(ii) be employed by, or retained as an independent contractor by, or otherwise pr ovide advisory or consulting services to (in each case, whether compensated or not compensated), any Competitive Business in any sort of position or capacity involving the performance of services that are the same as, or substantially similar to, the services the Grantee performed while an employee of any Related Company (collectively, “Competitive Services”);

(iii) serve (whether compensated or not compensated) as an officer or director of any Competitive Business;

(iv) organize, own (other than o wning up to 3% of the outstanding stock of a publicly traded company) or operate any Competitive Business;

(v) (w) be employed, or retained as an independent contractor (in each case, whether compensated or not compensated) by, (x) provide advisory or c onsulting services (in each case, whether compensated or not compensated) to, (y) organize or operate or (z) serve as a director of (whether compensated or not-compensated) any Anti-Tobacco Organization;

(vi) (x ) be employed, or retained as an independent contractor (in each case, whether compensated or not compensated) by, (y) provide advisory or consulting services (in each case, whether compensated or not compensated) to or (z) serve as a director or official of (in each case, whether compensated or non-compensated) any Regulator; or

(vii) solicit, offer employment to, or hire any employee, independent contractor or any other individual providing services to any Related Company (other than secretarial and c lerical personnel), who was employed by, or provided services to, any Related Company, at the time of the Grantee’s Termination of Employment, or who was employed by, or provided services to, any Related Company during the 90-day period preceding such date, to become employed by or otherwise provide services to, any person, firm, entity or corporation, or approach any such person for any of the foregoing reasons.

As used in this Agreement, the term “including,” or variations thereof, shall not be a term of limitation, but rather shall be deemed to be followed by the words “without limitation.”

7

(b) For purposes of Section 17 and Section 18 of this Agreement, the terms set forth below have the following definitions:

(i) “Anti-Tobacco Organization” mea ns any firm, organization, entity, group, or sole proprietorship, the activities or purposes of which include opposing, advocating or lobbying against, or seeking the imposition of restrictions or prohibitions with respect to, any of the Related Companies’ Businesses or the use or consumption of any of the Products.

(ii) “Competitive Business” means any corporation, limited liability company, partnership, person, firm, organization, entity, enterprise, business or activity that is engaged in any of the Related Companies’ Businesses in the Territory or seeking to engage in any of the Related Companies’ Businesses in the Territory.

(iii) “Confidential Information” means all data, materials and information (whether in the form of samples or in written, graphic, electronic or other form, and whether marked or identified as confidential or proprietary) concerning the business, operations or affairs of any Related Company including, without limitation, information concerning any of the Related Companies’ policies, plans, strategies, trade secrets, know-how, processes, systems, business methods, business or marketing plans, research and development initiatives, products, customers, suppliers and personnel, except that Confidential Information shall not include information that (A) is or becomes generally known to the public other than by reason of the Grantee’s breach of either the provisions of this Agreement or any other duty or obligation (whether arising by contract, statute or otherwise) the Grantee owes to any Related Company, (B) was known by the Grantee at the time of the disclosure to the Grantee by any Related Company, as evidenced by the Grantee’s written records in existence prior to such disclosure, or (C) is disclosed to the Grantee after the Date of Grant by a third party who has a legal right to make such disclosure, and who is subject to no confidentiality obligation to any Related Company.

(iv) “Governmental Authority” means the government of the United States of America, any other nation or political subdivision thereof, whether state or local, and any agency, authority, administration, instrumentality, regulatory body, court or other entity exercising executive, legislative, judicial, taxing, regulatory or administrative powers or functions of or pertaining to government.

(v) “Regulator” means: (x) the U.S. Food and Drug Administration (the “FDA”), the Center for Tobacco Products established within the FDA (the “CTP”), the Tobacco Products Scientific Advisory Committee established with in the CTP, or any other office, division, branch, committee, department or other body (collectively, an “Organizational Body”) established by the FDA or by an Organizational Body; or (y) any other Governmental Authority having the authority to regulate, or make recommendations regarding any proposed regulations affecting, any part of any of the Related Companies’ Businesses.

(vi) “Related Companies’ Businesses” means the businesses of manufacturing, distributing, advertising, promoting, marketing or s elling any of the following products (collectively, “Products”): (w) any cigarette, cigar, little cigar, “roll-your-own” tobacco, smokeless or smoke-free tobacco product (including moist snuff, dry snuff, snus, loose leaf, plug and twist tobacco and any other smokeless or smoke-free tobacco, including dissolvable products, that may be invented through the date of Grantee’s Termination of Employment); (x)

8

any nicotine replacement therapy products, including nicotine gum, mouth spray and pouches, and any pro ducts otherwise marketed or intended to be used as part of a smoking cessation program; (y) any product commonly referred to as an “e-cigarette”; and (z) any other product, including any tobacco or cigarette substitute, that any Related Company invents, de velops and/or markets through the date of the Grantee’s Termination of Employment.

(vii) “Related Company” means any one of the following, individually, and the term “Related Companies” means all of the following, collectively: the Company, R. J. Reyno lds Tobacco Company, R.J. Reynolds Vapor Company, RAI International, Inc., American Snuff Company, LLC, RAI Services Company, Santa Fe Natural Tobacco Company, Inc., Niconovum, USA, Inc., Kentucky BioProcessing, Inc., SFR Tobacco International GmbH, and their respective subsidiaries, parents, affiliates (including partnerships and joint ventures in which any Related Company is a partner or joint venturer), successors and assigns.

(viii) “Territory” means (v) the United States of America, its territories , commonwealths and possessions (including duty-free stores or outlets located anywhere in an of the foregoing places); (w) U.S. military installations located anywhere in the world; (x) Western Europe; (y) Japan; and (z) any other location in which any Related Company conducts any of the Related Companies’ Businesses through the date of the Grantee’s Termination of Employment.

(c) The Grantee understands and agrees that:

(i) the purpose of this Section 18 is solely to protect the Related Companies’legitimate business interests, including, but not limited to, the Related Companies’ Confidential Information, customer relationships and goodwill, all of which contribute to the Related Companies’ competitive advantage in operating the Related Companies’ Businesses in the Territory;

(ii) the Related Companies manufacture, distribute, advertise, promote, market and sell Products in the Territory, and the restrictive covenants contained in this Agreement are necessary to protect the Related Companies’ legitimate business assets and interests, and they are reasonable in time, territory, and scope, and in all other respects;

(iii) the restrictive covenants contained in this Agreement constitute a material inducement to RAI entering this Agreement, without which the Company would not have entered into this Agreement; and

(iv) the covenants set forth in this Section 18 are essential elements of this Agreement and shall be construed as agreements independent of any other provision in this Agreement, and the existence of any claim or cause of action of the Grantee against the Company or any other Related Company, whether predicated on this Agreement or otherwise, shall not excuse the Grantee’s breach, or constitute a defense to the enforcement by the Related Companies, of these restricted covenants. The Company and the Grantee have had the opportunity to independently consult with their respective counsel for advice in all respects concerning the reasonableness and propriety of such covenants, with specific regard to the nature of the businesses conducted by the Related Companies.

9

(d) The Grantee agrees that any breach of the covenants contained in Section 18 of this Agreement would irreparably injure the Related Companies and that their remedies at law would be inadequate. Accord ingly, in the event of any breach or threatened breach of Section 18 of this Agreement, the Related Companies, in addition to any other rights and remedies available at law or in equity, shall be entitled to an injunction (and/or other equitable relief), r estraining such breach or threatened breach, and be entitled to the reimbursement of court costs, attorneys’ fees and other costs and expenses incurred in connection with enforcing this Agreement. The existence of any claim or cause of action on the part of the Grantee against any Related Company shall not constitute a defense to the enforcement of these provisions. This Agreement shall be enforceable by any Related Company, either alone or together with any other Related Company or Related Companies. Th e rights and remedies hereunder provided to the Related Companies shall be cumulative and shall be in addition to any other rights or remedies available at law, in equity or under this Agreement.

(e) If any of the provisions of Section 18 of this Agreeme nt are determined by a court of law to be excessively broad, whether as to geographical area, time, scope or otherwise, such provision shall be reduced to whatever extent is reasonable and shall be enforced as so modified. Any provisions of Section 18 of this Agreement not so modified shall remain in full force and effect.

19. Recoupment Provisions . (a) Subject to the clawback provisions of the Sarbanes-Oxley Act of 2002, the Committee may, in its sole discretion, direct that the Company recoup, and upon demand by the Company the Grantee agrees to return to the Company, all or a portion of any Shares paid to the Grantee hereunder computed using financial information or performance metrics later found to be materially inaccurate. The number of Shares to be recovered shall be equal to the excess of the number of Shares paid out over the number of Shares that would have been paid out had such financial information or performance metric been fairly stated at the time the payout was made.

(b) The Committe e may direct recoupment of Shares pursuant to Section 19(a) of this Agreement whether or not it directs recoupment of related annual incentive award payouts. The Committee also may amend a yearly LTI Achievement Score for purposes of recoupment of Shares under this Agreement without directing recoupment of related annual incentive award payouts.

(c) If the Company reasonably determines that the Grantee has materially violated any of the Grantee’s obligations under Section 17 or 18 of this Agreement, then effective the date on which such violation began, (i) any Performance Shares that have not yet vested and been paid to the Grantee under this Agreement shall be forfeited and cancelled, and (ii) the Company may, in its sole discretion, recoup any and all of the Shares previously paid to the Grantee under this Agreement.

(d) If, after a demand for recoupment of Shares under Section 19 of this Agreement, the Grantee fails to return such Shares to the Company, the Grantee acknowledges that the Company (or t he Company through the actions of any of its subsidiaries employing the Grantee, if applicable) has the right to effect the recovery of the then current value of such Shares and the amount of its court costs, attorneys’ fees and other costs and expenses incurred in connection with enforcing this Agreement by (i) deducting (subject to applicable law and the terms and

10

conditions of the Plan) from any amounts the Company (and if applicable, any subsidiary of the Company employing the Grantee) owes to the Grant ee (including, but not limited to, wages or other compensation), (ii) withholding payment of future increases in compensation (including the payment of any discretionary bonus amount) or grants of compensatory awards that otherwise would have been made in accordance with the Company’s or any of its subsidiaries’ otherwise applicable compensation practices, or (iii) any combination of the foregoing. The right of recoupment set forth in the preceding sentence shall not be the exclusive remedy of the Company , and the Company may exercise each and every other remedy available to it under applicable law.

20. Qualified Performance-Based Awards . If the Grantee is a “Covered Employee” within the meaning of Section 162(m) of the Internal Revenue Code, the grant of Performance Shares evidenced by this Agreement shall be considered a Qualified Performance-Based Award. In furtherance thereof, and notwithstanding anything in this Agreement or the Plan to the contrary, the Earned Number of Performance Shares that the Grantee may earn for the Performance Period pursuant to the grant evidenced by this Agreement (the “Earned Shares”) shall be determined by the Committee based on, and must have a value (the “Earned Shares Value”) that in no event exceeds a value equal to, the percentage of the Company’s cumulative Cash Net Income (as defined below) for the Performance Period previously established by the Board of Directors of the Company in resolutions adopted on May 7, 2015 to apply with respect to the Grantee for the Performance Period (the “Award Pool Value”). Notwithstanding the prior sentence, the Committee shall have the power and authority, in its sole and absolute exercise of negative discretion, to reduce the Earned Shares such that the Earned Shares Value will be less than the Award Pool Value, which reduction may be made by taking into account the factors described above under Section 3 of this Agreement or any other criteria the Committee deems appropriate. The reductions in Earned Shares Value, if any, shall not result in any increases in the value of performance shares earned by any other awardee. For purposes of this Agreement, the term “Cash Net Income” shall mean the Company’s net income from continuing operations in the consolidated statement of income adjusted for the impact of non-cash items, such as depreciation, amortization, unrealized gains and losses, intangible asset impairments and other non-cash gains/losses included in net income (as reported in the Company’s quarterly and annual reports for the period from April 1, 2015 through March 31, 2016).

21. Electronic Signature . This Agreement is delivered electronically. The Grantee consents to using an electronic

signature to sign this Agreement and be legally bound to her acceptance or rejection of the grant. By electronically signing the Agreement, the Grantee also consents to entering into this Agreement in electronic form. The Grantee acknowledges that her electronic signature will have the same legal force and effect as a handwritten signature. The Grantee’s electronic signature, including date and time of signing will be stored electronically with the Performance Share grant record.

22. GOVERNING LAWS . THE LAWS OF THE STATE OF NORTH CAROLINA SHALL GOVERN THE

INTERPRETATION, VALIDITY AND PERFORMANCE OF THE TERMS OF THIS AGREEMENT, REGARDLESS OF THE LAW THAT MIGHT BE APPLIED UNDER PRINCIPLES OF CONFLICTS OF LAWS. EXCEPT AS OTHERWISE PROVIDED IN THIS SECTION 22, ANY CONTROVERSY OR DISPUTE ARISING OUT OF OR RELATED TO THIS AGREEMENT SHALL BE SETTLED EXCLUSIVELY IN THE COURTS (FEDERAL AND STATE) SITUATED IN THE STATE OF NORTH CAROLINA,

11

FORSYTH COUNTY. THE GRANTEE CONSENTS TO PERSONAL JURISDICTION IN THE STATE OF NORTH CAROLINA AND IN THE COURTS THEREOF FOR THE ENFORCEMENT OF THIS AGREEMENT, AN D WAIVES ANY RIGHTS THE GRANTEE OTHERWISE MAY HAVE UNDER THE LAWS OF ANY JURISDICTION TO OBJECT ON ANY BASIS TO JURISDICTION OR VENUE WITHIN THE STATE OF NORTH CAROLINA TO ENFORCE THIS AGREEMENT. IN ADDITION, AND NOTWITHSTANDING THE FOREGOING, THE COMPANY MAY ELECT, IN ITS DISCRETION, TO SEEK A TEMPORARY RESTRAINING ORDER OR PRELIMINARY OR PERMANENT INJUNCTIVE (OR SIMILAR) RELIEF TO ENFORCE ITS RIGHTS UNDER SECTIONS 17 AND 18 OF THIS AGREEMENT IN ANY JURISDICTION OR COURT ANYWHERE IN THE WORLD THAT THE COM PANY DETERMINES TO BE APPROPRIATE, AND THE GRANTEE HEREBY CONSENTS TO VENUE IN ANY SUCH JURISDICTION OR COURT IN SUCH EVENT.

IN WITNESS WHEREOF, the Company, by its duly authorized officer, and the Grantee have executed this Agreement as of the Date of Grant first above written.


By: /s/ Lisa J. Caldwell Authorized Signature /s/ Susan M. Cameron Grantee’s Signature Print Name: Susan M. Cameron

12

Exhibit 10.2

Amendment No. 1 to the Reynolds American Inc. Executive Severance Plan (Amended and Restated Effective December 1, 2012)

THIS AMENDMENT NO. 1 to the Reynolds American Inc. Executive Severance Plan (Amended and Restated Effective

December 1, 2012) is made and entered into the 12 th day of June, 2015.

W I T N E S S E T H

WHEREAS , Reynolds American Inc. (the “Company”) has in effect the Reynolds American Inc. Executive Severance Plan (Amended and Restated Effective December 1, 2012) (the “Plan”); and

WHEREAS , the Compensation and Leadership Development Committee of the Board of Directors of the Company (the “Committee”), by actions taken on June 12, 2015, authorized amendments to the Plan (i) to add Kentucky BioProcessing, Inc. as a participating company, effective as of January 1, 2014, and (ii) to reflect the transactions contemplated by the Agreement and Plan of Merger, dated as of July 15, 2014, among Lorillard, Inc., Reynolds American Inc. and Lantern Acquisition Co. (the “Merger Agreement”), effective as of the closing of the transaction contemplated by the Merger Agreement (the “Closing”); and

WHEREAS , such actions of the Committee further authorized the members of the Committee to perform any and all acts and execute any and all documents that they may deem necessary to effectuate the Committee’s resolutions.

NOW, THEREFORE, BE IT RESOLVED , that the Plan hereby is amended as follows:

1.

Effective as of January 1, 2014, Appendix A to the Plan hereby is amended in its entirety to read as follows:

“ Appendix A

List of Participating Companies

Reynolds American Inc. (plan sponsor) R. J. Reynolds Tobacco Company

R. J. Reynolds Global Products, Inc. R. J. Reynolds Tobacco (CI), Co. R. J. Reynolds Vapor Company

RAI International, Inc. Santa Fe Natural Tobacco Company, Inc.*

American Snuff Company, LLC* Reynolds Innovations Inc. RAI Services Company

Niconovum, USA SFR Tobacco International GmbH**

Kentucky BioProcessing, Inc.

With respect to a Participating Company that has an Executive Department(*), only individuals employed within that Executive Department will be considered to be employed by the Participating Company for purposes of this Plan.

**With respect to SFR Tobacco International GmbH (“SFRTI”), only individuals who satisfy the following requirements will be considered to be employed by the Participating Company for purposes of the Plan:

2.

Effective as of the date of the Closing, Section 2(t) of the Plan hereby is amended by inserting the following sentence at the end thereof:

“Notwithstanding the foregoing, for the period commencing on June 12, 2015 and ending on the second anniversary thereof, no employee who was a party to a Change in Control Severance Agreement with Lorillard, Inc. immediately prior to June 12, 2015 shall be an “Executive” hereunder or entitled to any benefit under this Plan.”

Remainder of Page Intentionally Left Blank

- 2 -

• Are transferred to employment by SFRTI immediately fr om employment by another Participating Company while in a position as an Executive of such Participating Company; and

• Have entered into an agreement with such Participating Company that provides for continuing participation in this Plan by the Executive following transfer of employment to SFRTI.”

IN WITNESS WHEREOF , the undersigned member of the Committee has executed this Amendment No. 1 as of the date

first written above.

RAI Compensation and Leadership Development Committee

By:

/s/ Nana Mensah

Name: NANA MENSAH

- 3 -

Exhibit 10.4 CONFIDENTIAL TREATMENT REQUESTED BY REYNOLDS AMERIC AN INC. – CONFIDENTIAL

PORTIONS OF THIS DOCUMENT, MARKED BY *****, HAVE BE EN REDACTED AND HAVE BEEN SEPARATELY FILED WITH THE SECURITIES AND EXCHANGE C OMMISSION PURSUANT TO RULE 24B-2

PROMULGATED UNDER THE SECURITIES EXCHANGE ACT OF 19 34, AS AMENDED.

RECIPROCAL MANUFACTURING AGREEMENT

This RECIPROCAL MANUFACTURING AGREEMENT (this “ Agreement ”) is entered into as of June 12, 2015 (the “ Effective Date ”), by and between R. J. Reynolds Tobacco Company, a North Carolina corporation (“ RJRT ”), and ITG Brands, LLC, a Texas limited liability company formerly known as Lignum-2, L.L.C. (“ Imperial ”). RJRT and Imperial are sometimes referred to in this Agreement collectively as the “ Parties ” and each, individually, as a “ Party ”; depending on the capacity in which a Party is acting under this Agreement, it may also be referred to as a Manufacturer or a Customer, as the context requires. Initially capitalized terms used throughout this Agreement have the meanings given to them in ARTICLE 1 below.

