10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2007

OR

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

For the transition period from                      to                     

Commission file number: 1-32258

Reynolds American Inc.

(Exact name of registrant as specified in its charter)

North Carolina	20-0546644
(State or other jurisdiction of	(I.R.S. Employer Identification Number)
incorporation or organization)

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 þ NO o

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

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: 294,998,893 shares of common stock, par value $.0001 per share, as of July 13, 2007

INDEX

	Page
Part I – Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Income (Unaudited) – Three Months and Six Months Ended June 30, 2007 and 2006	3
Condensed Consolidated Statements of Cash Flows (Unaudited) – Six Months Ended June 30, 2007 and 2006	4
Condensed Consolidated Balance Sheets (Unaudited) – June 30, 2007 and December 31, 2006	5
Notes to Condensed Consolidated Financial Statements (Unaudited)	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	61
Item 3. Quantitative and Qualitative Disclosures about Market Risk	77
Item 4. Controls and Procedures	77
Part II – Other Information
Item 1. Legal Proceedings	78
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	78
Item 4. Submission of Matters to a Vote of Security Holders	78
Item 5. Other Information	79
Item 6. Exhibits	80
Signature	81
EX-3.1
EX-10.5
EX-10.6
EX-10.7
EX-10.8
EX-10.9
EX-10.10
EX-10.11
EX-31.1
EX-31.2
EX-32.1

2

PART I – Financial Information

Item 1. Financial Statements

REYNOLDS AMERICAN INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)

	For the Three						For the Six
	Months Ended June 30,						Months Ended June 30,
	2007			2006			2007			2006
Net sales1	$	2,227		$	2,170		$	4,245		$	3,985
Net sales, related party		121			121			251			266
Net sales		2,348			2,291			4,496			4,251
Costs and expenses:
Cost of products sold1, 2		1,343			1,276			2,518			2,441
Selling, general and administrative expenses		404			392			797			734
Amortization expense		6			7			12			14
Operating income		595			616			1,169			1,062
Interest and debt expense		87			52			176			87
Interest income		(23	)		(23	)		(61	)		(59	)
Other expense (income), net		16			(3	)		15			(3	)
Income from continuing operations before income taxes		515			590			1,039			1,037
Provision for income taxes		191			223			387			390
Income before extraordinary item		324			367			652			647
Extraordinary item – gain on acquisition		1			9			1			74
Net income	$	325		$	376		$	653		$	721
Basic income per share:
Income from continuing operations	$	1.10		$	1.24		$	2.22		$	2.19
Extraordinary item		—			0.03			—			0.25
Net income	$	1.10		$	1.27		$	2.22		$	2.44
Diluted income per share:
Income from continuing operations	$	1.10		$	1.24		$	2.21		$	2.19
Extraordinary item		—			0.03			—			0.25
Net income	$	1.10		$	1.27		$	2.21		$	2.44
Dividends declared per share	$	0.75		$	0.625		$	1.50		$	1.25

1	Excludes excise taxes of $529 million and $569 million for the three months ended June 30, 2007 and 2006, respectively, and $1,023 million and $1,069 million for the six months ended June 30, 2007 and 2006, respectively.
2	See “Master Settlement Agreement and Federal Tobacco Buyout Expenses” in note 1.

See Notes to Condensed Consolidated Financial Statements (Unaudited)

3

REYNOLDS AMERICAN INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)

	For the Six Months Ended
	June 30,
	2007			2006
Cash flows from (used in) operating activities:
Net income	$	653		$	721
Adjustments to reconcile to net cash flows from (used in) operating activities:
Depreciation and amortization		70			87
Restructuring and asset impairment charges, net of cash payments		(2	)		(11	)
Acquisition restructuring charges, net of cash payments		(4	)		(65	)
Deferred income tax expense (benefit)		(14	)		34
Loss on extinguishment of debt		19			—
Extraordinary item – gain on acquisition		(1	)		(74	)
Other changes, that provided (used) cash:
Accounts and other receivables		(3	)		142
Inventories		99			89
Related party, net		(9	)		(4	)
Accounts Payable		(75	)		(25	)
Accrued liabilities including income taxes and other working capital		296			125
Tobacco settlement and related expenses		(653	)		(758	)
Pension and postretirement		(313	)		(177	)
Litigation bonds		92			24
Other, net		(11	)		(5	)
Net cash flows from operating activities		144			103
Cash flows from (used in) investing activities:
Purchases of short-term investments		(3,001	)		(2,966	)
Proceeds from short-term investments		3,451			3,621
Capital expenditures		(60	)		(73	)
Distribution from equity investees		9			8
Proceeds from sale of business		—			3
Business acquisition		—			(3,517	)
Other, net		(1	)		3
Net cash flows from (used in) investing activities		398			(2,921	)
Cash flows from (used in) financing activities:
Dividends paid on common stock		(444	)		(368	)
Repayment of long-term debt		(300	)		(190	)
Proceeds from issuance of long-term debt		1,547			1,641
Principal borrowings under term loan		—			1,550
Repayment of term loan		(1,542	)		—
Deferred debt issuance cost		(14	)		(48	)
Proceeds from exercise of stock options		—			3
Excess tax benefit from stock-based compensation		1			2
Repurchase of common stock		(60	)		—
Net cash flows from (used in) financing activities		(812	)		2,590
Net change in cash and cash equivalents		(270	)		(228	)
Cash and cash equivalents at beginning of period		1,433			1,333
Cash and cash equivalents at end of period	$	1,163		$	1,105
Income taxes paid, net of refunds	$	65		$	67
Interest paid	$	178		$	64

See Notes to Condensed Consolidated Financial Statements (Unaudited)

4

REYNOLDS AMERICAN INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Millions)
(Unaudited)

	June 30,			December 31,
	2007			2006
Assets
Current assets:
Cash and cash equivalents	$	1,163		$	1,433
Short-term investments		843			1,293
Accounts and other receivables, net of allowance (2007 – $2; 2006 – $4)		110			107
Accounts receivable, related party		48			62
Inventories		1,056			1,155
Deferred income taxes		835			793
Prepaid expenses and other current assets		119			92
Total current assets		4,174			4,935
Property, plant and equipment, net of accumulated depreciation (2007 – $1,503; 2006 – $1,449)		1,064			1,062
Trademarks, net of accumulated amortization (2007 – $521; 2006 – $517)		3,475			3,479
Goodwill		8,175			8,175
Other intangibles, net of accumulated amortization (2007 – $65; 2006 – $57)		207			215
Other assets and deferred charges		535			312
	$	17,630		$	18,178
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable	$	200		$	275
Tobacco settlement and related accruals		1,584			2,237
Due to related party		9			9
Deferred revenue, related party		39			62
Current maturities of long-term debt		29			344
Other current liabilities		1,491			1,165
Total current liabilities		3,352			4,092
Long-term debt (less current maturities)		4,399			4,389
Deferred income taxes		1,087			1,167
Long-term retirement benefits (less current portion)		1,171			1,227
Other noncurrent liabilities		404			260
Commitments and contingencies:
Shareholders’ equity:
Common stock (shares issued: 2007 – 294,995,393; 2006 – 295,624,741)		—			—
Paid-in capital		8,647			8,702
Accumulated deficit		(1,026	)		(1,241	)
Accumulated other comprehensive loss (defined benefit pension and post-retirement plans, net of tax: 2007 – $403; 2006 – $418)		(404	)		(418	)
Total shareholders’ equity		7,217			7,043
	$	17,630		$	18,178

See Notes to Condensed Consolidated Financial Statements (Unaudited)

5

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1–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 subsidiaries include its operating subsidiaries, R. J. Reynolds Tobacco Company; Lane, Limited, referred to as Lane; Santa Fe Natural Tobacco Company, Inc., referred to as Santa Fe; R. J. Reynolds Global Products, Inc., referred to as GPI; and Conwood Company, LLC, Conwood Sales Co., LLC, Scott Tobacco LLC and Rosswil LLC, collectively referred to as Conwood.

     RAI was created to facilitate the July 30, 2004, transactions to combine the U.S. assets, liabilities and operations 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, a wholly owned operating subsidiary of R.J. Reynolds Tobacco Holdings, Inc., referred to as RJR. As a result of the business combination, B&W owns approximately 42% of RAI’s outstanding common stock. Also, as part of the combination transactions, RAI acquired from an indirect subsidiary of BAT the capital stock of a subsidiary which then owned all of the capital stock of Lane, and RJR became a wholly owned subsidiary of RAI. These July 30, 2004, transactions generally are referred to as the B&W business combination.

     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. References to RJR Tobacco prior to July 30, 2004, relate to R. J. Reynolds Tobacco Company, a New Jersey corporation.

     On May 31, 2006, RAI, through its newly formed subsidiary, Conwood Holdings, Inc., acquired Conwood, in a $3.5 billion stock acquisition. Conwood is engaged in the business of developing, manufacturing and marketing smokeless tobacco products. Conwood’s headquarters and primary manufacturing facility are located in Memphis, Tennessee. The Conwood acquisition was funded by RAI borrowings, new RAI debt securities and available cash and was treated as a purchase of the Conwood net assets by RAI for financial accounting purposes. The condensed consolidated financial statements (unaudited) of RAI include the results of the Conwood operations subsequent to May 31, 2006.

     Beginning January 1, 2007, the management and distribution of Lane’s cigarette brands, DUNHILL and STATE EXPRESS 555, were transferred to RJR Tobacco, and the distribution of Lane’s remaining products was transferred to Conwood.

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, 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. For interim reporting purposes, certain costs and expenses are charged to operations in proportion to the estimated total annual amount expected to be incurred primarily based on sales volumes. The results for the interim period ended June 30, 2007, are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

6

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

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

     The 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, 2006. Certain reclassifications were made to conform prior years’ financial statements to the current presentation. All dollar amounts, other than per share amounts, are presented in millions, except for amounts set forth in note 9 and as otherwise noted. All share and per share amounts reflect the two-for-one split of RAI’s common stock on August 14, 2006.

Master Settlement Agreement and Federal Tobacco Buyout Expenses

     Cost of products sold includes the following components for the Master Settlement Agreement, referred to as the MSA, and other state settlements and federal tobacco buyout expenses:

	For The Three Months				For The Six Months
	Ended June 30,				Ended June 30,
	2007		2006		2007		2006
Settlement	$	751	$	705	$	1,425	$	1,327
Federal tobacco quota buyout	$	72	$	69	$	142	$	135
Federal quota tobacco stock liquidation assessment		—		—		—		(9	)
Total quota buyout expense	$	72	$	69	$	142	$	126

     For additional information, see “–Governmental Health-Care Cost Recovery Cases – MSA and Other State Settlement Agreements” and “–Tobacco Buyout Legislation” in note 9.

Intangible Assets

     The changes in the carrying amount of trademarks during the six months ended June 30, 2007, were as follows:

	RJR Tobacco					Santa Fe		Lane		Conwood
	Indefinite		Finite			Indefinite		Indefinite		Indefinite		Finite
	Life		Life			Life		Life		Life		Life			Consolidated
Balance as of January 1, 2007	$	1,859	$	47		$	155	$	25	$	1,390	$	3		$	3,479
Amortization expense		—		(3	)		—		—		—		(1	)		(4	)
Balance as of June 30, 2007	$	1,859	$	44		$	155	$	25	$	1,390	$	2		$	3,475

     The changes in the carrying amount of other intangibles during the six months ended June 30, 2007, were as follows:

	RJR Tobacco					Lane			GPI
	Indefinite		Finite			Indefinite			Indefinite
	Life		Life			Life			Life		Consolidated
Balance as of January 1, 2007	$	20	$	116		$	35		$	44	$	215
Balance transfer		35		—			(35	)		—		—
Amortization expense		—		(8	)		—			—		(8	)
Balance as of June 30, 2007	$	55	$	108		$	—		$	44	$	207

     Concurrent with the transfer of the management and distribution of DUNHILL and STATE EXPRESS 555 cigarette brands to RJR Tobacco from Lane on January 1, 2007, a $35 million indefinite-lived intangible asset was transferred to RJR Tobacco from Lane.

7

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

     There were no changes in the carrying amounts of goodwill during the six months ended June 30, 2007.

     Indefinite-lived intangibles include acquired distribution agreements of RJR Tobacco and acquired distribution rights of GPI. Details of finite-lived intangible assets as of June 30, 2007, were as follows:

			Accumulated
	Gross		Amortization		Net
Consumer database	$	3	$	3	$	—
Customer contracts		16		16		—
Contract manufacturing		151		44		107
Technology-based		3		2		1
Total other intangibles		173		65		108
Trademarks		86		40		46
	$	259	$	105	$	154

     As of June 30, 2007, the estimated remaining amortization associated with finite-lived intangible assets was expected to be expensed as follows:

Year	Amount
Remainder of 2007	$	11
2008		21
2009		21
2010		18
2011		19
2012		19
Thereafter		45
	$	154

Pension and Postretirement

     Recognized gains or losses include changes in the amount of either the benefit obligation or the market-related value of plan assets resulting from actual experience differing from that assumed or from changes in assumptions. The minimum amortization of unrecognized gains or losses, as described in Statement of Financial Accounting Standards, referred to as SFAS, No. 87, “Employers’ Accounting for Pensions,” is included in pension expense. Prior service costs, which are changes in benefit obligations due to plan amendments, are amortized on a straight-line basis over the average remaining service period for active employees. The market-related value of plan assets recognizes changes in fair value in a systematic and rational manner over five years.

     The components of the total benefit are set forth below:

	For The Three Months Ended												For The Six Months Ended
	June 30,												June 30,
							Postretirement												Postretirement
	Pension Benefits						Benefits						Pension Benefits						Benefits
	2007			2006			2007			2006			2007			2006			2007			2006
Service cost	$	10		$	11		$	2		$	2		$	20		$	20		$	3		$	3
Interest cost		79			78			23			22			157			154			46			44
Expected return on plan assets		(109	)		(93	)		(7	)		(7	)		(218	)		(184	)		(14	)		(14	)
Amortization of prior service cost		1			1			(3	)		(3	)		1			1			(6	)		(6	)
Amortization of net loss		11			18			5			7			21			35			11			13
Net periodic benefit cost		(8	)		15			20			21			(19	)		26			40			40
Curtailment/special benefits		—			2			—			—			—			2			—			—
Total benefit cost	$	(8	)	$	17		$	20		$	21		$	(19	)	$	28		$	40		$	40

8

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

Employer contributions

     RAI disclosed in its financial statements for the year ended December 31, 2006, that it expected to contribute $300 million to its pension plans in 2007. Of this amount, RAI contributed $292 million to its pension plans during the first six months of 2007.

Recently Adopted Accounting Pronouncements

     Effective January 1, 2007, RAI adopted Financial Accounting Standards Board, referred to as FASB, Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” referred to as FIN No. 48. FIN No. 48 clarifies SFAS No. 109, “Accounting for Income Taxes,” by providing specific guidance for consistent reporting of uncertain income taxes recognized in a company’s financial statements, including classification, interest and penalties and disclosures. RAI’s adoption of FIN No. 48 resulted in a cumulative adjustment to retained earnings as of January 1, 2007, of $5 million.

Recently Issued Accounting Pronouncements

     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement.” SFAS No. 157 does not require any new fair value measurements but provides a definition of fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 is effective for RAI as of January 1, 2008. RAI currently is assessing the impact of SFAS No. 157 on its consolidated financial position and results of operations.

     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 permits all entities to choose to elect to measure eligible financial instruments at fair value. RAI does not expect to elect to measure any eligible financial instruments at fair value upon adoption of SFAS No. 159 on January 1, 2008. Accordingly, RAI does not expect the adoption of SFAS No. 159 to have a material impact on its financial position, results of operations or cash flows.

Note 2–Restructuring and Asset Impairment Charges

2004 B&W Business Combination Restructuring Costs

     The components of the 2004 B&W business combination restructuring costs accrued and utilized were as follows:

	Employee
	Severance and			Relocation/
	Benefits			Exit Costs			Total
Original accrual	$	171		$	101		$	272
Utilized in 2004		(60	)		(26	)		(86	)
Balance, December 31, 2004		111			75			186
Utilized in 2005		(40	)		(28	)		(68	)
Adjusted in 2005		—			9			9
Adjustment to goodwill		1			(16	)		(15	)
Balance, December 31, 2005		72			40			112
Utilized in 2006		(69	)		(12	)		(81	)
Adjustment to goodwill		(2	)		(8	)		(10	)
Balance, December 31, 2006		1			20			21
Utilized in 2007		(1	)		(3	)		(4	)
Balance, June 30, 2007	$	—		$	17		$	17

     In connection with the allocation of the cost of the B&W business combination to assets acquired and liabilities assumed, RJR Tobacco accrued restructuring costs of $272 million in 2004. Of these costs, $171 million relate to the severance payments to approximately 2,450 former B&W employees in operations, sales and corporate functions, which were significantly completed by mid-year 2006. Other accruals include the cost to relocate former B&W employees retained and transferred from facilities that were to be exited. Additionally, other exit costs include contract

9

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

terminations and the closure of the acquired headquarters, a leased facility in Louisville, Kentucky, as well as the closure of a leased warehouse and certain leased sales offices, net of expected sub-lease income.

     As of June 30, 2007, $239 million of the accrued amount had been paid. In the condensed consolidated balance sheet (unaudited) as of June 30, 2007, $6 million is included in other current liabilities and $11 million is included in other noncurrent liabilities.

Note 3–Income Per Share

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

	For the Three Months				For the Six Months
	Ended June 30,				Ended June 30,
	2007		2006		2007		2006
Income from continuing operations	$	324	$	367	$	652	$	647
Extraordinary item – gain on acquisition		1		9		1		74
Net income	$	325	$	376	$	653	$	721
Basic weighted average shares, in thousands1		294,154		295,029		294,596		294,991
Effect of dilutive potential shares:
Options		248		286		251		308
Restricted stock		222		45		194		23
Diluted weighted average shares, in thousands		294,624		295,360		295,041		295,322

¹ Outstanding contingently issuable restricted stock of 0.8 million shares and 0.5 million shares for the three-month periods, and 0.7 million shares and 0.3 million shares for the six-month periods ended June 30, 2007 and 2006, respectively, were excluded from the basic share calculation, as the related vesting provisions had not been met.

Note 4–Inventories

     The major components of inventories were as follows:

	June 30,		December 31,
	2007		2006
Leaf tobacco	$	827	$	938
Raw materials		44		44
Work in process		54		54
Finished products		174		156
Other		25		26
Total		1,124		1,218
Less LIFO allowance		68		63
	$	1,056	$	1,155

     RAI recorded $1 million of expense from expected LIFO layer liquidations for the six-month period ended June 30, 2007. Such expense for the quarter ended June 30, 2007, was less than $1 million. RAI will perform its annual LIFO inventory valuation at December 31, 2007, and interim periods represent an estimate of the expected annual valuation.

10

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

Note 5–Income Taxes

     In the first quarter of 2007, RAI recorded a cumulative effect for a change in accounting principle of $5 million concerning a decrease of reserves related to uncertain tax positions. This change was accounted for as an increase to the opening balance of retained earnings. After the cumulative effect decrease, RAI had approximately $174 million of gross unrecognized tax benefits. Of this total, approximately $100 million, net of federal benefit on state issues and deposits, represents the amount of unrecognized tax benefits that would affect the effective income tax rate if recognized in future periods. Additionally, the gross unrecognized tax benefits included $59 million of accrued interest and penalties.

     In its adoption of FIN No. 48, RAI has elected, consistent with its past accounting practice, to classify interest and penalties related to its uncertain tax position as tax expense. RAI accrued $59 million of gross interest and penalties as of January 1, 2007.

     Pursuant to FIN No. 48, the total net amount of unrecognized tax benefits as of June 30, 2007, that, if recognized, would affect the tax rate, was $105 million. Of this amount, $45 million, represents net interest and penalties.

     For the three-month and six-month periods ended June 30, 2007, the gross amounts of increases in unrecognized tax benefits as a result of tax positions taken during prior years were $3 million and $6 million, respectively. The gross amounts of increases as a result of tax positions taken during the current year were $3 million and $7 million for the three months and six months, respectively. The gross amount of decreases in the unrecognized tax benefits relating to settlements with taxing authorities were $1 million and $2 million for the three months and six months ended June 30, 2007, respectively. There was no reduction of unrecognized tax benefits as a result of a lapse of the applicable statute of limitations.

     Included in the income tax expense for the three-month and six-month periods ended June 30, 2007, were approximately $4 million and $8 million, respectively, of additional tax, interest, net of federal benefit, and penalties associated with uncertain tax positions. Of these amounts, $2 million and $4 million for the three and six month periods, respectively, relate to net interest and penalties.

     It is expected that the amount of unrecognized tax benefits will change in the next 12 months. However, RAI does not expect the change to have a significant impact on its results of operations or financial position.

     The provision for income taxes in the second quarter of 2007 was $191 million, or an effective rate of 37.1%, compared with $223 million, or an effective rate of 37.8%, in the second quarter of 2006. The provision for income taxes for the first half of 2007 was $387 million, or an effective rate of 37.2%, compared with $390 million, or an effective rate of 37.6%, in the first half of 2006. The 2006 provision was impacted by the nondeductibility of certain expenditures relating to ballot initiatives, state taxes and other nondeductible items, partially offset by the resolution of certain prior years’ tax matters that resulted in a reduction of income tax expense of $9 million.

     The effective rate exceeds the federal statutory rate of 35% primarily due to the impact of state taxes and certain other nondeductible items, offset by the estimated domestic production credit of the American Jobs Creation Act enacted on October 22, 2004.

     RAI and its subsidiaries are subject to income taxes in the United States, certain foreign jurisdictions and multiple state jurisdictions. The Internal Revenue Service completed its examination and issued an assessment for the years 2002 and 2003. RAI filed a protest in 2006. Discussions with the IRS during the first quarter of 2007 indicate that a resolution is expected by the end of the year. The IRS adjustments have been reflected in the FIN No. 48 liability balance. Overpayments for the prior IRS audits are available to cover any additional tax and interest that may be due as the result of the 2002-2003 protest resolution. There are no additional IRS examinations scheduled at this time.

     For years through 1999, substantially all material state income tax matters have been concluded and the federal audit adjustments for years prior to 2002 have been reported to the states.

     RAI recorded favorable tax matter resolution adjustments of $1 million and $9 million in the second quarter of 2007 and 2006, respectively, and $1 million and $74 million, in the first six months of 2007 and 2006, respectively, to

11

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

the gain related to the acquisition of RJR’s former parent, Nabisco Group Holdings Corp., referred to as NGH. Including these adjustments, the net after-tax gain on the acquisition of NGH was $1.8 billion.

Note 6–Borrowing Arrangements

     On June 28, 2007, RAI entered into a Fifth Amended and Restated Credit Agreement, which provides for a five-year, $550 million senior secured revolving credit facility, which may be increased to $900 million at the discretion of the lenders upon the request of RAI. The credit agreement amends and restates RAI’s prior credit agreement dated May 31, 2006.

     The prior credit agreement provided for a five-year, $550 million senior secured revolving credit facility, which could be increased to $800 million at the discretion of the lenders upon the request of RAI and a six-year, $1.55 billion senior secured term loan. On June 21, 2007, RAI prepaid in full, using available cash and the net proceeds of a notes offering as described in note 7 below, the $1.54 billion principal amount outstanding under such term loan, plus accrued interest thereon.

     The amended credit agreement contains restrictive covenants that limit RAI’s and its subsidiaries’ ability to pay dividends and repurchase stock, make investments, prepay certain indebtedness, incur indebtedness, engage in transactions with affiliates, create liens, acquire, sell or dispose of specific assets and engage in specified mergers or consolidations. These covenants in the amended credit agreement are subject to a number of qualifications and exceptions. The maturity date of the amended credit agreement is June 28, 2012, which date may be extended in two separate one year increments.

     The amended credit agreement contains customary events of default, including upon a change in control, that could result in the acceleration of all amounts and cancellation of all commitments outstanding under the amended credit agreement.

     RAI is able to use the revolving credit facility under the amended credit agreement for borrowings and issuances of letters of credit at its option. Issuances of letters of credit reduce availability under such revolving credit facility. As of June 30, 2007, there were no borrowings, and $24 million of letters of credit outstanding, under the amended credit agreement.

     Under the terms of the amended credit agreement, RAI is required to pay a commitment fee of between 0.25% and 1.0% per annum on the unused portion of the revolving credit facility.

     Borrowings under the amended credit agreement bear interest, at the option of RAI, at a rate equal to an applicable margin plus:

• the reference rate, which is the higher of (1) the federal funds effective rate from time to time plus 0.5% and (2) the prime rate; or

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

     Certain of RAI’s subsidiaries, including its material domestic subsidiaries, referred to as the Guarantors, have guaranteed RAI’s obligations under the amended credit agreement.

     RAI has pledged substantially all of its assets, including the stock of its direct subsidiaries, to secure its obligations under the amended credit agreement. In addition, the Guarantors generally have pledged substantially all of their assets to secure their guarantees of RAI’s obligations under the amended credit agreement, including the stock, indebtedness and other obligations held by or owing to such Guarantor of a subsidiary. However, the pledge of RJR and its direct and indirect subsidiary Guarantors is limited to the stock of RJR’s direct, wholly owned subsidiary, RJR Tobacco, and RAI’s direct, wholly owned subsidiaries, Lane and Santa Fe, have pledged substantially all of their personal property, but no real property.

12

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

     Under the terms of the amended credit agreement, at such time, if any, as RAI has obtained a corporate credit rating of investment grade with not worse than stable outlooks from each of Moody’s and S&P, the security for the amended credit agreement will, generally, be released automatically.

     Pursuant to the amended credit agreement, in the event of RAI’s exposure under any hedging arrangement with a lender, RAI’s obligations under such hedging arrangement will be guaranteed by the same entities and secured by the same assets as under the amended credit agreement.

     As of June 30, 2007, Moody’s corporate credit rating of RAI was Ba1, positive outlook, and S&P’s rating was BB+, positive outlook. Concerns about, or lowering of, RAI’s corporate ratings by S&P or Moody’s could have an adverse impact on RAI’s ability to access the debt markets and could increase borrowing costs. However, given the cash balances and operating performance of RAI and its subsidiaries, RAI’s management believes that such concerns about, or lowering of, such ratings would not have a material adverse impact on RAI’s cash flows.

Note 7–Long-Term Debt

     Long-term debt consisted of the following:

	June 30, 2007			December 31, 2006
RJR 8.50% — 9.25% unsecured notes, due 2007 to 2013	$	89		$	89
RJR 6.5% — 7.875% guaranteed, unsecured notes, due 2007 to 2015		69			163
Total RJR debt		158			252
RAI 6.5% — 7.875% guaranteed, secured notes, due 2007 to 2037		3,870			2,939
RAI floating rate, guaranteed, secured, notes, due 2011		400			—
RAI floating rate, guaranteed, secured, term loan, due 2012		—			1,542
Total RAI debt		4,270			4,481
Total debt		4,428			4,733
Current maturities of long-term debt		(29	)		(344	)
	$	4,399		$	4,389

     On June 21, 2007, RAI completed the sale of $1.55 billion in aggregate principal amount of senior, secured notes, consisting of $400 million of floating rate notes due June 15, 2011, $700 million of 6.75% notes due June 15, 2017, and $450 million of 7.25% notes due June 15, 2037. These notes were sold under RAI’s shelf registration statement filed with the SEC on June 18, 2007. The net proceeds from the offering, together with available cash, were used to prepay in full the principal balance of $1.54 billion of a term loan, together with accrued interest.

     In February 2007, $48 million of RJR notes were exchanged for RAI notes. In June 2007, $46 million of RJR notes matured and were repaid.

     The Guarantors of RAI’s amended credit agreement also guarantee RAI’s senior secured notes. RAI’s senior secured notes are secured by a pledge of the stock, indebtedness and other obligations of RJR Tobacco owned by or owed to RAI or any restricted subsidiary. Such notes also are secured by any principal property of RAI and any Guarantor that is a restricted subsidiary. Santa Fe and Lane are excluded from the definition of restricted subsidiary. These assets constitute a portion of the security for the obligations of RAI and the Guarantors under the amended credit agreement. If these assets are no longer pledged as security for the obligations of RAI and the Guarantors under the amended credit agreement, or any other indebtedness of RAI, they will be released automatically as security for RAI’s senior secured notes and the related guarantees. Generally, the terms of RAI’s senior secured notes restrict the pledge of collateral, sale/leaseback transactions and the transfer of all or substantially all of the assets of certain of RAI’s subsidiaries.

     RAI, RJR and their affiliates were in compliance with all covenants and restrictions imposed by their indebtedness at June 30, 2007.

13

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

Note 8–Financial Instruments

     RAI and RJR use interest rate swaps to manage interest rate risk on a portion of their respective debt obligations. When entered into, these financial instruments are designated as hedges of underlying exposures.

     Swaps existed on the following principal amount of debt:

	June 30, 2007		December 31, 2006
RJR 6.5% unsecured notes, due 2007	$	—	$	63
RJR 7.25% unsecured notes, due 2012		57		82
Total swapped RJR debt		57		145
RAI 6.5% secured notes, due 2007		—		237
RAI 7.25% secured notes, due 2012		393		368
RAI 7.625% secured notes, due 2016		450		—
RAI 6.75% secured notes, due 2017		700		—
Total swapped RAI debt		1,543		605
Total swapped debt	$	1,600	$	750

     In February 2007, $42 million of RJR notes with swap agreements were exchanged for RAI notes with the associated swaps assigned to RAI. In June 2007, swaps related to $254 million of RAI debt and $46 million of RJR debt were settled.

     On June 21, 2007, RAI entered into swap agreements with respect to $450 million and $700 million of notes with fixed rates of 7.625% and 6.75%, due in 2016 and 2017, respectively. Including the impact of swaps, as of June 30, 2007, the average interest rate on RAI’s consolidated $4.4 billion long-term debt was 7.04%.

     The interest rate swaps’ notional amounts and termination dates match those of the corresponding outstanding notes. As of June 30, 2007, these fair value hedges were perfectly effective, resulting in no recognized net gain or loss. The unrealized gain on the hedges resulting from the change in the hedges’ fair value was $4 million and $15 million at June 30, 2007 and December 31, 2006, respectively, included in other assets and deferred charges and was equal to the increase in the fair value of the hedged long-term debt.

     Under certain conditions, any fair value that results in a liability position of certain interest rate swaps may require full collateralization with cash or securities.

Note 9–Commitments and Contingencies

Tobacco Litigation — General

Introduction

     Various legal proceedings, 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, Conwood or their affiliates, including RAI and RJR, or indemnitees, including B&W. As described in greater detail below, RJR Tobacco has agreed to indemnify B&W and its affiliates against certain litigation liabilities. These legal proceedings include claims relating to cigarette products manufactured by RJR Tobacco or certain of its affiliates and indemnitees, as well as claims relating to smokeless tobacco products manufactured by Conwood. 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 Conwood are discussed separately under the heading “— Smokeless Tobacco Litigation” below.

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

14

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

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 “settlement” refers to certain types of cases in which cigarette manufacturers, including RJR Tobacco and B&W, 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 and B&W are explained below under “— Accounting for Tobacco-Related Litigation Contingencies.”

Theories of Recovery

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

     The plaintiffs seek various forms of relief, including compensatory and 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 state to state and jurisdiction to jurisdiction, compensatory and punitive damages have been specifically pleaded in a number of cases, sometimes in amounts ranging into the hundreds of millions and even billions of dollars.

Defenses

     The defenses raised by RJR Tobacco, Conwood 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, 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 and RJR 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 and Conwood, as applicable, record any loss concerning litigation at such time as an unfavorable outcome becomes probable and the amount can be reasonably estimated. 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 or its affiliates or indemnitees, or the loss of any particular claim concerning the use of smokeless tobacco against Conwood, when viewed on an individual basis, is not probable.

     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, RJR 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. RJR Tobacco and its 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

15

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

claims brought against them continue to be dismissed at or before trial. Based on their experience in the smoking and health tobacco litigation against them 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.

     No liability for pending smoking and health tobacco litigation was recorded in RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2007. RJR has liabilities totaling $94 million that were recorded in 1999 in connection with certain indemnification claims asserted by JTI against RJR and RJR Tobacco relating to certain activities of Northern Brands International, Inc., a now inactive, indirect subsidiary of RAI formerly involved in the international tobacco business, referred to as Northern Brands. For further information on Northern Brands and related litigation and the indemnification claims of JTI, see “— Litigation Affecting the Cigarette Industry — Other Litigation and Developments” and “— Other Contingencies and Guarantees” below.

     Generally, RJR Tobacco and its affiliates and indemnitees have not settled, and currently RJR Tobacco and its affiliates do not intend to settle, any smoking and health tobacco litigation claims. It is the policy of RJR Tobacco and its affiliates to vigorously defend all tobacco-related litigation claims.

     The only smoking and health tobacco litigation claims settled by RJR Tobacco and B&W involved:

• the MSA and other settlement agreements with the states of Mississippi, Florida, Texas and Minnesota, and the funding by various tobacco companies of a $5.2 billion trust fund contemplated by the MSA to benefit tobacco growers; and

• the original Broin flight attendant case discussed below under “— Litigation Affecting the Cigarette Industry — Class-Action Suits.”

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

     The states were a unique set of plaintiffs and are not involved in any of the smoking and health cases remaining against RJR Tobacco or its affiliates and indemnitees. Although RJR Tobacco and certain of its 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 hospitals, 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.

     The pending U.S. Department of Justice case brought against various industry members, including RJR Tobacco and B&W, discussed below under “— Litigation Affecting the Cigarette Industry — Governmental Health-Care Cost Recovery Cases,” also can be distinguished from the circumstances surrounding the MSA and the other state settlement agreements. Under its Medical Care Recovery Act and Medicare Secondary Payer Act claims, the federal government made arguments similar to the states and sought to recover federal funds expended in providing health care to smokers who have developed diseases and injuries alleged to be smoking-related. These claims were dismissed, and the only claim remaining in the case involves alleged violations of civil provisions of the federal Racketeer Influenced and Corrupt Organizations Act, referred to as RICO. Under this statute, the federal government sought disgorgement of profits from the defendants in the amount of $280 billion. Reversing the trial court, the U.S. Court of Appeals for the District of Columbia held that disgorgement is not an available remedy. Trial of the case concluded on June 9, 2005. On August 17, 2006, the trial court found certain defendants liable for the RICO claims and issued an order for injunctive and other relief, but did not impose any direct financial penalties. Certain defendants, including RJR Tobacco, have

16

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

appealed to the U.S. Court of Appeals for the District of Columbia. The government also has appealed. A comprehensive discussion of this case is set forth below under “— Litigation Affecting the Cigarette Industry — Governmental Health-Care Cost Recovery Cases.”

     As with the claims that were resolved by the MSA and other state settlement agreements, the other cases settled by RJR Tobacco can be distinguished from existing cases pending against RJR Tobacco and its affiliates and indemnitees. The original Broin case, discussed below under “— Litigation Affecting the Cigarette Industry — Class-Action Suits,” was settled in the middle of trial during negotiations concerning a possible nation-wide settlement of claims similar to those underlying the MSA and other state settlement agreements.

     The DeLoach case, discussed below under “— Litigation Affecting the Cigarette Industry — Antitrust Cases,” was brought by a unique class of plaintiffs: a class of all tobacco growers and tobacco allotment holders. The class asserted that the defendants, including RJR Tobacco and B&W, engaged in bid-rigging of U.S. burley and flue-cured tobacco auctions. Despite valid legal defenses, RJR Tobacco and B&W separately settled this case to avoid a long and contentious trial with the tobacco growers. The few antitrust cases pending against RJR Tobacco and B&W involve different types of plaintiffs and different theories of recovery under the antitrust laws.

     Finally, as discussed under “— Litigation Affecting the Cigarette Industry — MSA — Enforcement and Validity,” RJR Tobacco and B&W each has settled certain cases brought by states concerning the enforcement of the MSA. Despite valid legal defenses, these cases were settled to avoid further contentious litigation with the states involved. Each MSA enforcement action involves alleged breaches of the MSA based on specific actions taken by the particular defendant. Accordingly, any future MSA enforcement action will be reviewed by RJR Tobacco on the merits and should not be affected by the settlement of prior MSA enforcement cases.

     Conwood also believes that it has valid defenses to the smokeless tobacco litigation against it. Conwood has 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 Conwood and its counsel. No verdict or judgment has been returned or entered against Conwood on any claim for personal injuries allegedly resulting from the use of smokeless tobacco. Conwood intends to defend vigorously all smokeless tobacco litigation claims asserted against it. No liability for pending smokeless tobacco litigation currently is recorded in RAI’s condensed consolidated balance sheet (unaudited) as of June 30, 2007.

Cautionary Statement

     Even though RAI’s management continues to conclude that the loss of any particular pending smoking and health tobacco litigation claim against RJR Tobacco or its affiliates or indemnitees, or the loss of any particular case concerning the use of smokeless tobacco against Conwood, when viewed on an individual basis, is not probable, 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, Conwood 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 in its pending cases, and RJR Tobacco and RAI believe they have valid defenses to all actions, and intend to defend all actions vigorously, 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 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 materially adversely affect the litigation against RJR Tobacco or its affiliates or indemnitees and could encourage the commencement of additional tobacco-related litigation. In addition, a number of political, legislative, regulatory and other developments relating to the tobacco industry and cigarette smoking have received wide media attention. These developments may negatively affect the outcomes of tobacco-related legal actions and encourage the commencement of additional similar litigation.

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

17

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

     Similarly, smokeless tobacco litigation is subject to many uncertainties. Notwithstanding the quality of defenses available to Conwood, it is possible that RAI’s results of operations, cash flows or financial condition could be materially adversely affected by the ultimate outcome of certain pending litigation matters against Conwood.

Litigation Affecting the Cigarette Industry

Overview

     Introduction. In connection with the business combination of RJR Tobacco and the U.S. cigarette and tobacco business of B&W on July 30, 2004, 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. Accordingly, the cases discussed below include cases brought solely against RJR Tobacco and its affiliates, including RAI and RJR; cases brought against both RJR Tobacco, its affiliates and B&W; and cases brought solely against B&W and assumed by RJR Tobacco in the business combination.

     During the second quarter of 2007, 27 tobacco-related cases were served against RJR Tobacco or its affiliates or indemnitees. On June 30, 2007, there were 1,185 cases (including 871 individual smoker cases pending in West Virginia state court as a consolidated action) pending in the United States against RJR Tobacco or its affiliates or indemnitees, as compared with 1,272 on June 30, 2006, and 1,371 on June 30, 2005, pending against RJR Tobacco or its affiliates or indemnitees.

     As of July 13, 2007, 1,214 tobacco-related cases were pending against RJR Tobacco or its affiliates or indemnitees: 1,209 in the United States; one in Puerto Rico; three in Canada; and one in Israel. Of the 1,209 total U.S. cases, 29 cases are pending against B&W that are not also pending against RJR Tobacco. The U.S. case number does not include the 2,623 Broin II cases, which involve individual flight attendants alleging injuries as a result of exposure to environmental tobacco smoke, referred to as ETS or secondhand smoke, in aircraft cabins, pending as of July 13, 2007, and discussed below. The following table lists the number of U.S. tobacco-related cases by state that were pending against RJR Tobacco or its affiliates or indemnitees as of July 13, 2007:

	Number of
State	U.S. Cases
West Virginia		876	*
Florida		109	**
Maryland		36
Mississippi		27
Missouri		26
New York		26
Louisiana		16
California		13
Illinois		7
New Jersey		4
Alabama		3
Tennessee		3
District of Columbia		3
Georgia		3
Connecticut		3
Pennsylvania		3
Ohio		3
Delaware		2
Minnesota		2
Michigan		2
North Carolina		2
South Dakota		2
Vermont		2
Massachusetts		2
Kentucky		2
Oregon		2

18

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

	Number of
State	U.S. Cases
Kansas		2
New Mexico		2
South Carolina		2
Arizona		2
Washington		2
Indiana		1
Arkansas		1
Colorado		1
Hawaii		1
Iowa		1
Idaho		1
Montana		1
North Dakota		1
Nebraska		1
New Hampshire		1
Nevada		1
Utah		1
Mariana Islands		1
Maine		1
Rhode Island		1
Wisconsin		1
Oklahoma		1
Wyoming		1
Alaska		1
Virginia		1
Total		1,209

*	871 of the 876 cases are pending as a consolidated action.
**	41 of the 109 cases are pending as Engle Progeny Cases, as defined below.

     Of the 1,209 pending U.S. cases, 59 are pending in federal court, 1,149 in state court and one in tribal court.

     The following table lists the categories of the U.S. tobacco-related cases pending against RJR Tobacco or its affiliates or indemnitees as of July 13, 2007, compared with the number of cases pending against RJR Tobacco, its affiliates or indemnitees as of April 13, 2007, as reported in RAI’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2007, filed with the SEC on May 4, 2007, and a cross-reference to the discussion of each case type.

			Change in
	RJR Tobacco’s		Number of
	Case Numbers as of		Cases Since
Case Type	July 13, 2007		April 13, 2007			Page Reference
Individual Smoking and Health		1,079		-28	*		24
Engle Progeny		41		*			26
Flight Attendant – ETS (Broin II)		2,623	No Change				26
Class-Action		19		-3			26
Governmental Health-Care Cost Recovery		1	No Change				33
Other Health-Care Cost Recovery and Aggregated Claims		3	No Change				36
Master Settlement Agreement-Enforcement and Validity		53		+5			36
Antitrust		4	No Change				38
Other Litigation		9		-3			40

* The Engle Progeny Cases have been separated from the Individual Smoking and Health cases for reporting purposes.

19

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

     Three pending cases against RJR Tobacco and B&W have attracted significant media attention: the Florida state court class-action case, Engle v. R. J. Reynolds Tobacco Co., the federal RICO case brought by the U.S. Department of Justice, and the federal lights class action Schwab [McLaughlin] v. Philip Morris USA, Inc.

     In 2000, a jury in Engle rendered a punitive damages verdict in favor of the “Florida class” of approximately $145 billion against all defendants. On July 6, 2006, the Florida Supreme Court, among other things, affirmed an appellate court’s reversal of the punitive damages award, decertified the class going forward, preserved several class-wide findings from the trial, including that nicotine is addictive and cigarettes are defectively designed, and authorized class members to avail themselves of these findings in individual lawsuits under certain conditions. After subsequent motions were resolved, the Florida Supreme Court issued its mandate on January 11, 2007, thus beginning a one-year period in which former class members may file individual lawsuits. Lawsuits by individuals requesting the benefit of the Engle ruling, whether filed before or after the January 11, 2007 mandate, are referred to as Engle Progeny Cases. On May 21, 2007, the defendants, including RJR Tobacco, filed a petition for writ of certiorari in the U.S. Supreme Court.

     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 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 have appealed to the U.S. Court of Appeals for the District of Columbia, and the trial court’s order has been stayed pending the appeal.

     In September 2006, the U.S. District Court for the Eastern District of New York in Schwab certified a nationwide class of “lights” smokers and set a trial date of January 22, 2007. On November 16, 2006, the U.S. Court of Appeals for the Second Circuit granted the defendants’ motions to stay the district court proceedings and for review of the class certification ruling. Oral argument occurred on July 10, 2007. A decision is pending.

     For a detailed description of these cases, see “— Class-Action Suits — Engle Case,” “— Governmental Health-Care Cost Recovery Cases — Department of Justice Case” and “— Class-Action Suits — ‘Lights’ Cases” below.

     In November 1998, the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, entered into the MSA with 46 U.S. states 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. The MSA and other state settlement agreements:

     • settled all health-care cost recovery actions brought by, or on behalf of, the settling jurisdictions;

     • released the major U.S. cigarette manufacturers from various additional present and potential future claims;

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

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

     The aggregate cash payments made by RJR Tobacco under the MSA and other state settlement agreements were $2.6 billion and $2.7 billion in 2006 and 2005, respectively. RJR Tobacco estimates its payments will be approximately $2.6 billion in 2007 and will be approximately $2.8 billion each year thereafter. These payments are subject to adjustments for, among other things, the volume of cigarettes sold by RJR Tobacco, RJR Tobacco’s market share and inflation. See “— Governmental Health-Care Cost Recovery Cases — MSA and Other State Settlement Agreements” below for a detailed discussion of the MSA and the other state settlement agreements, including RJR Tobacco’s monetary obligations under these agreements. 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. The following table lists the trial schedule, as of July 13, 2007, for RJR Tobacco or its affiliates and indemnitees through June 30, 2008.

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Trial Date	Case Name/Type	Defendant(s)	Jurisdiction
September 17, 2007	Hausrath v. Philip Morris USA, Inc. [Individual]	B&W	NY Supreme Court Erie County (Buffalo, NY)
October 10, 2007	Standish v. American Tobacco Co. [Individual]	RJR Tobacco, B&W	Supreme Court Bronx County (Bronx, NY)
October 29, 2007	Menchini v. Philip Morris, Inc. [Broin II/ETS]	RJR Tobacco, B&W	Circuit Court 11th Judicial Circuit Miami-Dade County (Miami, FL)
January 7, 2008	Brown v. R.J. Reynolds Tobacco Co. [Individual (Engle III)]	RJR Tobacco	U.S. District Court Southern District (Miami, FL)
January 14, 2008	Williams v. Brown & Williamson Tobacco Corp. [Individual]	RJR Tobacco, B&W	Circuit Court City of St. Louis (St. Louis, MO)
February 19, 2008	Smith v. R.J. Reynolds Tobacco Co. [Individual]	RJR Tobacco	U.S. District Court Eastern District (New Orleans, LA)
March 17, 2008	Coy v. Philip Morris, Inc. [Individual]	RJR Tobacco, B&W	U.S. District Court Southern District (Miami, FL)
March 17, 2008	In re: Tobacco Litigation (Individual Personal      Injury Cases) [Individual/Consolidated]	RJR Tobacco, B&W	Circuit Court Ohio County (Wheeling, WV)
March 24, 2008	Falconer v. R.J. Reynolds Tobacco Co. [Individual]	RJR Tobacco	Circuit Court Jackson County (Kansas City, MO)

     Trial Results. From January 1, 1999 through July 13, 2007, 53 smoking and health and health-care cost recovery cases in which RJR Tobacco or B&W were defendants were tried. Verdicts in favor of RJR Tobacco, B&W and, in some cases, RJR Tobacco, B&W and other defendants, were returned in 36 cases (including four mistrials) tried in Florida (10), New York (4), Missouri (4), Tennessee (3), Mississippi (2), California (2), West Virginia (2), Ohio (2), Connecticut (1), Louisiana (1), New Jersey (1), Pennsylvania (1), South Carolina (1), Texas (1) and Washington (1).

     Additionally, from January 1, 1999 through July 13, 2007, verdicts were returned in 20 smoking and health cases in which RJR Tobacco, B&W, or their respective affiliates were not defendants. Verdicts were returned in favor of the defendants in 11 cases — four in Florida, two in California, and one in each of New Hampshire, New York, Pennsylvania, Rhode Island and Tennessee. Verdicts in favor of the plaintiffs were returned in nine cases — four in California, two in each of Florida and Oregon and one in Illinois.

     One case was tried in the first half of 2007 in which RJR Tobacco was a defendant. In Whiteley v. R.J. Reynolds Tobacco Co., an individual smoker case in California state court, jury selection began in January 2007. On May 2, 2007, the jury awarded the plaintiff $2.46 million in compensatory damages jointly against RJR Tobacco and Philip Morris. On May 9, 2007, the jury returned a punitive damages verdict award of $250,000 against RJR Tobacco only. RJR Tobacco intends to file appropriate post-trial motions and, if necessary, appeal.

     The following chart reflects the verdicts and post-trial developments in the smoking and health cases that have been tried since January 1, 1999 and remain pending as of July 13, 2007, in which verdicts have been returned in favor of the plaintiffs and against RJR Tobacco or B&W, or both.

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Date of Verdict	Case Name/Type	Jurisdiction	Verdict	Post-Trial Status
July 7, 1999-Phase I April 7, 2000-Phase II July 14, 2000-Phase III	Engle v. R. J. Reynolds      Tobacco Co. [Class Action]	Circuit Court, Miami-Dade County (Miami, FL)	$12.7 million compensatory damages against all the defendants; $145 billion punitive damages against all the defendants, of which approximately $36.3 billion and $17.6 billion was assigned to RJR Tobacco and B&W, respectively.	On May 21, 2003, Florida’s Third District Court of Appeal reversed the trial court and remanded the case to the Miami-Dade County Circuit Court with instructions to decertify the class. The Florida Supreme Court on July 6, 2006 affirmed the dismissal of the punitive damages award and decertified, on a going-forward basis, the class. The court preserved a number of classwide findings from Phase I of the Engle trial, and authorized class members to avail themselves of those findings in individual lawsuits, provided they commence those lawsuits within one year of the date the court’s decision becomes final. In addition, the court reinstated compensatory damage verdicts in favor of two plaintiffs in the amounts of $2.85 million and $4.023 million, respectively. On December 21, 2006, the Florida Supreme Court, in response to motions from both sides, issued a revised opinion in which it set aside the jury’s finding of a conspiracy to misrepresent, and clarified that the future plaintiffs could rely on the Engle jury’s findings on express warranty. The Supreme Court mandate issued on January 11, 2007. On May 21, 2007, the defendants, including RJR Tobacco, filed a petition for writ of certiorari in the U.S. Supreme Court.
June 11, 2002	Lukacs v. R. J.      Reynolds Tobacco Co. [Engle class member]	Circuit Court, Miami-Dade County (Miami, FL)	$500,000 economic damages, $24.5 million non-economic damages and $12.5 million loss of consortium damages against Philip Morris, B&W and Lorillard, of which B&W was assigned 22.5% of liability. Court has not entered final judgment for damages. RJR Tobacco was dismissed from the case in May 2002, prior to trial.	Judge reduced damages to $25.125 million of which B&W’s share is approximately $6 million. On January 2, 2007, the defendants moved to set aside the June 11, 2002, verdict and to dismiss the plaintiffs’ punitive damages claim. On January 3, 2007, the plaintiffs filed a motion for entry of judgment. A hearing on the motions occurred on March 15, 2007. A decision is pending.

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Date of Verdict	Case Name/Type	Jurisdiction	Verdict	Post-Trial Status
December 18, 2003	Frankson v. Brown &       Williamson Tobacco Corp. [Individual]	Supreme Court, Kings County (Brooklyn, NY)	$350,000 compensatory damages; 50% fault assigned to B&W and two industry organizations; $20 million in punitive damages, of which $6 million was assigned to B&W, $2 million to a predecessor company and $12 million to two industry organizations.	On January 21, 2005, the plaintiff stipulated to the court’s reduction in the amount of punitive damages from $20 million to $5 million, apportioned as follows: $0 to American Tobacco; $4 million to B&W; $500,000 to the Council for Tobacco Research and $500,000 to the Tobacco Institute. On June 26, 2007, final judgment was entered in the amount of approximately $6.8 million (including interest and costs). The defendants filed a notice of appeal on July 3, 2007. Pursuant to its agreement to indemnify B&W, RJR Tobacco posted a supersedeas bond in the amount of $8.018 million on July 5, 2007.
May 21, 2004	Scott v. American       Tobacco Co. [Class Action]	District Court, Orleans Parish (New Orleans, LA)	$591 million against RJR Tobacco, B&W, Philip Morris, Lorillard, and the Tobacco Institute, jointly and severally, for a smoking cessation program.	On September 29, 2004, the defendants posted a $50 million bond and noticed their appeal to the Louisiana Court of Appeal. RJR Tobacco posted $25 million toward the bond. On February 7, 2007, the Louisiana Court of Appeal found that any class member who started smoking or whose right to participate in the program accrued after September 1, 1988, is not entitled to any recovery. The court also rejected the award of pre-judgment interest and most of the specific components of the smoking cessation program. However, the court upheld the class certification and found the defendants responsible for funding smoking cessation for eligible class members. The defendants filed an application for writ of certiorari with the Louisiana Supreme Court on April 2, 2007.

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Date of Verdict	Case Name/Type	Jurisdiction	Verdict	Post-Trial Status
February 2, 2005	Smith v. Brown &      Williamson Tobacco      Corp. [Individual]	Circuit Court, Jackson County (Independence, MO)	$2 million in compensatory damages (reduced to $500,000 because of jury’s findings that the plaintiff was 75% at fault); $20 million in punitive damages.	On June 1, 2005, B&W filed its notice of appeal. On July 31, 2007, the Missouri Court of Appeals reversed the punitive damages award, ordered a new trial on punitive damages and transferred the case to the Missouri Supreme Court. The Missouri Supreme Court may review the entire case.
March 18, 2005	Rose v. Brown &      Williamson Tobacco      Corp. [Individual]	Supreme Court, New York County (Manhattan, NY)	RJR Tobacco found not liable; $3.42 million in compensatory damages against B&W and Philip Morris, of which $1.71 million was assigned to B&W; $17 million in punitive damages against Philip Morris only.	On August 18, 2005, B&W filed its notice of appeal. Pursuant to its agreement to indemnify B&W, RJR Tobacco posted a supersedeas bond in the amount of $2.058 million on February 7, 2006. Oral argument occurred on December 12, 2006. A decision is pending.
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 and B&W 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.	On September 11, 2006, RJR Tobacco and B&W filed their notices of appeal. On October 16, 2006, the government filed its notice of appeal. In addition, the government has requested the defendants pay a total of approximately $1.9 million in costs. The court of appeals granted the defendants’ motion to stay the district court’s order on October 31, 2006. In May 2007, the court of appeals issued a briefing schedule that extends through May 19, 2008.
May 2, 2007	Whiteley v. R.J.      Reynolds Tobacco Co. [Individual]	Superior Court, San Francisco County, (San Francisco, CA)	$2.46 million in compensatory damages against RJR Tobacco and Philip Morris; $250,000 punitive damages against RJR Tobacco only.	RJR Tobacco filed its motion for judgment notwithstanding the verdict or, in the alternative, for a new trial on July 31, 2007.

