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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.

II .................................................................................................... ........................................ II II I II I II BATCO CONFIDENTIAL - CATEGORY l: MINNESOTA TOBACCO LITIGATION.

2.2 Crixical Issues There are significant operating risks due to the lack of convertibility of the Ukrainian currency, which is currently the Rouble. No timetable has been discussed for full convertibility with the IMF. Therefore, a two-phase approach is recommended with the initial phase (Phase 1) concentrating on securing the existing market share. The second phase (Phase 2) is dependent on full convertibility and focuses on increasing the market share through the introduction of Internadonal Filter Brands (IFBs). The current excise structure has the following main features: - Ad valorem excise expressed as a percentage of the manufacturer price inclusive of the excise. - Plain cigarettes do not attract any ad valorem excise. - Multiple pricing for the same brand according to the costs of each manufacturer. - Excise is payable 10 days in arrears based upon the value of cigarettes sold. Therefore, as a precondition to BAT's involvement, the excise structure would have to be changed to a Western structure which is described in Section 4.3.3. The third major issue that must be dealt with sa~is-factorily is tha~ of trademark ownership. The existing trademarks are made by a number of factories within the former Soviet Union. No clear ownership has been identified. Therefore, BAT must secure the right for the factories to continue to manufacture and trade the existing trademarks. 2.3 Underlying Strategies BAT proposes the establishment of a joint stock company which will own and operate the three existing enterprises as one integrated business. This will include the establishment of an office in Kiev which will be responsible for common functions such as marketing and for providing strategic direction. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

III:~tld 2.0 |.O 1.6 licit I.| 1.3 O.& O.Z 0.1 Iocat 0.9 0.$ total !0.1 6.| 10.1 plant |o~l 0,? 0,$ 0.0 1.6 toteL 0,7 0,5 0,0 6.T 6,| I~lx~'~l 0.1 0,1 0,1 0,5 0,1 Lc~l 1,0 0,3 0,$ 0.6 0,$ tote| 1,1 0,3 0,$ 0,6 0,3 S~rt~ (|~et) lmc~id O.i O.i 0.9 0.9 0.9 Io¢~L 0o0 0.0 0.0 0.0 0.0 TOTAl. tIi:~ttcl 14o9 11.1 13.6 12.3 9.0 ~t 5.5 ~.~ 3.0 ].9 ~,t totlt ~.t 15,5 16,8 16,2 13,0 TO~A~ I~d ~e~ 1 - S 61.1 t~t totlt 81,9 I c~(,~s, totol 8.0 6.1 I I PtlILUC~ toter 8,t ?,! 7,? 4,8 3.3 I I lIl:l~l.$Tltlll{ tetI| 1.1 1.1 0,5 5,0 6.9 I I [|I~ tOtl| lol 0.$ BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

2.3.1 Phase 1 - No convertibility Phase 1 covers the first five years. The objective will be to increase the market share from 30% to 36% when the total market is expected to grow by 1% per annum. The focus will be on the development of new brands and modification of the existing brands by improving the quality and presentation of brands manufactured with ex- Rouble zone of leaf and WMS. Net turnover will increase from $59 million in Year 1 to $85 million in Year 5. Trading profit will increase from $5.2 million in Year 1 to $12 million in Year 5. Plain cigarettes will decline from 17.5 billion cigarettes in Year 1 and 70% of net turnover to 17.1 billion in Year 5 and 53% of net turnover. Filter cigarettes will increase by 6.9 billion during Phase 1. Adequate resources for communication are budgeted at 2% of net turnover and rising to 3% in Year 2 and Year 3, Year 4 and then stabilising at 4% in Year 5. The establishment of a Marketing and Sales organisation in Kiev with four regional offices will ensure that the JV has national distribution and market information. As private wholesaling and transportation companies are established the JV will re-direct some of its efforts away from the state organisations to these new companies. Total capita! expenditure including spares will be nearly $82 million of which $61.1 million will require hard currency. The following actions will be taken in the production and fermentation plants in Phase 1: 1. Implement BAT safety standards, urgent replacement and refurbishment of infrastructure and initiate a QC programme ($20.5 million} 2. Primary upgrading ($10.8 million} 3. Seconda~ replacement ($35.2 million) The leaf strategy in Phase 1 will be to establish a framework in the Ukraine and between the three operation centres - within which the joint venture can achieve the following objectives: BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

To ensure an adequate supply of tobacco to enable current and future marketing opportunities to be fully exploited, whilst at the same time progressively increasing stock levels, and reducing dependence on imported tobacco. This will be achieved through the establishment of an extension service to facilitate the increased production of domestic tobacco the introduction of new Flue Cured and Burley varieties the introduction of new methods of handling and grading and processing systems appro- priate to the above the active encouragement of the growth in numbers of individual private farmers the establishment of an independent system for the purchase/import of tobacco. To rationalise the existing systems of tobacco handling, processing and storage to maximise the use of existing fixed assets, and enable the three operating centres to function efficiently as an integrated enterprise. To advise and co-operate with the appropriate authority(ies) in the privatisation of the Ukraine tobacco industry particularly in such areas as: creation of a "National Tobacco Board" or equivalent body establishing a policy for farmer prices introduction of an international standard grading system designation of land for tobacco production availability of credit/financial assistance for both private tobacco growers and collective farms. Total capital expenditure to support the leaf strategy is $1 5.4 million. The organisational structure of this company would consist of a Supervisory Board and a Board of Management. The Supervisory Board may, by law, not be full-time employees or executives. The Supervisory Board will be responsible for the strategic operations of the company. We recommend that the Supervisory Board should consist of a small group of five to seven people headed by a Chairmen. BA'TCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGAT|ON.

toc~t toc~! toter 0.1 0,| 0,| 0,| 0,| 2,0 2,0 ~00 2.0 1,0 0,2 0,2 O,Z 0,2 0,6 0,4 0,6 0,4 0.6 0.6 0,6 0,6 0.6 2,6 0,? 0,? ~.6 0o~ 0.? 0.~ 0,9 $,$ 1.4 1,~ $,5 2.5 1,6 0,0 0,0 1,8 1,$ 0,0 O,Y 4.3 Z.| O,O 0,7 2,9 3,1 3,2 $,& 2,8 3,8 6,0 L,I 6,1 0,| 0.3 ~,| 0,1 0,0 9,9 &,! ~,S 0,$ 0,1 0,3 0,0 0.3 Sperr* (|~d~et) Smorted 0.9 0,9 O,t 0,9 t,Z I~ll 0.0 0,0 0,| 0,0 0,0 totat 0.9 0,9 e,e 0.9 t,Z TOTAL ~Nx~r~ed 19,0 11,1 lo¢ot 6,$ &,9 Iotlt ZS.6 1S,9 11,& 1|,& 9.2 TOTAL IN~orteLI Te&r ~ - 10 rotor BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

As a majority shareholder in the new company BAT would expect to select and appoint the majority of the members including the Chairman, and the members of the Board of Management which will consist of nine members. The present factory [~irectors will be represented on this Board. The General Manager, Finance Manager, Leaf Manager, Production Manager, Marketing Manager and Personnel Manager will all be expatriates. In Kiev, an efficient head office will be set up to carry out the central function of General Manager, marketing production, to co-ordinate leaf and materials supplies and to carry out personnel training and finance. The factory management will be reinforced with experienced expatriates who will train the management to operate with BAT systems, technologies, and to meet accounting and reporting requirements. Overall, 15 expatriates are scheduled up to 1995; as from 1996 the company will be run by 8 expatriates. Manning levels will increase from 1,995 in 1992 to 2,348 in 1997. Capital expenditure of $2.7 million to support the sales force and head office will also be required. 2,3.2 Phase 2 - Convertibility Phase 2 is dependent on full convertibility. We expect it will be achieved at the beginning of Year 6 (1998). The objective will be to increase market share from 36% to 46% over a five year period. The focus will be on introducing a semi-American blend and an American blend brand. Existing brands will be further refined with expected growth in the higher priced local brands. Net turnover will increase from $108 million in Year 6 to $235 million in Year 10. Profit after tax will increase from $12 million in Year 6 to $40 million in Year 10. Filter production including IFBs will increase from 15.6 billion in Year 6 to 26.5 billion in Year 10. IFBs will account for 19% of net turnover in Year 6 and increase to 54% in Year 10. Media/Merchandising expenditure will be 4% of net turnover. There will be a 13% increase in the manning levels of the sales force. Total capital expenditure requirements (including spares} in Phase 2 are nearly $75 million for which the joint venture will provide the funds. Phase 2 will involve the following investments in manufacturing: 1. The completion of the construction of a GLT in the Monastirisk region ($8.3 million) ~, 2. The installation of an American blend primar~ in Prilucky ($19.4 million) BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

COHPA,/~ tO~NZNG FO~CAST yesr I992 1993 ~994 2995 ~996 299? 1998 1999 2000 200~ 2002 780 803 820 830 83S 84S 855 860 860 85S 876 899 910 940 94S 9SS 985 102$ 1070 1095 360 360 360 360 360 3S0 342 33S 327 32S TO'Z~A,T. JO2HT £HTZX299S 22)4 2285 223? 2323 2348 23?8 240S 2438 2480 24S3 BATCO CONFIDENTIAL- CATEGORy I: MINNESOTA TOBACCO LITIGATION.

3. Expansion of secondary capaciW ($17.3 million) In addition, the ongoing refurbishment of the infra-structure, upgrading of the primary and secondary replacement will require an additional $29 million in capital expenditure. As well as improving quality and productivity, the leaf department's emphasis in Phase 2 will be to minimise the amount of imported leaf required for the IFBs as the GLT comes on line at the end of Year 7. Manning levels will increase by 4% to 2,453 in Year 10. BATCO CONFIDENTIAL . CATEGORY I: MINNESOTA TOBACCO LITIGATION.

THE UKRAINE POPOLATION: ETEMICITT~ Inflation Discount rats 52,3 million Coal, iron, chemicals rich far=land 73% ~ralnian 22% Rusdlan con~rol~ ~ Russia since I cantur~ decline of 35% up to 1S94 moderate increase starting in 1998 increasing to 30t in year 1996; decreasing to 15% Ln the remaining plan period 200% in 1992; decrease to 30% at the end of the plan period. in line wL%h inflation difference. Business plan is based on US $/150 Roubles 15% no~nal BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION. CD

- !O SECTION 3 BUSINESS ENVIRONMENT - 3.1 People and Resources The population is 52.3 million and consists of 73% Ukrainians, 22% Russians and 5.2% other ethnic groups. The more industrialized Eastern provinces have a higher number of Russians. They were attracted to the Ukraine by factory jobs that offered increased income. Anti-Russian hostility is low and the two cultures are very similar. The control of the Black Sea Fleet and the Crimean desire for autonomy have pushed the Ukraine and Russia into controversy. The Ukraine is rich in coal and iron ore, accounting for 24% and 31% of CIS production, respectively. The republic has crude oil and natural gas reserves. It also produces ± 25% of the CIS grain, potatoes, vegetables, and non-citrus fruits and over 20% of its meat, milk, and eggs. The republic has 22 800 km of railways and 258 600 km of roads. Because of its importance to the union, Ukrainian infrastructure has been adequately maintained but is well below international standards. Telecommunications are substandard and a major obstacle to economic expansion. ForTy percent of the Ukraine's labour force works in industry and construction, 7% in transport and communication, and 8% in trade and other services. Because the republic is the "breadbasket" of the C.I.S., 20% work in agriculture and forestry. The number of trained specialists is relatively low. 3.2 Sociopolitical Analysis The independence movement culminated with the 1 December 1991 referendum. The country has won widespread international recognition. Support progressed furthest in the Western provinces that were a part of Poland between the two World Wars. The Communists' complicity in crimes during the Stalin era contributes to the absence of support for former Communist party members. Consequently, Ukrainian conservatives will not rise to power. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

