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SECRET UKRAINE IBUSINESS PLAN FOR JOINT ENTERPRISE BETWEEN BAT INDUSTRIES PLC AND THE CHERKASSY, PRILUOKY AND MONASTIRISK FACTORIES MAY 1992 BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

UKRAINE IBUSINESS PLAN Copy Number__ Distribution 1 Sir Patrick Sheehy 2 U. Herter 3 D,S. Watterton 4 A.Johnson 5 G, Oltermann 6 H. BSick 7 H. Taylor 8 :M: Magnacca~- 9 R. Duda 10 J. Wolfrum 11 NBD/London 12 NBD / London 13 NBD / London 14 Project Team / Hamburg 15 Project Team / Hamburg Project Tem'n ~L Dud= O. Po~mo H. J. Woltn,~n L 71mme~~ BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

TABLE OF CONTENTS Section 1 Section 2 Section 3 Section 2.1 2.2 2.3 3.1 3.2 3.3 4.1 4.2 4.3 4.4 Executive Summary Business Objective & Strategies Strengths of Partners Critical Issues Underlying Strategies 2.3.1 Phase 1 - No Convertibility 2.3.2 Phase 2 - Convertibility Business Environment People and Resources Sociopolitical Analysis Economic Analysis and Forecast Marketing and Sales Strategy Analysis of the Ukrainian Cigarette Market 4.1.1 Segmentation 4.1.2 Pricing and Excise 4.1.3 Trademark Issues Market Trends Marketing Strategy 4.3.1 Establishment of Marketing Function 4.3.2 4.3.3 4.3.4 4.3.5 Phase 4.3.6 4.3.7 4.3.8 Existing Ukrainian Trademarks Excise and Pricing Strategy Ukrainian Brands - Phase 1 International Filter Brands- 2 Product Development Communication Sales and Distribution Sales Forecast 4.4.1 Phase 1 4.4.2 Phase 2 BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION. 4 4 5 5 10 10 10 12 14 14 17 17 17 25

Section 5 Section 6 Section 7 Section 8 Appendix 6.1 6.2 6.3 Leaf Strategy Current Situation Leaf Strategy 5.2.1 Tobacco Supply Purchase Systems 5.2.2 Development of the Monastirisk Operating Centre 5.2.3 Leaf Extension Service 5.2.4 Training and Development Production Strategy Background 6.1.1 Cherkassy 6.1.2 Prilucky Production Strategy 6.2.1 Site Development and CAPEX 6.2.2 Primary Development 6.2.3 Secondary Development Sources, Security and Supply of Wrapping Materials 6.3.1 Risks and Opportunities Management/Personnel Issues 7.1 Management Structure/Head Office 7.2 Factory Management 7.3 The Workforce 7.4 Training and Development 8.1 8.2 8.3 8.4 8.5 Financial Summery Historical Performance Plan Assumptions Trend of Important Plan Figures Evaluation Sensitivities (separate book) BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION. 26 26 27 37 37 4O 43 46 46 48 49 51 52 52 53 54 59 60

:h Ljvov Prilucky 8O Cherkas,sy 30C • Charkow 1650 Dnepropetrovsk ~ 20C Donezk POPULATION x 1000 BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

SECTION 1 - EXECUTIVE SUMMARY The Ukraine cigarette market is estimated to be 80 billion cigarettes although current production capacity in the Ukraine is only 66 billion due to a lack of hard currency and underinvestment in the factories. The Ukrainian government and the industry have recognised the need for Western investment in the tobacco industry. A letter of intent was signed with Ukrtabakprom, the government agency responsible for the tobacco industry, the Prilucky and Cherkassy cigaret/.e factories and the Monastirisk fermentation production association. The objective of the letter of intent was to examine the opportunity in greater detail and to propose a business plan. The main highlights are as follows: A joint stock company will be created and own the three companies. It will be run as an integrated company. Due to the lack of convertibility, there is a two-phase approach for BAT in the Ukraine, predicated on the basis that until the Rouble becomes fully convertible, hard currency inputs will need to be funded externally. The underlying working assumption of the Plan is that the Rouble will not be convertible until 1998 {Year 6). During Phase 1 (covering the first five years) when we do not expect to have a convertible currency, the marketing strategy will increase sales volume by 25% from the current 24 billions per annum to 30.3 billions in Year 5 with market share forecast to improve from 30% to 36%. This will be achieved by: - A 100% increase in the production of filter cigarettes - An improvement in the quality of the total product range The planned increase in sales volume will be achieved with adequate advertising support and distribution via our own sales organisation. The trademark situation is unclear. Therefore, BAT will need to obtain access to the brands produced today so as not to be disadvantaged compared with other manufacturers. It must also be ensured that the current pricing and excise structure is adapted to western standards. An excise structure based on a mixed end- price framework has been proposed. Advertising for cigarettes must also be guaranteed. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