Individual Smoking and Health Cases

     As of July 13, 2007, 1,079 individual cases, including 871 individual smoker cases in West Virginia state court in a consolidated action, were pending in the United States against RJR Tobacco, B&W, as its indemnitee, or both. This category of cases includes smoking and health cases alleging personal injury brought by or on behalf of individual plaintiffs, but does not include the Broin II cases discussed below. A total of 1,113 of the individual cases are brought by or on behalf of individual smokers or their survivors, while the remaining seven cases are brought by or on behalf of individuals or their survivors alleging personal injury as a result of exposure to ETS.

     Below is a description of the individual smoking and health cases against RJR Tobacco or B&W, or both, which went to trial or were decided during the period from January 1, 2007 to July 13, 2007, or remained on appeal as of July 13, 2007.

     On March 20, 2000, in Whiteley v. Raybestos-Manhattan, Inc. (a case filed in April 1999 in Superior Court, San Francisco County, California), a jury awarded the plaintiffs $1.72 million in compensatory damages and $20 million in punitive damages. RJR Tobacco and Philip Morris were each assigned $10 million of the punitive

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damages award. The defendants appealed the final judgment to the California Court of Appeals. On April 7, 2004, the court of appeals reversed the judgment and remanded the case for a new trial. On April 28, 2006, the plaintiffs filed a consolidated amended complaint, alleging that use of the defendants’ products, along with exposure to asbestos, caused Mrs. Whiteley to develop lung cancer and ultimately die, and the case name became Whiteley v. R. J. Reynolds Tobacco Co. The jury awarded the plaintiff $2.46 million in compensatory damages jointly against RJR Tobacco and Philip Morris on May 2, 2007, and returned a punitive damages verdict award of $250,000 against RJR Tobacco on May 9, 2007. RJR Tobacco filed its motion for judgment notwithstanding the verdict or, in the alternative, for a new trial on July 31, 2007, and if necessary, RJR Tobacco will appeal.

     On August 15, 2003, a jury returned a verdict in favor of B&W in Eiser v. Brown & Williamson Tobacco Corp. (a case filed in March 1999 in the Court of Common Pleas, Philadelphia County, Pennsylvania). The plaintiff, Lois Eiser, sought compensatory and punitive damages in an amount in excess of $50,000, together with interest, costs of suit and attorneys’ fees in this wrongful death action against B&W. The plaintiff contends the decedent’s injury and death were directly related to the actions of the defendants. On January 19, 2006, the Superior Court of Pennsylvania affirmed the verdict. On September 22, 2006, the Pennsylvania Supreme Court granted the plaintiff’s petition to appeal. Oral argument occurred on May 16, 2007. A decision is pending.

     On December 18, 2003, in Frankson v. Brown & Williamson Tobacco Corp. (a case filed in August 2000 in Supreme Court, Kings County, New York), a jury awarded $350,000 in compensatory damages against B&W and two former tobacco industry organizations, the Tobacco Institute and the Council for Tobacco Research, in an action brought against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, seeking $270 million in compensatory damages, unspecified punitive damages, attorneys’ fees, costs and disbursements (other manufacturers were dismissed before trial). The plaintiff, Gladys Frankson, alleged that Mr. Frankson became physically and psychologically addicted to nicotine, was unable to cease smoking, developed lung cancer and died as a result. The defendants as a group and the deceased smoker were each found to be 50% at fault. On January 8, 2004, the jury awarded $20 million in punitive damages, assigning $6 million to B&W, $2 million to American Tobacco, a predecessor company to B&W, and $6 million to each of the Council for Tobacco Research and the Tobacco Institute. On June 22, 2004, the trial judge granted a new trial unless the parties consented to an increase in compensatory damages to $500,000 and a decrease in punitive damages to $5 million, of which $4 million would be assigned to B&W. On January 21, 2005, the plaintiff stipulated to the reduction in punitive damages.

     After all post-trial motions (and appeals therefrom) were denied, judgment was entered in favor of the plaintiffs for $175,000 in compensatory damages (the original jury award reduced by 50%) and $5 million in punitive damages (the amount to which the plaintiff stipulated). On June 26, 2007, final judgment was entered in the amount of approximately $6.8 million (including interest and costs). The defendants filed a notice of appeal to the Appellate Division, New York Supreme Court, Second Department on July 3, 2007. Pursuant to its agreement to indemnify B&W, RJR Tobacco posted a supersedeas bond in the amount of $8.018 million on July 5, 2007.

     On February 1, 2005, a jury returned a split verdict in Smith v. Brown & Williamson Tobacco Corp. (a case filed in May 2003 in Circuit Court, Jackson County, Missouri), finding in favor of B&W on two counts, fraudulent concealment and conspiracy, and finding in favor of the plaintiff on negligence (which incorporates failure to warn and product defect claims). The plaintiff, Lincoln Smith, claimed that the defendant’s tobacco products caused Mrs. Smith’s death from lung cancer and sought an unspecified amount of compensatory and punitive damages. The plaintiff was awarded $2 million in compensatory damages and $20 million in punitive damages; however, the jury found the plaintiff to be 75% at fault (and B&W 25% at fault), and thus the compensatory award was reduced to $500,000. B&W appealed to the Missouri Court of Appeals and on July 31, 2007, the court affirmed the compensatory damages award, and reversed the award for and ordered a new trial on punitive damages. The case was also transferred to the Missouri Supreme Court, which may review the entire case.

     On March 18, 2005, in Rose v. Brown & Williamson Tobacco Corp. (a case filed in December 1996 in New York Supreme Court, County of New York), a jury returned a verdict in favor of RJR Tobacco, but returned a $3.42 million compensatory damages verdict against B&W and Philip Morris, of which $1.71 million was assigned to B&W. A punitive damages verdict of $17 million against Philip Morris only was returned by the jury on March 28, 2005. The action was brought against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, seeking to recover $15 million in compensatory damages and $35 million in punitive damages. The plaintiffs, Norma Rose and Leonard Rose, allege that their use of the defendants’ products caused them to become addicted to nicotine and develop lung cancer, chronic obstructive pulmonary disease and other smoking related conditions and/or diseases. Oral argument on B&W’s appeal in the Appellate Division, New York Supreme Court, First Department occurred on

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December 12, 2006. A decision is pending. Pursuant to its agreement to indemnify B&W, RJR Tobacco posted a supersedeas bond in the amount of $2.058 million on February 7, 2006.

Engle Progeny Cases

     Pursuant to the Florida Supreme Court’s July 6, 2006 ruling in Engle v. R.J. Reynolds Tobacco Co., former class members have one-year from January 11, 2007 in which to file individual lawsuits. In addition, some individuals who filed suit prior to January 11, 2007 and who claim they meet the conditions in Engle are also attempting to avail themselves of the Engle ruling. Lawsuits by individuals requesting the benefit of the Engle ruling, whether filed before or after the January 11, 2007 mandate, are referred to as Engle Progeny Cases. As of July 13, 2007, RJR Tobacco has been served and is currently a defendant in 41 Engle Progeny Cases. For further information on the Engle case, see “—Class-Action Suits –Engle Case,” below.

Broin II Cases

     As of July 13, 2007, there were 2,623 lawsuits pending in Florida brought by individual flight attendants for personal injury as a result of illness allegedly caused by exposure to ETS in airplane cabins, referred to as the Broin II cases. In these lawsuits, filed pursuant to the terms of the settlement of the Broin v. Philip Morris, Inc. class action, discussed below under “— Class-Action Suits,” each individual flight attendant will be required to prove that he or she has a disease and that the individual’s exposure to ETS in airplane cabins caused the disease. Punitive damages are not available in these cases.

     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. 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 aircraft cabins (i.e., specific causation). Below is a description of the Broin II cases against RJR Tobacco and B&W that went to trial or were decided during the period from January 1, 2007 to July 13, 2007, or remained on appeal or were otherwise pending as of July 13, 2007.

     In Janoff v. Philip Morris, Inc. (a case filed in February 2000 in Circuit Court, Miami-Dade County, Florida), a jury found in favor of the defendants, including RJR Tobacco and B&W, on September 5, 2002, in an action brought against the major U.S. cigarette manufacturers seeking to recover compensatory damages pursuant to the Broin settlement. The plaintiff, Suzette Janoff, alleged that as a result of exposure to ETS in airline cabins, she suffered from, among other illnesses, chronic sinusitis, chronic bronchitis and other respiratory and pulmonary problems. The judge granted the plaintiff’s motion for a new trial on January 8, 2003. The defendants appealed to the Florida Third District Court of Appeal, which, on October 27, 2004, affirmed the trial court’s order. On November 1, 2005, the Florida Supreme Court refused to hear the case. On July 6, 2007, the plaintiff asked the trial court to set the case for trial.

     In Swaty v. Philip Morris, Inc. (a case filed in September 2000 in Circuit Court, Miami-Dade County, Florida), a jury found in favor of the defendants, including RJR Tobacco and B&W, on May 3, 2005, in an action brought against the major U.S. cigarette manufacturers seeking to recover an unspecified amount of compensatory damages pursuant to the Broin settlement. The plaintiff, Lorraine Swaty, alleged that as a result of exposure to ETS in airline cabins, she suffered from chronic sinusitis and asthma. On November 8, 2006, the Third District Court of Appeal affirmed the verdict. The plaintiff’s motion for rehearing and motion for clarification was denied on January 11, 2007. The mandate issued on January 29, 2007.

Class-Action Suits

     Overview. As of July 13, 2007, 19 class-action cases were pending in the United States against RJR Tobacco or its affiliates or indemnitees. In May 1996, in Castano v. American Tobacco Co., the Fifth Circuit Court of Appeals 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 and its affiliates and indemnitees in state or federal courts in California, Florida, Illinois, Louisiana, Minnesota, Missouri, New York, Oregon, Washington, West Virginia and the District of Columbia. All pending class-action cases are discussed below.

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     The pending class-actions against RJR Tobacco or its affiliates or indemnitees include nine 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 Florida, Illinois, Minnesota, Missouri and New York. Each of these cases is discussed below.

     Finally, certain third-party payers have filed health-care cost recovery actions in the form of class-actions. These cases are discussed separately below.

     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 federal district courts have certified a smoker class action — In re Simon (II) Litigation (in which the class was ultimately decertified) and Schwab [McLaughlin] v. Philip Morris USA, Inc., discussed below under “— ‘Lights’ Cases,” both of which were filed in the U.S. District Court for the Eastern District of New York.

     On February 10, 2003, in Simms v. Philip Morris, Inc. (a case filed in May 2001 in the U.S. District Court, District of Columbia), the court denied certification of a proposed nation-wide class of smokers who purchased cigarettes while under-age in an action brought against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, seeking: treble damages; disgorgement of unjust enrichment; to enjoin defendants from engaging in marketing or advertising campaigns that target and/or encourage under-age youth to purchase cigarettes, and from making false, misleading or deceptive statements concerning the health effects and addictive natures of cigarettes; to require the defendants to make corrective statements; and the recovery of attorneys’ fees, expert fees and costs. The action was brought to recover the purchase price paid by the plaintiffs and class members for defendants’ products while they were under-age, or in the alternative, to recover the unjust enrichment obtained by the defendants from the plaintiffs and class members while they were underage through the use of fraud, deception, misrepresentation, and other activities constituting racketeering, in violation of federal law. On December 21, 2006, the court denied the plaintiffs’ motions for reconsideration and reversal of the order that denied class certification.

     Medical Monitoring and Smoking Cessation Cases. Classes have been certified in several state court class-action cases in which either RJR Tobacco or B&W is a defendant. On November 5, 1998, in Scott v. American Tobacco Co. (a case filed in May 1996 in District Court, Orleans Parish, Louisiana), the trial court certified a medical monitoring or smoking cessation class of Louisiana residents who were smokers on or before May 24, 1996, in an action brought against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, seeking to recover an unspecified amount of compensatory and punitive damages. The plaintiffs allege that their use of the defendants’ products caused them to become addicted to nicotine. Opening statements occurred on January 21, 2003. On July 28, 2003, the jury returned a verdict in favor of the defendants on the plaintiffs’ claim for medical monitoring and found that cigarettes were not defectively designed. However, the jury also made certain findings against the defendants on claims relating to fraud, conspiracy, marketing to minors and smoking cessation. Notwithstanding these findings, this portion of the trial did not determine liability as to any class member or class representative. What primarily remained in the case was a class-wide claim that the defendants pay for a program to help people stop smoking.

     On March 31, 2004, phase two of the trial began to address only the scope and cost of smoking cessation programs. On May 21, 2004, the jury returned a verdict in the amount of $591 million on the class’s claim for a smoking cessation program. On September 29, 2004, the defendants posted a $50 million bond (pursuant to legislation that limits the amount of the bond to $50 million collectively for MSA signatories) and noticed their appeal. RJR Tobacco posted $25 million (i.e., the portions for RJR Tobacco and B&W) towards the bond. The Louisiana Court of Appeal issued its opinion on February 7, 2007. The court found that any class member who started smoking or whose right to participate in the program accrued after September 1, 1988, is not entitled to any recovery under Louisiana law. The court also rejected the award of pre-judgment interest and most of the specific components of the smoking cessation program. However, the court upheld the class certification and found the defendants responsible for funding smoking cessation for eligible class members. On March 2, 2007, the defendants’ application for rehearing and clarification was denied. The defendants filed an application for writ of certiorari with the Louisiana Supreme Court on April 2, 2007.

     In addition to the Scott case, one other medical monitoring class-action remains pending against RJR Tobacco, B&W, and other cigarette manufacturers. In Lowe v. Philip Morris, Inc. (a case filed in November 2001 in Circuit Court, Multnomah County, Oregon), a judge dismissed the complaint on November 4, 2003, for failure to state a claim in an action seeking creation of a court-supervised program of medical monitoring, smoking cessation and education, and recovery of attorneys’ fees. On September 6, 2006, the Court of Appeals affirmed the trial court’s dismissal. On

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March 20, 2007, the Oregon Supreme Court granted the plaintiffs’ petition for review. Oral argument is scheduled for September 5, 2007.

     Engle Case. Trial began in July 1998 in Engle v. R. J. Reynolds Tobacco Co. (a case filed in May 1994, and pending in Circuit Court, Miami-Dade County, Florida), in which a class consisting of Florida residents, or their survivors, alleges diseases or medical conditions caused by their alleged “addiction” to cigarettes. The action was brought against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, seeking actual damages and punitive damages in excess of $100 billion each and the creation of a medical fund to compensate individuals for future health-care costs. On July 7, 1999, the jury found against RJR Tobacco, B&W and the other cigarette-manufacturer defendants in the initial phase, which included common issues related to certain elements of liability, general causation and a potential award of, or entitlement to, punitive damages.

     The second phase of the trial, which consisted of the claims of three of the named class representatives, began on November 1, 1999. On April 7, 2000, the jury returned a verdict against all the defendants. It awarded plaintiff Mary Farnan $2.85 million, the estate of plaintiff Angie Della Vecchia $4.023 million and plaintiff Frank Amodeo $5.831 million.

     The trial court also ordered the jury in the second phase of the trial to determine punitive damages, if any, on a class-wide basis. On July 14, 2000, the jury returned a punitive damages verdict in favor of the “Florida class” of approximately $145 billion against all the defendants, with approximately $36.3 billion and $17.6 billion being assigned to RJR Tobacco and B&W, respectively.

     On November 6, 2000, the trial judge denied all post-trial motions and entered judgment. In November 2000, RJR Tobacco and B&W posted appeal bonds in the amount of $100 million each and initiated the appeals process. On May 21, 2003, Florida’s Third District Court of Appeal reversed the trial court’s final judgment and remanded the case to the Miami-Dade County Circuit Court with instructions to decertify the class. The class appealed, and the Florida Supreme Court accepted the case on May 12, 2004.

     On July 6, 2006, the court issued its decision. The court affirmed the dismissal of the punitive damages award and decertified the class, on a going-forward basis. The court preserved a number of class-wide findings from Phase I of the trial, including that cigarettes can cause certain diseases, that nicotine is addictive and that defendants placed defective and unreasonably dangerous cigarettes on the market, and authorized former class members to avail themselves of those findings under certain conditions in individual lawsuits, provided they commence those lawsuits within one year of the date the court’s decision becomes final. The court specified that the class is confined to those Florida citizen residents who suffered or died from smoking-related illnesses that “manifested” themselves on or before November 21, 1996 and that were caused by an addiction to cigarettes. In addition, the court reinstated the compensatory damages awards of $2.85 million to Mary Farnan and $4.023 million to Angie Della Vecchia, but ruled that the claims of Frank Amodeo were barred by the statute of limitations. Finally, the court reversed the Third District Court of Appeal’s 2003 ruling that class counsel’s improper statements during trial required reversal.

     On August 7, 2006, RJR Tobacco and the other defendants filed a rehearing motion arguing, among other things, that the findings from the Engle trial are not sufficiently specific to serve as the basis for further proceedings and that the Florida Supreme Court’s decision denied defendants due process. On the same day, the plaintiffs also filed a rehearing motion arguing that some smokers who became sick after November 21, 1996, and who are therefore not class members, should nevertheless have the statute of limitations tolled since they may have refrained from filing suit earlier in the mistaken belief that they were Engle class members. On December 21, 2006, the Florida Supreme Court withdrew its July 6, 2006, decision and issued a revised opinion, in which it set aside the jury’s findings of a conspiracy to misrepresent and clarified that the Engle jury’s finding on express warranty were preserved for use by eligible plaintiffs. The court also denied the plaintiffs’ motion and confirmed that the class was limited to those individuals who developed alleged smoking-related illnesses that manifested themselves on or before November 21, 1996. The court issued its mandate on January 11, 2007, which began the one-year period for former class members to file individual lawsuits. RAI anticipates individual case filings in Florida will increase as a result of the Engle decision. For further information on the individual cases, see “—Engle Progeny Cases” above.

     On April 17, 2007, RJR Tobacco’s motions for discharge of RJR Tobacco’s and B&W’s civil supersedeas bonds related to the punitive damages award were granted. During the second quarter of 2007, RJR Tobacco received the full amount of the $100 million cash collateral that it had posted. On May 21, 2007, the defendants, including RJR Tobacco, filed a petition for writ of certiorari in the U.S. Supreme Court.

28

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

     Prior to the Florida Supreme Court ruling on July 6, 2006, RJR Tobacco and/or B&W were named as a defendant(s) in several individual cases filed by members of the Engle class. One such case, Lukacs v. Philip Morris, Inc. (a case filed in February 2001, and pending in Circuit Court, Miami-Dade County, Florida), was tried against Philip Morris, Liggett and B&W, and resulted in a verdict for the plaintiffs on June 11, 2002, in a personal injury action brought against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, seeking to recover an unspecified amount in compensatory and punitive damages. The plaintiff alleged that his use of the defendants’ brands caused his development of bladder, throat, oral cavity and tongue cancer. RJR Tobacco was voluntarily dismissed on May 1, 2002. The Florida state court jury awarded the plaintiffs a total of $37.5 million in compensatory damages. The jury assigned 22.5% fault to B&W, 72.5% fault to the other defendants and 5% fault to plaintiff John Lukacs. On April 1, 2003, the Miami-Dade County Circuit Court granted in part the defendants’ motion for remittitur and reduced the jury’s award to plaintiff Yolanda Lukacs, on the loss of consortium claim, from $12.5 million to $0.125 million decreasing the total award to $25.125 million. On August 2, 2006, the plaintiff filed a motion for entry of partial judgment and notice of jury trial on punitive damages. Trial was scheduled to begin on November 27, 2006; however, on September 27, 2006, the trial court granted the defendants’ motion to strike as premature the plaintiffs’ motions and removed the case from the trial calendar. On January 2, 2007, the defendants asked the court to set aside the jury’s June 11, 2002, verdict for the plaintiffs and to dismiss the plaintiffs’ punitive damages claim. On January 3, 2007, the plaintiffs filed a motion for entry of judgment. A hearing on the motions occurred on March 15, 2007. A decision is pending.

     California Business and Professions Code Cases. On November 30, 2000, in Daniels v. Philip Morris Cos., Inc. (a case filed in April 1998 in Superior Court, San Diego County, California), a judge, based on a California unfair business practices statute, certified a class consisting of all persons who, as California resident minors, smoked one or more cigarettes in California between April 2, 1994 and December 1, 1999. The action had been brought against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, seeking to recover an unspecified amount of compensatory and punitive damages, restitution to each member of the class and to the general public, and an injunction prohibiting the defendants from engaging in further violation of California Business and Professions Code §17200 and §17500. The plaintiffs allege that due to the deceptive practices of the defendants, they became addicted to cigarettes as teenagers. The court granted the defendants’ motions for summary judgment on preemption and First Amendment grounds and dismissed the action on October 21, 2002. On October 6, 2004, the California Court of Appeal affirmed the trial court. On February 16, 2005, the California Supreme Court granted the plaintiffs’ petition for review. Oral argument occurred on June 6, 2007. A decision is pending.

     On April 11, 2001, in Brown v. American Tobacco Co., Inc. (a case filed in June 1997 in Superior Court, San Diego County, California), the same judge as in Daniels granted in part the plaintiffs’ motion for certification of a class composed of residents of California who smoked at least one of the defendants’ cigarettes from June 10, 1993 through April 23, 2001, and who were exposed to the defendants’ marketing and advertising activities in California. The action was brought against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, seeking to recover restitution, disgorgement of profits and other equitable relief under California Business and Professions Code §17200 et seq. and §17500 et seq. Certification was granted as to the plaintiffs’ claims that the defendants violated §17200 of the California Business and Professions Code pertaining to unfair competition. The court, however, refused to certify the class under the California Legal Remedies Act and on the plaintiffs’ common law claims. Following the November 2004 passage of a proposition in California that changed the law regarding cases of this nature, the defendants filed a motion to decertify the class. On March 7, 2005, the court granted the defendants’ motion. The plaintiffs filed a notice of appeal on May 19, 2005. On September 5, 2006, the California Court of Appeal affirmed the judge’s order decertifying the class. On October 13, 2006, the plaintiffs filed a petition for review with the California Supreme Court. The petition for review was granted on November 1, 2006. Briefing is complete. Oral argument has not been scheduled.

     “Lights” Cases. As noted above, “lights” class-action cases are pending against RJR Tobacco or B&W in Illinois (2), Missouri (2), Minnesota (2), Florida (2) and New York (1). 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.

     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 on November 14, 2001. On June 6, 2003, RJR Tobacco filed a motion to stay the case

29

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

pending Philip Morris’ appeal of the Price v. Philip Morris Inc. case, which is discussed below. RJR Tobacco filed an emergency stay/supremacy order request on October 15, 2003. On November 5, 2003, the Illinois Supreme Court granted RJR Tobacco’s motion for a stay pending the court’s final appeal decision in Price.

     In Howard v. Brown & Williamson Tobacco Corp. (another case filed in February 2000 in Circuit Court, Madison County, Illinois), a judge certified a class on December 18, 2001. On June 6, 2003, the trial judge issued an order staying all proceedings pending resolution of the Price v. Philip Morris, Inc. case, discussed below. The plaintiffs appealed this stay order to the Illinois Fifth District Court of Appeals, which affirmed the Circuit Court’s stay order on August 19, 2005.

     A “lights” class-action case is pending in the same jurisdiction in Illinois against Philip Morris, Price v. Philip Morris, Inc., formerly known as Miles v. Philip Morris, Inc. The case was filed on February 10, 2000, in the Circuit Court for the Third Judicial Circuit, Madison County, Illinois. Trial began on January 21, 2003. On March 21, 2003, the trial judge entered judgment against Philip Morris in the amount of $7.1 billion in compensatory damages and $3 billion in punitive damages to the State of Illinois. Based on Illinois law, the bond required to stay execution of the judgment was set initially at $12 billion. Because of the difficulty of posting a bond of that magnitude, Philip Morris pursued various avenues of relief from the $12 billion bond requirement. On April 14, 2003, the trial judge reduced the amount of the bond. He ordered the bond to be secured by $800 million, payable in four equal quarterly installments beginning in September 2003, and a pre-existing $6 billion long-term note to be placed in escrow pending resolution of the case. The plaintiffs appealed the judge’s decision to reduce the amount of the bond. On July 14, 2003, the appeals court ruled that the trial judge exceeded his authority in reducing the bond and ordered the trial judge to reinstate the original bond. On September 16, 2003, the Illinois Supreme Court ordered that the reduced bond be reinstated and agreed to hear Philip Morris’ appeal without need for intermediate appellate court review. On December 15, 2005, the Illinois Supreme Court reversed the lower state court’s decision and sent the case back to the lower court with instructions to dismiss the case. On December 18, 2006, the defendants filed a motion to dismiss and for entry of final judgment with the circuit court, which was granted by the court. Judgment was entered dismissing the case with prejudice on the same day. The plaintiffs filed a motion to vacate and/or withhold judgment in the Circuit Court on January 17, 2007. The mandate from the Illinois Fifth District Court of Appeals issued March 14, 2007. Oral argument on the plaintiffs’ motion to vacate occurred on May 2, 2007. A decision is pending. In the event RJR Tobacco and its affiliates or indemnitees lose the Turner or Howard cases, or one or more of the other pending “lights” class-action suits, RJR Tobacco could face similar bonding difficulties depending upon the amount of damages ordered, if any, which could have a material adverse effect on RJR Tobacco’s, and consequently RAI’s, results of operations, cash flows or financial condition.

     Schwab [McLaughlin] v. Philip Morris USA, Inc., a nation-wide “lights” class-action, was filed on May 11, 2004, in the U.S. District Court for the Eastern District of New York, against RJR Tobacco and B&W, as well as other tobacco manufacturers. The plaintiffs brought the case pursuant to RICO, challenging the practices of the defendants in connection with the manufacturing, marketing, advertising, promotion, distribution and sale of cigarettes that were labeled as “lights” or “light.” On September 25, 2006, the court issued its decision, among other things, granting class certification and setting a trial date of January 22, 2007. On November 16, 2006, the U.S. Court of Appeals for the Second Circuit granted the defendants’ motions to stay the district court proceedings and for review of the class certification ruling. Oral argument occurred on July 10, 2007. A decision is pending.

     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 on December 31, 2003. On April 9, 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 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 on September 23, 2005. On October 25, 2005, the plaintiffs filed a motion to remand, which was granted on March 17, 2006. As discussed in the prior paragraph, this case and certain other cases have been reassigned to a single general division.

     RJR Tobacco and B&W, respectively, removed two Louisiana “lights” class-actions to federal court. In Harper v. R. J. Reynolds Tobacco Co. (filed in May 2003, and pending in U.S. District Court, Western District, Louisiana), on January 27, 2005, the judge denied the plaintiffs’ motions to remand. The plaintiffs appealed the denial of the motion, and on July 17, 2006, the Fifth Circuit Court of Appeals affirmed the district court’s order. On June 17,

30

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

2005, RJR Tobacco and RJR filed a motion for summary judgment based on federal preemption. On July 6, 2007, the court granted the defendants’ motion for summary judgment and dismissed the case with prejudice.

     In Brown v. Brown & Williamson Tobacco Corp. (a case filed in April 2003, and pending in U.S. District Court, Western District, Louisiana), B&W filed a similar motion for summary judgment on July 5, 2005. On September 14, 2005, the court granted the motion in part by dismissing with prejudice the plaintiffs’ Louisiana Unfair Trade and Consumer Protection Act claims. The remainder of the motion was denied. On December 2, 2005, the judge denied B&W’s motion for reconsideration, but certified the case for interlocutory appeal. On February 14, 2007, the U.S. Court of Appeals for the Fifth Circuit reversed the judgment and remanded the case with directions to dismiss all claims with prejudice. On April 2, 2007, final judgment was entered in favor of B&W, and the case was dismissed with prejudice.

     In Dahl v. R. J. Reynolds Tobacco Co. (a case filed in April 2003, and pending in District Court, Hennepin County, Minnesota), a judge dismissed the case on May 11, 2005, because the “lights” claims are preempted by the Federal Cigarette Labeling and Advertising Act. On July 11, 2005, the plaintiffs filed a notice of appeal with the Minnesota Court of Appeals for the Fourth Judicial District. During the pendency of the appeal, RJR Tobacco removed the case to the U.S. District Court for the District of Minnesota. On February 28, 2007, the Eighth Circuit remanded the case to the Minnesota Court of Appeals. Briefing is complete. Oral argument has not been scheduled.

     In Thompson v. R. J. Reynolds Tobacco Co. (a case filed in February 2003 in District Court, Hennepin County, Minnesota), RJR Tobacco removed the case on September 23, 2005 to the United States District Court for the District of Minnesota. On August 7, 2006, the parties filed a stipulation to stay the case pending resolution of the appeal in Dahl v. R. J. Reynolds Tobacco Co.

     In Huntsberry v. R. J. Reynolds Tobacco Co. (a case filed in April 2004 in Superior Court, King County, Washington), the plaintiffs’ motion for class certification was denied on April 21, 2006. On September 18, 2006, the plaintiffs’ motion for discretionary review was denied. The plaintiffs’ motion to modify the ruling with the Washington Court of Appeals was denied on December 18, 2006. On March 1, 2007, the plaintiffs’ petition for review with the Washington Supreme Court was denied. The plaintiffs’ motion to modify the ruling of the Washington Supreme Court was denied on June 5, 2007. On June 19, 2007, the parties stipulated to a dismissal with prejudice. On June 27, 2007, the court dismissed the case with prejudice.

     Rios v. R. J. Reynolds Tobacco Co. (a case filed in February 2002 in Circuit Court, Palm Beach County, Florida) is dormant pending plaintiffs’ counsel’s attempt to appeal the Florida Fourth District Court of Appeal’s decertification in Hines v. Philip Morris, Inc. The plaintiffs in Rios brought the action against RJR Tobacco and RJR.

     Finally, in Rivera v. Brown & Williamson Tobacco Corp. (a case filed in October 2006 in Circuit Court, Broward County, Florida), B&W removed the case to the U.S. District Court for the Southern District of Florida on November 15, 2006, and answered the complaint on November 22, 2006.

     Other Class Actions. In Cleary v. Philip Morris, Inc. (a case filed in June 1998, and pending in Circuit Court, Cook County, Illinois), the plaintiffs filed their motion for class certification on December 21, 2001, in an action brought against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W. The case is brought on behalf of persons who have allegedly been injured by (1) the defendants’ purported conspiracy pursuant to which defendants concealed material facts regarding the addictive nature of nicotine, (2) the defendants’ alleged acts of targeting its advertising and marketing to minors, and (3) the defendants’ claimed breach of the public right to defendants’ compliance with the laws prohibiting the distribution of cigarettes to minors. The plaintiffs request that the defendants be required to disgorge all profits unjustly received through its sale of cigarettes to plaintiffs and the class, which in no event will be greater than $75,000 per each class member, inclusive of punitive damages, interest and costs. On April 8, 2005, the plaintiffs filed a second amended complaint. On February 3, 2006, a hearing on the defendants’ motion to dismiss occurred. The court dismissed count V (public nuisance) and count VI (unjust enrichment) on March 27, 2006. On April 5, 2006, the plaintiffs filed a motion to reconsider the court’s ruling on the motion to dismiss. In its ruling, the court reconsidered certain components of its analysis, but did not modify its original decision. On July 11, 2006, the plaintiffs filed a motion for class certification. A hearing is scheduled for September 6, 2007.

     Young v. American Tobacco Co., Inc. (a case filed in November 1997 in Circuit Court, Orleans Parish, Louisiana), is 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

31

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

themselves cigarette smokers, have been exposed to secondhand smoke from cigarettes which were manufactured by the defendants, and who suffer injury as a result of that exposure. The plaintiffs seek to recover an unspecified amount of compensatory and punitive damages. On October 13, 2004, the trial court stayed this case pending the outcome of the appeal in Scott v. American Tobacco Co., Inc., discussed above under “ — Medical Monitoring and Smoking Cessation Cases”.

     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 and B&W, and parent companies of U.S. cigarette manufacturers, including RJR, seeking to recover $1,000,000 in compensatory and punitive damages individually and an unspecified amount for the class in both compensatory and punitive damages. 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. The case has been stayed pending a final resolution of the plaintiffs’ motion to refer tobacco litigation to the judicial panel on multi-district litigation filed in In Re: Tobacco Litigation in the Supreme Court of Appeals of West Virginia. On December 26, 2000, three defendants (Nitral Liquidators, Inc., Desseaux Corporation of North American 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.

     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 on February 16, 1999. The action was brought against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, and parent companies of U.S. cigarette manufacturers, including RJR, on behalf of 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 on February 17, 1999. There has been limited activity in this case.

     Finally, in Espinosa v. Philip Morris USA, Inc., a class-action complaint was filed against certain cigarette manufacturers, including RJR Tobacco, and their parents, including RAI, in December 2006, in the Circuit Court for Cook County, Illinois. The plaintiffs allege that the defendants have increased the nicotine in their cigarette products and failed to inform the plaintiff and/or the class. The plaintiffs seek to recover an amount not less than the purchase price of defendants’ cigarette products, plus interest, attorneys’ fees and costs and such other relief as the court deems appropriate. The plaintiffs filed a motion for class certification and a motion for preservation of documents on December 11, 2006. On December 12, 2006, the defendants removed the case to the U.S. District Court for the Northern District of Illinois. The plaintiffs’ motion to remand was denied on March 26, 2007. The defendants’ motion to dismiss the complaint was granted on June 18, 2007.

     Broin Settlement. 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 suffer 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 aircraft cabins, referred to as “specific causation,” the individual plaintiff will have the burden of proof. Florida’s Third District Court of Appeal denied various challenges to this settlement on March 24, 1999. On September 7, 1999, the Florida Supreme Court approved the settlement. The Broin II cases, discussed above, arose out of the settlement of this case.

32

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

Governmental Health-Care Cost Recovery Cases

     MSA and Other State Settlement Agreements. In June 1994, the Mississippi attorney general brought an action, Moore v. American Tobacco Co., against various industry members, including RJR Tobacco and B&W. 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 and other U.S. cigarette manufacturers based on similar theories. The cigarette manufacturer defendants, including RJR Tobacco and B&W, 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 and B&W, entered into the MSA with attorneys general representing the remaining 46 states, the District of Columbia, Puerto Rico, Guam, the Virgin Islands, American Samoa and the Northern Marianas. 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, and their affiliates and indemnitees, including RAI, from:

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

     • all monetary claims 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 are tables depicting the unadjusted tobacco industry settlement payment schedule and the settlement payment schedule for RAI’s operating subsidiaries under the MSA and other state settlement agreements and related information for 2005 and beyond:

Unadjusted Original Participating Manufacturers’ Settlement Payment Schedule

																			2011 and
	2005			2006			2007			2008			2009			2010			thereafter
First Four States’ Settlements: 1
Mississippi Annual Payment	$	136		$	136		$	136		$	136		$	136		$	136		$	136
Florida Annual Payment		440			440			440			440			440			440			440
Texas Annual Payment		580			580			580			580			580			580			580
Minnesota Annual Payment		204			204			204			204			204			204			204
Remaining States’ Settlement:
Annual Payments1		7,004			7,004			7,004			7,143			7,143			7,143			7,143
Additional Annual Payments (through 2017)1		—			—			—			861			861			861			861
Base Foundation Funding		25			25			25			25			—			—			—
Growers’ Trust (through 2010) 2		500			500			500			500			295			295			—
Offset by federal tobacco buyout 2		(500	)		(500	)		(500	)		(500	)		(295	)		(295	)		—
Total	$	8,389		$	8,389		$	8,389		$	9,389		$	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.
2	The Growers’ Trust payments scheduled to expire in 2010 will be offset by obligations resulting from the federal tobacco buyout legislation, not included in this table, signed in October 2004. See “–Tobacco Buyout Legislation.”

RAI’s Operating Subsidiaries’ Settlement Expenses and Payment Schedule

													2011 and
	2005		2006		2007		2008		2009		2010		thereafter
Settlement expenses	$	2,600	$	2,611		—		—		—		—		—
Settlement cash payments	$	2,732	$	2,631		—		—		—		—		—
Projected settlement expenses		—		—		>$2,850		>$2,800		>$2,800		>$2,800		>$2,800
Projected settlement cash payments		—		—		>$2,600		>$2,850		>$2,800		>$2,800		>$2,800

33

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

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

     The MSA and other 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 condition 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 MSA and other state settlement agreements.

     Department of Justice Case. On September 22, 1999, the U.S. Department of Justice brought an action against RJR Tobacco, B&W 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. 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 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 U.S. Court of Appeals for the District of Columbia 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 bench (non-jury) trial began in September 2004, and closing arguments concluded on June 10, 2005.

     On August 17, 2006, the court found certain defendants liable for the RICO claims, but did not impose any direct financial penalties. The court instead enjoined 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 court also ordered 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 government. In addition, the court placed restrictions on the ability of the defendants to dispose of certain assets for use in the United States, unless the transferee agrees to abide by the terms of the court’s order, and ordered the defendants to reimburse the U.S. Department of Justice its taxable costs incurred in connection with the case.

     Certain defendants, including RJR Tobacco, filed notices of appeal to the U.S. Court of Appeals for the District of Columbia on September 11, 2006. The government filed its notice of appeal on October 16, 2006. In addition, the defendants, including RJR Tobacco, filed joint motions asking the district court to clarify and to stay its order pending defendants’ appeal. On September 28, 2006, the district court denied defendants’ motion to stay. On September 29, 2006, the defendants, including RJR Tobacco, filed a motion asking the court of appeals to stay the district court’s order pending the defendants’ appeal. The court granted the motion on October 31, 2006.

     On November 28, 2006, the court of appeals stayed the appeals pending the trial court’s ruling on the defendants’ motion for clarification. The defendants’ motion for clarification was granted in part and denied in part on March 16, 2007. The defendants’ motion as to the meaning and applicability of the general injunctive relief of the August 17, 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 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. The defendants filed amended notices of appeal on March 29, 2007 and March 30, 2007. In May 2007, the court of appeals issued a briefing schedule that extends through May 19, 2008.

     The stay of the district court’s order suspends the enforcement of the order pending the outcome of defendants’ appeal. RJR Tobacco does not know the timing of an appellate decision or, if the order is affirmed, the compliance deadlines that will be imposed. If the order is affirmed without modification, then RJR Tobacco believes that certain provisions of the order (such as the ban on certain brand style descriptors and the corrective advertising requirements)

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would have adverse business effects on the marketing of RJR Tobacco’s current product portfolio and that such effects could be material. Also, if the order is affirmed, then RJR Tobacco would incur costs in connection with complying with the order (such as the costs of changing its current packaging to conform to the ban on certain brand descriptors and the costs of corrective communications). Given the uncertainty over the timing and substance of an appellate decision, RJR Tobacco currently is not able to estimate reasonably the costs of such compliance. Moreover, if the order were ultimately affirmed and RJR Tobacco were to fail to comply with the order on a timely basis, then RJR Tobacco could be subject to substantial monetary fines or penalties.

     International Cases. A number of foreign countries have filed suit in state and federal courts in the United States against RJR Tobacco, B&W and other tobacco industry defendants to recover funds for health-care, medical and other assistance paid by those foreign governments to their citizens.

     No such cases currently are pending against RJR Tobacco and its affiliates or indemnitees in the United States. In the Republic of Panama v. The American Tobacco Co. and State of Sao Paulo v. The American Tobacco Co., the cases, originally filed in Louisiana, were consolidated and then dismissed by the trial court because Louisiana was not an appropriate forum. These plaintiffs filed new cases in the Superior Court for the State of Delaware in and for New Castle County on July 19, 2005, against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, seeking restitution, damages and compensation for all past and future damages including, but not limited to, all past and future health-care expenditures for illnesses associated with tobacco products, punitive or exemplary damages as may be allowed by law, pre- and post-judgment interest and all costs as provided by law, reasonable attorneys’ fees and costs for all general and equitable relief. The plaintiffs alleged that the defendants are liable under breach of duty, negligence, breach of implied warranty, breach of express warranty, misrepresentation and conspiracy. On July 13, 2006, the Delaware Superior Court granted the defendants’ motions to dismiss both cases. On February 23, 2007, the Delaware Supreme Court affirmed the dismissals.

     Two health-care reimbursement cases are pending against RJR Tobacco or B&W outside the United States, one in each of Canada and Israel. Pursuant to the terms of the 1999 sale of RJR Tobacco’s international tobacco business, JTI assumed RJR Tobacco’s liability, if any, in the health-care cost recovery cases brought by foreign countries.

     On November 12, 1998, the government of British Columbia enacted legislation creating a civil cause of action permitting the government to recover the costs of health-care benefits incurred for B.C. residents arising from tobacco-related disease. The government’s subsequent suit against Canadian defendants and foreign defendants (including RJR Tobacco) was dismissed in February 2000, when the B.C. Supreme Court ruled that the legislation was unconstitutional and set aside service ex juris against the foreign defendants for that reason. The government then enacted a revised statute and brought a new action (filed in January 2001, and pending in Supreme Court, British Columbia). The plaintiff seeks to recover the present value of the total expenditure by the government for health-care benefits provided for insured persons resulting from tobacco-related disease or the risk of tobacco-related disease, the present value of the estimated total expenditure by the government for health-care benefits that reasonably could be expected will be provided for those insured persons resulting from tobacco-related disease or the risk of tobacco-related disease, court ordered interest, and costs, or in the alternative, special or increased costs. The plaintiff alleges that the defendants are liable under the following theories: defective product, failure to warn, sale of cigarettes to children and adolescents, strict liability, deceit and misrepresentation, and violation of trade practice and competition acts. In response to motions of certain defendants challenging, among other things, the constitutionality of the new statute, the court, in June 2003, dismissed the government’s action and set aside service ex juris. The government appealed. On May 20, 2004, the Court of Appeal held that the statute was constitutionally valid and remitted the ex juris motions to the trial court for further consideration. On June 23, 2005, the trial court found that service was proper. On July 19, 2005, RJR Tobacco filed its notice of appeal of this ruling. On September 28, 2005, the Supreme Court, in response to motions of certain defendants, ruled that the statute is constitutionally valid. On September 15, 2006, the B.C. Court of Appeal unanimously ruled that the foreign defendants served ex juris are subject to British Columbia law, allowing the government to proceed with its lawsuit against them. On November 10, 2006, RJR Tobacco filed an application for leave to appeal. On April 5, 2007, the Supreme Court dismissed RJR Tobacco’s application. The case is in the preliminary stages.

     On September 1, 1998, the General Health Services filed a statement of claim against certain cigarette manufacturers, including RJR Tobacco and B&W, in the District Court of Jerusalem, Israel. The plaintiff seeks to recover the past and future value of the total expenditures for health-care services provided to residents of Israel resulting from tobacco-related disease, court ordered interest for past expenditures from date of filing the statement of

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claim, increased and/or punitive and/or exemplary damages and costs. The plaintiffs allege that the defendants are liable under the following theories: negligence, public nuisance, fraud, misleading advertisement, defective product, failure to warn, sale of cigarettes to children and adolescents, strict liability, deceit, concealment, misrepresentation and conspiracy. In 2002, the plaintiff obtained leave to serve RJR Tobacco and B&W outside the jurisdiction. On behalf of RJR Tobacco, JTI filed a motion challenging the grant of leave, which was denied. JTI appealed the decision to the Supreme Court of Israel. A hearing occurred on March 28, 2005, and a decision is pending.

Other Health-Care Cost Recovery and Aggregated Claims Cases

     Health-care cost recovery cases have been brought by a variety of plaintiffs. 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 July 13, 2007, three other health-care cost recovery cases were pending in the United States against RJR Tobacco, B&W, as its indemnitee, or both, discussed below.

     Native American Tribe Cases. As of July 13, 2007, one Native American tribe case was pending before a tribal court in South Dakota against RJR Tobacco and B&W, 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.

     Hospital Cases. As of July 13, 2007, one case brought by hospitals was pending against cigarette manufacturers, including RJR Tobacco and B&W: City of St. Louis v. American Tobacco Co., Inc., filed in November 1998, and pending in the Circuit Court of the City of St. Louis, Missouri. This case seeks recovery of uncompensated, unreimbursed health-care costs expended or to be expended by hospitals on behalf of patients who suffer, or have suffered, from illnesses allegedly resulting from the use of cigarettes. On June 28, 2005, the court granted the defendants’ motion for summary judgment as to claims for damages which accrued prior to November 16, 1993. The claims for damages which accrued after November 16, 1993, are still pending. The case is in discovery.

     Other Cases. On August 4, 2005, the United Seniors Association filed a case against the major U.S. cigarette manufacturers, including RJR Tobacco and B&W, in the U.S. District Court for the District of Massachusetts. The case seeks to recover for the Medicare program all of the expenditures that the Medicare program made from August 4, 1999, to present for the health-care services rendered to Medicare’s beneficiaries for the treatment of diseases attributable to smoking. The plaintiff alleges that the defendants concealed, denied and manipulated the addictive properties of their cigarettes; and engaged in tortious and other wrongful conduct. On October 24, 2005, the defendants filed a motion to dismiss or, in the alternative, transfer the case to the U.S. District Court for the Middle District of Florida where a virtually identical case against Philip Morris and Liggett was dismissed. On August 28, 2006, the defendants’ motion to dismiss was granted. The plaintiff appealed to the U.S. Court of Appeals for the First Circuit. Oral argument occurred on March 6, 2007. A decision is pending.

MSA-Enforcement and Validity

     As of July 13, 2007, there were 53 cases concerning the enforcement, validity or interpretation of the MSA and other state settlement agreements in which RJR Tobacco or B&W is a party. This number includes those cases relating to disputed payments under the MSA (discussed below).

     On April 7, 2004, a class-action lawsuit, Sanders v. Philip Morris USA, Inc., was filed in the Superior Court of Los Angeles County against RJR, RJR Tobacco, Philip Morris, Altria and B&W. The case was brought on behalf of California residents who purchased cigarettes in California from April 2, 2000 to the present. The plaintiff generally alleged that the MSA was anticompetitive in that the defendants used the terms of the MSA to reduce competition and to raise the price of cigarettes. The plaintiff voluntarily dismissed this case and, on June 9, 2004, filed a new action in the U.S. District Court for the Northern District of California. The defendants are RJR Tobacco, B&W, Philip Morris, Lorillard and Bill Lockyer, in his capacity as Attorney General for the State of California. The plaintiff asserts claims for declaratory and injunctive relief based on preemption and Supremacy Clause grounds (alleging that the MSA

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supposedly is inconsistent with the federal antitrust laws), for injunctive relief based on claimed violations of the Sherman Act, for damages and injunctive relief based on claimed violations of California’s state antitrust law (the Cartwright Act), for an accounting of profits based on claimed statutory and common law theories of unfair competition, and for restitution based on claimed unjust enrichment. On March 29, 2005, the U.S. District Court for the Northern District of California granted the defendants’ motion to dismiss with prejudice. The plaintiff appealed to the U.S. Court of Appeals for the Ninth Circuit. Oral argument occurred on February 15, 2007. A decision is pending.

     On March 28, 2005, the National Association of Attorneys General, referred to as NAAG, sent a notice, signed by 40 Attorneys General that one or more of the states intended to initiate proceedings against RJR Tobacco for violating Section III(r) of the MSA, the various Consent Decrees implementing the MSA and/or consumer fraud statutes in various states, all in connection with RJR Tobacco’s advertisements for Eclipse cigarettes. After a June 2005 meeting between representatives of RJR Tobacco and NAAG, the Vermont Attorney General filed suit in July 2005, in the Vermont Superior Court, Chittenden County, alleging that certain Eclipse advertising violated both the MSA and the Vermont Consumer Fraud Statute. The State of Vermont is seeking declaratory, injunctive, and monetary relief. On April 25, 2007, the court denied the State of Vermont’s motion to strike defendants’ demand for trial by jury. The case is scheduled to be trial ready by February 1, 2008.

     On April 13, 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. On April 28, 2005, B&W advised the state that it did not owe the state any money. On August 11, 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 now exceed $5.0 million. This matter is currently in the discovery phase.

     On May 17, 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 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. Discovery in this matter is underway.

     The MSA includes an adjustment, referred to as an NPM Adjustment, that potentially reduces RJR Tobacco’s and other participating manufacturers’ annual payment obligations. Certain requirements must be satisfied before the NPM Adjustment for a given year is available. An independent auditor designated under the MSA must determine that the participating manufacturers have experienced a market share loss beyond a triggering threshold to those manufacturers that do not participate in the MSA, referred to as NPMs, and a firm of independent economic consultants must find that the disadvantages of the MSA were a significant factor contributing to the loss.

     For 2003, the MSA independent auditor determined that the participating manufacturers suffered a market share loss sufficient to trigger an NPM Adjustment. In March 2006, the independent economic consulting firm issued a final, non-appealable determination that the disadvantages of the MSA were “a significant factor contributing” to the 2003 market share loss. Based on these determinations, on April 17, 2006, RJR Tobacco placed approximately $647 million of its MSA payment into a disputed payments account, in accordance with a procedure established by the MSA. That amount represented RJR Tobacco’s share of the 2003 NPM Adjustment as calculated by the MSA independent auditor. On March 28, 2007, the independent auditor issued revised calculations that reduced RJR Tobacco’s share of the NPM Adjustment for 2003 to approximately $615 million. On April 19, 2007, RJR Tobacco instructed the independent auditor to release to the settling states approximately $32 million from the disputed payments account.

     The settling states contend they have diligently enforced their respective Qualifying Statutes, within the meaning of the MSA, and that RJR Tobacco and other participating manufacturers are not entitled to the 2003 NPM Adjustment. The settling states also contend that this dispute must be resolved by MSA courts in each of the 52 settling states and territories. RJR Tobacco believes that the MSA requires that this dispute be resolved by a single, nation-wide arbitration before a panel of three former federal judges. Following RJR Tobacco’s payment of a portion of its 2006 MSA payment into the disputed funds escrow 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

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compelling RJR Tobacco and the other participating manufacturers that placed money in the disputed payments account to pay the disputed amounts to the settling states. In response, RJR Tobacco has moved to compel arbitration as provided in the MSA.

     On September 13, 2006, RJR Tobacco and certain of the other participating manufacturers sent letters to the 15 settling states that had not yet objected to the arbitration noticed by the tobacco manufacturers and/or filed legal proceedings relating to the dispute regarding the 2003 NPM Adjustment in their respective MSA courts. These letters stated that, unless the settling states indicated otherwise, the participating manufacturers would assume that these settling states would not object to the required arbitration. All but one of these settling states responded that they would not agree to submit the dispute to arbitration and would oppose any effort to compel arbitration of the dispute. The participating manufacturers, including RJR Tobacco, have filed motions to compel arbitration in the MSA courts of all of these settling states, except certain of the territories.

     As of July 13, 2007, 44 out of 45 courts that had addressed the question whether disputes concerning the 2003 NPM Adjustment are arbitrable had ruled that arbitration is required under the MSA.

     During 2006, proceedings were initiated with respect to an NPM Adjustment for 2004. The MSA independent auditor determined that the participating manufacturers again suffered a market share loss sufficient to trigger an NPM Adjustment for 2004. On April 17, 2006, RJR Tobacco and the other cigarette manufacturers initiated the “significant factor” proceedings called for under the MSA. On February 12, 2007, the independent economic consulting firm issued a final, non-appealable determination that the disadvantages of the MSA were “a significant factor contributing” to the 2004 market share loss. On April 16, 2007, RJR Tobacco placed approximately $561 million of its 2007 MSA payment into the disputed payments account. That amount represented RJR Tobacco’s share of the 2004 NPM Adjustment as calculated by the MSA independent auditor.

     On October 12, 2006, the State of New York sent a 30-day notice, signed by 26 additional Attorneys General, that one or more of these states intended to initiate proceedings seeking declarations construing one or more terms under the MSA. The terms that the signatory states identified relate to the questions presented to the economic consulting firm in the context of the “significant factor proceedings” relating to the expected NPM Adjustment for the year 2004. As of July 13, 2007, only the State of Ohio has filed an action pursuant to this notice.

Antitrust Cases

     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 July 13, 2007, all of the federal and state court cases on behalf of indirect purchasers have been dismissed, except for two state court cases pending in Kansas and in New Mexico.

     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 on November 15, 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. Discovery is underway.