- 13. The rhetoric and policy positions of newly elected President Leonid Kravchuk are liberal, although he is a former Communist. Kravchuk consistently advocated Ukrainian sovereignty in 1991. His stature differs from Boris Yeltsin's because the survival of Ukrainian democracy is independent of his personal survival. Ukrainian self-determination had progressed very far before he rose to power. Apparently the regions of the Ukraine act independently of the political power in Kiev. The Ukrainian presidency has strong executive powers. This will enable Kravchuk to implement structural change in the system. However, it also facilitates the establishment of an authoritarian regime. In conditions of instability and decline in the period leading to the winter of 1992/93, a high probability exists that the Ukrainian President will use his power to advance reforms. The failure of the economic reform process will create a deep recession. The country is not predicted to revert to a totalitarian government. Instead, a combination of nationalism and a gradually opening economy will emerge during the forecast period. Ukrainian nationalism gained momentum after the Chernobyl disaster, which Ukrainians blame on the central government. At first, this was a cultural movement, but it eventually became political. The reformist, umbrella organization "Rukh" (movement in Ukrainian) has been at the forefront of promoting political pluralism. Communist leaders with ties to the pre- Gorbachev era tried to block the nationalist movement through the second quarl.er of 1990. At that time the Communist position disintegrated in the face of popular demands for democracy. The Ukraine is obstructive in attempts to formalize the Commonwealth of Independent States, although isolation from the C.I.S. may devastate the economy. Ukrainians have refused to sign agreements that would (1) preserve previous trade links, (2} maintain a common market, (3) prevent state-owned enterprises from using monopolies to raise prices, (4) designate Russia as legal successor in payment of foreign debt, and (5) allow tariff-free transit across Commonwealth states. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

~,L~OR 'RISKS AND OPPORTU~TIES Superficial commit=one to Government Instabi1£ty Unclear legal Framework Depression - Inflation Lack of supplies to the factories - Raw Materials No conve~Ibillty Debt Service of the Ukraine Profit Control Trade w~r ~n the C.I.S. First in the market - Brand loyalty - Influence in development of marke' Unfulfilled demand on the market Investments are welcomed Export base for C.I.$. BATCO CONFIDENTIAL - CATEGORY h MINNESOTA TOBACCO LITIGATION.

12 - 3.3 Economic Analysis and Forecast The Ukraine's economy is the second-largest in the C.I,S., accounting for 16.2% of net output. Per capita GDP was US$ 4 325 in 1990, 22% less than Russia's because it does not have such high-unit value commodities as diamonds and gold. The Ukraine is second to Russia in the output of most major industrial products, including cast iron (4.0.8% of union output). A.C. electric motors ((35.8%), and excavators (29.2%). Last year's output of rolled steel products was 38.61 million MT, 33.5% of union production. In 1990, 195 412 motor cars and 106 221 tractors were assembled. These products and machinery are sold to Other republics, and light industrial goods, wood and paper, non-ferrous metals, and chemicals are imported. Most of the industrial capacity is very old and in need of investment. As a result of the Chernobyl catastrophe there is a high degree of contamination in the north-west of the Ukraine. However, an evaluation by independent sources did not reveal any impermissible radiation levels in the groceries, foodstuffs and water supply. The greatest risk is associated with another accident. Severed traditional trade links between Russia and the Ukraine and the transformation to market economy will cause the Ukrainian economy to break down. Factories are already closing and unemployment is on the rise. Strikes and wage hikes are becoming likely with ill effects on inflation. Mass poverty with the onset of a small but wealthy elite is leading to social tension. We expect an unco-ordinated transition to market economy with a lack of legislative clarity. Increasing energy prices will cause a shortfall in supply and the temporary shut-down of factories may occur. When prices are liberalized, the Ukraine will remain a net importer. It will be affected by the higher prices for energy imports and lower prices for its overvalued machinery and basic metal exports. However, market prices for agricultural output will partially offset this. Overall, 45.8% of GNP is dependent on interrepublic trade, and international trade involves 6.7% of GNP. The GNP will therefore decrease till the end of 1994 and will only increase moderately till the year 2002. The Ukraine.is planning to introduce its own currency the hryvna. We assumed an inflation rate of 200% in 1992 which decreases to 30% during the plan period. Currently, Kiev is using a specially stamped ruble (coupon) for mandatory foodstuff purchases. Convertibility is directly linked to the ability to increase foreign trade balance. Therefore a reduction in imports is to be expected. BATCO CONFIDENTIAL - CATEGORY i: MINNESOTA TOBACCO LITIGATION.

Moscow has made matters worse by freezing Ukrainian hard currency funds. Today, it is not clear to what extent hard currency is available in the Ukraine. The Ukraine will assume responsibility for its share of the C.I.S.'s foreign debt (± 16.3%), when it verifies the terms and conditions. At present the republic is using the issue to bargain for concessions in the C.I.So Debt service of the Ukraine is approximately US $ 2 billion p.a. The currency is not at present convertible. This imposes severe constraints on BAT's proposal, as the desire to introduce American style cigarettes and to increase production significantly can only be achieved when the local currency is fully convertible. Therefore, the proposal is based on a non- convertible scenario although reference is made to specific actions that will be taken when the local currency is fully convertible. BATCO CONFIDENTIAL - CATEGORY i: MINNESOTA TOBACCO LITIGATION.

3.4 - SECTION 4 MARKETING AND SALES STRATEGY - 4.1 Analysis of the Ukrainian cigarette market The market figures are based on information from Ukrtabakprom. Some figures/information have not, or not yet, been confirmed. Other information is based on discussions with Ukr~abakprom, the Ministry of Trade, regional offices and the trade organization. In 1991 the total Ukrainian cigarette market sold 61.8 bn cigarettes (including supplies to the army - 65.4 bn). But this does not reflect the true demand for cigarettes in the Ukraine. Estimates from Ukrtabakprom and the Ministry of Trade suggest a market potential of 80 - 85 bn cigarettes. In 1985, 76.3 bn cigarettes (including the army - 82.5 bn) were sold in the Ukraine. At that time - according to Ukrtabakprom - supplies to the population were to a large extent guaranteed and satisfactory. Since then, domestic volume has dropped dramatically. Ukrainian cigarette production was kept at a level of approx. 80 bn until the end of the 80's. Subsequently, the level dropped to 66.6 bn in 1991; for 1992 a further decrease in production volume to 64,2 bn cigarettes is forecast. A fundamental reason for this decrease is the technical equil~ment in the factories. Since the mid-80's no notable investments in machinery have been made. An additional factor is the increasing number of difficulties in the sul~ply of materials since the beginning of the 90's. This bottleneck factor may become even more crucial in the future. In the past, the Ukraine imported substantial quantities of cigarettes from the Soviet states, chiefly filter ciga- rettes from Bulgaria and Yugoslavia. In 1986 the volume peaked at approx. 11 bn cigarettes, in 1991 it was only 1 bn. "USSR Interstate imports" to the Ukraine (on average 2 bn cigarettes p.a.) did not in the past make any significant contribution to market supply. In 1991, these "imports" sank to approx. 300 mn cigarettes. BATCO CONF]DEI~TIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

- 15 - In contrast to this, the "USSR Interstate exports" led to a considerable worsening of the Ukrainian market situation from the middle to the end of the 80's. At the moment considerable quantities of cigarettes are "shifted" to other CIS republics by private organizations which are not recorded in the statistics. According to Ukrtabakprom there are approx. 18 mn smokers in the Ukraine: Incidence 34.7% Per capita consumption 1,250 cigs. Daily consumption 10 cigs. These figures reflect the extreme lack of supplies on the Ukrainian market, Based on a market demand of 80 -85 bn, the consumption would be: Per capita consumption 1,650 cigs. Daily consumption 13 cigs. 4.1.1 Segmentation The Ukrainian cigarette market is based 100% on Oriental tobaccos. Only national (Ukrainian) brands and brands of the former Soviet Union are produced. In the past there were individual cases of limited licensed production. Plain cigare[tes (70 mmloval) and papirosy (82ram, 92ram, 95mm, 105mm) are packed without foil; nor is there any polypropylene or cellophane insert. Filter cigarettes are sold in SC and HL versions (HL to a very limited extent); length 80ram or 85mm and filters 15ram or 18ram long. The plain segment dominates production with over 72% of the brands on offer in the Ukraine. It includes large brands such as VATRA (approx. 50%), POLJOT (approx. 15%} and PRIMA (approx. 4%). The packs are very simple flat boxes, most of which have major deficiencies in the printing. The HL filter versions are produced in Kiev, Charkov, Lvov (1991 - main brands KOSMOS and STOLIZNIE approx. 2.8%). Most of the Ukrainian cigarette factories are in a position to produce SC filter cigarettes. The quality differences in packaging are, however, tremendous. SC main brands are KOSMOS (approx. 4.8%), EXPRESS (approx. 4.4%) and FILTR (approx. 2.4%). BATCO CONFIDE]NTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

In the mid-80's the market was barter supplied with filter cigarettes via imports (up to 47%). At the moment filter cigara~es mostly have paper filters instead of acetate because of a lack of materials. Demand for filter cigarettes is, however, currently estimated at approx. 60% of the market. With approx. 24 bn cigarettes (1991) CPM has a 36% share in Ukrainian production. As on the total market, three quarters of the volume is plain cigarettes. (see Appendix - brands and classes - CPM). As the main brands (with the exception of LUG and PRILUKSKIE) awe also produced in large quantities by other factories, the clarification of trademark ownership problems is of vital importance to CPM. 4.1.2 Pricing and Excise The current taxation of cigarettes has the following features: - Ad valorem excise expressed as a percentage of the manufacturer price inclusive of the excise. - Plain cigarettes do not attract any ad valorem excise. - Multiple pricing for the same brand according to the costs of each manufacturer. - Value added tax at 28% (21.88% of the VAT inclusive price) applicable only up to the manufacturing stage. - A trade margin of 25% (20% of the price inclusive of the margin), - The manufacturer's markup is restricted to 25%. - Excise is payable 10 days in arrears based upon the value of cigarettes sold. 4.1.3 Trademark Issues Formerly, all trademark and patent law matters were dealt with centrally in Moscow. The brands KOSMOS, STOLICHNYE and PRIMA were developed in Moscow. Other brands were developed by Ukrtabakprom or by individual factories, The "factory trademarks" are ostensibly patented for the factories. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

lll.l ~.l 12.I ~4.1 31.1 |,I I,I I II fl.s II ....... II +.~ II Ioi ~.e , ....... II ll.e ~' BATCO CONFIDENTIAL - CATEGOI~Y 1: MINNESOTA TOBACCO LITIGATION.

