PHILIP MORRIS COMPANIES INC, 10-Q, 1998-08-14

PHILIP MORRIS COMPANIES INC
10-Q, 1998-08-14
FOOD AND KINDRED PRODUCTS

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<PAGE>

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 1998

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

For the transition period from to

Commission file number 1-8940

Philip Morris Companies Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

VIRGINIA 13-3260245
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

120 Park Avenue, New York, New York 10017
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code (212) 880-5000
------------------------------

- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last report

Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months, and (2) has been subject
to such filing requirements for the past 90 days. Yes X No
----- -----

At July 31, 1998, there were 2,432,090,598 shares outstanding of
the registrant's common stock, par value $0.33 1/3 per share.

<PAGE>

PHILIP MORRIS COMPANIES INC.

TABLE OF CONTENTS

Page No.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited).

Condensed Consolidated Balance Sheets at
June 30, 1998 and December 31, 1997 3 - 4

Condensed Consolidated Statements of Earnings for the
Six Months Ended June 30, 1998 and 1997 5
Three Months Ended June 30, 1998 and 1997 6

Condensed Consolidated Statements of Stockholders'
Equity for the Year Ended December 31, 1997 and the
Six Months Ended June 30, 1998 7

Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1998 and 1997 8 - 9

Notes to Condensed Consolidated Financial Statements 10 - 22

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 23 - 44

PART II - OTHER INFORMATION

Item 1. Legal Proceedings. 45

Item 6. Exhibits and Reports on Form 8-K. 45

Signature 46

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<PAGE>

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in millions of dollars)
(Unaudited)

June 30, December 31,
1998 1997
-------- ------------
<S> <C> <C>
ASSETS
CONSUMER PRODUCTS
Cash and cash equivalents $ 4,605 $ 2,282

Receivables, net 5,293 4,294

Inventories:
Leaf tobacco 4,166 4,348
Other raw materials 1,910 1,689
Finished product 3,043 3,002
------- -------

9,119 9,039

Other current assets 1,840 1,825
------- -------

Total current assets 20,857 17,440

Property, plant and equipment, at cost 20,595 20,002
Less accumulated depreciation 8,740 8,381
------- -------

11,855 11,621
Goodwill and other intangible assets
(less accumulated amortization of
$5,087 and $4,814) 17,557 17,789

Other assets 3,023 3,211
------- -------

Total consumer products assets 53,292 50,061

FINANCIAL SERVICES
Finance assets, net 5,900 5,712
Other assets 171 174
------- -------

Total financial services assets 6,071 5,886
------- -------

TOTAL ASSETS $59,363 $55,947
======= =======

</TABLE>

See notes to condensed consolidated financial statements.

Continued

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<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Continued)
(in millions of dollars, except per share data)
(Unaudited)

June 30, December 31,
1998 1997
-------- ------------
<S> <C> <C>
LIABILITIES
CONSUMER PRODUCTS
Short-term borrowings $ 847 $ 157
Current portion of long-term debt 1,577 1,516
Accounts payable 2,505 3,318
Accrued marketing 2,148 2,149
Accrued taxes, except income taxes 1,667 1,234
Accrued settlement charges 1,790 886
Other accrued liabilities 3,467 3,977
Income taxes 1,000 862
Dividends payable 975 972
------- -------

Total current liabilities 15,976 15,071

Long-term debt 12,289 11,585
Deferred income taxes 920 889
Accrued postretirement health care costs 2,506 2,432
Other liabilities 6,630 6,218
------- -------

Total consumer products liabilities 38,321 36,195

FINANCIAL SERVICES
Short-term borrowings 103
Long-term debt 838 845
Deferred income taxes 3,933 3,877
Other liabilities 146 110
------- -------

Total financial services liabilities 5,020 4,832
------- -------

Total liabilities 43,341 41,027

Contingencies (Note 3)

STOCKHOLDERS' EQUITY
Common stock, par value $0.33 1/3 per share
(2,805,961,317 shares issued) 935 935

Earnings reinvested in the business 26,111 24,924

Accumulated other comprehensive earnings:
Currency translation adjustments (1,330) (1,109)
------- -------
25,716 24,750
Less cost of repurchased stock
(374,902,778 and 380,474,028 shares) 9,694 9,830
------- -------

Total stockholders' equity 16,022 14,920
------- -------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $59,363 $55,947
======= =======

</TABLE>

See notes to condensed consolidated financial statements.

-4-

<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions of dollars, except per share data)
(Unaudited)

For the Six Months Ended
June 30,
------------------------
1998 1997
------- -------
<S> <C> <C>
Operating revenues $37,361 $36,630

Cost of sales 13,590 13,407

Excise taxes on products 8,419 8,247
------- -------

Gross profit 15,352 14,976

Marketing, administration and research costs 8,354 8,050

Settlement charges (Note 3) 1,005

Amortization of goodwill 290 296
------- -------

Operating income 5,703 6,630

Interest and other debt expense, net 482 566
------- -------

Earnings before income taxes 5,221 6,064

Provision for income taxes 2,103 2,455
------- -------

Net earnings $ 3,118 $ 3,609
======= =======

Per share data:

Basic earnings per share $ 1.28 $ 1.49
======= =======

Diluted earnings per share $ 1.28 $ 1.48
======= =======

Dividends declared $ 0.80 $ 0.80
======= =======

</TABLE>

See notes to condensed consolidated financial statements.

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<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions of dollars, except per share data)
(Unaudited)

For the Three Months Ended
June 30,
--------------------------
1998 1997
------- -------
<S> <C> <C>
Operating revenues $18,978 $18,413

Cost of sales 6,883 6,690

Excise taxes on products 4,192 4,123
------- -------

Gross profit 7,903 7,600

Marketing, administration and research costs 4,420 4,089

Settlement charges (Note 3) 199

Amortization of goodwill 144 147
------- -------

Operating income 3,140 3,364

Interest and other debt expense, net 238 279
------- -------

Earnings before income taxes 2,902 3,085

Provision for income taxes 1,166 1,249
------- -------

Net earnings $ 1,736 $ 1,836
======= =======

Per share data:

Basic earnings per share $ 0.72 $ 0.76
======= =======

Diluted earnings per share $ 0.71 $ 0.75
======= =======

Dividends declared $ 0.40 $ 0.40
======= =======

</TABLE>

See notes to condensed consolidated financial statements.

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<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Stockholders' Equity
for the Year Ended December 31, 1997 and
the Six Months Ended June 30, 1998
(in millions of dollars, except per share data)
(Unaudited)

Earnings Accumulated Total
Reinvested Currency Other Cost of Stock-
Common in the Translation Comprehensive Repurchased holders'
Stock Business Adjustments Earnings Stock Equity
------ ---------- ----------- ------------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1997 $ 935 $22,480 $ 192 $ 190 $(9,387) $14,218

Comprehensive earnings:
Net earnings 6,310 6,310
Other comprehensive earnings,
net of income taxes:
Currency translation adjustments (1,301) (1,301) (1,301)
Net unrealized appreciation
on securities 2 2
------- ------- -------
Total other comprehensive earnings (1,301) (1,299) (1,299)
------- ------- -------
Total comprehensive earnings 5,011

Exercise of stock options and
issuance of other stock awards 14 300 314
Cash dividends
declared($1.60 per share) (3,880) (3,880)
Stock repurchased (743) (743)
----- ------- ------- ------- ------- -------

Balances, December 31, 1997 935 24,924 (1,109) (1,109) (9,830) 14,920

Comprehensive earnings:
Net earnings 3,118 3,118
Other comprehensive earnings,
net of income taxes:
Currency translation adjustments (221) (221) (221)
------- ------- -------
Total other comprehensive earnings (221) (221) (221)
------- ------- -------
Total comprehensive earnings 2,897

Exercise of stock options and
issuance of other stock awards 12 136 148
Cash dividends
declared($0.80 per share) (1,943) (1,943)
----- ------ ------- ------- ------- -------

Balances, June 30, 1998 $ 935 $26,111 $(1,330) $(1,330) $(9,694) $16,022
===== ======= ======= ======= ======= =======

</TABLE>

Total comprehensive earnings, which primarily represent net earnings
partially offset by currency translation adjustments, were $1,696 million
and $1,670 million, respectively, for the quarters ended June 30, 1998 and
1997, and $2,761 million for the first six months of 1997.

See notes to condensed consolidated financial statements.

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Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in millions of dollars)
(Unaudited)

For the Six Months Ended
June 30,
------------------------
1998 1997
------- -------
<S> <C> <C>
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES

Net earnings - Consumer products $ 3,059 $ 3,541
- Financial services and real estate 59 68
------- -------

Net earnings 3,118 3,609
Adjustments to reconcile net earnings to
operating cash flows:
CONSUMER PRODUCTS
Depreciation and amortization 863 855
Deferred income tax provision 121 93
Gain on sale of a business (23)
Cash effects of changes, net of the effects
from acquired and divested companies:
Receivables, net (1,133) (973)
Inventories (63) (147)
Accounts payable (951) (864)
Income taxes 176 201
Other working capital items 778 455
Other 625 151
FINANCIAL SERVICES AND REAL ESTATE
Deferred income tax provision 59 48
Other 66 52
------- -------

Net cash provided by operating activities 3,659 3,457
------- -------

CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES

CONSUMER PRODUCTS
Capital expenditures (806) (745)
Purchases of businesses, net of acquired cash (223)
Proceeds from sales of businesses 164
Other 22 (5)
FINANCIAL SERVICES AND REAL ESTATE
Investments in finance assets (263) (328)
Proceeds from finance assets 67 181
------- -------

Net cash used in investing activities (980) (956)
------- -------

</TABLE>

See notes to condensed consolidated financial statements.
(continued)

-8-

<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Continued)
(in millions of dollars)
(Unaudited)

For the Six Months Ended
June 30,
------------------------
1998 1997
------- -------
<S> <C> <C>
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES

CONSUMER PRODUCTS
Net issuance(repayment)of short-term borrowings $ 693 $ (149)
Long-term debt proceeds 1,985 1,786
Long-term debt repaid (1,205) (1,277)
FINANCIAL SERVICES AND REAL ESTATE
Net issuance of short-term borrowings 103 252
Long-term debt proceeds 174
Long-term debt repaid (387)

Dividends paid (1,942) (1,946)
Issuance of shares 98 58
Repurchase of outstanding stock (805)
Other (73) (77)
------- -------

Net cash used in financing activities (341) (2,371)
------- -------

Effect of exchange rate changes on cash and
cash equivalents (15) (53)
------- -------

Cash and cash equivalents:
Increase 2,323 77

Balance at beginning of period 2,282 240
------- -------

Balance at end of period $ 4,605 $ 317
======= =======

</TABLE>

See notes to condensed consolidated financial statements.

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<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

NOTE 1. ACCOUNTING POLICIES:

The interim condensed consolidated financial statements of Philip Morris
Companies Inc. (the "Company") are unaudited. It is the opinion of the Company's
management that all adjustments necessary for a fair statement of the interim
results presented have been reflected therein. All such adjustments were of a
normal recurring nature. Operating revenues and net earnings for any interim
period are not necessarily indicative of results that may be expected for the
entire year.

These statements should be read in conjunction with the consolidated financial
statements and related notes which appear in the Company's annual report to
stockholders and which are incorporated by reference into the Company's Annual
Report on Form 10-K for the year ended December 31, 1997 (the "1997 Form 10-K").

Balance sheet accounts are segregated by two broad types of business. Consumer
products assets and liabilities are classified as either current or non-current,
whereas financial services assets and liabilities are unclassified, in
accordance with respective industry practices.

NOTE 2. RECENTLY ADOPTED ACCOUNTING STANDARDS:

Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings per Share" ("EPS") which
establishes standards for computing and presenting EPS and requires the
presentation of both basic and diluted EPS. Prior period EPS have been restated
to conform with the standards established by SFAS No. 128. Basic and diluted EPS
were calculated using the following:

For the Six Months Ended
June 30,
------------------------
1998 1997
---- ----
(in millions)
<S> <C> <C>
Net earnings $3,118 $3,609
====== ======

Weighted average shares for
basic EPS 2,427 2,418

Plus incremental shares from conversions:
Restricted stock and stock rights 1 1
Stock options 15 21
----- -----
Weighted average shares for
diluted EPS 2,443 2,440
====== ======

For the Three Months Ended
June 30,
--------------------------
1998 1997
---- ----
(in millions)
<S> <C> <C>
Net earnings $1,736 $1,836
====== ======
Weighted average shares for
basic EPS 2,428 2,414

Plus incremental shares from conversions:
Restricted stock and stock rights 1 1
Stock options 14 21
----- -----
Weighted average shares for
diluted EPS 2,443 2,436
====== ======

</TABLE>

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<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Options on shares of common stock were excluded from the calculation of weighted
average shares for diluted EPS because their effects were antidilutive, as
follows:

1998 1997
---- ----
(in millions)
For the three months ended June 30, 39 16
For the six months ended June 30, 20 8

In 1998, the American Institute of Certified Public Accountants' Accounting
Standards Executive Committee ("AcSEC") issued Statement of Position ("SOP") No.
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." SOP No. 98-1 requires certain costs incurred in connection with
developing or obtaining internal-use software to be capitalized and other costs
to be expensed. The Company adopted SOP No. 98-1 effective January 1, 1998, and
its application for the three and six month periods ended June 30, 1998 had no
material effect on the Company's financial position or results of operations.