     In Romero v. Philip Morris Cos., Inc. (a case filed in April 2000 in District Court, Rio Arriba County, New Mexico), the court granted class certification on May 14, 2003 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 amount not to exceed $74,000 per class member in actual and punitive damages, exclusive of interest and costs. The plaintiffs allege that the defendants conspired to fix, raise, advance and/or stabilize prices for cigarettes in the State of New Mexico from at least as early as January 1, 1998, through the present. On June 30, 2006, the court granted the defendants’ motion for summary judgment. On August 14, 2006, the plaintiff appealed to the New Mexico Court of Appeals. Briefing is underway.

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

     On February 16, 2000, an antitrust class-action complaint, DeLoach v. Philip Morris Cos., Inc., was brought against RJR Tobacco, B&W and other cigarette manufacturers and others, in the U.S. District Court for the District of Columbia on behalf of 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. On November 30, 2000, the case was moved to U.S. District Court for the Middle District of North Carolina. In May 2003, the plaintiffs reached a court-approved settlement with B&W and other cigarette manufacturer defendants, but not RJR Tobacco. The settling defendants agreed to pay $210 million to the plaintiffs, of which B&W’s share was $23 million, to pay the plaintiffs’ attorneys’ fees as set by the court, of which B&W’s share was $9.8 million, and to purchase a minimum amount of U.S. leaf for ten years, expressed as both a percentage of domestic requirements, with 35% for B&W, and as a minimum number of pounds per year, with an initial requirement of 55 million pounds for B&W (the amount changes each year pursuant to the settlement agreement).

     On April 22, 2004, RJR Tobacco and the plaintiffs settled, which settlement the court approved on March 21, 2005. Under that settlement, RJR Tobacco paid $33 million into a settlement fund, which included costs and attorneys’ fees. RJR Tobacco also agreed to purchase annually a minimum of 35 million pounds (exclusive of the pounds it must purchase as the successor to B&W) of domestic green leaf tobacco for the next ten years, beginning with the 2004 crop year. The obligation to purchase leaf was extended an additional year because the federal government eliminated the tobacco price quota and price support program at the end of 2005.

     By opinion dated December 6, 2004, the U.S. Court of Appeals for the Fourth Circuit held that the April 2004 settlement between RJR Tobacco and the plaintiffs triggered a Most Favored Nations Clause in the earlier May 2003 settlement between B&W and other defendants. The Most Favored Nations Clause reduces the number of pounds RJR Tobacco, as successor to B&W, is obligated to purchase. By order dated August 4, 2005, the U.S. District Court for the Middle District of North Carolina ruled that, pursuant to the Most Favored Nations Clause, the defendants to the May 2003 settlement are entitled to a reduction in their green leaf purchase commitment for any remaining whole years, commencing after the date of the court’s order, in the amount of 67.81 percent. This ruling applies to the minimum number of pounds RJR Tobacco, as successor to B&W, is required to purchase each year and reduces that amount by 67.81 percent each year for all future years.

     Pursuant to an amended complaint filed in the U.S. District Court for the Eastern District of Tennessee on October 23, 2003, in Smith Wholesale Co. v. R.J. Reynolds Tobacco Co., Smith Wholesale and Rice Wholesale asserted federal antitrust claims in connection with RJR Tobacco’s termination of distribution agreements with the plaintiffs. The plaintiffs seek preliminary and permanent injunctive relief, enjoining RJR Tobacco from, among other things: continuing with the termination of the plaintiffs’ distributorship; continuing to refuse to honor invoices from the plaintiffs toward retail buydowns and retail contract payments; further reducing the price discounts and back-end monies received by the plaintiffs; and continuing its allegedly discriminatory pricing scheme. The plaintiffs allege that RJR Tobacco, in August 2000, implemented a discriminatory pricing scheme whereby it sold cigarettes at different prices to competing distributors. As a result of the purported pricing scheme, the plaintiffs allegedly have suffered substantial damages in the form of lost profits and sales, loss of customers, loss of goodwill and additional injuries. Additional wholesalers, together with the states of Tennessee and Mississippi, have joined the case as plaintiffs. On June 3, 2005, the district court granted summary judgment in RJR Tobacco’s favor. On June 23, 2005, the district court dismissed the entire case, and the plaintiffs filed a notice of appeal of the summary judgment and dismissal.

     RJR Tobacco reached a non-monetary settlement with one wholesaler and with the states of Tennessee and Mississippi on July 22, 2005. RJR Tobacco terminated its distribution agreement with four plaintiffs several months after the granting of summary judgment in RJR Tobacco’s favor, and those plaintiffs thereafter moved for preliminary injunctions in the district court and court of appeals. The courts denied those motions on November 28 and November 29, 2005, respectively. On February 27, 2007, the U.S. Court of Appeals for the Sixth Circuit affirmed the trial court’s decision granting RJR Tobacco’s motion for summary judgment. Twelve of the plaintiffs filed a petition for writ of certiorari in the U.S. Supreme Court on May 29, 2007; the remaining eight plaintiffs did not join in the petition.

     On January 11, 2006, Smith Wholesale filed another lawsuit against RJR Tobacco and its customer, H.T. Hackney Corp., in Carter County, Tennessee Circuit Court. Smith Wholesale seeks $60 million in damages and a preliminary injunction against RJR Tobacco’s termination of Smith Wholesale’s direct-buying status. Smith Wholesale alleges that the defendants, through agreements with one another and other actions, engaged in a scheme to damage competition in the distribution of cigarettes and specifically damage the plaintiff. The case was removed to federal court on January 26, 2006. On September 28, 2006, the court granted the plaintiff’s motion to remand the case back to the

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state court. RJR Tobacco filed a motion to dismiss the first amended and reinstated complaints on November 27, 2006. The plaintiff filed a motion for temporary injunction on the same day. The court has not set a hearing date on the preliminary injunction.

Other Litigation and Developments

     By purchase agreement dated May 12, 1999, referred to as the 1999 Purchase Agreement, RJR and RJR Tobacco sold the international tobacco business to JTI. RJR and RJR Tobacco retained certain liabilities relating to the activities of Northern Brands including those relating to a 1998 guilty plea entered in the U.S. District Court for the Northern District of New York, as well as an investigation conducted by the Royal Canadian Mounted Police, referred to as RCMP, for possible violations of Canadian law related to the activities that led to the Northern Brands guilty plea and certain conduct by Stanley Smith, a former executive of RJR-Macdonald, Inc., referred to as RJR-MI, which led to the termination of his severance agreement. Under its reading of the indemnification provisions of the 1999 Purchase Agreement, JTI has requested indemnification for any damages arising out of the matters described below.

• In February 2003, the RCMP filed criminal charges in the Province of Ontario against, and purported to serve summonses on, JTI-Macdonald Corp., referred to as JTI-MC, Northern Brands, R. J. Reynolds Tobacco International, Inc., referred to as RJR-TI, R. J. Reynolds Tobacco Co. (Puerto Rico), referred to as RJR-PR, and eight individuals associated with RJR-MI and/or RJR-TI during the period January 1, 1991 through December 31, 1996. The charges allege fraud and conspiracy to defraud Canada and the Provinces of Ontario and Quebec in connection with the purchase, sale, export, import and/or re-export of cigarettes and/or fine cut tobacco. In October 2003, Northern Brands, RJR-TI and RJR-PR each challenged both the propriety of the service of the summonses and the jurisdiction of the court. On February 9, 2004, the Superior Court of Justice ruled in favor of these companies. The government filed a notice of appeal from that ruling on February 18, 2004, but did not perfect its appeal until May 8, 2007. A hearing on the appeal is set for October 29, 2007. A preliminary hearing was commenced on April 11, 2005 for the purpose of determining whether the Canadian prosecutor has sufficient evidence supporting the criminal charges to justify a trial of the defendants that have been properly served to date. On May 30, 2007, the court announced its decision to issue an order committing two of the accused, JTI-MC and Edward Lang, to stand trial on the charges filed in February 2003 and discharging the other six accused. JTI-MC and Mr. Lang have separately filed papers seeking an order quashing the order committing them to stand trial, and the government has filed papers seeking an order quashing the order discharging six of the accused.

• In July 2003, a Statement of Claim was filed against JTI-MC and others in the Superior Court of Justice, Ontario, Canada by Leslie and Kathleen Thompson. Mr. Thompson is a former employee of Northern Brands and JTI-MC’s predecessor, RJR-MI. Mr. and Mrs. Thompson have alleged breach of contract, breach of fiduciary duty and negligent misrepresentation, among other claims. They are seeking lost wages and other damages, including punitive damages, in an aggregate amount exceeding $12 million.

• On September 18, 2003, RJR, RJR Tobacco, RJR-TI, RJR-PR, and Northern Brands were served with a Statement of Claim filed in August 2003 by the Attorney General of Canada in the Superior Court of Justice, Ontario, Canada. Also named as defendants are JTI and a number of its affiliates. The Statement of Claim seeks to recover taxes and duties allegedly not paid as a result of cigarette smuggling and related activities. As filed, the Attorney General’s Statement of Claim seeks to recover $1.5 billion Canadian in compensatory damages and $50 million Canadian in punitive damages, as well as equitable and other forms of relief. (However, in the Companies’ Creditor Arrangement Act proceeding described below, the Attorney General amended and increased Canada’s claim to $4.3 billion Canadian). The parties have agreed to a stay of all proceedings pending in the Superior Court of Justice, subject to notice by one of the parties that it wishes to terminate the stay. On January 19, 2007, the court ordered that the case be scheduled for trial no later than December 31, 2008, subject to further order of the court.

• In August 2004, the Quebec Ministry of Revenue (1) issued a tax assessment, covering the period January 1, 1990 through December 31, 1998, against JTI-MC for alleged unpaid duties, penalties and interest in an amount of about $1.36 billion Canadian; (2) issued an order for the immediate payment of that amount; and (3) obtained an ex parte judgment to enforce the payment of that amount. On August 24, 2004, JTI-MC applied for protection under the Companies’ Creditor Arrangement Act in the Ontario Superior Court of Justice, Toronto, Canada, referred to as CCAA Proceedings, and the court entered an order staying the Quebec Ministry of Revenue’s proceedings as well as other claims and proceedings against JTI-MC. The stay has been

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

extended to May 30, 2008. In November 2004, JTI-MC filed a motion in the Superior Court, Province of Quebec, District of Montreal, seeking a declaratory judgment to set aside, annul and declare inoperative the tax assessment and all ancillary enforcement measures and to require the Quebec Minister of Revenue to reimburse JTI-MC for funds unduly appropriated, along with interest and other relief. Pursuant to a court-imposed deadline, Canada and several Provinces filed Crown claims against JTI-MC in the CCAA Proceedings in the following amounts: Canada ($4.3 billion Canadian); Ontario ($1.5 billion Canadian); New Brunswick ($1.5 billion Canadian); Quebec ($1.4 billion Canadian); British Columbia ($450 million Canadian); Nova Scotia ($326 million Canadian); Prince Edward Island ($75 million Canadian) and Manitoba ($23 million Canadian). In the CCAA Proceedings, the Canadian federal government and some of the provincial governments have asserted that they can make the same tax and related claims against RJR and certain of its subsidiaries, including RJR Tobacco. To date, none of those provincial governments have filed and served RJR or any of its affiliates with a formal Statement of Claim like the Canadian federal government did in August and September 2003.

• On November 17, 2004, a Statement of Claim was filed against JTI-MC in the Supreme Court of British Columbia by Stanley Smith, a former executive of RJR-MI, for alleged breach of contract and other legal theories. Mr. Smith is claiming $840,000 Canadian for salary allegedly owed under his severance agreement with RJR-MI, as well as other unspecified compensatory and punitive damages.

     In addition, 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 October 30, 2002 (see below) and against JTI on January 11, 2002. Although RJR and RJR Tobacco recognize that, under certain circumstances, they may have indemnification obligations to JTI under the 1999 Purchase Agreement, RJR and RJR Tobacco disagree with JTI as to whether the circumstances relating to any of these matters give rise to any indemnification obligation by RJR and RJR Tobacco. RJR and RJR Tobacco conveyed their position to JTI, and the parties have agreed to resolve their differences at a later time. In the interim, RJR and RJR Tobacco are paying defense costs and expenses in connection with certain of the Canadian litigation described above. In addition, RJR has liabilities of $94 million that were recorded in 1999 in connection with certain of the indemnification claims asserted by JTI. For further information on the JTI indemnification claims, see “— Other Contingencies and Guarantees” below.

     On May 15, 2007, RAI was served with a subpoena issued by the U.S. District Court for the Middle District of North Carolina. The subpoena seeks documents relating primarily to the business of RJR-TI regarding the manufacture and sale of Canadian brand cigarettes during the period 1990 through 1996. The subpoena was issued at the request of Canada pursuant to a Mutual Legal Assistance Treaty between the United States and Canada.

     On October 30, 2002, the European Community and ten of its member states filed a complaint in the EDNY 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 remains pending, but all proceedings were stayed while the plaintiffs sought review first by the U.S. Court of Appeals for the Second Circuit and then by the Supreme Court of the dismissal of their August 2001 complaint. The U.S. Court of Appeals for the Second Circuit affirmed the dismissal, and, on January 9, 2006, the Supreme Court denied the plaintiffs’ petition for a writ of certiorari. This case remains stayed while the court and the parties work out a scheduling order.

     RJR Tobacco has been served in two reparations actions (filed in October 2002) brought by descendants of slaves, claiming that the defendants, including RJR Tobacco, profited from the use of slave labor. These two actions have been transferred to the U.S. District Court for the Northern District of Illinois by the Judicial Panel on Multi-District Litigation for coordinated or consolidated pretrial proceedings with other reparation actions. The plaintiffs in these actions are asking for judgment in an amount to satisfy the jurisdictional limitations of the court, punitive damages sufficient to punish the defendants, an accounting, imposition of a constructive trust, restitution of the value of their ancestors’ slave labor, and restitution of the value of defendants’ unjust enrichment based upon slave labor and the cost of the action. RJR Tobacco is named, but has not been served, in another reparations case. That case was conditionally transferred to the Northern District of Illinois on January 7, 2003, but the plaintiffs contested that transfer, and the Judicial Panel on Multi-District Litigation has not yet issued a final ruling on the transfer. The plaintiffs filed a

41

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

consolidated complaint on June 17, 2003. On July 18, 2003, the defendants moved to dismiss the plaintiffs’ complaint. That motion was granted on January 26, 2004, although the court allowed the plaintiffs to file an amended complaint, which they did on April 5, 2004. In addition, several plaintiffs attempted to appeal the trial court’s January 26, 2004 dismissal. Because the dismissal was not a final order, that appeal was dismissed by the U.S. Court of Appeals for the Seventh Circuit. On July 6, 2005, the trial court granted the defendants’ motion to dismiss the amended complaint with prejudice. On August 3, 2005, the plaintiffs filed a notice of appeal to the Seventh Circuit. On December 13, 2006, the Seventh Circuit affirmed the dismissal of all claims except the consumer protection claims. The case was remanded to the district court for further proceedings. On May 14, 2007, the plaintiffs filed a petition for writ of certiorari in the U.S. Supreme Court.

     On May 23, 2001 and July 30, 2002, Star Scientific, Inc., referred to as Star, filed two patent infringement actions, which have been consolidated, against RJR Tobacco in the U.S. District Court for the District of Maryland. Both patents at issue are entitled “Method of Treating Tobacco to Reduce Nitrosamine Content, and Products Produced Thereby,” and bear U.S. Patent Nos. 6,202,649 and 6,425,401. The plaintiffs sought: the entry of an injunction restraining RJR Tobacco from further acts of infringement, inducement of infringement, or contributory infringement of the patents; an award of damages to compensate the plaintiff’s lost profits; an award of enhanced damages on account that the defendant’s conduct was willful; an award of pre-judgment interest and a further award of post-judgment interest; an award of reasonable attorneys’ fees; and an order requiring RJR Tobacco to deliver up to the court for destruction all products manufactured from any process which infringes upon, directly or indirectly or otherwise, any claim of such patent. RJR Tobacco filed counterclaims seeking a declaration that the claims of the two Star patents are invalid, unenforceable and not infringed by RJR Tobacco. Between January 31 and February 8, 2005, the court held a first bench trial on RJR Tobacco’s affirmative defense and counterclaim based upon inequitable conduct. Additionally, in response to the court’s invitation, RJR Tobacco filed two summary judgment motions on January 20, 2005.

     On January 19, 2007, the court released decisions on those two summary judgment motions. The court granted RJR Tobacco’s motion for summary judgment of invalidity based on indefiniteness. The court granted in part and denied in part RJR Tobacco’s other summary judgment motion concerning the effective filing date of the patents in suit. On June 26, 2007, the court ruled that Star’s patents are unenforceable due to inequitable conduct by Star and its representatives in the U.S. Patent & Trademark Office. On June 26, 2007, the court also entered final judgment in favor of RJR Tobacco and against Star, dismissing all of Star’s claims with prejudice. On June 27, 2007, Star filed a notice of appeal. On July 9, 2007, RJR Tobacco filed a bill of costs seeking reimbursement of its recoverable costs as the prevailing party, and a motion seeking reimbursement of its attorneys’ fees and excess costs incurred in defending Star’s lawsuit. The trial court has deferred that motion pending the appeal.

     On September 22, 2005, RJR Tobacco filed a case in the U.S. District Court for the Western District of North Carolina against Market Basket Food Stores and other cigarette retailers and wholesalers located in the states of North Carolina, Tennessee, Virginia and Kentucky to stop and remedy an ongoing conspiracy to abuse RJR Tobacco’s marketing programs, including the buy-down and coupon programs. The complaint alleged violations of the federal and North Carolina RICO statutes and the North Carolina Unfair and Deceptive Trade Practices Act, along with common law fraud, breach of contract and conspiracy. RJR Tobacco has settled with all of the 20 defendants, and the case has been dismissed.

     Finally, in the first quarter of 2005, Commonwealth Brands, Inc., referred to as Commonwealth, was served with two individual smoking and health cases, Croft v. Akron Gasket in Cuyahoga County, Ohio, and Ryan v. Philip Morris, U.S.A., Inc. in Jay County, Indiana, which was dismissed on May 23, 2007. Commonwealth requested indemnity from RJR Tobacco pursuant to the Asset Purchase Agreement dated July 24, 1996, between Commonwealth and B&W, referred to as the 1996 Purchase Agreement. As a result of the business combination of RJR Tobacco and the U.S. cigarette and tobacco business of B&W, RJR Tobacco agreed to indemnify Commonwealth for these claims to the extent, if any, required by the 1996 Purchase Agreement. The scope of the indemnity will be at issue and has not been determined.

Smokeless Tobacco Litigation

     As of July 13, 2007, Conwood was a defendant in eight actions brought by individual plaintiffs in West Virginia state court seeking damages in connection with personal injuries allegedly sustained as a result of the usage of Conwood’s smokeless tobacco products. These actions are pending before the same West Virginia court as the 942 consolidated individual smoker cases against RJR Tobacco, B&W, as RJR Tobacco’s indemnitee, or both. On December 3, 2001, the court severed the smokeless tobacco claims and defendants, and this litigation has been dormant.

42

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

     Pursuant to a second amended complaint filed in September 2006, Conwood is a defendant in Vassallo v. United States Tobacco Company, pending in the Eleventh Circuit Court in Miami-Dade County, Florida. The individual plaintiff in this case alleges that he sustained personal injuries, including addiction and cancer, as a result of his use of smokeless tobacco products, allegedly including products manufactured by Conwood. The plaintiff seeks unspecified compensatory and consequential damages in an amount greater than $15,000. There is not presently a punitive damages demand in this case, though the plaintiff retains the right to seek leave of court to add such a demand later. This case is still in its early stages.

Tobacco Buyout Legislation

     On October 22, 2004, the President signed the Fair and Equitable Tobacco Reform Act of 2004, referred to as FETRA, eliminating the U.S. government’s tobacco production controls and price support program. The buyout of tobacco quota holders provided for in FETRA is 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 is applied. The aggregate cost of the buyout to the industry is approximately $9.9 billion, including approximately $9.6 billion payable to quota tobacco holders and growers through industry assessments over ten years and approximately $290 million for the liquidation of quota tobacco stock. As a result of the tobacco buyout legislation, the MSA Phase II obligations established in 1999 will be continued as scheduled through the end of 2010, but will be offset against the tobacco quota buyout obligations. RAI’s operating subsidiaries’ annual expense under FETRA, excluding the tobacco stock liquidation assessment, is estimated to be approximately $230 million to $280 million. RAI’s operating subsidiaries incurred $81 million in 2005 related to assessments from quota tobacco stock liquidation. In the first quarter of 2006, a $9 million favorable adjustment was recorded relating to the tobacco stock liquidation assessment. Remaining contingent liabilities for liquidation of quota tobacco stock, if any, will be recorded when an assessment is made. See note 1 for additional information related to federal tobacco buyout expenses.

     RAI’s operating subsidiaries will record the FETRA assessment on a quarterly basis upon required notification of assessments. RAI’s operating subsidiaries estimate that their overall share of the buyout will approximate $2.4 billion to $2.9 billion prior to the deduction of permitted offsets under the MSA. In addition, future market pricing could impact the carrying value of inventory, and adversely affect RJR Tobacco’s financial condition and results of operations.

ERISA Litigation

     On May 13, 2002, in Tatum v. The R.J.R. Pension Investment Committee of the R. J. Reynolds Tobacco Company Capital Investment Plan, 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 violated ERISA by not overriding an amendment to RJR’s 401(k) plan requiring that, prior to February 1, 2000, the stock funds of the companies involved in the food business, NGH and Nabisco Holdings Corp., referred to as Nabisco, be eliminated as investment options from RJR’s 401(k) plan. 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.

     On July 29, 2002, the defendants filed a motion to dismiss, which the court granted on December 10, 2003. On December 14, 2004, the U.S. Court of Appeals for the Fourth Circuit reversed the dismissal of the complaint and remanded the case for further proceedings. On January 20, 2005, the defendants filed a second motion to dismiss on other grounds. On June 6, 2006, the plaintiff filed a motion to amend the complaint to name as party defendants six individuals who were members of the two defendant committees. On March 7, 2007, the court granted the plaintiff leave to file an amended complaint and denied all pending motions as moot, including the plaintiff’s motion to name as additional defendants the six committee members. On April 6, 2007, the defendants moved to dismiss the amended complaint. On May 31, 2007, 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

43

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

RJR Tobacco, filed their answer and affirmative defenses on June 14, 2007. On June 28, 2007, the plaintiff filed a motion to amend the complaint to add as parties defendant the six members of the RJR Pension Investment Committee and the RJR Employee Benefits Committee. The defendants filed their opposition to this motion on July 23, 2007.

Employment Litigation

     On March 19, 2007, in Marshall v. R.J. Reynolds Tobacco Co., the plaintiff filed a class action complaint against R.J. Reynolds Tobacco Company in the U.S. District Court for the Western District of Missouri alleging violations of the Fair Labor Standards Act. The allegations include failure to keep accurate records of all hours worked by RJR Tobacco’s employees and failure to pay wages and overtime compensation to non-exempt retail representatives. The lawsuit is currently in its preliminary stages.

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 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 condition of RAI or its subsidiaries.

     Regulations promulgated by the U.S. Environmental Protection Agency and other governmental agencies under various statutes have resulted in, and likely will continue to result in, substantial expenditures for pollution control, waste treatment, plant modification and similar activities. 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 or financial condition of RAI or its subsidiaries.

Other Contingencies and Guarantees

     In 2002, R. J. Reynolds Tobacco C. V., an indirect wholly owned subsidiary of RAI and referred to as RJRTCV, and an affiliate of Gallaher Group Plc, referred to as Gallaher, formed a joint venture, with each party owning a 50% membership interest. The joint venture, R. J. Reynolds-Gallaher International Sarl, markets American-blend cigarettes primarily in Italy, France and Spain.

     On April 18, 2007, an affiliate of Japan Tobacco Inc. acquired Gallaher, and Gallaher subsequently notified RJRTCV that the acquisition constituted a change of control of Gallaher within the meaning of the joint venture agreement, wherein RJRTCV may elect to terminate the joint venture prior to its expiration date. On May 15, 2007, RJRTCV notified the other member of the joint venture that RJRTCV had exercised its termination right, effective November 30, 2007. Unless the members agree otherwise, the joint venture will no longer conduct any business and will be liquidated following its termination.

     Upon a termination of the joint venture, the value of generally all of the trademarks each joint venture member or its affiliate has licensed to the joint venture will be calculated. The party whose licensed trademarks have the greater value will be required to pay the other party an amount equal to one-half of the difference between the value of the parties’ respective trademarks.

     RJRTCV believes that the current value of the trademarks licensed to the joint venture by Gallaher’s affiliate is materially greater than that of the trademarks licensed to the joint venture by RJRTCV’s affiliate. The value of the trademarks and the resulting termination amount are not yet known, and will be determined in accordance with the valuation procedures set forth in the joint venture agreement as described in RAI’s Current Report on Form 8-K, filed with the SEC on May 21, 2007. In accordance with the terms of the joint venture agreement, the termination amount shall be determined no later than July 2008, whereupon 40% of such amount shall be paid within 60 days of the final determination, and the remainder shall be paid in six equal annual installments.

44

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

     In connection with the business combination of RJR Tobacco and the U.S. cigarette and tobacco business of B&W on July 30, 2004, RJR Tobacco has agreed to indemnify B&W and its affiliates 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 business combination. In addition, pursuant to this indemnity, RJR Tobacco expensed $2 million and $4 million during the first six months of 2007 and 2006, respectively, for funds to be reimbursed to BAT for costs and expenses incurred arising out of certain tobacco-related litigation. Although it is impossible to predict the possibility or amount of any additional future payments by RJR Tobacco under this indemnity, a significant indemnification claim by B&W against RJR Tobacco could have an adverse effect on any or all of RAI, RJR and RJR Tobacco.

     As a result of the business combination of RJR Tobacco and the U.S. cigarette and tobacco business of B&W, RJR Tobacco also has agreed to indemnify Commonwealth Brands, Inc. for certain claims brought in two individual smoking and health cases, Croft v. Akron Gasket, and Ryan v. Philip Morris, U.S.A., Inc., to the extent, if any, such indemnification is required by the 1996 Purchase Agreement. See “— Litigation Affecting the Cigarette Industry — Other Litigation and Developments” above for further information on these cases.

     In connection with the sale of the international tobacco business to JTI, on May 12, 1999, pursuant to the purchase agreement, RJR and RJR Tobacco agreed to indemnify JTI against:

• any liabilities, costs and expenses arising out of the imposition or assessment of any tax with respect to the international tobacco business arising prior to the sale, other than as reflected on the closing balance sheet;

• any liabilities, costs and expenses that 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.

     As described above in “— Litigation Affecting the Cigarette Industry — Other Litigation and Developments,” RJR Tobacco has received several claims for indemnification from JTI. Although RJR and RJR Tobacco recognize that, under certain circumstances, they may have indemnification obligations to JTI under the 1999 Purchase Agreement, RJR and RJR Tobacco disagree whether the circumstances described in such claims give rise to any indemnification obligations by RJR and RJR Tobacco. RJR and RJR Tobacco have conveyed their position to JTI, and the parties have agreed to resolve their differences at a later date. RJR has liabilities totaling $94 million that were recorded in 1999 in connection with these indemnification claims.

     RJR Tobacco, Santa Fe, Conwood and Lane 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, Santa Fe has entered into an agreement to indemnify a supplier from liability and related defense costs arising out of the sale or use of Santa Fe’s products. The cost has been, and is expected to be, insignificant. RJR Tobacco, Santa Fe, Conwood and Lane 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.

     Under certain circumstances, any fair value that results in a liability position of the interest rate swaps will require full collateralization with cash or securities. See note 6 for further information.

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

Employees

     At June 30, 2007, RAI and its subsidiaries had approximately 7,400 full-time employees and approximately 200 part-time employees. The 7,400 full-time employees include approximately 5,800 RJR Tobacco employees and 800 Conwood employees. No employees of RAI or its subsidiaries are unionized.

45

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

Note 10–Shareholders’ Equity

									Accumulated
									Other			Total
	Common		Paid-In			Accumulated			Comprehensive			Shareholders’			Comprehensive
	Stock		Capital			Deficit			Loss			Equity			Income
Balance as of December 31, 2006	$	—	$	8,702		$	(1,241	)	$	(418	)	$	7,043
Cumulative effect of adoption of FIN No. 48		—		—			5			—			5
Adjusted balance as of January 1, 2007		—		8,702			(1,236	)		(418	)		7,048
Net income		—		—			653			—			653		$	653
Retirement benefits FAS 158, net of $12 million tax expense		—		—			—			15			15			15
Other		—		—			—			(1	)		(1	)		(1	)
Total comprehensive income		—		—			—			—					$	667
Dividends — $0.75 per share		—		—			(443	)		—			(443	)
Restricted stock amortization		—		4			—			—			4
Stock repurchased		—		(60	)		—			—			(60	)
Excess tax benefit on stock-based compensation plans		—		1			—			—			1
Balance as of June 30, 2007	$	—	$	8,647		$	(1,026	)	$	(404	)	$	7,217

     On February 6, 2007, the Board of Directors of RAI authorized the repurchase of up to $75 million of outstanding shares of RAI common stock to offset the dilution from restricted stock grants and the exercise of previously granted options under the Reynolds American Inc. Long-Term Incentive Plan, referred to as the LTIP. During March 2007, RAI repurchased 984,000 shares of its common stock at an average per share price of $60.65 for a total of $60 million. Due to RAI’s incorporation in North Carolina, which does not recognize treasury shares, the shares repurchased are cancelled at the time of repurchase.

     On February 6, 2007, the Board of Directors of RAI approved a grant, to key employees of RAI and its subsidiaries, of shares of restricted RAI common stock under the LTIP, effective March 6, 2007. The 373,082 restricted shares were granted based on the per share closing price of RAI common stock on March 6, 2007, of $59.50. The shares of the restricted RAI common stock generally will vest on March 6, 2010. Compensation expense includes the vesting period elapsed. Dividends on shares of outstanding restricted stock, which are paid concurrently with dividends on outstanding unrestricted shares of stock, are recognized as a reduction of equity.

     On February 6, 2007 and May 11, 2007, RAI’s board of directors declared a quarterly cash dividend of $0.75 per common share, or $3.00 on an annualized basis.

     On May 11, 2007, the shareholders of RAI approved an amendment to RAI’s amended and restated articles of incorporation increasing the number of authorized shares of RAI’s common stock, par value $.0001 per share, from 400,000,000 to 800,000,000.

Note 11–Segment Information

     RAI’s largest reportable operating segment, RJR Tobacco, is the second largest cigarette manufacturer in the United States. RJR Tobacco’s largest selling cigarette brands, CAMEL, KOOL, PALL MALL, DORAL, WINSTON and SALEM, are currently six of the ten best-selling brands of cigarettes in the United States. Those brands, and its other brands, including MISTY and CAPRI, are manufactured in a variety of styles and marketed in the United States. RJR Tobacco also manages contract manufacturing of cigarettes and tobacco products through arrangements with BAT affiliates. As of January 1, 2007, the management and distribution of the DUNHILL and STATE EXPRESS 555 cigarette brands were transferred from Lane to RJR Tobacco.

     RAI’s other reportable operating segment, Conwood, is the second largest smokeless tobacco products manufacturer in the United States. Conwood’s primary brands include its largest selling moist snuff brands, GRIZZLY and KODIAK, two of the six best-selling brands of moist snuff in the United States. Conwood’s other products include loose leaf chewing tobacco, dry snuff, plug, and twist tobacco products, which held the first or second position in market share in each category in 2006. The Conwood acquisition occurred on May 31, 2006. Beginning January 1,

46

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

2007, Conwood began distribution of a variety of tobacco products manufactured by Lane, including WINCHESTER and CAPTAIN BLACK little cigars, and BUGLER roll-your-own tobacco.

     The disclosures classified as All Other include the total assets and results of operations of Santa Fe, GPI and the R.J. Reynolds-Gallaher International Sarl joint venture. The financial condition and results of operations of these operating segments do not meet the materiality criteria to be reportable.

     Beginning in 2007, the practice of allocating certain corporate expenses for segment reporting was discontinued. The amounts presented for prior periods have been reclassified to reflect the current segment composition.

     Santa Fe manufactures and markets cigarettes and other tobacco products under the NATURAL AMERICAN SPIRIT brand. Santa Fe markets its products in the United States, and has a small, but growing, international tobacco business. On January 1, 2007, GPI began managing the international businesses of Conwood and Santa Fe. GPI also manufactures and exports tobacco products to U.S. territories, U.S. duty-free shops and U.S. overseas military bases and manages a contract manufacturing business.

     Segment Data:

	For the Three Months						For the Six Months
	Ended June 30,						Ended June 30,
	2007			2006			2007			2006
Net sales:
RJR Tobacco	$	2,061		$	2,111		$	3,960		$	3,945
Conwood		174			72			329			100
All Other		113			108			207			206
Consolidated net sales	$	2,348		$	2,291		$	4,496		$	4,251
Operating income:
RJR Tobacco	$	496		$	564		$	984		$	983
Conwood		90			32			170			37
All Other		35			39			70			78
Corporate expense		(26	)		(19	)		(55	)		(36	)
Consolidated operating income	$	595		$	616		$	1,169		$	1,062
Reconciliation to income before income taxes:
Operating income	$	595		$	616		$	1,169		$	1,062
Interest and debt expense		87			52			176			87
Interest income		(23	)		(23	)		(61	)		(59	)
Other expense, net		16			(3	)		15			(3	)
Income from continuing operations before income taxes	$	515		$	590		$	1,039		$	1,037

	June 30,			December 31,
	2007			2006
Assets:
RJR Tobacco	$	15,085		$	14,955
Conwood		4,552			4,578
All Other		1,028			996
Corporate		17,066			17,818
Elimination adjustments		(20,101	)		(20,169	)
Consolidated assets	$	17,630		$	18,178

Note 12–Related Party Transactions

     RAI’s operating subsidiaries engage in transactions with related parties in the normal course of business. The following is a summary of balances and transactions with affiliates.

47

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

	June 30,		December 31,
	2007		2006
Balances:
Accounts receivable, related party	$	48	$	62
Due to related party		9		9
Deferred revenue, related party		39		62

	2007		2006
Transactions for the six months ended June 30:
Net sales, related party	$	251	$	266
Research and development services billed to related parties		1		2
BAT related legal indemnification expenses		2		4
Purchases from related parties		5		4

     RAI’s operating subsidiaries have entered into various transactions with affiliates of BAT. RAI’s operating subsidiaries sell contract-manufactured cigarettes, processed strip leaf, pipe tobacco and little cigars to BAT affiliates. For 2007, pricing for contract-manufactured cigarettes was generally calculated based on 2004 prices, using B&W’s forecasted 2004 manufacturing costs plus 10%, increased by a multiple equal to the increase in the Producer Price Index for 2005 and 2006, reported by the U.S. Bureau of Labor Statistics. During the six-month period ended June 30, 2007, net sales to BAT affiliates were $251 million, primarily cigarettes, representing 6% of RAI’s total net sales.

     RJR Tobacco recorded $39 million of deferred sales revenue relating to leaf sold to BAT affiliates that had not been delivered as of June 30, 2007, given that RJR Tobacco had a legal right to bill the BAT affiliates. Leaf sales revenue to BAT affiliates will be recognized when the product is shipped to the customer.

     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. Royalty expense is paid to BAT affiliates that own the trademarks to imported brands of cigarettes and pipe tobacco. The royalty rates vary, although none is in excess of 10% of the local sales price. During the first six months of 2007, the aggregate purchases for leaf and cigarettes were $5 million and royalty expenses were less than $1 million.

     In the first half of 2007, RJR Tobacco recorded $2 million in selling, general and administrative expenses for funds to be reimbursed to BAT. These funds will be paid in connection with the indemnification of B&W and its affiliates for costs and expenses related to certain tobacco-related litigation in the United States. For additional information relating to this indemnification, see note 9.

     In 2006, RJR Tobacco seconded certain of its employees to BAT in connection with particular assignments at BAT locations. During their service with BAT, the seconded employees are paid by RJR Tobacco and participate in employee benefit plans sponsored by RAI. BAT will reimburse RJR Tobacco for certain costs of the seconded employees’ compensation and benefits during the secondment period. During the first six months of 2007, $2 million was billed to BAT related to secondees.

     At June 30, 2007, $9 million of accounts payable is included in due to related party in the condensed consolidated balance sheet (unaudited), primarily relating to cigarette purchases and the litigation reimbursement accrual.

Note 13—RAI Guaranteed, Secured Notes — Condensed Consolidating Financial Statements

     The following condensed consolidating financial statements have been prepared pursuant to Rule 3-10 of Regulation S-X, relating to the guarantors of RAI’s $4.3 billion guaranteed, secured notes. 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, Conwood, Conwood Holdings, Inc., Santa Fe, Lane, GPI, RJR Acquisition Corp., and certain of RJR Tobacco’s other subsidiaries, the guarantors; other indirect subsidiaries of RAI that are not guarantors; and elimination adjustments.

48

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

Condensed Consolidating Statements of Income
(Dollars in Millions)

	Parent						Non-
	Issuer			Guarantors			Guarantors			Eliminations			Consolidated
For the Three Months Ended June 30, 2007
Net sales	$	—		$	2,218		$	31		$	(22	)	$	2,227
Net sales, related party		—			121			—			—			121
Cost of products sold		—			1,349			16			(22	)		1,343
Selling, general and administrative expenses		14			375			14			1			404
Amortization expense		—			6			—			—			6
Operating income (loss)		(14	)		609			1			(1	)		595
Interest and debt expense		84			3			—			—			87
Interest income		(1	)		(22	)		—			—			(23	)
Intercompany interest (income) expense		(30	)		29			1			—			—
Intercompany dividend income		—			(10	)		—			10			—
Other (income) expense, net		20			(1	)		(3	)		—			16
Income (loss) before income taxes		(87	)		610			3			(11	)		515
Provision for (benefit from) income taxes		(28	)		219			—			—			191
Equity income from subsidiaries		384			3			—			(387	)		—
Income before extraordinary item		325			394			3			(398	)		324
Extraordinary item – gain on acquisition		—			1			—			—			1
Net income	$	325		$	395		$	3		$	(398	)	$	325
For the Three Months Ended June 30, 2006
Net sales	$	—		$	2,165		$	21		$	(16	)	$	2,170
Net sales, related party		—			121			—			—			121
Cost of products sold		—			1,285			7			(16	)		1,276
Selling, general and administrative expenses		8			375			9			—			392
Amortization expense		—			7			—			—			7
Operating income (loss)		(8	)		619			5			—			616
Interest and debt expense		22			30			—			—			52
Interest income		(1	)		(22	)		—			—			(23	)
Intercompany interest (income) expense		(15	)		15			—			—			—
Intercompany dividend income		—			(10	)		—			10			—
Other (income) expense, net		3			(2	)		(4	)		—			(3	)
Income (loss) before income taxes		(17	)		608			9			(10	)		590
Provision for (benefit from) income taxes		(5	)		227			1			—			223
Equity income from subsidiaries		388			8			—			(396	)		—
Income before extraordinary item		376			389			8			(406	)		367
Extraordinary item – gain on acquisition		—			9			—			—			9
Net income	$	376		$	398		$	8		$	(406	)	$	376

49

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

Condensed Consolidating Statements of Income
(Dollars in Millions)

	Parent						Non-
	Issuer			Guarantors			Guarantors			Eliminations			Consolidated
For the Six Months Ended June 30, 2007
Net sales	$	—		$	4,234		$	47		$	(36	)	$	4,245
Net sales, related party		—			251			—			—			251
Cost of products sold		—			2,537			17			(36	)		2,518
Selling, general and administrative expenses		29			744			23			1			797
Amortization expense		—			12			—			—			12
Operating income (loss)		(29	)		1,192			7			(1	)		1,169
Interest and debt expense		168			8			—			—			176
Interest income		(2	)		(58	)		(1	)		—			(61	)
Intercompany interest (income) expense		(62	)		60			2			—			—
Intercompany dividend income		—			(21	)		—			21			—
Other (income) expense, net		22			(2	)		(5	)		—			15
Income (loss) before income taxes		(155	)		1,205			11			(22	)		1,039
Provision for (benefit from) income taxes		(51	)		437			1			—			387
Equity income from subsidiaries		757			10			—			(767	)		—
Income before extraordinary item		653			778			10			(789	)		652
Extraordinary item – gain on acquisition		—			1			—			—			1
Net income	$	653		$	779		$	10		$	(789	)	$	653
For the Six Months Ended June 30, 2006
Net sales	$	—		$	3,974		$	44		$	(33	)	$	3,985
Net sales, related party		—			266			—			—			266
Cost of products sold		—			2,460			14			(33	)		2,441
Selling, general and administrative expenses		14			703			17			—			734
Amortization expense		—			14			—			—			14
Operating income (loss)		(14	)		1,063			13			—			1,062
Interest and debt expense		22			65			—			—			87
Interest income		(1	)		(58	)		—			—			(59	)
Intercompany interest (income) expense		(8	)		8			—			—			—
Intercompany dividend income		—			(21	)		—			21			—
Other (income) expense, net		3			(1	)		(5	)		—			(3	)
Income (loss) before income taxes		(30	)		1,070			18			(21	)		1,037
Provision for (benefit from) income taxes		(9	)		397			2			—			390
Equity income from subsidiaries		742			16			—			(758	)		—
Income before extraordinary item		721			689			16			(779	)		647
Extraordinary item – gain on acquisition		—			74			—			—			74
Net income	$	721		$	763		$	16		$	(779	)	$	721

50

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

Condensed Consolidating Statements of Cash Flows
(Dollars in Millions)

	Parent						Non-
	Issuer			Guarantors			Guarantors			Eliminations			Consolidated
For the Six Months Ended June 30, 2007
Cash flows from (used in) operating activities	$	402		$	(190	)	$	8		$	(76	)	$	144
Cash flows from (used in) investing activities:
Purchases of short-term investments		—			(3,001	)		—			—			(3,001	)
Proceeds from sale of short-term investments		—			3,451			—			—			3,451
Capital expenditures		(5	)		(51	)		(4	)		—			(60	)
Distributions from (investment in) equity investments		—			(1	)		10			—			9
Other, net		—			(1	)		—			—			(1	)
Intercompany notes receivable		20			(308	)		—			288			—
Net cash flows from investing activities		15			89			6			288			398
Cash flows from (used in) financing activities:
Dividends paid on common stock		(444	)		(55	)		—			55			(444	)
Dividends paid on preferred stock		(21	)		—			—			21			—
Repurchase of common stock		(60	)		—			—			—			(60	)
Excess tax benefit from stock-based compensation		1			—			—			—			1
Repayments of long-term debt		(254	)		(46	)		—			—			(300	)
Repayments of term loan		(1,542	)		—			—			—			(1,542	)
Issuance of long-term debt		1,547			—			—			—			1,547
Deferred debt issuance cost		(14	)		—			—			—			(14	)
Intercompany notes payable		297			(20	)		11			(288	)		—
Net cash flows from (used in)financing activities		(490	)		(121	)		11			(212	)		(812	)
Net change in cash and cash equivalents		(73	)		(222	)		25			—			(270	)
Cash and cash equivalents at beginning of period		296			1,065			72			—			1,433
Cash and cash equivalents at end of period	$	223		$	843		$	97		$	—		$	1,163
For the Six Months Ended June 30, 2006
Cash flows from (used in) operating activities	$	787		$	(68	)	$	16		$	(632	)	$	103
Cash flows from (used in) investing activities:
Purchases of short-term investments		—			(2,966	)		—			—			(2,966	)
Proceeds from sale of short-term investments		—			3,621			—			—			3,621
Capital expenditures		—			(71	)		(2	)		—			(73	)
Distributions from equity investments		—			—			8			—			8
Proceeds from the sale of businesses		—			3			—			—			3
Business acquisition		—			(3,517	)		—			—			(3,517	)
Intercompany notes receivable		(3,168	)		9			—			3,159			—
Net intercompany investments		(381	)		381			—			—			—
Other, net		(2	)		5			—			—			3
Net cash flows from (used in) investing activities		(3,551	)		(2,535	)		6			3,159			(2,921	)
Cash flows from (used in) financing activities:
Dividends paid on common stock		(368	)		(611	)		—			611			(368	)
Dividends paid on preferred stock		(21	)		—			—			21			—
Proceeds from exercise of stock options		3			—			—			—			3
Excess tax benefit from stock-based compensation		2			—			—			—			2
Repayment of long-term debt		—			(190	)		—			—			(190	)
Issuance of long-term debt		1,641			—			—			—			1,641
Principal borrowings under term loan		1,550			—			—			—			1,550
Deferred debt issuance costs		(48	)		—			—			—			(48	)
Intercompany notes payable		(9	)		3,168			—			(3,159	)		—
Net cash flows from financing activities		2,750			2,367			—			(2,527	)		2,590
Net change in cash and cash equivalents		(14	)		(236	)		22			—			(228	)
Cash and cash equivalents at beginning of period		227			1,076			30			—			1,333
Cash and cash equivalents at end of period	$	213		$	840		$	52		$	—		$	1,105

51

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

Condensed Consolidating Balance Sheets
(Dollars in Millions)

	Parent				Non-
	Issuer		Guarantors		Guarantors		Eliminations			Consolidated
June 30, 2007
Assets
Cash and cash equivalents	$	223	$	843	$	97	$	—		$	1,163
Short-term investments		—		843		—		—			843
Accounts and other receivables, net		5		95		10		—			110
Accounts receivable, related party		—		48		—		—			48
Inventories		—		1,027		30		(1	)		1,056
Deferred income taxes		5		830		—		—			835
Prepaid expenses and other current assets		1		123		1		(6	)		119
Short-term intercompany notes and interest receivable		82		112		—		(194	)		—
Other intercompany receivables		463		—		3		(466	)		—
Total current assets		779		3,921		141		(667	)		4,174
Property, plant and equipment, net		5		1,039		20		—			1,064
Trademarks, net		—		3,475		—		—			3,475
Goodwill		—		8,167		8		—			8,175
Other intangibles, net		—		207		—		—			207
Long-term intercompany notes		2,140		768		—		(2,908	)		—
Investment in subsidiaries		10,001		82		—		(10,083	)		—
Other assets and deferred charges		79		448		34		(26	)		535
Total assets	$	13,004	$	18,107	$	203	$	(13,684	)	$	17,630
Liabilities and shareholders’ equity
Tobacco settlement and related accruals	$	—	$	1,584	$	—	$	—		$	1,584
Accounts payable and other accrued liabilities		644		1,029		24		(6	)		1,691
Due to related party		—		9		—		—			9
Deferred revenue, related party		—		39		—		—			39
Current maturities of long-term debt		—		29		—		—			29
Short-term intercompany notes and interest payables		29		82		83		(194	)		—
Other intercompany payables		—		467		—		(467	)		—
Total current liabilities		673		3,239		107		(667	)		3,352
Intercompany notes and interest payable		768		2,140		—		(2,908	)		—
Long-term debt (less current maturities)		4,270		129		—		—			4,399
Deferred income taxes		—		1,113		—		(26	)		1,087
Long-term retirement benefits (less current portion)		43		1,114		14		—			1,171
Other noncurrent liabilities		33		370		1		—			404
Shareholders’ equity		7,217		10,002		81		(10,083	)		7,217
Total liabilities and shareholders’ equity	$	13,004	$	18,107	$	203	$	(13,684	)	$	17,630
December 31, 2006
Assets
Cash and cash equivalents	$	296	$	1,065	$	72	$	—		$	1,433
Short-term investments		—		1,293		—		—			1,293
Accounts and other receivables, net		4		98		5		—			107
Accounts receivable, related party		—		59		3		—			62
Inventories		—		1,135		20		—			1,155
Deferred income taxes		3		790		—		—			793
Prepaid expenses and other current assets		6		94		3		(11	)		92
Short-term intercompany notes and interest receivable		83		97		—		(180	)		—
Other intercompany receivables		522		—		6		(528	)		—
Total current assets		914		4,631		109		(719	)		4,935
Property, plant and equipment, net		—		1,046		16		—			1,062
Trademarks, net		—		3,479		—		—			3,479
Goodwill		—		8,167		8		—			8,175

52

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

	Parent				Non-
	Issuer		Guarantors		Guarantors		Eliminations			Consolidated
Other intangibles, net		—		215		—		—			215
Long-term intercompany notes		2,160		472		—		(2,632	)		—
Investment in subsidiaries		9,253		69		—		(9,322	)		—
Other assets and deferred charges		96		204		38		(26	)		312
Total assets	$	12,423	$	18,283	$	171	$	(12,699	)	$	18,178
Liabilities and shareholders’ equity
Tobacco settlement and related accruals	$	—	$	2,237	$	—	$	—		$	2,237
Accounts payable and other accrued liabilities		323		1,111		17		(11	)		1,440
Due to related party		—		9		—		—			9
Deferred revenue, related party		—		62		—		—			62
Current maturities of long-term debt		252		92		—		—			344
Short-term intercompany notes and interest payable		26		83		71		(180	)		—
Other intercompany payables		—		528		—		(528	)		—
Total current liabilities		601		4,122		88		(719	)		4,092
Intercompany notes and interest payable		472		2,160		—		(2,632	)		—
Long-term debt (less current maturities)		4,229		160		—		—			4,389
Deferred income taxes		—		1,193		—		(26	)		1,167
Long-term retirement benefits (less current portion)		41		1,172		14		—			1,227
Other noncurrent liabilities		37		222		1		—			260
Shareholders’ equity		7,043		9,254		68		(9,322	)		7,043
Total liabilities and shareholders’ equity	$	12,423	$	18,283	$	171	$	(12,699	)	$	18,178

53

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

Note 14–RJR Guaranteed, Unsecured Notes — Condensed Consolidating Financial Statements

     The following condensed consolidating financial statements have been prepared pursuant to Rule 3-10 of Regulation S-X, relating to the guarantees of RJR’s $69 million unsecured notes. RAI and certain of its direct or indirect, wholly 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 guarantor; RJR, the issuer of the debt securities; RJR Tobacco, RJR Acquisition Corp. and certain of RJR’s other subsidiaries, the other guarantors; other subsidiaries of RAI and RJR, including Santa Fe, Lane and Conwood, that are not guarantors; and elimination adjustments. GPI was added as a guarantor in September 2006. Comparative information for 2006 represents the guarantor subsidiaries during those periods.