- 17 - 4.2 Market Trends The market forecast is contained on the page opposite. Currently, the market is undersupplied. It is not assumed that supply will equal demand until Year 5. However, it is assumed that the production share of filter, plain and papirosy cigarettes mirrors the market demand for each product. Other significant trends are as follows: The Papirosy segment will continue to decline. The Plain segment will decrease from 71% in Year 1 to 55% in Year 5 to 39% in Year 10, The Filter segment will increase from 25% in Year 1 to 43% in Year 5 to 60% in Year 10. Imported cigarettes will develop a small niche and will account for 2 billion cigarettes in Year 1 and 6 billion in Year 10, No revenue has been assumed for the JV with regard to the sale and distribution of imported BAT cigarettes. It is assumed that the Ukrainian cigarette market will have a range of price segments to meet the needs of consumers. There will probably be 5 major segments: Low Price - Consisting of plain cigarettes Medium Price - Comparable to existing Class II, III and IV High Price - Class I type cigarettes Premium Price - Semi-American blend cigarettes Ultra-Premium Price - Locally made International Filter Brands and comparable imported Brands 4.3 Marketing Strategy 4.3.1 Estab!!shment of Marketing Function One of the most urgent steps that will be taken is the establishment of a professional marketing and sales organi-sation. The Marketing and Sales Manager will be an expatriate and will be responsible for a team of 69 which includes a field force of 56 individuals. There will be a Marketing Assistant who initially will also be an expatriate. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

4.3.2 Existing Ukrainian Trademarks It would be desirable for BAT to obtain exclusive pro-tection for existing Ukrainian brands manufactured in CPM. In pending negotiations, therefore, as a minimum it must be ensured that the brands so far produced in the CPM factories can be used in future by BAT. To obtain the right to manufacture all the brands produced in CPM we may have to pay a licence fee to Ukrtabakprom. This amount is not included in the Plan. As far as justifiable under market aspects, BAT should try to make appropriate preparations for converting the production of Ukrainian brands to BAT's own trademarks as soon as possible. As supplies will remain below demand in the first few years, there are favourable opportunities for "new launches" (renaming existing brands) without any great marketing spending. However, experience in east Germany has shown that "old" and familiar brands can be a tremendous asset. 4.3.3 Excise and Pricing Strategy 4.3.1.1 Excise As a precondition to BAT's involvement in the Ukraine, the excise system must be changed. There are four major princiloles that must be followed: Plain cigarettes should be taxed in line with filter cigarettes, VAT is part of the overall tax burden on cigare~es. The Ukrainian consumer must have a range of retail prices for cigarettes. The total tax burden should be narrowed to encourage the production of qualiW cigarettes. The following recommendations have been discussed in general terms with the Ministries of Finance and Economic Affairs. 1. The current variable ad valorem rates system for cigarettes is inequitable, complex to adminster and inappropriate to the new economic environment envisaged for the Ukraine. It should be replaced with a more simplified system. A mixed end-product structure with a 50/50 split between the specific and ad valorem element is recommended, it should be applied to all cigarettes including plain and papirossy. The objective of these changes would be to achieve a more equitable excise structure and to encourage the manufacture of higher quality cigarettes. C~ BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

19 - 2. TO secure Government revenue and to ensure equality of application of excise between manufacturers, and to prevent any excise evasion, the government should consider the introduction of a banderole system. 3. The establishment of a single retail price for each brand which should apply nationally and which should replace the current situation whereby the same brand made in different factories can have different retail prices because of manufacturing cost differences. 4. The trade markup which is currently 25% or 20% of the retail price should be reduced to a level which more accurately reflects the costs of retailers. A margin of 15% would be sufficient based on the current incidence of tax on Class I cigarettes. .5. The current VAT system which appears to be a multi-stage system applying up to the final point of manufacture only (not to be added value from distribution) works well and should not be changed. However, the VAT is part of the overall tax burden on cigarettes and should be considered as such. 4.3.3.2 Pricing The JV would, initially, compete in the low, medium and high price segments. The existing Ukrainian Class II-IV type filter cigarettes will be positioned in the medium price segment. Class I type filter cigarettes and the new Ukrainian products to be developed by the JV will be positioned in the high price segment. When the currency is convertible, Jt would compete in the Premium and Ultra-Premium segments with locally manufactured products subject to the competitive situation at that time. 4.3.4 Ukrainian Brands - Phase 1 To safeguard the existing business and to be able to satisfy demand from the weaker income groups the existing plain and filter cigarette brands ought to be improved without any great financial expenditure. The typical Ukrainian flavour must not, however, be altered. Steps should relate to the pack {improve printing and embossing, e.g. adding foil), to improving the physical cigarette quality and to lowering tobacco input weight. BATCO CONFIDENTIAL - CATEGOI~Y h MINNESOTA TOBACCO LITIGATION.

20 - There are the following decisive reasons for the planned increase in Ukrainian filter cigarettes: In the mid-80's the filter segment in a situation of satisfactory market supply achieved a leading 47% share (see Appendix Total Cigarette Market 1985 - 1991). This reflects the real significance of filter cigarettes. The gap between current production capacity and estimated demand potential is currently approx. 20 bn cigarettes. A prompt and noticeable increase in production capacity - taking account of timing aspects and expected competitive activities - is therefore necessary to improve our market position. For this reason, the position of Category II - V Ukrainian filter cigarettes should be further expanded as regards volume. A switch to a KS version will be prepared for short-term launch. To ensure differentiation from competing brands and to justif~ a higher price, the new Ukrainian KS filter brands must be developed with far better quality as regards product (Oriental flavour WPe with casing/flavour) and presentation (SC, polypropylene and aluminium foil). In view of foreseeable supply problems affecting materials a more rapid expansion than scheduled in the sales forecast is not possible in the first few years. Although there is clear market demand for HL packs for Ukrainian brands, too, the production of SC packs is scheduled - solely for profitability reasons as the HL would have to be imported from the west. "There are further market opportunities in the development of "specialities"/line extensions such as changes in format (100 ram) and changes in flavour (mentholated). 4.3.5 International Filter Brands - Phase 2 In future, demand for western cigarette brands will increase because the Ukraine has opened up politically. To build up a strong BAT position in the segment of semi-international brands tactical.brands (IFB 2) will have to be launched in the Ukraine. Under profitability aspects we shall have to examine the extent to which tobaccos which are available and can be developed in the Ukraine can be used in the blend without having too strong an impact on the American Blend character. In Year 6, production of an HL IBF2 is to begin. BATCO CONFIDENTIAL - CATEGORY 1: MINNESOTA TOBACCO LITIGATION,

21 - Today's estimate indicates that the BAT brands PALL MALL, HOLLYWOOD, GOLD DOLLAR and VICEROY, in particular, could be considered (presentation characteristics: SC, polypropylene and aluminium foil). The attractiveness of international brands is currently characterized exclusively by the very well-known brands MARLBORO and CAMEL. To build up BAT's strategic position in the Ukraine a strategic brand (LUCKY STRIKE) must be launched nationwide when convertibilty occurs. To be able to counter the approach expected from our competitors, an HL box will be scheduled for IFB 1. It can be assumed that our international competitors will also launch their strategic brands in the Ukraine when the currency is convertible. 4.3.6 Product Development The domestic style cigarettes in the Ukraine all have a very clear (distinctive) taste characteristic which is not similar to an American blend taste. The taste is more comparable to an Oriental cigarette with air-cured notes. The cigarettes have a good impact and high irritation. The Oriental/air-cured flavour in the side stream is very distinctive. The physical quality of the cigarettes is not of a very high standard. The cigarettes have bad ends stability and big differences in tobacco weight. Owing to bad printing, the optical appearance is not nice. Phase 1 - Targets for Product Development 1. Improvement of the physical quality and profitability of current domestic brands. - better ends stability - constant tobacco weight - better controlled moisture content of the cigarettes These improvements can be achieved by means of o a more careful and constant primary process which gives the tobacco better filling power - longer tobacco duration - be~er selected and graded domestic style tobaccos BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

22 - use of puffed stems - modern cigarette makers - better quality control The above-mentioned items will enable us to reduce tobacco losses and tobacco weight in the cigarettes. This will lead to improved profitability, 2. Blend maintenance of current domestic brands - keep the current typical smoke and taste characteristics. This can be achieved by means of - longer tobacco duration - better selected and graded domestic style tobaccos. There is no doubt that the typical taste characteristics should not be changed. The people are used to this taste and they should also get it in the future. 3. Introduction of new brands with domestic style taste character - get the current n/pical smoke and taste charac- teristics of the domestic brands - but with less irritation - cleaner tobacco taste - the physical quality should be improved Phase 2 - Targets for Product Development Introduction of new brands with American blend taste character through the use of: - high quality imported tobaccos - casing a~d flavour - CLD treatment - high quality cigarette materials such as filter, cigarette paper, ripping paper BATCO CONFIDENTIAL - CATEGORY 1: MINNESOTA TOBACCO LITIGATION.

23 - 4.3.7 Communication At the moment there are very few signs of western style advertising. So far there is no cigarette advertising. The fame of western brands is chiefly due to international TV programmes (sport, etc.). There is currently no advertising markel of any sort. It can, however, be assumed that - as in other east European states - tt~ere will be adequate openings for cigarette advertising. For this reason "lobbying" must ensure that the highest possible degree of marketing freedom is established. Apart from using selected basic media for the national advertising of our tactical and strategic brands, and the new Ukrainian brands, the focal point of activities should clearly be on "below the line" activities at the POS. Taking account of expected market entry by our competitors, and the change from seller's to buyer's market in the middle of the plan period, a graduated marketing budget is necessary (year 1 - 2% of net turnover; years 2-4 - 3% and as from year 5 - 4%). The resources in Phase 2 will be focused on the IFBs and, to a lesser extent, on the new Ukrainian brands. 4.3.8 Sales and Distribution The official sale of cigarettes at the retail trade level is via approx. 40,000 (overall approx. 54,000) grocery supermarkets, HOREKAS and kiosks. The retail trade outlets fetch the cigarettes direct from the factories or from the large distribution organizations. As a rule the range to be found in the trade comprises only 2 - 3 brands. A government resolution states that up to 30% of cigarette production can be used for barter trade (both intercompany barter, e,g. to acquire machines and replacemen~ parts, and barter trade to supply the workforce with groceries/consumer goods). Large, unquantifiable numbers of cigarettes are removed from the distribution channel factory-consumer by the wholesale trade systems (Bakalejas) and the regional distribution organizations (e.g. Raygastrcnomtork) and are used for legal/illegal trade transactions. In 1991 the three factories in Cherkassy, Priluky and Monastirisk covered approx. 36% of the market. Owing to the socialist supply structures high supply/market shares are only obtained in approx. 60% of the total 25 administrative districts (see Appendices - CPM deliveries into the regions). BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

4.3.8.1 Sales Strategy During Phase 1 the improved "old" Ukrainian brands and the newly developed Ukrainian brands are to be distributed nationwide. In the first few years, however, priority is to be given to safeguarding existing supply areas. To imptement these targets the early setting up of our own marketing and distribution organization is recommended. Focal point for the distribution organization is to be the professional handling (Key Account Management) of all the important large distribution organizations (State and private) and all the important retail trade sales outlets so as to achieve our sales and distribution targets. Another main task for the organization must be the general preparation of the Ukrainian market against the background of permanently changing market facts. Training (especially on-the-job) on the one hand and a planning, steering and control system tailor-made to suit Ukrainian conditions on the other hand are core pre-conditions for success. Access to existing and newly developing distribution systems will be ensured. The marketing and distribution head office is ~o be located in Kiev. To ensure widespread optimum handling of the market four regional distribution centres are scheduled: Kiev NORTH Head Office/ regional Distr. centre Donez.k . EAST regional Odessa SO. LITH f ..... regi.onal " - Lvov WEST i regional Per regional distribution centre a workforce - in addition to the management/oft3ce = 4 people - of approx. 15 per centre is to be appointed to the field force and trained within two years. In view of expected competitive activities and the change to a buyer's market in the middle of the plan period the staff of the sales force will increase during Phase 1 to 156 individuals. For reasons of cost the existing logistics system for cigarettes (some fetched personally, some supplied to the large distributor level) is largely to be maintained. Whenever the market demands it, the share of cigarettes supplied must be increased. In general, however, the solicitation of orders must be brought in line with the western level in the short term. BATCO CONFIDENTIAL - CATEGORY !: MINNESOTA TOBACCO LITIGATION.