NOTE 3. CONTINGENCIES:

Legal proceedings covering a wide range of matters are pending in various
U.S. and foreign jurisdictions against the Company, its subsidiaries and
affiliates, including Philip Morris Incorporated ("PM Inc."), the Company's
domestic tobacco subsidiary, Philip Morris International Inc. ("PMI"), the
Company's international tobacco subsidiary, and their respective indemnitees.
Various types of claims are raised in these proceedings, including products
liability, consumer protection, antitrust, securities law, tax, patent
infringement, employment matters and claims for contribution.

OVERVIEW OF TOBACCO-RELATED LITIGATION

TYPES AND NUMBER OF CASES

Pending claims related to tobacco products generally fall within three
categories: (i) smoking and health cases alleging personal injury brought on
behalf of individual plaintiffs, (ii) smoking and health cases alleging personal
injury and purporting to be brought on behalf of a class of individual
plaintiffs, and (iii) health care cost recovery cases brought by state and local
governments seeking reimbursement for Medicaid and/or other health care
expenditures allegedly caused by cigarette smoking, as well as similar cases,
including class actions, brought by non-governmental plaintiffs such as unions,
health maintenance organizations ("HMOs"), federal and state taxpayers, native
American tribes and others. Damages claimed in some of the smoking and health
class actions and health care cost recovery cases range into the billions of
dollars.

In recent years there has been a substantial increase in the number of smoking
and health cases being filed in the United States.

As of August 1, 1998, there were approximately 400 smoking and health cases
filed and served on behalf of individual plaintiffs in the United States against
PM Inc. and, in some cases, the Company (excluding approximately 50 cases in
Texas that were voluntarily dismissed but which may be refiled under certain
conditions), compared with approximately 375 such cases on December 31, 1997,
and 185 such cases on December 31, 1996. Many of the new cases were filed in
Florida and New

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<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

York. Twenty-two of the individual cases involve allegations of various
personal injuries allegedly related to exposure to environmental tobacco
smoke ("ETS").

In addition, as of August 1, 1998, there were approximately 65 purported smoking
and health class actions pending in the United States against PM Inc. and, in
some cases, the Company (including eight that involve allegations of various
personal injuries related to exposure to ETS), compared with approximately 50
such cases on December 31, 1997, and 20 such cases on December 31, 1996. Most of
these actions purport to constitute statewide class actions and were filed after
May 1996 when the Fifth Circuit Court of Appeals, in the CASTANO case, reversed
a federal district court's certification of a purported nationwide class action
on behalf of persons who were allegedly "addicted" to tobacco products.

The number of health care cost recovery actions in the United States also
increased, with approximately 140 such cases pending as of August 1, 1998,
compared with approximately 105 such cases on December 31, 1997, and 25 such
cases on December 31, 1996.

There are also a number of tobacco-related actions pending outside the United
States against affiliates and subsidiaries of PMI including, as of August 1,
1998, approximately 20 smoking and health cases initiated by one or more
individuals (Argentina (13), Brazil (1), Canada (1), Italy (1), Japan (1),
Scotland (1) and Turkey (2)), four smoking and health class actions (Brazil (2),
Canada (1) and Nigeria (1)) and one health care cost recovery action (Republic
of the Marshall Islands). In addition, the Republic of Guatemala has filed a
health care cost recovery action in the United States.

LITIGATION SETTLEMENTS

During 1997 and 1998, PM Inc. and other companies in the United States tobacco
industry settled health care cost recovery actions brought by the States of
Mississippi, Florida, Texas and Minnesota, and an ETS smoking and health class
action brought on behalf of airline flight attendants. The Minnesota settlement
is discussed in Note 3 of the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998. The other settlements are discussed in Part I,
Item 3. Legal Proceedings of the Company's 1997 Form 10-K. Recently, the
Mississippi and Texas settlement agreements were amended pursuant to their "most
favored nation" clause to reflect the terms of the Minnesota settlement
agreement. The amended settlement agreements are discussed below under the
heading "Health Care Cost Recovery Litigation - Most Favored Nation Provisions."
The Mississippi, Florida, Texas and Minnesota health care cost recovery
settlement agreements, the amendments to the Mississippi and Texas settlement
agreements and certain ancillary agreements are filed as exhibits to various of
the Company's reports filed with the Securities and Exchange Commission.

VERDICTS IN INDIVIDUAL CASES

During the last two years, juries have returned verdicts for defendants in three
smoking and health cases in Florida and in one individual ETS smoking and health
case in Indiana. In June 1998, a Florida appeals court reversed a $750,000 jury
verdict awarded in August 1996 against another United States cigarette
manufacturer. Also in June 1998, a Florida jury awarded the estate of a deceased
smoker in a smoking and health case against another United States cigarette
manufacturer $500,000 in compensatory damages, $52,000 for medical expenses and
$450,000 in punitive damages. In Brazil, a court in 1997 awarded plaintiffs in a

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<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

smoking and health case the Brazilian currency equivalent of $81,000, attorneys'
fees (in an amount to be determined by the court) and a monthly annuity for 35
years equal to two-thirds of the deceased smoker's last monthly salary. Neither
the Company nor its affiliates were parties to that action. Several of the above
verdicts and decisions are under appeal.

TRIAL DATES

Jury selection is currently underway in a smoking and health class action in
Florida in which PM Inc. is a defendant (ENGLE, ET AL. V. R.J. REYNOLDS TOBACCO
COMPANY, ET AL.). The State of Washington's health care cost recovery action is
scheduled for trial in September 1998. As set forth in Exhibit 99 hereto,
approximately 15 health care cost recovery actions and four smoking and health
class actions are scheduled for trial in 1999. During the remainder of 1998,
five individual smoking and health cases are scheduled for trial against PM
Inc., and approximately 15 such cases, including three in which the Company is a
defendant, are scheduled for trial in 1999. Trial dates, however, are subject to
change.

A description of the smoking and health litigation, health care cost recovery
litigation and certain other proceedings pending against the Company and/or its
subsidiaries and affiliates follows.

SMOKING AND HEALTH LITIGATION

Plaintiffs' allegations of liability in smoking and health cases are based on
various theories of recovery, including negligence, gross negligence, strict
liability, fraud, misrepresentation, design defect, failure to warn, breach of
express and implied warranties, breach of special duty, conspiracy, concert of
action, violations of deceptive trade practice laws and consumer protection
statutes, and claims under the federal Racketeer Influenced and Corrupt
Organization Act ("RICO") and state RICO statutes. In certain of these cases,
plaintiffs claim that cigarette smoking exacerbated the injuries caused by their
exposure to asbestos. Plaintiffs in the smoking and health actions seek various
forms of relief, including compensatory and punitive damages, treble/multiple
damages and other statutory damages and penalties, creation of medical
monitoring funds, disgorgement of profits, and injunctive and equitable relief.
Defenses raised in these cases include lack of proximate cause, assumption of
the risk, comparative fault and/or contributory negligence, statutes of
limitations, and preemption by the Federal Cigarette Labeling and Advertising
Act (the "Labeling Act"). In June 1992, the United States Supreme Court held
that the Labeling Act, as enacted in 1965, does not preempt common law damage
claims, but that the Labeling Act, as amended in 1969, preempts claims arising
after July 1969 against cigarette manufacturers "based on failure to warn and
the neutralization of federally mandated warnings to the extent that those
claims rely on omissions or inclusions in advertising or promotions." The Court
also held that the 1969 Labeling Act does not preempt claims based on express
warranty, fraudulent misrepresentation or conspiracy. The Court further held
that claims for fraudulent concealment were preempted except "insofar as those
claims relied on a duty to disclose...facts through channels of communication
other than advertising or promotion." (The Court did not consider whether such
common law damage claims were valid under state law.) The Court's decision was
announced by a plurality opinion. The effect of the decision on pending and
future cases will be the subject of further proceedings in the lower federal and
state courts. Additional similar litigation could be encouraged if legislation
to eliminate the federal

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<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

preemption defense, proposed in Congress in recent years, were enacted. It is
not possible to predict whether any such legislation will be enacted.

In May 1996, the Fifth Circuit Court of Appeals held that a purported class
consisting of all "addicted" smokers nationwide did not meet the standards and
requirements of the federal rules governing class actions (CASTANO, ET AL. V.
THE AMERICAN TOBACCO COMPANY, ET AL.). Since this class decertification, lawyers
for plaintiffs have filed numerous smoking and health class action suits in
various state and federal courts. In general, these cases purport to be brought
on behalf of residents of a particular state or states and raise "addiction"
claims similar to those raised in the CASTANO case and, in some cases, claims of
physical injury as well. As of August 1, 1998, putative smoking and health class
actions were pending in Alabama, Arkansas, California, the District of Columbia,
Florida, Georgia, Hawaii, Illinois, Indiana, Iowa, Kansas, Louisiana, Maryland,
Michigan, Minnesota, Mississippi, Nevada, New Jersey, New Mexico, New York,
Ohio, Oklahoma, Pennsylvania, Puerto Rico, South Carolina, Tennessee, Texas,
Utah, West Virginia and Wisconsin, as well as in Canada, Brazil and Nigeria. As
of August 1, 1998, class certification had been denied or reversed by courts in
six smoking and health class actions involving PM Inc., in Louisiana, the
District of Columbia, New York (2), Pennsylvania and Puerto Rico, while classes
remained certified in three cases in Florida, Louisiana and Maryland. A number
of the foregoing decisions relating to class certification are under appeal.
Class certification motions are pending in a number of the other purported
smoking and health class actions. One ETS smoking and health class action was
settled in 1997 as discussed in the Company's 1997 Form 10-K.

ENGLE TRIAL

Jury selection began in July 1998. Plaintiffs seek compensatory and punitive
damages ranging into the billions of dollars, as well as equitable relief
including, but not limited to, a medical fund for future health care costs,
attorneys' fees and court costs. The class consists of all Florida residents
and citizens, and their survivors, who have suffered, presently suffer or
have died from diseases and medical conditions caused by their addiction to
cigarettes that contain nicotine. For a discussion of certain recent rulings
in this case, see Exhibit 99 hereto.

The trial plan currently calls for the case to be tried in three phases.
Phase One will involve three stages. Phase One, Stage One will involve
evidence concerning common issues of liability and causation for all class
members, including scientific and statistical evidence, and common class
issues concerning plaintiffs' causes of action. Entitlement to punitive
damages will be decided at the end of Phase One, Stage Two. If the jury
determines that plaintiffs are entitled to punitive damages, evidence
concerning assessment of punitive damages, by way of a ratio to be applied in
the class members' subsequent individual trials, will be presented in Phase
One, Stage Three.

If plaintiffs prevail in Phase One, Phase Two will involve individual
determination of specific causation and other individual issues regarding
entitlement to compensatory damages for the class representatives. Phase
Three of the trial will be held before separate juries to address absent
class members' determination of specific causation and other individual
issues regarding entitlement to compensatory damages.

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<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

HEALTH CARE COST RECOVERY LITIGATION

In certain of the pending proceedings, foreign, state and local government
entities, unions, HMOs, federal and state taxpayers, native American tribes and
others seek reimbursement for Medicaid and/or other health care expenditures
allegedly caused by tobacco products and, in some cases, for future expenditures
and damages as well. Certain of these cases purport to be brought on behalf of a
class of plaintiffs, and in some cases, the class has been certified by the
court. In one health care cost recovery case, private citizens seek recovery of
alleged tobacco-related health care expenditures incurred by the federal
Medicare program. In others, Blue Cross subscribers seek reimbursement of
allegedly increased medical insurance premiums caused by tobacco products. In
the native American cases, claims are also asserted for alleged lost
productivity of tribal government employees. Other relief sought by some but not
all plaintiffs includes punitive damages, treble/multiple damages and other
statutory damages and penalties, injunctions prohibiting alleged marketing and
sales to minors, disclosure of research, disgorgement of profits, funding of
anti-smoking programs, disclosure of nicotine yields, and payment of attorney
and expert witness fees.

The claims asserted in these health care cost recovery actions vary. In most
cases, plaintiffs assert the equitable claim that the tobacco industry was
"unjustly enriched" by plaintiffs' payment of health care costs allegedly
attributable to smoking, and seek reimbursement of those costs. Other claims
made by some but not all plaintiffs include the equitable claim of indemnity,
common law claims of negligence, strict liability, breach of express and implied
warranty, violation of a voluntary undertaking or special duty, fraud, negligent
misrepresentation, conspiracy, public nuisance, claims under federal and state
statutes governing consumer fraud, antitrust, deceptive trade practices and
false advertising, and claims under federal and state RICO statutes.

Defenses raised include failure to state a valid claim, lack of benefit,
adequate remedy at law, "unclean hands" (namely, that plaintiffs cannot obtain
equitable relief because they participated in, and benefited from, the sale of
cigarettes), lack of antitrust injury, federal preemption, lack of proximate
cause, remoteness and statute of limitations. In addition, defendants argue that
they should be entitled to "set-off" any alleged damages to the extent the
plaintiff benefits economically from the sale of cigarettes through the receipt
of excise taxes or otherwise. Defendants also argue that these cases are
improper because plaintiffs must proceed under principles of subrogation and
assignment. Under traditional theories of recovery, a payor of medical costs
(such as an insurer or a state) can seek recovery of health care costs from a
third party solely by "standing in the shoes" of the injured party. Defendants
argue that plaintiffs should be required to bring an action on behalf of each
individual health care recipient and should be subject to all defenses available
against the injured party. In certain of these cases, defendants have also
challenged the ability of the plaintiffs to use contingency fee counsel to
prosecute these actions. Further, certain cigarette companies, including PM
Inc., have filed declaratory judgment actions in a number of states seeking to
block the state's health care cost recovery action and/or to prevent the state
from hiring contingency fee counsel.