54

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

Condensed Consolidating Statements of Income
(Dollars in Millions)

	Parent						Other			Non-
	Guarantor			Issuer			Guarantors			Guarantors			Eliminations			Consolidated
For the Three Months Ended June 30, 2007
Net sales	$	—		$	—		$	2,006		$	262		$	(41	)	$	2,227
Net sales, related party		—			—			116			5			—			121
Cost of products sold		—			—			1,289			95			(41	)		1,343
Selling, general and administrative expenses		14			—			332			58			—			404
Amortization expense		—			—			5			1			—			6
Operating income (loss)		(14	)		—			496			113			—			595
Interest and debt expense		84			3			—			—			—			87
Interest income		(1	)		(1	)		(18	)		(3	)		—			(23	)
Intercompany interest (income) expense		(30	)		(1	)		(18	)		49			—			—
Intercompany dividend income		—			(10	)		—			—			10			—
Other (income) expense, net		20			(1	)		—			(3	)		—			16
Income (loss) before income taxes		(87	)		10			532			70			(10	)		515
Provision for (benefit from) income taxes		(28	)		—			192			27			—			191
Equity income from subsidiaries		384			343			4			—			(731	)		—
Income before extraordinary item		325			353			344			43			(741	)		324
Extraordinary item-gain on acquisition		—			—			1			—			—			1
Net income	$	325		$	353		$	345		$	43		$	(741	)	$	325
For the Three Months Ended June 30, 2006
Net sales	$	—		$	—		$	2,032		$	172		$	(34	)	$	2,170
Net sales, related party		—			—			117			4			—			121
Cost of products sold		—			—			1,240			70			(34	)		1,276
Selling, general and administrative expenses		8			—			345			39			—			392
Amortization expense		—			—			7			—			—			7
Operating income (loss)		(8	)		—			557			67			—			616
Interest and debt expense		22			28			1			1			—			52
Interest income		(1	)		(2	)		(20	)		—			—			(23	)
Intercompany interest (income) expense		(15	)		1			(12	)		26			—			—
Intercompany dividend income		—			(10	)		—			—			10			—
Other (income) expense, net		3			(2	)		—			(4	)		—			(3	)
Income (loss) before income taxes		(17	)		(15	)		588			44			(10	)		590
Provision for (benefit from) income taxes		(5	)		(15	)		229			14			—			223
Equity income from subsidiaries		388			376			4			—			(768	)		—
Income before extraordinary item		376			376			363			30			(778	)		367
Extraordinary item-gain on acquisition		—			—			9			—			—			9
Net income	$	376		$	376		$	372		$	30		$	(778	)	$	376

55

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

Condensed Consolidating Statements of Income
(Dollars in Millions)

	Parent						Other			Non-
	Guarantor			Issuer			Guarantors			Guarantors			Eliminations			Consolidated
For the Six Months Ended June 30, 2007
Net sales	$	—		$	—		$	3,833		$	477		$	(65	)	$	4,245
Net sales, related party		—			—			243			8			—			251
Cost of products sold		—			—			2,425			158			(65	)		2,518
Selling, general and administrative expenses		29			—			655			113			—			797
Amortization expense		—			—			11			1			—			12
Operating income (loss)		(29	)		—			985			213			—			1,169
Interest and debt expense		168			8			—			—			—			176
Interest income		(2	)		(4	)		(49	)		(6	)		—			(61	)
Intercompany interest (income) expense		(62	)		(2	)		(33	)		97			—			—
Intercompany dividend income		—			(21	)		—			—			21			—
Other (income) expense, net		22			(2	)		—			(5	)		—			15
Income (loss) before income taxes		(155	)		21			1,067			127			(21	)		1,039
Provision for (benefit from) income taxes		(51	)		—			393			45			—			387
Equity income from subsidiaries		757			684			10			—			(1,451	)		—
Income before extraordinary item		653			705			684			82			(1,472	)		652
Extraordinary item-gain on acquisition		—			—			1			—			—			1
Net income	$	653		$	705		$	685		$	82		$	(1,472	)	$	653
For the Six Months Ended June 30, 2006
Net sales	$	—		$	—		$	3,770		$	284		$	(69	)	$	3,985
Net sales, related party		—			—			260			6			—			266
Cost of products sold		—			—			2,387			123			(69	)		2,441
Selling, general and administrative expenses		14			1			653			66			—			734
Amortization expense		—			—			14			—			—			14
Operating income (loss)		(14	)		(1	)		976			101			—			1,062
Interest and debt expense		22			60			1			4			—			87
Interest income		(1	)		(5	)		(53	)		—			—			(59	)
Intercompany interest (income) expense		(8	)		1			(22	)		29			—			—
Intercompany dividend income		—			(21	)		—			—			21			—
Other (income) expense, net		3			(2	)		1			(5	)		—			(3	)
Income (loss) before income taxes		(30	)		(34	)		1,049			73			(21	)		1,037
Provision for (benefit from) income taxes		(9	)		(26	)		403			22			—			390
Equity income from subsidiaries		742			735			11			—			(1,488	)		—
Income before extraordinary item		721			727			657			51			(1,509	)		647
Extraordinary item-gain on acquisition		—			—			74			—			—			74
Net income	$	721		$	727		$	731		$	51		$	(1,509	)	$	721

56

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

Condensed Consolidating Statements of Cash Flows
(Dollars in Millions)

	Parent						Other			Non-
	Guarantor			Issuer			Guarantors			Guarantors			Eliminations			Consolidated
For the Six Months Ended June 30, 2007
Cash flows from (used in) operating activities	$	402		$	184		$	(332	)	$	105		$	(215	)	$	144
Cash flows from (used in) investing activities:
Capital expenditures		(5	)		—			(42	)		(13	)		—			(60	)
Distribution from equity investees		—			—			(1	)		10			—			9
Purchases of short-term investments		—			(2	)		(2,899	)		(100	)		—			(3,001	)
Proceeds from short-term investments		—			120			3,331			—			—			3,451
Net intercompany investments		—			(260	)		260			—			—			—
Other, net		—			(1	)		—			—			—			(1	)
Intercompany notes receivable		20			9			(346	)		—			317			—
Net cash flows from (used in) investing activities		15			(134	)		303			(103	)		317			398
Cash flows from (used in) financing activities:
Dividends paid on common stock		(444	)		—			(139	)		(55	)		194			(444	)
Dividends paid on preferred stock		(21	)		—			—			—			21			—
Repurchase of common stock		(60	)		—			—			—			—			(60	)
Repayment of long-term debt		(254	)		(46	)		—			—			—			(300	)
Repayment of term loan		(1,542	)		—			—			—			—			(1,542	)
Issuance of long-term debt		1,547			—			—			—			—			1,547
Deferred debt issuance cost		(14	)		—			—			—			—			(14	)
Excess tax benefit from stock-based compensation		1			—			—			—			—			1
Intercompany notes payable		297			—			1			19			(317	)		—
Net cash flows used in financing activities		(490	)		(46	)		(138	)		(36	)		(102	)		(812	)
Net change in cash and cash equivalents		(73	)		4			(167	)		(34	)		—			(270	)
Cash and cash equivalents at beginning of period		296			22			848			267			—			1,433
Cash and cash equivalents at end of period	$	223		$	26		$	681		$	233		$	—		$	1,163
For the Six Months Ended June 30, 2006
Cash flows from (used in) operating activities	$	787		$	569		$	86		$	21		$	(1,360	)	$	103
Cash flows from (used in) investing activities:
Capital expenditures		—			—			(67	)		(6	)		—			(73	)
Distribution from equity investees		—			—			—			8			—			8
Purchases of short-term investments		—			(3	)		(2,963	)		—			—			(2,966	)
Proceeds from short-term investments		—			—			3,621			—			—			3,621
Intercompany notes receivable		(3,168	)		(3,157	)		7			—			6,318			—
Net intercompany investment		(381	)		219			(219	)		381			—			—
Business acquisition		—			—			—			(3,517	)		—			(3,517	)
Proceeds from sale of business		—			—			—			3			—			3
Other, net		(2	)		—			5			—			—			3
Net cash flows from (used in) investing activities		(3,551	)		(2,941	)		384			(3,131	)		6,318			(2,921	)
Cash flows from (used in) financing activities:
Dividends paid on common stock		(368	)		(611	)		(728	)		—			1,339			(368	)
Dividends paid on preferred stock		(21	)		—			—			—			21			—
Proceeds from exercise of stock options		3			—			—			—			—			3
Excess tax benefit from stock-based compensation		2			—			—			—			—			2
Repayments of long-term debt		—			(190	)		—			—			—			(190	)
Issuance of long-term debt		1,641			—			—			—			—			1,641
Principal borrowings under term loan credit facility		1,550			—			—			—			—			1,550
Deferred debt issuance cost		(48	)		—			—			—			—			(48	)
Intercompany notes payable		(9	)		3,169			(2	)		3,160			(6,318	)		—

57

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

	Parent						Other			Non-
	Guarantor			Issuer			Guarantors			Guarantors		Eliminations			Consolidated
Net cash flows from (used in) financing activities		2,750			2,368			(730	)		3,160		(4,958	)		2,590
Net change in cash and cash equivalents		(14	)		(4	)		(260	)		50		—			(228	)
Cash and cash equivalents at beginning of period		227			33			1,043			30		—			1,333
Cash and cash equivalents at end of period	$	213		$	29		$	783		$	80	$	—		$	1,105

58

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

Condensed Consolidating Balance Sheets
(Dollars in Millions)

	Parent				Other
	Guarantor		Issuer		Guarantors		Non-Guarantors		Eliminations			Consolidated
June 30, 2007
Assets
Cash and cash equivalents	$	223	$	26	$	681	$	233	$	—		$	1,163
Short-term investments		—		—		743		100		—			843
Accounts and other receivables, net		5		3		72		30		—			110
Accounts receivable, related party		—		—		42		6		—			48
Inventories		—		—		816		241		(1	)		1,056
Deferred income taxes		5		—		808		22		—			835
Prepaid expenses and other current assets		1		—		120		4		(6	)		119
Short-term intercompany notes and interest receivable		82		101		444		—		(627	)		—
Other intercompany receivables		463		—		—		—		(463	)		—
Total current assets		779		130		3,726		636		(1,097	)		4,174
Property, plant and equipment, net		5		—		946		113		—			1,064
Trademarks, net		—		—		1,902		1,573		—			3,475
Goodwill		—		—		5,303		2,872		—			8,175
Other intangibles, net		—		—		207		—		—			207
Long-term intercompany notes		2,140		234		810		—		(3,184	)		—
Investment in subsidiaries		10,001		8,512		64		—		(18,577	)		—
Other assets and deferred charges		79		31		418		36		(29	)		535
Total assets	$	13,004	$	8,907	$	13,376	$	5,230	$	(22,887	)	$	17,630
Liabilities and shareholders’ equity
Tobacco settlement and related accruals	$	—	$	—	$	1,571	$	13	$	—		$	1,584
Accounts payable and other accrued liabilities		644		6		968		79		(6	)		1,691
Due to related party		—		—		9		—		—			9
Deferred revenue, related party		—		—		39		—		—			39
Current maturities of long-term debt		—		29		—		—		—			29
Short-term intercompany notes and interest payable		29		407		2		189		(627	)		—
Other intercompany payables		—		39		420		5		(464	)		—
Total current liabilities		673		481		3,009		286		(1,097	)		3,352
Intercompany notes		768		—		3		2,413		(3,184	)		—
Long-term debt (less current maturities)		4,270		129		—		—		—			4,399
Deferred income taxes		—		—		542		574		(29	)		1,087
Long-term retirement benefits (less current portion)		43		18		1,042		68		—			1,171
Other noncurrent liabilities		33		91		269		11		—			404
Shareholders’ equity		7,217		8,188		8,511		1,878		(18,577	)		7,217
Total liabilities and shareholders’ equity	$	13,004	$	8,907	$	13,376	$	5,230	$	(22,887	)	$	17,630
December 31, 2006
Assets
Cash and cash equivalents	$	296	$	22	$	848	$	267	$	—		$	1,433
Short-term investments		—		117		1,176		—		—			1,293
Accounts and other receivables, net		4		3		70		30		—			107
Accounts receivable, related party		—		—		51		11		—			62
Inventories		—		—		910		246		(1	)		1,155
Deferred income taxes		3		1		768		21		—			793
Prepaid expenses and other current assets		6		—		96		6		(16	)		92
Short-term intercompany notes and interest receivable		83		99		433		—		(615	)		—
Other intercompany receivables		522		38		—		29		(589	)		—
Total current assets		914		280		4,352		610		(1,221	)		4,935

59

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

	Parent				Other
	Guarantor		Issuer		Guarantors		Non-Guarantors		Eliminations			Consolidated
Property, plant and equipment, net		—		—		955		107		—			1,062
Trademarks, net		—		—		1,906		1,573		—			3,479
Goodwill		—		—		5,303		2,872		—			8,175
Other intangibles, net		—		—		180		35		—			215
Long-term intercompany notes		2,160		244		472		—		(2,876	)		—
Investment in subsidiaries		9,253		7,684		52		—		(16,989	)		—
Other assets and deferred charges		96		29		173		40		(26	)		312
Total assets	$	12,423	$	8,237	$	13,393	$	5,237	$	(21,112	)	$	18,178
Liabilities and shareholders’ equity
Tobacco settlement and related accruals	$	—	$	—	$	2,216	$	21	$	—		$	2,237
Accounts payable and other accrued liabilities		323		8		998		127		(16	)		1,440
Due to related party		—		—		9		—		—			9
Deferred revenue, related party		—		—		62		—		—			62
Current maturities of long-term debt		252		92		—		—		—			344
Short-term intercompany notes and interest payable		26		407		3		179		(615	)		—
Other intercompany payables		—		—		589		—		(589	)		—
Total current liabilities		601		507		3,877		327		(1,220	)		4,092
Intercompany notes		472		—		4		2,400		(2,876	)		—
Long-term debt (less current maturities)		4,229		160		—		—		—			4,389
Deferred income taxes		—		—		605		588		(26	)		1,167
Long-term retirement benefits (less current portion)		41		19		1,101		66		—			1,227
Other noncurrent liabilities		37		91		123		9		—			260
Shareholders’ equity		7,043		7,460		7,683		1,847		(16,990	)		7,043
Total liabilities and shareholders’ equity	$	12,423	$	8,237	$	13,393	$	5,237	$	(21,112	)	$	18,178

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Item 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 policies and its consolidated results of operations and financial condition. Following the overview and discussion of business initiatives, the critical accounting policies disclose certain accounting policies that are material to RAI’s results of operations and financial condition for the periods presented in this report. The discussion and analysis of RAI’s results of operations compares the second quarter of 2007 with the second quarter of 2006 and the first six months of 2007 with the first six months of 2006. Disclosures related to liquidity and financial condition complete management’s discussion and analysis. You should read this discussion and analysis of RAI’s consolidated financial condition and results of operations in conjunction with the financial information included in the condensed consolidated financial statements (unaudited).

Overview and Initiatives

     RAI’s operating subsidiaries include RJR Tobacco, Conwood, Santa Fe and GPI. RAI’s largest reportable operating segment, RJR Tobacco, is the second largest cigarette manufacturer in the United States. RJR Tobacco’s largest selling cigarette brands, CAMEL, KOOL, PALL MALL, DORAL, WINSTON and SALEM, are currently six of the ten best-selling brands of cigarettes in the United States. Those brands, and its other brands, including MISTY and CAPRI, are manufactured in a variety of styles and marketed in the United States to meet a range of adult smoker preferences. RJR Tobacco also manages contract manufacturing of cigarettes and other tobacco products through arrangements with BAT affiliates. Beginning January 1, 2007, the management and distribution of DUNHILL and STATE EXPRESS 555 cigarette brands were transferred to RJR Tobacco from Lane.

     RAI’s other reportable segment, Conwood, is the second largest smokeless tobacco products manufacturer in the United States. RAI acquired Conwood on May 31, 2006. Conwood’s primary brands include its largest selling moist snuff brands, GRIZZLY and KODIAK, two of the six best-selling brands of moist snuff in the United States, and LEVI GARRETT, a loose leaf brand. Conwood’s other products include dry snuff, plug and twist tobacco products. Beginning January 1, 2007, Conwood began to distribute a variety of tobacco products manufactured by Lane, including WINCHESTER and CAPTAIN BLACK little cigars, and BUGLER roll-your-own tobacco.

     The disclosures classified as All Other include the total assets and results of operations of Santa Fe and GPI. Santa Fe manufactures and markets cigarettes and other tobacco products under the NATURAL AMERICAN SPIRIT brand. GPI manufactures and exports cigarettes to U.S. territories, U.S. duty-free shops and U.S. overseas military bases, manages a contract manufacturing business and, as of January 1, 2007, manages the international businesses of Conwood and Santa Fe.

RJR Tobacco

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

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

     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. 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. Competitive discounting has increased significantly over time as a result of higher state excise taxes and the strength of deep-discount brands. Deep-discount brands are brands marketed by manufacturers that are not original participants in the MSA, and accordingly, do not have cost structures burdened with MSA payments to the same extent as the original participating manufacturers.

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     RJR Tobacco’s refined brand portfolio strategy took effect at the beginning of 2007, and modified the three categories of brands to growth, support and non-support. The growth brands consist of two premium brands, CAMEL and KOOL, and a value brand, PALL MALL. Although all of these brands are managed for long-term accelerated growth and profit, CAMEL and KOOL will continue to receive significant investment support, consistent with their previous investment brand status. The support brands consist of three premium brands, WINSTON, SALEM and CAPRI, and two value brands, DORAL and MISTY, all of which receive limited support for scale and long-term profit. The non-support brands consist of all remaining brands and are managed to maximize near-term profitability. RJR Tobacco expects that, within the next four years, this focused portfolio strategy will result in growth in total RJR Tobacco share, as gains on growth brands more than offset declines among other brands.

Conwood

     Conwood offers a range of differentiated smokeless tobacco products to adult consumers. Conwood is the only company with brands in every category of the smokeless tobacco market, including moist snuff, loose leaf, dry snuff, plug and twist tobacco. The moist snuff category is divided into premium and price-value brands. GRIZZLY, the nation’s largest price-value brand, led to Conwood’s increased share of the smokeless market. KODIAK is Conwood’s leading premium brand.

     In contrast to the declining U.S. cigarette market, U.S. moist snuff volumes have grown at an average rate of approximately 4% per year over the last four years with an accelerated growth of price-value brands. Also, the profit margins on moist snuff are significantly higher than in the cigarette industry. Moist snuff’s growth is partially attributable to cigarette smokers switching from cigarettes to smokeless tobacco products or using both. Within the moist snuff category, premium brands have lost market share to price-value brands, led by GRIZZLY, in recent years.

     Conwood faces significant competition in the smokeless tobacco categories. 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. RAI is combining certain operations of Lane with Conwood, to be completed by the end of 2007, in order to consolidate and strengthen the companies’ portfolio of smokeless tobacco products and other non-cigarette tobacco products.

Critical Accounting Policies

     GAAP requires estimates and assumptions to be made that affect the reported amounts in RAI’s condensed consolidated financial statements and accompanying notes. Some of these estimates require difficult, subjective and/or complex judgments about matters that are inherently uncertain, and as a result, actual results could differ from those estimates. Due to the estimation processes involved, the following summarized accounting policies and their application are considered to be critical to understanding the business operations, financial condition and results of operations of RAI and its subsidiaries. For information related to these and other significant accounting policies, see note 1 to condensed consolidated financial statements (unaudited).

Tobacco-Related Litigation

     RAI discloses information concerning tobacco-related 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 tobacco litigation at such time as an unfavorable outcome becomes probable and the amount can be reasonably estimated. When the reasonable estimate is a range, the recorded loss will be the best estimate within the range. If no amount in the range is a better estimate than any other amount, the minimum amount of the range will be recorded.

     As discussed in note 9 to condensed consolidated financial statements (unaudited), RJR Tobacco, Conwood and 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. RJR Tobacco has paid approximately $26 million since January 1, 2005, related to such unfavorable judgments, including pre-acquisition contingencies related to the B&W business combination.

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     RAI and its subsidiaries believe, however, that they have valid bases for appeals in their pending cases and have valid defenses to all actions, and they 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 or its affiliates or indemnitees, including B&W, or the loss of any particular claim concerning the use of smokeless tobacco against Conwood, when viewed on an individual basis, is not probable or estimable. No liability for pending smoking and health tobacco litigation or smokeless tobacco litigation was recorded in RAI’s condensed consolidated financial statements (unaudited) as of June 30, 2007. As discussed in more detail in note 9 to condensed consolidated financial statements (unaudited), RJR has liabilities totaling $94 million that were recorded in 1999 in connection with certain indemnification claims, not related to smoking and health, asserted by JTI against RJR and RJR Tobacco, relating to the activities of Northern Brands and related litigation.

     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, Conwood or their affiliates, including RAI, and indemnitees. Any unfavorable outcome of such actions could have a material adverse effect on the financial condition, results of operations or cash flows of RAI or its subsidiaries.

Settlement Agreements

     As discussed in note 9 to condensed consolidated financial statements (unaudited), RJR Tobacco, Santa Fe and Lane are participants in the MSA, and RJR Tobacco is a participant in other state settlement agreements related to governmental health-care cost recovery actions. Their obligations and the related expense charges under the MSA and other state settlement agreements are subject to adjustments based upon, among other things, the volume of cigarettes sold by the operating subsidiaries, their relative market share and inflation. Since relative market share is based on cigarette shipments, the best estimate of the allocation of charges under these agreements is recorded in cost of products sold as the products are shipped. Adjustments to these estimates, which historically have not been significant, are recorded in the period that the change becomes probable and the amount can be reasonably estimated. Conwood is not a participant in the MSA. For more information related to historical and expected settlement expenses and payments under the MSA and other state settlement agreements, see “–Governmental Health-Care Cost Recovery Cases–MSA and Other State Settlement Agreements” and “–MSA–Enforcement and Validity” in note 9 to condensed consolidated financial statements (unaudited).

Income taxes

     Tax law requires certain items to be included in taxable income at different times than is required for book reporting purposes under SFAS No. 109, “Accounting for Income Taxes.” These differences may be permanent or temporary in nature. FIN No. 48, “Accounting for Uncertainty in Income Taxes,” clarifies SFAS No. 109 by providing guidance for consistent reporting of uncertain income tax positions recognized in a company’s financial statements.

     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 in each reporting period.

     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 as required under SFAS No. 109. To the extent that a deferred tax asset is created, management evaluates RAI’s ability to realize this asset. Management currently believes it is more likely than not that the deferred tax assets recorded in RAI’s condensed consolidated balance sheet (unaudited) will be realized. To the extent a deferred tax liability is established under SFAS No. 109, it is recorded, tracked and, once it becomes currently due and payable, paid to the taxing authorities.

     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 upon RAI’s effective income tax rate.

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Results of Operations

	Three Months Ended									Six Months Ended
	June 30,									June 30,
							%									%
	2007			2006			Change			2007			2006			Change
Net sales:1
RJR Tobacco	$	2,061		$	2,111			(2.4	)%	$	3,960		$	3,945			0.4	%
Conwood		174			72		NM3				329			100		NM3
All other		113			108			4.6	%		207			206			0.5	%
Net sales		2,348			2,291			2.5	%		4,496			4,251			5.8	%
Cost of products sold1, 2		1,343			1,276			5.3	%		2,518			2,441			3.2	%
Selling, general and administrative expenses		404			392			3.1	%		797			734			8.6	%
Amortization expense		6			7			(14.3	)%		12			14			(14.3	)%
Operating income:
RJR Tobacco		496			564			(12.1)	%		984			983			0.1	%
Conwood		90			32		NM3				170			37		NM3
All other		35			39			(10.3	)%		70			78			(10.3	)%
Corporate expense		(26	)		(19	)		36.8	%		(55	)		(36	)		52.8	%
	$	595		$	616			(3.4	)%	$	1,169		$	1,062			10.1	%

1 Excludes excise taxes of:
RJR Tobacco	$	492	$	532	$	940	$	997
Conwood		5		3		9		4
All other		32		34		74		68
	$	529	$	569	$	1,023	$	1,069

2	See below for further information related to MSA settlement and federal tobacco buyout expense included in cost of products sold.
3	Percent change is not meaningful.

RJR Tobacco

     Net Sales

     RJR Tobacco’s net sales for the second quarter of 2007 decreased $50 million from the comparable prior-year quarter, primarily due to a decrease in total volume of $157 million partially offset by higher pricing and lower discounting. For the first six months of 2007, RJR Tobacco’s net sales increased $15 million due to higher pricing coupled with lower discounting, mostly offset by a $219 million decrease in volume. The volume declines in the comparative periods were primarily due to inventory builds at wholesale during the second quarter of 2006 in preparation for an RJR Tobacco system conversion on June 30, 2006. RJR Tobacco’s net sales are dependent upon its shipment volume in a declining market, premium versus value brand mix and list pricing, offset by promotional spending, trade incentives and federal excise taxes.

     Domestic shipment volume, in billions of units for RJR Tobacco and the industry, were as follows¹:

	Three Months Ended June 30,							Six Months Ended June 30,
	2007		2006		% Change			2007		2006		% Change
Growth brands:
CAMEL excluding non-filter		6.6		6.3		5.4	%		12.2		11.6		5.1	%
KOOL		3.0		3.1		(4.8	)%		5.6		5.9		(4.9	)%
PALL MALL		1.9		1.8		3.1	%		3.5		3.3		7.0	%
		11.4		11.2		2.2	%		21.4		20.8		2.6	%
Support brands		10.7		11.8		(9.7	)%		20.7		22.3		(7.0	)%
Non-support brands		3.8		5.0		(22.6	)%		7.5		9.5		(20.7	)%
Total domestic		26.0		28.0		(7.2	)%		49.6		52.6		(5.7	)%

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	Three Months Ended June 30,							Six Months Ended June 30,
	2007		2006		% Change			2007		2006		% Change
Total premium		16.3		17.1		(5.1	)%		30.9		32.2		(3.8	)%
Total value		9.7		10.8		(10.5	)%		18.7		20.4		(8.6	)%
Total domestic		26.0		28.0		(7.2	)%		49.6		52.6		(5.7	)%
Industry2:
Premium		68.0		70.0		(2.9	)%		128.8		133.7		(3.7	)%
Value		25.1		27.1		(7.6	)%		47.5		52.0		(8.7	)%
Total domestic		93.1		97.1		(4.2	)%		176.2		185.6		(5.1	)%

1	Amounts presented in this table are rounded on an individual basis and, accordingly, may not sum on an aggregate basis.
2	Based on information from Management Science Associates, Inc., referred to as            MSAi. Prior year amounts have been restated to reflect current methodology.

     RJR Tobacco’s total domestic shipment volume decreased 7.2% and 5.7% in the second quarter and first six months of 2007, respectively, compared with prior-year periods. This decrease reflects the second quarter 2006 wholesale inventory build of approximately 1 billion units in preparation of RJR Tobacco’s SAP enterprise business system conversion along with declines in current consumption, or current retail sales to consumers. RJR Tobacco’s full-year 2007 shipment volume decline is expected to be approximately 4%. The expected overall domestic industry consumption decline is approximately 3%.

     Shipments in the premium tier increased to 62.6% of RJR Tobacco’s total domestic shipments during the second quarter of 2007 compared with 61.2% in the prior-year quarter. For the first six months, premium tier shipments as a percentage of total shipments were 62.4% in 2007 and 61.2% in 2006. These increases were driven by CAMEL with the introduction of CAMEL No. 9 and CAMEL Signature during the first half of 2007. The domestic industry’s premium shipments increased to 73.1% for the three months ended June 30, 2007, from 72.1% of total shipments for the three months ended June 30, 2006. For the first six months, premium tier shipments as a percentage of total shipments were 73.1% in 2007 and 72.0% in 2006.

     The shares of RJR Tobacco as a percentage of total share of U.S. retail cigarette sales according to data¹ from Information Resources, Inc./Capstone Research Inc., collectively referred to as IRI, were as follows:

				For the Three Months Ended2
	June 30,			March 31,			Share Point			June 30,			Share Point
	2007			2007			Change			2006			Change
Growth brands:
CAMEL excluding non-filter		7.82	%		7.39	%		0.43			7.34	%		0.49
KOOL		3.07	%		3.20	%		(0.13	)		3.11	%		(0.03	)
PALL MALL		2.09	%		2.04	%		0.05			1.92	%		0.18
Total growth brands		12.99	%		12.63	%		0.36			12.36	%		0.63
Support brands		11.67	%		11.99	%		(0.32	)		12.10	%		(0.43	)
Non-support brands		4.49	%		4.79	%		(0.30	)		5.33	%		(0.84	)
Total domestic		29.14	%		29.41	%		(0.27	)		29.79	%		(0.64	)

1

Retail share of U.S. cigarette sales data is included in this document because it is used by RJR Tobacco primarily as an indicator of the relative performance of industry participants and brands and market trends. You should not rely on the market share data reported by IRI as being a precise measurement of actual market share because IRI is not able to effectively track all volume. 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.

2

Amounts presented in this table are rounded on an individual basis and, accordingly, may not sum on an aggregate basis.

     The retail share of market of CAMEL’s filtered styles increased 0.43 share points in the second quarter of 2007 from the prior quarter and 0.49 share points from the second quarter of 2006. CAMEL continues to focus on brand innovation particularly in the menthol category. In February 2007, CAMEL introduced CAMEL No. 9 in regular and

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menthol styles designed to appeal to adult female smokers. CAMEL No. 9 has been well received and currently has a market share of almost a half point. KOOL’s market share in the second quarter of 2007 was relatively stable compared with the prior quarter and prior-year period. KOOL has been providing innovative products such as KOOL XL, the smoother and wider cigarette introduced in late 2006 and, most recently, a milder style KOOL XL Blue. Both KOOL XL and KOOL XL Blue will be expanded to national distribution during 2007. PALL MALL’s market share continues to grow, gaining 0.05 share points in the second quarter of 2007 over the first quarter of 2007 and 0.18 share points over the comparable quarter of 2006. PALL MALL offers a longer-lasting cigarette with a premium heritage at a less-than-premium price. During the second quarter of 2007, PALL MALL ultra lights were available in a bright, distinctive packaging design.

     The combined share of market of RJR Tobacco’s growth brands during the first half of 2007 showed improvement over the comparative prior-year period. However, as expected, the decline in share of support and non-support brands more than offset the gains on the growth brands.

     Operating Income

     RJR Tobacco’s operating income for the second quarter of 2007 decreased $68 million to $496 million, or 24.1% of net sales, from $564 million, or 26.7% of net sales, in the comparable prior-year quarter. For the first six months, operating income was stable at $984 million, or 24.8% of net sales, in 2007 compared with $983 million, or 24.9% of net sales, in 2006. Increased MSA settlement payments and volume declines were partially offset by improvements in pricing, product mix, productivity and pension expense during 2007.

     RJR Tobacco’s MSA settlement and federal tobacco buyout expenses, included in cost of products sold, are detailed in the schedule below:

	For The Three Months				For The Six Months
	Ended June 30,				Ended June 30,
	2007		2006		2007		2006
Settlement	$	743	$	699	$	1,410	$	1,315
Federal tobacco quota buyout		70		66		138		131
Federal quota tobacco stock liquidation assessment		—		—		—		(9	)
Total quota buyout expense	$	70	$	66	$	138	$	122

     MSA and other state settlement expenses are expected to be approximately $2.9 billion in 2007, subject to adjustment for changes in volume and other factors, and the federal tobacco quota buyout is expected to be approximately $260 million in 2007. For additional information, see “–Governmental Health-Care Cost Recovery Cases – MSA and Other State Settlement Agreements” in note 9 to condensed consolidated financial statements (unaudited) and “-Governmental Activity” below.

     Selling, general and administrative expenses include the costs of litigating and administering product liability claims, as well as other legal expenses. For the quarters ended June 30, 2007 and 2006, RJR Tobacco’s product liability defense costs were $23 million and $30 million, respectively. For the six-month periods ended June 30, 2007 and 2006, RJR Tobacco’s product liability defense costs were $51 million and $57 million, respectively.

     “Product liability” cases generally include the following types of smoking and health related cases:

• Individual Smoking and Health;

• Engle Progeny;

• Flight Attendant – ETS (Broin II);

• Class Actions;

• Governmental Health-Care Cost Recovery; and

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• Other Health-Care Cost Recovery and Aggregated Claims.

     “Product liability defense costs” include the following items:

• direct and indirect compensation, fees and related costs and expenses for internal legal and related administrative staff administering product liability claims;

• fees and cost reimbursements paid to outside attorneys;

• direct and indirect payments to third party vendors for litigation support activities;

• expert witness costs and fees; and

• payments to fund legal defense costs for the now dissolved Council for Tobacco Research–U.S.A.

     Numerous factors affect the amount of product liability defense costs. The most important factors are the number of cases pending and the number of cases in trial or in preparation for trial (that is, with active discovery and motions practice). See “Litigation Affecting the Cigarette Industry–Overview” in note 9 to condensed consolidated financial statements (unaudited) for detailed information regarding the number and type of cases pending, and “Litigation Affecting the Cigarette Industry–Scheduled Trials” in note 9 for detailed information regarding the number and nature of cases in trial and scheduled for trial through June 30, 2008.

     RJR Tobacco expects that the factors described above will continue to have the primary impact on its product liability defense costs in the future. Given the level of activity in cases in preparation for trial, in trial and on appeal and the amount of product liability defense costs incurred by RJR Tobacco over the past three years, RJR Tobacco’s recent experiences in defending its product liability cases and the reasonably anticipated level of activity in RJR Tobacco’s pending cases and possible new cases, RJR Tobacco does not expect that the variances in its product liability defense costs will be significantly different than they have been historically, aside from the assumption of certain B&W litigation and the potential for increased individual case filings in Florida due to the Engle decision. See “Litigation Affecting the Cigarette Industry–Engle Progeny Cases” and “Litigation Affecting the Cigarette Industry–Class Action Suits–Engle Case” in note 9 to the condensed consolidated financial statements (unaudited) for additional information. However, it is possible that adverse developments in the factors discussed above, as well as other circumstances beyond the control of RJR Tobacco, could have a material adverse effect on the financial condition, results of operations or cash flows 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.

Conwood

     Net Sales

     Conwood’s net sales for the second quarter and first half of 2007 were $174 million and $329 million, respectively, compared with $72 million and $100 million in the second quarter and first half of 2006, respectively. The Conwood acquisition occurred on May 31, 2006, and consequently, the RAI condensed consolidated statements of income (unaudited) include only the results of operations of Conwood subsequent to May 31, 2006. Additionally, for segment reporting purposes, comparative results of Lane operations that were transferred to Conwood on January 1, 2007, have been reclassified.

     The shares of Conwood’s moist snuff products and volume discussion presented below include periods prior to the acquisition by RAI for enhanced analysis. The shipment volume, in millions of cans, for Conwood was as follows:

	For the Three Months Ended							For the Six Months Ended
	June 30,		June 30,					June 30,		June 30,
	2007		2006		% Change			2007		2006		% Change
Premium:
KODIAK		14.2		14.9		(5.2	)%		27.0		28.7		(5.9	)%
Other		0.9		0.9		(6.3	)%		1.6		1.8		(9.3	)%
		15.0		15.9		(5.3	)%		28.6		30.5		(6.1	)%

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	For the Three Months Ended							For the Six Months Ended
	June 30,		June 30,					June 30,		June 30,
	2007		2006		% Change			2007		2006		% Change
Price-value:
GRIZZLY		59.2		50.6		17.1	%		113.5		95.2		19.2	%
Other		0.4		0.8		(45.6	)%		1.0		1.6		(36.5	)%
		59.7		51.4		16.1	%		114.5		96.9		18.2	%
Total moist snuff		74.7		67.2		11.1	%		143.2		127.3		12.4	%

     The Conwood shares of the moist snuff category as a percentage of total share of U.S. retail moist snuff sales, according to distributor reported data¹ processed by MSAi, were as follows:

	For the Three Months Ended2
	June 30,			March 31,			Share Point			June 30,			Share Point
	2007			2007			Change			2006			Change
Premium:
KODIAK		4.61	%		4.55	%		0.06			5.23	%		(0.62	)
Other		0.29	%		0.30	%		(0.01	)		0.35	%		(0.05	)
		4.90	%		4.85	%		0.05			5.58	%		(0.68	)
Price-value:
GRIZZLY		20.64	%		20.57	%		(0.07	)		18.74	%		1.90
Other		0.19	%		0.22	%		(0.03	)		0.26	%		(0.07	)
		20.83	%		20.79	%		0.04			19.00	%		1.83
Total moist snuff		25.73	%		25.64	%		0.09			24.58	%		1.15

1

Distributor shipments to retail share of U.S. moist snuff is included in this document because it is used by Conwood primarily as an indicator of the relative performance of industry participants and brands and market trends. You should not rely on the market share data reported by distributors and processed by MSAi as being a precise measurement of actual market share because this distributor data set is not able to effectively track all volume.

2

Amounts presented in this table are rounded on an individual basis and, accordingly, may not sum on an aggregate basis.

     GRIZZLY, Conwood’s leading price-value moist snuff brand, had a share position of 20.64% of the moist snuff market in the second quarter of 2007: an increase of 0.07 points from the prior quarter and up 1.90 points from the second quarter of 2006. In the second quarter of 2007, Conwood completed its national roll-out of GRIZZLY Long-Cut Natural. The retail market share of KODIAK, Conwood’s leading premium moist snuff brand, was adversely impacted in the second quarter of 2007 compared with the prior-year period by competitive discounting and timing of competitive promotional shipments. KODIAK experienced modest growth in retail market share from the prior quarter due to the timing of promotions.

     Operating Income

     Conwood’s operating income for the second quarter of 2007 increased to $90 million, or 51.7% of net sales, from $32 million, or 44.4% of net sales, in the comparable prior-year quarter. Operating income for the first six months of 2007 was $170 million, or 51.7% of net sales, compared with $37 million, or 37.0% of net sales, for the first six months of 2006.

RAI Consolidated

     Interest and debt expense was $87 million during the three-month period, and $176 million for the six months, ended June 30, 2007, an increase of $35 million and $89 million, respectively, from the comparable prior-year periods. These increases from the prior-year periods are primarily due to higher debt balances, resulting from the debt incurred by RAI to fund the Conwood acquisition in May 2006.

     Other expense (income) net was expense of $16 million for the second quarter of 2007 and expense of $15 million for the six months ended June 30, 2007, primarily due to the expensing of unamortized debt fees associated with

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the term loan that RAI pre-paid in full in June 2007. For each of the comparable periods for 2006, other income was $3 million consisting primarily of foreign exchange gain.

     Provision for income taxes was $191 million, or an effective rate of 37.1% in the second quarter of 2007 compared with $223 million or 37.8% in the second quarter of 2006. The provision for income taxes for the first half of 2007 was $387 million, or an effective rate of 37.2%, compared with $390 million, or an effective rate of 37.6%, in the first half of 2006. The effective tax rates exceeded the federal statutory rate of 35% primarily due to the impact of state taxes and certain non-deductible items, offset by the estimated domestic production credit of the American Jobs Creation Act, enacted on October 22, 2004. The 2006 provision was impacted by the nondeductibility of certain expenditures relating to ballot initiatives, state taxes and other nondeductible items, partially offset by the resolution of certain prior years’ tax matters that resulted in a reduction of income tax expense of $9 million.

     Extraordinary items included a gain of $1 million in the second quarter of 2007 and $9 million for the second quarter of 2006, related to the 2000 acquisition of RJR’s former parent, NGH, primarily from settlement of tax matters. Including this adjustment, the net after-tax gain on the acquisition of NGH was $1.8 billion. Year-to-date extraordinary gains attributable to the aforementioned tax matters were $1 million in 2007 and $74 million in 2006.

Liquidity and Financial Condition

Liquidity

     At present, the principal sources of liquidity for RAI’s operating subsidiaries’ businesses and operating needs are internally generated funds from their operations and borrowings through RAI and RJR. Cash flows from operating activities are believed to be sufficient for the foreseeable future to enable the operating subsidiaries to meet their obligations under the MSA, to fund their capital expenditures and to make payments to RAI and RJR that, when combined with RAI’s and RJR’s cash balances, will enable RAI and RJR to make their required debt-service payments, and enable RAI 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 or accelerated declines in consumption, cannot be predicted. RAI 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.

     The following contractual obligations have changed from those reported in RAI’s 2006 Annual Report on Form 10-K filed on February 27, 2007 and are updated as of June 30, 2007 as follows:

			Payments Due by Period
			Less than 1		1-3 Years		4-5 Years
	Total		Year-2007		2008-2009		2010-2011		Thereafter
RAI Credit Facilities(1)	$	—	$	—	$	—	$	—	$	—
Long term notes, exclusive of interest (1)		4,428		29		199		699		3,501
Interest payments related to long-term notes and RAI Credit Facility(1)		2,973		156		614		563		1,640
Purchase obligations(2)		1,266		246		386		213		421
Gross unrecognized tax benefits (3)
Total cash obligations	$	8,667	$	431	$	1,199	$	1,475	$	5,562

(1)	For more information about RAI’s long-term notes and credit facilities, see “ — Debt” below and notes 6 and 7 to condensed consolidated financial statements (unaudited).
(2)	Purchase obligations include commitments to acquire tobacco leaf. The major component is the estimated value of the commitment to purchase leaf as a part of the settlement agreement reached in the DeLoach antitrust case. See note 9 to condensed consolidated financial statements (unaudited) for additional information on the DeLoach case.
(3)	Gross unrecognized tax benefits of $158 million relate to the adoption of FIN No. 48. For more information, see note 5 to condensed consolidated financial statements (unaudited). Due to inherent uncertainties regarding the timing of the payment of these amounts, RAI cannot reasonably estimate the payment period.

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Cash Flows

     Net cash flows from operating activities were $144 million in the first six months of 2007, compared with net cash flows from operating activities of $103 million in the first six months of 2006. This change is primarily due to advanced collections on certain accounts receivables by customers who elected RJR Tobacco’s terms in April 2007. Net cash flows for the first half of 2007 also benefited from the classification of certain book overdrafts as accounts payable, reflecting changes in certain banking arrangements. Partially offsetting the increases were higher pension funding, as well as an increase in accrued income tax in 2007 due to a change in the timing of tax payments.

     Net cash flows from investing activities were $398 million in the first six months of 2007, compared with net cash flows used in investing activities of $2.9 billion in the prior-year period. This change is primarily driven by the acquisition of Conwood in 2006.

     Net cash flows used in financing activities were $812 million in the first six months of 2007, compared with net cash flows provided by financing activities of $2.6 billion in the prior-year period. This change is due to prior year RAI debt issuance and term loan indebtedness.

Stock Repurchases

     On February 6, 2007, the Board of Directors of RAI authorized the repurchase by RAI of up to $75 million of its outstanding shares of common stock to offset dilution from restricted stock grants and the exercise of previously granted options under the LTIP. Due to RAI’s incorporation in North Carolina, which does not recognize treasury shares, the shares repurchased are cancelled at the time of repurchase. RAI also repurchases and cancels shares of its common stock forfeited with respect to the tax liability associated with certain option exercises and vesting of restricted stock grants under the LTIP. During the first six months of 2007, RAI repurchased and cancelled 989,825 shares of its common stock at an aggregate cost of $60 million.

Dividends

     On May 11, 2007, RAI’s Board of Directors declared a quarterly cash dividend of $0.75 per common share. The dividend was paid on July 2, 2007, to shareholders of record as of June 11, 2007.

     On July 24, 2007, the RAI Board of Directors declared a quarterly cash dividend of $0.85 per common share, a more than 13% increase. The dividend will be paid on October 1, 2007, to shareholders of record as of September 10, 2007. On an annualized basis, the increased dividend rate is $3.40 per common share. The dividend reflects RAI’s dividend 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.

Capital Expenditures

     RAI’s operating subsidiaries’ cash capital expenditures were $60 million for the first six months of 2007, compared with $73 million for the first six months of 2006. The decrease in 2007 is primarily due to 2006 expenditures related to the implementation of an SAP enterprise business system and the purchase of a previously leased aircraft. RAI’s operating subsidiaries plan to spend an additional $130 million to $140 million for capital expenditures during the remainder of 2007, funded primarily by cash flows from operations. The majority of capital spending will be done in the RJR Tobacco segment. In addition, capital expenditures planned for 2007 include the expansion of a Conwood manufacturing facility expected to be completed in 2008. 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, 2007.

Debt

     Credit Facility

     On June 28, 2007, RAI entered into a Fifth Amended and Restated Credit Agreement, which provides for a five-year, $550 million senior secured revolving credit facility, which may be increased to $900 million at the discretion of the lenders upon the request of RAI. The credit agreement amends and restates RAI’s prior agreement dated May 31, 2006.

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     RAI is able to use the revolving credit facility for borrowings and issuances of letters of credit, at its option. RAI is required to pay a commitment fee ranging from 0.25% to 1.00% per annum on the unused portion of the revolving credit facility. Borrowings under the RAI credit facility bear interest, at the option of RAI, at a rate equal to an applicable margin plus: the reference rate, which is the higher of the federal funds effective rate plus 0.5% and the prime rate; or the Eurodollar rate, which is the rate at which Eurodollar deposits for one, two, three or six months are offered in the interbank Eurodollar market. At June 30, 2007, RAI had $24 million in letters of credit outstanding under its revolving credit facility. No borrowings were outstanding, and the remaining $526 million of the revolving credit facility was available for borrowing.

     The RAI credit facility has restrictive covenants that limit RAI’s and its subsidiaries’ ability to pay dividends and repurchase stock, make investments, prepay certain indebtedness, incur indebtedness, engage in transactions with affiliates, create liens, acquire, sell or dispose of specific assets and engage in specified mergers or consolidations.

     RAI’s material domestic subsidiaries guarantee RAI’s obligations under the credit facility. These guarantors also generally have pledged substantially all of their assets to secure these obligations. RAI has pledged substantially all of its assets, including the stock of its direct subsidiaries, to secure its obligations under the credit facility. The collateral for the credit facility generally will be released automatically in certain circumstances, including at such time, if any, as RAI obtains an investment grade corporate credit rating with not worse than stable outlooks by each of Moody’s and S&P. See note 7 to the condensed consolidated financial statements (unaudited) for additional information related to RAI’s credit facility.

     Long-Term Debt

     As of June 30, 2007, RAI had outstanding senior secured notes in the aggregate principal amount of $4.3 billion with maturity dates ranging from 2009 to 2037. As of June 30, 2007, RJR had outstanding unsecured notes in the aggregate principal amount of $158 million, with maturity dates ranging from 2007 to 2015. For more information regarding RAI’s and RJR’s long-term debt, see note 7 to the condensed consolidated financial statements (unaudited).

     On June 21, 2007, RAI completed the sale of $1.55 billion in aggregate principal amount of senior, secured notes, consisting of $400 million of floating rate notes due June 15, 2011, $700 million of 6.75% notes due June 15, 2017 and $450 million of 7.25% notes due June 15, 2037. These notes were sold under RAI’s shelf registration statement filed with the SEC on June 18, 2007. The net proceeds from the offering, together with available cash, were used to prepay in full the principal balance of $1.54 billion of a term loan, together with accrued and unpaid interest, which indebtedness was incurred in connection with the Conwood acquisition.

     In June 2007, $46 million of RJR notes matured and were paid off leaving $158 million of RJR notes outstanding as of June 30, 2007.

     The Guarantors of RAI’s amended credit agreement also guarantee RAI’s senior secured notes. RAI’s senior secured notes are secured by a pledge of the stock, indebtedness and other obligations of RJR Tobacco owned by or owed to RAI or any restricted subsidiary, as defined in the indenture governing the notes. Such notes also are secured by any principal property of RAI and any Guarantor that is a restricted subsidiary. Santa Fe and Lane are excluded from the definition of restricted subsidiary. These assets constitute a portion of the security for the obligations of RAI and the Guarantors under the amended credit agreement. If these assets are no longer pledged as security for the obligations of RAI and the Guarantors under the amended credit agreement, or any other indebtedness of RAI, they will be released automatically as security for RAI’s senior secured notes and the related guarantees. Generally, the terms of RAI’s senior secured notes restrict the pledge of collateral, sale/leaseback transactions and the transfer of all or substantially all of the assets of certain of RAI’s subsidiaries.

     As of June 30, 2007, Moody’s corporate credit rating of RAI was Ba1, positive outlook, and S&P’s rating was BB+, positive outlook. Concerns about, or lowering of, RAI’s corporate ratings by S&P or Moody’s could have an adverse impact on RAI’s ability to access the debt markets and could increase borrowing costs. However, given the cash balances and operating performance of RAI and its subsidiaries, RAI’s management believes that such concerns about, or lowering of, such ratings would not have a material adverse impact on RAI’s cash flows.

     At its option, RAI and RJR, as applicable, may redeem any or all of their outstanding fixed rate notes, in whole or in part at any time, subject to the payment of a make-whole premium. The floating rate notes are redeemable at par after 18 months.

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     RAI and RJR use interest rate swaps to manage interest rate risk on a portion of their debt obligations. Under certain conditions, any fair value that results in a liability position of certain interest rate swaps may require full collateralization with cash or securities.

     RAI, RJR and their affiliates were in compliance with all covenants and restrictions imposed by their indebtedness at June 30, 2007.

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:

• significantly increase their taxes on tobacco products;

• restrict displays, advertising and sampling of tobacco products;

• establish ignition propensity standards for cigarettes;

• raise the minimum age to possess or purchase tobacco products;

• restrict or ban the use of certain flavorings in tobacco products;

• require the disclosure of ingredients used in the manufacture of tobacco products;

• require the disclosure of nicotine yield information for cigarettes based on a machine test method different from that required by the U.S. Federal Trade Commission;

• impose restrictions on smoking in public and private areas; and

• restrict the sale of tobacco products directly to consumers or other unlicensed recipients, including over the Internet.

     In addition, during 2007, the U.S. Congress is considering regulation of the manufacture and sale of tobacco products by the FDA, and a further increase in the federal excise tax on cigarettes and other tobacco products. The U.S. Congress also may consider legislation regarding:

• regulation of environmental tobacco smoke;

• additional warnings on tobacco packaging and advertising;

• reduction or elimination of the tax deductibility of advertising expenses;

• implementation of a national standard for “fire-safe” cigarettes;

• regulation of the retail sale of tobacco products over the Internet and in other non-face-to-face retail transactions, such as by mail order and telephone; and

• banning of the delivery of tobacco products by the U.S. Postal Service.

     In February 2007, proposed legislation was introduced in the U.S. House of Representatives and the U.S. Senate that would give the FDA broad regulatory authority over tobacco products. The U.S. Senate Health, Education, Labor and Pensions Committee approved the FDA regulation bill on August 1, 2007. The proposals would grant the FDA authority to impose product standards (including standards relating to, among other things, nicotine yields and smoke constituents) and would reinstate the FDA’s 1996 regulations that would have restricted marketing. The proposed legislation also would govern modified risk products and would impose new and larger warning labels on tobacco products. At this time, RAI does not know whether FDA regulation over tobacco products will be approved by the balance of Congress or signed into law by the President.

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     Together with manufacturers’ price increases in recent years and substantial increases in state and federal taxes on tobacco products, these developments have had and will likely continue to have an adverse effect on the sale of tobacco products.

     Cigarettes are subject to substantial excise taxes in the United States. The federal excise tax per pack of 20 cigarettes is currently $0.39. The U.S. Senate Finance Committee has approved an excise tax per pack increase on cigarettes of $0.61 and proportional increases on other tobacco products to fund expansion of the State Children’s Health Insurance Program, referred to as SCHIP. The U.S. House of Representatives has approved its version of SCHIP, which included an excise tax per pack increase on cigarettes of $0.45 and proportional increases on other tobacco products. At this time, RAI does not know whether any excise tax increase will be approved by the balance of Congress and signed into law by the President. The adoption of any such increase could have a material adverse effect on the business or results of operations of RJR Tobacco.

     All states and the District of Columbia currently impose excise taxes at levels ranging from $0.07 per pack in South Carolina to $2.575 per pack in New Jersey. As of June 30, 2007, the weighted average state cigarette excise tax per pack, calculated on a 12-month rolling average basis, was approximately $0.886, an increase compared with the 12-month rolling average of $0.778 as of June 30, 2006. As of August 1, 2007, six states have increased their excise tax per pack this year. In addition, a number of other states are considering an increase in their excise taxes. Certain city and county governments, such as New York and Chicago, also impose substantial excise taxes on cigarettes sold in those jurisdictions.

     Cigars are generally taxed on an ad valorem basis, ranging from 3% in North Carolina to 75% in Alaska and Washington. Other states have unit-based tax schemes for cigars or tax little cigars the same as cigarettes.

     The federal excise tax on smokeless tobacco products currently is $0.195 per pound for chewing tobacco, and $0.585 per pound for snuff. The federal tax on small cigars, defined as those weighing three pounds or less per thousand, is $1.828 per thousand. Large cigars are taxed at a rate of 20.719% of the manufacturer’s price, with a cap of $48.75 per thousand.

     Forty-nine states also subject smokeless tobacco to excise taxes, and the Commonwealth of Pennsylvania, which currently levies no tax on other tobacco products, is considering one during its current legislative session. As of June 30, 2007, 39 states taxed moist snuff, and 46 states taxed chewing tobacco, on an ad valorem basis at rates that range from 3% in North Carolina to 90% in Massachusetts. Other states have a unit tax or a weight based tax. Since the beginning of 2006, four states have changed their tax on moist snuff from an ad valorem tax to a weight-based tax. In addition, legislation to convert from an ad valorem to a weight-based tax also has been introduced in approximately 19 other states.

     On October 25, 2006, the Alcohol and Tobacco Tax and Trade Bureau of the U.S. Department of Treasury, referred to as the TTB, issued a Notice of Proposed Rulemaking, proposing changes to the regulations that govern the classification and labeling of cigars and cigarettes for federal excise tax purposes. Both the CAPTAIN BLACK and WINCHESTER little cigar brands manufactured by Lane, which are classified and sold as “little cigars”, would be re-classified as “cigarettes” under these proposed regulations. Although it is not possible to fully assess and quantify the negative impact of the proposed regulations on the little cigar products of Lane, the immediate impact would be to increase the federal excise tax on such products by more than tenfold. The TTB now is considering written comments that were received prior to the March 26, 2007 deadline.

     On December 31, 2003, the New York Office of Fire Prevention and Control issued a final standard with accompanying regulations that requires all cigarettes offered for sale in New York State after June 28, 2004, to achieve specified test results when placed on ten layers of filter paper in controlled laboratory conditions. The cigarettes that RAI’s operating companies sell in New York State comply with this standard. As of July 13, 2007, 19 states in addition to New York have enacted fire-safe legislation of their own, adopting the same testing standard set forth in the OFPC regulations described above. Similar legislation is being considered in a number of other states. Varying standards from state to state could have an adverse effect on the business or results of operations of RJR Tobacco.

     In July, 2007, the State of Maine became the first state to enact a statute that prohibits the sale of cigarettes and cigars that have a characterizing flavor. The legislation defines characterizing flavor as “a distinguishable taste or aroma that is imparted to tobacco or tobacco smoke either prior to or during consumption, other than a taste or aroma from tobacco, menthol, clove, coffee, nuts or peppers.” On October 11, 2006, RJR Tobacco entered into an agreement with the States Attorneys Generals whereby it agreed not to use fruit, candy or alcoholic terms in its advertising or

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packaging of cigarette products other than in adult-only facilities. In contrast to this agreement, the Maine statute does not address the marketing or advertising, but focuses on the content of the product. Similar legislation has been filed in other states.

     Forty-two states by statute or court rule have limited, and several additional states are considering limiting, the amount of the bonds required to file an appeal of an adverse judgment in state court. The limitation on the amount of such bonds generally ranges from $25 million to $150 million. Such bonding statutes allow defendants that are subject to large adverse judgments, such as cigarette manufacturers, to reasonably bond such judgments and pursue the appellate process. In six other jurisdictions, the filing of a notice of appeal automatically stays the judgment of the trial court.

