Tobacco Documents Online

Visit to Advanced Tobacco Products, San Antonio, Texas~ 19th Februar7 ~985 Compiled b7 : A. L. Heard Present: N. Jacobsen E.G. Vfmond J.P. Ray I. Hill J.D. Simonsen C. Warren J. Unlack J.A.B. Kellagher R.P. Ferris A.L. Heard Chairman, C.E.O., A.T.P. Chairman of Marketing Commltcee President V.P. Technology V.P. Administration T.T.L., Canada BATCo Ltd. BATUKE, R&D BATCo Ltd. Back~roun~ In November 1985, C. Warren and A.L. Heard visited ATF to explore whether the potential existed for some form of collaborative arrangements between their respective companies and ATP, who had recently launched FAVOR, a smokeless cigarette. At that time, ATP foresaw no problems in covering distrlbutlon through USA but were interested In finding partners who could develop non-USA markets. They were well disposed to the BAT Group as a potential partner. Products were-supplied to both ITL and BAT foI consumer test work. BAT and ITL agreed that initially BAT, through the facilities available to R.P. Ferrls of the BATUKE ReD Laboratory, would conduct a detailed but small scale evaluation of regular FAVOE with a brief assessment of some product developments made available during the visit co ATP. Additionally, B&W would be asked to monitor the performance of FAVOR in the Texan cities where it was being launched. Purpose and Scope of Meetin,~ In the period between the November visit and this visit, ATP had suggested to ITL that they had further developments on FAVOR including some which related to conventional smoke generatlng products. At preseat, in the secrecy agreements signed by ITL and BATCo, our interests are confined to smokeless products and, so far, have been strictly limited to cigarette-like products (FAVOR). ~a view of BAT research interests and background in smoke generating products, including altering the nicotine/tar and flavour contents, it was stated at the outset of this meetlu~ by A.L. Heard that we did not wish to include on the agenda any smoke-related information. The purpose of the meeting was thu= ~o be confined to FAVOR and to the marketing/product development issues. mmlm~ O O~ <:D C li b PB'F-~- ~,'.G ~,',; ~:,,:~:f a's t'i'o-, c'o'm

- 2 - In view of the value of the detailed findings obtained in the UK study, ATP were asked to sign a secrecy agreement. They agreed (the signed copy is nov with Legal Department, Millbank). Finally, in order that, if necessary, information supplied to us could be shared vith B&W, an alternative form of a secrecy agreement, supplied by B&W, was signed by ATP and returned to Legal Department, Bag. Conclusions There appear to be several important issues governing our future involvement with ATP: 1. Do they have a concept which meets a real consumer demand? On the basis of all the consumer studies done by ATP or BAT, there appears little doubt that the consumer is seeking a product of this kind. 2. Does the ATP product meet this concept (or will it by reasonable developmental evolution)? We must concede that, although there may be a small segment of smokers who find the current product satisfactory, the majority of consumers appear reluctant to use FAVOR Regular. Whether this product can be modified to retain the consumer is a key issue. We are confident that the ATP development team, particularly if backed by BAT Group resources, could make considerable strides in improving 'smoking mechanics' and flavour. The real point at issue is whether ~he change in smoking style demanded of the consumer by FAVOR relative to conventional cigarettes will be acceptable in view of its lower per puff nicotine and very low overall mass delivered per puff. 3, Only extended practical experience will answer this question. Certainly, the more the basic mechanics are improved the greater the likelihood of the consumer to make the trade-off (which, of course, he may have to do many times each day if he uses FAVOR as a partial supplement). Is the ATP product protected by sufficiently robust patents that others (including ourselves) cannot easily copy the product? The patent position is not clear and needs very close investigation by expert counsel. 0 0 C IJ b PD'P-~- ~i:~t,?'. fiTsTi'oTc'o'm

-- 3 -- 4 • Alternatively, is ATP know-how such that they have a valuable lead-tlme for us? (We cannot answer that question in terms of our competlclou.) The know-how that ATP have is certainly worth 2 years lead time for BAT even if we gave such a project a high priority in R&D, itself an improbable situation if viewed realistically. We believe that subject to the continued employment of the key Personnel (especially J.P. Ray and I.D. Hill) the Company may be a most interesting proposition because of the pot~ntlal extension of the technology Into ordinary cigarettes, where use of the plug carrying nlcocine/flavourants in a filter can improve quality of conventional smoke. 5. ghat is the worth of ATP? On current performance in the test markets (using largely ATP indications) the company must be seen as high risk and worth far, far less than the $300 m projected by ATP. We are basically looking at an R&D company wlch a good concept, good know-how, useful production facilities but no proveu market - indeed, if anything, it has a disillusioned market. Other factors which may adversely affect the viability or profitability of Favor in the US market are the possibility of FDA regulation (even to the extent of prohibiting the product), of becoming subject to Federal Excise and Sta~e taxes as a tobacco product, and of the imposition of Advertising restrictions. Any such development would also then have implications for the product in other markets. If we wait until market share rises and approaches the 1% ATP expect by 1987, the buy-out price could be around $300 m. If, on the other hand, market share remains at 0.4% or, indeed, falls, or if the product returns predicted by B&W materialise, the company is likely to be in serious financial problems and could be purchased at a low price ($5 - I0 m?). &ecommendatious The sltuaCion argues for the following possible courses of action: Technical/Markettn# Strate$7 1. Check ATP patent situation. If not robust, we should consider withdrawing since others will 'move in'. 2. Check the toxicological information, taking expert advice on the safety of FAVOR. 3. ITL should proceed wlth their plan to run an extended study on 400-600 consumers using the FAVOR variant best suited to the Canadian market. <:D ~O C I i-b-P[9F'-~- t,? ~,,'J ~,,'Jtla's.t'i'o'r¢'o'm

