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- 11- ATP Business Plan ATP have noc flnallsed a business plan. Nevertheless, Dr. Jacobsen van prepared co oucllne the way he saw FAVOR earnings developing and the options for involvement vlch potential partners. Earnings: 1986 - profitable 1987 - $25 m net earnings pre-tax 1988 - $50 m " " " 1989 - $100 m " " " This is based on 25Z profits on sales assuming no 'tobacco' tax is imposed. However, ATP were keen to stress that the current product is certain ~o reduce in cost as new ideas and process improvements are made. The high gross margin (>70Z) for this product (which would be still >60Z if tax were imposed) means that providing the market share reaches a level of general availability, profits should be very high. ATP believe FAVOR could be a 'white hat' product (implying that it has an attraction Co medical groups, government and even anti-smoking factions,) and could be strongly supported. Zn the patent area ATP believe they are strong but recognise that their tr~e technical asset is in 'know-how' which they estimate equates to a 2-year lead rime. (We do not disagree.) In view of the positive outlook, ATP see for their product (once optlmised), they estimate company worth at $300 m based on the 2-year post tax profit ($15 m) combined with a 20 multiple. In terms of participation by other companies, Dr. Jacobsen saw three possibilities: i. Buy out 2. ~uy in at a percentage 3. Licensing arrangements or Joint Ventures. He seemed to favour option I. with the second option being 2. but 3. was not particularly favourably viewed. However, a combination of 2. and 3 was not discouuted. One possibility that ATP foresee for spreading activities internationally with a partner is to operate a 'Coke syrup' philosophy, l.e a key element of the process could be manufactured centrally in San Antonio and shipped to YAVO~ manufacturing locations (it is easy Co envisage the ntcotine/flavour plugs being so handled). Although not made clear, there was a suggestion Chat ATP are encountering distribution problems in USA and would welcome collaboration with a domestic US cigarette company. ALH/DET 7th March 1956 Distribution: Messrs. E.A.A. Bruell J-L Mercier C. Warren J.A.B. Kellagher R.P. Ferr£s O I J b P~E~.F---v.,z.vv.wd@s+i.o-:c o1~:1

~ote to J.A.~. Kellagher, Esq. FAVO~ Research P~porc - United SCares You asked for coffiments on the data relating Co the post-launch research study " of FAVOR smokeless cigarettes in a rest-market area of the United States. 519 smokers were questioned by telephone, a sample which yielded 20 current users of FAVOR and in order co boost this nuaber a further 30 users were contacted. Before ccmnenCinE on the findings there are one or two points which I should make about the val/dity of the data. 11 Our ability to say very much ~rlCh confidence about the outcome of any research study must always depend on its scale and where this particular type of project is concerned IC is only rarely thac we find thac sufficiently large samples have been used to permit a reliable comparison of Important sub-groups - for example buyers versus non-buyers of the p~oducc in terms of their comparative make-up by age and regular brand. Thus, such comments as ~ ,m able to make on differing patterns of behaviour or acclcude as-between the breakdowns by which the data is analysed mUSts for the most part, be tentative rather than firm: there are many tendencies and indications apparent in the data but few conclusions to which sign/ficance in terms of the conventionally acceptable level of statistical reliability can be attached. ~e Current users of a test-product are inevitably of particular interest in such a study but severely constrained by total sample-size. In this particular case the initial study yielded only 20 current users of FAVOR and even when boosted they totalled only 50. Such samples permit us to say very little with any confidence and in this instance, the situation is worsened by the possibility that the boosre~-sample has distorted the picture: the additional users were found by non-random means and comparison with the ma/n s"mple data suggests that they are excessively skewed towards women and older smokers. Without a 1-arKer user-sample, found by more representative methods (e.g. by inserting questions on an Omnibus or sim~larly large study) it is impossible to say vhat is the true age, brand and sex profile of those who are still using the product. Finally, in order to maximise the information on which analysis was based these additional users were added into the sample wherever possible and althouEh the effect is more diluted, this Coo may have had some adverse effect on such data as the total buyers' normal cigarette-type. 3, It is difficult to assess the representativeness of the basic smoker-sample: the profile by segment under-represents smokers of regular cigarettes and over-represents lights smokers when set against Maxwell nation-wide sales figures, the only data available to me. However, this could he due to regional differences. CD ~4D G t.n °. C li b P D F - vvw-w~l a.st.i,(~c~(~.r-l-1 ....