     It is not possible to determine what additional federal, state or local legislation or regulations relating to smoking, cigarettes or smokeless tobacco products will be enacted or to predict the effect of such new legislation or regulations, but any new legislation or regulations could have an adverse effect on RJR Tobacco, Conwood, the cigarette industry or the smokeless tobacco industry, as the case may be.

     Tobacco Buyout Legislation

     On October 22, 2004, the President signed the Fair and Equitable Tobacco Reform Act of 2004, referred to as FETRA, eliminating the U.S. government’s tobacco production controls and price support program. The buyout of tobacco quota holders provided for in FETRA is 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 is applied. The aggregate cost of the buyout to the industry is approximately $9.9 billion, including approximately $9.6 billion payable to quota tobacco holders and growers through industry assessments over ten years and approximately $290 million for the liquidation of quota tobacco stock. As a result of the tobacco buyout legislation, the MSA Phase II obligations established in 1999 will be continued as scheduled through the end of 2010, but will be offset against the tobacco quota buyout obligations. RAI’s operating subsidiaries’ annual expense under FETRA, excluding the tobacco stock liquidation assessment, is estimated to be approximately $230 million to $280 million. In the first quarter of 2006, a $9 million favorable adjustment was recorded relating to the tobacco stock liquidation assessment. Remaining contingent liabilities for liquidation of quota tobacco stock, if any, will be recorded when an assessment is made. See note 1 to condensed consolidated financial statements (unaudited) for additional information related to federal tobacco buyout expenses.

     RAI’s operating subsidiaries will record the FETRA assessment on a quarterly basis upon required notification of assessments. RAI’s operating subsidiaries estimate that their overall share of the buyout will approximate $2.4 billion to $2.9 billion prior to the deduction of permitted offsets under the MSA. In addition, future market pricing could impact the carrying value of inventory, and adversely affect RJR Tobacco’s financial condition and results of operations.

     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 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 condition of RAI or its subsidiaries.

     Regulations promulgated by the United States Environmental Protection Agency and other governmental agencies under various statutes have resulted in, and likely will continue to result in, substantial expenditures for pollution control, waste treatment, plant modification and similar activities. 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

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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 or financial condition of RAI or its subsidiaries.

     Other Contingencies and Guarantees

     In 2002, R. J. Reynolds Tobacco C. V., an indirect wholly owned subsidiary of RAI and referred to as RJRTCV, and an affiliate of Gallaher Group Plc, referred to as Gallaher, formed a joint venture, with each party owning a 50% membership interest. The joint venture, R. J. Reynolds-Gallaher International Sarl, markets American-blend cigarettes primarily in Italy, France and Spain.

     On April 18, 2007, an affiliate of Japan Tobacco Inc. acquired Gallaher, and Gallaher subsequently notified RJRTCV that the acquisition constituted a change of control of Gallaher within the meaning of the joint venture agreement, wherein RJRTCV may elect to terminate the joint venture prior to its expiration date. On May 15, 2007, RJRTCV notified the other member of the joint venture that RJRTCV had exercised its termination right, effective November 30, 2007. Unless the members agree otherwise, the joint venture will no longer conduct any business and will be liquidated following its termination.

     Upon a termination of the joint venture, the value of generally all of the trademarks each joint venture member or its affiliate has licensed to the joint venture will be calculated. The party whose licensed trademarks have the greater value will be required to pay the other party an amount equal to one-half of the difference between the value of the parties’ respective trademarks.

     RJRTCV believes that the current value of the trademarks licensed to the joint venture by Gallaher’s affiliate is materially greater than that of the trademarks licensed to the joint venture by RJRTCV’s affiliate. The value of the trademarks and the resulting termination amount are not yet known, and will be determined in accordance with the valuation procedures set forth in the parties’ agreement. Under certain circumstances, a dispute relating to the parties’ agreement may be submitted to binding arbitration for resolution.

     For information relating to other contingencies and guarantees of RAI, RJR and RJR Tobacco, see “— Other Contingencies and Guarantees” in note 9 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 Statements

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

• the substantial and increasing regulation and taxation of tobacco products;

• 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 substantial payment obligations and limitations on the advertising and marketing of cigarettes under the MSA and other state settlement agreements;

• the continuing decline in volume in the domestic cigarette industry;

• concentration of a material amount of sales with a single customer or distributor;

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• competition from other manufacturers, including any new entrants in the marketplace;

• increased promotional activities by competitors, including deep-discount cigarette brands;

• the success or failure of new product innovations and acquisitions;

• the responsiveness of both the trade and consumers to new products, marketing strategies and promotional programs;

• the ability to achieve efficiencies in manufacturing and distribution operations without negatively affecting sales;

• the cost of tobacco leaf and other raw materials and other commodities used in products, including future market pricing of tobacco leaf which could adversely impact inventory valuations;

• the effect of market conditions on foreign currency exchange rate risk, interest rate risk and the return on corporate cash;

• any adverse effects resulting from dependence on certain single-source suppliers, including supply interruption or quality issues;

• the effect of market conditions on the performance of pension assets or any adverse effects of any new legislation or regulations changing pension expense accounting or required pension funding levels;

• the rating of RAI’s securities;

• any restrictive covenants imposed under RAI’s debt agreements;

• the possibility of fire, violent weather and other disasters that may adversely affect manufacturing and other facilities; and

• the potential existence of significant deficiencies or material weaknesses in internal control over financial reporting that may be identified during the performance of testing required under Section 404 of the Sarbanes-Oxley Act of 2002.

     Due to these uncertainties and risks, you are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. Except as provided by federal securities laws, RAI is not required to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

     Market risk represents the risk of loss that may impact the consolidated financial position, results of operations and cash flows due to adverse changes in financial market prices and rates. 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 exposure to foreign currency exchange rate risk concerning obligations for, and service agreements related to, foreign operations denominated in Euros, British pounds, Swiss francs and Japanese yen. RAI and its subsidiaries have established policies and procedures to manage their exposure to market risks and use major creditworthy institutions as counterparties to minimize their investment and credit risk. Frequently, these institutions are also members of the bank group that provide RAI credit, and management believes this further minimizes the risk of nonperformance. Derivative financial instruments are not used for trading or speculative purposes.

     The table below provides information about RAI’s financial instruments, as of June 30, 2007, 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:

																					Fair
	2007			2008		2009			2010			2011			Thereafter			Total			Value 1
Investments
Fixed Rate	$	191			—		—			—			—			—		$	191		$	191
Average Interest Rate		5.8	%		—		—			—			—			—			5.8	%		—
Variable Rate	$	1,815			—		—			—			—			—		$	1,815		$	1,815
Average Interest Rate		5.2	%		—		—			—			—			—			5.2	%		—
Debt
Fixed Rate	$	29			—	$	200		$	300			—		$	3,510		$	4,039		$	4,181
Average Interest Rate 2		8.7	%		—		7.9	%		6.5	%		—			7.3	%		7.3	%		—
Variable Rate		—			—		—			—		$	400			—		$	400		$	400
Average Interest Rate 2		—			—		—			—			6.0	%		—			6.0	%		—
Swaps Notional Amount 3		—			—		—			—			—		$	1,600		$	1,600		$	4
Average Variable Interest Pay Rate2		—			—		—			—			—			6.9	%		6.9	%		—
Average Fixed Interest Receive Rate2		—			—		—			—			—			7.1	%		7.1	%		—

1	Fair values are based on current market rates available or on rates available for instruments with similar terms and maturities and quoted market values.
2	Based upon contractual interest rates for fixed rate indebtedness or current market rates for LIBOR plus negotiated spreads for variable rate indebtedness.
3	RAI has swapped $1.6 billion of fixed rate debt to variable rate debt.

     RAI’s exposure to foreign currency transactions was not material to results of operations for the six months ended June 30, 2007, but may be in future periods in relation to activity associated with RAI’s international operations. RAI currently has no hedges for its exposure to foreign currency. See “–Liquidity and Financial Condition” in Item 2 for additional information.

Item 4. Controls and Procedures

(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 second quarter of 2007 that have materially affected, or are reasonably likely to materially affect, RAI’s internal controls over financial reporting.

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PART II – Other Information

Item 1. Legal Proceedings

     For a discussion of the litigation and legal proceedings pending against RJR Tobacco, Conwood or their affiliates, including RAI and RJR, or indemnitees, including B&W, see note 9 to condensed consolidated financial statements (unaudited) and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Financial Condition – Litigation and Settlements” and “– Governmental Activity” included in Part I–Financial Information.

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 more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations–Liquidity and Financial Condition” in Part I, Item 2. RAI believes that the provisions of its credit facility and the guarantees of its credit facility, interest rate swaps and guaranteed, secured notes will not impair its payment of quarterly dividends.

     On February 6, 2007, the Board of Directors of RAI authorized the repurchase by RAI of up to $75 million of its outstanding shares of common stock to offset dilution from restricted stock grants and the exercise of previously granted options under the LTIP. RAI also repurchases and cancels shares of its common stock forfeited with respect to the tax liability associated with certain option exercises and vesting of restricted stock grants under the LTIP.

     The following table summarizes RAI’s purchases of its common stock during the second quarter of 2007:

					Total Number of		Approximate Dollar
					Shares Purchased		Value that May Yet
	Total Number		Average Price		as Part of Publicly		Be Purchased Under
	of Shares		Paid per		Announced Plans		the Plans or
	Purchased		Share		or Programs		Programs
April 1, 2007 to April 30, 2007		61	$	62.41		—	$	15
May 1, 2007 to May 31, 2007		—		—		—	$	15
June 1, 2007 to June 30, 2007		1,039	$	65.23		—	$	15
Second Quarter Total		1,100	$	65.07		—	$	15

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

The annual meeting of shareholders of RAI was held on May 11, 2007, in Winston-Salem, North Carolina, at which the following matters were submitted to a vote of shareholders:

(a) Votes regarding the re-election of three Class III directors and one Class I director were:

	For		Withheld
Class III
Martin D. Feinstein		242,345,853		7,512,477
Susan M. Ivey		242,351,854		7,506,477
Neil R. Withington		230,911,916		18,946,415
Class I
John T. Chain, Jr.		247,991,117		1,867,214

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(b) Votes to approve an amendment to RAI’s amended and restated articles of incorporation increasing the number of authorized shares of RAI’s common stock, par value $.0001 per share, from 400,000,000 to 800,000,000 were:

For	Against	Abstentions
205,754,343	42,176,677	1,927,309

(c) Votes regarding ratification of appointment of KPMG LLP as independent auditors for fiscal year 2007 were:

For	Against	Abstentions
248,053,615	800,123	1,004,590

Item 5. Other Information

     On July 12, 2007, the Board of Directors of RAI elected John J. Zillmer to serve on RAI’s Board as a Class I Director. Also on July 12, 2007, RAI’s Board elected Mr. Zillmer to serve on the Board’s Compensation Committee.

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Item 6. Exhibits

(a) Exhibits

Exhibit
Number	Description
1.1	Underwriting Agreement, dated June 18, 2007, by and among Reynolds American Inc., as issuer, Reynolds American Inc.’s subsidiaries that are guaranteeing the Notes and Citigroup Global Markets Inc., J.P. Morgan Securities Inc., Lehman Brothers Inc. and Morgan Stanley & Co. Incorporated, as representatives of the several underwriters named therein (incorporated by reference to Exhibit 1.1 to Reynolds American Inc.’s Form 8-K, filed June 22, 2007).
3.1	Articles of Amendment of Amended and Restated Articles of Incorporation of Reynolds American Inc.
4.1	Form of Reynolds American Inc. Floating Rate Senior Secured Note due 2011 (incorporated by reference to Exhibit 4.1 to Reynolds American Inc.’s Form 8-K, filed June 22, 2007).
4.2	Form of Reynolds American Inc. 6.750% Senior Secured Note due 2017 (incorporated by reference to Exhibit 4.2 to Reynolds American Inc.’s Form 8-K, filed June 22, 2007).
4.3	Form of Reynolds American Inc. 7.250% Senior Secured Note due 2037 (incorporated by reference to Exhibit 4.3 to Reynolds American Inc.’s Form 8-K, filed June 22, 2007).
10.1	Fifth Amended and Restated Credit Agreement, dated as of June 28, 2007, among Reynolds American Inc., the agents and other parties named therein, and the lending institutions listed from time to time on Annex I thereto (incorporated by reference to Exhibit 10.1 to Reynolds American Inc.’s Form 8-K, filed July 3, 2007).
10.2	Third Amended and Restated Pledge Agreement, dated as of June 28, 2007, among Reynolds American Inc., certain of its subsidiaries as pledgors and JPMorgan Chase Bank, N.A. as collateral agent and pledgee (incorporated by reference to Exhibit 10.2 to Reynolds American Inc.’s Form 8-K, filed July 3, 2007).
10.3	Third Amended and Restated Security Agreement, dated as of June 28, 2007, among Reynolds American Inc., certain of its subsidiaries as assignors and JPMorgan Chase Bank, N.A. as collateral agent and assignee (incorporated by reference to Exhibit 10.3 to Reynolds American Inc.’s Form 8-K, filed July 3, 2007).
10.4	Sixth Amended and Restated Subsidiary Guaranty, dated as of June 28, 2007, among certain of the subsidiaries of Reynolds American Inc. as guarantors and JPMorgan Chase Bank, N.A. as administrative agent (incorporated by reference to Exhibit 10.4 to Reynolds American Inc.’s Form 8-K, filed July 3, 2007).
10.5	Amended and Restated (effective as of May 10, 2007) Reynolds American Inc. Annual Incentive Award Plan.
10.6	Amended and Restated (effective as of May 11, 2007) Reynolds American Inc. Long-Term Incentive Plan.
10.7	Amended and Restated (effective as of July 12, 2007) Deferred Compensation Plan for Directors of Reynolds American Inc.
10.8	Amended and Restated (effective as of July 12, 2007) Equity Incentive Award Plan for Directors of Reynolds American Inc.
10.9	April 30, 2007 Amendments to the Contract Manufacturing Agreement, dated July 30, 2004, by and between RJ Reynolds Tobacco Company and BATUS Japan, Inc.
10.10	June 12, 2007 Amendments to the Contract Manufacturing Agreement, dated July 30, 2004, by and between RJ Reynolds Tobacco Company and BATUS Japan, Inc.
10.11	Form of Deed of Trust, Security Agreement, Assignment of Leases, Rents and Profits, Financing Statement and Fixture Filing (Tennessee), dated as of October 2, 2006, by Conwood Company, L.P., as the Trustor, to Richard F. Warren, as Trustee, for the benefit of JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent, as the Beneficiary for the benefit of the Secured Creditors.
31.1	Certification of Chief Executive Officer relating to RAI’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007.
31.2	Certification of Chief Financial Officer relating to RAI’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007.
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, 2007, pursuant to Section 18 U.S.C. §1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURE

     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.

REYNOLDS AMERICAN INC.
(Registrant)
 

/s/ Dianne M. Neal  

Dianne M. Neal 

Executive Vice President and
Chief Financial Officer 

Date: August 2, 2007

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EX-3.1

Exhibit 3 .1

ARTICLES OF AMENDMENT
OF
AMENDED AND RESTATED ARTICLES OF INCORPORATION
OF
REYNOLDS AMERICAN INC.

     Pursuant to Section 55-10-06 of the General Statutes of North Carolina, the undersigned corporation hereby submits the following Articles of Amendment for the purpose of amending its Amended and Restated Articles of Incorporation:

          1. The name of the corporation is Reynolds American Inc.

          2. The text of the amendment adopted is as follows:

     The first sentence of Article Sixth of the undersigned corporation’s Amended and Restated Articles of Incorporation is hereby deleted in its entirety and the following sentence is substituted in lieu thereof:

“The total number of shares of capital stock that the Corporation is authorized to issue is 900,000,000 shares, of which 800,000,000 shares are Common Stock, par value $.0001 each (“Common Stock”), and 100,000,000 shares are Preferred Stock, par value $.01 each (“Preferred Stock”).”

          3. The foregoing amendment was approved by shareholder action as required by Chapter 55 of the North Carolina General Statutes on May 11, 2007.

          4. These Articles of Amendment will be effective upon filing.

     This the 11th day of May, 2007.

REYNOLDS AMERICAN INC.
By:	/s/ McDara P. Folan
Name: McDara P. Folan, III
Title: SVP, Deputy General Counsel and Secretary

EX-10.5

Exhibit 10.5

REYNOLDS AMERICAN INC.

ANNUAL INCENTIVE AWARD PLAN

Effective July 30, 2004,

As Amended and Restated as of May 10, 2007

REYNOLDS AMERICAN INC.

ANNUAL INCENTIVE AWARD PLAN

Effective July 30, 2004,

As Amended and Restated as of May 10, 2007

INDEX

Section	Page
1.  Purpose		2
2.  Definitions		2
3.  Eligibility		2
4.  Company Performance Objectives		2
5.  Determination of Target Awards		3
6.  Determination of Employee Performance Rating Multipliers		3
7.  Determination of Cash Awards		3
8.  Determination of Cash Awards for SBC Program Participants		4
9.  Deferral		6
10. Tax Withholding		8
11. Adjustments, Amendment or Termination		8
12. Adoption/Withdrawal by Participating Companies		8
13. Miscellaneous		10
14. Effective Date		11
Exhibit A: Definitions		A-1

2

REYNOLDS AMERICAN INC.

ANNUAL INCENTIVE AWARD PLAN

Effective July 30, 2004

As Amended and Restated as of May 10, 2007

1.	Purpose
	The Reynolds American Inc. Annual Incentive Award Plan is established to link corporate and business priorities with individual and group performance objectives for employees of RAI and its affiliated companies. The Plan is an amendment, restatement and continuation of the R.J. Reynolds Tobacco Holdings, Inc. Annual Incentive Award Plan.
2.	Definitions
	Capitalized terms have the meanings set forth in Exhibit A.
3.	Eligibility
	To be eligible to participate in the Plan and receive an award, an employee must:

(a)	be employed by a Participating Company in an employment classification and at or above a job level or in a job category as designated by such Participating Company;
(b)	except as otherwise provided in Section 7, be employed by a Participating Company for at least three months during the year; and
(c)	except as otherwise provided herein, be actively employed by a Participating Company on the last day of the year.

4. Company Performance Objectives

(a)

Subject to the approval of the Committee, the Chief Executive Officer of each Participating Company may establish specific objectives (the “Company Performance Objectives”) for each Participating Company for each year. Subject to the approval of the Chief Executive Officer of RAI, the Chief Executive Officers of the Participating Companies also may establish Company Performance Objectives for some or all of their respective subsidiaries. Company Performance Objectives may be based on any financial, operational or other criteria, such as market share.

(b)

Each of the Company Performance Objectives will be weighted for the purpose of determining awards under the Plan. Different weights may be assigned to the objectives for different Participants and Participating Companies. However, the aggregate weights for the Company Performance Objectives will each range from 1-100% and together total 100%.

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(c) Company Performance Objectives may be reviewed and revised during the year pursuant to the procedures used for their adoption. The Chief Human Resources Officer may change the weighting of any objective for any Participant below Senior Vice President (job level 11).

5. Determination of Target Awards

(a)

Each Participant’s target award level is expressed as a percentage of Base Pay and falls within a range of target award levels set for the Participant’s salary grade. The Committee will periodically review and may modify the range of target award levels for each salary grade. Subject to the approval of the Chief Human Resources Officer, Reviewing Managers will periodically review and may modify specific target award levels for individual Participants. The Chief Executive Officer may modify the specific target award level for the Chief Human Resources Officer.

(b)

Each Participant’s target award for each year equals the product of (i) the Participant’s highest annual rate of Base Pay in effect for three months or more during the year, multiplied by (ii) the Participant’s highest target award level for which he was eligible for three months or more during the year; provided, however, that with respect to employees of RAI, R. J. Reynolds Tobacco Company and R. J. Reynolds Global Products, Inc. (exclusive of any Puerto Rico based employees), if the product of (i) and (ii) is less than $1,000, the Participant’s target award will be $1,000.

6.	Determination of Employee Performance Rating Multipliers
	Each Participant’s Employee Performance Rating Multiplier will be determined by his performance rating under each Participating Company’s Performance Management Center (PMC) process, as set forth in the following table; provided, that the Employee Performance Rating Multiplier shall never be greater than 1.0 for Participants above the vice president level:

	Employee Performance	Employee Performance
	Rating Multiplier	Rating Multiplier
PMC	If Company Performance	If Company Performance
Performance Rating	Rating is 100% or greater	Rating is less than 100%
Exceeds	1.5	1.0
High Achieves	1.2	1.0
Achieves	1.0	1.0
Almost Achieves	0.5	0.5
Fails to Meet	0	0

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7. Determination of Cash Awards

(a)

Promptly after the end of each year, the Chief Executive Officer of RAI will review the performance of each Participating Company with the Committee. Subject to the approval of the Committee, the Chief Executive Officers of the Participating Companies may give a rating to each Company Performance Objective for the year (a “Company Performance Rating”) ranging from 0-200% for each Company Performance Objective.

(b)

The amount of each Cash Award is determined by the following formula:

(i)	the product of the Company Performance Ratings multiplied by the respective weights assigned to the corresponding Company Performance Objectives pursuant to Section 4(c)
	multiplied by
(ii)	the target award for the Participant established pursuant to Section 5
	multiplied by
(iii)	the Employee Performance Rating Multiplier established pursuant to Section 6.

(c)	When a Participant becomes eligible to participate in the Plan after the start of the year, the Participant’s Cash Award will be prorated for the number of months of eligibility during the year. In the event a Participant is on a leave of absence during the year, the Participant’s Cash Award may be prorated, based on the number of full or partial months of active employment, at the discretion of the Chief Human Resources Officer.
(d)	If a Participant’s employment is interrupted by the Participant’s death, Disability or Retirement at any time during the year, the Participant will receive a Cash Award equal to his or her target award, prorated for the number of full or partial months of employment during the year, as soon as practicable after such death, Disability or Retirement. The Chief Human Resources Officer shall determine whether such pro ration will be on a daily or monthly basis, and if on a monthly basis, whether a full month’s credit will be given for any partial month of work or short-term disability.
(e)	If a Participant loses eligibility under the Plan as the result of a transfer to a non-Participating Company, the Participant will receive a Cash Award equal to his or her actual award determined in accordance with Section 7(b), prorated for the number of full and partial months as an eligible employee under the Plan. If the Participant’s employment has been for a period of less than three months, the Participant’s Cash Award shall be determined under this Plan at the Base Pay in effect on the date before the Participant loses eligibility under the Plan.

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(f)

If a Participant is reclassified into a job with a lower base job value as a result of a company-initiated redeployment (involuntary move for the Participant), the target award will equal the product of (i) the greater of the highest annual rate of Base Pay in effect for three months or more during the year or the Base Pay in effect prior to any reduction due to the redeployment, multiplied by (ii) the greater of the highest target award level in effect for three months or more during the year or the target award level in effect prior to any reduction due to the redeployment.

(g)

After obtaining approval from the Committee and satisfying its requirements, the Companies will pay the Cash Award as soon as practicable after the end of the year, but in any event no later than March 15 (other than for employees on international assignment, who will be paid the Cash Award no later than June 30) or as otherwise required by Section 409A of the Internal Revenue Code of 1986, as amended, except as provided in the event of death, Disability or Retirement pursuant to Section 7(d).

8. Determination of Cash Awards for SBC Program Participants

(a)	If a Participant’s employment terminates pursuant to the SBC Program at any time during the year, the Participant will receive a Cash Award for the year of termination of active employment equal to his or her actual award determined in accordance with Section 7(b), prorated for the number of full or partial months as an active employee. In addition, the SBC Program may provide the Participant with credit for some or all of the period of salary continuation and, if so, will establish criteria to determine the Company Performance Ratings for the Participant during this period. Payment of the resulting Cash Awards, if any, will be governed by the terms of the SBC Program.
(b)	If an employee returns from the SBC Program to active employment for a Participating Company, where such employee received credit under the Plan in accordance with Section 8(a) for some or all of the period of salary continuation pursuant to the SBC Program, but the employee’s active employment for the Participating Companies does not satisfy the eligibility requirements of Section 3, the employee will receive a Cash Award equal to his or her target award, prorated for the period he or she received salary continuation pursuant to the SBC Program and was eligible for credit under the Plan. A Cash Award to be made pursuant to this Section 8(b) will be paid to the employee as soon as practicable following his or her return to active service.
(c)	If an employee returns from the SBC Program to active employment for a Participating Company, where such employee received credit under the Plan in accordance with Section 8(a) for some or all of the period of salary continuation pursuant to the SBC Program and he or she continues to satisfy the eligibility requirements of Section 3, the Participant will receive (i) a Cash Award equal to his or her target award, prorated for the period he or she received salary continuation pursuant to the SBC Program and was eligible for credit under the Plan, and (ii) a Cash Award equal to his or her actual award determined in accordance with Section 7(b), prorated for the number of full or partial months as an active employee. Payment of the Participant’s Cash Award pursuant to Section

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	8(c)(i) will be paid as soon as practicable following his or her return to active service. Payment of the Participant’s Cash Award pursuant to Section 8(c)(ii) will be paid as provided in Section 7(g).
(d)	If an employee has his or her SBC interrupted (short-term) and he or she received credit under the Plan in accordance with Section 8(a) for some or all of the period of salary continuation pursuant to the SBC Program, but the employee’s active employment for Participating Companies does not satisfy the eligibility requirements of Section 3, he or she will receive a Cash Award equal to his or her target award, prorated for the period he or she received salary continuation pursuant to the SBC Program and was eligible for credit under the Plan, to be paid at the end of the employee’s SBC period.
(e)	If an employee has his or her SBC interrupted (short-term) and he or she returns to active employment for a Participating Company, where such employee received credit under the Plan in accordance with Section 8(a) for some or all of the period of salary continuation pursuant to the SBC Program and he or she continues to satisfy the eligibility requirements of Section 3, the Participant will receive (i) a Cash Award equal to his or her target award, prorated for the period he or she received salary continuation pursuant to the SBC Program and was eligible for credit under the Plan, and (ii) a Cash Award equal to his or her actual award determined in accordance with Section 7(b), prorated for the number of full or partial months as an active employee. Payment of the Participant’s Cash Award pursuant to Section 8(e)(i) will be paid at the end of the employee’s SBC period. Payment of the Participant’s Cash Award pursuant to Section 8(e)(ii) will be paid as provided in Section 7(g).

9. Deferral

(a)

As of the last day of each year prior to 2004, each Participant who was on a U.S. dollar payroll could elect to defer payment of the Cash Award for that year. An election to defer was made pursuant to procedures established by the Committee and was made in writing, signed by the Participant and delivered to a Participating Company by December 15 of the year preceding payment. The election was irrevocable and specified the percentage of the Cash Awards (from 5% to 100%) to be paid (i) as soon as practicable after the year in which the Participant’s Retirement, Disability or other termination of employment occurs or, if earlier, (ii) in January of any designated future year. If the Participant’s employment with all Participating Companies terminates before the designated year, the award will be paid in January of the year following termination. If a Participant was eligible for CIP and elected to defer the proceeds of Cash Awards, the Participant’s Participating Company contributed an additional 3% to the amount deferred on account of the 3% Company match that the Participant would have received under CIP if the Participant had not deferred the Cash Award.

(b)

Each Participant specified, on the notice electing deferred payment pursuant to Section 9(a), whether the Cash Award was deferred by cash credit, Common Stock credit, or a combination of the two. If a Participant elected to defer payment pursuant to Section 9(a) and failed to choose a mode of deferral, the

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Participant’s deferral was made by means of a cash credit. Cash credits and stock credits are recorded in accounts established in each Participant’s name on the books of the Participant’s Participating Company. At the direction of RAI, any Participant’s accounts may be consolidated on the books of RAI or any of its subsidiaries.

(i)

If the deferral is wholly or partly a cash credit, the Participant’s cash credit account will be credited, as of the date(s) that payment of the Cash Awards would otherwise have been made, with the dollar amount of the portion of the Cash Awards deferred by means of a cash credit. In addition, the Participant’s cash credit account will be credited as of the last day of each calendar quarter with an interest equivalent in an amount determined by applying to the current balance in the account an interest rate equal to the average prime rate of JPMorgan Chase & Co. or its successor during the preceding quarter. Interest will be credited for the actual number of days in the quarter using a 365-day year.

(ii)

If the deferral is wholly or partly a Common Stock credit, the Participant’s Common Stock credit account will be credited, as of the date(s) that payment of the Cash Awards would otherwise have been made, with the Common Stock equivalent of the number of shares of Common Stock (including fractions of a share) that could have been purchased with the portion of the Cash Awards deferred by means of a Common Stock credit at the Closing Price on the date that payment of the Cash Awards would otherwise have been made. As of the date any dividend is paid to shareholders of Common Stock, the Participant’s Common Stock credit account also will be credited with an additional Common Stock equivalent equal to the number of shares of Common Stock (including fractions of a share) that could have been purchased at the Closing Price on such date with the dividend paid on the number of shares of Common Stock to which the Participant’s Common Stock credit account is then equivalent. If dividends are paid in property, the dividend will be deemed to be the fair market value of the property at the time of distribution of the dividend, as determined by the Committee.

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(c)	Payment of deferred Cash Awards will be made in a single cash payment as soon as practicable in January of the appropriate year. If and to the extent that the deferral is by means of the Common Stock credit account the value of the payment will be based on the Closing Price of Common Stock on the last trading day of the year prior to payment. Notwithstanding the foregoing, if a Participant elects in writing before December 15 of the year his employment terminates due to Retirement or Disability, payment will be made in substantially equal annual installments (not to exceed ten) commencing in January following the Retirement or Disability. Notwithstanding any election under Section 9(a) to defer Cash Awards by means of a Common Stock credit, the Common Stock credit account of a Participant who elects to receive installment payments will be converted into a cash credit account as of January 1 of the year in which such installment payments commence. Any election by a Participant under this Section 9(c) will be irrevocable after December 15 of the year prior to commencement of payment.
(d)	At the one-time election of a Participant made in writing to the Committee, all or any designated portion of the Common Stock credit account may be converted to, and such Participant will be credited with, a cash credit account as of the first business day of the calendar quarter following the quarter in which the election is made. The amount credited to the cash credit account will be determined by multiplying the number of shares of Common Stock to which the Participant’s Common Stock credit account is then equivalent and as to which such election has been made by the Closing Price on the last business day of the calendar quarter in which the election is made. Any Common Stock credits attributable to dividends paid on Common Stock during the calendar quarter in which the election is made will be credited before making the conversion. Such election may be made by a Participant at any time prior to the end of the calendar year in which termination of employment occurs. An election by a Participant under this Section 9(d) will be irrevocable.
(e)	If the number of shares of Common Stock is increased or decreased as a result of any stock dividend, subdivision or reclassification of shares, the number of shares of Common Stock to which each Participant’s Common Stock credit account is equivalent shall be increased in proportion to the increase or decrease in the number of outstanding shares of Common Stock and the Closing Price on which payments hereunder is based will be proportionately decreased or increased. If the number of outstanding             shares of Common Stock is decreased as the result of any combination or reclassification of shares, the number of shares of Common Stock to which each Participant’s Common Stock credit account is equivalent will be decreased in proportion to the decrease in the number of outstanding shares of Common Stock. In the event RAI is consolidated with or merged into any other corporation and holders of Common Stock receive common shares of the resulting or surviving corporation, each Participant’s Common Stock credit account, in place of the shares then credited thereto, will be credited with a stock equivalent determined by multiplying the number of common shares of stock given in exchange for a share of Common Stock upon such consolidation or merger, by the number of shares of Common Stock to which the Participant’s account is then equivalent. If in such a consolidation or merger, holders of

9

Common Stock receive any consideration other than common shares of the resulting or surviving corporation, the Committee will determine the appropriate change in Participants’ accounts. In the event of an extraordinary dividend, including any spin-off, the Committee will make appropriate adjustments to each Participant’s Common Stock credit account.

(f)

If a Participant dies, whether before or after termination of employment, any cash credit account and Common Stock credit account to which he or she is entitled, including any award approved after the Participant’s death as to which an election to defer was made and any remaining installment payments, will be distributed in cash as soon as practicable (unless the Committee otherwise provides) to the Participant’s beneficiaries pursuant to Section 13(i).

10.	Tax Withholding
	Each Participant’s employer will deduct any taxes required to be withheld by federal, state, local or foreign governments from payments and distributions under the Plan.
11.	Adjustments, Amendments or Termination

(a)

The Committee may make appropriate and equitable adjustments in the Company Performance Ratings and the number, terms and conditions of any Cash Awards if it determines that conditions warrant such adjustment. Such conditions may include, without limitation, changes in the economy, laws, regulations and generally accepted accounting principles, as well as corporate events such as a merger, consolidation, recapitalization, reclassification, stock split, stock dividend, spin-off, change of control or other event. Any adjustment made by the Committee shall be final and binding upon the Participating Companies and the Participants.

(b)

The Committee may amend, suspend or terminate the Plan at will and at any time, but it will not take any action that would materially adversely affect the rights of Participants with respect to deferral accounts.

12. Adoption/Withdrawal by Participating Companies

(a)

Adoption of Plan. Any entity may, with the consent of the Committee, adopt the Plan and thereby become a Participating Company hereunder by executing an instrument evidencing such adoption and filing a copy thereof with the Committee. By this adoption of the Plan, Participating Companies (other than RAI) shall be deemed to consent to actions taken by RAI in entering into any arrangements for the purpose of providing benefits under the Plan, and to authorize RAI and/or the Committee on behalf of RAI to take any actions within the authority of RAI under the terms of the Plan.

(b)

Withdrawal/Effect of Termination. Notwithstanding the foregoing, in the case of any Participating Company that adopts the Plan and thereafter (i) ceases to exist or (ii) withdraws or is eliminated from the Plan, it shall not thereafter be considered a Participating Company thereunder and the employees of such

10

Participating Company shall no longer be eligible to participate in the Plan. Any Participating Company (other than RAI) which adopts the Plan may elect separately to withdraw from the Plan and such withdrawal shall constitute a termination of the Plan as to it; provided, however, that such terminating Participating Company shall continue to be a Participating Company for the purposes hereof as to Participants to whom it owes obligations hereunder, unless RAI or the Committee directs otherwise.

(c)	Expenses. The expenses of administering the Plan will be paid by RAI, unless RAI, in its sole and absolute discretion, directs the other Participating Companies to pay some or all of the expenses.
(d)	Liability for Payment/Transfers of Employment.

(i)	Subject to the provisions of subsections (ii) and (iii) hereof, each Participating Company shall be solely liable for and shall reimburse RAI for the Participating Company’s appropriate share of any funding necessary to provide benefits to its employees who are Participants under this Plan;
(ii)	Notwithstanding the foregoing, upon a transfer of employment among Participating Companies, any liability for the payment of a Cash Award to or on behalf of a Participant shall be transferred from the prior Participating Company to the new Participating Company. The last Participating Company of the Participant shall be responsible for the payment of any Cash Award payable hereunder after the Participant’s termination of employment, whether liability for such payment accrued before or after the Participant’s transfer of employment to such Participating Company; and
(iii)	Notwithstanding the foregoing, in the event that RAI is unable or refuses to satisfy its obligation hereunder with respect to the payment of any Cash Award to or on behalf of its Participants, each of the Participating Companies (unless it is insolvent), other than RAI, shall guarantee and be jointly and severally liable for a portion of such Cash Award under the Plan, allocated based on a fraction, the numerator of which is equal to the number of Participants in the Plan who are current or former employees of the Participating Company and the denominator of which is the total number of Participants in the Plan, excluding current or former RAI employees (as in effect on the date of the determination).

13. Miscellaneous

(a)	Except as determined by the Committee, no person will have any right to receive an award.
(b)	The Committee has the power to interpret the Plan and, together with the officers of the Companies, has complete discretion in making determinations and taking action pursuant to the Plan. All interpretations, determinations and actions by the

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	Committee will be final, conclusive and binding on all parties. Subject to the preceding sentence, the Chief Executive Officer of RAI will administer the Plan and will resolve all administrative questions and interpretations. The Committee and the Chief Executive Officer of RAI may delegate their authority to anyone. In such event, references in the Plan to the Committee or to the Chief Executive Officer of RAI will refer to their delegates when appropriate.
(c)	The Participating Companies, their boards of directors, the Committee, the officers and the other employees of RAI and its subsidiaries will not be liable for any action taken in good faith in interpreting and administering the Plan.
(d)	For purposes of the Plan, a Participant on leave of absence approved by a Participating Company will be considered an employee. Except as otherwise provided herein, a Participant on salary continuation under an SBC Program or agreement of severance will not be considered an employee but will be deemed to be terminated on his or her last day of active employment. A Participant absent due to short-term disability on the last day of a year is deemed to be actively employed if such Participant was actively employed at any time during the year.
(e)	Nothing herein creates a vested right. The Cash Awards and the interest, dividends and other expenses on Cash Awards deferred under Section 9 are not funded and, except to the extent provided in Section 12(d)(iii), are paid from the general assets of the Company from which the Participant terminated employment. Nothing herein shall be construed to require the Participating Companies to maintain any fund or segregate any amount for the benefit of any Participant and no Participant or other person shall have any claim against, right to, or security or other interest in, any fund, account or asset of any Participating Company from which he or she terminated employment. Other benefits referred to herein may be funded or unfunded as provided for in the individual plans.
(f)	The Plan does not create or confer on any Participant any right to employment, and the employment of any Participant may be terminated by the Participant or the Participant’s employer without regard to the effect that termination might have on the Participant with respect to the Plan.
(g)	Participants may not transfer, pledge or encumber any benefit under the Plan prior to its receipt in cash. Except as required by law, creditors may not attach or seize any such benefit.
(h)	The Plan will be governed by and subject to the laws of the State of North Carolina.
(i)	In the event of the death of a Participant, any distribution to which such Participant is entitled under the Plan shall be made to the beneficiary designated by the Participant to receive the proceeds of any noncontributory group life insurance coverage provided for the Participant by the Participant’s Participating Company (“Group Life Insurance Coverage”). If the Participant has not designated such beneficiary, does not have any Group Life Insurance coverage or desires to designate a different beneficiary, the Participant may file with the Chief

12

Human Resources Officer a written designation of a beneficiary under the Plan, which designation may be changed or revoked only by the Participant, in writing. If no designation of beneficiary has been made by a Participant under the Group Life Insurance Coverage or filed with the Chief Human Resources Officer under the Plan, distribution upon such Participant’s death shall be made in accordance with the provisions of the Group Life Insurance Coverage. If a Participant is no longer an employee of a Participating Company at the time of death, no longer has or never had any Group Life Insurance Coverage and has not filed a designation of beneficiary with the Chief Human Resources Officer under the Plan, distribution upon such Participant’s death shall be made to the Participant’s estate.

(j)

A Company may supersede some or all of the terms of the Plan with respect to individual Participants pursuant to an employment, termination or similar agreement. In case of conflict, the agreement will control.

14.	Effective Date
	The Plan is effective as of July 30, 2004. The Plan as set forth herein reflects amendments effective November 30, 2004, February 2, 2005, January 1, 2006, November 29, 2006, and May 10, 2007.

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EXHIBIT A

Definitions

(a)	“Base Pay” shall mean an amount or rate of compensation for a specified position of employment excluding any other payments or allowances, such as shift differential, overtime, merit or general increase lump sums or bonus payments.
(b)	“Board of Directors” shall mean the Board of Directors of RAI.
(c)	“Cash Award” shall mean annual cash payments made to Participants pursuant to the Plan.
(d)	“Chief Executive Officer” shall mean, for employees of RAI and the chief executive officers of the other Participating Companies, the chief executive officer of RAI. For the other employees of each Participating Company other than RAI, “Chief Executive Officer” shall mean the chief executive officer of the Participating Company primarily responsible for their performance.
(e)	“Chief Human Resources Officer” shall mean, for employees of RAI and the executive officers of the other Participating Companies, the chief human resources officer of RAI. For the other employees of each Participating Company other than RAI, “Chief Human Resources Officer” shall mean the chief human resources officer of the Participating Company primarily responsible for their performance.
(f)	“CIP” shall mean the Reynolds American Capital Investment Plan, or comparable Participating Company-sponsored 401(k) plan in which employees participate, or any successor thereof.
(g)	“Closing Price” shall mean the closing sale price of the Common Stock as shown on the New York Stock Exchange consolidated tape and reported in the Wall Street Journal.
(h)	“Committee” shall mean the Compensation Committee of the Board of Directors.
(i)	“Common Stock” shall mean the Common Stock of RAI.
(j)	“Company Performance Objectives” shall have the meaning set forth in Section 4(a) of the Plan.
(k)	“Company Performance Rating” shall have the meaning set forth in Section 7(a) of the Plan.
(l)	“Disability” shall mean being totally and permanently disabled as defined in the Long-Term Disability Plan of the Participating Company employing the participant.

(m)	“Employee Performance Rating Multiplier” shall have the meaning set forth in Section 6 of the Plan.
(n)	“Group Life Insurance Coverage” shall have the meaning set forth in Section 13(i) of the Plan.
(o)	“Participant” shall mean, for any year, an employee who is eligible for or who has deferred receipt of an award under the Plan. An eligible employee is a Participant only with respect to the Participating Company for which he works most directly. “Participant” shall also mean the heir or estate of a deceased Participant.
(p)	“Participating Companies” shall mean RAI, R. J. Reynolds Tobacco Company, FHS, Inc., R. J. Reynolds Global Products, Inc., Santa Fe Natural Tobacco Company, Inc., Lane, Limited, Conwood Company, LLC, and any other affiliates of RAI that adopt the Plan pursuant to Section 12(a).
(q)	“Plan” shall mean the Reynolds American Inc. Annual Incentive Award Plan.
(r)	“RAI” shall mean Reynolds American Inc. and its successor companies.
(s)	“Retirement” shall mean a Participant’s voluntary termination of employment on or after his or her 65th birthday, on or after his or her 55th birthday with 10 or more years of service with the Participating Companies, or on or after his or her 50th birthday with 20 or more years of service with the Participating Companies.
(t)	“Reviewing Manager” shall mean the manager to whom a Participant reports.
(u)	“SBC” or “SBC Program” shall mean a salary and benefits continuation or other program maintained by a Participating Company for the purpose of providing severance-type benefits to employees whose employment is involuntarily terminated.

EX-10.6

Exhibit 10.6

REYNOLDS AMERICAN INC.
LONG-TERM INCENTIVE PLAN
(Amended and Restated Effective May 11, 2007)

1. Purpose of Plan

     The Reynolds American Inc. Long-Term Incentive Plan (the “Plan”) is an amendment, restatement and continuation of the R.J. Reynolds Tobacco Holdings, Inc. 1999 Long-Term Incentive Plan. The Plan became effective June 14, 1999 and is designed:

(a)	to promote the long-term financial interests and growth of Reynolds American Inc. and its Subsidiaries (collectively, the “Corporation”) by attracting and retaining management personnel with the training, experience and ability to enable them to make a substantial contribution to the success of the Corporation’s business;
(b)	to motivate management personnel by means of growth-related incentives to achieve long range goals; and
(c)	to further the identity of interests of Participants with those of the stockholders of Reynolds American through opportunities for increased stock, or stock-based, ownership in Reynolds American.

2. Definitions

     As used in the Plan, the following words shall have the following meanings:

(a)	“Affiliate” of any person shall mean another person that directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with, such first person;
(b)	“Base Value” means not less than the Fair Market Value on the date a Stock Appreciation Right is granted, or, in the case of a Stock Appreciation Right granted retroactively in tandem with (or in replacement of) an outstanding Option, not less than the exercise price of such Option;
(c)	“BAT” shall mean, collectively, British American Tobacco, p.l.c., a public limited company incorporated under the laws of England and Wales, and its Affiliates;
(d)	“Board of Directors” means the Board of Directors of Reynolds American;
(e)	“Code” means the Internal Revenue Code of 1986, as amended;
(f)	“Committee” means the Compensation Committee of the Board of Directors;

(g)	“Common Stock” or “Share” means common stock, par value $0.0001 per share, of Reynolds American which may be authorized but unissued, or issued and reacquired;
(h)	“Effective Date” shall have the meaning set forth in Section 14;
(i)	“Exchange Act” means the Securities Exchange Act of 1934, as amended;
(j)	“Fair Market Value” means such value of a Share as reported for stock exchange transactions and/or determined in accordance with any applicable resolutions or regulations of the Committee in effect at the relevant time;
(k)	“Grant Agreement” means an agreement between Reynolds American and a Participant that sets forth the terms, conditions and limitations applicable to a Grant;
(l)	“Grant” means an award made to a Participant pursuant to the Plan and described in Section 5, including, without limitation, an award of an Incentive Stock Option, Other Stock Option, Stock Appreciation Right, Restricted Stock, Performance Units or Performance Shares or any combination of the foregoing;
(m)	“Incentive Stock Options” shall have the meaning set forth in Section 5(a);
(n)	“ Other Stock Options” shall have the meaning set forth in Section 5(b);
(o)	“ Options” shall mean Incentive Stock Options and Other Stock Options;
(p)	“Participant” means any employee, or other person having a unique relationship with Reynolds American or one of its Subsidiaries, to whom one or more Grants have been made and such Grants have not all been forfeited or terminated under the Plan; provided, however, that a Participant who is elected or appointed as a non-employee director of the Corporation may not receive any Grant during the term of his or her service as a non-employee director of the Corporation;
(q)	“Performance Units” shall have the meaning set forth in Section 5(e);
(r)	“ Performance Shares” shall have the meaning set forth in Section 5(f);
(s)	“Restricted Stock” shall have the meaning set forth in Section 5(d);
(t)	“Reynolds American” means Reynolds American Inc. and any successors thereto;
(u)	“RJR” means R.J. Reynolds Tobacco Holdings, Inc.
(v)	“Stock Appreciation Rights” shall have the meaning set forth in Section 5(c); and

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(w)       “Subsidiary” means any corporation or other entity in which Reynolds American has a significant equity or other interest as determined by the Committee.

3. Administration of Plan

(a)	The Plan shall be administered by the Committee or, in lieu of the Committee, the Board of Directors. The Committee may adopt its own rules of procedure and act either by vote at a telephonic or other meeting or by unanimous written consent in lieu of a meeting. The Committee shall have the power and authority to administer, construe and interpret the Plan, to make rules for carrying it out and to make changes in such rules. Any such interpretations, rules and administration shall be consistent with the basic purposes of the Plan.
(b)	The Committee may delegate its duties under the Plan to the Chief Executive Officer, to other senior officers of the Corporation, or to the Chairman of the Board of Directors, acting as a committee established by the Committee, subject to such conditions and limitations as the Committee shall prescribe; provided, however, that only the Committee may designate and make Grants to Participants who are subject to Section 16 of the Exchange Act.
(c)	The Committee may employ attorneys, consultants, accountants, appraisers, brokers or other persons. The Committee, Reynolds American and the officers and directors of Reynolds American shall be entitled to rely upon the advice, opinions or valuations of any such persons. All actions taken and all interpretations and determinations made by the Committee in good faith shall be final and binding upon all Participants, Reynolds American 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 the Grants, and all members of the Committee shall be fully protected by Reynolds American with respect to any such action, determination or interpretation.

4. Eligibility

     The Committee may from time to time make Grants under the Plan to such employees, or other persons having a unique relationship with Reynolds American or any of its Subsidiaries, and in such form and having such terms, conditions and limitations as the Committee may determine. No Grants may be made under this Plan to non-employee directors of Reynolds American or any of its Subsidiaries. Grants may be granted singly, in combination or in tandem. The terms, conditions and limitations of each Grant under the Plan shall be set forth in a Grant Agreement, in a form approved by the Committee, consistent, however, with the terms of the Plan; provided, however, such Grant Agreement shall contain provisions dealing with the treatment of Grants in the event of the termination, death or disability of a Participant, and may also include provisions concerning the treatment of Grants in the event of a change of control of Reynolds American.

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5. Grants

     From time to time, the Committee will determine the forms and amounts of Grants for Participants. Such Grants may take the following forms in the Committee’s sole discretion:

(a)

Incentive Stock Options — These are stock options within the meaning of Section 422 of the Code to purchase Common Stock. In addition to other restrictions contained in the Plan, an option granted under this Section 5(a), (i) may not be exercised more than 10 years after the date it is granted, (ii) may not have an option price less than the Fair Market Value of Common Stock on the date the option is granted, (iii) must otherwise comply with Section 422 of the Code, and (iv) must be designated as an “Incentive Stock Option” by the Committee. The maximum aggregate Fair Market Value of Common Stock (determined at the time of each Grant) with respect to which any Participant may first exercise Incentive Stock Options under this Plan and any Incentive Stock Options granted to the Participant for such year under any plans of Reynolds American or any Subsidiary in any calendar year is $100,000. Payment of the option price shall be made in cash or in shares of Common Stock, or a combination thereof, in accordance with the terms of the Plan, the Grant Agreement and any applicable guidelines of the Committee in effect at the time.

(b)

Other Stock Options — These are options to purchase Common Stock which are not designated by the Committee as “Incentive Stock Options.” At the time of the Grant, the Committee shall determine, and shall have contained in the Grant Agreement or other Plan rules, the option exercise period, the option price and such other conditions, restrictions or factors on the grant or exercise of the option as the Committee deems appropriate. In addition to other restrictions contained in the Plan, an option granted under this Section 5(b), (i) may not be exercised more than fifteen (15) years after the date it is granted and (ii) may not have an option exercise price less than the Fair Market Value of Common Stock on the date the option is granted. Payment of the option price shall be made in cash or in shares of Common Stock, or a combination thereof, in accordance with the terms of the Plan and of any applicable guidelines of the Committee in effect at the time. The requirement of payment in cash will be deemed satisfied if the Participant has made arrangements satisfactory to the Corporation with a duly registered broker-dealer that is a member of the National Association of Securities Dealers, Inc. to sell on the date of exercise a sufficient number of shares of Common Stock being purchased so that the net proceeds of the sale transaction will at least equal the full exercise price and pursuant to which the broker-dealer undertakes to deliver the full exercise price to the Corporation not later than the later of (A) the settlement date of the sale transaction and (B) the date on which the Corporation delivers to the broker-dealer the shares of Common Stock being purchased pursuant to the exercise of such option. This method is known as the “broker-dealer exercise method” and is subject to the terms and conditions set forth herein, in the Grant Agreement and in guidelines established by the Committee.

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(c)	Stock Appreciation Rights — These are rights that on exercise entitle the holder to receive the excess of (i) the Fair Market Value of a share of Common Stock on the date of exercise over (ii) the Base Value multiplied by (iii) the number of rights exercised in cash, stock or a combination thereof as determined by the Committee. Stock Appreciation Rights granted under the Plan may, but need not, be granted in conjunction with an Option under Sections 5(a) or 5(b). The Committee, in the Grant Agreement or by other Plan rules, may impose such conditions, restrictions or factors on the exercise of Stock Appreciation Rights as it deems appropriate, and may terminate, amend, or suspend such Stock Appreciation Rights at any time, subject to Section 9. No Stock Appreciation Right granted under this Plan may be exercised more than fifteen (15) years after the date it is granted.
(d)	Restricted Stock — Restricted Stock is a Grant of Common Stock or stock units equivalent to Common Stock subject to such conditions, restrictions or factors as the Committee shall determine. Any rights to dividends or dividend equivalents accruing due to a grant of Restricted Stock shall also be determined by the Committee. Grants of Restricted Stock shall be subject to a normal minimum vesting schedule of three (3) years. The number of shares of Restricted Stock and the restrictions or conditions on such shares, as the Committee may determine, shall be set forth in the Grant Agreement or by other Plan rules, and the certificate for the Restricted Stock shall bear evidence of the restrictions or conditions.
(e)	Performance Units — These are rights, denominated in cash or cash units, to receive, at a specified future date, payment in cash or Common Stock of an amount equal to all or a portion of the value of a unit granted by the Committee. At the time of the Grant, in the Grant Agreement or by other Plan rules, the Committee must determine the base value of the unit, the performance factors applicable to the determination of the ultimate payment value of the unit as set forth in Section 7 and the period over which performance will be measured.
(f)	Performance Shares — These are rights granted in the form of Common Stock or stock units equivalent to Common Stock to receive, at a specified future date, payment in cash or Common Stock, as determined by the Committee, of an amount equal to all or a portion of the Fair Market Value at which the Common Stock is traded on the last day of the specified performance period of a specified number of shares of Common Stock based on performance during the period. At the time of the Grant, the Committee, in the Grant Agreement or by Plan rules, will determine the factors which will govern the portion of the Grants so payable as set forth in Section 7 and the period over which performance will be measured.