As discussed in Exhibit 99 hereto, Maryland and Vermont have recently enacted
statutes that are intended to facilitate the state's ability to recover Medicaid
and/or other health care cost expenditures allegedly caused by cigarette
smoking. Other states are considering similar legislation. These statutes and
proposed bills vary by jurisdiction, but generally include provisions that
purport to

-15-

<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

abrogate certain affirmative defenses, create a direct cause of
action for the state (thus avoiding the need to proceed via subrogation) and
authorize the use of statistical models to prove damages and/or causation. The
legality of the Vermont statute is currently being challenged in court by PM
Inc. and other domestic tobacco manufacturers.

As of August 1, 1998, there were approximately 140 health care cost recovery
cases pending against PM Inc. and, in some cases, the Company. Thirty-seven of
these cases were filed by states, through their attorneys general and/or other
state agencies, in Alaska, Arizona, Arkansas, California, Colorado, Connecticut,
Georgia, Hawaii, Idaho, Illinois, Indiana (dismissed by trial court), Iowa
(dismissal of Medicaid reimbursement claims affirmed by appellate court),
Kansas, Louisiana, Maine, Maryland, Massachusetts, Michigan, Missouri, Montana,
Nevada, New Hampshire, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon,
Pennsylvania, Rhode Island, South Carolina, South Dakota, Utah, Vermont,
Washington, West Virginia and Wisconsin, and eight were filed by city and county
governments. Approximately 70 of the pending health care cost recovery actions
were filed by unions (four of which have been dismissed in their entirety by
courts in Florida, Maryland, Pennsylvania and Oregon, but for which appeals are
pending or may yet be filed), six by HMOs, five by federal and state taxpayers
and five by native American tribes. Health care cost recovery actions have also
been brought by the Republic of the Marshall Islands, the Commonwealth of Puerto
Rico and the Republic of Guatemala. In July 1998, the press reported that the
Clinton Administration is reviewing the possibility of filing a Medicare health
care cost recovery action on behalf of the federal government. As discussed
above, under the heading "Overview of Tobacco-Related Litigation--Litigation
Settlements," four health care cost recovery cases have been settled in 1997 and
1998.

WASHINGTON TRIAL

Trial in the Washington health care cost recovery action is scheduled to begin
in September 1998. Plaintiff seeks damages in unspecified amounts, funding of
smoking cessation and public education programs, civil penalties of $2,000 for
each violation of the state's unfair business practices statute, civil penalties
of $100,000 against each individual defendant and $500,000 against each
corporate defendant for each violation of the state's antitrust statute, costs
and attorneys' fees, various forms of non-monetary relief and such other relief
as the court deems appropriate. For a discussion of certain recent rulings in
this case, see Exhibit 99 hereto.

MOST FAVORED NATION PROVISIONS

Following the settlement of Minnesota's health care cost recovery action in May
1998, the States of Texas, Florida and Mississippi contacted PM Inc. to discuss
the issue of what effect, if any, the settlement of the Minnesota action has
upon the terms of the prior settlements with those states pursuant to the "most
favored nation" ("MFN") provision of those prior state settlements. That
provision provides that, in the event the settling defendants enter into a
subsequent pre-verdict settlement with a non-federal governmental entity on
terms more favorable to such entity than the terms of the prior state
settlements (after due consideration of relevant differences in population or
other appropriate factors), the terms of the prior state settlements will be
revised to provide treatment at least as relatively favorable. The Mississippi
and Texas settlement agreements were recently amended pursuant to this
provision, as described in detail below. Discussions with the State of Florida
have not concluded in an agreement. (Copies

-16-

<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

of the MFN amendments are filed as Exhibits to this Form 10-Q, and the
discussion herein is qualified by reference thereto.)

The Mississippi and Texas MFN amendments to the settlement agreements call for
the industry to make additional payments to Mississippi and Texas over a five-
year period aggregating $550 million and $2.275 billion, respectively. These
amounts are payable in January of the year indicated and, for payments after
1999, are to be adjusted for inflation, changes in domestic sales volume and,
under specified circumstances, increases in net operating profits from domestic
sales:

(in millions)
1999 2000 2001 2002 2003 Total
---- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C> <C>
Mississippi $ 41.738 $145.173 $145.173 $145.173 $ 72.743 $ 550.000

Texas 156.530 605.090 605.090 605.090 303.200 2,275.000
-------- -------- -------- -------- -------- ----------

$198.268 $750.263 $750.263 $750.263 $375.943 $2,825.000
======== ======== ======== ======== ======== ==========

</TABLE>

These payments will be allocated among the settling defendants in accordance
with their relative unit volume of domestic cigarette shipments in the year
preceding payment.

In the event a settling defendant defaults on its obligation to make timely
payment of the above amounts, the remaining settling defendants may, in their
absolute discretion, pay the missing payment. If they elect not to make up the
missing payment, each settling defendant can be required by the state to pay its
share of the remaining payments scheduled above within 30 days of the default,
subject to inflation and volume adjustments. The obligations of the settling
defendants under the amended settlement agreements are several and not joint;
the amended settlement agreements do not obligate any settling defendant to pay
the share of another settling defendant.

The stated amounts of the ongoing annual payments (the "Ongoing Annual
Payments") contemplated by the original Mississippi and Texas settlement
agreements are unchanged by the MFN amendments.

The MFN amendments modify the provisions of the original settlement agreements
that address the impact that enactment of federal tobacco legislation before
November 30, 2000, would have on such settlements. Under the MFN amendments, the
settling defendants will be entitled to receive a dollar-for-dollar offset
against their Ongoing Annual Payments for amounts that Mississippi or Texas, as
the case may be, could elect to receive pursuant to any such federal tobacco
legislation ("Federal Settlement Funds"), except to the extent that: (i) such
Federal Settlement Funds are required to be used for purposes other than health
care or tobacco-related purposes; (ii) such federal tobacco legislation does not
provide for the abrogation, settlement or relinquishment of state
tobacco-related claims; or (iii) state receipt of such Federal Settlement Funds
is conditioned upon (A) the relinquishment of rights or benefits under that
respective state's settlement (excepting any Ongoing Annual Payment amounts
subject to the offset); or (B) actions or expenditures by such state unrelated
to health care or tobacco (including but not limited to tobacco education,
cessation, control or enforcement).

The MFN amendments also supersede the MFN provisions contained in the original
settlement agreements. Under the MFN amendments, if the settling defendants
enter

-17-

<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

into any future pre-verdict settlement agreement of similar health care cost
recovery litigation on terms more favorable to a non-federal governmental
plaintiff, the Mississippi and Texas settlements will not otherwise be
revised except to the extent such future settlement provides for: (i) joint
and several liability for monetary payments, (ii) a parent company guaranty
or other credit assurance, (iii) the implementation of different non-economic
tobacco-related public health measures, or (iv) monetary offsets in the event
of federal tobacco legislation that are more favorable to such plaintiff than
those described above.

The settling defendants agreed as part of the MFN amendments to disclose
specified future payments for lobbying or related purposes in Mississippi and
Texas, to support enumerated legislative and regulatory proposals and to not
support legislation, rules or policies that would diminish Mississippi's and
Texas' rights under the amended settlement agreements. The settling defendants
further agreed not to make any payments for tobacco product placement in motion
pictures made in the United States.

The settling defendants also submitted to a Consent Judgment enjoining the
industry from (i) offering or selling non-tobacco services or merchandise (e.g.,
caps, jackets or bags) in Mississippi and Texas bearing the name or logo of a
tobacco brand other than tobacco products or items with the sole function of
advertising; (ii) making any material misrepresentation of fact regarding the
health consequences of using tobacco products; (iii) entering into any contract,
combination or conspiracy to limit health information or research into smoking
and health or product development; and (iv) taking any action to target children
in Mississippi and Texas in the advertising, promotion or marketing of
cigarettes.

In connection with the MFN amendments, the parties executed new agreements
governing settling defendants' payment of attorneys' fees to counsel for
Mississippi and Texas. (Copies of these agreements are filed as Exhibits to this
Form 10-Q, and the discussion herein is qualified by reference thereto.) The
agreements provide that beginning in November 1998, a three-member arbitration
panel will consider and determine the amount of attorneys' fees to be awarded.
These awards will be allocated among the settling defendants in accordance with
their relative unit volume of domestic cigarette shipments. Under the
agreements, there is an annual cap of $500 million on aggregate attorneys' fees
to be paid pursuant to arbitration awards, including those to be paid for
counsel for Mississippi and Texas. A one-time $250 million payment may be paid
for cases that were settled in 1997. This aggregate annual cap includes: (i) all
attorneys' fees paid pursuant to an award by the panel in connection with
settlements of any smoking and health cases (other than individual cases), (ii)
all attorneys' fees paid pursuant to an award by the panel for activities in
connection with smoking and health cases resolved by operation of federal
legislation provided such legislation imposes an obligation on the settling
defendants to pay attorneys' fees, and (iii) all attorneys' and professional
fees paid pursuant to an award by the panel for contributions made toward the
enactment of federal tobacco legislation.

The settling defendants have made payments to counsel for Mississippi and Texas
totaling $200 million as advances against awards of attorneys' fees by the
arbitration panel, such advances to be credited against the annual cap over
several years commencing in 1999.

-18-

<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The Company has recorded charges of $199 million in the second quarter of
1998 to accrue for PM Inc.'s share of all fixed and determinable portions of
the obligations described above.

CERTAIN OTHER TOBACCO-RELATED LITIGATION

Since September 1997, a number of suits have been filed by former asbestos
manufacturers and asbestos manufacturers' personal injury settlement trusts
against domestic tobacco manufacturers, including PM Inc., and others
(RAYMARK INDUSTRIES, INC. V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL.;
RAYMARK INDUSTRIES, INC. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL.; FIBREBOARD
CORPORATION AND OWENS CORNING V. THE AMERICAN TOBACCO COMPANY, ET AL.; ROBERT
A. FALISE, ET AL., TRUSTEES OF THE MANVILLE PERSONAL INJURY SETTLEMENT TRUST
V. THE AMERICAN TOBACCO COMPANY, ET AL.; KEENE CREDITORS TRUST V. BROWN &
WILLIAMSON TOBACCO CORPORATION, ET AL.; H.K. PORTER COMPANY, INC. V. B.A.T.
INDUSTRIES, PLC, ET al.; RAYMARK INDUSTRIES, INC. V. THE AMERICAN TOBACCO
COMPANY, ET AL.; H.K. PORTER COMPANY, INC. V. THE AMERICAN TOBACCO
COMPANY, ET AL.). These cases seek, among other things, contribution or
reimbursement for amounts expended for the defense and payment of asbestos
claims that were allegedly caused in whole or in part by cigarette smoking.
Plaintiffs in most of these cases also seek punitive damages.

Since June 1998, three class actions have been filed against PM Inc. and the
Company, in Florida, New Jersey and Pennsylvania on behalf of individuals who
purchased and consumed MARLBORO LIGHTS (HOGUE, ET AL. V. PHILIP MORRIS
COMPANIES, INC., ET AL., CIRCUIT COURT, THIRTEENTH JUDICIAL CIRCUIT
HILLSBOROUGH COUNTY, FLORIDA, FILED JUNE 30, 1998; CUMMIS, ET AL. V. PHILIP
MORRIS COMPANIES, INC., ET AL., SUPERIOR COURT OF NEW JERSEY, LAW DIVISION,
MORRIS COUNTY, FILED JULY 9, 1998; MCNAMARA, ET AL. V. PHILIP MORRIS
COMPANIES, INC., ET AL., COURT OF COMMON PLEAS, MONTGOMERY COUNTY,
PENNSYLVANIA, FILED JULY 16, 1998). These cases allege in connection with the
use of the term "Lights," among other things, deceptive and unfair trade
practices, unjust enrichment, and seek injunctive and equitable relief.
Similar class actions have been threatened in Massachusetts.

Since July 1998, two suits have been filed in California courts alleging that
domestic cigarette manufacturers, including PM Inc., and others have violated
the California statute known as "Proposition 65" by not informing the public
of the alleged risks of ETS to non-smokers. Plaintiffs also allege violations
of California's Business and Professions Code regarding unfair and fraudulent
business practices. Plaintiffs seek statutory penalties, injunctions barring
the sale of cigarettes, restitution, disgorgement of profits and other relief
(PEOPLE OF THE STATE OF CALIFORNIA, ET AL. V. PHILIP MORRIS INCORPORATED, ET
AL., SUPERIOR COURT, LOS ANGELES, CALIFORNIA, FILED JULY 14, 1998; PEOPLE OF
THE STATE OF CALIFORNIA, ET AL. V. BROWN & WILLIAMSON, ET AL., SUPERIOR
COURT, SAN FRANCISCO, CALIFORNIA, FILED JULY 28, 1998).

CERTAIN OTHER ACTIONS

In March 1994, the Company and certain officers and directors were named as
defendants in a complaint filed as a purported class action in the United
States District Court for the Eastern District of New York (LAWRENCE, ET AL.
V. PHILIP MORRIS COMPANIES INC., ET AL.). Plaintiffs allege that defendants
violated the federal securities laws by maintaining artificially high levels
of profitability through an inventory management practice pursuant to which
PM Inc. allegedly shipped more inventory to customers than was necessary to
satisfy market demand. The plaintiff class consists of all persons who
purchased common stock of the

-19-

<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Company between July 10, 1991, and April 1, 1993, and who held such stock at
the close of business on April 1, 1993.