BACKGROUND

A. This Agreement is being entered into concurrently with the consummation of the transactions contemplated by that certain Asset Purchase Agreement, dated as of July 15, 2014 (as may be amended from time to time, the “ APA ”), by and among (1) RJRT’s ultimate parent company, Reynolds American Inc., a North Carolina corporation (“ RAI ”); (2) Imperial; and (3) Imperial’s ultimate parent company, Imperial Tobacco Group, PLC, a public limited company incorporated under the laws of England and Wales.

B. As of the Effective Date, RAI, through a wholly-owned subsidiary, acquired Lorillard, Inc., a Delaware corporation (“ Lorillard ”), pursuant to the terms and conditions of the Merger Agreement (as defined in the APA). Immediately prior to the closing of the transactions contemplated by the APA and the Merger Agreement, RJRT manufactured the RJRT Products at a facility in Tobaccoville, North Carolina (the “ Tobaccoville Facility ”), and Lorillard, through a wholly-owned subsidiary, manufactured the Lorillard Products at a facility in Greensboro, North Carolina (the “ Greensboro Facility ”).

C. As of the Effective Date, pursuant to the APA: (1) the rights to manufacture, distribute, market and sell the RJRT Products (but not ownership of the Tobaccoville Facility) have been transferred to Imperial, and (2) ownership of the Greensboro Facility (but not the rights to manufacture, distribute, market and sell the Lorillard Products) has been transferred to Imperial. Consequently, RJRT has the facilities for, and expertise relating to, the manufacture of the RJRT Products, but Imperial has the right to manufacture, distribute, market and sell those Products, and Imperial has the facilities for, and expertise relating to, the manufacture of the Lorillard Products, but RJRT (as the successor to Lorillard’s subsidiary) has the right to manufacture, distribute, market and sell those Products.

D. The Parties desire to enter into this Agreement to cover a transitional period during which, in addition to fulfilling their respective obligations under this Agreement, (1) Imperial will, directly or indirectly through one or more Affiliates, prepare to manufacture the RJRT Products on its own, without the need for the Tobaccoville Facility, and (2) RJRT will,

-1-

CONFIDENTIAL TREATMENT REQUESTED BY REYNOLDS AMERIC AN INC. – CONFIDENTIAL PORTIONS OF THIS DOCUMENT, MARKED BY *****, HAVE BE EN REDACTED AND HAVE BEEN

SEPARATELY FILED WITH THE SECURITIES AND EXCHANGE C OMMISSION PURSUANT TO RULE 24B-2 PROMULGATED UNDER THE SECURITIES EXCHANGE ACT OF 19 34, AS AMENDED.

directly or indirectly through one or more Affiliates, prepare to manufacture the Lorillard Products on its own, without the need for the Greensboro Facility.

E. Based on the foregoing, and subject to the terms and conditions of this Agreement, during the Term, RJRT is willing to manufacture the RJRT Products at the Tobaccoville Facility on behalf of Imperial, and Imperial is willing to manufacture the Lorillard Products at the Greensboro Facility on behalf of RJRT.

AGREEMENT

NOW, THEREFORE, in consideration of the representations, warranties and covenants set forth in this Agreement, and for other good and valuable consideration, the mutuality, receipt and sufficiency of which are hereby acknowledged, the Parties agree as follows:

ARTICLE 1 DEFINED TERMS

As used in this Agreement, the following terms will have the meanings assigned to them below:

“*****” means *****.

“*****” means *****.

“ Accounting Firm ” has the meaning set forth in Section 4.3(c) .

“ Actual Costs ” has the meaning set forth in Section 4.3(a) .

“ Additional Tobacco Raw Materials ” means ***** and ***** tobacco *****.

“ Adjustment Notice ” has the meaning set forth in Section 4.3(c) .

“ Affiliate ” has the meaning given to such term in the APA.

“ Agreement ” has the meaning set forth in the Preamble.

“ APA ” has the meaning set forth in Background Paragraph A.

“*****” has the meaning set forth in *****.

“ Certifications/Listings ” has the meaning given to such term in the APA.

“*****” means *****.

-2-



“ Cold Storage ” has the meaning set forth in Section 2.12 .

“ Confidential Information ” means: (a) information or data (whether of a technical or business nature), including that relating to research, development, know-how, inventions, Trade Secrets (including the Specifications and Sensitive Information), engineering, manufacturing, proposals and business plans, marketing plans and materials, sales, suppliers or customers, in each case, of, or in respect of, a Party or any of its Affiliates; (b) proprietary information or data of a Party or of a third Person with whom such Party has an obligation of confidence (including all such information owned by any Affiliate of such Party), whether created by a Party or its Affiliates individually or through the efforts contemplated by this Agreement; and (c) any other information, data or Intellectual Property, not publicly known, of a Party or of a third Person with whom such Party has an obligation of confidence (including all such information owned by any Affiliate of such Party); regardless of whether any of the foregoing set forth in clauses (a) - (c) above is observed or in oral, written, graphic or electronic form, and whether or not marked or otherwise identified as “confidential.”

“ Contingency Equipment ” means any equipment or machinery in the possession of a Manufacturer that, at the time of determination, is not used by the Manufacturer to manufacture any Products, and represents excess capacity or is otherwise reserved for contingency purposes.

“ Corrective Statement Onserts ” has the meaning set forth in Section 2.8(f) .

“ Cost Cap ” has the meaning set forth in Section 4.3(d)(ii) .

“ Costs ” means, without duplication, the costs and expenses incurred by a Manufacturer in connection with the manufacture and packaging of a Customer’s Products, including costs and expenses in the following categories: (a) costs of direct labor and allocated costs of indirect labor (including hourly wages, overtime, standard bonuses and allocated non-retirement benefits); (b) costs of raw materials and product components, including Additional Tobacco Raw Materials and any Corrective Statement Onserts (but, in each case, only to the extent purchased or supplied by the Manufacturer ***** pursuant to Section 2.6 ) and the allocated costs to manage inventory levels; (c) the allocated costs of handling and storing raw materials and product components, including with respect to the Customer’s Tobacco Leaf (including its Initial Tobacco Leaf Inventory), in accordance with Section 2.6(c) or 2.6(d) ; (d) allocated utility costs, including electricity, gas, water, sewer, fire sprinkler charges, refuse collection, steam, heat, cooling and any other similar services exclusively serving the Tobaccoville Facility or Greensboro Facility, as applicable; (e) ***** and allocated costs for maintenance and repair of other facilities and equipment incurred in the ordinary course of business consistent with this Agreement; (f) allocated costs for waste and disposal of raw materials, product components and other items in a manner consistent with the Specifications, including *****; (g) allocated costs for complying with applicable Laws and regulations affecting the manufacture of the Products; (h) allocated costs of insurance maintained in accordance with Section 2.7(a) ; (i) allocated costs for handling regulatory matters in accordance with Section 2.8 ; (j) direct costs for quality control

-3-



measures taken in accordance with Sections 2.3(b) and 2.6(c) ; ( k ) allocated fees for obtaining and maintaining necessary Governmental Approvals to manufacture, package and transfer the Products; ( l ) depreciation and amortization expenses over the useful life of applicable facilities and equipment; ( m ) preparation and transportation of Contingency Equipment to the extent necessary to alleviate an event of Force Majeure; ( n ) allocated property taxes; ( o ) Transfer Taxes (but only to the extent paid by the Manufacturer pursuant to Section 9.1(a) ); ( p ) federal and State excise taxes (if any) as set forth in Sections 9.1(b) and 9.1(c) ; (q) di rect costs for preparing Products for loading and transfer ; ( r ) allocated costs for the use of computers, other electronic equipment and software; ( s ) allocated overhead and administrative costs ; (t) costs incurred in obtaining Certifications/Listings in any State that requires the Manufacturer rather than the Customer to obtain such Certifications/Listings in respect of the Customer’s Products; and (u) any amount equal to a write-off of raw materials or pr oduct components based on instructions of the Customer or for reasons directly attributable to the Customer. All Costs will be calculated on the basis of U.S. generally accepted accounting principles applied on a consistent basis with historical practices for each category of Costs. All labor, administrative and overhead Costs, and other allocated Costs that are not directly and exclusively attributable to the manufacture of the Products , will be allocated on an equitable basis in accordance with the prin ciples and methodologies set forth on Exhibits B-1 (with respect to the RJRT Products) and B-2 (with respect to the Lorillard Products). Notwithstanding the foregoing, Costs will not include any of the following: (i) costs incurred by the Manufacturer as the result of any breach of its representations, warranties or covenants in this Agreement , or *****; (ii) costs incurred by a Party in its capacity as a Customer, including for the purchase of Tobacco Leaf (including the Initial Tobacco Leaf Inventory pu rchased (by Imperial) or retained (by RJRT) pursuant to the APA or otherwise); (iii) costs for extraordinary or discretionary bonuses, equity-based or equity indexed compensation or other similar compensation; (iv) employee severance costs; (v) costs assoc iated with pensions or other post-retirement benefits, including *****; (vi) costs not incurred in the ordinary course of business or not otherwise authorized by this Agreement; ( vii ) capital expenditures (except as provided in clause (l) above or as other wise agreed in advance in writing by the Parties) and *****; (viii) interest expense and other carrying costs related to borrowed funds; (ix) costs or expenses subject to reimbursement to the Manufacturer by a Person other than its Customer; ( x ) costs or e xpenses payable to any Affiliate of the Manufacturer, unless on arms-length terms; ( xi ) any late fees, penalties or similar charges, except to the extent incurred as a result of the Customer ’ s actions or at the Customer ’ s request; ( xii ) legal fees related to regulatory compliance matters; ( xiii ) any tax levied or imposed (or measured by reference to) the net income of the Manufacturer ; or (xiv) *****.

“ Customer ” means (a) with respect to the RJRT Products, Imperial, and (b) with respect to the Lorillard Products, RJRT.

“ Damages ” has the meaning set forth in Section 6.7(a) .

“*****” means *****.

-4-



“ Direct Claim ” has the meaning set forth in Section 6.7(e) .

“ Disclosing Party ” has the meaning set forth in Section 7.1(b) .

“ Effective Date ” has the meaning set forth in the Preamble.

“ Force Majeure ” means one or more of the events described in Section 9.6 .

“ Governmental Approval ” means any permit, license, approval, qualification, consent or authorization issued by a Governmental Authority, including Certifications/Listings, but excluding substantial equivalence reports and associated documents filed pursuant to Section 905(j) of the Food, Drug and Cosmetic Act, as amended by the Family Smoking Prevention and Tobacco Control Act of 2009.

“ Governmental Authority ” has the meaning given to such term in the APA.

“ Greensboro Facility ” has the meaning set forth in Background Paragraph B.

“ Indemnified Party ” has the meaning set forth in Section 6.7(a) .

“ Indemnifying Party ” has the meaning set forth in Section 6.7(a) .

“ Initial Term ” has the meaning set forth in Section 8.1 .

“ Initial Tobacco Leaf Inventory ” means (a) with respect to the RJRT Products, the RAI Leaf that was acquired by Imperial or its Affiliates on or about the Effective Date pursuant to the APA or otherwise, and (b) with respect to the Lorillard Products, the Lorillard Leaf that was retained by RJRT or its Affiliates on or about the Effective Date pursuant to the APA or otherwise; the relative amounts of RAI Leaf and Lorillard Leaf comprising the Initial Tobacco Leaf Inventory, as determined by the Parties in accordance with the APA, is set forth on Exhibit I .

“ Intellectual Property ” has the meaning given to such term in the APA.

“ Imperial ” has the meaning set forth in the Preamble.

“ Imperial Migration Plan ” means the plans and timelines for the Manufacturing Migration in respect of the RJRT Products as set forth on Exhibit F , which will be reasonably coordinated with the RJRT Migration Plan and be designed to minimize, to the extent reasonably possible, inefficiencies and excess capacities at the affected facilities.

“ Law ” means any law, statute, code, ordinance, rule, regulation or other requirement of any Governmental Authority.

-5-



“ Lorillard ” has the meaning set forth in Background Paragraph B.

“ Lorillard Leaf ” has the meaning given to such term in the APA.

“ Lorillard Products ” means, collectively, those products relating to the brands and brand styles identified under the heading “Lorillard Products” on Exhibit A .

“ Long-Term Forecast ” has the meaning set forth in Section 3.1 .

“ Manufacturer ” means (a) with respect to the RJRT Products, RJRT, and (b) with respect to the Lorillard Products, Imperial.

“ Manufacturing Fee ” has the meaning set forth in Section 4.1 .

“ Manufacturing Migration ” has the meaning set forth in Section 2.11 .

“ Merger Agreement ” has the meaning given to such term in the APA.

“ Migration Machinery ” means such agreed upon machinery and equipment (including agreed upon spare parts) used by a Manufacturer for the manufacturing or packaging of the Customer’s Products, which in connection with the Manufacturing Migration of such Products, is reasonably required for production at the Customer’s production facilities, and which (a) with respect to the RJRT Products, are set out in the Imperial Migration Plan, and (b) with respect to the Lorillard Products, are set out in the RJRT Migration Plan.

“ NAAG ” has the meaning given to such term in the APA.

“ Non-Conforming Products ” means Products that (a) do not fall within the control and rejection standards of the Specifications for such Products, in each case, as defined in Exhibit C-1 or C-2 , as applicable, or (b) are otherwise manufactured, packaged, stored or packed in breach of the Manufacturer’s representations, warranties or obligations in this Agreement ( provided that , for purposes of this definition, matters concerning conformance or compliance with the Specifications are exclusively addressed in clause (a) hereof).

“ Objection Period ” has the meaning set forth in Section 4.3(c) .

“ Order ” means Order #51 – Remand, Consent Order Implementing the Corrective Statements Remedy under Order #1015 and Order #34 – Remand, issued in the case styled as United States v. Philip Morris USA Inc. , 449 F. Supp. 2d 1, 938-41 (D.D.C. 2006), aff’d in part & vacated in part , 566 F.3d 1095 (D.C. Cir. 2009) ( per curiam ), cert. denied , 561 U.S. __, 130 S. Ct. 3501 (2010), and/or any subsequent order(s) modifying RJRT’s or Imperial’s obligations thereunder.

-6-



“ Packaging ” means containment materials of Products (including containme nt materials that provide enclosure

features of Products) for the purpose of distribution and sale to end consumers (including materials for packages, cartons and cases, as applicable and as the case may be), and including component materials referred to a s paper, paper-board, foil, formed metal, molded plastic, closures, labels, films, tear tapes, optional pack inserts and onserts (including any Corrective Statement Onserts), including all graphics, holographics and printed matter on such materials.

“ Party ” or “ Parties ” has the meaning set forth in the Preamble.

“ Person ” has the meaning given to such term in the APA.

“ Product ” or “ Products ” means any one or more of the RJRT Products or the Lorillard Products, as the context requires.

“ Purchase Order ” means a purchase order containing the information specified in Section 3.2(a) , as well as the following information about an order for Products in accordance with this Agreement: (a) identity of Products ordered (by SKU); (b) quantity of Products ordered; (c) delivery instructions and required delivery date(s) for the Products; (d) shipping/transfer instructions; (e) consignee identification, if any; (f) contact personnel; (g) marking requirements for packing; (h) matters including “bill to” and “sold to”; and (i) such other requirements or information as the Customer or the Manufacturer may reasonably specify or require.

“ RAI ” has the meaning set forth in Background Paragraph A.

“ RAI Leaf ” has the meaning given to such term in the APA.

“ Recall ” has the meaning set forth in Section 2.8(e) .

“ Receiving Party ” has the meaning set forth in Section 7.1(b) .

“ Recon ” means reconstituted tobacco sheets used as a raw material for manufacturing the applicable Product and meeting the Specifications for that Product.

“ Recon Supply Agreement ” means that certain Supply Agreement for Reconstituted Tobacco, dated on or about the Effective Date, between RJRT, as the supplier, and Imperial, as the customer.

“ Renewal Term ” has the meaning set forth in Section 8.1 .

“ RJRT ” has the meaning set forth in the Preamble.

-7-



“ RJRT Migration Plan ” means the plans and timelines for the Manufacturing Migration in respect of the Lorillard

Products as set forth on Exhibit F , which will be reasonably coordinated with the Imperial Migration Plan and be designed to minimize, to the extent reasonably possible, inefficiencies and excess capacities at the affected facilities.

“ RJRT Products ” means, collectively, those products relating to the brands and brand styles identified under the heading “RJRT Products” on Exhibit A .

“ Sensitive Information ” has the meaning set forth in Section 4.3(a) .

“ Short-Term Forecast ” has the meaning set forth in Section 3.2 .

“ Specifications ” means (a) with respect to the RJRT Products, the specifications and standards used by RJRT to manufacture the RJRT Products at the Tobaccoville Facility immediately prior to the Effective Date, including information submitted by RJRT to the U.S. Food and Drug Administration and information with respect to the Packaging of the RJRT Products, and (b) with respect to the Lorillard Products, the specifications and standards used by Lorillard Tobacco Company, a subsidiary of Lorillard, to manufacture the Lorillard Products at the Greensboro Facility immediately prior to the Effective Date, including information submitted by Lorillard to the U.S. Food and Drug Administration and information with respect to the Packaging of the Lorillard Products; in each case, including information, specifications and standards for any of the following: (i) ingredients; (ii) compositions or materials; (iii) formulations; (iv) recipes; (v) process conditions; (vi) physical properties, including weight; (vii) chemical properties, including shelf life; (viii) appearance, including size, shape and color; (ix) quality standards or indices; (x) graphics or indicia; (xi) Packaging materials and requirements; (xii) packing processes and materials for transfer; (xiii) storage requirements and guidelines; and (xiv) tolerances relating to any of the foregoing, all as may be amended from time to time by written agreement between the Parties.

“ Standard Costs ” means (a) with respect to the RJRT Products, the estimated Costs for each such Product as set forth on Exhibit B-1 , and (b) with respect to the Lorillard Products, the estimated Costs for each such Product as set forth on Exhibit B-2 ; in each case (i) adjusted to account for the manner in which Tobacco Leaf is acquired by or on behalf of each Customer pursuant to Section 2.6(b) , and (ii) subject to adjustment pursuant to Section 4.2(b) .

“ States ” has the meaning given to such term in the APA.

“ State Settlements ” has the meaning given to such term in the APA.