6. Limitations and Conditions

(a)      The number of shares of Common Stock available for Grants under this Plan shall be eight (8) million shares of the authorized Common Stock, plus 5,772,814 shares of Common Stock that cover grants under the RJR Nabisco

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	Holdings Corp. 1990 Long Term Incentive Plan that were converted into options to acquire RJR stock or restricted shares of RJR common stock. The maximum number of shares of Common Stock subject to Grants of Options and Stock Appreciation Rights to any one Participant in any calendar year shall not exceed two (2) million shares of Common Stock for each type of Grant, plus any amount of shares of Common Stock that were available within this limit for such type of Grant for any prior year such limitation was in effect and which were not covered by Options or Stock Appreciation Rights granted to such Participant during such year. No more than three (3) million shares of Common Stock may be granted as Incentive Stock Options. The maximum payment that any one Participant may be paid in respect of any Grant of Performance Units granted for any specified performance period shall not exceed $10 million. The maximum payment that any one Participant may receive in respect of any Grant of Performance Shares granted for any specified performance period shall not exceed 500,000 shares of Common Stock or the cash equivalent thereof. The aggregate maximum number of shares of Common Stock to which Restricted Stock granted may relate shall not exceed three (3) million shares of Common Stock. Shares of Common Stock related to Grants that are withheld, forfeited, terminated, cancelled, expire unexercised, settled in cash in lieu of stock, received in full or partial payment of any exercise price or in such manner that all or some of the shares of Common Stock covered by a Grant are not issued to a Participant, shall immediately become available for Grants. A Grant may contain the right to receive dividends or dividend equivalent payments which may be paid either currently, credited to a Participant or deemed invested in shares of Common Stock or share units of Common Stock. Any such crediting of dividends or dividend equivalents or reinvestment in shares of Common Stock may be subject to such conditions, restrictions and contingencies as the Committee shall establish, including the reinvestment of such credited amounts in Common Stock equivalents. Subject to the overall limitation on the number of shares of Common Stock that may be delivered under this Plan, the Committee may use available shares of Common Stock as the form of payment for compensation, grants or rights earned or due under any other compensation plans or arrangements of Reynolds American, including the plan of any entity acquired by Reynolds American.
(b)	At the time a Grant is made or amended or the terms or conditions of a Grant are changed, the Committee may provide for limitations or conditions on such Grant. Reynolds American may adopt other compensation programs, plans or arrangements as it deems appropriate.
(c)	Nothing contained herein shall affect the right of the Corporation to terminate any Participant’s employment at any time or for any reason.
(d)	No benefit under the Plan shall, prior to receipt thereof by the Participant, be in any manner liable for or subject to the debts, contracts, liabilities, engagements, or torts of the Participant.

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(e)	Except to the extent otherwise provided in any other retirement or benefit plan, any Grant under this Plan shall not be deemed compensation for purposes of computing benefits or contributions under any retirement plan of Reynolds American or its Subsidiaries and shall not affect any benefits under any other benefit plan of any kind or subsequently in effect under which the availability or amount of benefits is related to level of compensation.
(f)	This Plan is not a “Retirement Plan” or “Welfare Plan” under the Employee Retirement Income Security Act of 1974, as amended. This Plan shall be unfunded and shall not create (or be construed to create) a trust or a separate fund or funds. The Plan shall not establish any fiduciary relationship between Reynolds American and any Participant or beneficiary of a Participant. To the extent any person holds any obligation of Reynolds American by virtue of an award granted under this Plan, such obligation shall merely constitute a general unsecured liability of Reynolds American and accordingly shall not confer upon such person any right, title or interest in any assets of Reynolds American.
(g)	Unless the Committee determines otherwise, no benefit or promise under the Plan shall be secured by any specific assets of Reynolds American or any of its Subsidiaries, nor shall any assets of Reynolds American or any of its Subsidiaries be designated as attributable or allocated to the satisfaction of Reynolds American’s obligations under the Plan.

7. Performance Factors

(a)

The performance factors, if any, selected by the Committee in respect of any Grant shall be based on any one or more of the following: price of Common Stock or the stock of any affiliate, shareholder return, level of dividend return, return on equity, return on investment, return on capital, return on invested capital, economic profit, economic value added, net income, cash net income, free cash flow, earnings per share, cash earnings per share, operating company contribution or market share. These factors shall have a minimum performance standard below which no amount will be paid (to the extent not waived by the Committee or except as otherwise provided in a Grant Agreement) and may have a maximum performance standard above which no additional payments will be made. The applicable performance period shall not exceed ten (10) years.

(b)

In addition to any performance factors established pursuant to section 7(a), the Committee may, in its sole discretion, assign individual performance objectives in respect of any Grant made hereunder to a Participant who at the time of such Grant is not a “covered employee” for purposes of section 162(m) of the Code.

8. Adjustments

(a)      In the event of any stock split, spin-off, stock dividend, extraordinary cash dividend, stock combination or reclassification, recapitalization or merger, change

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	in control, or similar event, the Committee shall adjust appropriately the number or kind of shares subject to the Plan and available for or covered by Grants, share prices related to outstanding Grants and the other applicable limitations of Section 6(a), and make such other revisions to outstanding Grants and the Plan as it deems are equitably required.
(b)	In the event of a Change of Control, except as otherwise set forth in the terms of a Grant:

(i)	Options granted pursuant to Sections 5(a) or 5(b) hereof shall become fully vested and exercisable; provided, however, that the Committee may make a cash payment to Participants (A) in cancellation of such Options as provided in the applicable Grant Agreements or any amendments or deemed amendments thereto entered into by Reynolds American and the Participant in such amount as shall be provided in such Grant Agreements or amendments or (B) in lieu of the delivery of shares of Common Stock upon exercise, equal to the product of (x) and (y), where (x) is the excess of the Fair Market Value on the date of exercise over the exercise price, and (y) is the number of shares of Common Stock subject to the Options being exercised;
(ii)	Stock Appreciation Rights shall become fully vested and exercisable;
(iii)	Restricted Stock shall have all restrictions removed;
(iv)	Performance Units whose performance period ends after the date of the Change of Control shall become vested as to a percentage of Performance Units granted equal to the number of months (including partial months) in the performance period before the date of the Change of Control, divided by the total number of months in the performance period. The value of the Performance Units shall be equal to the greater of the target value of the Performance Units or the value derived from the actual performance as of the date of the Change of Control;
(v)	Performance Shares whose performance period ends after the date of the Change of Control shall become vested pro rata as to the number of Performance Shares granted equal to the number of months (including partial months) in the performance period before the date of Change of Control, divided by the total number of months in the performance period. The prorated number of Performance Shares derived from the preceding calculation shall be further adjusted by applying the higher of target or actual performance to the date of Change of Control; and
(vi)	The Committee shall have authority to establish or to revise the terms of any such Grant or any other Grant as it, in its discretion, deems appropriate; provided, however, that the Committee may not make

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revisions that are adverse to the Participant without the Participant’s consent unless such revision is provided for or contemplated in the terms of the Grant.

(c)       For purposes of the Plan, a “Change of Control” shall mean the first to occur of the following events:

(i)	an individual, corporation, partnership, group, associate or other entity or “person”, as such term is defined in Section 14(d) of the Exchange Act, other than any employee benefit plans sponsored by Reynolds American, is or becomes the “beneficial owner” (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of thirty percent (30%) or more of the combined voting power of Reynolds American’s outstanding securities ordinarily having the right to vote at elections of directors; provided, however, that the acquisition of Reynolds American securities by BAT pursuant to the Business Combination Agreement, dated as of October 27, 2003, between RJR and Brown & Williamson Tobacco Corporation (“B&W”), as thereafter amended (the “BCA”) or as expressly permitted by the Governance Agreement, dated as of July 30, 2004, among British American Tobacco, p.l.c., B&W and Reynolds American (the “Governance Agreement”), shall not be considered a Change of Control for purposes of this subsection (i);
(ii)	individuals who constitute the Board of Directors (or who have been designated as directors in accordance with Section 1.09 of the BCA) on July 30, 2004 (the “Incumbent Board”) cease for any reason to constitute at least a majority thereof, provided that any person becoming a director subsequent to such date whose election, or nomination for election by Reynolds American’s stockholders, was (1) approved by a vote of at least three-quarters of the directors comprising the Incumbent Board (either by a specific vote or by approval of the proxy statement of Reynolds American in which such person is named as a nominee of Reynolds American for director) or (2) made in accordance with Section 2.01 of the Governance Agreement, but excluding for this purpose any such individual whose initial assumption of office occurs as a result of either an actual or threatened election contest (as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act) or other actual or threatened solicitation of proxies or consents by or on behalf of an individual, corporation, partnership, group, associate or other entity or person other than Reynolds American’s Board, shall be, for purposes of this paragraph (ii), considered as though such person were a member of the Incumbent Board; and
(iii)	the approval by the stockholders of Reynolds American of a plan or agreement providing (A) for a merger or consolidation of Reynolds American other than with a wholly owned Subsidiary and other than a merger or consolidation that would result in the voting securities of

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Reynolds American outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) more than fifty percent (50%) of the combined voting power of the voting securities of Reynolds American or such surviving entity outstanding immediately after such merger or consolidation, or (B) for a sale, exchange or other disposition of all or substantially all of the assets of Reynolds American, other than any such transaction where the transferee of all or substantially all of the assets of Reynolds American is a wholly owned Subsidiary or an entity more than fifty percent (50%) of the combined voting power of the voting securities of which is represented by voting securities of Reynolds American outstanding immediately prior to the transaction (either remaining outstanding or by being converted into voting securities of the transferee entity). If any of the events enumerated in this paragraph (iii) occur, Reynolds American’s Board shall determine the effective date of the Change of Control resulting therefrom for purposes of this Plan and the Grants hereunder.

9. Amendment and Termination

     Except as otherwise required by law or as provided under the New York Stock Exchange Rules, the Committee shall have the authority to make such amendments to any terms and conditions applicable to outstanding Grants as are consistent with this Plan, provided that, except for adjustments under Sections 8(a) and 10 hereof, no such action shall modify such Grant in a manner adverse to the Participant without the Participant’s consent except as such modification is provided for or contemplated in the terms of the Grant. Except as provided in Section 8(a), the exercise price of any outstanding Option or Stock Appreciation Right may not be adjusted or amended, whether through amendment, cancellation or replacement, unless such adjustment or amendment is properly approved by Reynolds American’s shareholders. Likewise, the share and payment limitations set forth in Section 6(a) cannot be increased, and the minimum Option or Stock Appreciation Right grant price limitations set forth in Sections 5(a), 5(b) and 5(c) cannot be reduced, in either case without proper stockholder approval. Subject to the foregoing and except as otherwise required by law or as provided in the New York Stock Exchange Rules, the Corporation’s Board of Directors may amend, suspend or terminate this Plan as it deems necessary and appropriate to better achieve the Plan’s purpose.

10. Compliance with Section 409A of the Code

     The Plan is intended to comply with Section 409A of the Code and shall be construed and interpreted in accordance with such intent.

11. Foreign Options and Rights

(a)       The Committee may make Grants to employees who are subject to the tax laws of nations other than the United States, which Grants may have terms and conditions that differ from the terms thereof as provided elsewhere in the Plan for the purpose of complying with the foreign tax laws. Grants of stock options may

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	have terms and conditions that differ from Incentive Stock Options and Other Stock Options for the purpose of complying with the foreign tax laws.
(b)	The terms and conditions of stock options granted under Section 11(a) may differ from the terms and conditions which the Plan would require to be imposed upon Incentive Stock Options and Other Stock Options if the Committee determines that the Grants are desirable to promote the purposes of the Plan.

12. Withholding Taxes

     The Corporation shall have the right to deduct from any payment or settlement made under the Plan any federal, state or local income or other taxes required by law to be withheld with respect to such payment.

13. Distribution upon Death

     In the event of the death of a Participant, any distribution to which such Participant is entitled under the Plan shall be made to the beneficiary designated by the Participant to receive the proceeds of any noncontributory group life insurance coverage provided for the Participant by the Corporation (“Group Life Insurance Coverage”). If the Participant has not designated such beneficiary, or desires to designate a different beneficiary, the Participant may file with the Corporation a written designation of a beneficiary under the Plan, which designation may be changed or revoked only by the Participant, in writing. If no designation of beneficiary has been made by a Participant under the Group Life Insurance Coverage or filed with the Corporation under the Plan, distribution upon such Participant’s death shall be made in accordance with the provisions of the Group Life Insurance Coverage. If a Participant is no longer an employee of the Corporation at the time of death, no longer has any Group Life Insurance Coverage and has not filed a designation of beneficiary with the Corporation under the Plan, distribution upon such Participant’s death shall be made to the Participant’s estate.

14. Effective Date and Termination Dates

     The Plan was adopted by Reynolds American on July 30, 2004 and amended and restated effective February 2, 2005, and May 11, 2007. The Plan originally became effective on and as of June 14, 1999 (the “Effective Date”), and shall terminate ten (10) years later, subject to earlier termination by the Board of Directors pursuant to Section 9. The terms of Grants made on or before the expiration of the Plan shall extend beyond such expiration. Grants shall be governed by the terms of the Plan as in effect on the date such Grant was made, except as may be necessary to comply with Section 409A of the Code.

15. Governing Law

     All questions arising in respect of the Plan, including those pertaining to its validity, interpretation and administration, shall be governed, controlled and determined in accordance with the applicable provisions of federal law and, to the extent not preempted by federal law, the laws of the State of North Carolina.

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EX-10.7

Exhibit 10.7

DEFERRED COMPENSATION PLAN FOR
DIRECTORS OF
REYNOLDS AMERICAN INC.
(Amended and Restated Effective July 12, 2007)

ARTICLE I

     1.1 NAME AND PURPOSE. The name of this plan is the “Deferred Compensation Plan for Directors of Reynolds American Inc.” (the “Plan”). The Plan is an amendment, restatement and continuation of the Deferred Compensation Plan for Directors of R.J. Reynolds Tobacco Holdings, Inc. The purpose of this Plan is to provide non-employee Directors of the Company with increased flexibility in timing the receipt of board service fees and to assist the Company in attracting and retaining qualified individuals to serve as Directors.

     1.2 DEFINITIONS. Whenever used in the Plan, the following terms shall have the meaning set forth below:

(a)	“Closing Price” means the closing price of the Company’s Common Stock as reported in THE WALL STREET JOURNAL.
(b)	“Code” means the Internal Revenue Code of 1986, as amended.
(c)	“Common Stock” means the Common Stock, par value $0.0001 per share, of Reynolds American Inc.
(d)	“Company” means Reynolds American Inc.
(e)	“Compensation” means all remuneration paid to a Director for service as a Director other than reimbursement for expenses and shall include, but not be limited to, Board of Directors retainer fees, Board of Directors committee chairmanship and/or committee attendance fees, and any fees for attendance at Board of Directors meetings.
(f)	“Director” means any individual serving on the Board of Directors of the Company who is not an employee of the Company or any of its subsidiaries.
(g)	“Participant” means a Director who has filed an election to participate under Section 3.1 with regard to any Plan Year.
(h)	“Plan Administrator” means the Corporate Governance, Nominating and Leadership Development Committee of the Board of Directors of the Company.
(i)	“Plan Year” means the calendar year except the first Plan Year is the period July 30, 2004 through December 31, 2004.

ARTICLE II

     2.1 PARTICIPATION IN THE PLAN. Any individual who is a Director as defined in Section 1.2(f) may participate in the Plan.

ARTICLE III

     3.1 ELECTION TO PARTICIPATE. Each Director may elect annually to have payment of all or any increment of twenty-five percent (25%) of his or her Compensation for that Plan Year deferred. An election to defer may provide that the Compensation deferred will be paid in January of a specified year in the future or in January following the end of the Plan Year during which the Participant ceased to be a Director.

     No election to defer under this Plan may be made after December 31 of the year preceding the Plan Year during which Compensation would otherwise be paid or, if later, within thirty (30) days after the date a Director becomes a Director. Except for the Plan Year during which a Director becomes a Director, and then only with respect to compensation earned after such election, an election to defer shall be delivered to the Plan Administrator. Except for the Plan Year during which a Director becomes a Director, and then only with respect to compensation earned after such election, an election to defer shall be effective only for the Plan Year immediately following the date on which it was filed. In the absence of a written election to defer filed by a Director with the Plan Administrator, any Compensation will be paid directly to the Director.

     For all Compensation deferred under this Plan after December 31, 2004, the election to defer shall specify whether payment shall be made in a lump sum or in any number of annual installments not exceeding ten (10).

     3.2 MODE OF DEFERRAL. Payment of a Participant’s Compensation may be deferred in twenty-five percent (25%) increments by means of a cash credit, a stock credit or a combination of the two as the Participant shall elect in writing at the same time as the election provided for in Section 3.1. If a Participant fails to make an election as to mode of deferral, he or she shall be deemed to have elected deferral by means of a cash credit. Cash credits and stock credits shall be recorded in accounts established in Participants’ names on the books of the Company.

(a) CASH CREDITS. If the deferral is wholly or partly by means of a cash credit, the Participant’s cash credit account shall be credited, as of the last day of the calendar quarter, with the dollar amount of Compensation deferred during the quarter. As of the last day of each calendar quarter, the Participant’s cash credit account shall also be credited with interest equivalent in an amount determined by applying to the balance in the account as of the first day of the quarter (less any distributions during the quarter) an interest rate for such quarter which, when annualized, shall be the prime rate of JPMorgan Chase & Co. as of the first business day of the quarter. Interest shall be calculated on the actual number of days in the quarter based upon a 360-day year.

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(b)

STOCK CREDITS. If the deferral is wholly or partly by means of a stock credit, the Participant’s stock credit account shall be credited, as of the last day of the calendar quarter, with a Common Stock equivalent equal to the number of shares of Common Stock (including fractions of a share) that could have been purchased at the average of the Closing Price on each business day during the last month of the calendar quarter with the amount of the Compensation deferred during the quarter. As of the date any dividend is paid to shareholders of Common Stock, the Participant’s stock credit account shall also be credited with an additional Common Stock equivalent equal to the number of shares of Common Stock (including fractions of a share) that could have been purchased at the Closing Price on such date with the dividend paid on the number of shares of Common Stock to which the Participant’s stock credit account is then equivalent. In case of dividends paid in property, the dividend shall be deemed to be the fair market value of the property at the time of distribution of the dividend, as determined by the Plan Administrator.

(c)

A Participant may elect in writing that all or any designated portion of his stock credit account or his cash credit account be changed to, and such Participant shall instead be credited with, the other type of account as of the first day of the month following the month in which the election is received by the Plan Administrator. For this purpose, the value of a participant’s stock credit account will be determined using the average of the Closing Price on each business day during the month preceding the effective date of the election. Notwithstanding the foregoing, any election to transfer between accounts may be made no more frequently than once in any six (6) month period and no such election may be made unless the transfer would be an exempt transaction for purposes of Section 16(b) of the Securities Exchange Act of 1934.

     3.3 DISTRIBUTION OF CREDITS.

(a) For all Compensation deferred under this Plan prior to December 31, 2004, the distribution of a Participant’s stock credit account or cash credit account will be made as follows:

(i) Elections made pursuant to Section 3.1 shall be irrevocable by the Director.

(ii) Unless as otherwise elected in Section 3.3(a)(iii), payment of a Participant’s deferred stock units shall be made in one (1) lump sum as soon as practicable in the year in which the Participant had elected to receive payment.

(iii) At the election of the Participant made in writing and delivered to the Plan Administrator at any time on or before December 1 of the year prior to the year in which the Participant had elected to receive payment, distribution of all of his or her account shall be made in any number of annual installments not exceeding ten (10). Any such election, unless made irrevocable by its terms, may be changed by written notice to the Plan Administrator at any time prior to December 1 of the

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Plan Year prior to the year in which the Participant had elected to receive payment.

(b) For all Compensation deferred under this Plan after December 31, 2004, the distribution of a Participant’s stock credit account or cash credit account will be made as follows:

(i) According to the election made by each Participant pursuant to Section 3.1, payment of a Participant’s stock credit account or cash credit account will be made either in a lump sum or in any number of annual installments not exceeding ten (10), both commencing in the January of the year or years specified or in the January following the termination of service as a Director.

(ii) Elections made pursuant to Sections 3.1 and 3.3(b)(i) are not irrevocable; provided, however, any subsequent election that changes the timing or form of a Participant’s previous distribution election shall comply with Section 409A of the Code, including requirements that such selection election (A) may not be effective until twelve (12) months after the date the election is made, (B) any subsequent elections relating to payments scheduled for a particular date or dates must be made at lease twelve (12) months prior to the date of the first scheduled payment, and (C) all subsequent elections for distributions, other than those triggered by disability, death or an unforeseeable emergency, must delay distribution by at least five (5) years from the original distribution date.

(c) Distribution of a Participant’s cash credit and stock credit accounts shall be made in cash. For this purpose, the value of a Participant’s stock credit account shall be determined by multiplying the number of shares of Common Stock attributable to the payment by the average of the Closing Price on each business day in the month of December immediately prior to the Plan Year in which the payment is to be paid.

     3.4 ADJUSTMENT. If the number of outstanding shares of Common Stock is increased or decreased or decreased as a result of any stock dividend, subdivision or reclassification of shares, the number of shares of Common Stock to which each Participant’s stock credit account is equivalent shall be increased or decreased in proportion to the increase or decrease in the number of outstanding shares of Common Stock and the Closing Price on which payments hereunder is based will be proportionately decreased or increased. In the event the Company shall at any time be consolidated with or merged into any other corporation and holders of the Company’s Common Stock receive common shares of the resulting or surviving corporation, there shall be credited to each Participant’s stock credit account, in place of the shares then credited thereto, a stock equivalent determined by multiplying the number of common shares of stock given in exchange for a share of Common Stock upon such consolidation or merger, by the number of shares of Common Stock to which the Participant’s account is then equivalent. If in such a consolidation or merger, holders of the Company’s Common Stock shall receive any consideration other than common shares of the resulting or surviving corporation, the Plan Administrator, in its sole discretion, shall determine the appropriate change in Participants’ accounts.

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     3.5 INSTALLMENT AMOUNT. In the event a Participant has elected to receive distribution of his or her accounts in more than one installment, the amount of each installment shall be determined either (a) by multiplying the current balance (denominated in cash units for the portion elected to be deferred as cash credits and denominated in stock units for the portion elected to be deferred in stock credits) in the accounts as determined under Section 3.2, by a fraction, the numerator of which is one, and the denominator of which is the number of installments yet to be paid or (b) by any other method acceptable to the Plan Administrator.

     3.6 DISTRIBUTION UPON DEATH. In the event of the death of a Participant, whether before or after ceasing to serve as a Director, any cash credit account and stock credit account to which he or she was entitled, shall be converted to cash and distributed in one (1) lump-sum to such person or persons or the survivors thereof, including corporations, unincorporated associations or trusts, as the Participant may have designated. All such designations shall be made in writing signed by the Participant and delivered to the Plan Administrator. A Participant may from time to time revoke or change any such designation by written notice to the Plan Administrator. If there is no unrevoked designation on file with the Plan Administrator at the time of the Participant’s death, or if the person or persons designated therein shall have all predeceased the Participant or otherwise ceased to exist, such distributions shall be made in accordance with the Participant’s will or in the absence of a will, to the administrator of the Participant’s estate. Any distribution under this Section 3.6 shall be made as soon as practicable following the end of the fiscal quarter in which the Plan Administrator is notified of the Participant’s death. In this case, a Participant’s stock credit account shall be converted to cash by multiplying the number of whole and fractional shares of Common Stock to which the Participant’s stock credit account is equivalent by the average of the Closing Price of Common Stock on each business day during the last month of the calendar quarter prior to the date of death.

     3.7 WITHHOLDING TAXES. The Company shall deduct from all distributions under the Plan any taxes required to be withheld by federal, state, or local governments.

ARTICLE IV

     4.1 PLAN ADMINISTRATOR. The Plan Administrator shall have full power and authority to administer the Plan including the power to promulgate forms to be used with regard to the Plan, the power to promulgate rules of Plan administration, the power to settle any disputes as to rights or benefits arising from the Plan, and the power to make such decisions or take such action as the Plan Administrator, in its sole discretion, deems necessary or advisable to aid in the proper maintenance of the Plan.

ARTICLE V

     5.1 FUNDING. No promise hereunder shall be secured by any specific assets of the Company, nor shall any assets of the Company be designated as attributable or allocated to the satisfaction of such promises. Nothing herein creates a vested right. Cash credit and stock credit accounts are not funded and are paid from the general assets of the Company from which the Participant terminated service as a Director. Nothing herein shall be construed to require the Company to maintain any fund or segregate any amount for the benefit of any Participant and no

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Participant or other person shall have any claim against, right to, or security or other interest in, any fund, account or asset of the Company.

ARTICLE VI

     6.1 NON-ALIENATION OF BENEFITS. No benefit under the Plan shall 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 Participant, be in any manner liable for or subject to the debts, contracts, liabilities, engagements, or torts of the Participant.

ARTICLE VII

     7.1 DELEGATION OF ADMINISTRATIVE DUTIES. Administrative duties imposed by this Plan may be delegated by the Plan Administrator or the individual charged with such duties.

     7.2 GOVERNING LAW. All questions arising in respect of the Plan, including those pertaining to its validity, interpretation and administration, shall be governed, controlled and determined in accordance with the applicable provisions of federal law and, to the extent not preempted by federal law, the laws of the State of North Carolina.

     7.3 AMENDMENT, MODIFICATION AND TERMINATION OF THE PLAN. The Plan Administrator at any time may terminate and in any respect, amend or modify the Plan.

     7.4 COMPLIANCE WITH SECTION 409A OF THE CODE. The Plan is intended to comply with Section 409A of the Code and shall be construed and interpreted in accordance with such intent.

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EX-10.8

Exhibit 10.8

EQUITY INCENTIVE AWARD PLAN FOR
DIRECTORS OF REYNOLDS AMERICAN INC.
(Amended and Restated Effective July 12, 2007)

     Reynolds American Inc., a North Carolina corporation, hereby adopts this Equity Incentive Award Plan for Directors of Reynolds American Inc. (amended and restated effective July 12, 2007). The Plan is an amendment, restatement and continuation of the Amended and Restated Equity Incentive Award Plan for Directors of R.J. Reynolds Tobacco Holdings, Inc. and Subsidiaries. The purposes of this Plan are as follows:

     (1) To further the growth, development and financial success of the Company by providing additional incentives to its Directors by assisting them to become owners of capital stock of the Company and thus to benefit directly from its growth, development and financial success.

     (2) To enable the Company to obtain and retain the services of the type of Directors considered essential to the long-term success of the Company by providing and offering them an opportunity to become owners of capital stock of the Company.

ARTICLE I
DEFINITIONS

Section 1.1 — General

     Whenever the following terms are used in this Plan they shall have the meaning specified below unless the context clearly indicates to the contrary.

Section 1.2 — Affiliate

     “Affiliate” of any person shall mean another person that directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with, such first person.

Section 1.3 — BAT

     “BAT” shall mean, collectively, British American Tobacco, p.l.c., a public limited company incorporated under the laws of England and Wales, and its Affiliates.

Section 1.4 — Board

     “Board” shall mean the Board of Directors of the Company.

Section 1.5 — Code

     “Code” shall mean the Internal Revenue Code of 1986, as amended.

Section 1.6 — Committee

     “Committee” shall mean the Corporate Governance, Nominating and Leadership Development Committee of the Board.

Section 1.7 — Common Stock

     “Common Stock” shall mean the common stock, par value $0.0001 per share, of the Company.

Section 1.8 — Company

     “Company” shall mean Reynolds American Inc., a North Carolina corporation.

Section 1.9 — Director

     “Director” shall mean a member of the Board.

Section 1.10 — Eligible Director

     “Eligible Director” shall mean a Director who has never been an employee or officer of the Company, any Subsidiary, BAT or any of their Affiliates; provided, however, that the Non-Executive Chairman shall be an Eligible Director.

Section 1.11 — Grant

     “Grant” shall mean an award made to a Participant pursuant to the Plan.

Section 1.12 — Non-Executive Chairman

     “Non-Executive Chairman” shall mean the Non-Executive Chairman of the Board.

Section 1.13 — Option

     “Option” shall mean an option granted under the Plan to purchase Common Stock.

Section 1.14 — Option Price

     “Option Price” shall have the meaning given in Section 4.2.

Section 1.15 — Optionee

     “Optionee” shall mean a Director to whom an Option is granted under the Plan.

Section 1.16 — Participant

     “Participant” shall mean a Director to whom a Grant has been made.

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Section 1.17 — Plan

     “Plan” shall mean the Equity Incentive Award Plan for Directors of Reynolds American Inc.

Section 1.18 — Secretary

     “Secretary” shall mean the Secretary of the Company.

Section 1.19 — Stock Award

     “Stock Award” shall mean the annual award, either in the form of deferred stock units or shares of Common Stock, made pursuant to Article VI.

Section 1.20 — Subsidiary

     “Subsidiary” shall mean any corporation in an unbroken chain of corporations beginning with the Company if each of the corporations, or if each group of commonly controlled corporations, other than the last corporation in an unbroken chain then owns stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

ARTICLE II
SHARES SUBJECT TO PLAN

Section 2.1 — Shares Subject to Plan

     The shares of stock subject to Grant shall be shares of Common Stock. The aggregate number of shares of Common Stock which are available for Grants under the Plan shall not exceed 500,000. Shares of Common Stock related to Grants that are forfeited, terminated, canceled, expire unexercised, settled in cash in lieu of stock or in such manner that all or some of the shares of Common Stock covered by a Grant are not issued to a Participant, shall immediately become available for Grants.

ARTICLE III
GRANTING OF OPTIONS

Section 3.1 — Eligibility

     Any Eligible Director shall be eligible to be granted Options as set forth in this Article III.

Section 3.2 — Granting of Options to Directors

     Options may be granted at any time and solely in the discretion of the Committee to each Eligible Director elected to serve on the Board. Such Options shall be subject to the terms and conditions set forth in Article IV.

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ARTICLE IV
TERMS OF OPTIONS FOR DIRECTORS

Section 4.1 — Option Agreement

     A grant of Options to Eligible Directors shall be evidenced by a Stock Option Agreement, which shall be executed by the Optionee and an authorized officer of the Company and which shall incorporate the terms and conditions of this Article IV and such other terms and conditions as the Committee shall determine, consistent with the Plan.

Section 4.2 — Option Price

     The exercise price of each share of Common Stock subject to an Option granted pursuant to Section 3.2 shall be the final closing price of a share of Common Stock (as reported on the New York Stock Exchange consolidated tape) on the date of grant.

Section 4.3 — Commencement of Exercisability

     Options granted pursuant to Section 3.2 shall not be exercisable prior to six (6) months after the date of grant, and thereafter shall be exercisable in full, subject to applicable securities regulations.

Section 4.4 — Expiration of Option

     The Option shall expire and may not be exercised to any extent after the expiration of ten (10) years from the date the Option was granted.

ARTICLE V
EXERCISE OF OPTIONS

Section 5.1 — Persons Eligible to Exercise

     During the lifetime of the Optionee, only he or his guardian may exercise an Option granted to him, or any portion thereof. After the death of the Optionee, any exercisable portion of an Option may, prior to the time when such portion becomes unexercisable under Section 4.4, be exercised by his personal representative or by any person empowered to do so under the deceased Optionee’s will or under the then applicable laws of descent and distribution.

Section 5.2 — Partial Exercise

     At any time and from time to time prior to the time when any exercisable Option or exercisable portion thereof expires or becomes unexercisable under Section 4.4, such Option or portion thereof may be exercised in whole or in part; provided, however, that the Company shall not be required to issue fractional shares.

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Section 5.3 — Manner of Exercise

     An exercisable Option, or any exercisable portion thereof, may be exercised solely by delivering to the Secretary or his office all of the following prior to the time when such Option or such portion becomes unexercisable:

     (a) Notice in writing signed by the Optionee or other person then entitled to exercise such Option or portion thereof, stating that such Option or portion thereof is exercised;

     (b) Full payment of the Option Price shall be made in cash, by check or a combination thereof, for the shares of Common Stock with respect to which such Option or portion thereof is thereby exercised, together with payment of any federal income or other tax required to be withheld by the Company with respect to such shares of Common Stock, in accordance with the terms of the Plan and of any applicable guidelines of the Committee in effect at the time. The requirement of payment will be deemed satisfied if the Participant has made arrangements satisfactory to the Company with a duly registered broker-dealer that is a member of the National Association of Securities Dealers, Inc. to sell on the date of exercise a sufficient number of shares of Common Stock being purchased so that the net proceeds of the sale transaction will at least equal the full exercise price and pursuant to which the broker-dealer undertakes to deliver the full exercise price to the Company not later than the later of (i) the settlement date of the sale transaction and (ii) the date on which the Company delivers to the broker-dealer the shares of Common Stock being purchased pursuant to the exercise of such Option. This method is known as the “broker-dealer exercise method” and is subject to the terms and conditions set forth herein, in the Option grant agreement and in guidelines established by the Committee;

     (c) Such representations and documents as the Committee reasonably deems necessary or advisable to effect compliance with all applicable provisions of the Securities Act of 1933, as amended and any other federal, state or foreign securities laws or regulations. The Committee may, in its absolute discretion, also take whatever additional actions it deems appropriate to effect such compliance, including, without limitation, placing legends on share certificates and issuing stop-transfer orders to transfer agents and registrars; and

     (d) In the event that the Option or portion thereof shall be exercised pursuant to Section 5.1 by any person or persons other than the Optionee, appropriate proof of the right of such person or persons to exercise the Option or portion thereof.

Section 5.4 — Rights as Stockholders

     The holders of Options shall not be, nor have any of the rights or privileges of, stockholders of the Company in respect of any shares of Common Stock purchasable upon the exercise of any part of an Option unless and until certificates representing such shares of Common Stock have been issued by the Company to such holders.

Section 5.5 — Transfer Restrictions

     The Committee, in its absolute discretion, may impose such restrictions on the transferability of the shares of Common Stock purchasable upon the exercise of an Option as it

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deems appropriate, and any such restriction shall be set forth in the respective Stock Option Agreement and may be referred to on the certificates evidencing such shares of Common Stock.

ARTICLE VI
STOCK AWARDS

Section 6.1 — Granting of Initial Stock Award to Directors

     (a) Each Eligible Director who is elected to serve on the Board shall receive an initial Stock Award as of the date of such Director’s initial election to serve on the Board (an “Initial Stock Award”). Such Initial Stock Award shall be granted only once to each Eligible Director as soon as practicable following the Director’s initial election to serve on the Board and shall be subject to the terms and conditions set forth in this Article VI. Notwithstanding this Section 6.1(a), in the event of the appointment of an existing Director who is or was an employee of the Company to the position of Non-Executive Chairman and such Director has not yet received an Initial Stock Award, the Non-Executive Chairman shall receive an Initial Stock Award upon his or her appointment to the position of Non-Executive Chairman.

     (b) Except as provided in Section 6.1(c) below, the Initial Stock Award shall be made in the form of deferred stock units, as described in Section 6.4. Each Eligible Director shall receive an Initial Stock Award of 3,500 deferred stock units.

     (c) Notwithstanding the foregoing, commencing with the Initial Stock Award for 2004, an Eligible Director may elect to receive the Initial Stock Award in the form of 3,500 shares of Common Stock. The election to receive shares of Common Stock must be made in writing within thirty (30) days after the date a Director becomes a Director. An election to receive shares of Common Stock shall be irrevocable by the Director.

Section 6.2 — Granting of Annual Stock Awards

     (a) Each Eligible Director shall receive an annual Stock Award as of the date of the Company’s annual meeting of stockholders or the one (1) year anniversary of the preceding year’s annual meeting of stockholders, if no meeting has been scheduled for such subsequent year, provided that the Director serves on the Board immediately following such date (an “Annual Stock Award”). The Annual Stock Award for 2005 shall be made as of July 30, 2005 or, if later, the date of the Director’s election or re-election to serve on the Board.

     (b) Except as provided in Section 6.2(c) below, the Annual Stock Award shall be made in the form of deferred stock units, as described in Section 6.4. Each Eligible Director, other than the Non-Executive Chairman, shall receive an Annual Stock Award of 2,000 deferred stock units. The Non-Executive Chairman shall receive an Annual Stock Award of 4,000 deferred stock units. [Note: the amounts of the Annual Stock Awards increased as a result of the Company’s two-for-one stock split on August 14, 2006.]

     (c) Notwithstanding the foregoing, commencing with the Annual Stock Award for 2005, an Eligible Director or the Non-Executive Chairman may elect to receive the Annual Stock Award in the form of shares of Common Stock. The election to receive shares of Common Stock must be made in writing by December 31 of the year preceding the year during which the

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Annual Stock Award would otherwise be granted or, if later, within thirty (30) days after the date a Director becomes a Director. An election to receive shares of Common Stock shall be irrevocable by the Director and shall be effective only for the year immediately following the date on which it was filed.

Section 6.3 — Grant of Quarterly Stock Awards

     (a) Each Eligible Director shall receive a quarterly Stock Award on the last day of each calendar quarter, provided that the Director has served on the Board at any time during such calendar quarter (a “Quarterly Stock Award”).

     (b) The Quarterly Stock Award shall be made in the form of deferred stock units, as described in Section 6.4. The number of deferred stock units to be credited to each Eligible Director’s account, other than the Non-Executive Chairman’s account, on the last day of each calendar quarter shall be determined pursuant to the following formula: $10,000 divided by the average of the closing price of a share of Common Stock (as reported on the New York Stock Exchange (“NYSE”) consolidated tape for each business day during the last month of such calendar quarter). The number of deferred stock units to be credited to the Non-Executive Chairman’s account on the last day of each calendar quarter shall be determined pursuant to the following formula: $20,000 divided by the average of the closing price of a share of Common Stock (as reported on the NYSE consolidated tape for each business day during the last month of such calendar quarter). In the event an Eligible Director has served on the Board or in the position of Non-Executive Chairman for less than an entire quarter, the number of deferred stock units to be credited to his or her account on the last day of such quarter shall be prorated based on the actual number of days of his or her service on the Board during the quarter.

Section 6.4 — Deferred Stock Units

     Each deferred stock unit shall be equal in value to one (1) share of Common Stock. As of the date any dividend is paid to shareholders of Common Stock, the Director shall be credited with additional deferred stock units equal to the number of shares of Common Stock (including fractions of a share) that could have been purchased at the closing price of Common Stock on such date with the dividend paid on the number of shares of Common Stock to which the Director’s deferred stock units are then equivalent. In case of dividends paid in property, the dividend shall be deemed to be the fair market value of the property at the time of distribution of the dividend, as determined by the Committee.

Section 6.5 — Distribution of Deferred Stock Units

     (a) For all Grants made under this Plan prior to December 31, 2004, the distribution of a Participant’s deferred stock units will be made as follows:

     (i) Unless as otherwise elected in Section 6.5(a)(ii), payment of a Participant’s deferred stock units shall be made in one (1) lump sum as soon as practicable following the end of the year in which the Participant ceases to be a Director.

     (ii) At the election of the Participant made in writing and delivered to the Committee at any time on or before December 1 of the year of termination of the

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Participant’s service as a Director, distribution of all of his or her deferred stock units, commencing as soon as practicable following the end of the year in which the Participant ceases to be a Director, shall be made in any number of annual installments not exceeding ten (10). Any such election, unless made irrevocable by its terms, may be changed by written notice to the Committee at any time prior to December 1 of the year of a Participant’s termination of service as a Director.

     (b) For all Grants made under this Plan after December 31, 2004 and prior to December 31, 2007, the distribution of a Participant’s deferred stock units will be made in the following manner. According to the election made by each Participant on an annual election form provided by the Company to the Participant prior to December 31 of the year preceding the grant of any award under this Plan in the next Plan year or, if later, within thirty (30) days after the date a Director becomes a Director, payment of a Participant’s deferred stock units will be made either in a lump sum or in any number of annual installments not exceeding ten (10), both commencing in the January following the termination of service as a Director.

     (c) For all Grants made under this Plan after December 31, 2007, the distribution of a Participant’s deferred stock units will be made in the following manner. Each Participant shall elect annually to have payment of his or her deferred stock units with respect to a grant (i) be made either in a lump sum or in any number of annual installments not exceeding ten (10), and (ii) commence either (A) in the January following the termination of his or her service as a Director, or (B) in the later of the January of the year specified and the January following the termination of his or her service as a Director. Such election by each Participant shall be made on an annual election form provided by the Company prior to December 31 of the year preceding the grant of any award under this Plan in the next Plan year or, if later, within thirty (30) days after the date a Director becomes a Director.

     (d) Elections made pursuant to Section 6.5(b) and (c) are not irrevocable; provided, however, (A) any subsequent election may not be effective until twelve (12) months after the date the election is made, (B) any subsequent election relating to payments scheduled for a particular date or dates must be made at least twelve (12) months prior to the date of the first scheduled payment, and (C) any subsequent election for distributions, other than those triggered by disability, death or an unforeseeable emergency, must delay distribution by at least five (5) years from the original distribution date.

     (e) Distribution of a Participant’s deferred stock units received in connection with such Participant’s Quarterly Stock Awards shall be made only in cash. Distribution of a Participant’s deferred stock units received in connection with such Participant’s Initial Stock Award and Annual Stock Awards shall be made in cash or stock, at the election of the Participant made in writing and delivered to the Committee at any time on or before December 1 of the year of termination of the Participant’s service as a Director. If distribution is made in cash, the amount of distribution shall be determined by multiplying the number of deferred stock units attributable to the installment by the average of the closing price in Common Stock on each business day in the month of December immediately prior to the year in which the installment is to be paid. If distribution is made in stock, any fractional shares of stock shall be paid in cash equal to the value of the fractional share multiplied by the closing price of the Common Stock on the last business day immediately preceding the date of distribution.

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Section 6.6 — Installment Amount

     In the event a Participant has elected to receive distribution of his or her deferred stock units in more than one (1) installment, the amount of each installment shall be determined by multiplying the current number of deferred stock units by a fraction, the numerator of which is one (1), and the denominator of which is the number of installments yet to be paid.

Section 6.7 — Distribution upon Death

     In the event of the death of a Participant, whether before or after ceasing to serve as a Director, any deferred stock units to which he or she was entitled, shall be converted to cash and distributed in a lump sum to such person or persons or the survivors thereof, including corporations, unincorporated associations or trusts, as the Participant may have designated. All such designations shall be made in writing signed by the Participant and delivered to the Committee. A Participant may from time to time revoke or change any such designation by written notice to the Committee. If there is no unrevoked designation on file with the Committee at the time of the Participant’s death, or if the person or persons designated therein shall have all predeceased the Participant or otherwise ceased to exist, such distributions shall be made in accordance with the Participant’s will or in the absence of a will, to the administrator of the Participant’s estate. Any distribution under this Section 6.7 shall be made as soon as practicable following the end of the fiscal quarter in which the Committee is notified of the Participant’s death. In this case, a Participant’s deferred stock units shall be converted to cash by multiplying the number of whole and fractional shares of Common Stock to which the Participant’s deferred stock units are equivalent by the average of the closing price of Common Stock on each business day during the last month of the calendar quarter prior to the date of death.

Section 6.8 — Withholding Taxes

     The Company shall deduct from all distributions under the Plan any taxes required to be withheld by federal, state, or local governments.

Section 6.9 — Terms and Conditions

     All Stock Awards shall be subject to the terms and conditions of this Article VI and such other terms and conditions as the Committee shall determine, consistent with the Plan.

ARTICLE VII
ADMINISTRATION

Section 7.1 — Plan Administrator

     The Plan shall be administered by the Committee.

Section 7.2 — Duties and Powers of Committee

     It shall be the duty of the Committee to conduct the general administration of the Plan in accordance with its provisions. The Committee shall have the power to interpret the Plan and the Grants and to adopt such rules for the administration, interpretation, and application of the Plan

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as are consistent therewith and to interpret, amend or revoke any such rules. Any such interpretations and rules shall be consistent with the basic purpose of the Plan to make Grants. In its absolute discretion, the Board may at any time and from time to time exercise any and all rights and duties of the Committee under the Plan. The Committee may act either by vote at a telephonic or other meeting or by unanimous written consent in lieu of a meeting.

Section 7.3 — Compensation; Professional Assistance; Good Faith Actions

     Members of the Committee shall not receive compensation for their services as members in connection with the administration of the Plan, but all expenses and liabilities they incur in connection with the administration of the Plan shall be borne by the Company. The Committee may employ attorneys, consultants, accountants, appraisers, brokers or other persons. The Committee, the Company, the Directors and the officers of the Company shall be entitled to rely upon the advice, opinions or valuations of any such persons. All actions taken and all interpretations and determinations made by the Committee in good faith shall be final and binding upon all Participants, 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 the Grants, and all members of the Committee shall be fully protected by the Company with respect to any such action, determination or interpretation.

ARTICLE VIII
MISCELLANEOUS PROVISIONS

Section 8.1 — Amendment, Suspension or Termination of the Plan

     The Plan may be wholly or partially amended or otherwise modified, suspended or terminated at any time or from time to time by the Board. Except as expressly permitted by the terms of the Plan, neither the amendment, suspension nor termination of the Plan shall, without the consent of the Participant alter or impair any rights or obligations under any Grant theretofore granted. No Grant may be made during any period of suspension nor after termination of the Plan.

Section 8.2 — Effect of Plan Upon Other Options and Compensation Plans

     Nothing in this Plan shall be construed to limit the right of the Company or any of its Subsidiaries (a) to establish any other forms of incentives or compensation for Directors of the Company or any of its Subsidiaries or (b) to grant or assume options other than under this Plan in connection with any proper corporate purpose, including, but not by way of limitation, the grant or assumption of options in connection with the acquisition by purchase, lease, merger, consolidation or otherwise, of the business, stock or assets of any corporation, firm, association or other entity.

Section 8.3 — Adjustments

     (a) In the event of any change in the outstanding Common Stock by reason of a stock split, spin-off, stock dividend, stock combination or reclassification, recapitalization or merger, change of control, or similar event, the Committee may adjust appropriately the number of shares of Common Stock subject to the Plan and available for or covered by Grants and share prices

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related to outstanding Grants and make such other revisions to outstanding Grants as it deems are equitably required. Any such adjustment made by the Committee shall be final and binding upon all Participants, the Company and all other interested persons.

(b) In the event of a Change of Control (as defined in paragraph 8.3(c) hereof):

     (i) Options granted pursuant to Article III hereof shall become fully vested and exercisable; provided, however, that the Committee may elect to make a cash payment to Participants in cancellation of such Options in such amount as the Committee in its sole discretion shall determine, which amount shall not be less than the product of (x) and (y), where (x) is the excess of the fair market value of Common Stock on the date of exercise over the exercise price, and (y) is the number of shares of Common Stock subject to the Options being canceled.

     (ii) Subject to Section 8.4, deferred stock units granted pursuant to Article VI hereof shall be distributed to Participants in a single lump sum.

     (c) For purposes of the Plan, a “Change of Control” shall mean the first to occur of the following events:

     (i) an individual, corporation, partnership, group, associate or other entity or “person”, as such term is defined in Section 14(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), other than the Company or any employee benefit plans sponsored by the Company, is or becomes the “beneficial owner” (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of thirty percent (30%) or more of the combined voting power of the Company’s outstanding securities ordinarily having the right to vote at elections of directors; provided, however, that the acquisition of Company securities by BAT pursuant to the Business Combination Agreement, dated as of October 27, 2003, between R.J. Reynolds Tobacco Holdings, Inc. (“RJR”) and Brown & Williamson Tobacco Corporation (“B&W”), as thereafter amended (the “BCA”) or as expressly permitted by the Governance Agreement, dated as of July 30, 2004, among British American Tobacco, p.l.c., B&W and the Company (the “Governance Agreement”), shall not be considered a Change of Control for purposes of this subsection (i).

     (ii) individuals who constitute the Board (or who have been designated as directors in accordance with Section 1.09 of the BCA) on July 30, 2004 (the “Incumbent Board”) cease for any reason to constitute at least a majority thereof, provided that any person becoming a director subsequent to such date whose election, or nomination for election by the Company’s shareholders, was (1) approved by a vote of at least three-quarters of the directors comprising the Incumbent Board (either by a specific vote or by approval of the proxy statement of the Company in which such person is named as a nominee of the Company for director) or (2) made in accordance with Section 2.01 of the Governance Agreement, but excluding for this purpose any such individual whose initial assumption of office occurs as a result of either an actual or threatened election contest (as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act) or other actual or threatened solicitation of proxies or consents by or on

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behalf of an individual, corporation, partnership, group, associate or other entity or “person” other than the Board, shall be, for purposes of this paragraph (ii), considered as though such person were a member of the Incumbent Board;

     (iii) the approval by the shareholders of the Company of a plan or agreement providing (1) for a merger or consolidation of the Company other than with a wholly-owned Subsidiary and other than a merger or consolidation that would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) more than fifty percent (50%) of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (2) for a sale, exchange or other disposition of all or substantially all of the assets of the Company, other than any such transaction where the transferee of all or substantially all of the assets of the Company is a wholly owned subsidiary or an entity more than fifty percent (50%) of the combined voting power of the voting securities of which is represented by voting securities of the Company outstanding immediately prior to the transaction (either remaining outstanding or by being converted into voting securities of the transferee entity). If any of the events enumerated in this paragraph (iii) occur, the Board shall determine the effective date of the Change of Control resulting therefrom for purposes of the Plan or the Grants hereunder.

Section 8.4 — Compliance with Section 409A of the Code

     The Plan is intended to comply with Section 409A of the Code and shall be construed and interpreted in accordance with such intent.

Section 8.5 — Titles

     Titles are provided herein for convenience only and are not to serve as a basis for interpretation or construction of the Plan.

Section 8.6 — Pronouns

     The masculine pronoun shall include the feminine and neutral and the singular shall include the plural, where the context so indicates.

Section 8.7 — Governing Law

     All questions arising in respect of the Plan, including those pertaining to its validity, interpretation and administration, shall be governed, controlled and determined in accordance with the applicable provisions of federal law and, to the extent not preempted by federal law, the laws of the State of North Carolina.

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EX-10.9

Exhibit 10.9

Via UPS Overnight

April 30, 2007

Teresa M. Riggs
President
BATUS Japan, Inc.
103 Foulk Road, Suite 117
Wilmington, Delaware 19803

     Re: Contract Manufacturing Agreement dated 30^th July 2004 by and between R. J. Reynolds Tobacco Company and BATUS Japan, Inc.; Section 3.2 Invoices — Amendment

Dear Teresa:

     R. J. Reynolds Tobacco Company (RJRTC) recently has made a shift in the shipment of product for BATUS Japan, Inc. (BATUS Japan) with regard to the Contract Manufacturing Agreement (“the Agreement”) referenced above. Shipments of product by RJRTC to BATUS typically have been made from the west coast of the United States. RJRTC and BATUS Japan deem it mutually beneficial for shipments to be made with a mix of routes from the east and west coasts of the United States. As a result of this change, a majority of shipments are made through the east coast, and RJRTC and BATUS Japan agreement that typical title passage of product shipped now occurs 10 to 14 days sooner than those contemplated by the guidelines originally documented in the Agreement. In light of this, RJRTC and BATUS Japan agree to amend Section 3.2 of the Agreement by replacing Section 3.2 with the following:

     3.2 Invoices. RJRTC shall invoice BATUS Japan (or, where applicable RFEBV) monthly for Products shipped by RJRTC during the applicable month. BATUS Japan’s obligation to make payment shall accrue once title and risk of loss to the applicable Products pass to BATUS Japan. Such invoices shall be due and payable by BATUS Japan (or RFEBV) by 9 days after the last calendar day of the month following the month of shipment from RJRTC’s manufacturing facilities.

     The terms of amended Section 3.2 shall be reviewed on a periodic basis by both parties to insure relevance to the current transportation model, and amended to reflect a payment schedule that is fair to both parties.

     All other terms and conditions of the Agreement that are in place as of this letterhead date and not expressly amended by this letter shall remain in full force and effect.

     If the foregoing accurately sets forth our understanding, please indicate by executing and returning two originals.

Agreed and accepted:

R. J. REYNOLDS TOBACCO COMPANY

By: /s/ Daniel Snyder                        

Title: Executive Vice President – Operations

Date: May 18, 2007

BATUS JAPAN, INC.

By: /s/ Andrew T. Panaccione                        

Title: Secretary

Date: May 9, 2007

EX-10.10

Exhibit 10.10

Via UPS Overnight

June 12, 2007

Teresa M. Riggs
President
BATUS Japan, Inc.
103 Foulk Road, Suite 117
Wilmington, Delaware 19803

     Re: Contract Manufacturing Agreement dated 30^th July 2004, and Guidelines for Pricing New Products and Line Extensions dated 14^th October 2005, which are by and between R. J. Reynolds Tobacco Company and BATUS Japan, Inc

Dear Teresa:

          R. J. Reynolds Tobacco Company (RJRTC) and BATUS Japan, Inc. (BATUS Japan) are parties to the Contract Manufacturing Agreement (“the Agreement”) referenced above, and the Guidelines for Pricing New Products and Line Extensions referenced above (which is part of a document entitled “Principles For BATUSJ and RJRTC To Follow When Considering Matters Arising From The Contract Manufacturing Agreement.” Those documents are incorporated herein by reference. RJRTC and BATUS Japan deem it mutually beneficial to clarify how application of the PPI (as defined in the Agreement) to current pricing guidelines is treated when new components and other items are incorporated within product that RJRTC manufactures for BATUS Japan. In light of this, RJRTC and BATUS Japan agree to amend Section 9 of the Guidelines for Pricing New Products and Line Extensions by replacing that Section 9 with the following:

9. For specification changes to existing products which already have a current price, the cost, and resulting price, will be adjusted as follows:

– If a standard price already exists for the new component in connection with a product RJRTC already produces, then the difference, plus 10%, will be added (or subtracted) to the current price to arrive at a new price.