In April 1994, the Company and certain officers and directors were named as
defendants in several other purported class actions that were later
consolidated in the United States District Court in the Southern District of
New York (KURZWEIL, ET AL. V. PHILIP MORRIS COMPANIES INC., ET AL.). In those
cases, plaintiffs assert that defendants violated the federal securities laws
by making allegedly false and misleading statements regarding the allegedly
"addictive" qualities of cigarettes. The plaintiff class consists of all
persons who purchased common stock of the Company between June 11, 1991, and
May 6, 1994.

In June 1998, the court gave preliminary approval to an agreement reached by the
parties to settle the KURZWEIL case. Pursuant to the agreement, the Company
deposited into escrow $105 million to create a fund for the benefit of class
members. In July 1998, the court gave preliminary approval to a revision of the
June agreement, pursuant to which the Company has deposited an additional $10.5
million into the escrow fund for the benefit of class members. This $115.5
million fund will also cover any attorneys' fees and other expenses ordered by
the court if the settlement is finally approved. If so approved, the settlement
will also result in a release of all claims in the LAWRENCE action by class
members who do not request exclusion from the KURZWEIL class. If the settlement
is finally approved, the parties to the LAWRENCE action will seek the dismissal
of that action. The settlement is subject to a number of conditions, including
final court approval.

Since April 1996, five purported class action suits have been filed in
Wisconsin alleging that Kraft Foods, Inc. ("Kraft") and others engaged in a
conspiracy to fix and depress the prices of bulk cheese and milk through
their trading activity on the National Cheese Exchange (STUART, ET AL. V.
KRAFT FOODS, INC., ET AL.; SHEEKS, ET AL. V. KRAFT FOODS, INC., ET AL.;
SERVAIS, ET AL. V. KRAFT FOODS, INC. AND THE NATIONAL CHEESE EXCHANGE, INC.;
DODSON, ET AL. V. KRAFT FOODS, INC., ET AL.; and NOLL, ET AL. V. KRAFT FOODS,
INC., ET AL.). Plaintiffs seek injunctive and equitable relief and treble
damages. The court has granted the SHEEKS and STUART plaintiffs' motions for
voluntary dismissal without prejudice. Plaintiffs in the three remaining
cases have filed a consolidated class action complaint in Wisconsin seeking
certification of a class consisting of all milk producers in the United
States. In June 1998, the court in this consolidated action denied Kraft's
motion to dismiss as to the antitrust and tortious interference claims and
granted Kraft's motion to dismiss on breach of contract and false advertising
claims. In October 1997, a purported class action suit was filed in Illinois
against Kraft only (VINCENT, ET AL. V. KRAFT FOODS, INC.), and in April 1998,
a purported class action suit was filed in California against Kraft and
others (KNEVELBOARD DAIRIES, ET AL. V. KRAFT FOODS, INC., ET AL., SUPERIOR
COURT OF CALIFORNIA, LOS ANGELES COUNTY, FILED APRIL 14, 1998). Both of these
suits contain allegations similar to those in the consolidated Wisconsin
class action, but the VINCENT case seeks a class comprising all of Kraft's
milk suppliers, and the KNEVELBOARD case seeks a class comprising all of
defendants' milk suppliers in California. In June 1998, the Illinois court in
the VINCENT case granted Kraft's motion to dismiss, but has allowed
plaintiffs to file an amended complaint.

Tax assessments alleging the nonpayment of taxes in Italy (value-added taxes for
the years 1988 to 1995 and income taxes for the years 1987 to 1995) have been
served upon certain affiliates of the Company. The aggregate amount of unpaid
taxes assessed to date is alleged to be the Italian lira equivalent of $2.5

-20-

<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

billion. In addition, the Italian lira equivalent of $3.5 billion in interest
and penalties has been assessed (reduced from $6.0 billion to reflect a change
in law). The Company anticipates that value-added and income tax assessments may
also be received in respect of 1996 and 1997. In September 1997, the Italian
administrative tax court in Milan overturned one of the assessments for
value-added taxes, and that decision has been appealed by the tax authorities.
In May and June 1998, the Italian administrative tax court in Milan overturned
42 additional assessments for value-added and income taxes. In a separate
proceeding in Naples, in October 1997, a court dismissed charges of criminal
association against certain present and former officers and directors of
affiliates of the Company, but permitted charges of tax evasion to remain
pending. In February 1998, the tax evasion charges were dismissed by the
criminal court in Naples following a determination that jurisdiction was not
proper, and the case file was transmitted to the public prosecutor in Milan, who
will determine whether to bring charges, in which case a preliminary
investigations judge will make a new finding as to whether there should be a
trial on these charges. The Company, its affiliates and the officers and
directors who are subject to the proceedings believe they have complied with
applicable Italian tax laws and are vigorously contesting the pending tax
assessments and pending proceedings.

THE JUNE 1997 PROPOSED RESOLUTION AND PROPOSED FEDERAL TOBACCO LEGISLATION

In June 1997, PM Inc. and other companies in the United States tobacco industry
entered into a Memorandum of Understanding (the "Resolution") to support the
adoption of federal legislation and ancillary undertakings that would resolve
many of the regulatory and litigation issues affecting the United States tobacco
industry and, thereby, reduce uncertainties facing the industry and increase
stability in business and capital markets. (The proposed Resolution is discussed
in the Company's 1997 Form 10-K, and a copy of the proposed Resolution is filed
as Exhibit 10.17 thereto.) Such legislation was never enacted.

In April 1998, the Senate Commerce Committee approved a bill that was
substantially different and significantly more adverse to the domestic tobacco
industry and the Company than the proposed Resolution (the "Commerce Bill").
That Bill, as approved by the Commerce Committee, contemplated industry payments
in excess of one-half trillion dollars over the first twenty-five years,
provided the United States Food and Drug Administration ("FDA") with broad
regulatory control over tobacco products, applied, in certain respects, to
international sales of tobacco products, and eliminated virtually all of the
provisions of the proposed Resolution that would limit liability of the tobacco
industry in civil litigation in the United States. In June 1998, the United
States Senate voted to return the Commerce Bill to the Senate Commerce Committee
for further consideration. Other federal tobacco bills are also under
consideration by Congress. The Company cannot predict whether the Commerce Bill
or any other such federal tobacco legislation will be enacted or the form any
such enactment might take.

-------------------------

-21-

<PAGE>

Philip Morris Companies Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

industry that have received widespread media attention. These developments may
negatively affect the perception of potential triers of fact with respect to the
tobacco industry, possibly to the detriment of certain pending litigation, and
may prompt the commencement of additional similar litigation.

Management is unable to make a meaningful estimate of the amount or range of
loss that could result from an unfavorable outcome of pending litigation. The
present legislative and litigation environment is substantially uncertain and it
is possible that the Company's business, results of operations, cash flows or
financial position could be materially affected by an unfavorable outcome or
settlement of certain pending litigation or by the enactment of federal tobacco
legislation discussed above. The Company and each of its subsidiaries named as a
defendant believe, and each has been so advised by counsel handling the
respective cases, that it has a number of valid defenses to all litigation
pending against it. All such cases are, and will continue to be, vigorously
defended. However, the Company and its subsidiaries periodically may enter into
discussions in an attempt to settle various cases when they believe it is in the
best interests of the Company's stockholders to do so. In that regard, PM Inc.
has discussed with certain state attorneys general the possibility of settling
the asserted and unasserted health care cost recovery claims of most states. No
assurance can be given that any cases will be settled or what the terms of any
settlement might be.

Reference is made to Exhibit 99 to this Form 10-Q for a list of pending
smoking and health class actions and health care cost recovery actions, and
for a description of certain developments in such proceedings.

NOTE 4. RECENTLY ISSUED ACCOUNTING STANDARDS:

During the second quarter of 1998, the Financial Accounting Standards Board
issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities," which must be adopted by the Company by January 1, 2000, with early
adoption permitted. SFAS No. 133 requires that all derivative instruments be
recorded on the consolidated balance sheet at their fair value. Changes in the
fair value of derivatives will be recorded each period in earnings or other
comprehensive earnings, depending on whether a derivative is designated as part
of a hedge transaction and, if it is, the type of hedge transaction. Gains and
losses on derivative instruments reported in other comprehensive earnings will
be reclassified as earnings in the periods in which earnings are affected by the
hedged item. The Company has not yet determined the timing of adoption or the
impact that adoption or subsequent application of SFAS No. 133 will have on its
financial position or results of operations.

In 1998, AcSEC issued SOP No. 98-5, "Reporting on the Costs of Start-Up
Activities." SOP No. 98-5 establishes standards on accounting for start-up
and organization costs and in general, requires such costs to be expensed as
incurred. This standard is required to be adopted on January 1, 1999. The
Company currently estimates that adoption of SOP No. 98-5 will have no
material effect on the Company's financial position or results of operations.

-22-

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CONSOLIDATED OPERATING RESULTS

FOR THE SIX MONTHS ENDED JUNE 30,

OPERATING REVENUES
------------------------------
(in millions)
1998 1997
------- -------
<S> <C> <C>
Tobacco $21,336 $20,073
Food 13,710 14,164
Beer 2,176 2,193
Financial services and real estate 139 200
------- -------
Operating revenues $37,361 $36,630
======= =======

OPERATING INCOME
------------------------------
(in millions)
1998 1997
------- -------
<S> <C> <C>
Tobacco $ 3,731 $4,672
Food 2,193 2,118
Beer 286 285
Financial services and real estate 93 106
------- -------
Operating companies income 6,303 7,181
Amortization of goodwill (290) (296)
General corporate expenses (248) (222)
Minority interest in earnings of
consolidated subsidiaries (62) (33)
------- -------
Operating income $ 5,703 $ 6,630
======= =======

FOR THE THREE MONTHS ENDED JUNE 30,

OPERATING REVENUES
------------------------------
(in millions)
1998 1997
------- -------
<S> <C> <C>
Tobacco $10,673 $10,153
Food 7,035 6,953
Beer 1,196 1,207
Financial services and real estate 74 100
------- -------
Operating revenues $18,978 $18,413
======= =======

OPERATING INCOME
------------------------------
(in millions)
1998 1997
------- -------
<S> <C> <C>
Tobacco $ 2,083 $ 2,318
Food 1,156 1,102
Beer 158 166
Financial services and real estate 51 58
------- -------
Operating companies income 3,448 3,644
Amortization of goodwill (144) (147)
General corporate expenses (133) (113)
Minority interest in earnings of
consolidated subsidiaries (31) (20)
------- -------
Operating income $ 3,140 $ 3,364
======= =======

</TABLE>

-23-

<PAGE>

RESULTS OF OPERATIONS

Operating revenues for the first six months of 1998 increased 2.0% over the
first six months of 1997, and operating revenues for the second quarter of 1998
increased 3.1% over the comparable 1997 period. These increases were primarily
due to domestic tobacco, international tobacco and North American food
operations. Food segment operating revenues were affected by the 1997 sales of
Brazilian ice cream businesses, North American maple-flavored syrup businesses
and a Scandinavian sugar confectionery business. Financial services and real
estate operating revenues decreased due to the 1997 sale of the real estate
business. Excluding the operating revenues of these and other smaller operations
divested in 1997, underlying operating revenues for the first six months of 1998
increased $1.1 billion (3.1%) over the first six months of 1997, and underlying
operating revenues for the second quarter of 1998 increased $724 million (4.0%)
over the comparable 1997 period.

Operating income for the first six months and second quarter of 1998 decreased
14.0% and 6.7%, respectively, from the comparable 1997 periods, reflecting
charges related to voluntary early retirement and separation programs and the
settlement of tobacco litigation. In February 1998, the Company announced
voluntary early retirement and separation programs for salaried and hourly
employees, primarily at PM Inc. The programs resulted in pre-tax charges of $327
million during the first six months of 1998, of which $232 million was recorded
during the second quarter. First-half results also reflect first-quarter pre-tax
charges of $806 million related to settling health care cost recovery litigation
in Minnesota and second quarter charges of $199 million related to "Most Favored
Nation" clauses in previous state settlement agreements with the states of
Mississippi and Texas, as previously discussed in Note 3 to the Condensed
Consolidated Financial Statements. Excluding the charges for voluntary early
retirement and separation programs and for tobacco litigation settlements, as
well as results from operations divested since the beginning of 1997, underlying
operating income increased $484 million (7.4%) and $238 million (7.1%) over the
first six months and second quarter of 1997, respectively, reflecting favorable
results in domestic tobacco, international tobacco and North American food
operations.

Currency movements, primarily the strengthening of the U.S. dollar versus
European and Asian currencies, decreased operating revenues by $1.7 billion
($1.0 billion, excluding excise taxes) and operating income by $224 million in
the first six months of 1998 versus the comparable 1997 period. During the
second quarter, currency movements decreased operating revenues by $645 million
($388 million, excluding excise taxes) and operating income by $91 million
versus the comparable 1997 period. Although the Company cannot predict future
movements in currency rates or economic developments, it anticipates that the
continued strength of the U.S. dollar will have a significant adverse impact on
operating revenues and operating income during the remainder of 1998 and 1999
and that economic instability in Asia will continue to slow the Company's
businesses in that region.

Interest and other debt expense, net, decreased $84 million (14.8%) in the first
six months of 1998 and $41 million (14.7%) in the second quarter from the
respective comparable 1997 periods. These decreases were due primarily to lower
average debt outstanding during 1998 and higher interest income, reflecting
increased cash and cash equivalents.

Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings per
Share." SFAS No. 128 establishes standards for computing and presenting EPS and

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<PAGE>

requires the presentation of both basic and diluted EPS. Prior period EPS have
been restated to conform with the standards established by SFAS No. 128.