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25 To transport the cigarettes to the trade organizations existing and newly developing freight organizations should be used, A decision on se~ing up our own supply organization cannot be reached until the middle of the plan period, i.e. wt~en the change from seller's to buyer's market occurs, The IFB's will be launched selectively in the first year of Phase 2 due to production constraints and extensively in the following year. 4.4 Sales Forecast 4.4.1 Phase 1 The JV will increase its share of the market from 30% in Year 1 to 36% in Year 5. Sales of plain cigarettes will decrease during Phase I from 17.5 billion in Year 1 to 17.1 billion in Year 5. However, the JV's share of the plain segment will increase due to improved presentation and consistency of product qualiW. Sales of filter cigarettes will increase from 6.5 billion in Year I to 13.2 billion in Year 5. This is based on the unfulfilled market demand and the improved qualiW and consistency of the JV's brands, Growth is primarily in the medium price segment due to the low purchasing power of consumers during this period of economic reform. 4.4,2 Phase 2 When convertibility is achieved, there will be a decrease in the sate of the low and medium price segment as people react to the perceived increase in their purchasing power. Sales of high priced cigarette will increase signifi- canUy. The sale of the JV's Ukrainian filter cigarettes will increase by over 100%. Trial of the IFBs will be significant in Year 6, During Year 7, there will be an increase in the JV's sales of medium priced cigarettes to 10.5 bn as the novelty and the effect of convertibility reduces the purchasing power of some consumers and others trade up to IFBs. At the end of Year 10, sales of higher priced filter cigarettes will account for 5.4 bn cigarettes and medium priced cigarettes 12.6 bn. Sales of IFBs increase dramatically as the exposure to imports has increased awareness of American swle cigarettes, In addition, given BAT's investment in sales and marketing during Phase 1, there are benefits in terms of local knowledge and leverage with the wholesalers to ensure good placement of the product. IFBs will account for 20% of unit sales or 8,5 bn in Year 10. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

- 26 - SECTION 5 LEAF STRATEGY 5.1 Current Situation - The Ukraine in General - Supply and Demand At current production levels {1991 - 61 bn cigs), the Ukraine's annual tobacco requirement is estimated at around 60,000 T of which some 14,000 T is produced within the Ukraine, the remainder being imported, mainly from other CIS republics. - Procurement System Ukrtabakprom has actively encouraged the Ukraine's cigarette factories to develop their own independent means of sourcing their leaf requirements. Current economic difficulties however have led Ukrtabakprom to retain one of its traditional roles - the allocation of tobacco to factories in proportion to their cigarette output - as well as continuing to act as the overseer organisation of the tobacco industry. - Tobacco Production, Types and Grading System The majority of the Ukraine's tobacco is produced by collective farms although the number of private farms has increased in recent years. The main variew is Podolski, semi-Oriental variety, although small quantities of Flue Cured Virginia and Burley are also grown. Podolski is cured in different ways, the method of curing being more often dependent on what curing facilities are available at the particular farm than on a deliberate attempt to produce a specific style. This variety appears to have a common smoke character which is manifest regardless of the method of curing but whose intensity of character varies according to the method of curing. Many of the semi-Oriental varieties imported from other CIS republics share a common genetic origin and thus possess a similar smoke character. This similarity of smoke enables reasonably consistent taste and flavour characteristics to be maintained in cigarettes despite relatively frequent and large changes in blend composition, allowing a relatively flexible approach to tobacco sourcing. BATCO CONFIDENTIAL - CATEGORY !: MINNESOTA TOBACCO LITIGATION.

27 - Joint Venture Operation Centres The proposed joint venture will involve two cigarette factories and two leaf processing/fermentation plants one of which also has a small cigarette manufacturing operation. Of the above, the cigarette factories currently operate under the Ukrtabakprom umbrella on whom they depend for a substantial portion of their leaf supply although they are developing their own independent methods of sourcing, principally by conc}uding direct contracts with leaf processing plants. The processing/fermentation plants are also at-tempting to increase their volumes by directly contracting (often with a pre-financing element) tobacco production with collective and private farms in the Ukraine and to a limited extent in other republics. 5.2 Strategy for the Proposed Joint Venture The BAT leaf strategy will be to establish a framework - in the Ukraine and between the operating centres - within which the joint venture can achieve the following objectives: To ensure an adequate supply of tobacco to enable current and future marketing opportunities to be fully exploited, whilst at the same time progressively increasing stock levels, and reducing dependence on imported tobacco, This will be achieved through the establishment of an extension service to facilitate - the increased production of domestic tobacco - the introduction of new Flue Cured and Burley varieties - the introduction of new methods of handling and grading and processing systems appropriate to the above - active encouragement of the growth in numbers of individual private farmers. Also important to success will be the establishment of an independent system for tobacco particularly in the longer term. To rationalise the existing systems of tobacco handling, processing and storage, to maximise the use of existing fixed assets, and enable the operating centres to function efficiently as an integrated enterprise. This will include the installation of a green leaf threshing plant capable of processing Flue Cured and Burley tobaccos to international standards. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

- 28 - To advise and co-operate with the appropriate authority(ies) in the privatisation of the Ukrainian tobacco industry particularly in such areas as: - creation of a "National Tobacco Board" or equivalent body - establishing a policy for farmer prices - introduction of an international standard grading system - designation of land for tobacco production - availability of credit.lfinancial assistance for both private tobacco growers and collective farms Reference to a "National Tobacco Board" is made in a generaJ rather than a specific sense; ie some form of organisation/body representing the various groups making up the industry from farm to cigarette sales and acting as a coordinator and/or spokesman. Although BAT can expect to start operations in the Ukraine free of international competitors, it would be unrealistic to plan on this continuing in the future. By hell:)ing to shape the industry's coordinating body BAT would indirectly be able to influence its philosophy. 5,2.1 Tobacco Supply Purchase Systems The JV's primary obiective would be to maximise cigarette output and progressively build up tobacco stocks to create a t 2 month year end duration by Year 7. Stock ~ 330 7889 8252 1121~ 12205 17052 25034 32185 33316 ~3316 3~41 U~ng= (T) 2399~ 251~ 273~ 24750 25S34 27690 32185 33316 33327 3~41 It is felt if the JV adopts an integrated approach whereby the tobacco requirements of all three manufacturing operations are served from centrally sourced stocks, the pressure on the limited domestic crop, and on hard currency/barter items for imported tobaccos will be reduced, and better use made of both the financial and physical assets of the enterprise. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

29 Under joint venture conditions the tobacco requirement would continue to be sourced both through importation and domestically. The JV would expect to be able to continue to participate in the existing allocation systems for tobacco imported by Ukrtabakprom although it would expect exclusive use of imports arranged and funded by itself. Similarly, the JV would expect exclusive use of all the domestic tobacco that it causes to be grown or for which the JV itself arranges and finances contracts. - Domestic Supply The JV intends to maximise the production of domestic tobacco including Podolski and to introduce new varieties of Flue Cured Virginia and Burtey tobaccos to reduce dependence on imports. This will largely be achieved through the establishment of an extension service and the creation of a system to offer financial assistance (loans/credit) for tobacco production to both collective and private farms (see section 5.2.4 for more details). - Imported Tobaccos Tobaccos from outside the CIS will almost certainly have to be purchased in hard currency and the proposed requirement for these types has been kept to a minimum. Barter will play a major role in purchases from CIS republics and possibly some other East European countries. The JV will seek to use cigarettes and other non-tobacco materials available in the Ukraine as bar~er items but the use of imported items (eg: filter tow, cigarette papers, spare parts) will also be considered if the net purchase price is to the JV's advantage. 5.2.2 Development of the Monastirisk Operating Centre As the JV will be a single integrated enterprise composed of the three principal operating centres - Cherkassy, Priluk,/, Monastirisk I und II (Jalgonitsa) - it is proposed that the existing fermentation plants be developed to rationalise the use of fixed assets, to optimise the benefit to the JV and to provide the JV with suitable centres for the following operations. Leaf extension service - Leaf processing (GLT and Oriental manipulation/ fermentation) BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

- 30 - It is proposed that the leaf extension service and the GLT be located at Monastirisk I and that both the existing manipulation/fermentation plants be maintained. The results of the flue cured and Burley trials (1992 crop) will give an indication of the rate at which production of these types can be expanded. The blending requirements for these wpes and the availability of adequate processing facili-ties (GLT plant) will determine the actual rate at which expansion of their production will take place after the beginning of JV operations. As these tobaccos will require some form of processing - they cannot be cut in cigarette factory primary departments as can semi-Oriental tobaccos - interim measures to provide for this are planned. These will include installation of threshing equipment in the PMDs of the cigarette factories (see production section for more detail) and processing in neighbouring countries, eg Hungary. The exact timing of the initiation of the proposed interim measures will be largely determined by the actual rate of crop expansion, the final plans for PMD modifi-cation, and the exac~ timing of GLT construction in Monastirisk, These assumptions will be reviewed when more detailed information is available at the outset of JV operations, but based on currently available information, Monastirisk I is favoured for the leaf extension service because it has access to the largest tobacco supply and for the GLT location because the site, although requiring modernisation, already has some of the essential services tie steam, water, electricity). (Details of proposed site changes and capital expenditure requirement can be found in ApDendix 5 and 6 respectively) The GLT is required because the Flue Cured and Burley tobaccos being {ntroduced require processing to separate them into their two component parts - lamina and stem. Some grades of traditional semi-Oriental tobacco which have a significant stem content could also be processed this way. Processing broad leaved tobacco to produce stem and lamina enables separate treatment in the primary department of the cigarette factories from which the following benefits are derived. - maximisation of tobacco filling power (reduced tobacco utilisation) - introduction of an increased number of blends and a wider range of blends costs - improvement in the uniformiw and quality of tobacco in cigaretles. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

31 - The planned GLT will have an inital capacity, of 6000 kg/hr with potential for future expansion and will be capable of producing stem and lamina packed to international specifi-cations in C48 type cardboard and cartons. Around 1 50 people will be required to man it, so that the closure of cigarette manufacture which would be required to accommodate the GLT plant on the site will not cause any loss of employment. A quality control laboratory would be included in the purpose-built GLT building which would carry out physical and chemical analysis of tobacco as well as soil and fertilizer/crop chemical testing as a suppor~ service for leaf extension. (Outline details of the GLT process can be found in Appendix 5) As the GLT would be capable of processing to international standards, exports for hard currency could be developed if tobacco supply is surplus to requirements and should foreign exchange availabiliW become a constraint on the JV. If the existing system, which permits the purchase of unprocessed/unfermented tobacco from other republics, is maintained in the future, it may also be possible for the JV to export Oriental tobaccos as these could be bought from the Asian republics of the CIS in Roubles or by barter, and processed and fermented by the JV to international standards for export. Should expor~ volumes increase significantly, it would probably be to the JV's benefit to involve an international leaf dealer as has been so successfully done by BAT in Brazil. Given large enough volumes, a second processing plant could be required, in which the chosen leaf dealer could invest, thereby committing himself to the long-term future of the JV's exports. 5.2.3 Proposals for Development of the Leaf Extension Service As indicated in Section 5.2.2, the expansion of the Ukraine domestic crop and the introduction of Flue Cured Virginia and Burley tobacco production are key factors in assuring the JV's tobacco requirement, and will be achieved through a leaf extension operation. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

32 The exact organisational structure (numbers, operating locations, functions) will be determined at the outset of JV operations, but it is proposed that the extension service be headed by a Leaf Operations Manager based at Monastirisk to whom would report a number of Leaf Area Managers who would have permanent use of 4-wheel drive vehicles. In areas where there are large numbers of individual private farmers Leaf Supervisors equipped with motorbikes or small pick-ups would be placed under the control of Leaf Area Managers. (A proposed organisation chart can be found in Appendix 5). Under the overall control of the Leaf Operations Manager the role of the extension service is to promote the production of the desired types and quantities of tobacco. This is achieved through the Leaf Area Managers/Supervisors whose main functions are: - to assess the production potential of each producer by ensuring that planned tobacco production matches the available production capability (sufficient barn space, labour availability, land availability, etc.) - to assess input requirements, eg fertilizer, crop chemicals, etc. - to communicate these and their needs to the JV. - to ensure that producers employ the correct cultural practices at the right time, eg timely harvesting, correct curing regime, correct grading of tobacco on farm before sale. The extension service thus forms the crucial link between producer and JV, playing an important role in the gathering of information necessary for the JV to plan its crop expansion programme and the financial requirement necessaw to achieve its objectives. The key objectives of the extension services are: - To register (ie sign contracts with) sufficient collective/private farmers to enable production to rise from 4,300 T in year 1 to 19,150 T by year 10 (within this, Flue Cured and Burley production would respectively increase from 100 T and 200 T- year 1 to 4,700 T and 6,450 T- year 10). By year 10, around 25 % of production would be by private farmers. - To introduce a system of financial assistance to producers to ensure that the necessary crop inputs are available, and that sufficient barn space is provided. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