~o -2- Awareness Smoker-awareness of the new product is remarkably high, at 91%. It is higher among men (93Z) than women (88Z); it rends Co be slightly higher among the youngest age-group (the 18-24's) and lower among the over 50'8. And smokers whose daily-consumption of conventional clgarecces is classed as 'moderate' appear also to be rather more aware of the product than ocher smokers. Trial Over half of all smokers quesCloued had Cried the product, and men to a greater extent than women. The pattern of trial by age and by normal clgareCte usage is similar to that for awareness. Purchase One in three of all smokers had got as far as buying the produnC. Men and women appear Co have done 8o Co an equal extent, as did all age-groups bu.t the over-50's, of whom only one in four made a purchase. 'Moderate' consumption smokers were signlflcancly more likely to buy than ochers. Of Chose who had ever bought the product, however, only 12Z (4Z of all smokers) were still using £t aC the C£me of the research and-although they were drawn equally from the sexes and the three cigarette-cons,-.pt$on groups, the age-groups show a more marked fall-off in buying among the under-35's than older smokers, There are indications (but no more than this) Chat users may be " sllghcly'skewed towards the upper educaclonal groups and towards ~.ce~ rather than Blacks. The brand-share profile of chose smokers who were aware of FAVOR, Cried lc or purchased it approximates to that of the smokar-semple as a whole but Marlboro smokers appear to he slightly under-cepreeented when it comes to pnrchasln8 the product. Source of purchase There were no significant differences in the place of purchase as between the first occasion ou which FAVOR was bought and the most recent occasion. Nearly half of all buying Cook place in a Supermarket (46Z), and the next most important outlet was the Convenience S~ore (37Z). Drugstores accounted for 7Z of purchases, and r~scounc Stores 3X. The incidence of buying in Supermarkets and Drug Stores was markedly higher among women and older smokers, while men and the under-35's were more likely to make their purchases in a Convenience Store. ~xD C3~ Crx C li b P D F - w.w.w-l.a.s¢i,®-.e®,m

-3- The pattern of source of purchase as between first-films buyinE and the most recent occasion vas the same. ~uanetcy purchased Whereas normal cigarette purchases vere predominantly (67Z) made in cartons, purchases of FAVOR vere almost invariably (96Z) in indLvidual packs: 84Z of purchases ou the last buying occasion cook the form of a single pack, and a further 10Z, two packs. Female and older buyers, however, tended to show a higher incidence of two-pack buying. Froduct-type purchased The majority (84Z) of smokers of "regular" cigarettes bought the regular version of FAVOR, and 75~ of menthol cigarette smokers boushC the menthol version. Those who normally smoked lights, however, were much less likely co buy the lights version: only 37Z did so, the majority (58Z) buying regular FAVOR. The nec result of this was ehac over half of all buyers chose the regular version, a quarter Che menthol, and the'remainder the lights. Former users 88Z of those smokers who had st esme t4me bought FAVOR had discontinued using it. Of these nearly half had made use of the product for only one day, and tthree-quarters for less than one week. Regular smokers of a menthol brand and those ~ao boushC the menthol verslou of the FAVOR product appear to have abandoned FAVOR =ore quickly Chart other smokers: 87Z of buyers who normally smoke menthol dropped the use of FAVOR ~chin a week of trial. Nevertheless, a small core of smokers (around 10-15Z of FAVOR purchasers), ![drawn to a similar extent ~rom the regular, lights and menthol segments of the market, claim Co have persisted with FAVOR for as lone as three months or more. ~easons for quiCCtn8 42X of Chose who vere no longer us£nS FAVOR crtcicised its taste and there vat little difference in the level of Chic criticism as between buyers of the regular, iishCs or menthol versions. Those who normally smoked lights cigarettes, hovever, shoved a Cendeucy Co be less critical In this respect. The second most frequently mentioned criticism (34Z) was of a lack of satisfaction, a complaint which appeared to be more frequent among those who had bought the menthol version of FAVOR. 29Z of former users cricictsed the product for excessive irritation, a ~omplainc which tended co be higher among women, older smokers and those who normally smoked lights cigarettes. C li b PDF - ~l~R~'t'l o.c o m 0 ',...rl ",,I