Diluted and basic EPS, both of which were $1.28 for the first six months of
1998, decreased by 13.5% and 14.1%, respectively, from the comparable 1997
period due primarily to previously discussed charges for voluntary early
retirement and separation programs and tobacco litigation settlements. Excluding
the after-tax impact of these charges, first-half underlying net earnings
increased 8.9% to $3.9 billion, diluted EPS increased 8.8% to $1.61 and basic
EPS increased 8.7% to $1.62. Reported diluted EPS of $0.71 and basic EPS of
$0.72 in the second quarter of 1998 each decreased by 5.3% from the comparable
1997 period. Excluding the after-tax impact of charges for voluntary early
retirement and separation programs and tobacco litigation settlements, second
quarter underlying net earnings increased 8.9% to $2.0 billion, diluted EPS
increased 9.3% to $0.82 and basic EPS increased 7.9%, to $0.82.

YEAR 2000

As many computer systems and other equipment with embedded chips or processors
(collectively, "Business Systems") use only two digits to represent the year,
they may be unable to process accurately certain data before, during or after
the year 2000. As a result, business and governmental entities are at risk for
possible miscalculations or systems failures causing disruptions in their
business operations. This is commonly known as the Year 2000 ("Y2K") issue or
Century Date Change ("CDC") issue. The CDC issue can arise at any point in the
Company's supply, manufacturing, processing, distribution, and financial chains.

The Company and each of its operating subsidiaries are in the process of
implementing a CDC readiness program with the objective of having all of their
significant Business Systems, including those that affect facilities and
manufacturing activities, functioning properly with respect to the CDC before
January 1, 2000. Each operating subsidiary is in a different stage of CDC
readiness. Generally, those subsidiaries with primarily North American
operations (Philip Morris USA, Kraft Foods North America, Miller Brewing Company
and Philip Morris Capital Corporation) are closer to CDC readiness than those
with extensive international operations (Philip Morris International and Kraft
Foods International).

The first component of the CDC readiness program is to identify the internal
Business Systems of the Company and its operating subsidiaries that are
susceptible to system failures or processing errors as a result of the CDC
issue. This effort is substantially complete with all operating subsidiaries
having identified the Business Systems that may require remediation or
replacement and established priorities for repair or replacement. Those Business
Systems considered most critical to continuing operations are being given the
highest priority.

The second component of the CDC readiness program involves the actual
remediation and replacement of Business Systems. The Company and its operating
subsidiaries are using both internal and external resources to complete this
process. Business Systems ranked highest in priority have either been remediated
or replaced or scheduled for remediation or replacement. Business Systems
previously earmarked for retirement and replacement without regard to the CDC
issue have been evaluated for early replacement with CDC compliant systems or
programs or, in the alternative, remediation. The Company's objective is to
complete substantially all remediation and replacement of internal Business
Systems by March 1999, and to complete final testing and certification for CDC
readiness by September 1999.

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<PAGE>

As part of the CDC readiness program, significant service providers, vendors,
suppliers, customers and governmental entities ("Key Business Partners") that
are believed to be critical to business operations after January 1, 2000, have
been identified and steps are being undertaken in an attempt to reasonably
ascertain their stage of CDC readiness through questionnaires, interviews,
on-site visits and other available means. In conjunction with this effort, key
governmental agencies and utilities upon which the Company and its operating
subsidiaries rely are being approached on a worldwide basis to identify their
level of CDC preparedness. In many cases, these entities (particularly outside
North America) have a lower level of CDC awareness and are less willing to
provide information concerning their state of CDC readiness.

Because of the vast number of Business Systems used by the Company and its
operating subsidiaries, the significant number of Key Business Partners, the
extent of the Company's foreign operations, including operations within
countries that are not actively promoting remediation of the CDC issue, the
Company presently believes that it may experience some disruption in its
business due to the CDC issue. More specifically, because of the interdependent
nature of Business Systems, the Company and its operating subsidiaries could be
materially adversely affected if utilities, private businesses and governmental
entities with which they do business or that provide essential services are not
CDC ready. The Company currently believes that the greatest risk of disruption
in its businesses exists in certain international markets. The possible
consequences of the Company or Key Business Partners not being fully CDC
compliant by January 1, 2000 include, among other things, temporary plant
closings, delays in the delivery of products, delays in the receipt of supplies,
invoice and collection errors, and inventory and supply obsolescence.
Consequently, the business and results of operations of the Company could be
materially adversely affected by a temporary inability of the Company and its
operating subsidiaries to conduct their businesses in the ordinary course for a
period of time after January 1, 2000. However, the Company believes that its CDC
readiness program, including the contingency planning discussed below, should
significantly reduce the adverse effect any such disruptions may have.

Concurrently with the CDC readiness measures described above, the Company and
its operating subsidiaries are developing contingency plans intended to
mitigate the possible disruption in business operations that may result from
the CDC issue, and are developing cost estimates for such plans. Contingency
plans may include stockpiling raw and packaging materials, increasing
inventory levels, securing alternate sources of supply, adjusting facility
shut-down and start-up schedules and other appropriate measures. Once
developed, contingency plans and related cost estimates will be continually
refined as additional information becomes available.

It is currently estimated that the aggregate cost of the Company's CDC efforts
will be approximately $400 million to $500 million, of which approximately
$150 million has been spent. These costs are being expensed as they are
incurred and are being funded through operating cash flow. These amounts do not
include any costs associated with the implementation of contingency plans,
which are in the process of being developed. The costs associated with the
replacement of computerized systems, hardware or equipment (currently estimated
to be approximately $100 million), substantially all of which would be
capitalized, are not included in the above estimates.

The Company's CDC readiness program is an ongoing process and the estimates
of costs and completion dates for various components of the CDC readiness
program described above are subject to change.

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<PAGE>

EURO

On January 1, 1999, eleven of the fifteen member countries of the European Union
are scheduled to establish fixed conversion rates between their existing
currencies ("legacy currencies") and one common currency - the euro. The euro
will then trade on currency exchanges and may be used in business transactions.
Beginning in January 2002, new euro-denominated bills and coins will be issued,
and legacy currencies will be withdrawn from circulation. The Company's
operating subsidiaries affected by the euro conversion have established plans to
address the systems and business issues raised by the euro currency conversion.
These issues include, among others, (1) the need to adapt computer and other
business systems and equipment to accommodate euro-denominated transactions; and
(2) the competitive impact of cross-border price transparency, which may make it
more difficult for businesses to charge different prices for the same products
on a country-by-country basis particularly once the euro currency is issued in
2002. The Company anticipates that the euro conversion will not have a material
adverse impact on its financial condition or results of operations.

OPERATING RESULTS BY BUSINESS SEGMENT

TOBACCO

BUSINESS ENVIRONMENT

The tobacco industry, both in the United States and abroad, has faced, and
continues to face, a number of issues that may adversely affect the business,
volume, operating revenues, cash flows, operating income and financial position
of PM Inc., PMI and the Company.

In the United States, these issues include actual and proposed excise tax
increases; proposed federal regulatory controls (including, as discussed
below, the issuance of final regulations by the FDA that regulate cigarettes
as "drugs" or "medical devices"); actual and proposed requirements regarding
disclosure of cigarette ingredients and other proprietary information; actual
and proposed requirements regarding disclosure of the yields of "tar",
nicotine and other constituents found in cigarette smoke; governmental and
grand jury investigations; increased smoking and health litigation, including
private plaintiff class action litigation and health care cost recovery
actions brought by state and local governments, unions and others seeking
reimbursement for Medicaid and/or other health care expenditures allegedly
caused by cigarette smoking; actual and proposed federal, state and local
governmental and private bans and restrictions on smoking (including in
workplaces and in buildings permitting public access); actual and proposed
restrictions on tobacco manufacturing, marketing, advertising (including
decisions by certain companies to limit or not accept tobacco advertising)
and sales; actual and proposed legislation and regulations to require
substantial additional health warnings on cigarette packages and in
advertising, and to eliminate the tax deductibility of tobacco advertising
and promotional costs; proposed legislation to require the establishment of
ignition propensity performance standards for cigarettes; increased
assertions of adverse health effects associated with both smoking and
exposure to ETS; legislation or other governmental action seeking to ascribe
to the industry responsibility and liability for the purported adverse health
effects associated with both smoking and exposure to ETS; the diminishing
social acceptance of smoking; increased pressure from anti-smoking groups;
unfavorable press reports; and federal tobacco legislation under
consideration by Congress.

Cigarettes are subject to substantial excise taxes in the United States and to
similar taxes in most foreign markets. The United States federal excise tax on

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<PAGE>

cigarettes is currently $12 per 1,000 cigarettes ($0.24 per pack of 20
cigarettes). In August 1997, legislation was enacted that will raise the federal
excise tax to $17 per 1,000 cigarettes ($0.34 per pack of 20 cigarettes)
starting in the year 2000 and then to $19.50 per 1,000 cigarettes ($0.39 per
pack of 20 cigarettes) in 2002. In general, excise taxes and other
cigarette-related taxes levied by federal, state and local governments have been
increasing. These taxes vary considerably and, when combined with sales taxes
and the current federal excise tax, may be as high as $1.50 per pack in a given
locality. Congress has been considering a number of bills that provide for
significant increases in the federal excise tax or other payments from tobacco
manufacturers. Increases in other cigarette-related taxes have been proposed at
the state and local level.

In the opinion of PM Inc. and PMI, past increases in excise and similar taxes
have had an adverse impact on sales of cigarettes. Any future increases, the
extent of which cannot be predicted, could result in volume declines for the
cigarette industry, including PM Inc. and PMI, and might cause sales to shift
from the premium segment to the discount segment.

In August 1996, the FDA issued final regulations pursuant to which it asserts
jurisdiction over cigarettes as "drugs" or "medical devices" under the
provisions of the Food, Drug and Cosmetic Act. The final regulations include
severe restrictions on the distribution, marketing and advertising of
cigarettes, and would require the industry to comply with a wide range of
labeling, reporting, recordkeeping, manufacturing and other requirements
applicable to medical devices and their manufacturers. For the most part, the
regulations were scheduled to become effective on August 28, 1997. The FDA's
exercise of jurisdiction, if not reversed by judicial or legislative action,
could lead to more expansive FDA-imposed restrictions on cigarette operations
than those set forth in the final regulations, and could materially adversely
affect the volume, operating revenues, cash flows and operating income of PM
Inc. and the Company. PM Inc. and others challenged in the courts the FDA's
authority to regulate cigarettes. In April 1997, a U.S. district court ruled
that Congress has not precluded the FDA from regulating cigarettes as "drugs"
or "medical devices" and that the FDA may regulate cigarettes if the facts
asserted in support of the FDA's assertion of jurisdiction are proven to be
correct. The court also ruled, however, that the section of the Food, Drug
and Cosmetic Act relied upon by the agency does not give the FDA authority to
implement its regulations restricting cigarette advertising and promotions.
The court stayed implementation of the FDA's regulations scheduled for August
1997. The court left in effect the specific regulations that took effect in
February 1997 establishing a federal minimum age of 18 for the sale of
tobacco products and requiring proof of age for anyone under age 27. The
tobacco company plaintiffs, including PM Inc., are appealing that portion of
the district court's order relating to the FDA's assertion of jurisdiction.
The FDA is appealing that portion of the order enjoining the advertising and
promotion restrictions. The respective appeals were heard by the U.S. Court
of Appeals for the Fourth Circuit in August 1997. In March 1998, a member of
the Fourth Circuit panel that was considering the appeals died and as a
result the appeals were reargued in June 1998. The outcome of this litigation
cannot be predicted.

In August 1996, the Commonwealth of Massachusetts enacted legislation to require
cigarette manufacturers to disclose to the Massachusetts Department of Public
Health ("DPH") the flavorings and other ingredients used in each brand of
cigarettes sold in the Commonwealth, and to provide "nicotine-yield ratings" for
their products based on standards to be established by the DPH. PM Inc. believes
that enforcement of the ingredient disclosure provisions of the statute could
permit the disclosure by DPH to the public of valuable proprietary information
concerning its brands. PM Inc. and three other domestic cigarette manufacturers
have filed suit in federal district court in Boston challenging the legislation.

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<PAGE>

In December 1997, the court granted a preliminary injunction to the tobacco
company plaintiffs and enjoined the Commonwealth from enforcing the ingredient
disclosure provisions of the legislation until further order of the court. In
July 1998, the Commonwealth's appeal of this ruling was argued before the First
Circuit Court of Appeals. In addition, both parties' cross-motions for summary
judgment were argued before the district court earlier this year. The ultimate
outcome of this lawsuit cannot be predicted. The enactment of this legislation
has encouraged efforts to enact, and the enactment of, ingredient disclosure
legislation in other states, such as Texas and Minnesota.

In December 1997, PM Inc. disclosed to the DPH "nicotine-yield ratings" for its
products sold in the Commonwealth based on standards established by the DPH for
determining "nicotine delivery under average smoking conditions." The
"nicotine-yield ratings" produced using the DPH standards are higher than the
yields produced using the standards established by a 1970 voluntary agreement
between the Federal Trade Commission ("FTC") and domestic cigarette
manufacturers, including PM Inc., and which are required to be included in all
cigarette advertising. In September 1997, the FTC issued a request for public
comments on its proposed revision of the "tar" and nicotine testing and
reporting standards established by the 1970 voluntary agreement. In February
1998, PM Inc. and three other domestic cigarette manufacturers filed comments on
the proposed revisions in which they stressed the value of historical continuity
with respect to "tar" and nicotine testing and disclosure; expressed the opinion
that the proposed revisions are unnecessary; but, agreed to assist the FTC in
its efforts to improve consumer understanding of the meaning of routine testing
results.