“ Supplemental Order ” means the order expected to be issued by the United States District Court for the District of Columbia in the case styled as United States v. Philip Morris USA Inc. , 449 F. Supp. 2d 1, 938-41 (D.D.C. 2006), aff’d in part & vacated in part , 566 F.3d 1095 (D.C. Cir. 2009) ( per curiam ), cert. denied , 561 U.S. __, 130 S. Ct. 3501 (2010), subjecting

-8-



Imperial to the jurisdiction of such Court and setting forth the requirements (expected to be substantially similar to those set forth in the Order), and incorporating certain provisions of the Order that I mperial must meet with respect to the RJRT Products, and/or any subsequent order(s) modifying Imperial’s obligations thereunder.

“ Term ” has the meaning set forth in Section 8.1 .

“ Third Party Claim ” has the meaning set forth in Section 6.7(b) .

“ Tobacco Leaf ” means tobacco leaf (and resulting tobacco by-products), *****, virgin tobacco stems and virgin tobacco scrap, in each case, used as raw materials for manufacturing the applicable Product and meeting the Specifications for that Product, excluding any Additional Tobacco Raw Materials.

“*****” has the meaning set forth in *****.

“ Tobaccoville Facility ” has the meaning set forth in Background Paragraph B.

“ Trademark Agreement ” means that certain Retained Trademarks and Retained UPC Codes Agreement, dated on or about the Effective Date, between RJRT and Lorillard Licensing Company, LLC, as the licensors, and Imperial, as the licensee.

“ Trade Secret ” means information and data, including Specifications and Sensitive Information, that: (a) derive independent economic value, actual or potential, from not being generally known to the public or other Persons who can obtain economic value from their disclosure and use, and (b) are the subject of efforts that are reasonable under the circumstances to maintain their secrecy.

“ Transfer Taxes ” has the meaning set forth in Section 9.1(a) .

“ True-Up Statement ” has the meaning set forth in Section 4.3(a) .

ARTICLE 2 MANUFACTURING AND RELATED RESPONSIBILITIES

2.1 Reciprocal Appointments . Imperial hereby appoints RJRT as Imperial’s exclusive manufacturer of Imperial’s requirements for the RJRT Products for sale in the States, and RJRT hereby appoints Imperial as RJRT’s exclusive manufacturer of RJRT’s requirements for the Lorillard Products for sale in the States; provided that either such Customer may manufacture its own requirements (or any portion thereof) of its Products while implementing its Manufacturing Migration in accordance with Section 2.11 . RJRT will not be required to manufacture any product for Imperial other than the RJRT Products, and Imperial will not be required to manufacture any product for RJRT other than the Lorillard Products.

-9-



2.2 Manufacturing Facilities; Workforce; Inspections .

(a) During the Term, (i) RJRT agrees to manufacture the RJRT Products exclusively at the Tobaccoville Facility in accordance with the Specifications, and (ii) Imperial agrees to manufacture the Lorillard Products exclusively at the Greensboro Facility in accordance with the Specifications. Subject to Sections 2.3(e) and 2.11(b) , (A) RJRT agrees to maintain the Tobaccoville Facility and all equipment used or useful in the manufacture of the RJRT Products (and all components thereof) in good, clean, safe and hygienic condition and repair (subject only to normal wear and tear), and (B) Imperial agrees to maintain the Greensboro Facility and all equipment used or useful in the manufacture of the Lorillard Products (and all components thereof) in good, clean, safe and hygienic condition and repair (subject only to normal wear and tear). Subject to Sections 2.3(e) and 2.11(b) , each Manufacturer agrees to maintain production capacity at the Tobaccoville Facility or Greensboro Facility, as applicable, to manufacture the applicable Products in the volumes projected in the most-recently provided Short-Term Forecast for such Products, subject to the limitations set forth in Section 3.2(a) .

(b) During the Term, each Manufacturer agrees to employ a sufficient workforce with the requisite ability, experience, expertise and licensure to manufacture the Products in accordance with the Specifications and other requirements of this Agreement.

(c) Representatives of each Customer may, upon reasonable notice and at times and frequencies reasonably acceptable to the applicable Manufacturer, visit and inspect the Tobaccoville Facility or Greensboro Facility, as the case may be, where the Products are being manufactured, packaged and stored. Each Customer will bear its own expenses with regard to any such visits, unless otherwise agreed in writing by the Parties. If requested by any Customer, the relevant Manufacturer will cause appropriate individuals working on the activities relating to this Agreement to be available for meetings during any such visit and inspection. The visitation and inspection rights covered by this Section 2.2(c) include the right to inspect all inventory of the Products, the manufacturing, packaging and storage facilities and processes relating to the manufacture, packaging and storage of the Products (including quality control measures) and the machinery, equipment and materials used in all such processes (including the storage and handling of the Customer’s Initial Tobacco Leaf Inventory or subsequently procured Tobacco Leaf or Additional Tobacco Raw Materials). Each Customer will be responsible for ensuring that its representatives abide by all of the Manufacturer’s standard rules and procedures with regard to safety, regulatory compliance, security, personnel matters, confidentiality, computer use and computer network use while at the Manufacturer’s facilities. In addition, each Customer will be responsible for ensuring that its representatives refrain from actions and conduct that materially interfere with the Manufacturer’s business and operations, and will instruct such representatives not to conduct unauthorized activities at the Manufacturer’s facilities or otherwise. Notwithstanding the foregoing, however, if a Manufacturer is then in breach of any of its representations, warranties or covenants in this Agreement (or the Customer has a reasonable basis to assert any such breach), then the Customer may visit and inspect the

-10-



Manufacturer’s facility on 24 hours’ notice and, in the event of such breach, the costs and expenses of such visit and inspection will be the responsibility of the Manufacturer.

2.3 Specifications .

(a) Each Customer agrees to provide to its Manufacturer, on the Effective Date, a full set of the Specifications required to manufacture and package such Customer’s Products in accordance with this Agreement. The control and rejection standards for the Specifications are defined in Exhibits C-1 (for the RJRT Products) and C-2 (for the Lorillard Products).

(b) During the Term, the Manufacturer will use the same quality control measures as were used in connection with the manufacture of the Products immediately before the Effective Date or, subject to the approval of the Customer, which approval may not be unreasonably withheld or delayed, such other quality control standards as the Manufacturer may elect to apply consistent with the quality control standards the Manufacturer uses for cigarette brands that it manufactures for its own account.

(c) If a Customer desires to modify the Specifications for one or more of its Products, then such Customer will inform the Manufacturer in writing of such desired modifications. The Manufacturer will implement such modifications to the extent they relate to Corrective Statement Onserts as required by, and in accordance with, Section 2.8(f) , and will reasonably cooperate with all other such desired modifications; provided that the Manufacturer will not be required to make any such other modifications (i) if, in the good faith judgment of the Manufacturer, such modifications would unreasonably interfere with the manufacture of its own products, including *****, (ii) that require capital expenditures or other costs that would not be fully reimbursed by the Customer to the reasonable satisfaction of the Manufacturer, or (iii) if a Governmental Approval is required for such modifications, if such Governmental Approval has not yet been obtained. If a Manufacturer does not intend to implement any change to its Customer’s Specifications, it will notify its Customer in writing, citing the reason or reasons for such intention, as soon as practicable after the Customer’s request to change its Specifications and, in any event, within ten business days of such request.

(d) A Manufacturer may not modify the Specifications for any of its Customer’s Products without the prior written consent of that Customer; provided that : (i) the Manufacturer may *****, (ii) the Manufacturer must (A) follow its Customer’s instructions in accordance with Section 6.6 with respect to the rotation and use of relevant Surgeon General warning labels, and (B) affix Corrective Statement Onserts and include them in the Packaging for the Customer’s Products to the extent required by, and in accordance with, Section 2.8(f); and (iii) the Parties may agree from time to time on other routine manufacturing activities. None of the actions taken, or agreed to, by a Manufacturer pursuant to this Section 2.3(d) will constitute an unauthorized modification of the Customer’s Specifications.

-11-



(e) The Parties acknowledge that, in order for a Manufacturer to meet its obligations under this

Agreement, the Manufacturer will, from time to time, carry out customary maintenance activities on the Tobaccoville Facility and its equipment or Greensboro Facility and its equipment, as applicable, to ensure that manufactured Products and the manufacturing process in respect there of continue to conform to their Specifications. The Manufacturer agrees to schedule such maintenance activities in a manner that does not unreasonably disrupt manufacturing or delivery schedules.

(f) The Parties will cooperate with one another (and relevant third Persons) to ensure that each Party is provided with relevant information regarding the physical and chemical properties (including toxicological information) of raw materials, equipment, manufacturing processes and conditions and other processes that a Manufacturer may employ when producing Products. If requested by a Customer, the Manufacturer will provide samples of Products or raw materials, at the times and in the amounts reasonably requested, to the Customer or its designee for testing and evaluation against the Specifications, whether in connection with a Manufacturing Migration or otherwise.

2.4 Intentionally Omitted .

2.5 Packaging . Each Customer will be responsible for ensuring that the Specifications for the Packaging used on its Products are such that the Packaging bears markings as required by applicable Laws and Governmental Approvals.

2.6 Raw Materials; Tobacco Leaf; ***** ; Inventory .

(a) Subject to Section 2.6(b) , and unless otherwise agreed in writing between a Manufacturer and its Customer, the Manufacturer will purchase and be responsible for supplying the raw materials and product components that are to be used by it in manufacturing and packaging the Customer’s Products in accordance with the Specifications, including any Additional Tobacco Raw Materials.

(b) Notwithstanding anything to the contrary in Section 2.6(a) , and unless otherwise agreed in writing between a Manufacturer and its Customer, the procurement of Tobacco Leaf and ***** to be used in the manufacture of the Products will be handled as follows:

(i) Each Customer will be responsible for procuring the Tobacco Leaf to be used in the manufacture of its Products, which will initially be comprised of that Customer’s Initial Tobacco Leaf Inventory and thereafter be procured by such Customer in accordance with this Section 2.6(b) ; provided that , *****.

-12-



(ii) Imperial will acquire Recon for the RJRT Products from RJRT subject to the terms and

conditions set forth in, and during the term of, the Recon Supply Agreement.

(iii) Each Customer agrees to acquire Tobacco Leaf (other than *****) required for the production of its Products (and, with respect to Imperial, its requirements for Tobacco Leaf for the Maverick tobacco cigarette brand) pursuant to *****, as more specifically described on Exhibit I . Except as provided in Exhibit I , RJRT agrees to provide the Tobacco Leaf to be acquired by Imperial under the ***** as it is delivered, *****.

(iv) *****.

(v) Imperial will acquire ***** to be used in the manufacture of the Lorillard Products for RJRT from *****.

Throughout the Term, the Customer will retain exclusive title to any raw materials or product components that it procures and provides to the Manufacturer for the manufacture of such Customer’s Products, including all Tobacco Leaf procured by such Customer (including its Initial Tobacco Leaf Inventory), and at no time will title thereto transfer to the Manufacturer even though the Manufacturer will possess or control such materials at its facilities and will be responsible for insuring such materials in accordance with Section 2.7(a) and have the risk of loss with respect to such materials in accordance with Section 5.2 . In addition, in the event that a Customer procures any raw materials or product components (in addition to its Tobacco Leaf) necessary for the manufacture of its Products by the Manufacturer, the Manufacturer and the Customer will cooperate in good faith to equitably adjust the Standard Costs for the Products into which those raw materials or product components are incorporated for the purpose of the Manufacturer’s relevant invoice or invoices prepared pursuant to Section 4.2 . Subject to the foregoing, and unless otherwise agreed in writing between the Manufacturer and the Customer, the Manufacturer will be solely responsible for purchasing, receiving, storing, maintaining, using and disposing of all raw materials and product components, in each case, in accordance with the Specifications or, if not addressed by the Specifications, as set forth in this Agreement or as otherwise reasonably instructed by the Customer.

(c) Unless the Parties otherwise agree in writing, they will cause (i) the Tobacco Leaf to be used for production of the RJRT Products at the Tobaccoville Facility to be delivered to RJRT’s storage facility located in *****, and (ii) the Tobacco Leaf to be used for production of the Lorillard Products at the Greensboro Facility to be delivered to Imperial’s storage facility located in *****, in each case, including any Tobacco Leaf procured pursuant to *****. The applicable Customer will be solely responsible for re-ticketing and/or relabeling the Tobacco Leaf to be used for the manufacture of its Products in accordance with its own standards and practices. Each Manufacturer will cause the Tobacco Leaf received at its storage facility to be received, cared for and stored in accordance with the Specifications and, if not addressed in the Specifications, then in accordance with the same standards used to receive, care for and store

-13-



its own raw materials and product components and, in any event, in a commercially reasonable manner, including with respect to security, fumigation, infestation and environmental contr ols. The Manufacturer will remove its Customer’s Tobacco Leaf from the storage facility on an as-needed basis for the manufacture of the Customer’s Products. Once received at the manufacturing facility, the Manufacturer will inspect raw materials and pro duct components to be used in manufacturing its Customer’s Products (*****) using the same inspection measures that were used in connection with the manufacture of the Products immediately before the Effective Date or such other inspection measures as are mutually agreed upon by the Manufacturer and its Customer. The Manufacturer will promptly notify the Customer in the event that the Manufacturer’s inspections of raw materials or product components (including Tobacco Leaf) identify any quality or quantity issues and, if necessary, implement the procedures set forth in Section 2.6(f) and otherwise, to the extent practicable, consult with the Customer in addressing those issues with the supplier. Each Customer will be solely responsible for all in-bound tra nsfer, handling and logistics expenses associated with its Tobacco Leaf stored in accordance with this Section 2.6(c) , including any such expenses associated with transporting such Tobacco Leaf from storage facilities to manufacturing facilities .

(d) Subject to Section 2.6(c) , the Manufacturer agrees to receive, care for and store all raw materials and product components, including its Customer’s Tobacco Leaf (including its Initial Tobacco Leaf Inventory) and any other raw materials or product components procured by such Customer for use in the manufacture of its Products by the Manufacturer, in accordance with the Specifications and, if not addressed in the Specifications, then in accordance with the same standards used to receive, care for and store its own raw materials and product components and, in any event, in a commercially reasonable manner, including with respect to security, fumigation, infestation and environmental controls.

(e) Each Manufacturer will (i) maintain a sufficient supply of raw materials and product components to meet each Customer’s Short-Term Forecast in a timely manner (but will not be responsible for the level of supply of any such raw materials or product components that the Customer sources directly pursuant to Section 2.6(a) or 2.6(b) ), and (ii) use commercially reasonable efforts to avoid holding raw materials or product components materially in excess of the levels called for by such Short-Term Forecast; provided that the foregoing requirements will not apply to Tobacco Leaf procured by a Customer for use in the manufacture of its Products by the Manufacturer (including the Customer’s Initial Tobacco Leaf Inventory), it being understood that if such Customer’s Initial Tobacco Leaf Inventory is insufficient to complete production of the applicable Products during the entire Term, that Customer will procure additional Tobacco Leaf meeting the Specifications for such Products and in accordance with Section 2.6(a) or 2.6(b) . Each Manufacturer will track its Customer’s inventory of Tobacco Leaf and monitor the infestation levels thereof in accordance with the principles and methodologies (including with respect to acceptable waste) set forth on Exhibit J , and will furnish its Customer the following reports, each prepared in accordance with such principles and methodologies: (A) a monthly inventory tracking report, which may be provided

-14-



with each invoice submitted in accordance with Section 4.2(a) , and (B) from May 1 through October 31 of each year, a weekly inventory infestation report. Each Customer and its Manufacturer will communicate to ensure that the Manufacturer has enough inventory and that both Parties have accurate information regarding inv entory levels and requirements.

(f) *****.

(g) *****.

2.7 Insurance .

(a) Each Manufacturer will maintain throughout the Term with financially sound and reputable carriers insurance in such amounts and against such risks (including loss or damage by fire and loss in transit; theft, burglary, larceny and other criminal activities; business interruption; and general liability) and such other hazards as is customarily maintained by companies engaged in the same or similar businesses operating in the States. Each Manufacturer will cause its Customer to be named as a loss payee, as its interests appear, on all such insurance policies covering personal property. Upon request, each Manufacturer will furnish to its Customer (i) a certificate of insurance evidencing such insurance coverage and the Customer’s designation as such a loss payee, and (ii) such other information in reasonable detail as to the insurance so maintained. In addition to, and without limiting the generality of, the foregoing, each Manufacturer will have the risk of loss with respect to and (A) will insure its Customer’s Tobacco Leaf (including its Initial Tobacco Leaf Inventory) in such Manufacturer’s possession or control at its facilities (including its storage facilities used in accordance with Section 2.6(c) or 2.12 ) as it customarily maintains on its own raw materials inventory, and (B) except as set forth in Section 2.11(d) , will insure the Migration Machinery in such Manufacturer’s possession or control, regardless of the actual ownership of such machinery.

(b) Subject to Section 2.11(d) , in case of any damage to or destruction of a Customer’s property (including a Customer’s Tobacco Leaf and the Migration Machinery) while it is in the possession or control of a Manufacturer, due to an event of Force Majeure or otherwise, (i) the Manufacturer will provide prompt written notice thereof to the Customer describing generally the nature and extent of such damage or destruction; (ii) the Manufacturer will then promptly commence, or cause to be commenced and, to the extent feasible under the circumstances, complete, or cause to be completed, repair or replacement (as applicable) of the Customer’s property to a condition and character thereof substantially equivalent to that existing immediately prior to such damage or destruction (it being understood that if it is not feasible to complete such repair or replacement, the Customer will be entitled to Damages for the value of the applicable property); and (iii) in connection with such repair or replacement of the Customer’s property, the Manufacturer will promptly make any applicable claims against insurance and use the net proceeds from any such insurance recoveries towards such repair or replacement.

-15-



2.8 Cooperation on Regulatory Matters; Governmental Approvals .

(a) Each Party agrees to cooperate with any reasonable requests for assistance from the other Party with respect to (i) obtaining and maintaining any and all Governmental Approvals (including taking the actions described on Exhibit E ), (ii) responding to requests for information from any and all Governmental Authorities, and (iii) complying with any and all applicable Laws required in connection with the relevant Product or this Agreement, including at each such Party’s own cost, the following: (A) making its employees, consultants and other staff available upon reasonable notice during normal business hours to attend meetings with Governmental Authorities concerning the manufacturing process, equipment and machinery, raw materials and product components and Products; and (B) disclosing and making available to the other Party, in whatever form such Party may reasonably request, all information relating to the relevant Product, in each case, as is reasonably necessary or desirable to prepare, file, obtain and maintain any such Governmental Approval of the Product in the States. In addition, each Party agrees to use its commercially reasonable efforts to obtain at the earliest practicable date all Governmental Approvals required, but not yet obtained, for such Party to provide and transfer any ***** to the other Party.

(b) Each Manufacturer agrees, to the extent that any State requires the Manufacturer rather than the Customer to obtain a Certification/Listing in the State, to obtain and maintain such Certification/Listing during the Term, including taking any actions in connection therewith as set forth in the APA.