33 - To modify the existing grading system so that it reflects - plant position - qualiw as determined by ripeness/maturity and not purely colour/freedom from blemish. - To develop the private farmer sector in the Ukraine, and concentrate their efforts on Flue Cured and Burley production. If sufficient farmers are ~o be a~racted to tobacco growing, they must be certain of being able to obtain the necessary crop inputs o or financial assistance to purchase them - as well as finding tobacco at least as profitable to grow as alternative crops. - Crop Inputs/Loans In order to ensure that crop inputs will be available to farmers the JV would develop a system whereby registered (contracted) farmers would be eligible to receive loans (in cash or kind) the size of which would depend on the JV's assessment of the farmers' producing potential and would be based largely on information obtained by the Leaf Area Managers and Supervisors. These loans would be recovered by the JV when the producers sell their tobacco production to it. Initially it is thought that the JV will have to provide the inputs and necessary materials (eg fertilizers, crop chemicats, construction materials for barns, tractors, vehicles). Progressively however, loans will be made in cash rather than in kind, and via the banking system. With loans made via banks, the JV would act as guarantor and administrator, and would agree producers' loan limits in conjunction with the bank, and ensure that loan accounts were credited on the sale of tobacco to the JV. Two types of loan would be available: - Short-term or current loans - these would be for crop inputs (for fertilizer, crop chemicals, fuel) and would be recovered totally at the end of each season. - Long-term or capital loans - these would be for the purchase of tractors, vehicles, bulk barns, or barn construction materials and would be recovered over a 2 or 3 year period. These programmes increase working capital requirements by $1.3 million in Year 1 to a maximum of $2.6 million in Year 3. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

34 - Price Price must be sufficently attractive to give the producer an adequate reward for his efforts, and to make tobacco at least as attractive as other alternative crops. The JV's leaf extension service will undertake annual reviews of the cost of tobacco production based on realistic estimates of the quantities/costs of crop inputs as compared to the purchase price that provides an attractive return for producers. If tobacco prices are set by the Government, the JV would expect to be able to make recommendations based on the price reviews. The JV would also expect to be able to regard any "officially" set price as a minimum price. It is expected that the projected production volumes of domestic tobacco can be achieved if the JV is free to fix prices. - Domestic/Rouble Zone Tobaccos An average price equivalent of 225 Rlbslkg has been used in Year 1 with inflation adjustment in subsequent years. This is based on comparable BATCo domestic leaf stock values averages as well as on estimates of production costs (and thus farmer prices) obtained in the Ukraine. - Grading System As the existing grading system is based on colour rather than plant position, it does not encourage the production of ripe/mature tobacco. Moreover, most major international tobacco producers/exporters have now adopted plant position based grading systems and have a corresponding range of prices. By changing the grading system the price structure used for tobacco purchased from farmers can be used to encourage the production of riper, more flavourful tobaccos which, as production techniques are refined/adapted to local conditions, can gradually replace more costly imported tobaccos. It is essential that this change of approach to tobacco grading takes place so that growers who devote the necessary time and effort to producing quality tobaccos are properly rewarded, BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

35 - 5.2.4 Training and Development of Leaf Management The Leaf Department of the JV will be headed by a Senior Manager based in Kiev to whom will report - The Leaf Operations Manager - based in Monastirisk I and in charge of the extension service. - The Leaf Processing Manager - based in Kiev and Monastirisk I and in charge of both fermentation plants and the GLT. - Leaf Buyer/Blender - based in Kiev and responsible for all aspects of leaf purchase and blending. - There will also be a Financial Manager based in Monastirisk I who will partially report to the Senior Manager - Leaf. - Also based in Kiev will be an Assistant Leaf Manager reporting to but working alongside the Senior Manager, and in a similar manner an Assistant Leaf Blender/Buyer. - It is felt that in the first phase of operations both the Head of Department and the Leaf Blender/Buyer will have to devote a great amount of time to leaf procurement from outside the Ukraine but within the "Rouble zone". They will therefore be in much closer touch with other CIS capitals if based in Kiev. - In addition, the HoD will have to act as Purchaser/Coordinator for crop inputs, arrangement of credit via banks and movement of tobacco to the factories. In the light of present information this task seems better performed from Kiev. - One of the key objectives for the Blender will be to introduce a greater degree of uniformity and control of blend composition and tobacco usage. Again, Kiev seems the appropriate base from which to best service Prilucky and Cherkassy. (A proposed Organisation Chart can be found in Appendix 5). Initially the posts of Senior Manager and Leaf Buyer/Blender will be occupied by expatriates for a maximum of two years. Other employees will be focal although in years 1 and 2 experts in leaf processing and leaf production (agronomy/extension activities) will be seconded to the JV for long periods. BATCO CONFIDENTIAL - CATEGORY 1: MINNESOTA TOBACCO LITIGATION.

3(; - It is intended that Ukrainian nationals occupy the "assistant" posts and that they be identified at the outset of JV operations; through intensive training programmes both on the job in the Ukraine and overseas in BAT operating companies they should be prepared to assume full responsibility for these functions by the start of year 3 or earlier. Promotion to full job responsibility will not, however, be automatic, but will depend on performance during the 2-year preparation period. On-the-job/overseas training will also be used to develop the skills of the Leaf Processing and Operations Managers in years 1 and 2, and shorter overseas secondments used to develop the Area Managers in subsequent years, (A proposed training schedule can be found in Appendix 5). BATCO CONFIDENTIAL - CATEGORY !: MINNESOTA TOBACCO LITIGATION.

37 - SECTION 6 CIGARETTE PRODUCTION STRATEGY 6.1 Background Cigarette production in the Ukraine is distributed over a total of 11 factories with capacities of 1 - 12 bn ciga-rettes p.a. The factories come under the jurisdiction of the Ministry of Food and are run by a central organization in Kiev (Ukrtabakprom), This relatively small organization (30 people) has co* ordinating functions and its main task is to obtain leaf and packing materials, preferably from other CIS states. An evaluation of the production plants according to criteria such as level of technology, product quality, management and workforce qualifications, and factory structure has revealed a clear preference for the factories in I~rilucky and Cherkassy. Compared with other sites, these factories offer better preconditions for a co-operative venture. In both factories - as in the central organization too - the people are willing to co-operate with BAT. The two selected factories have the largest production capacities in the Ukraine. They represent a production share of 36% in the Ukraine. The initial years will focus on improving the quality (best Ukrainian cigarettes) and yield of the factories with an increase in capacity. "~he second phase will see an expansion of capacity and the introduction of IFBs. 6.1.1 Cherkassy The factory site is in the centre of the town of Cherkassy and is located on a square piece of ground (approx. 26,000 sq. m) which is bordered by four streets. The town has a population of roughly 400,000 and is on the Dnepr reservoir approx.200 km south-east of Kiev. The factory has three outside leaf warehouses with a total storage capacity of roughly 9,000 t. In 1991 production volume was about 12 bn cigarettes, of which roughly 75 % were plain, and mainly oval in shape. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

38 - At present the factory has a workforce of roughly 780, approx. 60 % women and 40 % men. 70 employees work on the social side, in the, palace of culture, the canteen, the medical service or the kindergarten. The factory was founded 113 years ago. As yet there has been little new building or renovation work. The production building has three storeys; on the ground floor and first floor is the Primary. On the second floor is cigarette production and packing. It is a purely "Oriental factory', i.e. the whole process technology is geared only to processing Oriental tobacco. There is therefore no equipment for threshing, processing stems or casing and flavouring. The Secondary has relatively old cigarette makers and packers (up to 30 years old), most of which come from the former Socialist countries. There are only a few western machines, such as Garant 4, Schmermund packing lines or Molins Mark 9. One of the biggest problems is how to obtair~ replacement parts and parts subject to wear. By B-A-T standards the product quality is very low, in line with the available production equipment. During the production process no *on-line" measurements of tobacco moisture, weight or temperature are made. In addition there is a blanks printer and cutter for the "domestic plain box" brands. The only environmental problem affecting the residents of the neighbouring blocks of flats has been the lorry emissions. Supplies and waste removal are only possible by road. 6.1.2 Prilucky The town of Prilucky is approx. 150 km east of Kiev. It has a population of roughly 60,000 and, apart from the cigarette factory, has only one larger industrial operation which produces tanker lorries. The factory is located on the edge of the town. Next to it are two pieces of ground for leaf storage and storing raw materials. A fourth piece of ground is further off and is the site for leaf warehouses (railway link). There is total storage capacity of roughly 6,000 t. The factory has several blocks of flats, a kindergarten and a gymnasium. The factory supplies heating not only to its own buildings but also to the neighbouring houses. BATCO CONFIDE~FI~IAL - CATEGORY I: ~4INNESOTA TOBACCO LITIGATION.

39 In 1991 production volume was just 12 bn cigarettes, of which roughly 75 % were plain cigarettes, mostly oval in shape, and the rest Oriental filter SC. At the moment the factory has a workforce of about 850, 60 % women. The factory was founded in 1888. The state of the buildings differs widely. There are modern buildings (Primary, finished goods store) of prefabricated concrete and then there are very old buildings. Production technology is housed in a 3-storey building. As in Cherkassy this factory is only equipped to process Oriental tobaccos, i.e. there is no equipment for American blend processing. The Primary, which has been in opera~ion for 4 years, is impressive - it has clear structures with two Oriental processing lines and performance of 2000 kg/h per line {Bulgarian supplier). The Secondary is equipped with relatively old makers and packers. Apart from a Garant 4/Max S/Schmermund aggregate and a Decoufle- Schmermund unit there are only machines from the old eastern bloc. The technical facilities are decentralized and in parts meet the requirements of western production technology. Most of the production rooms and stores for leaf, packaging materials and finished goods have fire protection equipment such as smoke alarms or sprinklers. Cigarette production also has a blanks printer and cutter for the "Oriental plain box" brands. Particularly effective are the building gang and the transport people (a total of approx. 70 staff). Here too, quality is relatively low compared with western standards. Initial steps towards "on-line" measurements can be seen in the Primary. There appeared to be no environmental problems. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

3,3 +,~ 5,$ 6,0 0,0 0,0 0,0 0,0 0,0 I,I I.| l.| 8,5 8,| 3,0 3,+ +,$ 5,5 i.O 0,0 0,0 0.0 0,0 0,0 11,1 11,9 ~3o0 +~o0 I~,5 1,I 1.1 I,~ 1,1 1,1 0,I e,l OoZ 0.2 0,| PoO P.O Y.O P,O l,O l.O 1,0 P.O 1,0 9.0 I0,0 O.l I.$ +,0 5°0 lS,l ll,S |t,O U,5 0.0 0o0 0,0 0.~ 0,0 ¢]1 ... Domestic 0rfl~tl( ~J ... kmrlc~ Iler~ 1¢ ... soft c~ BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

40 - 6.2 Production - Strategy 6.2.1 Site Development and Capital Expenditure The main objective of the production strategy is to put the two factories in a position to fulfil the defined marketing requirements. In the long term the factories are to meet the demands of internationally competitive production. in the first few years particular attention will have to be paid to existing risks relating to safeW at work, hygiene and protection of the premises. On the existing factory site the Prilucky factory offers the possibility of further use for more production buildings. The factory site can also be extended. In the Cherkassy factory, capacity can be expanded to a limited extent. The central location of the site means that extensions to the buildings are limited. The following development steps are planned for the production plants in Phase 1 : 1. Safety According to a more detailed investigation both safety at work and protection of the equipment must be ensured in line with BAT guidelines. 2. Urgent replacement and spares To be able to maintain current production certain urgent investments, e.g. in Primary and in supply facilities, are necessary. A basic source of replacement parts must also be provided. 3. Infrastructure In the medium term and with varying degrees of urgency, an investment programme is necessary to renovate energy equipment and infrastructure. Initially, this programme does not contain any steps to counter risks connected with the energy supply (electricity, gas). 4. Quality control This programme includes requisite equipment for measuring quality parameters, both on-line and off-line measurements in production and in the Quality Control laboratory. 5. Primary upgrading Steps to improve both quality and yield and also cleanli-ness, order and hygiene are possible and essential. A com-prehensiva programme of instruction, training and know-how transmission will, of course, be necessary. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

tOtaL O.T O.S 0.0 ~.~ 6.8 ~rS~ 8L~ 1~td 0,0 O,O 0,0 O,O O,i P~ti~ I~*l 0.0 0.~ 0.0 0.0 torsi 0,0 0,~ 0,0 0,0 (~*t LO 0.3 0.3 0.6 to,eL 1.1 0.3 0.3 0.6 0.3 ~r~ (l~et) l~t~ 0,6 O,l O.t 0,~ Y~ I - 5 27,? T,~ 6 - 10 Y+ I - 15,+ TI4P 6 " I0 10.9 r~r I • I 2.P 0,6 0,4 0.~ O,L 0.~ 0.6 0,6 0o6 0,6 0,6 1,6 0.7 O,T |,6 0,9 O,Y O,P 0,9 2.$ 1.L +.+ 3.$ ~.S !,6 0,0 O.O !.| S.3 0.4 O,T O,S ~.$ I.I 0,0 0,7 0.| l,t 3,t 3,1 3,i ~.0 O,l 0.9 O,Y 0,6 9, I 3,? I,| lot 0.1 0,$ I.l 0,1 0,| 9.9 &.1 I.$ e.O 0.~ 0,~ 0.~ O.l 0.! 0.9 0.9 0.9 0,9 0,0 O,O 0,0 O,O 0,0 0,I 0,9 0,9 0,9 .-;;:;-..;;:; .... ;:; .... ;:; .... 6,3 L.t 3.5 3,9 BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