In June 1995, PM Inc. announced that it had voluntarily undertaken a program to
limit minors' access to cigarettes. Elements of the program include
discontinuing free cigarette sampling to consumers in the United States,
discontinuing the distribution of cigarettes by mail to consumers in the United
States, placing a notice on cigarette cartons and packs for sale in the United
States stating "Underage Sale Prohibited," working with others in support of
state legislation to prevent youth access to tobacco products, taking measures
to encourage retailer compliance with minimum-age laws, and independent auditing
of the program.

In October 1997, at the request of the United States Senate Judiciary Committee,
PM Inc. provided the Committee with a document setting forth the Company's
position on a number of issues. On the issues of the causal role played by
cigarette smoking in the development of lung cancer and other diseases in
smokers, and whether nicotine, as found in cigarette smoke, is "addictive", the
Company stated that despite the differences that may exist between its views and
those of the public health community, it would, in order to ensure that there
will be a single, consistent public health message on these issues, refrain from
debating the issues other than as necessary to defend itself and its opinions in
the courts and other forums in which it is required to do so. The Company also
stated that in relation to these issues, and the alleged health effects of
exposure to ETS, the Company is prepared to defer to the judgment of public
health authorities as to what health warning messages will best serve the public
interest.

In 1993, the U.S. Environmental Protection Agency ("EPA") issued a report
relating to certain alleged health effects of ETS. The report included, among
other things, a risk assessment relating to the alleged association between ETS
and lung cancer in nonsmokers, and a determination by EPA to classify ETS as a
"Group A" carcinogen. The risk assessment and classification has been one of the
primary sources cited in support of smoking restrictions in workplaces and
public places around the world. PM Inc. and others challenged the risk
assessment and classification on several grounds in a U.S. district court. In
July 1998, the court vacated those sections of the EPA report relating to lung
cancer, finding,

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<PAGE>

among other things, that, although the agency has been authorized by Congress
to conduct a risk assessment and classification of ETS, EPA may have reached
different conclusions had it complied with certain relevant statutory
requirements. The federal government has announced that it intends to appeal
the court's ruling. It is not possible to predict what impact, if any, the
ruling will have on existing or proposed regulations banning or restricting
smoking in workplaces and public places.

In late January 1998, the chief executive officers of the four leading domestic
tobacco companies or their parent corporations, including the Company, pledged
to Congress to publicly release millions of pages of industry documents placed
into the document depository established in connection with Minnesota's health
care cost recovery action. The documents comprise a wide range of smoking and
health issues covered in scientific and marketing research reports, memoranda,
executive correspondence, handwritten notes and other materials. They do not
include highly sensitive trade secret information, certain third-party and
personnel information, or documents for which attorney client privilege or work
product doctrine claims have been asserted. Several installments of these
documents have been made available via the Internet. The remaining installments
are expected to be posted on the Internet before year end.

Many foreign countries, as well as the European Union, have also taken a number
of different steps to regulate the manufacture and/or marketing of cigarettes.
Most prominently, these steps include: restricting or prohibiting cigarette
advertising and promotion, banning or severely restricting smoking in workplaces
and public places or otherwise discouraging cigarette smoking and increasing
taxes on cigarettes. Some countries have taken further steps, including
requiring ingredient disclosure, imposing maximum constituent levels,
controlling prices, and restricting imports. It is not possible to predict what,
if any, other foreign governmental legislation or regulations will be adopted
relating to the manufacturing, advertising, sale or use of cigarettes or to the
tobacco industry generally.

In June 1998, a European Communities Directive, effective July 6, 1998, was
published in the Official Journal of the European Communities. The directive
bans virtually all forms of tobacco advertising and sponsorship in the European
Union. Member States must enact implementing legislation by July 2001. However,
Member States may delay full implementation of the ban for additional periods
(one year for print advertising, two years for sponsorships generally, and until
October 1, 2006 for sponsorship of events such as Formula One racing). The
directive does not apply to a few limited types of advertising such as point of
sale displays which may be regulated by Member States as they see fit.

In March 1998, pursuant to a regulation in Thailand that requires manufacturers
and importers of tobacco products to disclose to the Ministry of Public Health
("MPH") the ingredients of their products to be sold in Thailand on a by-brand
basis, a subsidiary of PMI disclosed to the MPH by-brand ingredient lists for
its products imported into Thailand for sale in that country. The disclosure was
accompanied by a claim of confidentiality under applicable Thai and
international law. Although this Thai regulation does not require the MPH to
make public the submitted ingredient lists, there are no assurances that the
confidentiality of the lists submitted will be maintained.

PM Inc. has received requests for information (including grand jury subpoenas)
in connection with governmental investigations of the tobacco industry, and is
cooperating with respect to such requests. Certain present and former employees
of PM Inc. have testified or have been asked to testify in connection with
certain of these matters. The investigations include an investigation by the
United States

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<PAGE>

Attorney for the Eastern District of New York relating to The Council for
Tobacco Research-U.S.A., Inc., a research organization of which PM Inc. is a
sponsor; and an investigation by the United States Department of Justice
relating to issues raised in testimony provided by tobacco industry
executives before Congress and other related matters. While the outcomes of
these investigations cannot be predicted, PM Inc. believes it has acted
lawfully.

As further discussed above in Note 3 to the Condensed Consolidated Financial
Statements, there is litigation pending in various U.S. and foreign
jurisdictions related to tobacco products. These cases generally fall within
three categories: (i) smoking and health cases alleging personal injury brought
on behalf of individual plaintiffs, (ii) smoking and health cases alleging
personal injury and purporting to be brought on behalf of a class of individual
plaintiffs, and (iii) health care cost recovery cases brought by state and local
governments seeking reimbursement for Medicaid and/or other health care
expenditures allegedly caused by cigarette smoking, as well as similar cases,
including class actions, brought by non-governmental plaintiffs such as unions,
HMOs, federal and state taxpayers, native American tribes and others. Damages
claimed in some of the smoking and health class actions and health care cost
recovery cases range into the billions of dollars.

In recent years there has been a substantial increase in the number of smoking
and health cases being filed in the United States.

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<PAGE>

During 1997 and the first half of 1998, PM Inc. and other companies in the
United States tobacco industry settled health care cost recovery actions brought
by the States of Mississippi, Florida, Texas and Minnesota and an ETS smoking
and health class action brought on behalf of airline flight attendants. As
discussed above in Note 3, the Mississippi and Texas settlement agreements were
amended recently pursuant to their "most favored nation" clause to reflect the
terms of the Minnesota settlement.

THE JUNE 1997 PROPOSED RESOLUTION AND PROPOSED FEDERAL TOBACCO LEGISLATION

In June 1997, PM Inc. and other companies in the United States tobacco industry
entered into a Memorandum of Understanding (the "Resolution") to support the
adoption of federal legislation and ancillary undertakings that would resolve
many of the regulatory and litigation issues affecting the United States tobacco
industry and, thereby, reduce uncertainties facing the industry and increase
stability in business and capital markets. (The proposed Resolution is discussed
in the Company's 1997 Form 10-K and a copy of the proposed Resolution is filed
as Exhibit 10.17 thereto.) Such legislation was never enacted.

In April 1998, the Senate Commerce Committee approved a bill that was
substantially different and significantly more adverse to the domestic tobacco
industry and the Company than the proposed Resolution (the "Commerce Bill").
That Bill, as approved by the Commerce Committee, contemplated industry payments
in excess of one-half trillion dollars over the first twenty-five years,
provided the FDA with broad regulatory control over tobacco products, applied,
in certain respects, to international sales of tobacco products, and eliminated
virtually all of the provisions of the proposed Resolution that would limit
liability of the tobacco industry in civil litigation in the United States. In
June 1998, the United States Senate voted to return the Commerce Bill to the
Senate Commerce Committee for further consideration. Other federal tobacco bills
are also under consideration by Congress. The Company cannot predict whether the
Commerce Bill or any other such federal tobacco legislation will be enacted or
the form any such enactment might take.

-------------------------

It is not possible to predict the outcome of the litigation pending against the
Company and its subsidiaries. Litigation is subject to many uncertainties, and
it is possible that some of these actions could be decided unfavorably. An
unfavorable outcome or settlement of a pending smoking and health or health care
cost recovery case could encourage the commencement of additional similar
litigation. There have also been a number of adverse legislative, regulatory,
political and other developments concerning cigarette smoking and the tobacco
industry that have received widespread media attention. These developments may
negatively affect the perception of potential triers of fact with respect to the
tobacco industry, possibly to the detriment of certain pending litigation, and
may prompt the commencement of additional similar litigation.

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<PAGE>

the Company and its subsidiaries periodically may enter into discussions in
an attempt to settle various cases when they believe it is in the best
interests of the Company's stockholders to do so. In that regard, PM Inc. has
discussed with certain state attorneys general the possibility of settling
the asserted and unasserted health care cost recovery claims of most states.
No assurance can be given that any cases will be settled or what the terms of
any settlement might be.

OPERATING RESULTS

FOR THE SIX MONTHS ENDED JUNE 30,
------------------------------------------------------
OPERATING REVENUES OPERATING INCOME
------------------------------------------------------
(in millions)

1998 1997 1998 1997
------ ------- ------ -----
<S> <C> <C> <C> <C>
Domestic tobacco $ 7,011 $ 6,369 $1,049 $2,259

International tobacco 14,325 13,704 2,682 2,413
------- ------- ------ ------

Total $21,336 $20,073 $3,731 $4,672
======= ======= ====== ======

</TABLE>

DOMESTIC TOBACCO. During the first six months of 1998, PM Inc.'s operating
revenues increased 10.1% over the comparable 1997 period, due to pricing
($765 million) and improved product mix ($27 million), partially offset by
lower volume ($150 million).

During the first six months of 1998, PM Inc. recorded pre-tax charges of $1,005
million related to tobacco litigation settlements, as discussed in Note 3 to the
Condensed Consolidated Financial Statements. In addition, PM Inc. recorded
pre-tax charges of $309 million related to voluntary early retirement and
separation programs for salaried and hourly employees.

Operating income for the first six months of 1998 decreased 53.6% from the
comparable 1997 period, due primarily to tobacco litigation settlement charges
($1,005 million), higher marketing, administration and research costs ($327
million), charges for the voluntary early retirement and separation programs
($309 million) and lower volume ($99 million), partially offset by price
increases, net of cost increases (aggregating to $514 million) and improved
product mix ($17 million). Excluding the impact of the voluntary early
retirement and separation programs and the tobacco litigation settlement
charges, PM Inc.'s underlying operating income for the first six months of 1998
increased 4.6% over the comparable 1997 period.

Domestic tobacco industry shipment volume during the first six months of 1998
declined 3.2% from the first six months of 1997. PM Inc. estimates that
second-quarter, and to a lesser extent, year-to-date industry shipments were
affected by a second-quarter reduction in trade inventories, which wholesalers
had increased in late 1997 in anticipation of price increases. PM Inc. further
estimates that its second-quarter, and to a lesser extent, its year-to-date
shipments and resultant shipment market shares were adversely affected by the
timing of its consumer promotions and a disproportionate reduction in its trade
inventories. While PM Inc. cannot predict future rates of change in industry
shipments, it believes that, over the long term, industry shipments should
continue to decline in line with historical trends, subject to the effects of
price increases related to tobacco litigation settlements or the possible
enactment of federal tobacco legislation discussed under "Tobacco--Business
Environment" above.

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PM Inc.'s shipment volume for the first six months of 1998 was 111.8 billion
units, a decrease of 2.1% from the first six months of 1997. However, PM Inc.
estimates that, excluding the factors mentioned above, its volume would have
decreased by less than 0.5%. MARLBORO shipment volume for the first six months
of 1998 increased 0.3 billion units (0.4%) over the comparable 1997 period to
79.6 billion units for a 35.2% share of the total industry, an increase of 1.3
share points over 1997. For the first six months of 1998, PM Inc.'s shipment
market share was 49.4%, an increase of 0.5 share points over the comparable
period of 1997. However, PM Inc. estimates that, excluding the factors mentioned
above, its shipment share grew by more than 1.0 point to approximately 49.7%.
This increase is consistent with consumer purchases as measured by retail data
from an independent market research company.

Based on shipments, the premium segment accounted for approximately 72.9% of the
domestic cigarette industry volume in the first six months of 1998, an increase
of 0.9 share points over the comparable period of 1997. This reflects a
continued shift toward higher-margin premium cigarettes and away from the
discount segment, a trend which began in the second half of 1993. In the premium
segment, PM Inc.'s volume decreased 0.8% in the first half of 1998, compared
with a 2.0% decrease for the industry, resulting in a premium segment share of
58.5%, an increase of 0.7 share points over the comparable period of 1997.

In the discount segment, PM Inc.'s shipments decreased 9.7% to 15.2 billion
units in the first six months of 1998, compared with an industry decline of
6.3%, resulting in a discount segment share of 24.8%, a decrease of 0.9 share
points from the comparable period of 1997. BASIC shipment volume for the first
six months of 1998 was flat at 11.5 billion units, for an 18.7% share of the
discount segment, an increase of 1.1 share points over the comparable 1997
period.

PM Inc. cannot predict future change or rates of change in the relative sizes of
the premium and discount segments or in PM Inc.'s shipments, shipment market
share or retail market share; however, it believes that PM Inc.'s shipments
would be materially adversely affected by price increases related to tobacco
litigation settlements or the possible enactment of federal tobacco legislation
discussed under "Tobacco--Business Environment" above.