(c) Each Manufacturer will promptly notify its Customer in writing of, and will provide such Customer with copies of, any correspondence and other documentation received by the Manufacturer from a third Person in connection with any of the following events: (i) any inspection or audit of such Manufacturer’s facility by or on behalf of any Governmental Authority; (ii) receipt of a communication (oral or written), regulatory letter, warning, inquiry, request for information or similar item from or on behalf of any Governmental Authority in connection with, or related to, the Customer’s Products, any such inspection or audit of the manufacture of the Customer’s Products or any other activity conducted as part of the manufacturing process for such Products; (iii) receipt of any regulatory comments relating to the manufacture of the Customer’s Products requiring a response or action by any Party or notice of any safety or toxicity issue regarding the Customer’s Products; or (iv) test results that indicate that any of the Customer’s Products may be Non-Conforming Products.

(d) Each Manufacturer will (i) notify its Customer (by telephone and in writing) of any notice that the Manufacturer receives, or any knowledge that the Manufacturer otherwise acquires, of an event or complaint that asserts any material environmental or human health and safety concerns or risks (excluding inherent risks associated with the Products themselves) in respect of the Customer’s Products no later than the second business day following the Manufacturer’s receipt of such notice or its acquisition of such knowledge, as the case may be, and (ii) provide its Customer with copies of any written materials received in

-16-



connection with or as part of any such report not later than the second business day following the Manufacturer’s receipt thereof.

(e) Each Party will promptly notify the other Party in writing if such first Party reasonably believes that a recall, field alert, Product withdrawal or field correction (each, a “ Recall ”) of a Customer’s Product (or any of its components) may be necessary or advisable. With respect to implementing any Recall, or otherwise dealing with any Recall in any respect, the Customer will make all contacts with the applicable Governmental Authorities and will be responsible for coordinating, managing and controlling all of the necessary activities in connection with any such Recall; provided that the Manufacturer may take any action it deems reasonably necessary in order to comply with applicable Law. The Manufacturer will cooperate with any reasonable requests for assistance from its Customer with respect to considering or implementing a Recall, including retaining, and not releasing for sale to consumers, any affected Products (or product components) that are still in the Manufacturer’s possession or control. The Manufacturer will not, and will ensure that its Affiliates do not, issue any press release or make any public statement regarding any Recall in respect of its Customer’s Products (or product components) without the prior written consent of that Customer. The Customer will review and investigate with the Manufacturer the relevant facts underlying any issues related to the Manufacturer that may result in a Recall prior to implementing it (to the extent reasonably practicable). The Customer will bear the costs and expenses of each Recall, unless the Manufacturer is obligated to indemnify the Customer for such costs and expenses pursuant to Section 6.7 , in which case, in addition to and not in limitation of, any rights the Customer may have under this Agreement (including Section 6.7 ) or applicable Laws: (i) the Customer will continue to manage, coordinate and control the Recall and any and all of the necessary activities in connection with such Recall; and (ii) the Manufacturer will promptly reimburse the Customer for any and all documented costs reasonably incurred by the Customer with respect to such Recall, including associated retrieval of Product, returns of Product, destruction of Product, replacement of Product, and fees and penalties owed to third Persons (but excluding personnel and overhead costs incurred by the Customer internall y).

(f) The Parties acknowledge that, during the Term, RJRT may become subject to the Order and Imperial may become subject to the Supplemental Order, in each case, once such Order or Supplemental Order has become final and non-appealable (or RJRT and Imperial (if applicable), with respect to the Order, or Imperial, with respect to the Supplemental Order, withdraws or otherwise fails to pursue any such appeal). The Parties further acknowledge that the Order currently requires, and the Supplemental Order is expected to require, each of the Products to be packaged and distributed during specific time periods with onserts that provide certain “corrective statements” and otherwise comply with the Order or the Supplemental Order, as applicable (collectively, the “ Corrective Statement Onserts ”). If, during the Term, RJRT becomes subject to the Order as it relates to Corrective Statement Onserts, then Imperial (as RJRT’s Manufacturer of the Lorillard Products) agrees to (i) affix the Corrective Statement Onserts and include them in the Packaging for the Lorillard Products in accordance with the

-17-



Order (provided that Imperial will be permitted to affix such compliant Corrective Statement Onserts using its own equipment and machinery), and (ii) otherwise coope rate with any reasonable request from RJRT in connection with Packaging the Lorillard Products in a manner to comply with the Order as it relates to Corrective Statement Onserts. Similarly, if, during the Term, Imperial becomes subject to the Supplemental Order and/or the Order, as modified by the Supplemental Order as either relates to Corrective Statement Onserts, then RJRT (as Imperial’s Manufacturer of the RJRT Products) agrees to (A) affix the Corrective Statement Onserts and include them in the Packa ging for the RJRT Products, all in accordance with the Supplemental Order and/or the Order, as modified by the Supplemental Order (provided that RJRT will be permitted to affix such compliant Corrective Statement Onserts using its own equipment and machine ry), and (B) otherwise cooperate with any reasonable request from Imperial in connection with Packaging the RJRT Products in a manner to comply with the Supplemental Order and/or the Order, as modified by the Supplemental Order as either relates to Correct ive Statement Onserts.

2.9 Limited License for Intellectual Property . Each Customer hereby grants (or will cause its Affiliates holding any applicable Intellectual Property to grant) to its Manufacturer a fully paid-up, non-exclusive, non-transferrable, non-sublicensable license to use such of the Customer’s (or its Affiliate’s) Intellectual Property in respect of the Products solely as is necessary to enable the Manufacturer to perform its obligations under this Agreement with respect to the manufacture and packaging of the Products on behalf of the Customer. Each Manufacturer will treat, use and apply that Intellectual Property in respect of the Products only in strict compliance with any limitations, restrictions and instructions that may be prescribed in writing to the Manufacturer by the Customer, through the Specifications or otherwise. The Manufacturer is not entitled to use the Intellectual Property in respect of the Products in any other manner without the prior written consent of the Customer. The Parties acknowledge and agree that any Intellectual Property relating exclusively to each Customer’s Products which arises from the manufacture of such Customer’s Products, or the performance of any other obligations in relation to such manufacture, under this Agreement or otherwise, will vest in the respective Customer (or any of its designated Affiliates). Each Party acknowledges and agrees that if and to the extent that any Intellectual Property relating exclusively to a Customer’s Product unintentionally vests in the Manufacturer (or any of its Affiliates), the Manufacturer will, and will cause any such Affiliates to, at no cost to the Customer, transfer the full, right, title and interest in such Intellectual Property to the Customer (or its Affiliates).

2.10 Project Teams . Promptly after the Effective Date, each Party will designate a project team of its primary contact individuals for purposes of this Agreement, each of which must include representatives reasonably acceptable to the other Party and which may include different team members when the Party is acting as a Customer and when it is acting as a Manufacturer. Each Party will be entitled to change the members of its project team, and will notify the other Party of any such changes. Each Party’s project team will serve as the primary point of contact between the Parties for purposes of the transactions covered by this Agreement,

-18-



and will be primarily responsible for facilitating the flow of information and otherwise promoting c ommunication, coordination and collaboration between the Parties. The project teams will conduct regular telephone, video conference or in-person meetings as deemed necessary or appropriate to exchange information regarding the transactions covered by thi s Agreement, and at a minimum, the project teams will conduct monthly meetings to discuss general operations under this Agreement, including matters concerning the Products, the status of each Customer’s Manufacturing Migration, Long-Term Forecasts, Short- Term Forecasts, inventory levels (including the levels of applicable Tobacco Leaf and Additional Tobacco Raw Materials), materials sourcing, quality control, mitigation of Costs and any disputes or controversies affecting a Party’s rights or obligations un der this Agreement. All disputes and controversies, or other issues, identified by the project teams during any such meetings will be promptly evaluated, addressed and remedied as soon as commercially reasonable.

2.11 Transition to Customer Manufacturing .

(a) The Parties acknowledge that the arrangements contemplated by this Agreement are intended to be temporary in nature and, subject to ARTICLE 8 , last (i) with respect to the appointment of RJRT as the manufacturer of Imperial’s requirements for the RJRT Products, for such time as anticipated in the Imperial Migration Plan, or if later, until such time as Imperial, in its reasonable judgment, has determined that it is prepared and capable of manufacturing (or having manufactured) the RJRT Products on its own, and (ii) with respect to the appointment of Imperial as the manufacturer of RJRT’s requirements for the Lorillard Products, for such time as anticipated in the RJRT Migration Plan, or if later, until such time as RJRT, in its reasonable judgment, has determined that it is prepared and capable of manufacturing (or having manufactured) the Lorillard Products on its own (each, a “ Manufacturing Migration ”). Each Customer will use its commercially reasonable efforts to effect a Manufacturing Migration, and each Manufacturer agrees to reasonably cooperate with its Customer to facilitate such Customer’s Manufacturing Migration, in each case, in accordance with the RJRT Migration Plan or the Imperial Migration Plan, as the case may be, unless otherwise agreed in writing between the Parties.

(b) Each Manufacturer agrees to maintain the Migration Machinery (and all components thereof) in its possession or control in good, clean, safe and hygienic condition and repair in the ordinary course of business (subject only to normal wear and tear); provided that , if a Manufacturer reasonably expects to incur maintenance or repair costs in excess of ***** with respect to any particular maintenance event (or during any period of 30 consecutive days), then (i) the Manufacturer will promptly notify its Customer thereof, including a reasonably-detailed description of the required maintenance and repairs, and (ii) within ten days after receipt of any such notice, the Customer may instruct the Manufacturer not to undertake all or any of the subject maintenance or repairs, but if the Customer fails to timely respond with any such instructions, then the Customer will be deemed to have approved such maintenance and repairs, as described in the Manufacturer’s notice. Notwithstanding anything to the contrary in this

-19-



Agreement, if a Customer instructs its Manufacturer not to undertake maintenance or repairs pursuant to this Section 2.11(b) and, as a result, the subject Migration Machinery fails to produce Produ ct in accordance with this Agreement, then the Customer assumes the risk thereof and the Manufacturer will not be liable therefor.

(c) In connection with a Manufacturing Migration, the Manufacturer will, on the reasonable request of the Customer, allow for the reasonable use of the Manufacturer’s Migration Machinery, and provide reasonable manufacturing assistance, for purposes of ensuring, to the reasonable satisfaction of the Customer, that its products are identical to the Customer Products as produced by the Manufacturer.

(d) In addition to the indemnification provisions set forth in Section 6.7 (but subject to the limitations set forth therein), each Customer agrees to indemnify, defend and hold harmless its Manufacturer’s Indemnified Parties from and against any and all Damages that any such Indemnified Party may suffer in connection with, or arising out of, the activities of the Customer, the Customer’s Affiliates or any of its or their respective officers, directors, employees, representatives, agents or contractors conducted on the premises of the Manufacturer or any of its Affiliates in connection with the Manufacturing Migration, including with respect to the removal of any of the Migration Machinery, except to the extent such Damages are caused by a Manufacturer Indemnified Party. Prior to entering the premises of the Manufacturer or any of its Affiliates, the Customer will provide the Manufacturer with a certificate of insurance, naming the Manufacturer or the applicable Affiliate as an additional insured and evidencing commercial general liability insurance coverage for any Person that will enter the premises of the Manufacturer or any of its Affiliates in order to remove any of the Migration Machinery on behalf of the Customer, which insurance coverage must be reasonably acceptable to the Manufacturer. The risk of loss with respect to each item of Migration Machinery will pass to the Customer when it commences the removal process thereof from the premises of its Manufacturer or any of its Affiliates.

(e) *****.

(f) In connection with a Manufacturing Migration, and on the request of one Party to the other, the Parties agree to negotiate in good faith with respect to the supply of any excess non-Tobacco Leaf components by one Party to the other (including paper and wrapping materials, *****, and Packaging materials), in order to help ensure the successful manufacture of the applicable Products by the Customer immediately following such Manufacturing Migration, with m inimal disruptions and in accordance with the Specifications. Any such supply agreement will provide for a price equal to ***** and include other customary terms and conditions.

(g) *****.

(h) Each Customer will use its commercially reasonable efforts, but will not be required, to achieve a Manufacturing Migration as soon as practicable after the Effective Date

-20-



and, in any event, will endeavor to achieve a Manufacturing Migration before the expiration of the Initial Term.

(i) In connection with a Manufacturing Migration, to the extent that RJRT is subject to the Order (as it relates to Corrective Statement Onserts) while the Manufacturing Migration is occurring, Imperial shall reasonably cooperate with RJRT to ensure that Corrective Statement Onserts are affixed to Lorillard Products in accordance with the Order, or that a sufficient supply of such Products with Corrective Statement Onserts affixed is made available during the pendency of the Manufacturing Migration. Similarly, in connection with a Manufacturing Migration, to the extent that Imperial is subject to the Supplemental Order and/or the Order, as modified by the Supplemental Order (as either relates to Corrective Statement Onserts), while the Manufacturing Migration is occurring, RJRT shall reasonably cooperate with Imperial to ensure that Corrective Statement Onserts are affixed to RJRT Products in accordance with the Supplemental Order and/or Order, as modified by the Supplemental Order, or that a sufficient supply of such Products with Corrective Statement Onserts affixed is made available during the pendency of the Manufacturing Migration.

2.12 Cold Storage . At the request of RJRT, Imperial agrees to allow RJRT to store Lorillard Products at Imperial’s existing cold storage facilities in Greensboro, North Carolina, up to a maximum of ***** or such other maximum amount as the Parties may agree to in writing (“ Cold Storage ”). Imperial will cause any such Lorillard Products stored in Cold Storage to be received, cared for and stored in accordance with the Specifications and, if not addressed in the Specifications, then in accordance with the same standards used to receive, care for and store its own finished products and, in any event, in a commercially reasonable manner, including with respect to security, fumigation, infestation and environmental controls. In consideration for the Cold Storage, RJRT agrees to pay Imperial *****. Delivery of Lorillard Products into Cold Storage will not constitute delivery of such Products to RJRT, as Imperial’s Customer, for purposes of Section 5.2 , and delivery will take place only upon transfer of the Product from Cold Storage to RJRT; provided that , RJRT will bear the risk that changes to the Packaging of any Products may be required while they are stored in Cold Storage. At the request of Imperial, RJRT will be required to take delivery of any Product from Cold Storage (on a first-in, first-out basis) that has been in such storage for more than 180 days, or such other maximum number of days as the Parties may agree to in writing.

ARTICLE 3 FORECASTS AND PURCHASING

3.1 Long-Term Forecasts . Commencing on the Effective Date, each Customer will provide to its Manufacturer, on a monthly basis, rolling 12-month forecasts for projected volumes of Products (by SKU) for which such Customer expects to place Purchase Orders during the covered period (each, a “ Long-Term Forecast ”). The initial Long-Term Forecasts for RJRT and Imperial are attached as Exhibits G-1 and G-2 , respectively. Each subsequent Long-Term Forecast must be delivered at least five days before the first day of the first month of the

-21-



covered 12-month period. Each Long-Term Forecast must be prepared for the relevant Products in a manner consistent with the practices used to forecast consumer demand for such Products for the 12-month period (approximated as necessary) ending immediately prior to the Effective Date, after giving effect to any production by the Customer in progressing towards a Manufacturi ng Migration or otherwise; provided that a Customer may modify its practices for forecasting consumer demand for purposes of preparing its Long-Term Forecasts, subject to the approval of its Manufacturer, which approval may not be unreasonably withheld or delayed. Each Long-Term Forecast will be non-binding and will be used solely for general planning and inventory control purposes.

3.2 Purchase Orders; Short-Term Forecasts and Related Matters .

(a) From time to time during the Term, each Customer, in its sole discretion, may issue (or have issued on its behalf) one or more Purchase Orders to the Manufacturer. Unless the Parties otherwise agree in writing, each Customer will place one Purchase Order per month, which will set forth (i) a binding order for Products for such month, and (ii) a non-binding forecast of orders for the succeeding three-month period (each such three-month forecast, a “ Short-Term Forecast ”), which will supersede any inconsistent portion of the Customer’s Long-Term Forecast and any prior Short-Term Forecast covering the same period; provided that each Customer will issue its initial Purchase Order no later than the Effective Date. Each Purchase Order may designate multiple delivery dates for Products, and (except for each Customer’s initial Purchase Order) must be received by the Manufacturer at least 28 days before the first delivery date stated therein. Each Manufacturer will schedule the production of Products based on the Short-Term Forecasts, as long as such Short-Term Forecasts are not materially inconsistent with the corresponding Long-Term Forecast or the immediately preceding Short-Term Forecast covering the same period. Any terms of a Purchase Order, sales order, invoice or other similar transaction document that are inconsistent with the terms of this Agreement will have no force or effect.

(b) A Manufacturer will be entitled (but not obligated) to reject, in whole or in part, any Purchase Order if, and only if: (i) the Purchase Order does not comply in all material respects with Section 3.2(a) ; (ii) the Purchase Order would require the Manufacturer to use raw materials or product components (A) at levels materially in excess of the levels required for the production reflected for the applicable month in the most-recently delivered Short-Term Forecast, or (B) that the Customer agreed to procure pursuant to Section 2.6(a) or 2.6(b) (including pursuant to *****) but which have not yet been provided (it being understood that such right of rejection will apply only to that portion of the Purchase Order for which raw materials or product components are unavailable and, to the extent applicable, Section 3.2(c) will apply); (iii) the Products cannot be timely delivered due to modifications to be made to the manufacturing process in respect of a Product as a result of a change in Specifications requested by the Customer; (iv) the production in accordance with the Purchase Order would, in the Manufacturer’s good faith belief based on credible evidence, violate any applicable Law; or (v)

-22-



an event of Force Majeure with respect to the Manufacturer has occurred (it being understood that such right of rejection will apply only until such time as the event of Force Majeure has been alleviated). To reject a Purchase Order, in whole or in part, the Manufacturer must promptly (and, in any event, within four business days after receiving the Purchase Order) notify the Customer in writing, which notice must include (A) a statement regarding what portion of the Purchase Or der (if any) will be filled, (B) if applicable, any alternative delivery date(s) proposed in accordance with Section 3.2(c) , and (C) a reasonably detailed description of the circumstances giving rise to one or more of the events described above entitling t he Manufacturer to so reject, in whole or in part, the Purchase Order. If the Manufacturer fails to timely notify the Customer of the Manufacturer’s rejection of a Purchase Order (or any portion thereof), such Purchase Order (or the portion that has not b een timely rejected) will be deemed to have been accepted by the Manufacturer.