- 4 - ~o . 6Q BAT should extend the A0-person monitor on potential FAVOR usage iniClaced in January 1986, Co test the ~Ime dependence on views elicited from thac pilot study. B&W should complete the 1000-smoker Texas-vide telephone study scheduled for completion end-March. This-should provide corroboration of the ATP study nov being analysed by Marketlng Department, Hillbank. Evaluation of current marker position in the field by BAT Marketlng management. Business Strategy 1. In the short term ITL and BAT should maintain dialogue rich ATP. In the light of knowledge gained from the above initiatives, BAT/ITL might consider in exchange for: (i) input of their own technology (i£) assistance An distribution from B&~ (ili) S one-off payment to ATP a) Exclusive rights to all smoke-related applications of ATP's current future technology and patents. b) An agreement that ATP ~ill restrict the expansion of FAVOR during the next 12 months to permit further Joint development of the product co eliminate or minlmise the negatives revealed so far by research. c) BAT/ITL would be given an option on the purchase of shares in the company producing FAVOR on a performance related formula: the option to. remain valid for 18 months. d) Any payments or know-how contributions from BAT vould be capicallsed if the option co purchase a share and participate in the equity of ATF is taken up. O G C7~ C l i I~P'D'F - vv vv vv. f ~--~t, o. c o Ill

- 5 - Karketln6 and Sales Situation No Harketlng presentation was made by the ATP Board to give us any real information about strategy, advertising, current sales and distribution arrangements etc. We were informed only that FAVOR vas launched in the last week of September 1985 in Austin, Texas (which represents O.3Z of the United States market) using a Broker and Wholesalers and that distribution yes extended to Hetro Dallas in November and rolled out to Houston in January. They intend to continue a roll-out to cover the whole of the US in ten steps completing step one with extension to the remainder of Texas, California, Arizona and Nevada in the near future. The objective stated by Ed Vtmond (vho was hilled as Director and Chairman of the Marketing Committee) was ~o achieve a major share of the US Cigarette Market. It was only subsequently that it emerged that this major share objective vas in fact 1Z. Hr. Vimond who vas President and CEO of RJR Xnternattonal from X980-1982 was not particularly impressive. Subsequent to the visit J.A.B. Kellagher read two New York stock exchange reports relating to ATP, one of which dated 30th August 1985 included In the 1let of Officers and Directors, Hr. Jim Rarkness under the title of VP Harketing. There is no mention of him however in another report dated 9th September 1985 and he was neither present nor mentioned at our meeting, wo it may be assumed that he has left the Company. ATP has recently completed a Favor Attitude and Usage study based on a telephone interview survey carried out in the Austin initial market after the first thirteen weeks. No management analysis of these results was presented except for the information that the product had achieved 91Z awareness amongst smokers, that 55X had tried Favor, 33Z had actually bought Favor themselves and 4Z are currently using the product. The share of market calculated by them on the basis of the research Information results in a figure of 0.9Z of the Austin cigarette market for the whole 13 week period and 0.4Z current share. Share figures, incidentally, are all calculated on a per pack, not per stick, basis. The research revealed that current users are 65Z female and tend to be upper income, white and aged 35+. The full Survey report has, however, been broughc back to Hlllbank and a more detailed analysis will be prepared. ~r. Vtmond claimed chat ATP had gained a good breadth of distribution and that only two firms had turned down the product buC admitted that ATP eere lacking in depth o~ distribution due to the absence of any field-force. This, of course, is one of the reasons that they are anxious to form an association with a large F~CC company and preferably a tobacco company. C li t~'P-D-F - ~la-"~i~i