Subsequent to the end of the second quarter, PM Inc. announced a price increase
of $3.00 per thousand cigarettes on its premium and discount brands in August
1998. This increase follows similar announcements of price increases of $2.50
per thousand cigarettes in May 1998, $2.50 per thousand cigarettes in April
1998, $1.25 per thousand cigarettes in January 1998, $3.50 per thousand
cigarettes in September 1997 and $2.50 per thousand cigarettes in March 1997.
Each $1.00 per thousand increase by PM Inc. equates to a $.02 increase to the
wholesale price of each pack of twenty cigarettes.

INTERNATIONAL TOBACCO. During the first six months of 1998, international
tobacco operating revenues of PMI increased 4.5% over 1997, including excise
taxes. Excluding excise taxes, operating revenues increased 5.8%, due primarily
to price increases ($331 million), favorable volume/mix ($254 million) and the
consolidation of previously unconsolidated subsidiaries ($273 million),
partially offset by unfavorable currency movements ($584 million). Operating
income for the first six months of 1998 increased 11.1% over the comparable 1997
period, due primarily to price increases, net of cost increases ($285 million),
favorable volume/mix ($117 million), the consolidation of previously
unconsolidated subsidiaries ($53 million) and lower marketing, administration
and research costs, partially offset by unfavorable currency movements ($192
million).

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PMI's volume in the first six months of 1998 grew 16.1 billion units (4.4%) over
the comparable 1997 period to 384.1 billion units. PMI's volume growth was
impeded by weaker business conditions in Asia, particularly in Korea, Indonesia
and the Philippines. Volume advanced strongly in a number of important markets,
including Germany, Italy, France, the Benelux countries, Spain, Greece, Austria,
Poland, Hungary, Turkey, Eastern Europe, Japan, Mexico and Argentina. However,
volume growth in the Eastern Europe region slowed during the second quarter as a
result of adverse economic developments in Russia. PMI recorded market share
gains in virtually all major markets. Overall volume growth was driven by
aggregate gains for PMI's portfolio of major international brands, including
MARLBORO, which grew strongly over the first half of 1997.

FOR THE THREE MONTHS ENDED JUNE 30,
-----------------------------------------------------------
OPERATING REVENUES OPERATING INCOME
------------------------- -----------------------
(in millions)

1998 1997 1998 1997
------- ------- ------ ------
<S> <C> <C> <C> <C>
Domestic tobacco $ 3,700 $ 3,457 $ 825 $1,185

International tobacco 6,973 6,696 1,258 1,133
------- ------- ------ ------

Total $10,673 $10,153 $2,083 $2,318
======= ======= ====== ======

</TABLE>

DOMESTIC TOBACCO. During the second quarter of 1998, PM Inc.'s operating
revenues increased 7.0% over the comparable 1997 period, due to pricing
($437 million) and improved product mix ($9 million), partially offset by
lower volume ($203 million).

Operating income for the second quarter of 1998 decreased 30.4% from the
comparable 1997 period, due to charges for voluntary early retirement and
separation programs ($214 million), tobacco litigation settlement charges ($199
million), higher marketing, administration and research costs ($127 million),
lower volume ($133 million), partially offset by price increases, net of cost
increases (aggregating to $299 million), lower fixed manufacturing costs ($9
million) and improved product mix ($5 million). Excluding the impact of charges
for the voluntary early retirement and separation programs and tobacco
litigation settlements, PM Inc.'s underlying operating income for the second
quarter of 1998 increased 4.5% over the comparable 1997 period.

Domestic tobacco industry shipment volume during the second quarter declined
4.4% from the comparable 1997 period. However, PM Inc. estimates that industry
shipments during the quarter were significantly affected by a reduction in trade
inventories, which wholesalers had increased in late 1997 in anticipation of
price increases. PM Inc. also estimates that its shipments and resultant
shipment market share were adversely affected by the timing of consumer
promotions and a disproportionate impact of the reduction in trade inventories.
While PM Inc. cannot predict future rates of change in industry shipments, it
believes that, over the long term, industry shipments should continue to decline
in line with historical trends, subject to the effects of price increases
related to tobacco litigation settlements or the possible enactment of federal
tobacco legislation discussed under "Tobacco--Business Environment" above.

PM Inc.'s shipment volume for the second quarter of 1998 was 57.3 billion units,
a decrease of 5.8% from the second quarter of 1997, reflecting the factors
mentioned above. Second-quarter MARLBORO shipment volume decreased 1.8 billion
units (4.1%) to 40.8 billion units for a 34.5% share of the total industry, an

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<PAGE>

increase of 0.1 share points over the second quarter of 1997. PM Inc.'s second
quarter 1998 shipment market share was 48.5%, a decrease of 0.7 share points
from the comparable period of 1997. PM Inc. estimates that, excluding the
factors mentioned above, its shipment share grew by approximately 1.2 share
points to 50%. This increase is consistent with the trend of consumer purchases
as measured by retail data from an independent market research company.

Based on shipments, the premium segment accounted for approximately 73.1% of
domestic cigarette industry volume in the second quarter of 1998, an increase of
0.7 share points over the comparable 1997 period. This reflects a continued
shift toward higher-margin premium cigarettes and away from the discount
segment, a trend which began in the second half of 1993. In the premium segment,
PM Inc.'s second-quarter volume decreased 4.4%, compared with a 3.4% decrease
for the industry, resulting in a premium segment share of 57.6%, a decrease of
0.6 share points from the second quarter of 1997.

In the discount segment, PM Inc.'s second quarter shipments decreased 14.2% to
7.4 billion units in 1998, compared with an industry decline of 6.9%, resulting
in a discount segment share of 23.4%, a decrease of 2.0 share points from the
comparable period of 1997. BASIC second quarter shipment volume decreased 528
million units to 5.5 billion units, for a 17.2% share of the discount segment, a
decrease of 0.4 share points from the comparable 1997 period.

INTERNATIONAL TOBACCO. During the second quarter of 1998, international tobacco
operating revenues of PMI increased 4.1% over 1997, including excise taxes.
Excluding excise taxes, operating revenues increased 4.8%, due primarily to
price increases ($122 million), favorable volume/mix ($109 million) and the
consolidation of previously unconsolidated subsidiaries ($61 million), partially
offset by unfavorable currency movements ($228 million). Operating income for
the second quarter of 1998 increased 11.0% over the comparable 1997 period, due
primarily to price increases ($122 million), favorable volume/mix ($78 million)
and the consolidation of previously unconsolidated subsidiaries ($25 million),
partially offset by unfavorable currency movements ($81 million).

PMI's volume in the second quarter of 1998 grew 7.1 billion units (4.0%) over
the comparable 1997 period to 184.2 billion units. PMI's volume growth was
impeded by weaker business conditions in Asia, particularly in Korea, Indonesia
and the Philippines. Volume advanced strongly in a number of important markets,
including Germany, Italy, France, the Benelux countries, Spain, Greece, Austria,
Poland, Hungary, Turkey, Eastern Europe, Japan, Mexico and Argentina. However,
volume growth in the Eastern Europe region has slowed during the quarter as a
result of adverse economic developments in Russia. In Japan, volume growth
reflects, in part, a favorable comparison to the second quarter of 1997, when
volume declined following first-quarter trade purchases in advance of an April
1, 1997 tax-driven retail price increase. PMI recorded market share gains in
virtually all major markets. Overall volume growth was driven by aggregate gains
for PMI's portfolio of major international brands, including MARLBORO, which
grew strongly over the second quarter of 1997.

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<PAGE>

FOOD

BUSINESS ENVIRONMENT

Kraft Foods, Inc. ("Kraft"), the largest processor and marketer of retail
packaged food in the United States, and its subsidiary, Kraft Foods
International, Inc. ("KFI"), which markets coffee, confectionery and grocery
products in Europe and the Asia/Pacific region, are subject to fluctuating
commodity costs, currency movements and competitive challenges in various
product categories and markets. Certain subsidiaries and affiliates of PMI that
manufacture and sell food products in Latin America are also subject to
competitive challenges in various product categories and markets. To confront
these challenges, Kraft, KFI and PMI continue to take steps to build the value
of premium brands, with new product and marketing initiatives, to improve their
food business portfolios and to reduce costs.

Increases in commodity costs can cause retail price volatility and influence
consumer and trade buying patterns, leading to price competition in some
markets. The North American and international food businesses are subject to
fluctuating commodity costs, particularly coffee bean and cocoa prices. Coffee
bean prices reached a twenty-year high in May 1997, leading to price increases
by Kraft, KFI and their competitors. In 1998, coffee bean prices have declined
from their 1997 levels.

During 1997, PMI sold its Brazilian ice cream businesses in the fourth quarter,
Kraft sold North American maple-flavored syrup businesses in the third quarter
and KFI sold a Scandinavian sugar confectionery business in the first quarter.
Kraft and KFI also sold several smaller non-strategic businesses in 1997. The
operating results of businesses divested in 1997 were not material to operating
results in any of the periods presented.

In the fourth quarter of 1997, KFI and the food operations of PMI recorded
realignment charges related primarily to the downsizing or closure of
manufacturing and other facilities, as well as the discontinuance of certain
low-margin product lines. Included in the charges were provisions for
incremental postemployment benefits, primarily related to severance.

OPERATING RESULTS

FOR THE SIX MONTHS ENDED JUNE 30,
------------------------------------------------------
OPERATING REVENUES OPERATING INCOME
----------------------- ----------------------
(in millions)

1998 1997 1998 1997
------- ------- ------ ------
<S> <C> <C> <C> <C>
North American food $ 8,905 $ 8,731 $1,686 $1,558

International food 4,805 5,433 507 560
------- ------- ------ ------

Total $13,710 $14,164 $2,193 $2,118
======= ======= ====== ======

</TABLE>

NORTH AMERICAN FOOD. During the first six months of 1998, operating revenues
increased 2.0% over the first six months of 1997, due primarily to favorable
volume ($293 million) and pricing ($92 million), partially offset by unfavorable
product mix ($77 million), the impact of divestitures ($90 million) and
unfavorable currency movements ($44 million). Operating income for the first six

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<PAGE>

months of 1998 increased 8.2% over the first six months of 1997, due
primarily to volume increases in ongoing operations ($167 million) and
pricing ($92 million), partially offset by unfavorable product mix ($76
million), higher marketing, administration and research costs ($31 million)
and the impact of divestitures ($22 million).

Excluding operating results of the divested North American food businesses
discussed above, underlying operating revenues and underlying operating income
increased 3.1% and 9.8%, respectively, in the first six months of 1998 versus
the comparable 1997 period.

Strong underlying volume gains were achieved by frozen pizza, resulting from the
continued success of rising crust pizza; meals, due to the growth of Taco Bell
grocery products as well as strength in macaroni and cheese dinners; beverages,
from the strength of ready-to-drink products and new product introductions,
partially offset by declines in higher-margin powdered soft drinks; and cereals,
aided by new products. Volume also grew in cheese, across all major product
lines; processed meats, due to the strength lunch combinations, which reflected
the continued success of new product introductions, and to increases in hot dogs
and bacon; and desserts and snacks on the strength of refrigerated ready-to-eat
desserts and shelf-stable puddings and new product introductions. Enhancers
volume grew slightly, reflecting strong growth in spoonable dressings, partially
offset by lower barbecue sauce shipments. Coffee volume in the first half of
1998 declined from the comparable 1997 period due largely to market contraction
resulting from higher retail prices in the first quarter of 1998. In Canada,
volume was essentially flat, reflecting the solid performance in retail branded
products, offset by the planned reduction of low margin products.

INTERNATIONAL FOOD. Operating revenues for the first six months of 1998
decreased 11.6% from the first six months of 1997, due to unfavorable currency
movements ($407 million), lower volume/mix ($142 million) and the impact of
divestitures ($230 million), partially offset by pricing ($117 million) and the
consolidation of a previously unconsolidated subsidiary ($34 million). Operating
income for the first six months of 1998 decreased 9.5% from the first six months
of 1997, due primarily to cost increases net of price increases (netting to $57
million, primarily related to higher coffee costs), lower volume/mix ($22
million), the impact of divestitures ($29 million) and unfavorable currency
movements ($26 million), partially offset by lower marketing, administration and
research costs ($75 million) and the consolidation of a previously
unconsolidated subsidiary.

Excluding the operating results of the divested international food businesses
discussed above, underlying operating revenues decreased 7.6% and underlying
operating income decreased 4.5% in the first six months of 1998 from the first
six months of 1997.

KFI's coffee volume continued to be adversely affected by soft consumption and
trade de-stocking in anticipation of price declines in certain markets, as well
as a difficult comparison against the prior year, when shipments were heavy in
advance of rising prices. Confectionery volume increased on the strength of
continued growth and new product introductions in Central and Eastern Europe.
These increases more than offset volume declines due to the contraction of
several key European chocolate markets, as well as higher prices in Germany.
Volume also increased in KFI's cheese and grocery business as a result of higher
shipments of cheese in the United Kingdom, snacks in Scandinavia, powdered soft
drinks in the Middle East and China and processed cheese slices and peanut
butter in Australia. Cheese and grocery volume in Germany was down due primarily
to the impact of retail price increases. Cheese and grocery volume was also down
in

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<PAGE>

Southeast Asia, reflecting the current economic instability of the region. In
Latin America, volume grew solidly due primarily to powdered soft drinks in
Brazil and ready-to-drink beverages in Puerto Rico.