(c) The Parties acknowledge that there may be occasions when a Purchase Order deviates materially from the forecasted purchase volumes for the same month in the immediately preceding Short-Term Forecast and, as a result, the Manufacturer may be required to make adjustments to its production schedule to meet the requested delivery date(s). In any such circumstance, the following will apply:

(i) If the Purchase Order exceeds the forecasted purchase volumes for the same month from the immediately preceding Short-Term Forecast, and the Manufacturer determines that it cannot fill any portion of a Purchase Order by the specified delivery date(s), then the Manufacturer will promptly (and, in any event, within four business days after receiving the Purchase Order) notify the Customer in writing and propose alternative delivery date(s) for the Products (or any portion thereof). In any such case, the Parties will negotiate in good faith towards revised delivery date(s), and will confirm any new delivery date(s) in writing. If the Manufacturer does not object to the original delivery date(s) stated in the Purchase Order, then such date(s) will become firm delivery date(s), and the Manufacturer will be responsible for delivering the Products on time in accordance with the Purchase Order, even though the Purchase Order may have deviated materially from forecasted purchase volumes for the same month in the Long-Term Forecast or Short-Term Forecast.

(ii) The Manufacturer will be entitled to quantify the impact on Costs of any such positive or negative adjustments in its production schedule, and the Parties will work together in good faith to mitigate any such Costs. Subject to the foregoing obligation to mitigate Costs, the Manufacturer will be entitled to reimbursement for any such impact on Costs that results from any such adjustments in its production schedule, which Costs will be deemed Actual Costs hereunder.

-23-



ARTICLE 4

PRICING, INVOICING AND INSPECTION OF PRODUCTS

4.1 Cost Plus Pricing . Unless otherwise agreed between the Manufacturer and the Customer in writing, the price for Products will equal the sum of (x) the Costs of such Products, plus (y) ten percent (such percentage, the “ Manufacturing Fee ”); provided that ***** will not be subject to the Manufacturing Fee or any other mark-up.

4.2 Invoicing Procedures; Standard Costs .

(a) Each Manufacturer will invoice its Customer on a monthly basis for all Products transferred under Purchase Orders during the preceding month and, because the Parties recognize that it may be impracticable for the Manufacturer to calculate its Actual Costs on a monthly basis, each such invoice will reflect the Manufacturer’s Standard Costs (instead of its Actual Costs) for the covered Products. Each invoice will be delivered by the tenth calendar day of the month immediately following the month it covers and will be due and payable by the Customer within ten days of receipt.

(b) Each Manufacturer may propose to modify its Standard Costs for any calendar year during the Term to reflect its good faith estimate of Actual Costs for that calendar year by providing written notice of such modifications to its Customer by no later than October 1st of the preceding calendar year. Any such proposal will require the approval of the Customer, which will not be unreasonably withheld or delayed. As soon as practicable after the Parties agree to modify a Manufacturer’s Standard Costs as set forth in this Section 4.2(b) , the Parties will update Exhibits B-1 and/or B-2 , as applicable, to reflect the same.

(c) RJRT will invoice Imperial for all Tobacco Leaf acquired by Imperial pursuant to either Section 2.6(b)(i) or 2.6(b)(iii) as such Tobacco Leaf is deemed to have been sold to Imperial (if pursuant to Section 2.6(b)(i) ) or delivered to Imperial (if pursuant to Section 2.6(b)(iii) ). Each such invoice will be due and payable by Imperial within ten days of receipt.

4.3 Invoice Adjustments .

(a) As soon as practicable (and, in any event, within 90 days) after every sixth invoice delivered by a Manufacturer pursuant to Section 4.2(a) ( i.e. , approximately every six months during the Term), and as soon as practicable (and, in any event, within 90 days) after the non-renewal or termination of a Manufacturer-Customer relationship hereunder in accordance with ARTICLE 8, the Manufacturer will deliver to its Customer a statement (a “ True-Up Statement ”) reflecting the Manufacturer’s calculation of Costs actually incurred by it (“ Actual Costs ”) with respect to the Products for which previous invoices were delivered pursuant to Section 4.2(a) and which had not yet been subjected to adjustment pursuant to this Section 4.3(a) . In delivering its calculation of Actual Costs, the Manufacturer will provide reasonable substantiation of its calculations, but will only share itemized calculations or provide

-24-



de tailed substantiation with respect to Actual Costs that it deems to be competitively sensitive, including Actual Costs for Tobacco Leaf, Additional Tobacco Raw Materials, other tobacco components, paper and wrapping materials, filter tow (except as acquire d pursuant to Section 2.6(b)(v) ) and other filter materials and direct labor (collectively, “ Sensitive Information ”) with a group of individuals designated by the Customer for the purpose of receiving such Sensitive Information, and who are reasonably acc eptable to the Manufacturer and who agree to maintain the confidentiality of such Sensitive Information and not to disclose it to any third Person or to the Customer outside of such designated group.

(b) The Manufacturer must calculate its Actual Costs in accordance with the principles and methodologies (including any assumptions and limitations, as well as rules for the allocation of indirect Costs) described on Exhibits B-1 (with respect to the RJRT Products) and B-2 (with respect to the Lorillard Products). The Parties will discuss in good faith any required changes in the principles and methodologies for determining Actual Costs (and, to the extent applicable, Standard Costs) at least 60 days before such changes are implemented.

(c) The Customer will have 30 days from the date it receives a True-Up Statement in which to review it (the “ Objection Period ”). If, in the Customer’s good faith judgment, the True-Up Statement does not fairly present the Manufacturer’s Actual Costs for the covered invoices, then the Customer will have the right to propose an adjustment to those Actual Costs (or any component thereof) within such Objection Period. Any such proposed adjustment must be in writing (an “ Adjustment Notice ”) and must specify (i) the amount of the proposed adjustment, (ii) the item to which such proposed adjustment relates, and (iii) the facts and circumstances supporting the reasonableness of such adjustment. Upon the submission of any Adjustment Notice, the Manufacturer and the Customer will work together in good faith in an attempt to agree on the disputed values, but without disclosing any Sensitive Information outside of the group of individuals designated to receive such information pursuant to Section 4.3(a) . If any such dispute is not resolved within 30 days after the Manufacturer’s receipt of an Adjustment Notice, then either Party may submit the dispute for resolution by an independent, nationally recognized firm of certified public accountants (an “ Accounting Firm ”). The decision of the Accounting Firm as to the resolution of the dispute will be conclusive and binding on the Parties. The fees and expenses of the Accounting Firm will be divided equally between the Manufacturer and the Customer. The Accounting Firm will at all times (A) give the Parties a reasonable opportunity to make written representations and to require that copies of any written representations are supplied to the other Party without delay, (B) make its determination as soon as reasonably practicable, and (C) make its determination available in writing to both Parties. If the Customer fails to submit an Adjustment Notice within the Objection Period, then the Customer will be deemed to have accepted the True-Up Statement and the Manufacturer’s calculation of Actual Costs therein.

(d) Based on the Manufacturer’s Actual Costs for the covered invoices (as finally determined in accordance with this Section 4.3 ), the following adjustments will be made:

-25-



(i) If the Manufacturer’s Actual Costs are less than the Standard Costs (adjusted to account

for any agreements between the Parties pursuant to Section 2.6(a) and 2.6(b) ) for the same invoices, then the Manufacturer will pay the Customer the amount of such difference, plus an amount equal to the Manufacturing Fee thereon (if any).

(ii) If the Manufacturer’s Actual Costs are greater than the Standard Costs (adjusted to account for any agreements between the Parties pursuant to Section 2.6(a) and 2.6(b) ) for the same invoices by no more than ten percent of such Standard Costs (the “ Cost Cap ”), then the Customer will pay the Manufacturer an amount equal to the difference between such Actual Costs and such Standard Costs, plus an amount equal to the Manufacturing Fee thereon (if any).

(iii) If the Manufacturer’s Actual Costs are greater than the Standard Costs (adjusted to account for any agreements between the Parties pursuant to Section 2.6(a) and 2.6(b) ) for the same invoices by more than the Cost Cap, then such invoices will be automatically adjusted downward such that the Manufacturer’s Actual Costs do not exceed such Standard Costs by more than the Cost Cap, and the Customer will pay the Manufacturer an amount equal to the difference between such Actual Costs (as adjusted to reflect the Cost Cap) and such Standard Costs, plus an amount equal to the Manufacturing Fee thereon (if any).

(e) Any payments required to be made under Section 4.3(d) , will be made within five business days of the later of: (i) the expiration of the Objection Period, (ii) the date on which the Manufacturer and the Customer agree on the Actual Costs for the covered invoices, and (iii) the date of which the decision of the Accounting Firm is rendered.

4.4 Payments . Unless otherwise agreed in writing between the Parties, all payments made under this ARTICLE 4 will be made, without set off, by wire transfer of immediately available funds to the account designated by the payee. All payments will be made in U.S. dollars. All payments made by a Customer for Products will be deemed made without prejudice to any rights that the Customer may have under this Agreement, and will not constitute acceptance of Products or otherwise affect the Customer’s rights with respect to Non-Conforming Products.

4.5 Inspection and Approval of Products; Rejection of Non-Conforming Products . Upon receipt of the Products at the destination point, the Customer will have the right to inspect and approve for acceptance those Products. Such inspection and approval must be made within 30 days of delivery. If the Customer fails to timely notify the Manufacturer of the Customer’s rejection of the Products, the Customer will be deemed to have accepted those Products as conforming. The Customer may only reject and refuse acceptance of Products that are Non-Conforming Products. Upon discovery of any Non-Conforming Products, the Customer will promptly (and, in any event, before expiration of the 30-day inspection period) inform the Manufacturer in writing, setting forth in reasonable detail the reasons why the Products should be characterized as Non-Conforming Products. Within ten days after receiving such a notice, the

-26-



Manufacturer may contest the rejection and provide documen tation and other evidence relating to the quality of the applicable Products. The Manufacturer may also inspect the Products and collect a representative sample thereof for testing and analysis. Thereafter, the Parties will confer in good faith to resolv e the controversy. If any Products are finally deemed to be Non-Conforming Products, they will be destroyed or otherwise handled pursuant to the Customer’s instructions, at no cost to the Customer. The Customer will not be responsible for any payment for Non-Conforming Products (and in the event that the Customer has paid for those Non-Conforming Products, the Customer will be entitled, at the Customer’s election, to a credit for or refund of that payment); provided that the Customer agrees to pay for the Costs and Manufacturing Fee associated with the manufacture of Non-Conforming Products up to a maximum ***** by aggregate annual volume of the Products manufactured by the *****. If the Customer requests that the Manufacturer replace or correct any Non-C onforming Products, the Manufacturer will be responsible for promptly remanufacturing, substituting or otherwise correcting those Non-Conforming Products, and for supplying remanufactured or corrected Products at no cost to the Customer.

4.6 Audit Rights . Each Party agrees to maintain accurate and complete books and records regarding its activities under this Agreement, including correspondence, instructions, invoices, receipts, quality assurance records, Specifications, Purchase Orders, raw materials and component procurement records (including Tobacco Leaf inventory tracking and infestation records), warehousing records and cost data, transportation records and cost data, other manufacturing cost records and data (including calculations and supporting documentation for Actual Costs, whether or not deemed to be Sensitive Information), and similar documents and data relating to the manufacture, purchase and sale of Products from a Manufacturer to a Customer hereunder. Each Party agrees to keep such records in sufficient detail to enable the other Party to determine or verify such Party’s compliance with this Agreement. Each Party will keep such records for a period of time as determined by its normal document retention policies, but in any event not less than three years after the date of the transaction to which those records relate, or longer if required by Law. Notwithstanding the foregoing, before a Manufacturer destroys any records relating to the Products it has manufactured for its Customer, it must notify that Customer in writing and allow that Customer a reasonable opportunity to make copies of those records (other than records containing Sensitive Information) before they are destroyed. In addition to the visitation and inspection rights set forth in Section 2.2(c) , during regular business hours and upon not less than five business days written notice, each Party will permit each other Party (and its representatives), at such other Party’s cost and expense, to examine and audit all of the first Party’s books and records relating to its activities under this Agreement, in each case, to the extent necessary for the Party(ies) to make the foregoing determination and verification and subject to restrictions implemented in good faith to (a) ensure compliance with applicable Law, (b) preserve any applicable privilege (including the attorney-client privilege), or (c) comply with any applicable contractual confidentiality obligations; provided that , if any Party is then in breach of any of its representations, warranties or covenants in this Agreement (or one or more of the other Party has a reasonable basis to assert any such breach), then any such audit will be

-27-



permitted upon 24 hours’ notice and if a breach is confirmed, the costs and expenses of the aud it will be the responsibility of the breaching Party; and, provided , further , that , with respect to any audit that would involve the disclosure of a Party’s Sensitive Information, the other Party may only conduct such audit through (i) the group of individ uals designated as permitted to receive such information pursuant to Section 4.3(a) , or (ii) a legal representative or independent accountant who has agreed to (A) analyze such information solely for the purpose of advising the Parties with respect to comp liance with this Agreement and (B) maintain the confidentiality of such information and not disclose it to any of the Parties.

ARTICLE 5 CERTAIN COMMERCIAL TERMS

5.1 Commercial Terms .

(a) Unless otherwise agreed in writing between the Parties, (i) RJRT will make available for collection all RJRT Products, as specified in Purchase Orders submitted by Imperial, F.O.B. (shipping point), the warehouse associated with the Tobaccoville Facility, and (ii) Imperial will make available for collection all Lorillard Products, as specified in Purchase Orders submitted by RJRT, F.O.B. (shipping point), the warehouse associated with the Greensboro Facility. Each Manufacturer will transfer Products (A) on a first in / first out basis as determined by the date of manufacture, (B) using a commercial common carrier selected by the Customer, and (C) unless otherwise agreed in writing with its Customer, to the Customer’s central distribution center. The Manufacturer will be responsible for all necessary shipping/transfer documentation relating to the Products and for arranging loading.

(b) For information purposes only, Exhibit H sets forth a description of the flow of finished Products from the Manufacturer to the Customer.

5.2 Title and Risk of Loss . Title to, and risk of loss for, the Products (and all components thereof) will transfer to the Customer once the Products are loaded by the Manufacturer on the common carrier’s conveyance at the shipping point; provided that title to raw materials, product components and other items procured by the Customer for the manufacture of such Customer’s Products pursuant to Section 2.6(a) or 2.6(b) , including such Customer’s Tobacco Leaf (including its Initial Tobacco Leaf Inventory), will, once procured, remain with that Customer, while the risk of loss with respect to those items will transfer to and remain with the Manufacturer while they are in the Manufacturer’s possession or control at its facilities (including its storage facilities used in accordance with Section 2.6(c) or 2.12 ) until such time as they are delivered F.O.B. (shipping point) to the Customer as part of finished Products or otherwise. The Manufacturer will transfer title to the Products (and all components thereof), to the extent title was vested in the Manufacturer, to the Customer free and clear of any and all liens, security interests, claims and other encumbrances.

-28-



5.3 Packing for Transport . Each Manufacturer will be responsible for proper packing of the Products for

delive ry to the Customer’s specified destination within the States. All such packing and packing materials must (a) comply with handling, weight and safety requirements, in each case, in accordance with the Specifications or, if not addressed by the Specificati ons, as reasonably instructed by the Customer, and (b) be adequate to withstand the normal rigors of transfer, storage and distribution, and prevent damage and/or deterioration of Products prior to arrival at the specified destination.

ARTICLE 6 REPRESENTATIONS, WARRANTIES, COVENANTS AND INDEMNIT Y

6.1 Warranties and Disclaimer of Warranties .

(a) EACH MANUFACTURER REPRESENTS AND WARRANTS THAT PRODUCTS MANUFACTURED BY IT PURSUANT TO THIS AGREEMENT WILL BE (I) MANUFACTURED SUCH THAT THE PRO DUCTS ARE NOT NON-CONFORMING PRODUCTS AND (II) PACKAGED AND TRANSFERRED IN COMPLIANCE WITH THIS AGREEMENT. ANY MEASURES TAKEN TO REMEDY NON-CONFORMANCE WITH THIS REPRESENTATION AND WARRANTY WILL BE AT THE MANUFACTURER’S SOLE COST AND EXPENSE. SUBJECT TO THE FOREGOING, PRODUCTS SUPPLIED BY THE MANUFACTURER ARE PROVIDED “AS IS” AND WITHOUT ANY REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, INCLUDING ANY IMPLIED WARRANTY OF MERCHANTABILITY OR OF FITNESS FOR ANY PARTICULAR PURPOSE.

(b) EXCEPT FOR THE REPRESENTATION AND WARRANTY SET FORTH IN SECTION 2.11(b) WITH RESPECT TO THE MAINTENANCE AND REPAIR OF MIGRATION MACHINERY (INCLUDING GIVING EFFECT TO A CUSTOMER’S INSTRUCTIONS FOR ITS MANUFACTURER NOT TO PERFORM MAINTENANCE OR REPAIRS), THE MIGRATION MACHINERY WILL BE MADE AVAILABLE FOR REMOVAL AS CONTEMPLATED BY SECTION 2.11(d) WITHOUT ANY REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, INCLUDING ANY IMPLIED WARRANTY OF MERCHANTABILITY OR OF FITNESS FOR ANY PARTICULAR PURPOSE.

6.2 Limitation of Remedies, Liability and Damages . NO PARTY WILL BE ENTITLED TO RECOVER FOR ANY CONSEQUENTIAL, INCIDENTAL, PUNITIVE, EXEMPLARY OR INDIRECT DAMAGES, LOST PROFITS OR OTHER BUSINESS INTERRUPTION DAMAGES, BY STATUTE, IN TORT OR BY CONTRACT, EXCEPT (A) TO THE EXTENT AN INDEMNIFIED PARTY IS LIABLE TO A THIRD PARTY FOR ANY SUCH DAMAGES BASED ON A BREACH FOR WHICH THE INDEMNIFIED PARTY IS INDEMNIFIED IN ACCORDANCE WITH SECTION 6.7 , (B) WHERE BASED UPON A

-29-



BREACH OF ARTICLE 7 , OR (C) WHERE SUCH DAMAGES ARE THE RESU LT OF GROSS NEGLIGENCE OR WILLFUL MISCONDUCT OF THE INDEMNIFYING PARTY.

6.3 Compliance with Laws .

(a) In performance of their respective obligations under this Agreement, each Party will comply with, and will ensure that its employees and Affiliates comply with, all Laws, Governmental Approvals, agreements, licenses and consents applicable to or otherwise relating to the subject matter of this Agreement.

(b) Without limiting the generality of Section 6.3(a) , each Party further represents, warrants and covenants as follows:

(i) Neither it nor any of its Affiliates will manufacture, transfer, provide, resell, facilitate or promote the resale of, export, re-export, distribute, or dispose of any Product or component thereof or any related technology or technical data, directly or indirectly, without first obtaining the written consent of the other Party, and all necessary written consents, permits and authorizations and completing such formalities as may be required by any applicable Laws.

(ii) Neither it nor any of its Affiliates will sell or otherwise provide Products to any Person that it knows, believes or has reason to believe will take any action which, if done by it, would constitute a violation of any of the terms and conditions of this Agreement or would otherwise violate applicable Law.