41 - 6. Secondary replacement The objective of this programme is to replace the very old machines with modern making and packing machines. Both overhauled, modernized second-hand machines and also new machines are scheduled. With this step the planned production of existing brands and new domestic brands (filter cigarettes) is to be safeguarded. At the same time an improvement in quality will be achieved. To obtain the greatest benefit from this investment 3-shift working for the new machines is recommended. Phase 1 is sufficient to meat the needs of the local market given the lack of convertibility. The marketing environment would change dramatically with convertibility. Phase 2 would then proceed if the following preconditions are met: 1. the availability of adequate quantities of improved leaf qualities, including flue-cured and burley, and 2. convertible currency Phase 2 would consist of the following steps: 1. GLT plant The construction of green leaf threshing equipment is scheduled for Monastirisk - as described in Section 5. 2. American blend primary The installation of a new Primary is a vital precondition for the production of modern quality cigarettes and especially for producing American blend. At the moment the preconditions for this only exist in the Prilucky factory. The investment calls for an appropriate extension of the buildings. After start-up the gradual takeover of cut rag imports and supplies to Cherkassy are scheduled. 3. Secondary capacity expansion To expand the production of American blend filter ciga-rertes more machines are required. BATCO CONFIDENTIAL - CATEGORY i: MINNESOTA TOBACCO LITIGATION.

42 The total Capital Expenditure Plan contains data for the factories in Cherkassy, Prilucky and Monastirisk. As a general rule it has been assumed in the plan that part of the investments, e.g. buildings, fit-tings and fitments, installations, will be bought locally, i.e. for Ukrainian currency. The plan opposite page 40 shows total capital expenditure in US$. On average, approx. 25% of it can be paid for in local currency. 6.2.2 Primary Development In the Primary departments of both factories rapid steps to improve both the quality and yield of the tobacco are possible. These steps ought to concentrate on conditioning, cutting and drying. It is planned to replace very old cutting machines with KTH 8 machines, to upgrade conditioning and drying cylinders with a view to achieving higher tobacco moisture and to install equipment to achieve the even flow and control of the process parameters. Also planned are steps to improve the storage and air-conditioning of cut rag. The installation of a VT thresher is an option for the Primary in Prilu~'-ky which would quickly (before the GLT plant starts up) be in a position to solve the quality problems connected with the high share of stems i~n certain Oriental grades. Thus, for the first few years it is planned to prepare the stems equipment for a stems line. This step will make a clear contribution to improving yield. Cut rag storage capacity will have to be extended to cope with 3-shift working in the Secondary. Phase 2 contains the production of American blend Cigarettes. For IFB 1 brand, supplies of cut rag are planned for the first 3 years of its production. For semi-American blend cigarettes (IFB 2), it is assumed that the appropriate cut rag can be produced in the Primary in Prilucky. For this, supplementary equipment is necessary so that casing humectants and flavour can be added on the existing equipment. As an alternative or complementary to this, expanded stems (STS) or treated Burley strips can also be supplied. The start-up of a new Primary is planned in Prilucky. This will make the complete production of American blend tobacco possible. The major advantages of this plant are: - a strips processing line, incl. equipment for casing and flavour applications - Burley treatment BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

- 43 - a stem processing line with stem expansion - equipment for blending and storing cut rag 6.2.3 Secondary Development For the additional production of filter cigarettes (domestic brands), the installation of extra machines is necessary. There is enough room available in the two factories to install such extra machines, in Phase 1. At a later date the Secondary building in Prilucky will have to be extended. Our concept for the machines assumes performance of 5000 to 7000 cigarettes per minute for the making machines. To determine what type of machines should be used (Mk 9/ Molins or Protos, LOG and Max S/K6rber AG can be considered|, further investigations are necessary. In particular, the difficult economic conditions such as machine supplies, capability/sturdiness when processing the available materials, service and skills will have to be evaluated more accurately. The choice of machines should be made jointly with local management. For the soft cup packers, machine performance of 350 to 400 packs per minute is planned. For these machines, too, the Capital Expenditure Plan assumes overhauled units incl. essential adaptations to the requirements of the relevant products. HLP aggregates are scheduled as the 2 hinge lid packers which are planned. Mainly for reasons of quality but also for economic reasons a direct link is scheduled for the aggregates. In the long term the cigarette production areas are to include the manufacture of filter plugs. For this reason the plan contains the gradual build-up of a filter making plant including the manufacture of paper filters. 6.3 Sources, Security and Supply of Wrapping Materials The former Soviet Union had a centralized industrial structure which was directed from Moscow. The result was that focal points of production were formed in the individual republics. Imports from western countries were also obtained centrally via Moscow, which means that the hard currency reserves of the Soviet Union are concentrated in Moscow. BATCO CONFIDENTIAL - CATEGORY i: MINNESOTA TOBACCO LITIGATION.

- 44 - Terms of delivery, materials specifications and inspection methods for quality controls were worked out centrally for all the factories in the individual republics. The supply of materials was relatively stable, with controls on incoming goods and quality controls. Within the centralized system of the Soviet Union, Ukrainian industry concentrated on the production of foodstuffs, steel and paper. In the Ukraine all the cigarette paper produced in the Soviet Union is produced in two paper factories, the cellulose being supplied from Russia. On the other hand there are two factories in Russia which can print and cut cardboard. For the cigarette factories located in the Ukraine there is the central organization, Ukrtabakprom, which maintains contacts with the central control office in Moscow. Via Ukrtabakprom, tobacco, production materials, replacement parts and imports were obtained from western countries. There were no direct contacts with factories in other republics or with suppliers in western countries. Ukrtabakprom is currently trying to conclude agreements with supply companies; this also applies to raw materials for the paper factories in the Ukraine. These transactions are of a barter nature, i.e. in addition to payments in roubles groceries, sugar, cigarettes and to some extent building materials also have to be supplied. To export these goods to other republics an export licence has to be obtained from the Ukrainian government.. So far, Ukrtabakprom has been able to maintain cigarette production in the Ukrainian factories by taking the initiative and making changes in the materials used. This leads on the one hand to high logistics costs and on the other hand to extreme changes in the cigarettes, e.g. as filter materials are lacking, plain cigarettes are produced. At the moment materials specifications and quality controls do not apply. Ukrtabakprom is currently trying, in co-operation with institutes, to find suppliers for all the materials and replacement parts in the Ukraine. These include raw materials such as cellulose for producing cigarette paper. This scarcity and the economic situation of the Ukraine, however, also leads to drastic price increases for production materials. The production volume of the cigarette factories is adversely affected by changes in materials, the degree of effectiveness and the lack and qualiW of replacement pars. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

45 - 6.3.1 Risks and Opportunities for future Supply Current economic developments in the Ukraine are closely linked with the devaluation of the rouble. Another precondition for improving the supply of materials is to build up new supplier structures with focal points in the Ukraine and stable supply agreements with suppliers in the other CIS states. For this the support of the Ukrainian government is essential, which must issue appropriate licences for barter trade, because barter trade will be essential for supplies from other CIS states in the next few years. In addition, however, joint enterprises with western companies are also necessary, not only to provide support in the form of investments in the cigarette industry but also to build up supplier structures in the Ukraine. For these assumptions it was assumed that the focal point of production in the factories will be local brands because due to the varying economic systems the import of materials from the West is likely to remain limited to small quantities. This means that for supplies to the cigarette factories by local suppliers Ukrtabakprom will play a significant role in supplying production materials as it has relations since with the Ministries and with the suppliers in the CIS states. There are already companies in the West which import from the Ukraine, which means that rouble transfers can be made in the Ukraine and DM or US $ transfers in the West. The future supply of materials to the cigarette factories depends to a large extent on economic developments in the Ukraine, on the relationships between the Ukraine and the other CIS states and on the convertibility of the currency. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

SECTION 7 MANAGEMENT STRUCTURE AND PERSONNEL ISSUES - 7.1 Management Structure/Head Office BAT proposes the establishment of a joint stock company which will own and operate the three existing factories as one integrated business. The organisational structure of this company would consist of: (I) a Supervisory Board to determine and approve broad strategic issues relating to the company; and (11) a Board of Management headed by a Director General/ General Manager, which will be responsible for the day-to-day operations and management of the com- pany's business. In order to operate the company's business as an integrated unit, we would also propose the establishment of a head office in Kiev, in addition to the existing three factory locations. Supervisory Board The Supervisory Board is elected by shareholders and would be responsible for approving broad strategic decisions relating to the company's business, e.g. approval of plans and budgets. The Supervisory Board would meet regularly on a three monthly basis, although additional meetings would be held should business needs so dictate. Decisions by the Supervisory Board would be taken by majority vote. The Director General/General Manager should attend Supervisory Board Meetings so as to be able to report on the operations of the company, but he would have no vote on matters raised at the meetings. The Supervisory Board would delegate day-to-day management of the company's business and operations to the Board of Management and would be responsible for appointing the members of the Board of Management. BATCO CONFIDENTIAL - CATEGORY 1: MINNESOTA TOBACCO LITIGATION.

- 4? - Members of the Supervisory Board We would recommend that the Supervisory Board should consist of a fairly small group - say 5 or 7 people, headed by a Chairman. As the majority shareholder in the new company, BAT would expect to select and appoint the majority of the members, including the Chairman, from senior managers within the BAT Group who can bring the benefit of their experience and skills in the tobacco industry to the new company. The members should, we would recommend, be selected from influential and experienced Ukrainians who can contribute to the development of the new company. Board of Management As already mentioned, the day-to-day management of the company would be in the hands of the Board of Management, headed by a Director General/General Manager. The Board of Management will also be responsible for devising and preparing strategy recommendations, business plans, budgets, etc., for submission to the Supervisory Board. The Board of Management should meet weekly and should comprise the following members: The Director General/General Manager The Director of the Cherkassy Factory The Director of the Monastirisk Factory The Director of the Prilucky Factory The Senior Finance Manager The Senior Leaf Manager The Senior Production Manager The Senior Marketing Manager The Senior Personnel/Training Manager In the short term we would propose that all these managers, with the exception of the three Facton/Directors, should be BAT expatriates who would be transferred to the new company. However, in the medium term we would expect the Senior Production Manager and the Senior Personnel/Training Manager to be selected from Ukrainian employees. Ukrainian employees would replace other expatriates in time, as and when the necessary skills and expertise are available, although we would expect the Director General/General Manager to remain a BAT expatriate. BATCO CONFIDENTIAL . CATEGORY I: MINNESOTA TOBACCO LITIGATION,

~9.4.92 FILE: EXPAT Senior Harkening Hanager Marketing & Sales Manager Senior Finance Manager Senior Leaf/Materials Manager Leaf Buyer, Blender Senior Production Manager Senior Personnel/Training Manager C~£RF~$SY FACTORY Production Manager Technical Pro~ect Manager Finance Manager PRILUCK¥ FACTORY Production Manager Technical Project Manaqer Finance Manager SUB TOTAL MONASTIRISK FACTORY Finance Manager 1993-1995 i I I 1 I 1996 onwards I BATCO CONFIDENTIAL - CATEGORY h MINNESOTA TOBACCO LITIGATION.