– If a standard price for the new component does not currently exist, then a standard cost will be established via RJRTC’s normal quote/bidding process. For calculation purposes, the difference in price between the existing component and new component, plus 10% of that difference, will be added (or subtracted) to the current price of the product. PPI (as defined in the Agreement) and adjustment of the price of the product using PPI pursuant to the Agreement shall remain in effect, and shall apply to new components when formulating the price of such products.

          All other terms and conditions of the Agreement and the document entitled “Principles For BATUSJ and RJRTC To Follow When Considering Matters Arising From The Contract Manufacturing Agreement” that are in place as of this letterhead date and not expressly amended by this letter shall remain in full force and effect.

          If the foregoing accurately sets forth our understanding, please indicate by executing and returning two originals.

Agreed and accepted:

R. J. REYNOLDS TOBACCO COMPANY

By: /s/ Dan Snyder            

Title: EVP Operations

Date: 6/25/07

BATUS JAPAN, INC.

By: /s/ Andrew Panaccione            

Title: VP & Secretary

Date: June 20, 2007

EX-10.11

Exhibit 10.11

MAXIMUM PRINCIPAL INDEBTEDNESS FOR
TENNESSEE RECORDING TAX PURPOSES IS
[___]

THIS INSTRUMENT SECURES OBLIGATORY FUTURE
ADVANCES FOR COMMERCIAL PURPOSES

This Deed of Trust was prepared by,
and when recorded should be returned to: This document is intended
to be recorded in
[___] County, TENNESSEE

Leila Rachlin, Esq.
White & Case LLP
1155 Avenue of the Americas
New York, New York 10036
(212) 819-8720
1107993-0127

DEED OF TRUST, SECURITY AGREEMENT, ASSIGNMENT OF LEASES, RENTS AND
PROFITS, FINANCING STATEMENT AND FIXTURE FILING

made by

CONWOOD COMPANY, L.P., as the Trustor, to

Richard F. Warren, Jr., as Trustee, a resident of Davidson County, Tennessee

JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent for the Secured
Creditors, as the Beneficiary

COLLATERAL IS OR INCLUDES FIXTURES. THIS DEED OF TRUST SHALL BE EFFECTIVE AND SHALL CONSTITUTE A UCC FINANCING STATEMENT, FILED AS A FIXTURE FILING IN ACCORDANCE WITH T.C.A. SECTION 28-2-111. TRUSTOR IS THE RECORD OWNER OF THE REAL PROPERTY DESCRIBED ON EXHIBIT A.

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DEED OF TRUST, SECURITY AGREEMENT,
ASSIGNMENT OF LEASES, RENTS AND PROFITS,
FINANCING STATEMENT AND FIXTURE FILING

          THIS DEED OF TRUST, SECURITY AGREEMENT, ASSIGNMENT OF LEASES, RENTS AND PROFITS, FINANCING STATEMENT AND FIXTURE FILING, dated as of October ___, 2006 (as the same may be amended, restated, supplemented and/or otherwise modified from time to time, this “Deed of Trust”) made by Conwood Company, L.P., a Delaware limited partnership (the “Trustor”), having an address at 401 North Main Street, Winston-Salem, North Carolina 27102 as the Trustor, to Richard F. Warren, Jr. (“Trustee”), a resident of Nashville, Davidson County, Tennessee, having an address at 1600 Division Street, Suite 700, Nashville, Tennessee 37203, for the benefit of JPMorgan Chase Bank, N.A. (together with any successor beneficiary, the “Beneficiary”), having an address at 270 Park Avenue, New York, NY 10017, as Administrative Agent and Collateral Agent, as the Beneficiary for the benefit of the Secured Creditors (as defined below).

          All capitalized terms used but not otherwise defined herein shall have the same meanings ascribed to such terms in the Credit Agreement described below.

W I T N E S S E T H :

          WHEREAS, Reynolds American Inc. (the “Borrower”), the various lending institutions from time to time party thereto (the “Lenders”), JPMorgan Chase Bank, N.A., as Administrative Agent (the “Administrative Agent”), Lehman Brothers Commercial Paper, Inc. and Citicorp. USA, Inc. as Syndication Agents (the “Syndication Agents”), General Electric Capital Corporation and Mizuho Corporate Bank, Ltd. as Documentation Agents (the “Documentation Agents”), Lehman Brothers Inc., J.P. Morgan Securities Inc., Citigroup Global Markets Inc. and General Electric Capital Corporation, as Joint Lead Arrangers and Joint Bookrunners and Lehman Brothers Inc., J.P. Morgan Securities Inc. and Citigroup Global Markets Inc., as Joint Bookrunners (the “Joint Bookrunners”) have entered into a Credit Agreement, dated as of May 7, 1999, as amended and restated as of November 17, 2000, as further amended and restated as of May 10, 2002, as further amended and restated as of July 30, 2004 and as further amended and restated as of May 31, 2006, providing for a credit facility of up to $2,350,000,000 for the making of Loans to the Borrower and the issuance of, and participation in, Letters of Credit for the account of the Borrower, all as contemplated therein (with (i) the Lenders, the Swingline Lender, each Letter of Credit Issuer, the Administrative Agent, the Syndication Agents, the Documentation Agents, the other Agents and the Collateral Agent being herein collectively called the “Lender Creditors” and (ii) the term “Credit Agreement” as used herein to mean the Credit Agreement described above in this paragraph, as the same may be amended, modified, extended, renewed, replaced, restated, supplemented and/or refinanced from time to time, and including any agreement extending the maturity of, or refinancing or restructuring (including, but not limited to, the inclusion of additional borrowers or guarantors thereunder or any increase in the amount borrowed) all or any portion of, the indebtedness under such agreement or any successor agreement, whether or not with the same agent, trustee, representative lenders or holders; provided that, with respect to any agreement providing for the refinancing or replacement of indebtedness under the Credit Agreement, such

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agreement shall only be treated as, or as part of, the Credit Agreement hereunder if (x) either (A) all obligations under the Credit Agreement being refinanced or replaced shall be paid in full at the time of such refinancing or replacement, and all commitments and letters of credit issued pursuant to the refinanced or replaced Credit Agreement shall have terminated in accordance with their terms or (B) the Required Lenders shall have consented in writing to the refinancing or replacement indebtedness being treated as indebtedness pursuant to the Credit Agreement, and (y) a notice to the effect that the refinancing or replacement indebtedness shall be treated as issued under the Credit Agreement shall be delivered by the Borrower to the Collateral Agent);

          WHEREAS, the Borrower and/or one or more of its Subsidiaries has from time to time entered into, and/or may in the future from time to time enter into, one or more agreements or arrangements with JPMCB or any of its affiliates (even if JPMCB ceases to be a Lender under the Credit Agreement for any reason (JPMCB and any such affiliate and their respective successors and assigns, each, a “Credit Card Issuer”)) providing for credit card loans to be made available to certain employees of the Borrower and/or one or more of its Subsidiaries (each such agreement or arrangement with a Credit Card Issuer, a “Secured Credit Card Agreement”);

          WHEREAS, the Borrower and/or one or more of its Subsidiaries has from time to time entered into, and or may in the future from time to time enter into or guarantee one or more (i) interest rate protection agreements (including, without limitation, interest rate swaps, caps, floors, collars and similar agreements), and/or (ii) foreign exchange contracts, currency swap agreements, commodity agreements or other similar agreements or arrangements designed to protect against the fluctuations in currency or commodity values (each such agreement or arrangement with a Hedging Creditor (as hereinafter defined), together with the Existing Interest Rate Swap Agreement, a “Secured Hedging Agreement”), with any Lender, any affiliate thereof or a syndicate of financial institutions organized by a Lender or an affiliate of a Lender (even if any such Lender ceases to be a Lender under the Credit Agreement for any reason) (any such Lender, affiliate or other such financial institution that participates therein, together with Calyon (as counterparty to the Existing Interest Rate Swap Agreement), and in each case their subsequent successors and assigns, collectively, the “Hedging Creditors”, and together with the Lender Creditors and each Credit Card Issuer, the “Lender Secured Creditors”);

          WHEREAS, R. J. Reynolds Tobacco Holdings, Inc., a Wholly-Owned Subsidiary of the Borrower (“RJRTH”) and the Existing Senior Notes Trustee, on behalf of the holders of the Existing Senior Notes, have entered into the Existing Senior Notes Indenture, providing for the issuance of Existing Senior Notes by RJRTH;

          WHEREAS, the Borrower and the New Senior Notes Trustee, on behalf of the holders of the New Senior Notes, have entered into the New Senior Notes Indenture, providing for the issuance of New Senior Notes by the Borrower;

          WHEREAS, the Borrower and the Refinancing Senior Notes Trustee, on behalf of the holders of the Refinancing Senior Notes, may from time to time enter into the Refinancing Senior Notes Indenture, providing for the issuance of Refinancing Senior Notes by the Borrower, providing for the issuance from time to time of Refinancing Senior Notes by the Borrower;

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          WHEREAS, the Trustor is the owner of fee simple title to the Trust Property (as hereinafter defined), subject to Permitted Liens;

          WHEREAS, pursuant to the Subsidiary Guaranty, the Trustor has (together with the other Subsidiaries of the Borrower party thereto) jointly and severally guaranteed to the Lender Secured Creditors the payment when due of the Guaranteed Obligations (as and to the extent defined in the Subsidiary Guaranty);

          WHEREAS, the Trustor has guaranteed to the Existing Senior Notes Creditors the payment when due of principal, premium (if any) and interest on the Existing Senior Notes;

          WHEREAS, the Trustor has guaranteed to the New Senior Notes Creditors the payment when due of principal, premium (if any) and interest on the New Senior Notes;

          WHEREAS, the Trustor may from time to time guarantee to the Refinancing Senior Notes Creditors the payment when due of principal, premium (if any) and interest on the Refinancing Senior Notes;

          WHEREAS, the Credit Agreement requires this Deed of Trust be executed and delivered to the Beneficiary by the Trustor and the Secured Hedging Agreements, the Secured Credit Card Agreements, the Existing Senior Notes Indenture and the New Senior Notes Indenture, require that this Deed of Trust secure the respective Obligations as provided herein; and

          WHEREAS, the Trustor desires to execute and deliver this Deed of Trust in order to satisfy the condition in the preceding paragraph and to secure (and this Deed of Trust shall secure) the following:

     (i) the full and prompt payment when due (whether at the stated maturity, by acceleration or otherwise) of all obligations (including obligations which, but for the automatic stay under Section 362(a) of the Bankruptcy Code, would become due) and liabilities of the Trustor, now existing or hereafter incurred under, arising out of or in connection with any Credit Document to which the Trustor is a party (including, without limitation, indemnities, fees and interest (including all interest that accrues after the commencement of any case, proceeding or other action relating to the bankruptcy, insolvency, reorganization or similar proceeding of the Borrower or any other Credit Party at the rate provided for in the respective documentation, whether or not a claim for post-petition interest is allowed in any such proceeding)) and the due performance of and compliance by the Trustor with the terms of each such Credit Document (all such obligations and liabilities under this clause (i), except to the extent consisting of obligations or liabilities with respect to Secured Hedging Agreements, being herein collectively called the “Credit Document Obligations”);

     (ii) the full and prompt payment when due (whether at the stated maturity, by acceleration or otherwise) of all obligations (including obligations which, but for the automatic stay under Section 362(a) of the Bankruptcy Code, would become due) and liabilities of the Trustor, now existing or hereafter incurred under, arising out of or in connection with each Secured Credit Card Agreement (including, all obligations, if any,

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of the Trustor under the Subsidiary Guaranty in respect of any Secured Credit Card Agreement), and all interest that accrues after the commencement of any case, proceeding or other action relating to the bankruptcy, insolvency, reorganization or similar proceeding of the Borrower or any other Credit Party at the rate provided for in the respective documentation, whether or not a claim for post-petition interest is allowed in any such proceeding (all such obligations and liabilities under this clause (ii) being herein collectively called the “Credit Card Obligations”);

     (iii) the full and prompt payment when due (whether at the stated maturity, by acceleration or otherwise) of all obligations (including obligations which, but for the automatic stay under Section 362(a) of the Bankruptcy Code, would become due) and liabilities of the Trustor, now existing or hereafter incurred under, arising out of or in connection with each Secured Hedging Agreement (including, all obligations, if any, of the Trustor under the Subsidiary Guaranty in respect of any Secured Hedging Agreement), and all interest that accrues after the commencement of any case, proceeding or other action relating to the bankruptcy, insolvency, reorganization or similar proceeding of the Borrower or any other Credit Party at the rate provided for in the respective documentation, whether or not a claim for post-petition interest is allowed in any such proceeding (all such obligations and liabilities under this clause (iii) being herein collectively called the “Hedging Obligations”);

     (iv) the full and prompt payment when due (whether at the stated maturity, by acceleration or otherwise) of all obligations (including obligations which, but for the automatic stay under Section 362(a) of the Bankruptcy Code, would become due) and liabilities of the Trustor, now existing or hereinafter incurred under, arising out of or in connection with each Existing Senior Notes Document to which it is a party (including all interest that accrues after the commencement of any case, proceeding or other action relating to the bankruptcy, insolvency, reorganization or similar proceeding of the Borrower or any other Credit Party at the rate provided for in the respective documentation, whether or not a claim for post-petition interest is allowed in any such proceeding) and the due performance and compliance by the Trustor with the terms of each such Existing Senior Notes Document (all such obligations and liabilities under this clause (iv) being herein collectively called the “Existing Senior Notes Obligations”);

     (v) the full and prompt payment when due (whether at the stated maturity, by acceleration or otherwise) of all obligations (including obligations which, but for the automatic stay under Section 362(a) of the Bankruptcy Code, would become due) and liabilities of the Trustor, now existing or hereinafter incurred under, arising out of or in connection with each New Senior Notes Document to which it is a party (including all interest that accrues after the commencement of any case, proceeding or other action relating to the bankruptcy, insolvency, reorganization or similar proceeding of the Borrower or any other Credit Party at the rate provided for in the respective documentation, whether or not a claim for post-petition interest is allowed in any such proceeding) and the due performance and compliance by the Trustor with the terms of each such New Senior Notes Document (all such obligations and liabilities under this clause (v) being herein collectively called the “New Senior Notes Obligations”);

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     (vi) the full and prompt payment when due (whether at the stated maturity, by acceleration or otherwise) of all obligations (including obligations which, but for the automatic stay under Section 362(a) of the Bankruptcy Code, would become due) and liabilities of the Trustor now existing or hereinafter incurred under, arising out of or in connection with each Refinancing Senior Notes Document to which it is a party (including all interest that accrues after the commencement of any case, proceeding or other action relating to the bankruptcy, insolvency, reorganization or similar proceeding of the Borrower or any other Credit Party at the rate provided for in the respective documentation, whether or not a claim for post-petition interest is allowed in any such proceeding) and the due performance and compliance by the Trustor with the terms of each such Refinancing Senior Notes Document (all such obligations and liabilities under this clause (vi) being herein collectively called the “Refinancing Senior Notes Obligations” and together with the New Senior Notes Obligations, the “RAI Senior Notes Obligations”);

     (vii) any and all sums advanced by the Beneficiary in order to preserve the Trust Property or preserve its lien and security interest in the Trust Property;

     (viii) in the event of any proceeding for the collection or enforcement of any indebtedness, obligations, or liabilities of the Trustor and/or the Borrower referred to above after an Event of Default (as hereinafter defined) shall have occurred and be continuing, all expenses of re-taking, holding, preparing for sale or lease, selling or otherwise disposing of or realizing on the Trust Property, or of any exercise by the Beneficiary of its rights hereunder, together with reasonable attorneys’ fees and disbursements (as set forth in Section 4.09 hereof) and court costs;

     (ix) all amounts paid by any Indemnitee as to which such Indemnitee has the right to reimbursement under Section 4.10 hereof;

     (x) any and all other indebtedness now owing or which may hereafter be owing by the Trustor to the Beneficiary, however and whenever incurred or evidenced, whether express or implied, direct or indirect, absolute or contingent, or due or to become due; and

     (xi) any and all renewals, extensions and modifications of any of the obligations and liabilities referred to in clauses (i) through (ix) above;

all such obligations, liabilities, sums and expenses set forth in clauses (i) through (xi) above being herein collectively called the “Obligations”, provided that notwithstanding the foregoing, (i) the Existing Senior Notes Obligations shall be excluded from the Obligations, to the extent the Existing Senior Notes Documents do not require the Existing Senior Notes Obligations to be secured pursuant to this Deed of Trust, (ii) the New Senior Notes Obligations shall be excluded from the Obligations, to the extent the New Senior Notes Documents do not require the New Senior Notes Obligations to be secured pursuant to this Deed of Trust and (iii) the Refinancing Senior Notes Obligations shall be excluded from the Obligations, to the extent the Refinancing Senior Notes Documents do not require the Refinancing Senior Notes Obligations to be secured pursuant to this Deed of Trust. Interest accrues on certain of the Obligations at a variable rate.

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          NOW, THEREFORE, as security for its Applicable Obligations (as defined below) and in consideration of the sum of ten dollars ($10.00) and the other benefits accruing to the Trustor, the receipt and sufficiency of which are hereby acknowledged, THE TRUSTOR HEREBY MORTGAGES, GIVES, GRANTS, BARGAINS, SELLS, CONVEYS AND CONFIRMS TO THE TRUSTEE FOR THE BENEFIT OF THE BENEFICIARY AND (WITH RESPECT TO THE PERSONAL PROPERTY) TO THE BENEFICIARY AND THEIR SUCCESSORS AND ASSIGNS FOREVER, TOGETHER WITH POWER OF SALE (subject to applicable law) all of the Trustor’s estate, right, title and interest, whether now owned or hereafter acquired, whether as lessor or lessee and whether vested or contingent, in and to all of the following:

          A. The land described in Exhibit A hereto, together with all rights, privileges, franchises and powers related thereto which are appurtenant to said land or its ownership, including all minerals, oil and gas and other hydrocarbon substances thereon or therein; waters, water courses, water stock, water rights (whether riparian, appropriative, or otherwise, and whether or not appurtenant), sewer rights, shrubs, crops, trees, timber and other emblements now or hereafter on, under or above the same or any part or parcel thereof (the “Land”);

          B. All buildings, structures, tenant improvements and other improvements of every kind and description now or hereafter located in or on the Land, including, but not limited to all machine shops, structures, improvements, rail spurs, dams, reservoirs, water, sanitary and storm sewers, drainage, electricity, steam, gas, telephone and other utility facilities, parking areas, roads, driveways, walks and other site improvements of every kind and description now or hereafter erected or placed on the Land; and all additions and betterments thereto and all renewals, alterations, substitutions and replacements thereof (collectively, the “Improvements”);

          C. All fixtures, attachments, appliances, equipment, machinery, building materials and supplies, and other tangible personal property, now or hereafter attached to said Improvements or now or at any time hereafter located on the Land and/or Improvements including, but not limited to, artwork, decorations, draperies, furnaces, boilers, oil burners, piping, plumbing, refrigeration, air conditioning, lighting, ventilation, disposal and sprinkler systems, elevators, motors, dynamos and all other equipment and machinery, appliances, fittings and fixtures of every kind located in or used in the operation of the Improvements, together with any and all replacements or substitutions thereof and additions thereto, including the proceeds of any sale or transfer of the foregoing (hereinafter sometimes collectively referred to as the “Equipment”);

          D. All surface rights, appurtenant rights and easements, rights of way, and other rights appurtenant to the use and enjoyment of or used in connection with the Land and/or the Improvements;

          E. All streets, roads and public places (whether open or proposed) now or hereafter adjoining or otherwise providing access to the Land, the land lying in the bed of such streets, roads and public places, and all other sidewalks, alleys, ways, passages, vaults, water courses, strips and gores of land now or hereafter adjoining or used or intended to be used in connection with all or any part of the Land and/or the Improvements;

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          F. Any leases, lease guaranties and any other agreements, relating to the use and occupancy of the Land and/or the Improvements or any portion thereof, including but not limited to any use or occupancy arrangements created pursuant to Section 365(h) of he Bankruptcy Code or otherwise in connection with the commencement or continuance of any bankruptcy, reorganization, arrangement, insolvency, dissolution, receivership or similar proceedings, or any assignment for the benefit of creditors, in respect of any tenant or occupant of any portion of the Land and/or the Improvements (collectively, “Leases”);

          G. All revenues, rents, receipts, income, accounts receivable, issues and profits of the Trust Property (collectively, “Rents”);

          H. To the extent assignable, all permits, licenses and rights relating to the use, occupation and operation of the Land and the Improvements, any business conducted thereon or therein and any part thereof;

          I. All real estate tax refunds payable to the Trustor with respect to the Land and/or the Improvements, and refunds, credits or reimbursements payable with respect to bonds, escrow accounts or other sums payable in connection with the use, development, or ownership of the Land or Improvements;

          J. Any claims or demands with respect to any proceeds of insurance in effect with respect to the Land and/or the Improvements, including interest thereon, which the Trustor now has or may hereafter acquire and any and all awards made for the taking by eminent domain, condemnation or by any proceedings, transfer or purchase in lieu or in anticipation of the exercise of said rights, or for a change of grade, or for any other injury to or decrease in the value of the whole or any part of the Trust Property;

          K. Any zoning lot agreements and air rights and development rights which may be vested in the Trustor together with any additional air rights or development rights which have been or may hereafter be conveyed to or become vested in the Trustor; and

          L. All proceeds and products of the conversion, voluntary or involuntary, including, without limitation, those from sale, exchange, transfer, collection, loss, damage, disposition, substitution or replacement of any of the foregoing; whether into cash, liquidated claims or otherwise.

All of the foregoing estates, right, properties and interests hereby conveyed to the Beneficiary may be referred to herein as the “Trust Property”. Notwithstanding the foregoing, (x) the Trust Property that secures the Existing Senior Notes Obligations shall be limited to Trust Property consisting of any Principal Property (as defined in the Existing Senior Notes Indenture (in each case as in effect on the date hereof)) of the Trustor (the “Designated Existing Senior Notes Trust Property”), all of which Trust Property shall also ratably secure all other Applicable Obligations of the Trustor, and the Trust Property Proceeds (as defined in Section 4.04(a)) that are to be applied to the Existing Senior Notes Obligations shall be limited to Trust Property Proceeds resulting from the sale of, and Rents and other amounts generated by the holding, leasing, management, operation or other use pursuant to this Deed of Trust of, the Designated Existing Senior Notes Trust Property, with such Trust Property Proceeds to also be applied ratably to all

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other Applicable Obligations of the Trustor and (y) the Trust Property that secures the RAI Senior Notes Obligations shall be limited to Trust Property consisting of any Principal Property (as defined in the New Senior Notes Indenture (as in effect on the date hereof) or the Refinancing Senior Notes Indenture) of the Trustor (the “Designated RAI Senior Notes Trust Property”, and together with the Designated Existing Senior Notes Trust Property, the “Limited Trust Property”), all of which Trust Property shall also ratably secure all other Applicable Obligations of the Trustor, and the Trust Property Proceeds (as defined in Section 4.04(a)) that are to be applied to the RAI Senior Notes Obligations shall be limited to Trust Property Proceeds resulting from the sale of, and Rents and other amounts generated by the holding, leasing, management, operation or other use pursuant to this Deed of Trust of, the Designated RAI Senior Notes Trust Property, with such Trust Property Proceeds to also be applied ratably to all other Applicable Obligations of the Trustor.

“Applicable Obligations” shall mean all of the Obligations; provided that (x) the Existing Senior Notes Obligations shall be excluded from the Applicable Obligations of the Trustor to the extent the Existing Senior Notes Documents do not require the Existing Senior Notes Obligations to be secured pursuant to this Deed of Trust, (y) the New Senior Notes Obligations shall be excluded from the Applicable Obligations of the Trustor to the extent the New Senior Notes Documents do not require the New Senior Notes Obligations to be secured pursuant to this Deed of Trust, and (z) the Refinancing Senior Notes Obligations shall be excluded from the Applicable Obligations of the Trustor to the extent the Refinancing Senior Notes Documents do not require the Refinancing Senior Notes Obligations to be secured pursuant to this Agreement.

          TO HAVE AND TO HOLD the above granted and described Trust Property unto the Trustee for the benefit of the Beneficiary and to their successors and assigns forever, and the Trustor hereby covenants and agrees on behalf of itself and its successors and assigns to warrant and defend the Trust Property unto the Trustee for the benefit of the Beneficiary, their successors and assigns forever against the claim or claims of all persons and parties whatsoever.

          PROVIDED, HOWEVER, that if Obligations shall have been paid in cash at the time and in the manner stipulated in the Secured Debt Agreements and all other sums payable hereunder and all other indebtedness secured hereby shall have been paid and all other covenants contained in the Secured Debt Agreements (as defined below) shall have been performed, then, in such case the Beneficiary shall, subject to the provisions of Section 6.19 of this Deed of Trust, at the request and expense of the Trustor, satisfy this Deed of Trust (without recourse and without any representation or warranty) and the estate, right, title and interest of the Trustee and the Beneficiary in the Trust Property shall cease, and the Beneficiary shall release this Deed of Trust and the lien hereof by proper instrument.

ARTICLE I

REPRESENTATIONS, WARRANTIES, COVENANTS

          1.01 Title to this Property. The Trustor represents and warrants: (a) it has good and marketable fee title to the Trust Property, free and clear of any liens and encumbrances, other than Liens permitted under Section 8.03 of the Credit Agreement (or, after the CA

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Termination Date (as defined below), the Credit Agreement as in effect immediately prior to the occurrence of the CA Termination Date) and any other easements, rights and claims of record (collectively “Permitted Liens”), and is lawfully seized and possessed of the Trust Property; (b) this Deed of Trust is a valid first priority lien upon the Trust Property subject to the Permitted Liens; (c) it has full power and authority to encumber the Trust Property in the manner set forth herein; and (d) there are no defenses or offsets to this Deed of Trust or to the Obligations which it secures. The Trustor shall preserve such title and the validity and priority of this Deed of Trust and shall forever warrant and defend the same to the Beneficiary and the Beneficiary’s successors and assigns against the claims of all persons and parties whatsoever. The Trustor shall take no action nor shall it fail to take any action which could result in an impairment of the lien of this Deed of Trust or which could form the basis for any Person(s) to claim an interest in the Trust Property (including, without limitation, any claim for adverse use or possession or any implied dedication or easement by prescription other than leases permitted under the Credit Agreement). If any Lien (other than Permitted Liens) is asserted against the Trust Property, the Trustor shall promptly, at its expense: (a) provide the Beneficiary with written notice of such Lien, including information relating to the amount of the Lien asserted; and (b) pay the Lien in full or take such other action to cause the Lien to be released, or, so long as the Lien of this Deed of Trust is not compromised, contest the same pursuant to the provisions of the Credit Agreement. From and after the occurrence of an Event of Default, the Beneficiary may, but shall not be obligated, to pay any such asserted Lien if not timely paid by the Trustor.

          1.02 Compliance with Law. The Trustor represents and warrants that it possesses all material certificates, licenses, authorizations, registrations, permits and/or approvals necessary for the ownership, operation, leasing and management of the Trust Property, including, without limitation, all material environmental permits, all of which are in full force and effect and not the subject of any revocation proceeding, undisclosed amendment, release, suspension, forfeiture or the like. The present and contemplated use and occupancy of the Trust Property does not conflict with or violate any such certificate, license, authorization, registration, permit or approval, including, without limitation, any certificate of occupancy which may have been issued for the Trust Property. The Trustor will not take any action, or fail to take any required action, so as to compromise or adversely affect the zoning classification of the Trust Property.

          1.03 Payment and Performance of Obligations. Subject to the terms of the Secured Debt Agreements, the Trustor shall pay all of the Obligations when due and payable without offset or counterclaim, and shall observe and comply in all material respects with all of the terms, provisions, conditions, covenants and agreements to be observed and performed by it under this Deed of Trust, the other Credit Documents to which it is a party, the Secured Credit Card Agreements, the Secured Hedging Agreements, the Existing Senior Notes Documents, the New Senior Notes Documents and the Refinancing Senior Notes Documents (collectively, the “Secured Debt Agreements”).

          1.04 Maintenance, Repair, Alterations, Etc. The Trustor will: (i) keep and maintain the Trust Property, to the extent used in Trustor’s day to day business, in good condition and repair (normal wear and tear excepted); (ii) make or cause to be made, as and when necessary, all material repairs, renewals and replacements, structural and nonstructural, exterior and interior, ordinary and extraordinary, foreseen and unforeseen which are necessary to so maintain the Trust Property in Trustor’s reasonable business judgment; (iii) restore any Improvement, to the extent

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used in Trustor’s day to day business, which may be damaged or destroyed so that the same shall be at least substantially equal to its value, condition and character immediately prior to the damage or destruction; (iv) not commit or permit any waste or deterioration (normal wear and tear excepted) of the Trust Property, to the extent used in Trustor’s day to day business; (v) not permit any material Improvements, to the extent used in Trustor’s day to day business, to be demolished or substantially altered in any manner that substantially decreases the value thereof; (vi) promptly pay when due all claims for labor performed and materials furnished therefor or contest such claim and; (vii) comply with all applicable statutes, regulations and orders of, and all applicable restrictions imposed by, all governmental authorities having jurisdiction over the Trust Property, as well as comply with the provisions of any lease, easement or other agreement affecting all or any part of the Trust Property.

          1.05 Required Insurance; Use of Proceeds. The Trustor will, at its expense, at all times provide, maintain and keep in force policies of property, hazard and liability insurance in accordance with Section 7.03 of the Credit Agreement with respect to the Trust Property, together with statutory workers’ compensation insurance with respect to any work to be performed on or about the Trust Property. To the extent required under the Credit Agreement, the Trustor shall give prompt written notice to the Beneficiary of the occurrence of any material damage to or material destruction of the Improvements or the Equipment. In the event of any damage to or destruction of the Trust Property or any part thereof, so long as a Noticed Event of Default (as defined in Section 3.03(a) hereof) has not occurred and is not continuing the Trustee and Beneficiary will release any interest they have in the proceeds of any insurance to the Trustor on account of such damage or destruction and Trustor may use such proceeds for repair restoration replacement or other business purposes as Trustor may reasonably determine. In the event of foreclosure of the Lien of this Deed of Trust or other transfer of title or assignment of the Trust Property in extinguishment, in whole or in part, of the Obligations, all right, title and interest of the Trustor in and to all proceeds then payable under any policy of insurance required by this Deed of Trust shall inure to the benefit of and pass to the successor in interest of the Trustor, or the purchaser or mortgagor of the Trust Property. After the occurrence of an Event of Default, the Beneficiary shall be afforded the right to participate in and approve the settlement of any claim made by the Trustor against the insurance company.

          1.06 Preservation of Property. The Trustor agrees to pay for any and all reasonable and actual fees, costs and expenses of whatever kind or nature incurred in connection with the creation, preservation or protection of the Beneficiary’s liens on, and security interest in, the Trust Property, including, without limitation, all fees and taxes in connection with the recording or filing of instruments and documents in public offices (including stamp and mortgage recording taxes or other taxes imposed on the Beneficiary by virtue of its ownership of this Deed of Trust), which are imposed upon the recording of this Deed of Trust or thereafter, all reasonable attorneys’ fees, payment or discharge of any taxes or Liens upon or in respect of the Trust Property, premiums for insurance with respect to the Trust Property and all other reasonable fees, costs and expenses in connection with protecting, maintaining or preserving the Trust Property and the Trustee’s and the Beneficiary’s interest therein, whether through judicial proceedings or otherwise, or in defending or prosecuting any actions, suits or proceedings arising out of or relating to the Trust Property.

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          1.07 Condemnation. Should the Trustor receive any notice that a material portion of the Trust Property or interest therein may be taken or damaged by reason of any public improvements or condemnation proceeding or in any other similar manner (a “Condemnation”), the Trustor, to the extent required under the Credit Agreement, shall give prompt written notice thereof to the Beneficiary. In the event of any Condemnation, after the occurrence and during the continuation of any Event of Default, the Beneficiary shall have the right to participate in any negotiations or litigation and shall have the right to approve any settlement. So long as no Noticed Event of Default has occurred and is continuing, the Trustee and Beneficiary will release any interest they have in any and all compensation, awards, damages and proceeds paid to the Trustor or the Borrower on account of such Condemnation and Trustor may use such compensation awards, damages and proceeds for repair, restoration, replacement or other business purposes as Trustor may reasonably determine.

          1.08 Inspections. The Trustor hereby authorizes the Beneficiary, its agents, employees and representatives, upon reasonable prior written notice to the Trustor (except in an emergency or following the occurrence and during the continuance of any Event of Default, in which case notice shall not be required) to visit and inspect the Trust Property or any portion(s) thereof, all at such reasonable times and as often as the Beneficiary may reasonably request.

          1.09 Transfers. Except as otherwise permitted in accordance with the terms of the Credit Agreement, no part of the Trust Property or of any legal or beneficial interest in the Trust Property shall be sold, assigned, conveyed, transferred or otherwise disposed of (whether voluntarily or involuntarily, directly or indirectly, by sale of stock or any interest in the Trustor, or by operation of law or otherwise).

          1.10 After Acquired Property Interests. Subject to applicable law, all right, title and interest of the Trustor in and to all extensions, improvements, betterments, renewals, substitutes and replacements of, and all additions and appurtenances to, the Trust Property, hereafter acquired by, or released to, the Trustor or constructed, assembled or placed by the Trustor on the Land, and all conversions of the security constituted thereby (collectively, “After Acquired Property Interests”), immediately upon such acquisition, release, construction, assembling, placement or conversion, as the case may be, and in each such case, without any further mortgage, conveyance, assignment or other act by the Trustor, shall become subject to the lien of this Deed of Trust as fully and completely, and with the same effect, as though now owned by the Trustor and specifically described in the granting clauses hereof. The Trustor shall execute and deliver to the Beneficiary all such other assurances, mortgages, conveyances or assignments thereof as the Beneficiary may reasonably require for the purpose of expressly and specifically subjecting such After Acquired Property Interests to the lien of this Deed of Trust. The Trustor hereby irrevocably authorizes and appoints the Beneficiary as the agent and attorney-in-fact of the Trustor to execute all such documents and instruments on behalf of the Trustor, which appointment shall be irrevocable and coupled with an interest, if the Trustor fails or refuses to do so within ten (10) days after a request therefor by the Beneficiary.

ARTICLE II

SECURITY AGREEMENT

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          2.01 Grant of Security; Incorporation by Reference. This Deed of Trust shall, in addition to constituting a mortgage lien on those portions of the Trust Property classified as real property (including fixtures to the extent they are real property), constitute a security agreement within the meaning of the Uniform Commercial Code or within the meaning of the common law with respect to those parts of the Trust Property classified as personal property (including fixtures to the extent they are personal property) to the extent a security interest therein can be created by this Deed of Trust. The Trustor hereby grants to the Beneficiary a security interest in and to the following property whether now owned or hereafter acquired (collectively, the “Secured Property”) for the benefit of the Beneficiary to further secure the payment and performance of its Applicable Obligations:

     (a) Those parts of the Trust Property classified as personal property (including (i) fixtures to the extent they are personal property and (ii) personal property and fixtures that are leased, but only to the extent the Trustor can grant to the Beneficiary a security interest therein without breaching the terms of such lease);

     (b) All general intangibles, contract rights, accounts and proceeds arising from all insurance policies required to be maintained by the Trustor and related to the Trust Property hereunder;

     (c) All proceeds of any judgment, award or settlement in any condemnation or eminent domain proceeding in connection with the Trust Property, together with all general intangibles, contract rights and accounts arising therefrom;

     (d) All permits, consents and other governmental approvals in connection with the construction of the Improvements or the operation of the Trust Property, to the extent any of the same may be assigned, transferred, pledged or subjected to a security interest;

     (e) All plans and specifications, studies, tests or design materials relating to the design, construction, repair, alteration or leasing of the Trust Property, to the extent any of the same may be assigned, transferred, pledged or subjected to a security interest; and

     (f) All cash and non-cash proceeds of the above-mentioned items.

; provided that notwithstanding the foregoing, Secured Property securing Existing Senior Notes Obligations and RAI Senior Notes Obligations shall be limited to Limited Trust Property, as the case may be.

          The provisions contained in the Security Agreement are hereby incorporated by reference into this Deed of Trust with the same effect as if set forth in full herein. In the event of a conflict between the provisions of this Article II and the Security Agreement, the Security Agreement shall control and govern and the Trustor shall comply therewith.

          2.02 Fixture Filing and Financing Statements. This Deed of Trust constitutes a security agreement, fixture filing and financing statement as those terms are used in the Uniform Commercial Code. For purposes of this Section, this Deed of Trust is to be filed and recorded in,

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among other places, the real estate records of the County in which the Trust Property is located and the following information is included: (1) the Trustor shall be deemed the “Debtor” with the address set forth for the Trustor on the first page of this Deed of Trust which the Trustor certifies is accurate; (2) the Beneficiary shall be deemed to be the “Secured Party” with the address set forth for the Beneficiary on the first page of this Deed of Trust and shall have all of the rights of a secured party under the Uniform Commercial Code; (3) this Deed of Trust covers goods which are or are to become fixtures on the real property described in Exhibit A attached hereto; (4) the name of the record owner of the land is the Trustor; (5) the organizational identification number of Conwood Company L.P. is DE2678324; (6) Conwood Company L.P. is a limited partnership, organized under the laws of the State of Delaware; and (7) the legal name of the Debtor is Conwood Company, L.P. The Debtor hereby authorizes the Beneficiary to file any financing statements and terminations thereof or amendments or modifications thereto without the signature of the Debtor where permitted by law.

ARTICLE III

ASSIGNMENT OF LEASES, RENTS AND PROFITS

          3.01 Assignment. The Trustor hereby absolutely, irrevocably and unconditionally sells, assigns, transfers and conveys to the Beneficiary all of the Trustor’s right, title and interest in and to all current and future Leases and Rents, including those now due, past due, or to become due by virtue of any Lease or other agreement for the occupancy or use of all or any part of the Trust Property regardless of to whom the Rents are payable. The Trustor intends that this assignment of Leases and Rents constitutes a present and absolute assignment and not an assignment for additional security only. Such assignment to the Beneficiary shall not be construed to bind the Beneficiary to the performance of any of the covenants, conditions or provisions contained in any such Lease or otherwise impose any obligation upon the Beneficiary. The Trustor covenants that the Trustor will not hereafter collect or accept payment of any Rents more than one month prior to the due dates of such Rents, and that no payment of any of the Rents to accrue for any portion of the Trust Property (other than a de minimis amount) will be waived, released, reduced, discounted or otherwise discharged or compromised by the Trustor, except as may be approved in writing by the Beneficiary. The Trustor agrees that it will not assign any of the Leases or Rents to any other Person. The Beneficiary shall have no liability for any loss which may arise from a failure or inability to collect Rents, proceeds or other payments. The Trustor shall maintain all security deposits in accordance with applicable law.

          3.02 Revocable License; Agent. Notwithstanding the foregoing, subject to the terms of this Article III, the Beneficiary grants to the Trustor a revocable license to operate and manage the Trust Property and to collect the Rents and hereby directs each tenant under a Lease to pay such Rents to, or at the direction of, the Trustor, until such time as the Beneficiary provides notice to the contrary to such tenants. The Trustor shall hold the Rents, or a portion thereof sufficient to discharge all current sums due in respect of the Obligations, in trust for the benefit of the Beneficiary for use in the payment of such sums.

          3.03 Rents. (a) Upon the occurrence and during the continuance of a Noticed Event of Default, without the need for notice or demand, the license granted pursuant to this

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Article III shall immediately and automatically be revoked and the Beneficiary shall immediately be entitled to possession of all Rents, whether or not the Beneficiary enters upon or takes control of the Trust Property. Upon the revocation of such license, the Trustor grants to the Beneficiary the right, at its option, to exercise all the rights granted in Section 4.02(a). Nothing herein contained shall be construed as constituting the Beneficiary a trustee in possession in the absence of the taking of actual possession of the Trust Property by the Beneficiary pursuant to Section 4.02(a). As used herein, a “Noticed Event of Default” shall mean (i) an Event of Default with respect to the Borrower under Section 9.05 of the Credit Agreement and (ii) any other Event of Default in respect of which the Beneficiary has given the Borrower notice that such Event of Default constitutes a “Noticed Event of Default”.

          (b) From and after the termination of such license, the Trustor may, at the Beneficiary’s direction, be the agent for the Beneficiary in collection of the Rents and all of the Rents so collected by the Trustor shall be held in trust by the Trustor for the sole and exclusive benefit of the Beneficiary and the Trustor shall, within one (1) business day after receipt of any Rents, pay the same to the Beneficiary to be applied by the Beneficiary as provided for herein. All Rents collected shall be applied against all expenses of collection, including, without limitation, attorneys’ fees, against costs of operation and management of the Trust Property and against the Obligations, in whatever order or priority as to any of the items so mentioned as the Beneficiary directs in its sole and absolute discretion and without regard to the adequacy of its security. Neither the demand for or collection of Rents by the Beneficiary shall constitute any assumption by the Beneficiary of any obligations under any Lease or agreement relating thereto.

          (c) Any reasonable funds expended by the Beneficiary to take control of and manage the Trust Property and collect the Rents shall become part of the Obligations secured hereby. Such amounts shall be payable from the Trustor to the Beneficiary upon the Beneficiary’s demand therefor and shall bear interest from the date of disbursement at the interest rate set forth in Section 1.08(c) of the Credit Agreement unless payment of interest at such rate would be contrary to applicable law, in which event such amounts shall bear interest at the highest rate which may be collected from the Trustor under applicable law.

          3.04 Sale of Trust Property. (a) Upon any sale of any portion of the Trust Property by or for the benefit of the Beneficiary pursuant to this Deed of Trust, the Rents attributable to the part of the Trust Property so sold shall be included in such sale and shall pass to the purchaser free and clear of any rights granted herein to the Trustor.

          (b) The Trustor acknowledges and agrees that, upon recordation of this Deed of Trust, the Beneficiary’s interest in the Rents shall be deemed to be fully perfected, “choate” and enforceable against the Trustor and all third parties, including, without limitation, any debtor in possession or trustee in any case under title 11 of the United States Code, without the necessity of (i) commencing a foreclosure action with respect to this Deed of Trust, (ii) furnishing notice to the Trustor or tenants under the Leases, (iii) making formal demand for the Rents, (iv) taking possession of the Trust Property as a lender-in-possession, (v) obtaining the appointment of a receiver of the Rents, (vi) sequestering or impounding the Rents or (vii) taking any other affirmative action.

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          3.05 Bankruptcy Provisions. Without limiting the provisions of Article III hereof or the absolute nature of the assignment of the Rents hereunder, the Trustor and the Beneficiary agree that, to the extent that the assignment of the Rents hereunder is deemed to be other than an absolute assignment, (a) this Deed of Trust shall constitute a “security agreement” for purposes of Section 552(b) of the Bankruptcy Code, (b) the security interest created by this Deed of Trust extends to property of the Trustor acquired before the commencement of a bankruptcy case and to all amounts paid as Rents and (c) such security interest shall extend to all Rents acquired by the estate after the commencement of any bankruptcy case. Without limitation of the absolute nature of the assignment of the Rents hereunder, to the extent the Trustor (or the Trustor’s bankruptcy estate) shall be deemed to hold any interest in the Rents after the commencement of a voluntary or involuntary bankruptcy case, the Trustor hereby acknowledges and agrees that such Rents are and shall be deemed to be “cash collateral” under Section 363 of the Bankruptcy Code.

ARTICLE IV

EVENTS OF DEFAULT AND REMEDIES

          4.01 Events of Default. The occurrence of (i) an “Event of Default” under and as defined in the Credit Agreement, (ii) any “event of default” under the Existing Senior Notes Documents, the New Senior Notes Documents or the Refinancing Senior Notes Documents and (iii) any payment default, after any applicable grace period, under any Secured Credit Card Agreement or any Secured Hedging Agreement shall constitute an Event of Default (each, an “Event of Default”) hereunder.

          4.02 Remedies Upon Default. Upon the occurrence of a Noticed Event of Default, the Beneficiary may, in the Beneficiary’s sole discretion, either itself or by or through the Trustee, a nominee, assignee or otherwise, to the fullest extent permitted by law, exercise any or all of the following rights and remedies individually, collectively or cumulatively:

     (a) either in person or by its agent, with or without bringing any action or proceeding, or by a receiver appointed by a court and without regard to the adequacy of its security, (i) enter upon and take possession of the Trust Property or any part thereof and of all books, records and accounts relating thereto or located thereon, in its own name or in the name of the Trustor, and do or cause to be done any acts which it deems necessary or desirable to preserve the value of the Trust Property or any part thereof or interest therein, collect the income therefrom or protect the security hereof; (ii) with or without taking possession of the Trust Property make such repairs, alterations, additions and improvements as the Beneficiary deems necessary or desirable and do any and all acts and perform any and all work which the Beneficiary deems necessary or desirable to complete any unfinished construction on the Trust Property; (iii) make, cancel or modify Leases and sue for or otherwise collect the Rents thereof, including those past due and unpaid; (iv) make any payment or perform any act which the Trustor has failed to make or perform hereunder; (v) appear in and defend any action or proceeding purporting to affect the security hereof or the rights or powers of the Beneficiary or the Trustee; (vi) pay, purchase, contest or compromise any encumbrance, charge or Lien on the Trust

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Property; and (vii) take such other actions as the Beneficiary deems necessary or desirable;

     (b) commence and maintain one or more actions at law or in equity or by any other appropriate remedy (i) to protect and enforce the rights of the Beneficiary or the Trustee hereunder, including for the specific performance of any covenant or agreement herein contained (which covenants and agreements the Trustor agrees shall be specifically enforceable by injunctive or other appropriate equitable remedy), (ii) to collect any sum then due hereunder, (iii) to aid in the execution of any power herein granted, or (iv) to foreclose this Deed of Trust in accordance with Section 4.03 hereof;

     (c) exercise any or all of the remedies available to a secured party under the Uniform Commercial Code;

     (d) by notice to the Trustor (to the extent such notice is required to be given under the Credit Documents), but without formal demand, presentment, notice of intention to accelerate or of acceleration, protest or notice of protest, all of which are hereby waived by the Trustor, declare all of the Obligations (except for the Existing Senior Notes Obligations and the RAI Senior Notes Obligations) secured hereby to be immediately due and payable, and upon such declaration all of such indebtedness shall become and be immediately due and payable, anything in this Deed of Trust or any other Credit Documents to the contrary notwithstanding; and

     (e) exercise any other right or remedy available to the Beneficiary under the Secured Debt Agreements.

          4.03 Right of Foreclosure. (a) Upon the occurrence of a Noticed Event of Default, the Beneficiary shall have the right, in its sole discretion, to declare all sums secured hereby immediately due and payable as provided in the Credit Agreement and to instruct the Trustee to foreclose this Deed of Trust with respect to all or any portion of the Trust Property by poser of sale upon such notice and according to such procedures as may be required by law. If the Trust Property consists of several lots, parcels or items of Trust Property, the Beneficiary may, in its sole discretion, to the extent permitted by law, instruct the Trustee to: (i) designate the order in which such lots, parcels or items shall be offered for sale or sold, or (ii) elect to sell such lots, parcels or items through a single sale, or through two or more successive sales, or in any other manner the Beneficiary deems in its best interest. Should the Beneficiary desire that more than one sale or other disposition of the Trust Property be conducted, the Beneficiary may to the extent permitted by law, at its option, instruct the Trustee to cause the same to be conducted simultaneously, or successively, on the same day, or at such different days or times and in such order as the Beneficiary may deem to be in its best interests, and no such sale shall terminate or otherwise affect the lien of this Deed of Trust on any part of the Trust Property not sold until all Obligations have been fully paid and performed. The Beneficiary may elect to sell the Trust Property for cash or credit. The Beneficiary may, to the extent permitted by law, instruct the Trustee to adjourn from time to time any sale by it to be made under or by virtue of this Deed of Trust by announcement at the time and place appointed for such sale or for such adjourned sale or sales; and, except as otherwise provided by an applicable provision of law, the Beneficiary may make such sale at the time and place to which the same shall be so adjourned. With respect

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to all components of the Trust Property, the Beneficiary is hereby irrevocably appointed the true and lawful attorney-in-fact of the Trustor (coupled with an interest), in its name and stead, to make all necessary conveyances, assignments, transfers and deliveries of the Trust Property in connection with any foreclosure of this Deed of Trust, and for that purpose the Beneficiary may execute all necessary instruments of conveyance, assignment, transfer and delivery, and may substitute one or more persons with such power, the Trustor hereby ratifying and confirming all that its said attorney-in-fact or such substitute or substitutes shall lawfully do by virtue hereof. Notwithstanding the foregoing, the Trustor, if so requested by the Beneficiary, shall ratify and confirm any such sale or sales by executing and delivering to the Beneficiary or to such purchaser or purchasers all such instruments as may be advisable, in the judgment of the Beneficiary, for such purpose, and as may be designated in such request. To the extent permitted by law, any such sale or sales made under or by virtue of this Article IV shall operate to divest all the estate, right, title, interest, claim and demand whatsoever, whether at law or in equity, of the Trustor in and to the properties and rights so sold, and shall be a perpetual bar both at law and in equity against the Trustor and against any and all persons claiming or who may claim the same, or any part thereof, from, through or under the Trustor. Upon any sale made under or by virtue of this Article IV, the Beneficiary may, to the extent permitted by law, bid for and acquire the Trust Property or any part thereof and in lieu of paying cash therefor may make settlement for the purchase price by crediting upon the Obligations secured hereby the net sales price after deducting therefrom the expenses of the sale and the cost of the action and any other sums which the Beneficiary is authorized to deduct by law or under this Deed of Trust. Trustor expressly waives the statutory right of redemption under TCA Section 66-8-101. Any sale shall be held at any such location in the county in which the Trust Property is located as the foreclosure notice may specify. The Trustee may retain a professional auctioneer to preside over the bidding and the customary charge for the auctioneer’s services shall be paid from sale proceeds as an expense of sale.

          (b) Any foreclosure of this Deed of Trust and any other transfer of all or any part of the Trust Property in extinguishment of all or any part of the Obligations may, to the extent permitted by law, at the Beneficiary’s option, be subject to any or all Leases of all or any part of the Trust Property and the rights of tenants under such Leases. No failure to make any such tenant a defendant in any foreclosure proceedings or to foreclose or otherwise terminate any such Lease and the rights of any such tenant in connection with any such foreclosure or transfer shall be, or be asserted to be, a defense or hindrance to any such foreclosure or transfer or to any proceedings seeking collection of all or any part of the Obligations (including, without limitation, any deficiency remaining unpaid after completion of any such foreclosure or transfer).

          (c) If the Trustor retains possession of the Trust Property or any part thereof subsequent to a sale, the Trustor will be considered a tenant at sufferance of the purchaser, and will, if the Trustor remains in possession after demand to remove, be guilty of forcible detainer and will be subject to eviction and removal, forcible or otherwise, with or without process of law, and all damages to the Trustor by reason thereof are hereby expressly waived by the Trustor.

          (d) It is agreed and understood that (x) this Deed of Trust may be enforced only by the action of the Beneficiary acting upon the instructions of the Required Lenders or, if the CA Termination Date has occurred, the holders of a majority of the outstanding principal

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amount of all remaining Obligations, provided that if prior to the CA Termination Date a payment default with respect to at least $300,000,000 principal amount in the aggregate of Existing Senior Notes, New Senior Notes and/or Refinancing Senior Notes has continued for at least 180 days (and such defaulted payment has not been received pursuant to a drawing under any letter of credit), the holders of a majority of the outstanding principal amount of the Indebtedness subject to such payment default or defaults can direct the Beneficiary to commence and continue enforcement of the Liens created hereunder, which the Beneficiary shall comply with subject to receiving any indemnity which it reasonably requests, provided further, that the Beneficiary shall thereafter comply only with the directions of the Required Lenders as to carrying out such enforcement so long as such directions are not adverse to the aforesaid directions of the holders of Indebtedness subject to such payment default or defaults, and (y) no other Secured Creditor shall have any right individually to seek to enforce or to enforce this Deed of Trust or to realize upon the security to be granted hereby, it being understood and agreed that such rights and remedies shall be exercised exclusively by the Beneficiary for the benefit of the Secured Creditors as their interest may appear upon the terms of this Deed of Trust and the other Secured Debt Agreements.