.j m -4- Asked the likelihood of their buying the product at some c~ne in the future, those former users who had last bought the lights version of FAVOR and who were in the 25-34 age group Cook a rather more positive attitude than other respondents. • Current users As my opening remarks indicated, the small size of the coral user sample (51) and uncertainty as to £Cs reliabilicy restrict firm to,went on this particular sub-sample, and especially the user-profile. However, if we ass~e Chat it fairly reflects current buyers of FAVOR, the following points may be noted:- Ii 14% of current buyers had made use of the product on the day they were contacted, and about 50% between one and seven days ago. Only 14% of the sample used more than one FAVOR cigarette per day. 2o 8% of current users claimed to have bought a carton at their last purchase buc nearly three-quarters had bought only one pack. 6 1~ used FAVOE only in situations in vh/ch they were free to smoke conventional cigarettes; 40% used FAVOR where conventional smoking was forbidden, and the remainder in both smoking end non-smoking situations. 4. It is particularly interesting Co note ChaC a high proportion of current FAVOR users said that they were using the product in order to help cham cut dovu their e~ok.'Lng of regular cigarettes (25%) or as an aid Co quirting sacking all together (22%). The next most frequently mentioned reason was as an alternative co regular cLgaretCes in a non-smoking situation (35%); and, third most often mentioned, as a means of avoiding offending others (29%). t" ~%." of current users believed ic co be safer than regular ~igarectes. 5. Asked ~hat they liked about the product ~ 44% of current users praised ice Satisfying qualicles. Posiclve c~eut on Caste aspects, however, li were considerably lower, at 16%. The majority of favourable responses related to the absence of "smoke (58%), and 22% singled out the fact Chat FAVOR was noC offensive Co ochers. No ocher favourable comments were made by more than 6% of users • 0 G~ ClibPDF - www.fastio.conl --

-5- 7e Users' volunteered dislikes were ma£nly centred on the pc.duct's taste characteristics (35Z) and a lack of satisfaction (31Z). OoJ.y 14% missed the smoke from convenct0nal cigarettes. Crct7 one-third of current users agreed chac Chef would definitely buy the pc.duct in future, although a further 45Z said thac they would probably do so. Main conclusions lm Awareness, trial and initial purchase In the rest-marker area were undoubceck~y high. B Hovever, early rejection of the produce after initial trial was also high, largely for Caste and irritation reasons and a lack of satisfaction - criticisms made even b7 current users. The menthol version appears Co be less successful in produce terms than the lights and regutar versions. . The absence of smoke does not appear to be a major obstacle to acceptance. Information on the reasons for purchase is confined to tie small s=mple of current users. Nevertheless this indicates a strikingly high claimed level of the use of FAVOR as an aid to cutting down or quitting smoking, as well as a solur~ton co the problem of nou-mok£ns situations. . Those smokers clain~nS Co be us~ FAVOE at the time of the research totalled'some 4Z of all smokers; however, less than one in seven current users were found to have used the produce on the day of interview, and oul~ one in three said that they would deftnicely continue to buy the produce. Thus, although the concept has plainly g~nerated a high degree of interest and trial the attrition-race is also high and it would be interesting co re-cent-act current users ac a later date co find ouc at whac level purchase finally settles. On its present showing the product, as currently marketed, does not appear to represeuc a serious threat Co cigarette-sales. 7thPLarch 1986 C.J. Pendrr cJP/~0c o LIl C IJ b P DF~--~,7~,'~W-f astioTc-orfi ....