- 48 Head Office In order to co-ordinate the business and the operations of the three lactories as a single unit, to provide a focal point for negotiations at government level and also in order to undertake certain functions common to all three factories such as marketing, it will be necessary to establish a central head office for the company which we would recommend should be based in Kiev. The head office would have a comparatively small staff - preliminary indications suggest 39 employees plus 56 sales force employees and would comprise the following central departments and functions: - The Director General/General Manager Central Finance Function - incorporating audit and control, systems, reporting - Marketing, including sales force and supply/ distribution services - Production co-ordination - Leaf/materials supplies co-ordination - Personnel/Training/Recruitment co-ordination Central administration Initially - say for the first two years, depending on development, - we would anticipate that a total of 8 ex- patriates would be required in the head office namely the General Manager, the Senior Finance, Marketing, Leaf, Production and Personnel Managers and an Assistant Marketing Manager. After that we would expect the number of expatriates to be reduced to say three - the General Manager and the Senior Finance and Marketing and Manager, with advisory services available from BAT in the other areas. 7.2 Factory Management Each of the three factories would continue to be under the overall supervision of a Factory Director who will continue to be based at the factory and who will have two functions; (I) a member of the Executive Management Committee of the company, responsible jointly with other members of the Committee for the overall opera- tions of the company; and (11) a Factory Director responsible for the specific operations of his factory, including implementation of the strategies and policies laid down by the Executive Management Committee. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

- 49 - We would also recommend that the following management functions should exist at each of the factories: Factory Director Factory Finance/Accounts Production including Project Engineers Purchasing Personnel and Training Administration Existing Factory Management Owing to the high degree of independence under the former central organisation, there are strong management teams in each of the three factories. They have a well-founded knowledge of technology and the production process as well as possessing the necessary authority. Their relationships with unions and staff are considered excellent. It would be our intention to continue working on a co- operative basis with existing management. BAT proposes that a small number of expatriates should join the factories to complement and extend the existing management functions rather than to take over responsibility from present incumbents. At the same time they will have the task of introducing the present management team to BAT systems, methodology, reporting requirements, etc. We would propose that a BAT Production Manager and Finance Manager should join each of the three factories. Initially there would also be a BAT expatriate Technical Projects Manager at both Cherkassy and Prilucky, and a Leaf Processing Manager at Monastirisk. 7.3 The Workforce In general the existing workforces in the three factories are disciplined and hard-working. Motivation on the part of the workers has tended to increase as the factories have become more and more independent. The capability and commitment with which they have tried to keep production going in the face of extremely hard basic conditions (old plant and machinery and supplies of spares and materials) is admirable. The most remarkable talents for improvisation have developed as result. Activities on the production side have been marked by a low level of automation, old low-speed machinery and simple tobacco processing methods. The proportion of comparatively unqualified, untrained workers is equivalently high. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGA~TION.

50 - Taking these difficulties into account, I~roduction in the factories can be said to be excellent, and there is a markedly low absentee rate (below 4 %). There are, however, deficits where knowledge of modern machinery and modern tobacco processing techniques are concerned as well as of quality requirements and controls and problems of work safety, hygiene and cleanliness. There should also be stiffer regulations where problems of theft/pilferage are concerned. Training programmes would be implemented by BAT as out-lined below. In terms of numbers of employees at each of the three factories: (details see Appendix) Prilucky Factory The highest increase in production volume is planned for Prilucky. Running a new Primary, additional product/on aggregates in Secondary and quality control requirements will all call for higher numbers of employees and higher qualifications. Cherkassy Factory As the production r}lan entails only a slight increase in the volume of production, with the main emphasis here on the progressive renewal of secondary machinery, employment numbers in this case will increase only slightly. Monastirisk Factory Workforca requirements will be dictated by the new emphasis which is to be placed on leaf production and leaf processing. This plan assumes that the staff at present employed in cigarette production will be taken over for new leaf processing assignments. No redundancies are foreseen. BATCO CONFIDENTIAL - CATEGORY I: MIP4NESOTA TOBACCO LITIGA'TION.

51 7.4 Training and Development Training and development at all levels of the business will be given a high 13riorit~ by BAT; this area will be the key to the speed of progress of the business. BAT would provide on-the-job training through the expatriate staff transferred to the new company and through the temporary secondment of technical experts. In addition Ukrainian employees will, where apprc, priate, be invited to train overseas in other BAT companies. At present the language problem is a major hindrance to quick, direct communication. The first step here is for both partners to learn the other's language. BAT actively supports this move. A detailed programme of classes and further training - which are to be carried out at locations in the Ukraine, at BAT companies and in ex~:ernal organisations such as machinery manufacturers - is to be developed during the next co-operation phase. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

P & L i%%1 - Roubles Thousands - Government Levies Net turnover Leaf costs wrapping/making costs Royalties Total variable cost Total contribution ~ixed and semi variable expenses Depreciation T&A fees Other income Other expenses Trading profi~ Net interest (paid)/earned Profit before taxation Taxation Extraordinary items Profit after taxation Monastirisk Priluky Cherkassy Total 47,099 326,904 310,219 684,222 7,524 81,079 63,993 152,596 39,575 24S,825 24t,225 531,625 25,084 1,383 126,051 15,946 26,467 141,997 130,729 299,193 13,108 4,174 411 0 1,325 758 9,090 -499 8,591 2,455 651 1,627 0 3,4G8 0 80,135 -I,586 78,550 13,249 $,485 1,817 0 :3,319 0 77,974 23,720 269,821 29,372 232,433 67,350 3,855 0 8,112 758 -3,467 165,115 39,424 651 125,040 BATCO CONFIDENTIAL - CATEGORY h MINNESOTA TOBACCO LITIGATION.

52 - SECTION 8 FINANCIAL SUMMARY 8.1 Historical Performance 1991 The financial statements of each of the three factories have been reviewed, but not audited, on BAT's behalf by Coopers & Lybrand (international). The balance sheet as at Dec. 31, 1990 and as at Dec. 31, 1991 has been re- stated according to UK GAAP as has the P&L for the year ended Dec. 31, 1991. There is a report on each of the three factories available in separate form as well as an overview encompassing the critical issues pertaining to all the factories. The enterprises did not experience any significant inflation until the final quarter of 1991. Since it was a planned economy and prices were not set by the market, the validity of the relationship of the value of various inputs to net turnover is questionable. In 1991, based on the allocations made by Coopers, each of the factories was profitable. Trade Investments for Monastirisk includes a debt of 5.745 million Roubles from the Jagolnitsa fermentation facility (Monastirisk II) for which Monastirisk is responsible. Jagolnitsa has a processing capacity equal to Monastirisk and is included in the proposed Plan, Existing Business Valuation The value of shareholders funds or equiW of the three enterprises as at Dec 31, 1991 was 217 million Rbls. However, the environment has changed and the employees recognize the need for additional funding and investment to ensure each enterprise has a viabte future. BATCO CONFIDENTIAL - CATEGORY !: MINNESOTA TOBACCO LITIGATION.

53 8.2 Plan Assumptions The plan has been prepared in constant (real) terms. The decision to proceed in constant terms was to demonstrate the trends in the plan without requiring the reader to strip out inflationary effects that were common to all price movements. The primary issue is not the inflation rate but whether or not, and at what rate, the Ukrainian currency will be convertible. As a result, the financial schedules demonstrate non- inflationary changes in the various relationships. The major assumptions are as follows: The Ukrainian currency will be linked to the Rouble and offer the same degree of conversion. The Ukrainian currency will become fully convertible by the beginning of Year 6 and hard currency will be available at a real rate no higher than 150 Roubles per USD. The existing price control mechanism whereby retail prices are limited to a 25% markup on costs of production will be removed by year 1 and the joint venture will be free to set prices. The excise structure will be a mixed end-price structure with a 50/50 split between the specific and ad valorem elements. The ad valorem element includes VAT. It will be equivalent to 25% of the RSP of the medium price filter segment. It will apply to all cigarettes including plain and papirossy. The assumptions are described in greater detail in Appendix 8.1. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

P'. L in USD 000's - * 1993 1994 1998 2001 2002 'Net Turnover * 58674 63618 107799 211427 234561 *Total Contribution * 13840 15232 37691 84364 96097 *F&S.VoE ' 8614 10884 21735 30665 32269 *Trading Profit * 5226 4348 15956 53699 63828 *Profit before tax * 4327 3505 14679 51809 62157 ,Profit after tax * 4327 3505 12285 35699 39818 *Dividends Payable ~ 0 0 7371 28559 31854 RATIOS * 1993 1994 1998 2001 2002 ........................ ~ ........................................... *Leaf/Net Turnover * 61.8% 61.4% 47.9% 39.9% 38.9% 'Cont./Net Turnover ' 23.6% 23.9% 35.0% 39.9% 41.0% ,F&SVE/Ne~ Turnover * 14.7% 17.1% 20.2% 14.5% 13.7% *T P/Net Turnover * 8.9% 6.8% 14.8% 25.4% 27.2% *Asset Turnover (times) * 1.6 1.3 0.8 1.2 1.3 'RONA (NTA) ' 14.2% 8.6% 12.5% 29.9% 34.2% CD BATCO CONFIDENTIAL - CATEGORY h MINNESOTA TOBACCO LITIGATION.

54 - 8,3 Trend of important Plan Figures Profit Plan In the Plan period, the joint venture's net turnover increases on average by 15% per annum whilst unit volume increases 5% per annum. During Phase 1, net turnover increases by 10% and unit volume by 5%. Plain cigarettes account for 70% of the net turnover in Year 1 and 53% in Year 5. Net turnover in Year 5 will be $85 million. In Phase 2, net turnover increases by 17% and unit volume by 5%. In Year 6, plain cigarettes account for 39% of net turnover and decline to 19% in Year 10. IFBs account for 19% of net turnover in Year 6 and 54% in Year 10. Net turnover in Year 10 will be $235 million. No export sales are assumed although, given the capaciW, there is an opportunity for sales to the C.I.S. Government levies are expected to be harmonised in Year 1 to a combination of excise specific and ad valorem. Government Levies/Retail Sales declines from 32.3% in Year 1 to 24.3% in Year 10 due to the increase in the sale of higher priced cigarettes. Contribution increases during the Plan from 23.6% in Year 1 to 41.1% in Year 10. It is assumed that Drices will be increased in year 1 to reflect the desired change to the current excise/price control system, together with benefit from an additional real increase of_~ %. Thereafter prices are assumed to increase in real terms by 3% per annum compared with projected real increases in leaf costs of 3% per annum and WMS costs of 1% per annum. Actions to decrease tobacco weight are effected by the end of Year 4, resulting in an increase in the contribution from 24.3% to 33.2% at that time. Owing to greater weight savings in filter cigarettes, their average contribution increases by 10% to 36.6% whilst plain cigarettes have a slightly lower contribution of 30.3%. Contribution increases significantly in Phase 2 from 35.0% in Year 6 to 41.1 % in Year 10. This is primarily due to the introduction and growth of the IFBs. IFB 2's contribution increases from 36.0% in Year 6 to 46.0% in Year 10 due to a substantial decrease in the blend of imported leaf, IFB l's contribution increases from 34.2% to 43.2% for a similar reason. (t is assumed that WMS for the IFBs will have to be imported during the whole Plan period constraining a greater increase in their contribution levels,. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

- 55 - Fixed and semi-variable expenses excluding depreciation increase from 11% in Year 1 to 12.1% in Year 5, declining slightly to 10.0% in Year 10. The average wage is expected to be $800 per annum in Year 1 with a 5% real increase per annum. Wage taxes are 52% of gross wages and show a corresponding increase. Media/Merchandising expenditure increases from 2% of net turnover to 4% during the ten year period, becoming the largest expense category. Sales and distribtuion costs have been provisionally estimated at 1% of net turnover. Production expenses show a substantial increase in Year 1 due to rising energy prices. Thereafter, they increase in proportion to volume. T~ere is an additional increase of 1% when the GLT comes on-line in Year 8. Depreciation expense increases from 3.7% in Year 1 to 7.3% in Year 5. During Phase 2, it decreases from 7.4% in Year 6 to 3.7% in Year 10. Administration overheads (excluding T&A Fees and Buying Commissions) remain constant throughout the Plan. Administration expenses are expected to be reduced at the factories as the Kiev office assumes responsibility for common functions. T&A Fees and Commissions have been included from year 6 [when the rouble is assumed to be convertible), and represent 1,5% of net turnover. Trading Profit increases from $5,2 million in Year 1 to $12,2 million in Year 5 due to the increased sales of higher contribution cigarettes. During Phase 2, it increases from $16.0 million in Year 6 to $63.8 million in Year 10 primarily as a result of the sale of IFBs. During Phase 1, profit after tax is slightly less than trading profit due to interest charges as there is a tax holiday for the five years from first profit. In Year 6 profit after tax is projected at $12.3 million and increasing to $39.8 million in Year 10. RONA varies during Phase 1 from 14.2% in Year 1 to 6.9% inYear 3 to 13.2% in Year 5. From Year 6 onwards, it shows a steady increase to 34.2% in Year 10 as capital expenditure declines and the average contribution increases. BATCO CONFIDENTIAL - CATEGORY i: MINNESOTA TOBACCO LITIGATION.