- 6 - ~r. Vimond was informed that the information we had received from B&R suggested that although substantial quantities of Favor had been dls~ributed to the Trade much of this stock would, in due course, be returned. Hr. Vlmond denied that any stock had been returned. It is worth ootlng, however, that B&W obtained this information from their Broker in Austin which is the same ss that used by ATP. Hr. Vimond predicted that market share would now steadily increase, claiming in effect that 0.&X share is the bottom of the curve. When questioned ou this subject, however, there appeared to be no'statistical or other objective Justification for this expectation. Production process A visit was arranged Co see the production facilities and laboratories. The factory is clean, bright and tidy as are the adjoining quality control/research facilities. FAVOR comprises an extruded plastic (85 mm) tube containing a small mioroporous plug (9 mm) vlth a brovu tipping paper at the mouth end ~remoce from the plug). The microporous plug contains adsorbed high purity free nicotine and selected volatile flavourants. Impure nicotine (extracted from tobacco) is imported as a 95Z (impure) extract from India and is distilled (in a plant located outside of city limits for t6xicological reasons) to better than 99.9X purity. This is diluted eith ethanol and flavourants added. A batch of plugs checked for pressure drop is floated ou this solution and by applying a vacuum, the air is removed enabling the nicotine solution to penetrate. Solvent is removed by rotary vacuum drying leaving pure nicotine/flavourants adsorbed on the pore surfaces. According to Dr. Z. Hill, the dimensions of the plug/pores places an upper safe limit on nicotine loading, a feature ehich will need careful probing if collaboration is pursued. The plugs are transported in sealed churns to the assembly factory situated at the rear of the ATF office premises. This occupies 25,000 (?) sq. ft. Currently, ATP have two making lines from blank cubes to wrapped cartons, ac present laid out in the typical U-conformation of a cigarette making assembly. (This rill be replaced by an in-line conformation when these two machines are transferred co the adjoining building where tvo other assembly lines are being built.) Blank tubes of double FAVOR length are fed by hopper Co a grooved block which transports them approximately 1.5"metres by which time plugs are rammed into either end of each Cube. Tn the subsequent operation, tipping is applied co the centre of this dual rod and the rod is cut. The product (6 to a pack) is sealed ou a heat seal chocolate wrapping type machine and packed in a hinge-lid box. G ClibPDF - www.fastio.com

- 7 - Production, which is currently packer speed llmlced, is between 80 and 130 packs/minute. ATP claim chat on four shift operation the four production lines soon co be available will be capable of supplying the 1Z market share they foresee for FAVOR within the next year. Patent Position ATP claim that their issued US patent (No. 4,284,089) covers securely the basic principle of nicotine volatisacion implicit in YAVOR. They also cited the EEC patent applications (already known to us) and stated that other patents on details of construction etc. are in progress. A.L. Heard expressed his concern for the robustness of the US patent following a first survey by BAT Patents Department. He expressed an intention, fully agreed by ATP, to explore in depth the soundness of the ATP patent position since this is a keystone of any collaboration. Toxicolo~ical DaCe relatin~ co FAVOR ATP provided both BAT and TTL with a copy of a 30-page document eutitled "Toxicology of Nicotine Base - an assessment for ATP" by Dr. Daniel M. Fords a consultant toxicologist. This covers the acute and chronic toxicity of nicotine and goes on Co consider implications for FAVOK. Abuse, risk to children and workers are considered. The conclusions suggest no real concern but the document has now been passed to T.G. Mitchell of BATUKZ KaD for expert comment. ATP were made aware of the kind of requirements that the BAT Additives Cuidance Committee would seek in approving use of ~AVOR or similar items. It was made clear that BAT would, if it pursued further with ATP, ask for all confidential details of ingredients, materials etc. to be disclosed to a nominated person. UK Consumer Stud~ on YAVOK The results of a small-scale consumer study carried out in UK using Regular FAVOK were shared with ATP (under a Secrecy Agreement). The'trial was based on 40 subjects selected by delivery, sex and concern (expressed as ability to cope for • periods without cigarettes). The study was divided into three stages: Cr~• 0 C I J bpIDF - ~J. f ~TWti 0-. c o ill

- 8 - 1. introduction co concept and produ:c ~a a ~-hour period of clKarecce deprivation buc free access co FAVOK a &-day period of free choice - conventional clsareCCes or FAVOR ac will The findings are summarlsed in the attached uoce by R.P. ¥erris. ATP vere excreme&y interested in our findings and were clearly i~pressed by the skill shown in both constructing and implementing such an informative study ac short notice. They were quick co see the benefits that access co the BAT Croup techniques and knowledge of cigarette design and human smoking/preference could brine Co them in the developmenC of FAV0~. Development Potential of FAVOR Two features distinguish FAVOR from ocher nicotine-delivering alternatives co the conventional cigarette (e.g. sums, tablets, dry and wet snuffs): a) the delivery device is physically and visually very similar to conventional cigarettes b) the mode of delivery, albeit vapour and noc aerosol based, relies on inhalation in a personally controlled series of puffs. These are extremely important features in chat Chef offer familiarity to conventional cisaretCe smokers. However, FAVOR has important known constraints. Firstly, nicotine delivery per puff has been maxinised at 10 us, only 10Z of the typical nicotine level/puff from a eouvenclonal mld-car cigarette. The potential of one stick to yield up to tO0 such puffs leads co a behaviouraI chanse in the direction of more rapid puffins by the user. Hore importantly, the Coral matter delivered per puff of FAVOR is merely ~Z of Chat from a conventional mid-tar cigarette. This will call for considerable ingenuity in product modification co restore traditional sensory cues such as mouthful and reward for draw effort. Dr. Hill will seek to achieve such improvements by selection of approved volatile flavourancs. o C~ Cr~ U~ ~mmm~ Clit~PDF - www.fastio.com