(iii) As applicable, in its performance of activities associated with this Agreement, such Party and its Affiliates will comply with: United States of America regulation of tobacco products by the US FDA pursuant to 111 P.L. 31; 123 Stat. 1776; 2009 Enacted H.R. 1256; 111 Enacted H.R. 1256 (the so-called “Family Smoking Prevention and Tobacco Control Act”) and regulations promulgated thereunder.

(iv) It and its Affiliates will perform the obligations imposed upon it by this Agreement: (A) in strict compliance with all applicable Laws pertaining to employment discrimination; and (B) without harassment, retaliation or discrimination by reason of race, sex, creed, religion, color, national origin, citizenship status, age, disability, veteran status, or any factor protected by Law.

(v) It and its Affiliates will comply with all requirements of the Fair Labor Standards Act, as amended, and of regulations and orders of the United States Department of Labor issued under Section 14 thereof, as well as all applicable state and local Laws and regulations regarding wages and hours.

-30-



(vi) To the extent required by Law, it and its Affiliates will comply with, and furnish an y

required certifications of compliance with, the following federal Laws and all rules and regulations promulgated thereunder: (A) Executive Order 11246, as amended; (B) The Americans with Disabilities Act of 1990 as implemented at 41 C.F.R. Part 60-741; (C) The Vietnam Era Veterans Readjustment Assistance Act of 1974 as implemented at 41 C.F.R. Part 60-250; and (D) any amendments or supplements to 29 C.F.R. Part 60-1.4(a). Each Manufacturer and its subcontractors shall abide by the requirements of 41 C.F .R. §§ 60-741.5(a), 60-300.5(a) and 60-741.5(a). These regulations prohibit discrimination against qualified individuals based on their status as protected veterans or individuals with disabilities, and prohibit discrimination against all individuals base d on their race, color, religion, sex or national origin. Moreover, these regulations require that covered prime contractors and subcontractors take affirmative action to employ and advance in employment individuals without regard to race, color, religion , sex, national origin, protected veteran status or disability.

(vii) If a Customer notifies its Manufacturer that the Products manufactured by it hereunder will be used by the Customer in the performance of a government contract, then such Manufacturer will, to the extent required by applicable Law, comply with Executive Order 13496, including the requirement of such order to post the employee notice set forth in 29 C.F.R. part 471, appendix A to subpart A.

(viii) Neither it nor any of its Affiliates will undertake any act that may cause the other Party or its Affiliates to be in violation of (A) the United States Foreign Corrupt Practices Act, the United Kingdom Bribery Act 2010 or equivalent legislation in any other jurisdiction; or (B) the principles contained in the Organization for Economic Co-operation and Development Convention on Combating Bribery of Foreign Public Officials or any existing or future applicable legislation in any jurisdiction (including, for the avoidance of doubt, United Kingdom legislation) which has similar provisions to the OECD Convention.

6.4 Right to Intellectual Property . RJRT represents and warrants to Imperial that RJRT (directly or through its Affiliates) has the right to use all Intellectual Property required for Imperial to manufacture the Lorillard Products in accordance with the Specifications, subject to any limitations or qualifications with respect to such Intellectual Property set forth in the Merger Agreement.

6.5 Product for States Only . Except for limited quantities of Product manufactured for testing purposes only, each Party represents and warrants that Products produced or sold by it in accordance with this Agreement are intended to be manufactured solely in the Tobaccoville Facility and the Greensboro Facility, as applicable, solely for lawful transfer therefrom and for sale only within the States in accordance with all applicable Laws. No Manufacturer will provide Product manufactured by it to any Person other than to its Customer under this Agreement, except with such Customer’s prior written consent. No Party will transport, or cause

-31-



to be transported, any Products outside of the States for use, distribution or sale, without the consent of the other Party.

6.6 Customer Specifications and Instructions . Subject to Section 2.8 , each Customer will be solely responsible for (a) establishing all Specifications for the Products to be purchased by it hereunder in order to ensure that each such Products comply with all applicable Laws, and (b) giving the Manufacturer full and complete instructions to ensure that all Packaging is appropriately marked with relevant Surgeon General warning labels (including with respect to any rotation plan for such labels) and other relevant markings mandated by any relevant Governmental Authority.

6.7 Mutual Indemnification; Indemnification Procedures .

(a) Subject to Section 6.2 , each Party (the “ Indemnifying Party ”) agrees to indemnify, defend and hold harmless the other Party, its Affiliates and its and their respective current and former officers, directors, employees, representatives and agents (each, an “ Indemnified Party ”) from and against any and all losses, damages, claims, liabilities, demands, assessments, judgments, settlements, compromises and related costs and expenses (including reasonable attorneys’ fees and costs) (collectively, “ Damages ”) an Indemnified Party may suffer in connection with, or arising out of (i) a breach of the Indemnifying Party’s representations, warranties, covenants or confidentiality obligations set forth in this Agreement, or (ii) the marketing, advertising, distribution or sale by the Indemnifying Party, in its capacity as a Customer (or its Affiliates) of any Products manufactured by the Indemnified Party (or its Affiliates), including any Damages that relate to any claimed adverse health effects or health risks relating to the use of such Products, provided that , to the extent that clause (ii) of this Section 6.7(a) would be inconsistent with the indemnification provisions set out in the APA (to the extent that such provisions would be applicable to such claim), the terms of the APA shall prevail. Notwithstanding the foregoing, no Indemnified Party will be entitled to indemnification for Damages to the extent (but only to the extent) they relate to, result from or arise out of (A) the failure of such Indemnified Party to comply with its obligations under this Agreement, or (B) the negligence or willful misconduct of such Indemnified Party.

(b) An Indemnified Party must promptly notify the Indemnifying Party in writing of any pending or threatened claim or demand that the Indemnified Party has determined has given or would reasonably be expected to give rise to a right of indemnification arising under this Section 6.7 or under Section 2.11(d) (including a pending or threatened claim or demand asserted by a third party against the Indemnified Party, such claim being a “ Third Party Claim ”), describing in reasonable detail the facts and circumstances with respect to the subject matter of such claim or demand; provided that the failure to provide such notice will not release the Indemnifying Party from any of its obligations under this Section 6.7 or under Section 2.11(d) except to the extent the Indemnifying Party is materially prejudiced by such failure.

-32-



(c) Upon receipt of a notice of a claim for indemnity from an Indemnified Party pursuant to Section

6.7(b) , the Indemnifying Party will be entitled to assume the defense and control of an y Third Party Claim and will be responsible for all costs and attorney fees of such defense, but must, if it determines to assume such defense, allow the Indemnified Party a reasonable opportunity to participate in the defense of such Third Party Claim wit h its own counsel and at its own expense; provided that the Indemnifying Party will not be entitled to assume such defense (and will bear the reasonable fees, costs and expenses of separate counsel for the Indemnified Party) (i) unless it first acknowledge s in writing its obligation hereunder to indemnify the Indemnified Party with respect to all material elements of such Third Party Claim and (ii) in case of a Third Party Claim where the defendants in, or targets of, such Third Party Claim include both an Indemnified Party and Indemnifying Party, and the Indemnified Party has reasonably concluded, based on the advice of counsel, that there is a material conflict of interest between the Indemnifying Party and the Indemnified Party with respect to such Third Party Claim. Notwithstanding the foregoing, the Indemnifying Party is not entitled to assume the defense of any Third Party Claim if the Third Party Claim seeks an order, injunction or other equitable relief or relief for other than money damages against the Indemnified Party that the Indemnified Party reasonably determines (upon advice of its outside counsel) cannot be separated from any related claim for money damages. If such equitable or other relief portion of the Third Party Claim can be so separate d from that for money damages, the Indemnifying Party will (subject as aforesaid) be entitled to assume the defense of the portion relating to money damages and, in such event, the Indemnifying Party will continue to be liable for the reasonable fees and e xpenses of counsel employed by the Indemnified Party with respect to the portion of the defense of such Third Party Claim that the Indemnifying Party has not assumed. Each Party, will, and will cause each of its Affiliates and representatives to, cooperat e fully with the Indemnifying Party in the defense of any Third Party Claim and the Indemnifying Party agrees to keep the Indemnified Party reasonably informed of developments in connection with the defense or prosecution of such Third Party Claim. The In demnifying Party is authorized to consent to a settlement of, or the entry of any judgment arising from, any Third Party Claim, without the consent of any Indemnified Party; provided that (A) the Indemnifying Party pays or causes to be paid all amounts arising out of such settlement or judgment concurrently with the effectiveness of such settlement or resolution, (B) such settlement or judgment does not encumber any of the assets of any In demnified Party or provide for injunctive or other nonmonetary relief affecting the Indemnified Party, or otherwise provide for any restriction or condition that would apply to or adversely affect any Indemnified Party or the conduct of any Indemnified Par ty’s business, (C) to the extent that the Indemnified Party may have any liability with respect to such Third Party Claim, the complete and unconditional release of any Indemnified Party potentially affected by such Third Party Claim must be made a conditi on of any such settlement or other resolution, and (D) such settlement does not include any admission of wrongdoing or misconduct by the Indemnified Party.

(d) Following an assumption by the Indemnifying Party of a Third Party Claim pursuant to Section 6.7(c) , the Indemnified Party may reassume control of any defense of

-33-



a Third Party Claim if the Indemnifying Party fails to prosecute the defense of such Third Party Claim within a period of 20 days after receipt of written notice of such failure to p rosecute by the Indemnified Party. The Indemnifying Party will be liable for the reasonable fees, costs and expenses of counsel employed by the Indemnified Party (i) for any period during which the Indemnifying Party has not assumed the defense thereof, o r (ii) following re-assumption of control pursuant to the first sentence of this Section 6.7(c) .

(e) In the event any Indemnifying Party receives a notice of a claim for indemnity from an Indemnified Party pursuant to Section 6.7(b) that does not involve a Third Party Claim (such claim being a “ Direct Claim ” ), the Indemnifying Party must notify the Indemnified Party within 45 days following its receipt of such notice if the Indemnifying Party disputes its liability to the Indemnified Party under this Section 6.7 or under Section 2.11(d) . If the Indemnifying Party does not so notify the Indemnified Party, the Direct Claim specified by the Indemnified Party in such notice will be conclusively deemed to be a liability of the Indemnifying Party under this Section 6.7 or under Section 2.11(d) , as applicable, and the Indemnifying Party will pay, the amount of such Damages to the Indemnified Party on demand or, in the case of any notice in which the amount of Damages in respect of the Direct Claim (or any portion thereof) is estimated, on such later date when the amount of such Damages in respect of Direct Claim (or any portion thereof) becomes finally determined.

ARTICLE 7 CONFIDENTIALITY

7.1 Confidentiality Obligations .

(a) Notwithstanding anything to the contrary in this Agreement, each Party agrees not to disclose its Confidential Information to the other Party hereunder, except to the extent required to enable such other Party to perform its obligations under this Agreement. In addition, (i) neither Party will share its Sensitive Information with the other Party, except (A) in a format that restricts its use to ensure compliance with applicable Law, (B) to the group of individuals designated as permitted to receive such information pursuant to Section 4.3(a) , or (C) to a legal representative for purposes of conducting an audit pursuant to Section 4.6 , and (ii) neither Party will share the identification of Migration Machinery or information concerning its transfer (or the timing thereof) to the other Party, except to those employees, representatives, agents or contractors of such Party that need to know such information in connection with carrying out the Manufacturing Migration and who agree to maintain the confidentiality of such information and not to disclose it to anyone outside of such designated group.

(b) During the Term and for a period of five years thereafter, each Party receiving Confidential Information (a “ Receiving Party ”) will maintain in confidence all Confidential Information disclosed to it by any other Party (a “ Disclosing Party ”). Notwithstanding the foregoing, but subject to Section 7.2 , each of the Party’s respective obligations of confidentiality with respect to another Party’s Trade Secrets, including the

-34-



Specifications, will be perpetual. No Party will use, disclose or grant the use of such Confidential Information except as expressly authorized by this Agreement. To the extent that disclosure is authorized by this Agreement, the Receiving Party must i nform its employees, representatives and contracting parties to whom disclosure is to be made of this ARTICLE 7 , and instruct such Persons to hold in confidence and not make use of such information for any purpose other than those purposes permitted by thi s Agreement. Each Receiving Party will use at least the same standard of care (but not less than a reasonable standard of care) as it uses to protect its own proprietary and Trade Secret information to ensure that such employees, representatives and contr acting parties do not disclose or make any unauthorized use of such Confidential Information. Each Receiving Party will promptly notify the other upon discovery of any unauthorized use or disclosure of Confidential Information. The Receiving Party will b e responsible to the Disclosing Party for any loss of Confidential Information of the Disclosing Party or breach of the provisions of this Section 7.1 by any employee, representative or contracting party of the Receiving Party.

7.2 Exceptions . The obligations of confidentiality contained in Section 7.1 will not apply to the extent that it can be established by the Receiving Party by competent proof that such Confidential Information: (a) was generally available to the public or otherwise part of the public domain at the time of its receipt from the Disclosing Party; (b) becomes generally available to the public or otherwise part of the public domain after its disclosure and other than through any act or omission of the Receiving Party in breach of this Agreement; or (c) was received by the Receiving Party, other than under an obligation of confidentiality, by a third Person lawfully in possession of the information.

7.3 Authorized Disclosure . Notwithstanding the foregoing, no Party (nor third Persons, as applicable) will be precluded from disclosing Confidential Information to the extent it is required to do so in response to a valid order by a Governmental Authority, or to the extent it reasonably believes, on the basis of advice from outside counsel, that it is required to disclose such Confidential Information by Law, or to the extent necessary to establish its rights under this Agreement; provided that , in the event a Party believes it is so required to disclose another Party’s Confidential Information, it will promptly provide notice of such requirement so that the Disclosing Party may seek an appropriate order or other action as it deems appropriate to prevent or limit such disclosure, and the Party required to make the disclosure will use its reasonable efforts to preserve the confidentiality of the other Party’s Confidential Information, including by cooperating with the other Party to obtain an appropriate order or other reliable assurance of confidential treatment. In any event, the Party required to make the disclosure may disclose only that portion of another Party’s Confidential Information that is legally required to be disclosed. Notwithstanding the foregoing, if any Party (or an Affiliate of such Party) is required to include a copy of this Agreement as an exhibit to any current or periodic report filed with the U.S. Securities and Exchange Commission, such Party (or its Affiliate) may make such filing without the prior written consent of any other Party as long as it seeks (or causes its Affiliate to seek) confidential treatment of any portions of this Agreement that, in the opinion of such filing Party,

-35-



contain confidential or competitively sensitive information, regardless of whether such treatment is obtained.

ARTICLE 8 TERM AND TERMINATION

8.1 Term of Agreement . The term of this Agreement will commence on the Effective Date and this Agreement and the Manufacturer-Customer relationships hereunder will remain in effect until the day before the two-year anniversary of the Effective Date (the “ Initial Term ”), after which this Agreement and such Manufacturer-Customer relationships may be renewed for successive one-year periods (each, a “ Renewal Term ”) by either Party in accordance with Section 8.9 , unless earlier terminated or not renewed as provided in this ARTICLE 8 . The Initial Term and all Renewal Terms, if any, are referred to in this Agreement collectively as the “ Term ”.

8.2 General Termination Provisions . Notwithstanding anything to the contrary in this Agreement, this Agreement may be terminated as follows:

(a) by mutual consent of the Parties; and

(b) by a Party, by giving written notice to the other Party at any time upon the occurrence of any of the following events:

(i) the voluntary bankruptcy of the other Party, or the filing of an involuntary petition in bankruptcy against the other Party that is not dismissed within 60 days of filing, in which case, the termination will become effective immediately upon the non-terminating Party’s receipt of notice of termination or at such later date as may be specified in that notice;

(ii) the other Party ceases to pay its debts as they mature in the ordinary course of business, or makes an assignment for the benefit of its creditors, in which case, the termination will become effective immediately upon the non-terminating Party’s receipt of notice of termination or at such later date as may be specified in that notice; or

(iii) a receiver is appointed for the other Party or its property, in which case, the termination will become effective immediately upon the non-terminating Party’s receipt of notice of termination or at such later date as may be specified in that notice.

8.3 Termination of a Manufacturer -Customer Relati onship . Notwithstanding anything to the contrary in this Agreement:

(a) a Customer may terminate or elect not to renew, as applicable, its Manufacturer-Customer relationship with its Manufacturer:

-36-



(i) at the end of the Initial Term or the then effective Renewal Term, by giving written

notice of its desire not to so renew such relationship to the Manufacturer at least 90 days before the end of the Initial Term or such then effective Renewal Term, as applicable;

(ii) if the Manufacturer suffers an event of Force Majeure, and such event is not alleviated to the reasonable satisfaction of the Customer within 90 days of the Manufacturer’s receipt of notice of the Customer’s intent to terminate;

(iii) immediately upon written notice to the Manufacturer in the event the Manufacturer suffers one or more of the events described in Section 8.2(b) , subject to any cure or grace periods set forth therein;

(iv) in accordance with Section 8.4 , 8.5 or 8.6 ; and

(b) a Manufacturer may terminate or elect not to renew, as applicable, its Manufacturer-Customer relationship with its Customer immediately upon written notice to the Customer in the event the Customer suffers one or more of the events described in Section 8.2(b) , subject to a ny cure or grace periods set forth therein.

8.4 Termination of Manufacturer -Customer Relationship in Connection with a Material Breach . Notwithstanding anything to the contrary in this Agreement, a Party may terminate the affected Manufacturer-Customer relationship with the other Party, in the event that the other Party is in breach of any material term of this Agreement and the breaching Party fails to cure such breach within 30 days of receipt of notice of breach from the terminating Party, or if such breach is not reasonably capable of cure within such 30-day period, such breaching Party fails to cure the breach within 60 days of receipt of notice of breach from the terminating Party; provided that the foregoing right to cure (a) will not apply to any breach by any Party involving violation of any applicable Law, Governmental Approval or any breach that is not capable of being cured, and (b) is conditioned upon the breaching Party promptly commencing and thereafter diligently pursuing the cure to the reasonable satisfaction of the non-breaching Party.

8.5 Termination in Connection with a Manufacturing Migr ation . In recognition of a Manufacturing Migration in accordance with Section 2.11 , (a) if, in Imperial’s good faith judgment, it believes that it can complete a Manufacturing Migration in accordance with the Imperial Migration Plan, or if later, as determined by it in accordance with Section 2.11 , it may terminate its Manufacturer-Customer relationship under this Agreement with respect to RJRT as the Manufacturer of the RJRT Products by giving RJRT written notice of termination at least 90 days before the effective date of termination (it being understood that, in such event, this Agreement would continue in accordance with its terms with respect to the other Manufacturer-Customer relationship), provided that the effective date of termination will not be earlier than the actual completion date of the Imperial Migration Plan, and (b) if, in RJRT’s good faith judgment, it believes that it can complete a Manufacturing Migration in accordance with the RJRT

-37-



Migration Plan, or if later, as determined by it in accordance with Section 2.11 , it may terminate its Manufacturer-Customer relationship under this Agreement with respect to Imperial as the M anufacturer of the Lorillard Products by giving Imperial written notice of termination at least 90 days before the effective date of termination (it being understood that, in such event, this Agreement would continue in accordance with its terms with respe ct to the other Manufacturer-Customer relationship), provided that the effective date of termination will not be earlier than the actual completion date of the RJRT Migration Plan.