          4.04 Application of Proceeds. (a) To the fullest extent permitted by law, the proceeds of any sale of, and the Rents and other amounts generated by the holding, leasing, management, operation or other use of, each item of the Trust Property pursuant to this Deed of Trust (the “Trust Property Proceeds”) shall be applied by the Beneficiary (or the receiver, if one is appointed) as follows:

          (i) first, to the payment of all Obligations owing to the Beneficiary of the type described in clauses (vii), (viii), (ix), (x) and (xi) of the definition of Obligations herein;

          (ii) second, to the extent Trust Property Proceeds of Trust Property remain after the application pursuant to preceding clause (i), an amount equal to the outstanding Applicable Obligations secured by such item of Trust Property shall be paid to the Secured Creditors as their interests may appear, with (x) each Secured Creditor receiving an amount equal to its outstanding Applicable Obligations secured by such item of Trust Property or, if the proceeds are insufficient to pay in full all such Applicable Obligations, its Pro Rata Share of the amount so remaining to be distributed and (y) in the case of the Credit Document Obligations, the Existing Senior Notes Obligations, the New Senior Notes Obligations and the Refinancing Senior Notes Obligations included in such Applicable Obligations, any such amount to be applied (1) first to the payment of interest in respect of the unpaid principal amount of Loans, Existing Senior Notes, New Senior Notes or Refinancing Senior Notes, as the case may be, (2) second to the payment of principal of Loans, Existing Senior Notes, New Senior Notes or Refinancing Senior Notes, as the case may be, and (3) third to the other Credit Document Obligations, Existing Senior Notes Obligations, New Senior Notes Obligations or Refinancing Senior Notes Obligations, as the case may be; and

          (iii) third, to the extent proceeds remain after the application pursuant to the preceding clauses (i) and (ii) to the Trustor or, to the extent directed by the Trustor or a

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court of competent jurisdiction, to whomever may be lawfully entitled to receive such surplus.

          (b) For purposes of this Agreement, “Pro Rata Share” shall mean when calculating a Secured Creditor’s portion of any distribution or amount pursuant to clause (a) above, the amount (expressed as a percentage) equal to a fraction the numerator of which is the then outstanding amount of the relevant Applicable Obligations secured by the relevant item of Trust Property owed such Secured Creditor and the denominator of which is the then outstanding amount of all relevant Applicable Obligations secured by the relevant item of Trust Property.

          (c) All payments required to be made to the (i) Lender Creditors hereunder shall be made to the Administrative Agent for the account of the respective Lender Creditors, (ii) Credit Card Issuers hereunder shall be made to the Credit Card Issuer(s) under the applicable Secured Credit Card Agreement, (iii) Hedging Creditors hereunder shall be made to the paying agent under the applicable Secured Hedging Agreement or, in the case of Secured Hedging Agreements without a paying agent, directly to the applicable Hedging Creditors, (iv) Existing Senior Notes Creditors hereunder shall be made to the Existing Senior Notes Trustee for the account of the respective Existing Senior Notes Creditors, (v) New Senior Notes Creditors hereunder shall be made to the New Senior Notes Trustee for the account of the respective New Senior Notes Creditors and (vi) Refinancing Senior Notes Creditors hereunder shall be made to the Refinancing Senior Notes Trustee for the account of the respective Refinancing Senior Notes Creditors.

          (d) For purposes of applying payments received in accordance with this Section 4.04, the Beneficiary shall be entitled to rely upon (i) the Administrative Agent for a determination of the outstanding Credit Document Obligations, (ii) any Credit Card Issuer for a determination of the outstanding Credit Card Obligations owed to such Credit Card Issuer, (iii) upon any Hedging Creditor for a determination of the outstanding Hedging Obligations owed to such Hedging Creditor, (iv) the Existing Senior Notes Trustee for a determination of the outstanding Existing Senior Notes Obligations, (v) the New Senior Notes Trustee for a determination of the outstanding New Senior Notes Obligations and (vi) the Refinancing Senior Notes Trustee for a determination of the outstanding Refinancing Senior Notes Obligations. Unless it has actual knowledge (including by way of written notice from a Secured Creditor) to the contrary, the Administrative Agent under the Credit Agreement, in furnishing information pursuant to the preceding sentence, and the Beneficiary, in acting hereunder, shall be entitled to assume that no Credit Document Obligations other than principal, interest and regularly accruing fees are owing to any Lender Creditor.

          (e) It is understood and agreed that the Trustor shall remain liable to the extent of any deficiency between (x) the amount of the Obligations for which it is responsible directly or as a guarantor that are satisfied with proceeds of the Trust Property and (y) the aggregate outstanding amount of such Obligations.

          4.05 Appointment of Receiver. Upon the occurrence and during the continuance of a Noticed Event of Default, the Beneficiary as a matter of strict right and without notice to the Trustor or anyone claiming under the Trustor, and without regard to the adequacy or the then value of the Trust Property or the interest of the Trustor therein or the solvency of any party

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bound for payment of the Obligations, shall have the right to apply to any court having jurisdiction to appoint a receiver or receivers of the Trust Property, and the Trustor hereby irrevocably consents to such appointment and waives notice of any application therefor. Any such receiver or receivers shall have all the usual rights, powers and duties of receivers in like or similar cases and all the rights, powers and duties of the Beneficiary in case of entry as provided in Section 4.02 hereof, including but not limited to the full power to rent, maintain and otherwise operate the Trust Property upon such terms as are approved by the court and shall continue as such and exercise all such powers until the date of confirmation of sale of the Trust Property unless such receivership is sooner terminated.

          4.06 Exercise of Rights and Remedies. The entering upon and taking possession of the Trust Property, the collection of any Rents and the exercise of any of the rights contained in this Article IV, shall not, alone, cure or waive any Event of Default or notice of default hereunder or invalidate any act done in response to such Event of Default or pursuant to such notice of default and, notwithstanding the continuance in possession of the Trust Property or the collection, receipt and application of Rents, the Beneficiary shall be entitled to exercise every right provided for herein or in the Secured Debt Agreements, or at law or in equity upon the occurrence of any Event of Default.

          4.07 Remedies Not Exclusive. The Beneficiary shall be entitled to enforce payment and performance of the Obligations and to exercise all rights and powers under this Deed of Trust or other agreement or any laws now or hereafter in force, notwithstanding that some or all of the Obligations may now or hereafter be otherwise secured, whether by mortgage, deed of trust, security deed, pledge, lien, assignment or otherwise. Neither the acceptance of this Deed of Trust nor its enforcement, whether by court action or pursuant to the powers herein contained, shall prejudice or in any manner affect the Beneficiary’s right to realize upon or enforce any other security now or hereafter held by the Beneficiary, it being agreed that the Beneficiary shall be entitled to enforce this Deed of Trust and any other security now or hereafter held by the Beneficiary in such order and manner as it may in its absolute and sole discretion and election determine. No remedy herein conferred upon or reserved to the Beneficiary is intended to be exclusive of any other remedy herein or in any of the other Secured Debt Agreements or by law provided or permitted, but each shall be cumulative and shall be in addition to every other remedy given hereunder or now or hereafter existing at law or in equity or by statute. Every power or remedy to which the Beneficiary is entitled may be exercised, concurrently or independently, from time to time and as often as may be deemed expedient by the Beneficiary, and the Beneficiary may pursue inconsistent remedies. No delay or omission of the Beneficiary to exercise any right or power accruing upon any Event of Default shall impair any right or power or shall be construed as a waiver of any Event of Default or any acquiescence therein. If the Beneficiary shall have proceeded to invoke any right or remedy hereunder or under any other Secured Debt Agreement, and shall thereafter elect to discontinue or abandon it for any reason, the Beneficiary shall have the unqualified right to do so and, in such an event, the rights and remedies of the Beneficiary shall continue as if such right or remedy had never been invoked, but no such discontinuance or abandonment shall waive any Event of Default which may then exist or the right of the Beneficiary thereafter to exercise any right or remedy under the Secured Debt Agreements for such Event of Default.

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          4.08 WAIVER OF REDEMPTION, NOTICE, MARSHALLING, ETC. NOTWITHSTANDING ANYTHING HEREIN CONTAINED TO THE CONTRARY, TO THE EXTENT PERMITTED BY LAW, THE TRUSTOR ACKNOWLEDGING THAT IT IS AWARE OF AND HAS HAD THE ADVICE OF COUNSEL OF ITS CHOICE WITH RESPECT TO ITS RIGHTS HEREUNDER; (A) WILL NOT (I) AT ANY TIME INSIST UPON, OR PLEAD, OR IN ANY MANNER WHATSOEVER, CLAIM OR TAKE ANY BENEFIT OR ADVANTAGE OF ANY STAY OR EXTENSION OR MORATORIUM LAW, PRESENT OR FUTURE STATUTE OF LIMITATIONS, ANY LAW RELATING TO THE ADMINISTRATION OF ESTATES OF DECEDENTS, APPRAISEMENT, VALUATION, REDEMPTION, STATUTORY RIGHT OF REDEMPTION, OR THE MATURING OR DECLARING DUE OF THE WHOLE OR ANY PART OF THE OBLIGATIONS, NOTICE OF INTENTION OF SUCH MATURING OR DECLARING DUE, OTHER NOTICE (WHETHER OF DEFAULTS, ADVANCES, THE CREATION, EXISTENCE, EXTENSION OR RENEWAL OF ANY OF THE OBLIGATIONS OR OTHERWISE, EXCEPT FOR RIGHTS TO NOTICES EXPRESSLY GRANTED HEREIN OR IN THE SECURED DEBT AGREEMENTS), SUBROGATION, ANY SET-OFF RIGHTS, HOMESTEAD OR ANY OTHER EXEMPTIONS FROM EXECUTION OR SALE OF THE TRUST PROPERTY OR ANY PART THEREOF, WHEREVER ENACTED, NOW OR AT ANY TIME HEREAFTER IN FORCE, WHICH MAY AFFECT THE COVENANTS AND TERMS OF PERFORMANCE OF THIS DEED OF TRUST, OR (II) CLAIM, TAKE OR INSIST UPON ANY BENEFIT OR ADVANTAGE OF ANY LAW NOW OR HEREAFTER IN FORCE PROVIDING FOR THE VALUATION OR APPRAISAL OF THE TRUST PROPERTY OR ANY PART THEREOF, PRIOR TO ANY SALE OR SALES THEREOF WHICH MAY BE MADE PURSUANT TO ANY PROVISION HEREOF, OR PURSUANT TO THE DECREE, JUDGMENT OR ORDER OF ANY COURT OF COMPETENT JURISDICTION; OR (III) AFTER ANY SUCH SALE OR SALES, CLAIM OR EXERCISE ANY RIGHT UNDER ANY STATUTE HERETOFORE OR HEREAFTER ENACTED TO REDEEM THE TRUST PROPERTY SO SOLD OR ANY PART THEREOF; AND (B) COVENANTS NOT TO HINDER, DELAY OR IMPEDE THE EXECUTION OF ANY POWER HEREIN GRANTED OR DELEGATED TO THE TRUSTEE OR BENEFICIARY, BUT TO SUFFER AND PERMIT THE EXECUTION OF EVERY POWER AS THOUGH NO SUCH LAW OR LAWS HAD BEEN MADE OR ENACTED. THE TRUSTOR, FOR ITSELF AND ALL WHO MAY CLAIM UNDER IT, WAIVES, TO THE EXTENT THAT IT LAWFULLY MAY, ALL RIGHT TO HAVE THE TRUST PROPERTY MARSHALLED UPON ANY FORECLOSURE HEREOF.

          4.09 Expenses of Enforcement. In connection with any action to enforce any remedy of the Beneficiary under this Deed of Trust, the Trustor agrees to pay all costs and expenses which may be paid or incurred by or on behalf of the Beneficiary or the Trustee, including, without limitation, reasonable attorneys’ fees, receiver’s fees, appraiser’s fees, outlays for documentary and expert evidence, stenographer’s charges, publication costs, and costs (which may be estimated as to items to be expended after entry of the decree) of procuring all such abstracts of title, title searches and examinations, title insurance policies and similar data and assurances with respect to title and value as the Beneficiary may deem necessary or desirable, and neither the Beneficiary nor any other Person shall be required to accept tender of any portion of the Obligations unless the same be accompanied by a tender of all such expenses, costs and commissions. All of the costs and expenses described in this Section 4.09, and such expenses and fees as may be incurred in the protection of the Trust Property and the maintenance

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of the Lien of this Deed of Trust, including the reasonable fees of any attorney employed by the Beneficiary or the Trustee in any litigation or proceeding, including appellate proceedings, affecting this Deed of Trust or the Trust Property (including, without limitation, the occupancy thereof or any construction work performed thereon), including probate and bankruptcy proceedings, or in preparation for the commencement or defense of any proceeding or threatened suit or proceeding whether or not an action is actually commenced, shall be immediately due and payable by the Trustor, with interest thereon at the rate of interest set forth in the Secured Debt Agreements and shall be part of the Obligations secured by this Deed of Trust.

          4.10 Indemnity. (a) The Trustor agrees to indemnify, reimburse and hold the Beneficiary, the Trustee, each other Secured Creditor and their respective successors, permitted assigns, employees, agents and servants (hereinafter in this Section 4.10 referred to individually, as “Indemnitee,” and collectively as “Indemnitees”) harmless from any and all liabilities, obligations, losses, damages, penalties, claims, demands, actions, suits, judgments and any and all reasonable costs and expenses (including reasonable attorneys’ fees and expenses) (for the purposes of this Section 4.10 the foregoing are collectively called “expenses”) of whatsoever kind and nature imposed on, asserted against or incurred by any of the Indemnitees in any way relating to or arising out of this Deed of Trust, or the documents executed in connection herewith or in any other way connected with the enforcement of any of the terms of, or the preservation of any rights hereunder, or in any way relating to or arising out of the ownership, lease, financing, possession, operation, condition, sale or other disposition, or use of the Trust Property, the violation of the laws of any country, state or other governmental body or unit, any tort (including, without limitation, claims arising or imposed under the doctrine of strict liability, or for or on account of injury to or the death of any Person (including any Indemnitee), or property damage), or contract claim; provided that no Indemnitee shall be indemnified pursuant to this Section 4.10(a) for expenses, losses, damages or liabilities to the extent caused by the gross negligence or wilful misconduct of such Indemnitee. The Trustor agrees that upon written notice by any Indemnitee of the assertion of such a liability, obligation, loss, damage, penalty, claim, demand, action, judgment or suit, the Trustor shall assume full responsibility for the defense thereof. Each Indemnitee agrees to use its best efforts to promptly notify the Trustor of any such assertion of which such Indemnitee has knowledge.

          (b) Without limiting the application of Section 4.10(a), the Trustor agrees to pay, indemnify and hold each Indemnitee harmless from and against any loss, costs, damages and expenses which such Indemnitee may suffer, expend or incur in consequence of or growing out of any material misrepresentation by Trustor in this Deed of Trust, or in any statement or writing contemplated by or made or delivered pursuant to or in connection with this Deed of Trust.

          (c) If and to the extent that the obligations of the Trustor under this Section 4.10 are unenforceable for any reason, the Trustor hereby agrees to make the maximum contribution to the payment and satisfaction of such obligations which is permissible under applicable law.

          4.11 Indemnity Obligations Secured by Collateral; Survival. Any amounts paid by any Indemnitee as to which such Indemnitee has the right to reimbursement shall constitute Obligations secured by the Trust Property. The indemnity obligations of the Trustor contained in

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Sections 4.09 and 4.10 shall continue in full force and effect notwithstanding the full payment of all of the Notes issued under the Credit Agreement, the termination of all Secured Hedging Agreements, the full payment of all Existing Senior Notes issued under the Existing Senior Notes Indenture, the full payment of all New Senior Notes issued under the New Senior Notes Indenture, the full payment of all Refinancing Senior Notes issued under the Refinancing Senior Notes Indenture and the payment of all of the other Obligations and notwithstanding the discharge thereof.

ARTICLE V

ADDITIONAL COLLATERAL

          5.01 Additional Collateral. (a) The Trustor acknowledges and agrees that its Applicable Obligations are secured by the Trust Property and various other collateral including, without limitation, at the time of execution of this Deed of Trust certain personal property of the Trustor described in the Credit Documents. The Trustor specifically acknowledges and agrees that the Trust Property, in and of itself, if foreclosed or realized upon would not be sufficient to satisfy the outstanding amount of the Obligations. Accordingly, the Trustor acknowledges that it is in the Trustor’s contemplation that the other collateral pledged to secure the Applicable Obligations may be pursued by the Beneficiary in separate proceedings in the various States, counties and other countries where such collateral may be located and additionally that the Trustor liable for payment of the Obligations will remain liable for any deficiency judgments in addition to any amounts the Beneficiary may realize on sales of other property or any other collateral given as security for the Obligations. Specifically, and without limitation of the foregoing, it is agreed that it is the intent of the parties hereto that in the event of a foreclosure of this Deed of Trust, the Indebtedness evidencing the Obligations shall not be deemed merged into any judgment of foreclosure, but rather shall remain outstanding. It is the further intent and understanding of the parties that the Beneficiary, following a Noticed Event of Default, may pursue all of its collateral with the Obligations remaining outstanding and in full force and effect notwithstanding any judgment of foreclosure or any other judgment which the Beneficiary may obtain.

          (b) The Trustor acknowledges and agrees that the Trust Property and the property which may from time to time be encumbered by the other Secured Debt Agreements may be located in more than one State or country and therefore the Trustor waives and relinquishes any and all rights it may have, whether at law or equity, to require the Beneficiary to proceed to enforce or exercise any rights, powers and remedies it may have under the Secured Debt Agreements in any particular manner, in any particular order, or in any particular State or other jurisdiction. Furthermore, the Trustor acknowledges and agrees that the Beneficiary shall be allowed to enforce payment and performance of the Obligations and to exercise all rights and powers provided under this Deed of Trust, or the other Secured Debt Agreements or under any provision of law, by one or more proceedings, whether contemporaneous, consecutive or both in any one or more States in which the security is located. Neither the acceptance of this Deed of Trust, or any Credit Document nor its enforcement in one State, whether by court action, power

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of sale, or otherwise, shall prejudice or in any way limit or preclude enforcement of the Credit Documents through one or more additional proceedings, in that State or in any other State or country.

          (c) The Trustor further agrees that any particular remedy or proceeding, including, without limitation, foreclosure through court action (in a state or federal court) or power of sale, may be brought and prosecuted in the local or federal courts of any one or more States as to all or any part of the Trust Property or the property encumbered by the Secured Debt Agreements wherever located, without regard to the fact that any one or more prior or contemporaneous proceedings have been situated elsewhere with respect to the same or any other part of the Trust Property and the property encumbered by the Secured Debt Agreements.

          (d) The Beneficiary may resort to any other security held by the Beneficiary for the payment of the Obligations in such order and manner as the Beneficiary may elect.

          (e) Notwithstanding anything contained herein to the contrary, the Beneficiary shall be under no duty to the Trustor or others, including, without limitation, the holder of any junior, senior or subordinate mortgage on the Trust Property or any part thereof or on any other security held by the Beneficiary, to exercise or exhaust all or any of the rights, powers and remedies available to the Beneficiary.

ARTICLE VI

MISCELLANEOUS

          6.01 Governing Law. The provisions of this Deed of Trust regarding the creation, perfection and enforcement of the liens and security interests herein granted shall be governed by and construed under the laws of the state in which the Trust Property is located. All other provisions of this Deed of Trust shall be governed by the laws of the State of New York (including, without limitation, Section 5-1401 of the General Obligations Law of the State of New York), without regard to choice of laws provisions.

          6.02 Limitation on Interest. It is the intent of the Trustor and the Beneficiary in the execution of this Deed of Trust and all other instruments evidencing or securing the Obligations to contract in strict compliance with applicable usury laws. In furtherance thereof, the Beneficiary and the Trustor stipulate and agree that none of the terms and provisions contained in this Deed of Trust shall ever be construed to create a contract for the use, forbearance or retention of money requiring payment of interest or loan charges at a rate in excess of the maximum interest rate permitted to be charged by relevant law. If this Deed of Trust or any other instrument evidencing or securing the Obligations violates any applicable usury law, then the interest rate and loan charges payable in respect of the Loans shall be reduced to the highest rate permissible by law.

          6.03 Notices. All notices and other communications provided for hereunder shall be in writing (including telegraphic, telex, facsimile transmission or cable communications) and

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mailed, telegraphed, telexed, telecopied, cabled or delivered (including by way of overnight courier):

(i)	if to the Trustor, at;
	R. J. Reynolds Tobacco Company 401 North Main Street, Winston-Salem, North Carolina 27102
(ii)	if to the Beneficiary, at:
	JPMorgan Chase Bank, N.A. 270 Park Avenue New York, New York 10017 Attn.: Raju Nanoo Tel. No.: 212-270-2272 Fax. No.: 212-270-5120

     (iii) if to any Lender (other than the Beneficiary), at such address as such Lender shall have specified in the Credit Agreement;

     (iv) if to any Credit Card Issuer, at such address as such Credit Card Issuer shall have specified in writing to the Trustor and the Beneficiary;

     (v) if to any Hedging Creditor, at such address as such Hedging Creditor shall have specified in writing to the Trustor and the Beneficiary;

     (vi) if to any Existing Senior Notes Creditor, at such address of the Existing Senior Notes Trustee as the Existing Senior Notes Trustee shall have specified in writing to the Trustor and the Beneficiary;

     (vii) if to any New Senior Notes Creditor, at such address of the New Senior Notes Trustee as the New Senior Notes Trustee shall have specified in writing to the Trustor and the Beneficiary;

     (viii) if to any Refinancing Senior Notes Creditor, at such address of the Refinancing Senior Notes Trustee as the Refinancing Senior Notes Trustee shall have specified in writing to the Trustor and the Beneficiary;

or at such other address as shall have been furnished in writing by any Person described above to the party required to give notice hereunder. Except as otherwise expressly provided herein, all such notices and communications shall be deemed to have been duly given or made (i) in the case of any Secured Creditor, when received and (ii) in the case of the Trustor, when delivered to the Trustor in any manner required or permitted hereunder.

          6.04 Captions. The captions or headings at the beginning of each Article and Section hereof are for the convenience of the parties and are not a part of this Deed of Trust.

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          6.05 Amendment. None of the terms and conditions of this Deed of Trust may be changed, waived, modified or varied in any manner whatsoever unless in writing duly signed by the Trustor and the Beneficiary (with the consent of (x) if prior to the CA Termination Date, the Required Lenders or, to the extent required by Section 12.12 of the Credit Agreement, all of the Lenders and (y) if on and after the CA Termination Date, the holders of at least a majority of the outstanding principal amount of the Obligations remaining outstanding), provided that (i) no such change, waiver, modification or variance shall be made to Section 4.04 hereof or this Section 6.05 without the consent of each Secured Creditor adversely affected thereby and (ii) that any change, waiver, modification or variance affecting the rights and benefits of a single Class of Secured Creditors (and not all Secured Creditors in a like or similar manner) shall require the written consent of the Requisite Creditors of such Class of Secured Creditors. For the purpose of this Agreement, the term “Class” shall mean each class of Secured Creditors, i.e., whether (1) the Lender Creditors as holders of the Credit Document Obligations, (2) the Credit Card Issuers as holders of the Credit Card Obligations, (3) the Hedging Creditors as holders of the Hedging Obligations, (4) the Existing Senior Notes Creditors as holders of the Existing Senior Notes Obligations, (5) the New Senior Notes Creditors as holders of the New Senior Notes Obligations and (6) the Refinancing Senior Notes Creditors as holders of the Refinancing Senior Notes Obligations. For the purpose of this Agreement, the term “Requisite Creditors” of any Class shall mean each of (1) with respect to each of the Credit Document Obligations, the Required Lenders, (2) with respect to the Credit Card Obligations, the holders of at least a majority of all Credit Card Obligations outstanding from time to time, (3) with respect to the Hedging Obligations, the holders of at least a majority of all Secured Hedging Obligations outstanding from time to time, (4) with respect to the Existing Senior Notes Obligations, the holders of at least a majority of the outstanding principal amount of the Existing Senior Notes, (5) with respect to the New Senior Notes Obligations, the holders of at least a majority of the outstanding principal amount of the New Senior Notes and (6) with respect to the Refinancing Senior Notes Obligations, the holders of at least a majority of the outstanding principal amount of the Refinancing Senior Notes.

          6.06 Obligations Absolute. The Obligations of the Trustor hereunder shall remain in full force and effect without regard to, and shall not be impaired by, (a) any bankruptcy, insolvency, reorganization, arrangement, readjustment, composition, liquidation or the like of the Trustor; (b) any exercise or non-exercise, or any waiver of, any right, remedy, power or privilege under or in respect of this Deed of Trust, any other Credit Document or any other Secured Debt Agreement, except as specifically set forth in a waiver granted pursuant to Section 6.05 hereof; or (c) any amendment to or modification of any Credit Document or any other Secured Debt Agreement, except as specifically set forth in a waiver granted pursuant to Section 6.05 hereof, or any security for any of the Obligations; whether or not the Trustor shall have notice or knowledge of any of the foregoing.

          6.07 Further Assurances. The Trustor shall, upon the request of the Beneficiary and at the expense of the Trustor: (a) promptly correct any defect, error or omission which may be discovered in the contents of this Deed of Trust or any UCC financing statements filed in connection herewith; (b) promptly execute, acknowledge, deliver and record or file such further instruments (including, without limitation, further mortgages, deeds of trust, security deeds, security agreements, financing statements, continuation statements and assignments of rents or leases) and promptly do such further acts as may be necessary, desirable or proper to carry out

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more effectively the purposes of this Deed of Trust and to subject to the liens and security interests hereof any property intended by the terms hereof to be covered hereby, including specifically, but without limitation, any renewals, additions, substitutions, replacements or appurtenances to the Trust Property; and (c) promptly execute, acknowledge, deliver, procure and record or file any document or instrument (including specifically any financing statement) deemed advisable by the Beneficiary to protect, continue or perfect the liens or the security interests hereunder against the rights or interests of third persons.

          6.08 Partial Invalidity. If any of the provisions of this Deed of Trust or the application thereof to any person, party or circumstances shall to any extent be invalid or unenforceable, the remainder of this Deed of Trust, or the application of such provision or provisions to persons, parties or circumstances other than those as to whom or which it is held invalid or unenforceable, shall not be affected thereby, and every provision of this Deed of Trust shall be valid and enforceable to the fullest extent permitted by law.

          6.09 Partial Releases. No release from the Lien of this Deed of Trust of any part of the Trust Property by the Beneficiary shall in any way alter, vary or diminish the force or effect of this Deed of Trust on the balance of the Trust Property or the priority of the Lien of this Deed of Trust on the balance of the Trust Property.

          6.10 Priority. This Deed of Trust is intended to and shall be valid and have priority over all subsequent liens and encumbrances, including statutory liens, excepting solely taxes and assessments levied on the real estate, to the extent of the maximum amount secured hereby.

          6.11 Covenants Running with the Land. All Obligations are intended by the Trustor and the Beneficiary to be, and shall be construed as, covenants running with the Trust Property. As used herein, the “Trustor” shall refer to the party named in the first paragraph of this Deed of Trust and to any subsequent owner of all or any portion of the Trust Property. All persons who may have or acquire an interest in the Trust Property shall be deemed to have notice of, and be bound by, the terms of the Credit Agreement and the other Secured Debt Agreements; provided, however, that no such party shall be entitled to any rights thereunder without prior written consent of the Beneficiary.

          6.12 Successors and Assigns. This Deed of Trust shall be binding upon and inure to the benefit of the Beneficiary and the Trustor and their respective successors and assigns. Except as otherwise permitted by Credit Agreement, the Trustor shall not, without the prior written consent of the Beneficiary, assign any rights, duties, or obligations hereunder.

          6.13 Purpose of Loans. The Trustor hereby represents and agrees that the Loans, Existing Senior Notes, New Senior Notes and Refinancing Senior Notes have or are being obtained or issued for business or commercial purposes, and the proceeds thereof will not be used for personal, family, residential, household or agricultural purposes.

          6.14 No Joint Venture or Partnership. The relationship created hereunder and under the other Credit Documents, the Secured Hedging Agreements, the Secured Credit Card Agreements, the Existing Senior Notes Documents, the New Senior Notes Documents and the

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Refinancing Senior Notes Documents is that of creditor/debtor. The Beneficiary does not owe any fiduciary or special obligation to the Trustor and/or any of the Trustor’s, officers, partners, agents, or representatives. Nothing herein or in any other Credit Document, any Secured Hedging Agreement, any Secured Credit Card Document, any Existing Senior Notes Document, any New Senior Notes Document or any Refinancing Senior Notes Document is intended to create a joint venture, partnership, tenancy-in-common or joint tenancy relationship between the Trustor and the Beneficiary.

          6.15 The Beneficiary as Collateral Agent for Secured Creditors. It is expressly understood and agreed that the rights and obligations of the Beneficiary as holder of this Deed of Trust and as Collateral Agent for the Secured Creditors and otherwise under this Deed of Trust are only those expressly set forth in this Deed of Trust and in the Credit Agreement. The Beneficiary shall act hereunder pursuant to the terms and conditions set forth herein in Section 11 of the Credit Agreement and in Annex M to the Security Agreement, the terms of which shall be deemed incorporated herein by reference as fully as if same were set forth herein in their entirety (for such purpose, treating each reference to the “Security Agreement” as a reference to this Deed of Trust, each reference to the “Collateral Agent” as a reference to the Beneficiary and each reference to an “Assignor” as a reference to a “Trustor”).

          6.16 Full Recourse. This Deed of Trust is made with full recourse to the Trustor and pursuant to and upon all the warranties, representations, covenants, agreements on the part of the Trustor contained herein, in the other Credit Documents and the other Secured Debt Agreements and otherwise in writing in connection herewith or therewith.

          6.17 Reduction of Secured Amount. In the event the amount secured by this Deed of Trust is less than the aggregate Obligations, then the amount secured hereby shall be reduced only by the last and final sums that the Trustor or the Borrower repays with respect to the Obligations and shall not be reduced by any intervening repayments of the Obligations. So long as the balance of the Obligations exceeds the amount secured hereby, any payments of the Obligations shall not be deemed to be applied against, or to reduce, the portion of the Obligations secured by this Deed of Trust. Such payments shall instead be deemed to reduce only such portions of the Obligations as are secured by other collateral located outside of the state in which the Trust Property is located or are unsecured.

          6.18 Acknowledgment of Receipt. The Trustor hereby acknowledges receipt of a true copy of this Deed of Trust.

          6.19 Release Payment. (a) After the Termination Date (as defined below), this Deed of Trust shall terminate (provided that all indemnities set forth herein shall survive any such termination) and the Beneficiary, at the request and expense of the Trustor, will execute and deliver to the Trustor a proper instrument or instruments (without recourse and without representation or warranty) acknowledging the satisfaction and termination of this Deed of Trust. As used in this Deed of Trust, (i) “CA Termination Date” shall mean the date upon which the Total Commitment has been terminated, no Letter of Credit or Note under the Credit Agreement is outstanding and all other Credit Document Obligations have been paid in full in cash (other than arising from indemnities for which no request for payment has been made) and (ii) “Termination Date” shall mean the date upon which (x) the CA Termination Date shall have

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occurred and (y) if (but only if) a Notified Non-Credit Agreement Event of Default (as defined below) shall have occurred and be continuing on the CA Termination Date (and after giving effect thereto), either (I) such Notified Non-Credit Agreement Event of Default shall have been cured or waived by the requisite holders of the relevant Obligations subject to such Notified Non-Credit Agreement Event of Default or (II) all Secured Credit Card Agreements and all Secured Hedging Agreements (if any) giving rise to a Notified Non-Credit Agreement Event of Default shall have been terminated and all Obligations subject to such Notified Non-Credit Agreement Event of Default shall have been paid in full (other than arising from indemnities for which no request for payment has been made). As used herein “Notified Non-Credit Agreement Event of Default” means (i) the acceleration of the maturity of any Existing Senior Notes, New Senior Notes or Refinancing Senior Notes or the failure to pay at maturity any Existing Senior Notes, New Senior Notes or Refinancing Senior Notes, or the occurrence of any bankruptcy or insolvency Event of Default under the Existing Senior Notes Indenture, the New Senior Notes Indenture or the Refinancing Senior Notes Indenture, (ii) any Event of Default under a Secured Credit Card Agreement or (iii) any Event of Default under a Secured Hedging Agreement, in the case of any event described in clause (i), (ii) or (iii) to the extent the Existing Senior Notes Trustee, New Senior Notes Trustee, the Refinancing Senior Notes Trustee, the relevant Hedging Creditor or the relevant Credit Card Issuer, as the case may be, has given written notice to the Beneficiary that a “Notified Non-Credit Agreement Event of Default” exists; provided that such written notice may only be given if such Event of Default is continuing and, provided further, that any such Notified Non-Credit Agreement Event of Default shall cease to exist (I) once there is no longer any Event of Default under the Existing Senior Notes Indenture, the New Senior Notes Indenture, the Refinancing Senior Notes Indenture, the respective Secured Credit Card Agreement or the respective Secured Hedging Agreement, as the case may be, in existence, (II) in the case of an Event of Default under the Existing Senior Notes Indenture, the New Senior Notes Indenture, or the Refinancing Senior Notes Indenture, after all Existing Senior Notes Obligations, New Senior Notes Obligations or Refinancing Senior Notes Obligations, as the case may be, have been repaid in full, (III) in the case of an Event of Default under a Secured Credit Card Agreement or a Secured Hedging Agreement, such Secured Hedging Agreement, as the case may be, has been terminated and all Credit Card Obligations or Hedging Obligations, as the case may be, thereunder have been repaid in full, (IV) in the case of an Event of Default under the Existing Senior Notes Indenture, New Senior Notes Indenture or the Refinancing Senior Notes Indenture, if the Existing Senior Notes Creditors, New Senior Notes Creditors or the Refinancing Senior Notes Creditors, as the case may be, holding at least a majority of the aggregate principal amount of the outstanding Existing Senior Notes, New Senior Notes or the Refinancing Senior Notes, as the case may be, at such time have rescinded such written notice and (V) in the case of an Event of Default under a Secured Credit Card Agreement or a Secured Hedging Agreement, the requisite Credit Card Issuers with Credit Card Obligations or Hedging Creditors with Hedging Obligations thereunder at such time have rescinded such written notice.

          (b) So long as no Notified Non-Credit Agreement Event of Default has occurred and is continuing, in the event that (x) prior to the CA Termination Date, (i) any part of the Trust Property is sold or otherwise disposed of in connection with a sale or other disposition permitted by Section 8.02 of the Credit Agreement (it being agreed for such purposes that a release will be deemed “permitted by Section 8.02 of the Credit Agreement” if the proposed transaction constitutes an exception to Section 8.02(f) of the Credit Agreement) or (ii) all or any part of the Trust Property is released at the direction of the Required Lenders (or all the Lenders

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if required by Section 12.12 of the Credit Agreement), and the proceeds of such sale or disposition or from such release (if any) are applied in accordance with the terms of the Credit Agreement to the extent required to be so applied or (y) on and after the CA Termination Date, any part of the Trust Property is sold or otherwise disposed of without violating the Existing Senior Notes Documents, the New Senior Notes Documents, the Refinancing Senior Notes Documents, the Secured Credit Card Agreements and the Secured Hedging Agreements, the Beneficiary, at the request and expense of the Trustor, will release such Trust Property from this Deed of Trust in the manner provided in clause (a) above (it being understood and agreed that upon the release of all or any portion of the Trust Property by the Beneficiary at the direction of the Lenders as provided above, the Lien on the Trust Property in favor of the Credit Card Issuers, the Hedging Creditors, the Existing Senior Notes Creditors, the New Senior Notes Creditors and the Refinancing Senior Notes Creditors shall automatically be released).

          (c) In addition to the foregoing, all Trust Property shall be automatically released (subject to reinstatement upon the occurrence of a new Trigger Event) in accordance with Section 7.10(i) of the Credit Agreement.

          (d) At any time that the Trustor desires that the Beneficiary take any action to give effect to any release of Trust Property pursuant to the foregoing Section 6.19(a), (b) or (c), it shall deliver to the Beneficiary a certificate signed by an authorized officer describing the Trust Property to be released and certifying its entitlement to a release pursuant to the applicable provisions of Sections 6.19(a), (b) or (c) and in such case the Beneficiary, at the request and expense of the Trustor, will execute such documents (without recourse and without any representation or warranty) as required to duly release such Trust Property. The Beneficiary shall have no liability whatsoever to any Secured Creditor as the result of any release of Trust Property by it as permitted by (or which the Beneficiary in good faith believes to be permitted by) this Section 6.19. Upon any release of Trust Property pursuant to Section 6.19(a), (b) or (c), so long as no Noticed Event of Default is then in existence, none of the Secured Creditors shall have any continuing right or interest in such Trust Property, or the proceeds thereof (subject to reinstatement rights upon the occurrence of a new Trigger Event in the case of a release pursuant to Section 6.19(c)(i)).

          6.20 Time of the Essence. Time is of the essence of this Deed of Trust.

          6.21 The Beneficiary’s Powers. Without affecting the liability of any other Person liable for the payment and performance of the Obligations and without affecting the Lien of this Deed of Trust in any way, the Beneficiary (acting at the direction of the requisite holders of the relevant Obligations affected thereby) may, from time to time, regardless of consideration and without notice to or consent by the holder of any subordinate Lien, right, title or interest in or to the Trust Property, (a) release any Persons liable for the Obligations, (b) extend the maturity of, increase or otherwise alter any of the terms of the Obligations, (c) modify the interest rate payable on the principal balance of the Obligations, (d) release or reconvey, or cause to be released or reconveyed, all or any portion of the Trust Property, or (e) take or release any other or additional security for the Obligations.

          6.22 Rules of Usage. The following rules of usage shall apply to this Deed of Trust unless otherwise required by the context:

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     (a) Singular words shall connote the plural as well as the singular, and vice versa, as may be appropriate.

     (b) The words “herein”, “hereof” and “hereunder” and words of similar import appearing in each such document shall be construed to refer to such document as a whole and not to any particular section, paragraph or other subpart thereof unless expressly so stated.

     (c) References to any Person shall include such Person and its successors and permitted assigns.

     (d) Each of the parties hereto and their counsel have reviewed and revised, or requested revisions to, such documents, and the usual rule of construction that any ambiguities are to be resolved against the drafting party shall be inapplicable in the construction and interpretation of such documents and any amendments or exhibits thereto.

     (e) Unless an express provision requires otherwise, each reference to “the Trust Property” shall be deemed a reference to “the Trust Property or any part thereof”, and each reference to “Secured Property” shall be deemed a reference to “the Secured Property or any part thereof”.

          6.23 No Off-Set. All sums payable by the Trustor shall be paid without counterclaim, other compulsory counterclaims, set-off, or deduction and without abatement, suspension, deferment, diminution or reduction, and the Obligations shall in no way be released, discharged or otherwise affected (except as expressly provided herein or in the Credit Agreement) by reason of: (i) any damage or any condemnation of the Trust Property or any part thereof; (ii) any title defect or encumbrance or any eviction from the Trust Property or any part thereof by title paramount or otherwise; or (iii) any bankruptcy, insolvency, reorganization, composition, adjustment, dissolution, liquidation or other like proceeding relating to the Beneficiary or the Trustor, or any action taken with respect to this Deed of Trust by any agent or receiver of the Beneficiary. The Trustor waives, to the extent permitted by law, all rights now or hereafter conferred by statute or otherwise to any abatement, suspension, deferment, diminution or reduction of any of the Obligations.

          6.24 Consent to Jurisdiction and Service of Process; Waiver of Jury Trial. (a) ANY LEGAL ACTION OR PROCEEDING WITH RESPECT TO THIS DEED OF TRUST OR ANY OTHER CREDIT DOCUMENT MAY BE BROUGHT IN THE COURTS OF THE STATE OF NEW YORK OR OF THE UNITED STATES FOR THE SOUTHERN DISTRICT OF NEW YORK, AND, BY EXECUTION AND DELIVERY OF THIS AGREEMENT, THE TRUSTOR HEREBY IRREVOCABLY ACCEPTS FOR ITSELF AND IN RESPECT OF ITS PROPERTY, GENERALLY AND UNCONDITIONALLY, THE JURISDICTION OF THE AFORESAID COURTS. THE TRUSTOR HEREBY IRREVOCABLY DESIGNATES, APPOINTS AND EMPOWERS PRENTICE-HALL CORPORATION SYSTEM, INC., WITH OFFICES ON THE DATE HEREOF AT 80 STATE STREET, ALBANY, NEW YORK 12207-2543 AS ITS DESIGNEE, APPOINTEE AND AGENT TO RECEIVE, ACCEPT AND ACKNOWLEDGE

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FOR AND ON ITS BEHALF, AND IN RESPECT OF ITS PROPERTY, SERVICE OF ANY AND ALL LEGAL PROCESS, SUMMONS, NOTICES AND DOCUMENTS WHICH MAY BE SERVED IN ANY SUCH ACTION OR PROCEEDING. IF FOR ANY REASON SUCH DESIGNEE, APPOINTEE AND AGENT SHALL CEASE TO BE AVAILABLE TO ACT AS SUCH, THE TRUSTOR SHALL DESIGNATE A NEW DESIGNEE, APPOINTEE AND AGENT IN THE STATE OF NEW YORK ON THE TERMS AND FOR THE PURPOSES OF THIS PROVISION SATISFACTORY TO THIS DEED OF TRUST. THE TRUSTOR FURTHER IRREVOCABLY CONSENTS TO THE SERVICE OF PROCESS OUT OF ANY OF THE AFOREMENTIONED COURTS IN ANY SUCH ACTION OR PROCEEDING BY THE MAILING OF COPIES THEREOF BY REGISTERED OR CERTIFIED MAIL, POSTAGE PREPAID, TO THE TRUSTOR AT ITS ADDRESS FOR NOTICES PURSUANT TO SECTION 6.03 HEREOF, SUCH SERVICE TO BECOME EFFECTIVE 30 DAYS AFTER SUCH MAILING. THE TRUSTOR HEREBY IRREVOCABLY WAIVES ANY OBJECTION TO SUCH SERVICE OF PROCESS AND FURTHER IRREVOCABLY WAIVES AND AGREES NOT TO PLEAD OR CLAIM IN ANY ACTION OR PROCEEDING COMMENCED HEREUNDER OR ANY OTHER CREDIT DOCUMENT THAT SERVICE OF PROCESS WAS IN ANY WAY INVALID OR INEFFECTIVE. NOTHING HEREIN SHALL AFFECT THE RIGHT OF THE ADMINISTRATIVE AGENT UNDER THE CREDIT AGREEMENT, ANY LENDER OR THE HOLDER OF ANY NOTE TO SERVE PROCESS IN ANY OTHER MANNER PERMITTED BY LAW OR TO COMMENCE LEGAL PROCEEDINGS OR OTHERWISE PROCEED AGAINST ANY CREDIT PARTY IN ANY OTHER JURISDICTION.

          (b) THE TRUSTOR HEREBY IRREVOCABLY WAIVES ANY OBJECTION WHICH IT MAY NOW OR HEREAFTER HAVE TO THE LAYING OF VENUE OF ANY OF THE AFORESAID ACTIONS OR PROCEEDINGS ARISING OUT OF OR IN CONNECTION WITH THIS DEED OF TRUST OR ANY OTHER CREDIT DOCUMENT BROUGHT IN THE COURTS REFERRED TO IN CLAUSE (a) ABOVE AND HEREBY FURTHER IRREVOCABLY WAIVES AND AGREES NOT TO PLEAD OR CLAIM IN ANY SUCH COURT THAT ANY SUCH ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM.

          (c) EACH OF THE PARTIES TO THIS DEED OF TRUST HEREBY IRREVOCABLY WAIVES ALL RIGHT TO A TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM ARISING OUT OF OR RELATING TO THIS DEED OF TRUST, THE OTHER CREDIT DOCUMENTS OR THE TRANSACTIONS CONTEMPLATED HEREBY OR THEREBY.

          6.25 Future Advances. This Deed of Trust is given to secure the Trustor’s Applicable Obligations under, or in respect of, the Secured Debt Agreements to which the Trustor is “party” and shall secure not only Applicable Obligations with respect to presently existing indebtedness under the foregoing documents and agreements but also any and all other indebtedness now owing or which may hereafter be owing by the Trustor or the Borrower, as the case may be, to the Secured Creditors, however incurred, whether interest, discount or otherwise, and whether the same shall be deferred, accrued or capitalized, including future advances and re-

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advances, whether such advances are obligatory or to be made at the option of the Secured Creditors, or otherwise, to the same extent as if such future advances were made on the date of the execution of this Deed of Trust. The lien of this Deed of Trust shall be valid as to all indebtedness secured hereby, including future advances, from the time of its filing for record in the recorder’s office of the county in which the Property is located. This Deed of Trust is intended to and shall be valid and have priority over all subsequent liens and encumbrances, including statutory liens, excepting solely taxes and assessments levied on the real estate, to the extent of the maximum amount secured hereby, and Permitted Encumbrances. Although this Deed of Trust is given wholly or partly to secure all future obligations which may be incurred hereunder and under the other Secured Debt Agreements, whether obligatory or optional, the Trustor and the Beneficiary hereby acknowledge and agree that the Beneficiary and the other Secured Creditors are obligated by the terms of the Secured Debt Agreements to make certain future advances, including advances of a revolving nature, subject to the fulfillment of the relevant conditions set forth in the Secured Debt Agreements.

          6.26 Maturity Date. The Obligations have a final maturity on May 31, 2012.

ARTICLE VII

CONCERNING THE TRUSTEE

          7.01 Covenants of the Trustee. The Trustee, by its acceptance hereof, covenants faithfully to perform and fulfill the trusts herein created, and hereby waives any statutory fee and agrees not to require any compensation for any services rendered by it in accordance with the terms hereof. The Trustee may consult with counsel upon any matters arising hereunder and shall be fully protected in relying as to the legal matters or on the advice of counsel. The Trustee shall not incur any personal liability hereunder except for his gross negligence or willful misconduct, and the Trustee may rely on any instrument, document, or signature authorizing or supporting any action taken or proposed to be taken by him hereunder, believed by him in good faith to be genuine.

          7.02 Resignation; Removal of the Trustee. The Trustee may resign at any time without notice. In the event of the resignation or death or dissolution of the Trustee, or the Trustee’s failure, refusal or inability, for any reason, to make any sale or to perform any of the trusts herein declared, or, at the option of the Beneficiary, without cause, the Beneficiary may appoint a substitute trustee, who shall thereupon succeed to all the estates, titles, rights, powers, and trusts herein granted to any vested in the Trustee. The instrument of appointment may, but shall not be required to, be recorded in the recorder’s office(s) in which this Deed of Trust is recorded. If the Beneficiary is a corporation, such appointment may be made on behalf of such Beneficiary by any person who is then the president, or a vice-president, assistant vice-president, treasurer, cashier, secretary, or any other authorized officer or agent of the Beneficiary. In the event of the resignation or death of any substitute trustee, or such substitute trustee’s failure, refusal or inability to make any such sale or perform such trusts, or, at the option of the Beneficiary, without cause, successive substitute trustees may thereafter, from time to time, be appointed in the same manner.

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ARTICLE VIII
DEFINITIONS

          “Existing Senior Notes” shall mean, collectively, (i) RJRTH’s 6.50% Notes due June 1, 2007 in an initial aggregate principal amount equal to $300,000,000, (ii) RJRTH’s 7.875% Notes due May 15, 2009 in an initial aggregate principal amount equal to $200,000,000, (iii) RJRTH’s 6.50% Notes due July 15, 2010 in an initial aggregate principal amount equal to $300,000,000, (iv) RJRTH’s 7.25% Notes due June 1, 2012 in an initial aggregate principal amount equal to $450,000,000, and (v) RJRTH’s 7.30% Notes due July 15, 2015 in an initial aggregate principal amount equal to $200,000,000, in each case as the same may be amended, modified and/or supplemented from time to time in accordance with the terms thereof and the Credit Agreement.

          “Existing Senior Notes Creditors” shall mean the Existing Senior Notes Trustee and the holders of the Existing Senior Notes.

          “Existing Senior Notes Documents” shall mean the Existing Senior Notes and the Existing Senior Notes Indenture.

          “Existing Senior Notes Indenture” shall mean, collectively, (i) the indenture, dated as of May 20, 2002, as amended among RJRTH, the guarantors of the notes issued pursuant thereto, and The Bank of New York, as trustee and (ii) the indenture, dated as of May 15, 1999, as amended among RJRTH, the guarantors of the notes issued pursuant thereto, and The Bank of New York, as trustee, in each case as the same may be amended, modified and/or supplemented from time to time in accordance with the terms thereof and the Credit Agreement.

          “Existing Senior Notes Trustee” shall mean, collectively, the trustee and/or trustees under the under the Existing Senior Notes Indenture.

          “Initial New Senior Notes” shall mean, collectively, (i) the Borrower’s 7.25% Senior Secured Notes due 2013 in an initial aggregate principal amount equal to $625,000,000, (ii) the Borrower’s 7.625% Senior Secured Notes due 2016 in an initial aggregate principal amount equal to $775,000,000 and (iii) the Borrower’s 7.75% Senior Secured Notes due 2018 in an initial aggregate principal amount equal to $250,000,000, in each case issued pursuant to the New Senior Notes Indenture, as in effect on the Fourth Restatement Effective Date and as the same may be amended, modified and/or supplemented from time to time in accordance with the terms thereof and the Credit Agreement.

          “New Senior Notes” shall mean (i) the Initial New Senior Notes, (ii) the Exchange Senior Notes and (iii) the Additional Senior Notes, in each case as the same may be amended, modified and/or supplemented from time to time in accordance with the terms thereof and the Credit Agreement.

          “New Senior Notes Creditors” shall mean the New Senior Notes Trustee and the holders of the New Senior Notes.

          “New Senior Notes Documents” shall mean the New Senior Notes and the New Senior Notes Indenture.

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          “New Senior Notes Indenture” shall mean the Indenture, dated as of May 31, 2006, among the Borrower, the Subsidiary Guarantors and The Bank of New York, as trustee, as in effect on the Fourth Restatement Effective Date and as the same may be amended, modified and/or supplemented from time to time in accordance with the terms thereof and the Credit Agreement.

          “New Senior Notes Trustee” shall mean the trustee under the New Senior Notes Indenture.

          “Refinancing Senior Notes Creditors” shall mean the Refinancing Senior Notes Trustee and the holders of the Refinancing Senior Notes.

          “Refinancing Senior Notes Documents” shall mean, collectively, the Refinancing Senior Notes and the Refinancing Senior Notes Indenture.

          “Refinancing Senior Notes Indenture” shall mean one or more indentures entered into from time to time providing for the issuance of Refinancing Senior Notes by the Borrower, in each case as the same may be amended, modified and/or supplemented from time to time in accordance with the term thereof and the Credit Agreement.

          “Refinancing Senior Notes Trustee” shall mean, collectively, the trustee and/or trustees under the Refinancing Senior Notes Indenture.

          “Secured Creditors” shall mean, collectively, the Lender Secured Creditors, the Existing Senior Notes Creditors, the New Senior Notes Creditors and the Refinancing Senior Notes Creditors.

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          IN WITNESS WHEREOF, the Trustor has caused this Deed of Trust to be duly executed and delivered under seal as of the day and year first above written.

	Trustor:
	CONWOOD COMPANY, L.P., a
	Delaware limited partnership
[SEAL]	By:
		Name:
		Title:

State of                                         
County of                     

          Before me, the undersigned, a Notary Public in and for the State and County aforesaid, personally appeared                                         , with whom I am personally acquainted, or proved to me on the basis of satisfactory evidence, and who, upon his (her) oath, acknowledged (her)himself to be the partner of                     , the within named bargainor, a partnership, and that (s)he, as such partner, being authorized so to do, executed the foregoing instrument for the purposes therein contained by signing the name of the partnership by (him)herself as such partner as his(her) free act and deed.

Witness my hand seal at office this ___day of                     , 20___.

                                                            
Notary Public

My Commission Expires:                                         

EXHIBIT A

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EX-31.1

EXHIBIT 31.1

I, Susan M. Ivey, certify that:

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.

Date: August 2, 2007

/s/ Susan M. Ivey  

Susan M. Ivey 

Chairman of the Board, President and
Chief Executive Officer 

EX-31.2

EXHIBIT 31.2

I, Dianne M. Neal, certify that:

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.

Date: August 2, 2007

/s/ Dianne M. Neal  

Dianne M. Neal 

Executive Vice President and
Chief Financial Officer 

EX-32.1

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, each of the undersigned, Susan M. Ivey, Chief Executive Officer, and Dianne M. Neal, Chief Financial Officer, of Reynolds American Inc. (“RAI”), hereby certifies, to her knowledge, that:

1)	RAI’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007, 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, 2007, fairly presents, in all material respects, the financial condition and results of operations of RAI.
	EXECUTED this 2nd day of August, 2007.

/s/ Susan M. Ivey  

Susan M. Ivey, Chairman of the Board, President and
Chief Executive Officer of Reynolds American Inc.

/s/ Dianne M. Neal  

Dianne M. Neal, Executive Vice President and Chief
Financial Officer of Reynolds American Inc.