Hard Currency Requirements in USD 000's - ~ 1993 1994 1998 2001 2002 *Capex * 14340 10511 18171 7786 4538 'Leaf ' 0 0 6788 21299 23503 *WMS ' 0 0 4845 22709 25737 ~Media/Merch * 0 0 2156 4229 4691 ,Replacement * 600 600 900 900 1200 ,Par~S *Total , 14940 IIIII 32860 56922 59669 BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

o 56 - Hard Currency Requirements Owing to the lack of convertibiliw, the joint venture's hard currency requirements for the first five years is the basis for BAT's investment. Phase 2 is planned to begin in Year 6 when the local currency is expected to become fully convertible. At that point, the enterprise will have four main demands for hard currency: capital expenditures, leaf, WMS und media/merchandising expenditure. These requirements are the result of the planned launch of the IFBs. The requirement in Year 6 is $33 million, increasing to $60 million in Year 10. Leaf requirements to support IFB 1 and 2 grow from $6.8 million in Year' 6 to $23.5 million in Year 10. WMS requirements increase from $4.8 million in Year 6 to $25.7 million in Year 10. Media/merchandising requirements increase from $2.2 million in Year 6 to $4.7 million in Year 10. During Phase 2, total hard currency capital expenditure {excluding spares) is expected to be $48 million. BATCO CONFIDENTIAL - CATEGORY l: MINNESOTA TOBACCO LITIGATION.

Balance Sheet in USD 000's - * 1992 1993 1994 1998 2001 2002 • Net Fixed Asset, m 495 18148 29685 73410 84953 84165 • Stocks Leaf ' 483 11917 12840 46639 84415 91333 • Stocks - WMS * 94 706 767 1437 3064 3359 • Stocks - FG * 30 1720 1856 2689 4874 5311 • Stocks - R&RS • 72 1803 1803 2404 2404 3005 • Debtors * 547 3790 7032 10514 16411 17756 • Less : Creditors ' 0 0 1017 6412 11571 12612 • Gov. Levies * 0 1221 2468 3526 5164 5559 ,Working Capital * 1226 18714 20813 53746 94433 102593 ~Net Trading Assets * 1721 36862 50498 127156 179386 186759 • Net Assets * 1766 36907 50543 119829 150872 154949 • Shareholders Funds * 1766 21033 35650 97266 117478 125441 • Net Debt * 0 15874 14893 22563 33394 29508 ~Net Funds Employed * 1766 36907 50543 119829 150872 154949 'ROSF ' 20.6% 9.8% 12.6% 30.4% 31.7% ,Debt/Equlty * 75.5% 41.8% 23.2% 28.4% 23.5% • Interest Cover (times) ' 6 5 12 28 38 ,PBT Growth (real) * -19.0% 20.8% 25.8% 20.0% • Dividend Growth (real} * 0.0% 0.0% 121.3% 17.5% 11.5% CD BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

5"7 - Balance Sheet Owing to the poor state of the current factories, there is significant capital expenditure during Years 1 to 5. Net fixed assets increase by nearly 3 times. This expenditure is designed to maintain existing production and to increase filter production. Net fixed assets increase a further 50% during Phase 2. Total capital expenditure during the Plan is aDproximately $148 million. Net fixed asset turnover decreases horn 3.2 times in Year 1 ~Io 1.5 in Year 5. It increases to 2.8 in Year 10. Working capital turnover decreases from 3.1 times to 2.4 in Year 5. It decreases to 2.0 times in Year 6 reflecting the increase in leaf stocks to 330 days before returning to 2.3 times at the end of the Plan. Leaf stocks increase from 120 days in Year 1 to 240 days in Year 5 to 365 days in Year 7. WMS and FG stocks are held at 30 and 14 days respectively during the Plan. However, the increased sales in Year 7, particularly of IFBs, increases the stock of FG by 45% and WMS stock by 65%. Repair and Renewal stocks increase to $2.4 million in Year 3 to match the investment in new equipment. There is a further increase to $3.0 million in Year 10 to reflect the aging of the equipment installed during Phase 1. Debtors will be stringently controlled in Year 1 at an average of 8 days. Thereafter, they will increase to 15 days. In addition, two leaf programmes: current loans for crop inputs and capital loans for barns are initiated in Year 1. These increase working capital requirements by $1.3 million in Year 1 to a maximum of $2.6 million in Year 3. Owing to the deteriorating economic conditions, it is assumed that no credit will be granted by suppliers during Year 1. However, credit is expected to be secured and increase from 7 days to 15 days to 30 days during years 2 to 4, conb'ibuting to the small increase in working capital in that year. The Debt/Equity ratio in Phase 1 decreases from 75.5% (reflecting the expected squeeze on working capital in 1992} in Year 1 to 27% in Year 3. During Phase 2, and with the introduction of dividend payments (50% distribution in Year 5 increasing to 80% by year 8),the DebUEquity ratio peaks at 36.9% in Year 7. Asset turnover is very low during the plan period, decreasing from 1.6 times in Year 1 to 1.3 times in Year 10 whilst bottoming out in Year 6 at 0.8 times. This is due to three main factors: farmer support programmes, the lack of a domestic supplier t~ase for IFBs and the lack of domestic equipment suppliers. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

Cash Flow Statement in USD 000's - ' 1992 1993 1994 1998 2001 2002 *Trading Profit , 0 5526 4348 15956 53699 63828 *Fees Due , 0 0 0 2034 3370 3654 * 0 2152 3346 7938 8891 8763 • Depreciation , ................................................... ,Cash Generated ' 0 • Net Capital ' 0 • Expenditure * • Change in WC ' -231 ?378 ?694 25925 65960 76245 "19805 "14883 -24526 "11698 -7975 "17488 "2099 "18300 "561.2 "8160 • Fees ' 0 0 0 -2034 -3370 -3654 ' 'Net Trading ' -231 ,Cash Fl~w • ,*Net Interes~ Income* 0 *Tax Paid * -85 • Repayment of ' -186 *~revious Borrowing * • Dividends Paid ' 0 -29915 -9288 -899 -843 0 0 0 0 0 0 "18933 45279 56455 -1277 -1890 -1670 "2393 -16110 "22340 0 0 0 -6075 -24300 -28559 'Paid in Capital 'Total Cash flow ,Opening cash • 185 0 -15874 6115 ~ -36374 -33394 *(Overdraft) 'Closing Cash • 0 -15874 -14893 -22563 -33394 -29508 CD BATCO CONFIDENTIAL - CATEGORY I: b41NNESOTA TOBACCO LITIGATION.

58 - The increase in share capital in Years 1 to 5 is due to the assumed BAT equity investment of ~67 mns which is required to fund Phase 1 capital expenditure. ROSF decreases during Phase 1 from 20.6% in Year 1 to 13.2% in Year 5. This is partly a result of the lack of convertibility which prevents the payment of a dividend during Phase 1. In Phase 2, ROSF increases from 12.6% in Year 6 to 31.7% at the end of the Plan. Cash Row At the beginning of BAT's involvement, it is assumed that creditors and government levies will need to be paid immediately as will any outstanding tax due. The existing overdrafts will probably need to be cleared, resulting in an initial cash injection from BAT of $0.3 million. Net trading cash flow becomes positive in Year 4 as the increased trading profit resulting from investment in the initial years is sufficient to cover the capital expenditure requirements. In addition, credit terms of 30 days are expected to be obtained from suppliers. However, due primarily to the increased leaf stockpile and phase 2 capital expenditure, net trading cash flow is negative in Years 5 and 6. Beginning in Year 6, corporate taxes are charged. Dividends, fees to BAT for T&A and equipment sourcing assistance begin to be paid. The business begins to generate a positive net cash flow from Year 8. BATCO CONFIDENTIAL - CATEGORY !: MINNESOTA TOBACCO LITIGATION.

Project Evaluatlon in USD 000's - '1992 1993 1994 1998 2001 :!002 Residual, ~ Value 'Trading Profit * 0 5226 4348 15956 53699 • Fees Due * 0 0 0 2034 3370 • BAT Group Royalty ' 0 0 0 1036 5365 • Depreciation * 0 2152 3346 7938 8891 • Cash Generated * 0 7378 7694 26964 71325 • from Operations 'Less Tax * 0 0 0 2393 16110 • Change in Working * 231 17488 2099 18300 5612 •Capital 'Net Capital * 0 19805 14883 24526 11698 "Expenditure • BAT Expatriate ' 0 2632 2632 1402 1401 *Costs 63828 3654 6262 8763 82507 22340 0 8160 0 7975 0 1400 Net Present Value of Projects Time Period Nomlnal Rate Real Rats NPV $000s Years 1-5 18.0% 13.5% ($48 206) Years 6-10 18.0% 13.5% 21 256 Residual Value 16.0% 11.5% 140 100 $113 149 BATCO CONFIDENTIAL - CATEGORY !: MINNESOTA TOBACCO LITIGATION.

59 8.4 Evaluation Project Evaluation The project has been evaluated on the basis of e DCF analysis of the project cash flows. On this basis the NPV of the project/business opportunity has been determined as being US $113 million. This has been arrived at after considering the 'after tax' trading profit cash flows, adding back the net income forecast to be receivable by the BAT Group for royalties, T&A fees and buying commissions, less expatriate costs, and deducting incremental working capital and capital expenditure requirements. However, the project is dependent on two assumptions. Firstly, the Residual Value. As a result of the long term strategic nature of the investment, with the phasing of the capital expenditure spread over a ten year period, and with the forecast introduction of IFB's only from year 6, the residual value attributed to the project of US $140.1 million. This has been calculated by assuming a 3% real growth in Year 10 cash flows which recognises the increasing trend of sales of higher value products after Year 10. The second main factor is the discount factor for this project evaluation. Two different discount rates have been used to reflect the perceived specific risk of the project in different time periods. These are: YEAR NOMINAL RATE REAL RATE 1-5 18.0% 13.5% 6-10 18.0% 13.5% Residual Value 16.0% 11.5% These compare with BAT Industries' minimum cost of capital of around 14% in nominal terms. BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.

60 8.5 Sensitivities The Plan has been tested under various sensitivities compared with the Base Scenario. and their effect on the Project NPV is as follows: Sensitivities Base Case No real increase in retail prices above real increase in variable costs 10% reduction in unit volume with no change in product mix 10 % reduction in unit volume of local brands only Residual value with 2% p.a. growth rate not 3% Includes royalW(5% of NTO) for use of Ukranian trademarks Leaf stock durations increased to 12 months w.e.f Years 1 Existing excise structure/pricing mechanism unchanged - years 1 to 3 Corporate Tax rate increased to 35% - years 6 to 10 NPV USD O00'S 113 149 57 680 86 069 99 941 98 402 98 500 103 369 106 058 107 256 BATCO CONFIDENTIAL - CATEGORY !: MINNESOTA TOBACCO LITIGATION.

BATCO CONFIDENTIAL - CATEGORY I: MINNESOTA TOBACCO LITIGATION.