8.6 Termination for Interference or Frustration of Purp ose . If both (a) the action of any Governmental Authority prohibits or declares unlawful or otherwise impairs, inhibits or frustrates in any material respect (i) the Customer’s intended use of the Products being manufactured for it under this Agreement, (ii) the Manufacturer’s ability to manufacture or package Products as required under this Agreement, or (iii) any other material obligation of a Party as contemplated by this Agreement, and (b) the Parties are unable to propose a feasible way of either avoiding such interference or of reorganizing the Parties’ arrangements under this Agreement so as to eliminate the effect of such interference or to minimize, or minimize the effect of, such interference to the point where it is no longer material within a period of 60 days of a Party notifying the other Party of such interference (including by taking legal action in respect of such interference), then the affected Customer may terminate the affected Manufacturer-Customer relationship hereunder, effective upon the earlier of (A) 30 days following receipt by the Manufacturer of notice of termination from the Customer, and (B) the date on which such action of the Governmental Authority becomes effective. Any notice by a Party to the other Party of such interference pursuant to this Section 8.6 must include a reasonably detailed description of the action of the Governmental Authority and the resulting prohibition, declaration of unlawfulness or material impairment, inhibition or frustration of purpose.

8.7 Effects of Non-Renewal or Termination; Cooperation .

(a) Upon one Party’s delivery of a notice of non-renewal or termination hereunder (or where the Parties otherwise reasonably anticipate a non-renewal or termination), the Parties agree to work together in good faith with a view to achieving an orderly transition of the manufacturing arrangements subject to such non-renewal or termination, in connection with a Manufacturing Migration or otherwise, including with respect to the transfer of any Migration Machinery.

(b) Upon a non-renewal or termination in accordance with its terms, this Agreement will terminate and become void and of no further force and effect, and there will be no further liability or obligation on the part of any Party hereto; provided that , if only one of the Manufacturer-Customer relationships is not renewed or terminated under Section 8.3 , 8.4 , 8.5 or 8.6 , then the remaining Manufacturer-Customer relationship will continue unaffected by such non-renewal or termination and the terms and conditions of this Agreement will survive (and remain unaffected) as they relate to that continuing relationship. Each Party’s right of non-

-38-



renewal or termination under Sections 8.3 , 8.4 , 8.5 and 8.6 , is in addition to any other rights it may h ave under this Agreement or otherwise, and the exercise of a right of non-renewal or termination will not constitute an election of remedies and will not relieve any Party of liability for any breach of this Agreement. The non-renewal or termination of th is Agreement or any Manufacturer-Customer relationship hereunder will not affect any other projects, activities, collaborations, commercial arrangements or service arrangements that the Parties (or any of them) may have with one another.

(c) Upon a non-renewal or termination of this Agreement, or the non-renewal or termination of one of the Manufacturer-Customer relationships hereunder,

(i) the Manufacturer agrees to: (A) deliver to the Customer or its designee all raw materials and product components inventory that were supplied by or sourced on behalf of the Customer, including the Customer’s Tobacco Leaf (including any remaining Initial Tobacco Leaf Inventory of the Customer); (B) return all of the Customer’s Confidential Information; (C) deliver all finished Products to the Customer or its designee, together with a final invoice therefor; (D) deliver a final True-Up Statement in accordance with Section 4.3 ; (E) cooperate with the Customer in the preparation of a final accounting of activities under this Agreement or the applicable Manufacturer-Customer relationship; and (F) stop producing Products, except, in each case, as the Customer may otherwise approve in writing;

(ii) the Customer agrees to: (A) promptly pay the Manufacturer for open invoices (including the final True-Up Statement delivered pursuant to Section 8.7(c)(i)(D) ) in accordance with Sections 4.2 and 4.4 and any other amounts owed; (B) purchase, at the cost to the Manufacturer of such raw materials and product components, all raw materials and product components inventory (including any Additional Tobacco Raw Materials) that were purchased by the Manufacturer pursuant to Section 2.6(a) or 2.6(b) (other than Tobacco Leaf subject to the last sentence of Section 2.6(b)(iv) ) and that (I) are not yet incorporated into the Customer’s Products and (II) the Manufacturer does not elect to use in its other activities; (C) return all of the Manufacturer’s Confidential Information; and (D) cooperate with the Manufacturer in the preparation of a final accounting of activities under this Agreement or the applicable Manufacturer-Customer relationship, except, in each case, as the Manufacturer may otherwise approve in writing; and

(iii) the Manufacturer and the Customer agree to follow through with any required adjustments in accordance with Section 4.3 .

8.8 Survival . Notwithstanding anything to the contrary in this Agreement, the provisions of Sections 2.6(b) (with respect to ownership of any raw materials or product components procured by a Customer, including its Tobacco Leaf (including its Initial Tobacco Leaf Inventory)), 2.8 (for one year following non-renewal or termination), 2.11(d) , 5.2 , 8.7 , and this Section 8.8 , as well as ARTICLE 4 , ARTICLE 6 , ARTICLE 7 and ARTICLE 9 will

-39-



continue in full force and effect and survive any non-renewal or termination of this Agreement or any particular Manufacturer-Customer relationship hereunder.

8.9 Renewal Conditions . Either Party, in its capacity as a Customer, may exercise its option for one or more Renewal Terms by providing its Manufacturer with written notice thereof at least 90 days before the end of the Initial Term or then effective Renewal Term, as applicable, and such Renewal Term shall take effect as of the end of such Initial Term or Renewal Term, as long as:

(a) the Customer is not in breach of its obligations to use its commercially reasonable efforts to achieve a Manufacturing Migration in accordance with Section 2.11 (such obligations for purposes of this condition to apply to the Initial Term and any then-applicable Renewal Term), and the Manufacturer would not otherwise be entitled to terminate this Agreement pursuant to Section 8.2(b) , 8.3(b) or 8.4 ;

(b) *****; and

(c) the Manufacturer has received (i) a certificate, dated as of the commencement of such Renewal Term and signed by an executive officer of such Customer, confirming the matters set forth in clause (a) above, *****, and (ii) such other documents or information the Manufacturer reasonably requests in connection with the matters described in this Section 8.9 .

ARTICLE 9 MISCELLANEOUS

9.1 Tax Matters .

(a) Notwithstanding anything to the contrary in this Agreement, all transfer, documentary, sales, use, stamp, registration, value added and other such taxes and fees (including any penalties and interest (other than incurred as a result of the Manufacturer’s breach of any of its representations, warranties or covenants in this Agreement)) (collectively, “ Transfer Taxes ”) imposed in connection with the purchase of (a) Products from a Manufacturer will be borne and paid by the Customer when due, and (b) raw materials or product components from a supplier will be borne and paid when due by the Party that purchases such raw materials or product components pursuant to Section 2.6(a) or 2.6(b) . To the extent applicable, the Parties will cooperate with one another in good faith to obtain any tax exemption certificates that would eliminate or mitigate any obligations to pay Transfer Taxes in connection with the transactions contemplated by this Agreement.

(b) As long as the applicable Products are transferred F.O.B. (shipping point) in accordance with Section 5.1(a) , the Parties intend that no federal excise taxes (if any) levied pursuant to 26 U.S.C. §§ 5701 et seq. will be payable until such Products are removed from the

-40-



Customer’s Alcohol and Tobacco Tax and Trade Bureau bonded facility. The Customer will be responsible for the p ayment of any such federal excise taxes in accordance with 26 U.S.C. § 5703, and in the event that any such taxes are levied against the Manufacturer, such taxes will constitute Actual Costs hereunder or otherwise be reimbursable by the Customer.

(c) The Parties intend that neither the Manufacturer nor the Customer will be liable for any state excise taxes pursuant to the Tobacco Products Tax Act, N.C.G.S., §§ 105-113.2 et seq. , in connection with the transaction contemplated hereunder. In the event, however, that it is finally determined otherwise, the Parties agree to further cooperate with one another in good faith to mitigate any such state excise taxes to the greatest extent practicable and, in any event, such taxes will constitute Actual Costs hereunder or otherwise be reimbursable by the Customer.

9.2 State Settlements . The Parties agree that the Customer will be responsible for performance of all obligations agreed to or assumed by the Customer or ordered by a court under any State Settlements with respect to the Customer’s Products, including all reporting, payment and conduct obligations. The Customer agrees that in the event it does not perform these obligations and the compliance is sought or compelled from the Manufacturer because it manufactured the Products, the Customer will indemnify the Manufacturer for all costs of compliance.

9.3 Further Assurances . Each Party agrees to enter into or execute, or procure the entering into or execution, of such agreements, assignments or further assurances, or do such other acts as any other Party may reasonably request to carry out the terms and conditions of this Agreement.

9.4 Integration, Modification and Waiver . This Agreement, together with the Exhibits hereto, constitutes the entire agreement between the Parties with respect to the subject matter of this Agreement and supersedes all prior understandings of the Parties with respect thereto. No supplement, modification or amendment of this Agreement will be binding unless executed in writing by each Party. No waiver of any of the provisions of this Agreement will be deemed to be or will constitute a continuing waiver. No waiver will be binding unless executed in writing by the Party making the waiver. No consent will be required from any Indemnified Party (other than the Parties themselves) to supplement, modify, amend, or grant a waiver under, this Agreement. All rights and remedies of a Party under, arising out of, in connection with or related to this Agreement are cumulative of, and not exclusive of, any rights or remedies otherwise available.

9.5 Relationship of the Parties . For purposes of this Agreement, the Parties will be and remain independent contractors (and, in certain respects, active competitors), and this Agreement will not be construed as establishing a general agency, employment, partnership, joint venture, coalition, alliance or any other similar relationship between the Parties with regards to the relationship created by this Agreement. In accordance with this Agreement, no

-41-



Party will have the authority to make any statements, representations or commitments of any kind (whether express or implied) regarding the subject matter of this Agreement, or to take any action, which would be binding on any other Party or create any liability or obligation on behalf of any other Party regarding the subject matter of this Agreement, without the prior written authorization of such other Party to do so. No Party will have the right to direct or control the employees of any other Party. No Party will be liable for the debts, obligations or other liabilities of any other Party or of any of its agents, employees or contractors, including any costs for salaries, benefits or taxes.

9.6 Force Majeure . Notwithstanding anything to the contrary in this Agreement, no Party will be liable for any loss, injury, delay, damage or other casualty suffered by any other Party due to any inability to perform any obligation hereunder, and no Party will be deemed to have defaulted under or breached this Agreement for failure or delay in fulfilling or performing any term or provision of this Agreement (other than payment of monies due), when such failure or delay is caused by or results from causes beyond the control of the affected Party, including acts of God, fire, flood, storm, earthquake, explosion, epidemic, delays in transportation, shortages of trucks or vessels, shortages of fuel, shortages of raw materials, environmental catastrophe, embargo, war, acts of war (whether war be declared or not), acts of terrorism, insurrection, riot, civil commotion, labor dispute, or acts, omissions or delays in acting by any Governmental Authority (including legislative, administrative, judicial, police or any other official governmental acts). In the case of any delay or failure that a Party anticipates will cause an excusable delay hereunder, such Party will inform the other Party by written notice of the anticipated effect of such delay within ten days of becoming aware of it, the written notice to include a reasonably detailed description of the steps that the notifying Party is taking to alleviate the problem, including any use of Contingency Equipment.

9.7 Construction . The Parties have participated jointly in the negotiation and drafting of this Agreement. In the event an ambiguity or question of intent or interpretation arises, this Agreement must be construed as if drafted jointly by the Parties and no presumption or burden of proof will arise favoring or disfavoring any Party by virtue of the authorship of any of the provisions of this Agreement. The word “including” means including without limitation. Any reference to the singular in this Agreement also includes the plural and vice versa .

9.8 Governing Law . The validity, construction and performance of this Agreement will be governed and interpreted in accordance with the substantive laws of the State of Delaware, without giving effect to principles of conflicts of laws thereof.

9.9 Jurisdiction . The Parties agree that any suit, action or proceeding seeking to enforce any provision of, or based on any matter arising out of or in connection with, this Agreement or the transactions contemplated hereby may be brought only in the Chancery C ourt of the State of Delaware or, if such court does not have jurisdiction, any federal court located in the State of Delaware or other Delaware State Court.

-42-



9.10 Waiver of Jury Trial . Each Party hereby waives to the fullest extent permitted by appl icable Law, any

right it may have to a trial by jury in respect to any litigation directly or indirectly arising out of, under, or in connection with, this Agreement, or any transaction contemplated hereby. Each Party certifies (a) that no representative, agent or attorney of any other Party has represented, expressly or otherwise, that such other Party would not, in the event of litigation, seek to enforce the foregoing waiver, and (b) acknowledges that it and the other Party hereto have been induced to e nter into this Agreement by, among other things, the mutual waivers and certifications in this Section 9.10 .

9.11 No Third Party Beneficiaries . This Agreement is not intended to and may not be construed to give any Person (other than the Parties signatory hereto and to the extent provided herein, their respective Indemnified Parties), including any employee or former employee, any interest or rights (including any third-party beneficiary rights) with respect to or in connection with any agreement or provision contained herein or contemplated hereby.

9.12 Severability . If any provision of this Agreement is held to be invalid or unlawful, such provisions will be deemed to be deleted from this Agreement, but this Agreement will remain in full force and effect as if the deleted provision had never been contained in it. The Parties agree to negotiate in good faith as to the terms of a mutually acceptable and satisfactory provision in place of any deleted provision (which reflects, as closely as possible, the commercial intention of such deleted provision), and if such terms are agreed upon, this Agreement will be amended accordingly.

9.13 Notices . Unless otherwise provided in this Agreement, day-to-day commercial communications, such as Purchase Orders, may be exchanged by any reasonable means. All notices must be in writing, and will be deemed effective upon receipt, if personally delivered; on the third business day after deposited with the U.S. Postal Service, if mailed by certified mail, return receipt requested, postage prepaid; on the first business day after sent if sent prepaid by nationally recognized overnight courier service with next day delivery specified; or when sent if sent by facsimile transmission or electronic mail (if fax numbers or email addresses have been provided) with confirmation of receipt.

-43-

If to RJRT, to:

R. J. Reynolds Tobacco Company c/o Reynolds American Inc. 401 North Main Street Winston-Salem, North Carolina 27101 Attn: General Counsel

If to Imperial, to:

ITG Brands, LLC 5900 North Andrews Avenue, Suite 1100 Fort Lauderdale, Florida 33309 Attn: General Counsel



9.14 Assignment . This Agreement will be binding upon and inure to the benefit of the Parties and their respective legal successors and assigns. This Agreement may not be assigned or otherwise transferred, nor, except as expressly provided hereunder, may any right or obligation hereunder be assigned, subcontracted, licensed or transferred by any Party without the prior written consent of the other Parties, which consent may not be unreasonably withheld, delayed or conditioned; provided that any Party may, without the prior consent of any other Party, assign this Agreement and its rights and obligations hereunder to an Affiliate of such Party; provided , further , that (a) the assignor Party remains secondarily liable for the obligations of its assignee Affiliate, and (b) if such assignee ceases to be an Affiliate of such Party, the assignee must immediately re-assign its remaining rights and obligations hereunder back to the assignor. Any permitted assignee must expressly assume all the rights and obligations of its assignor under this Agreement. Any assignment in violation of the foregoing is null and void.

9.15 Counterparts . This Agreement may be executed in one or more counterparts, and by the different Parties in separate counterparts, each of which when executed will be deemed to be an original but all of which taken together will constitute one and the same agreement. Delivery of an executed counterpart of a signature page to this Agreement by facsimile or electronic means will be as effective as delivery of a manually executed counterpart of this Agreement.

9.16 Exhibits . The Exhibits to this Agreement, including any Appendices to those Exhibits, form part of and are incorporated into this Agreement, and the Parties will act in accordance with their terms at all times during the Term. The following Exhibits are attached hereto:

-44-

Exhibit Description A Products (RJRT Products and Lorillard Products) B-1 Standard Costs and Relevant Principles and Methodologies – RJRT Products B-2 Standard Costs and Relevant Principles and Methodologies – Lorillard Products & Cold

Storage Fees C-1 Control and Rejection Standards – RJRT Products C-2 Control and Rejection Standards – Lorillard Products D Intentionally Omitted E Actions to Obtain Governmental Approvals F Plans and Timelines for Manufacturing Migrations G-1 Initial Long-Term Forecast – RJRT Products G-2 Initial Long-Term Forecast – Lorillard Products H Flow of Finished Products I ***** J Tobacco Inventory Tracking and Infestation Reports



IN WITNESS WHEREOF, the Parties have caused this Agreement to be executed by their duly authorized

representatives to be effective as of the Effective Date.