BAT Ukraine "Sales Volume ' 24.0 * 25.1 * 27.3 ~ 31.1 ' 39.5 ~ 41.0 ~rke~ share % ~ 38.7 ~ 36.6 ~ 36.6 ~ 36.5 * 44.9 ~ 46.1 ~Ne~ ~rnover ' 58.7 ~ 63.6 * 71.8 * 107.8 ~ 211.4 ' 234.6 = Trading Profi~ * 5.2 = 4.3 ~ 4.7 = 16.0 = 53.7 ~ 63.8 ~ -US $O00'S- ' ' ~ ~ = ~ ~Profit after T~ , 4.3 ' 3.5 ~ 3.9 ~ 12.3 ~ 35.7 ~ 39.8 ~ -US $000's- ~ ~ = ~ ~ ~ ~Dividends , 0 ~ 0 ~ 0 ~ 7.4 ~ 28.6 ~ 31.9 BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

Production in the factories is characterised by obsolete equipment. A capital expenditure programme is planned to meet the marketing requirements. It is geared to securing existing production, increasing quality and yield, and increasing the production of filter cigarettes. The total capital expenditure during Phase 1 is estimated at $82 million including spares and local spending. Of this amount, $ 61 million will be in hard currency. The scheduled increases in production volume and quality are dependent on improving the quantity and quality of supplies to the factories. Adequate supplies of leaf will be secured by introducing new tobacco varieties, providing active support for private farmers, improving handling, grading and processing. Permission for barter trade from the Ukrainian government and support from Ukrtabakprom will be required to ensure sufficient WMS and leaf. The effect of the operating strategies will be to increase net turnover from $59 million in Year 1 to $85 million in Year 5. In the same period, trading profit is projected to rise from $5 million to $12 million. The organisation structure of management will consist of a Supervisory Board and a Board of Management which in view of the current personnel situation on the three sites, will consist of nine members who will be nominated by BAT. The head office will be in Kiev and will have a small workforce consisting of central Finance, Marketing, Production Co-ordination and Personnel. Due to the three sites, 15 expatriates are scheduled up to 1995. From 1996 onwards, the business will operate with 8 expatriates. When convertibility is achieved (assumed to be in Year 6), Phase 2 will commence. Sales volumes are shown to increase by 37% to 41 billions in Year 10, which represents a market share of 46%. The marketing strategy to achieve this will be reflected in: - a doubling in the production of filter cigarettes to 26.6 billions, including - the launch of IFB 1 and IFB 2 brands totalling 8.6 billions (10% share of market in Year 10). There will be a 13% increase in the manning levels of the sales force to ensure adequate coverage. Phase 2 will involve an additional $75 million for spares and capital expenditure to bring a GLT on-line and to install the required equipment for the IFBs. In addition, continuous activities to increase quality and yield are planned. BATCO CONFIDENTIAL - CATEGORY !: MINNESOTA TOBACCO LITIGATION.

Net turnover is forecast to increase by 175% in real terms, reflecting the volume increase, improved brand mix and benefit of real annual price increases, to $235 millions in Year 10, Trading profit shows strong growth to $63.8 millions in Year 10. Dividends are scheduled for the first time in the fifth year of activities with a 50% payout rate which increases progressively to 80% by Year 8. BATCO CONFIDENTIAL - CATEGORY 1: MINNESOTA TOBACCO LITIGATION.

SECTION 2 . BUSINESS OBJECTIVE AND STRATEGIES The objective of the joint venture is to secure long-term profitable growth in the Ukrainian cigarette market. The joint venture is the preferred vehicle for combining the strengths of the existing enterprises with those of BAT. The joint venture should be a fully integrated business from leaf development and processing to cigarette manufacture and distribution. 2.1 Strengths of Partners The Ukrainian government and the industry have recognised the need for Western investment in the tobacco industry. Each of the potential partners identified has unique strengths from BAT's viewpoint. The Cherkassy and Prilucky cigarette factories currently account for over 36% of the existing production capacity in the Ukraine, The Prilucky site has sufficient room for future expansion whilst the Cherkassy factory is located in a major urban centre with good infrastructure and distribution links with the rest of the country. Monastirisk is located in the western Ukraine close to the major tobacco growing areas. It has an existing customer base. Each factory has a skilled employee base which has been demonstrated by their ability to maximise the life of their factory equipment. They have had a paternalistic culture which has contributed to the loyalty of the employees. In addition, they have begun to develop expertise in sourcing materials and in barter deals, although they still rely on Ukrtabakprom for support including access to hard currency. All the factories have strong administrative and control systems which were suitable for a centrally planned economy. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.