ADVANCED TOBACCO PRODUCTS, INC. February 19, Z986 lCeeCing: 9:00 AM Par~£cipan~s Alan Heard Cliff Waz-ceu Jim Yniacke Robb ¥erris - BAT - Imperial Tobacco Ltd. - Imperial Tobacco Ltd. -BAT Alan F,.ellagher - BAT ATPI Norman L. Jacobson, Chairman and Ch'(e£ Ex.ecueive Officer ~./e-mmzl~a~ J. Philip Ray, President e"~'m~,~Q,/~ee,KC/4,,,Cmb,o~ Edmond C. Vimond, D£.reccor, Chairman o£ MarkeCCnK Committee ~ ~ /~t Ira Hill, Vice Pzes£deut, Technolosy - t~/¢,e, mv-¢~.,~e,,.m,m,~ James D. S~noneeu, Vice President, Administration ~ ~,~/~ zese~mes/waNh~r 0 r'O 0", 0 0", 0 C l i bPDF - ~ cq--Stl o. c o ii1 " "

FAVOR U.K. RESEARCH FOLLOW UP: FURTHER CONSIDEP~TIOIIS Previous U.K. research on the FAVOR product has indicated that, in the short term, response to the concept Is hlghly favour~ble whllst response to product ts somewhat less favourable. Price elasticity of demand for FAVOR REGULAR is htghly Inelastic, but becomes elastic tn relation to other product variants sampled. It now becomes necessary to examine longer run trends fn attitudes and usage of FAVnR. Three al ternatlve research strategies are posslble, all of which assume that a pre-product screening exerctse will have been performed on ATP's range of product variants in order to determine the optimal product for placement: Ii EXTEHD THE CURRERT POSITIOiI i.e. 6 week placement wlth existing 40 respondents using dlary monltoring, weekly attltudes/usage questionnaire, butt collectlon and weekly product placement. STRENGTH: low cost. WEAKtIESS: professlonalt sed and biassed panel. e COST: c. £6,000 VALIDATE nH A DIFFERS)IT PAHEL i.e. Inltlal concept aualitatlve sessions followed by 6 week placeuent wtth new sample of naive consumers {c. ~0) again using diary monttortnq, weekly attitudes/usage questionnaire, butt collection and wc~ekly product ptacenent. STRE)fGTH: validation of earlier work, avoidance of 'loyal responding'. WEAKt!ESS: cost of pre-recruitment. 1 COST: c. £9,000 SITI'JLATED TEST tIARKET MOnFLLItlG: i.e. to use a new sample and apply a classic ASSESSOR evaluation to promote trial, re-trtal and subsequent modell I ng of long run market share. STRENGTH: WEAKNESS: will provide a prediction of product performance in the marketplace in ter~s of share. within reasonable costtng,saemle stze would be small (c. 60) therefore accuracy of prediction would have high error variance. Loss of richness in usage/attitudinal information would occur. COST: C. £11,000 C~ ",C) C~ (~ CP~ C li b P D F °--'VC/'C'~W':fra's't'i'oTc-o~ll