R. J. REYNOLDS TOBACCO COMPANY By: /s/ Martin L. Holton III Name: Martin L. Holton III Title: EVP & General Counsel ITG BRANDS, LLC By: /s/ Rob Wilkey Name: Rob Wilkey Title: EVP & General Counsel

-45-



EX HIBIT A

Products

RJRT Products

KOOL KINGS (6M)

KOOL BOX 100S (12M)

KOOL BLUE BOX 100S (6M)

KOOL BLUE BOX (12M)

KOOL BLUE BOX GS (6M)

KOOL BOX (12M)

KOOL BOX GS (6M)

KOOL BOX 100S SUPER LONG GS (6M)

KOOL BLUE BOX XL (6M)

KOOL BOX XL (6M)

SALEM BOX PR (12M)

SALEM BOX 100S (12M)

SALEM BOX (12M)

SALEM GOLD BOX 100S (12M)

SALEM GOLD BOX (12M)

SALEM GOLD BOX PR (12M)

SALEM GOLD BOX GS (6M)

SALEM BOX GS (6M)

SALEM SILVER BOX 100S (12M)

SALEM SILVER BOX (6M)

SALEM SLIM BOX 100S (12M)

WINSTON BOX PR (12M)

A-1



WI NSTON MENTHOL BOX PR (12M)

WINSTON BLUE BOX PR (6M)

WINSTON BOX GS (12M)

WINSTON BOX 100S PR (6M)

WINSTON GOLD BOX 100S GS (6M)

WINSTON GOLD BOX 100S (12M)

WINSTON GOLD BOX (12M)

WINSTON GOLD BOX GS (6M)

WINSTON MENTHOL BOX 100S GS (6M)

WINSTON MENTHOL BOX 100S PR (6M)

WINSTON MENTHOL BOX GS (12M)

WINSTON RED BOX 100S (6M)

WINSTON RED BOX 100S GS (6M)

WINSTON RED BOX (12M)

WINSTON RED BOX GS (6M)

WINSTON WHITE BOX 100S (6M)

WINSTON WHITE BOX (6M) Lorillard Products

KENT 100S 6M

KENT GOLDEN 100S 6M

KENT GOLDEN KINGS 6M

KENT III 100S 6M

KENT III KINGS 6M

KENT KINGS 6M

NEWPORT 100 BOX $0.50 1 PK 6M

A-2



NEWPORT 100 BOX 12M

NEWPORT 100 BOX 6M

NEWPORT 100 BOX GS 12M

NEWPORT 100 BOX PR 12M

NEWPORT 100 BOX TD 12M

NEWPORT 100 BOX UP 6M

NEWPORT 100S 12M

NEWPORT 100S 6M

NEWPORT BOX $0.50 1 PK 6M

NEWPORT BOX 12M

NEWPORT BOX 6M

NEWPORT BOX GS 12M

NEWPORT BOX PR 12M

NEWPORT BOX TD 12M

NEWPORT BOX UP 6M

NEWPORT KINGS 12M

NEWPORT KINGS 6M

NEWPORT MEN BLUE 100 BX 6M

NEWPORT MEN BLUE 100 BX TD 6M

NEWPORT MEN BLUE BOX 6M

NEWPORT MEN BLUE BOX TD 6M

NEWPORT MEN GOLD 100 BX 12M

NEWPORT MEN GOLD 100 BX 6M

NEWPORT MEN GOLD 100 BX TD 12M

NEWPORT MEN GOLD 100S 6M

A-3



NEWPORT MEN GOLD BOX 12M

NEWPORT MEN GOLD BOX 6M

NEWPORT MEN GOLD BOX PR 12M

NEWPORT MEN GOLD BOX TD 12M

NEWPORT MEN GOLD KINGS 12M

NEWPORT MEN GOLD KINGS 6M

NEWPORT NM 100 BX $0.50 1PK 6M

NEWPORT NM BOX $0.50 1PK 6M

NEWPORT NM SM GOLD 100 BX 6M

NEWPORT NM SMOOTH GOLD BX 6M

NEWPORT NONMEN 100 BOX 6M

NEWPORT NONMEN BOX 6M

NEWPORT NONMEN GOLD 100 BX 6M

NEWPORT NONMEN GOLD BOX 6M

NEWPORT SMOOTH SEL 100 BX TD 6M

NEWPORT SMOOTH SELECT 100 BX 6M

NEWPORT SMOOTH SELECT BOX 6M

NEWPORT SMOOTH SELECT BX TD 6M

OLD GOLD 100 BOX 6M

OLD GOLD BLUE 100S 6M

OLD GOLD BOX 6M

OLD GOLD GOLD 100 BOX 6M

OLD GOLD GOLD BX 6M

OLD GOLD KINGS 6M

TRUE 100 BOX 6M

A-4



TRUE 100S 6M

TRUE BOX 6M

TRUE KINGS 6M

TRUE MENTHOL 100S 6M

TRUE MENTHOL KINGS 6M

A-5



EXHIBIT B-1

Standard Costs / Principles and Methodologies for Determining Costs

(RJRT Products)

B-1-1

Note: *****

Cost items Scope of included cost Allocation Methodology

*****:

***** ***** *****

***** ***** *****

***** ***** *****

*****:

***** ***** *****

*****:

***** ***** *****

*****:

***** ***** *****



Exhibit B-1: Standard Costs for RJRT Products

B-1-2

***** *****

Products (SKU) Standard Cost* ($/TH) ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** *****



EXHIBIT B-2

Standard Costs / Principles and Methodologies for Determining Costs (Lorillard Products) & Cold Storage Fees

Exhibit B-2: Principles and Methodologies – Lorillard

B-2-1

Note: *****

Cost items Scope of included cost Allocation Methodology *****:

***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** *****

*****: ***** *****

*****

***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** *****

*****: ***** *****

*****

***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** *****

***** ***** *****

***** ***** ***** ***** ***** ***** ***** ***** *****

***** ***** *****

***** ***** *****

***** *****

Exhibit B -2: Standard Costs (Lorillard Products)

B-2-2

***** *****

Products (SKU) Standard Cost* ($/M) ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** *****

Other Relevant costs Cost ($) Units ***** ***** ***** ***** *****



EXHIBIT C-1

Control and Rejection Standards for RJRT Products

(2 pages redacted)

*****



EXHIBIT C-2

Control and Rejection Standards for Lorillard Products

(2 pages redacted)

*****



EXHIBIT D

Intentionally Omitted



EXHIBIT E

Actions to Obtain Governmental Approvals

Regulatory Obligations For Acquired Brands During RMA Period

E-1

Ongoing Regulatory Reporting Requirements 1

Legal Citation

Timing

Legal Responsible Party

Cooperation During RMA Period

Federal

HHS Cigarette Ingredient Reports 15 U.S.C. § 1335a Annual (March 31) Manufacturer/Packager/Importer

Both companies continue to report per legal requirements. Manufacturer and Customer to share copies of reports and confirmation of compliance documentation for the acquired brands throughout the duration of the RMA period, regardless of specific brand style transition schedule.

FDA “Harmful and Potentially Harmful Constituents” Submissions

FDCA 2 § 904(d) (21 U.S.C. § 387e(d))

TBD Manufacturer/Importer

Potential reporting requirement with unknown timing. If required during RMA period, Parties will work together to meet reporting obligations.

FDA Facility Registration and Product Listings

FDCA § 905(b) (21 U.S.C. § 387e(b)) and 905(i)(1) (21 U.S.C. §387e(i)(1))

Product Listing - Biannual (June 30 and December 31)); Facilities Registration - Annual (December 31)

Manufacturer/Importer

Each Manufacturer and Customer would file based on current registration requirements. RJRT intends to register as product owner. Product listings and packaging images as Customer would be identical to Manufacturer’s listing. Other content for registration (e.g., representative advertising and marketing materials) are to be determined.

1

Substantial equivalence (Section 905(j)) submissions to the Food and Drug Administration are expressly excluded from this list. Support and cooperation regarding the Government Approval for substantial equivalence reports filed with the FDA as to RJRT Products shall be addressed by and covered in the Intellectual Property License Agreement.

2

Federal Food, Drug and Cosmetic Act, 21 U.S.C. § 301 et seq.



Exhibit E Actions to Obtain Governmental Approvals


E-2


Legal Citation

Timing



FDA Ingredient Reports

FDCA § 904(a)(1) (21 U.S.C. § 387d(a)(1)) and FDCA § 904(c))

90 days in advance of new brand style introduction or modifications to existing brand style

Manufacturer/Importer

Parties evaluate need for reporting on case by case basis and agree to work together as needed to meet reporting obligations.

FTC Order to File Special Reports 15 U.S.C. § 46(b)

Annually (upon receipt of order) Party to which order is directed

No specific data is generated specifically for this report. Parties agree to work together as needed to meet reporting obligations.

State

Massachusetts Nicotine Yield Reports

105 CMR 660.000 et seq .: M.G.L. c 94, § 307B

Annual (December 1) Manufacturer

Manufacturer to provide production samples to Customer to allow completion of data in a timely manner. Customer will generate required reporting data and submit report. In the event Manufacturer has generated data prior to close for 2015 reporting requirements, data to be provided to Customer.

Minnesota Substance Reports Minn. Stat. § 461.17

Annual (February 15) Manufacturer

Complete for current year. Parties agree to work together as needed to meet reporting obligations.





E-3


Legal Citation

Timing



Texas Nicotine Yield/Ingredient Reports

25 T.A.C. § 101.1 et seq.

Annual (December 1) Manufacturer

Manufacturer to provide production samples to Customer to allow completion of data in a timely manner. Customer will generate required reporting data and submit report. In the event Manufacturer has generated data and/or ingredient reports prior to close for 2015 reporting requirements, data to be provided to Customer.

Fire Standards Compliant (FSC) Certifications (all states but RI) Varies by state

Every 3 years or upon new brand style introduction; annual date varies by state

Manufacturer

Manufacturer to continue FSC testing per current respective protocols and provide supporting data to Customer until production of each brandstyle is fully migrated to Customer’s manufacturing facility. Customer to submit certifications as required to states according to current state certification schedule.





FSC Re-certifications: Due Dates by State for Winston, Salem and Kool Brands

E-4

2015 FSC Re-certifications 2016 FSC Re-certifications 2017 FSC Re-certifications

State Date State Date State Date DE 1/1/2015 AL 1/1/2016 IL 1/1/2017 IA 1/1/2015 AR 1/1/2016 MA 1/1/2017 OK 1/1/2015 CA 1/1/2016 ME 1/1/2017 PA 1/1/2015 FL 1/1/2016 SD 1/1/2017 TX 1/1/2015 GA 1/1/2016 KY 4/1/2017 ID 4/1/2015 MI 1/1/2016 MT 5/1/2017 VT 5/1/2015 NM 1/1/2016 NJ 6/1/2017 CO 7/1/2015 NC 1/1/2016 CT 7/1/2017 IN 7/1/2015 SC 1/1/2016 UT 7/1/2017 LA 7/1/2015 TN 1/1/2016 DC 7/1/2017 KS 7/1/2015 VA 1/1/2016 WY 7/1/2017 WA 8/1/2015 WV 1/1/2016 MD 7/1/2017 AZ 8/1/2015 OH 5/1/2016 AK 8/1/2017 HI 9/30/2015 NV 6/3/2016 MN 12/1/2017 WI 10/1/2015 MS 7/1/2016 PR 6/16/2017 NY 7/1/2016

Completed OR 7/1/2016 ND 8/1/2016 NH 8/31/2016 MO 12/1/2016 NB 12/1/2016





FSC Re-certifications: Due Dates by State for Newport, Old Gold, Kent and True Brands

E-5

2015 FSC Re-certifications 2016 FSC Re-certifications 2017 FSC Re-certifications

State Date State Date State Date AZ 6/1/2015 AR 1/1/2016 MA (Full Special) 1/1/2017 IN 6/25/2015 MA (Special) 3/26/2016 MO 1/1/2017 CO 7/1/2015 OH 4/1/2016 SD 1/1/2017 WA 7/16/2015 OR 4/17/2016 DC (Washington) 2/1/2017 LA 7/24/2015 NH 4/30/2016 KY 3/31/2017 KS 7/31/2015 NY 5/1/2016 IL 4/30/2017 WI 8/1/2015 NV 6/1/2016 AK 5/1/2017 HI 9/30/2015 MS 7/1/2016 MT 5/1/2017 TN 11/30/2015 ND 7/1/2016 NJ 5/30/2017 FL 12/1/2015 MA (Special) 7/12/2016 MD 6/30/2017 GA 12/1/2015 MA (Special) 8/23/2016 CT 7/1/2017 NM 12/1/2015 MA (Special) 8/26/2016 UT 7/1/2017 NC 12/1/2015 ME 9/16/2016 WY 7/1/2017 WV 12/1/2015 MA (Special) 10/13/2016 OK 9/1/2017 SC 12/30/2015 NE 11/1/2016 TX 9/10/2017 VA 12/30/2015 MN 11/30/2017 AL 12/31/2015 IO 12/1/2017 MI 12/31/2015 PA 12/23/2017 2018 FSC Re-certifications DE 12/31/2017

Completed State Date CA 3/1/2018 ID 3/1/2018 VT 3/1/2018 RI DELAYED PR PENDING



EXHIBIT F

Plans and Timelines for Manufacturing Migrations

(168 pages redacted)

*****



EXHIBIT G-1

Initial Rolling Forecast of RJRT

G-1-1

(in 1000 sticks)

ITG/LO Material

RJRT Material Description May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar -

16 Apr -16

May-16 Jun-16

***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ** *** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ** *** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ** *** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ** *** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ** *** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ** *** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ** *** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** *****



EXHIBIT G-2

Initial Rolling Forecast of Imperial

G-2-1

(In

1,000 sticks)

RJRT Material

Lorillard Material Description Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar -

16 Apr -16 May-16 Jun-16

***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** *****



G-2-2

(In

1,000 sticks)

RJRT Material

Lorillard Material Description Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar -

16 Apr -16 May-16 Jun-16

***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** ***** *****



EXHIBIT H

Flow of Finished Products

Reciprocal Manufacturing Agreement Exhibit H Flow of Finished Products Winston, Salem & Kool brands RJRT Manufacturing Plant

H-1



EXHIBIT I

*****

(7 pages redacted)

*****



EXHIBIT J

Tobacco Inventory Tracking and Infestation Reports

Principles

_***** _*****

_*****

_***** _***** _*****

_***** _***** _***** _***** _*****

J-1

• Leaf inventory will be decremented based on the following formula:

• Inventory is decremented at the time finished goods are made available at FOB (sold) as described in the RMA • Inventory will be tracked by grade and mutual inventory updated will be provided on monthly basis in agreed upon format • In the event Products are determined to be Non-Conforming Products

• Leaf inventory consumption per calculation above includes standard waste, net of any Tobacco reclaimed as follows:

• Waste or by products generated are as follows and considered to be part of consumption calculation:

• Leaf inventory true-up due to Non-Conforming Products will occur at the end of each calendar year, if needed. *****

• Final leaf inventory true-up will be done at the end of the RMA period, if needed



Exhibit J : ***** Storage Inventory Report (Templat e)

Starting Report Period 12-Jun-15 Associated monthly Customer Statement date 30-Jun-15

1 Increment may include sales of leaf and/or adjustments (credits) for non conforming finished goods

J-2

Decrement Leaf owned by Imperial Beginning

inventory Increment 1 RMA consumption Direct shipment to Customer Misc, Adjustments Ending inventory

Comments Grades Inv Lbs Inv Lbs Inv Lbs Inv Lbs Inv Lbs Inv Lbs

***** Totals



Exhibit J: ***** Storage Inventory Report (Templat e)

Starting Report Period 12-Jun-15 Associated monthly Customer Statement date 30-Jun-15

1 Increment may include sales of leaf and/or adjustments (credits) for non conforming finished goods

J-3

Decrement

Leaf owned by RJRT Beginning inventory Increment 1 RMA

consumption

Direct shipment to Customer

Misc, Adjustments

Ending inventory Comments

Grades Inv Lbs Inv Lbs Inv Lbs Inv Lbs Inv Lbs Inv Lbs ***** Totals

. CONFIDENTIAL TREATMENT REQUESTED BY REYNOLDS AMERIC AN INC. – CONFIDENTIAL




J-4

Week 1 Week 2 Week 3 Week 4 Week 5 Week 6 Week 7 Week 8 Week 9 Week 10 Week 11 Week 12 Week 13 Week 14 Week 15 Week 16 Week 17 Building No. Trap No. 6/15/2015 6/22/2015 6/29/2015 7/6/2015 7/13/2015 7/20/2015 7/27/2015 8/3/2015 8/10/2015 8/17/2015 8/24/2015 8/31/2015 9/7/2015 9/14/2015 9/21/2015 9/28/2015 10/5/2015

111

1 2 3 4

112

5 6 7 8

113

9 10 11 12

114

13 14 15 16

121

17 18 19 20

122

21 22 23 24

123

25 26 27 28

124

29 30 31 32

131

33 34 35 36

132

37 38 39 40

133

41 42 43 44

134

45 46 47 48

141

49 50 51 52

142

53 54 55 56

143

57 58 59 60

144

61 62 63 64

211

65 66 67 68




J-5


212

69 70 71 72

213

73 74 75 76

214

77 78 79 80

221

81 82 83 84

222

85 86 87 88

223

89 90 91 92

224

93 94 95 96

231

97 98 99 100

232

101 102 103 104

233

105 106 107 108

234

109 110 111 112

241

113 114 115 116

242

117 118 119 120

243

121 122 123 124

244

125 126 127 128

311

129 130 131 132

312

133

134

135

136

313

137

138

139

140

314

141

142

143

144

321

145

146

147 148




J-6


322

149 150 151 152

323

153 154 155 156

324

157 158 159 160

331

161 162 163 164

332

165 166 167 168

333

169 170 171 172

334

173 174 175 176

341

177 178 179 180

342

181 182 183 184

343

185 186 187 188

344

189 190 191 192




J-7


411

193 194 195 196

412

197 198 199 200

413

201 202 203 204

414

205 206 207 208

421

209 210 211 212

422

213 214 215 216

423

217 218 219 220

424

221 222 223 224

431

225 226 227 228

432

229 230 231 232

433

233 234 235 236

434

237 238 239 240

441

241 242 243 244

442

245 246 247 248

443

249 250 251 252

444

253 254 255 256

400

257 258 259 260 261 262 263 264

Total

Trap average





J-8


A3 E W

A4 E W

A5 E W

A6 E W

A7 E W

A8 E W

B3 E W

B4 E W

B5 E W

B6 E W

B7 E W

B8 E W

C3 E W

C4 E W

C5 E W

C6 E W

C7 E W

C8 E W

D4 E W

D5 E W

D6 E W

D7 E W

D8 E W

D9 E W

E7 E W

E8 E W

E9 E W

F8 E W

F9 E W

Receiving Room

1 2 3 4 5 6

Exhibit 31.1 I, Susan M. Cameron, certify that:

Date: August 6, 2015

1. I have reviewed this quarterly report on Form 10-Q of Reynolds American Inc.;

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

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

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

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

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/ Susan M. Cameron Susan M. Cameron

President and Chief Executive Officer

Exhibit 31.2 I, Andrew D. Gilchrist, certify that:

Date: August 6, 2015

1. I have reviewed this quarterly report on Form 10-Q of Reynolds American Inc.;

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

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

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

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

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/ Andrew D. Gilchrist Andrew D. Gilchrist

Executive Vice President and Chief Financial Officer

Exhibit 32.1

REYNOLDS AMERICAN INC. ________________

Certification Pursuant to 18 U.S.C. §1350 ________________

Pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, Susan M. Cameron, Chief

Executive Officer, and Andrew D. Gilchrist, Chief Financial Officer, of Reynolds American Inc. (“RAI”), hereby certifies, to her or his knowledge, that:

EXECUTED this 6 th day of August, 2015.

1) RAI’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2) the information contained in RAI’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, fairly presents, in all material respects, the financial condition and results of operations of RAI.

/s/ Susan M. Cameron Susan M. Cameron, President and

Chief Executive Officer of Reynolds American Inc.

/s/ Andrew D. Gilchrist Andrew D. Gilchrist, Executive Vice President and

Chief Financial Officer of Reynolds American Inc.

Documents

Reynolds American Inc.s2.q4cdn.com/.../Reynolds-Q2-2015-Form-10-Q.pdf · Reynolds Tobacco Company on July 30, 2004, with such combination referred to as the B&W business combination