- 9 - Potentlal gAY Asslst~nce in FAVOE Development There are three ways in which ATP development of FAVOR could be accelerated if BAT resources were made available: C1) Sensor7 Development ATP currently use ad ho¢ in-house evaluations for sensory assessment of the product. Lack of a panel approach using a set of standard attributes means that ATP have not crated their progress with a development history of comparative sensory profiling. BAT research has established a basic sensory pro£iling technique which can be used to indicate sensory shortcomings and provide guidance on levels o£ sensory magnitude which would improve product acceptability. Notably TAVOE ~CULAR shows problems on taste level (too low) irritation (coo high) and mechanics (poor perceived draw due to the fact that ATP wrongly define draw ef£ort in terms of measurable draw resistance instead of against the consumer criterion of reward for draw effort). BAT sensory pro£iling of ATP's more recent ex~erimental prototypes shows chat these problems are surmountable ~o some large extent. Use of a sensory testing approach would significantly £ocus and speed up the current empirical approach and should concentrate on determininS the interdependence og mechanics and taste masuicude perceptions (the two seem to interact such chat increasing taste magnitude will produce improved perceived mechanics even against a fixed measurable draw resistance baseline). The method should also allow an understanding of the relative contribution or salience of particular sensory attributes co overall product acceptability. Ic will be important to compare such a "contribution heirachy" for FAVO~ with that more typical of conventional cigarettes. Looking at the same problem from the consumer perspective, it will be important to understand relative sensory requirement hairachies of low and full £1avour smokers if KEGULAK and LIGHTS versions of FAVOR are Co be successfully di£ferentially marketed to such consumers (at present, data on FAVOR REGULAR shows no differentiation of sensory response by delivery level of smoker, buc a clear dif£erenclacion by acceptability). Cli) Behavioural-Heasuremeut Diary monitoring of FAVOK use patterns indicates that the product is used in a very dif£erenC manner to conventional cigarettes (often in use continually for periods of over one hour) and chat its use alongside cigarettes is associated with a reduction in cigarette consumption. Sensory testing also indicates that 'getting the mechanics right' (i.e. achieving an appropriate effort/reward relationship) is key to product acceptability. A central issue concerning C7~ C li tiP D-F - ~1 a-~'tT6T'_~oWfi

Clii) - 10 - eventual success/failure of FAVOR will be whether users can learn to trade getting nicoClne in large doses from a small number of puffs for the FAVOr alternatlve (small per puff dose, large number of puffs). The observation that cigarette consumption declines when FAVOR is used supports the view that FAVOr Is satisfylng a pharmacological demand. Therefore the prime use of behavloural measurement would be to ensure that the sensory cues driving smoking behavlour are optlmised. Smoker effort can be measured dlrectly as puffing pressures aud'volumes using smoking behaviour equipment. It should be technically feasible to convert current equipment to monitor FAVOR smokers and derive the following important information: a) A concrete measure of smoker effort being applied to an7 FAVOR variant, which can be used as a criterion for arrlving at satisfactory 'mechanics', and may also be correlated to sensory perceptions of draw effort. b) Characcerisation of physical smoking style learned in using FAVOR relative to conventional cigarettes. c) Examination of how critical the role of satisfactory mechanics will be in FAVOr acceptance. Will the most acceptable FAVOr simply be the variant with the best effort-reward relatlonshlp (i.e. closest to conventional axpectatloos) or will the quallt~ of reward £n taste and irritation terms support trade offs against the effort criterion? Product *Cosmetics' UK qualitative work has defined a number of product appearance factors which aeem to contribute significantly to product acceptance/rejection. Most notable of these are tactile feel of the rod, requirements for more perceived solidity at the mouth end (perhaps by use of a baffle), stick use/depletion indication, improved (preferably single stick) inner wrap, improved pack design (in terms of function and appearance). While ATP are larsely aware of these aspects, the use of a panel of *Innovation sensitive' consumers, such as are available in the UK for. qualltatlve evaluation would he a considerable asset. .....a. O r~D O', O ClibPDF - www.fastio.com