-2- Choice of option is heavily dependent on whether the objective ts to learn more in depth about attitudes and usage trends with time, or to atilt predictions of market share potential on the basis of some reallstlc purchase opportunity situation. The former objective is addressed by options I and 2, of which option 2 is the most desirable since it combines validation with a move to a less biassed sample base. Ootlon 3, while attractive in commercial decision making terms, really requires e much larger sample slze to be done well and Is, in any case, somewhat pre- empted by Al~ providing, In effect, a ready made test market (assuming we can monitor it satisfactorily). PRICING EFFECTS Earlier discussions lead to the view that product placement would be by purchase of both FAVOR and own brand conventional cigarettes at an equated, lower than Market, rate. Whlle provldlng a welcon~ element of 'hard reality' Into the testing sltuatlon, the Introductlon of a purchaslnq varlable carrles several problems: I. Sample size is already small and would reduce to unrealistic levels, even by the most optimistic prediction, If a purchasing criterion were introduced. 1 Consumers are very uncomfortable buylnq supplies of clgarettes on a weekly basis. . To achieve an equated price slt.atlon means either conventional cigarettes will be priced unreasonably low, or FAVOR may be orlced too hloh (relative to perceived costing data from the earlier study). In either case. 'normal' consumption patterns will be significantly distorted. 4t Relaxation of the requirement to equate on price begs the nuestton "what should be the price for FAVOR?'. This question is complex and outside of the scooe of a small scale exploratory study since price elasticity of response at various pricing pitches would have to be modelled. RECORV£NOATION Since the scale of thls U.K. research wlll not support a credible evaluatlon of long run market potential of FAVOR, and since this objective is currently better addressed by researching the llve market and by the proposed Canadian study, tt ts recommended to droo the purchase variable from U.K. research stnce at best tt wtll reduce available data and contHbute significant bias. Concentration on the objective of tn-depth diagnostic research on usage and attitudes would be most suftably achteved through Option 2 (with perhaps a low cost parallel placement to the orlgtnal sample). R.P.FERRI$ RPFIBCH 13.3.86 0 P~ C~ P~ C l i b P-D.F - ~ v.w.w~.l.a-s.t.i,o-, e®.m

Mr. R.P. Ferrls/JJ 27th February, 1986 DEVELOPMENT POTENTIAL OF THE FAVOR PRODUCT Two features destlnsuish FAVOR from other nicotine delivering alternatives to the conventional cigarette (e.g. gums, 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 not aerosol based, relies on inhalation in a personally controlled series of puffs. The presence of these features is highly significant, since the former all.as the user to re-assemble the familiar gestural routines associated with smoking around the new behav£our of raping, and the latter ensures the high efficiency pulsed dose lung uptake which is central to the development of a behavlourally reinforced product use pattern. In developin8 the potential of the FAVOR product, one known constraint Is thac the nicotine delivery potential per puff hss been optlmlsed to a ceiling of c I0 micrograms per puff, therefore future development wlll be about optimlslng stimulus values of the sensory and physical context which the product places around a nicotine element which is essentially providing lower per puff nicotine levels across an extended puff number potential (90 - 100 puffs per stick). It is significant that FAVOR development thus far has been considerably faster than new product development cycles typical of corporate R&D. This is due co the small scale entrepreneurial nature at ATP linked with unique high level capability in nicotine delivery development and flavour formulation. A corporate R&D approach to support of ATF should be avoided in favour of a fast, praKumCi¢ and product oriented input, ideally 'hands on' alongside Ira Hill on whom most tertiary development of the basic product wlll now begin to rely. BAT could prow/de product development support at 3 levels: Sensory Development ATP currently use ad hoc In-house evaluations for sensory assessment of the product. Lack of a panel approach uslnE a set of standard attributes means that ATT have not traced their progress wlth a development h/story of comparative sensory profiling. RAT research has established a basic sensory profiling technique which can be used to indicate sensory shortcomings and provide guidance on levels of sensory maEuitudewhiohwould contribute to improvements of product acceptability. Notably FAVOR REGULAR shows problems on taste level (too low) irritation (too hl8h) and mechanics (poor perceived draw due to the fact that ATP wrongly define draw effort in terms of measurable draw resistance instead of against the consumer criterion of draw effort in relation to achievement of a given sensoric reward). P~D CD C li b P D F - vvw_w,.ta,sI, i.o,.,c- o.ra.1.