FOR THE THREE MONTHS ENDED JUNE 30,
-------------------------------------------------------
OPERATING REVENUES OPERATING INCOME
---------------------- ----------------------
(in millions)

1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
North American food $4,540 $4,331 $ 884 $ 815

International food 2,495 2,622 272 287
------ ------ ------ ------

Total $7,035 $6,953 $1,156 $1,102
====== ====== ====== ======

</TABLE>

NORTH AMERICAN FOOD. During the second quarter of 1998, operating revenues
increased 4.8% over the second quarter of 1997, due primarily to favorable
volume ($299 million), partially offset by the impact of divestitures ($40
million), unfavorable product mix ($27 million) and unfavorable currency
movements ($21 million). Operating income for the second quarter of 1998
increased 8.5% over the second quarter of 1997, due primarily to volume
increases in ongoing operations ($155 million) and cost decreases, net of price
decreases (aggregating to $8 million), partially offset by higher marketing,
administration and research costs ($60 million), unfavorable product mix ($26
million) and the impact of divestitures ($11 million).

Excluding operating results of the divested North American food businesses
discussed above, underlying operating revenues and underlying operating income
increased 5.8% and 10.0%, respectively, in the second quarter of 1998 versus the
comparable 1997 period.

Coffee volume in the second quarter of 1998 increased strongly over the
comparable 1997 period when coffee shipments were unusually low following
accelerated purchases in the first quarter of 1997 in advance of
commodity-driven price increases. Strong coffee volume in the second quarter of
1998 also reflects the favorable impact of reductions in retail prices as green
coffee bean costs declined. Strong underlying volume gains were also achieved by
frozen pizza, resulting from the continued success of rising crust pizza; meals,
due to the growth of Taco Bell grocery products, as well as strength in macaroni
and cheese dinners; and processed meats, due to the strength of lunch
combinations, which reflected the continued success of new product
introductions, and to increases in hot dogs, cold cuts and bacon; cheese due to
strength across all major product categories; and enhancers due to growth in
spoonable and pourable salad dressings, reflecting new advertising and a new
line of pourable salad dressings. Cheese and enhancers volumes were also
favorably affected by the timing of the Easter holiday. Volume also grew in
desserts and snacks on the strength of refrigerated ready-to-eat desserts and
shelf-stable puddings, as well as new products; cereals, aided by new products;
and beverages, from the strength of ready-to-drink products and new product
introductions, partially offset by lower shipments of higher-margin powdered
soft drinks. In Canada, volume decreased slightly due to the planned reduction
of low margin products.

INTERNATIONAL FOOD. Operating revenues for the second quarter of 1998 decreased
4.8% from the second quarter of 1997, due to unfavorable currency movements
($139 million) and the impact of divestitures ($85 million), partially offset by
higher ongoing volume/mix ($64 million), pricing ($19 million) and the
consolidation of

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<PAGE>

a previously unconsolidated subsidiary ($14 million). Operating income for
the second quarter of 1998 decreased 5.2% from the second quarter of 1997,
due primarily to cost increases net of price increases (aggregating to $26
million, primarily related to higher coffee costs), higher marketing,
administration and research costs ($13 million), and unfavorable currency
movements ($7 million), partially offset by higher volume/mix from ongoing
operations ($29 million).

Excluding the operating results of the divested international food businesses
discussed above, underlying operating revenues decreased 1.7% and underlying
operating income decreased 5.9% in the second quarter of 1998 from the second
quarter of 1997.

KFI's coffee volume continued to be adversely affected by soft consumption and
trade de-stocking in anticipation of price declines in certain markets.
Confectionery volume increased on the strength of successful promotions in
Germany, continued growth and new product introductions in Central and Eastern
Europe and the timing of Easter shipments. Volume also grew in KFI's cheese and
grocery business as a result of higher shipments of cheese in the United
Kingdom; snacks in Scandinavia; cheese, cream cheese and meats in Italy;
powdered soft drinks in the Middle East and China; and processed cheese slices
and peanut butter in Australia. Cheese and grocery volume was down in Southeast
Asia, reflecting the current economic instability of the region. In Latin
America, volume increased strongly due primarily to powdered soft drinks in
Brazil and Mexico, as well as higher shipments of ready-to-drink beverages in
Puerto Rico.

BEER

SIX MONTHS ENDED JUNE 30

Operating revenues of the Miller Brewing Company ("Miller") for the first six
months of 1998 decreased $17 million (0.8%) from the first six months of 1997,
due primarily to lower volume ($15 million) and unfavorable price/mix ($2
million). Operating income for the first six months of 1998 increased $1 million
(0.4%) over the first six months of 1997, due primarily to lower marketing,
administration and research costs ($20 million, primarily lower marketing),
partially offset by lower volume ($8 million), unfavorable price/mix ($6
million) and higher fixed manufacturing costs ($5 million). Excluding the 1997
results of then 20%-owned Molson Breweries of Canada, underlying operating
income increased 1.1%.

Miller's domestic shipment volume of 21.9 million barrels for the first six
months of 1998 increased 0.1% from the comparable 1997 period, reflecting
increases in near-premium brands and steady performance in premium and budget
brands. Export volume decreased 28.2%, as volume shifted to sales under
international licensing agreements. Domestic shipments of premium products were
even with 1997 as higher shipments of MILLER LITE and double-digit gains in
ICEHOUSE and FOSTER'S were offset by lower shipments of MILLER beer and MILLER
GENUINE DRAFT. Domestic shipments of near-premium products increased slightly on
the performance of RED DOG. Domestic shipments of budget brands were even with
1997, despite volume growth in the MILWAUKEE'S BEST FAMILY OF BEERS.
Wholesalers' sales to retailers in the first six months of 1998 decreased
slightly from the comparable 1997 period, reflecting lower sales of MILLER LITE,
MILLER GENUINE DRAFT and MILLER beer, partially offset by double-digit increases
for ICEHOUSE and FOSTER'S, as well as solid increases for the MILWAUKEE'S BEST
FAMILY OF BEERS.

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<PAGE>

THREE MONTHS ENDED JUNE 30

Miller's operating revenues for the second quarter of 1998 decreased $11 million
(0.9%) from the second quarter of 1997, due primarily to lower volume ($14
million), partially offset by favorable price/mix ($3 million). Operating income
for the second quarter of 1998 decreased $8 million (4.8%) from the second
quarter of 1997, due primarily to the impact of a divested equity investment ($9
million), lower volume ($7 million), unfavorable price/mix ($2 million) and
higher fixed manufacturing costs ($3 million), partially offset by lower
marketing, administration and research costs ($13 million). Excluding the 1997
results of then 20%-owned Molson Breweries of Canada, underlying operating
income increased 0.6%.

Miller's domestic shipment volume of 12.0 million barrels for the second quarter
of 1998 decreased 0.3% from the comparable 1997 period, reflecting slight
decreases in near-premium and budget brands. Domestic shipments of premium
brands were essentially even with the comparable 1997 period, as higher MILLER
LITE shipments, coupled with double-digit increases for ICEHOUSE and FOSTER'S,
were offset by lower domestic shipments of MILLER beer and MILLER GENUINE DRAFT,
which continues to be adversely affected by intense competition in the key
markets of California and Texas. Domestic shipments of near-premium products
decreased slightly on lower shipments of RED DOG. Domestic budget brand volume
decreased slightly, despite increases for the MILWAUKEE'S BEST FAMILY OF BEERS.
Wholesalers' sales to retailers in the second quarter of 1998 decreased slightly
from the comparable 1997 period, reflecting lower sales of MILLER LITE, MILLER
GENUINE DRAFT and MILLER beer, partially offset by double-digit increases for
ICEHOUSE and Foster's, as well as higher sales of the MILWAUKEE'S BEST FAMILY OF
BEERS.

During the second quarter of 1998, Miller announced an agreement with S&P
Company to contract manufacture certain Pabst brands, as well as the brands of
other S&P subsidiaries, in several states. The five-year contract, which is
renewable in its fourth year, will result in manufacturing fee income for
Miller, which is not expected to materially affect Miller's operating income in
1998. Miller's shipments of Pabst brands are expected to begin in the third
quarter of 1998.

FINANCIAL SERVICES AND REAL ESTATE

Philip Morris Capital Corporation's ("PMCC") financial services and real estate
operating revenues and operating income declined in the first six months and the
second quarter of 1998 from the comparable 1997 periods, reflecting the sale of
its real estate subsidiary, Mission Viejo Company, in the third quarter of 1997.
Operating revenues and operating income from PMCC's financial services business
increased in the first six months and second quarter of 1998 over the comparable
1997 periods due to increased leasing and structured finance investments and the
continued profitability of PMCC's existing portfolio of finance assets.

FINANCIAL REVIEW

NET CASH PROVIDED BY OPERATING ACTIVITIES

During the first six months of 1998, net cash provided by operating activities
was $3.7 billion compared with $3.5 billion in the comparable 1997 period. The
increase primarily reflects higher underlying net earnings, partially offset by
the payment of tobacco litigation settlements charged to earnings in the second
half of 1997. Included in net earnings for the first six months of 1998 were
previously discussed charges for voluntary early retirement programs and the

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<PAGE>

settlement of tobacco litigation (aggregating to $814 million on an after-tax
basis), payments for the majority of which will be made in future periods.

NET CASH USED IN INVESTING ACTIVITIES

During the first six months of 1998, net cash used in investing activities was
$980 million, substantially unchanged from $956 million used during the
comparable 1997 period. During the first six months of 1997, cash used by PMI
for the purchase of a controlling interest in a cigarette manufacturer in
Portugal more than offset cash provided by KFI from the sale of a Scandinavian
sugar confectionery business.

NET CASH USED IN FINANCING ACTIVITIES

During the first six months of 1998, net cash of $341 million was used in
financing activities, as compared with $2.4 billion used in financing activities
during the comparable 1997 period. This difference was primarily due to higher
net issuance of debt in 1998 and to stock repurchases during the first half of
1997.

DEBT

The Company's total debt (consumer products and financial services) was $15.7
billion and $14.1 billion at June 30, 1998 and December 31, 1997, respectively.
Total consumer products debt was $14.7 billion and $13.3 billion at June 30,
1998 and December 31, 1997, respectively. At June 30, 1998 and December 31,
1997, the Company's ratio of consumer products debt to total equity was 0.92 and
0.89, respectively. The ratio of total debt to total equity was 0.98 and 0.95 at
June 30, 1998 and December 31, 1997, respectively.

The Company and its subsidiaries maintain credit facilities with a number of
lending institutions, amounting to approximately $12.0 billion at June 30, 1998.
These include revolving bank credit agreements totaling $10.0 billion, which may
be used to support any commercial paper borrowings by the Company and which are
available for acquisitions and other corporate purposes. An agreement that
enables the Company to borrow $2.0 billion for short-term purposes expires in
October 1998. The Company intends to negotiate a new short-term agreement to
replace the current agreement. An agreement for $8.0 billion expires in 2002,
enabling the Company to refinance short-term debt on a long-term basis. The
Company expects to refinance long-term and short-term debt from time to time.
The nature and amount of the Company's long-term and short-term debt and the
proportionate amount of each can be expected to vary as a result of future
business requirements, market conditions and other factors.

The Company operates internationally, with manufacturing and sales facilities in
various locations around the world. The Company continually evaluates its
foreign currency net asset exposure (primarily the Swiss franc, German mark,
Netherlands guilder, Swedish krona and Canadian dollar) based on current market
conditions and business strategies, and it acts to manage such exposure, when
deemed prudent, through various hedging transactions. The Company has entered
into currency and related interest rate swap agreements to manage a portion of
its exposure to currency movements. The U.S. dollar value of aggregate notional
principal amounts for these agreements outstanding was equivalent to $2.5
billion and $1.4 billion, respectively, at June 30, 1998 and December 31, 1997.
Of these amounts, $1.8 billion and $736 million related to consumer products
debt at June 30, 1998 and December 31, 1997, respectively. In addition, during
the first half of 1998, the Company entered into a swap agreement that
effectively converts $800 million of fixed rate debt to variable rate debt.

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<PAGE>

The Company enters into forward exchange and option contracts, for purposes
other than trading, to reduce the effects of fluctuating foreign currency on
foreign currency denominated current assets, liabilities, commitments and
short-term intercompany transactions. At June 30, 1998 and December 31, 1997,
the Company had entered into contracts, with maturities of less than one year
and U.S. dollar equivalents of $2.4 billion (including $873 million in option
contracts) and $2.5 billion (including $1.1 billion in option contracts),
respectively.

Use of the above-mentioned derivative financial instruments has not had a
material impact on the Company's financial position at June 30, 1998 or
results of operations for the three or six months then ended.

The Company's credit ratings by Moody's at June 30, 1998 and December 31, 1997
were "P-1" in the commercial paper market and "A2" for long-term debt
obligations. The Company's credit ratings by Standard & Poor's ("S&P") at June
30, 1998 and December 31, 1997 were "A-1" in the commercial paper market and "A"
for long-term debt obligations. The debt ratings of the Company remain on S&P's
CreditWatch list, as S&P monitors tobacco litigation and legislation
developments.

As discussed above under "Tobacco--Business Environment," the present
legislative and litigation environment is substantially uncertain and could
result in material adverse consequences for the business, financial condition,
cash flows or results of operations of the Company, PM Inc. and PMI.

EQUITY AND DIVIDENDS

During the first quarter of 1997, the Board of Directors announced an $8.0
billion share repurchase program. The Company repurchased common stock at an
aggregate cost of $51 million under this program prior to its suspension in
April 1997.

Dividends paid in the first six months of 1998 were substantially unchanged
from the comparable 1997 period. The current quarterly dividend rate of $0.40
per share was established by the Company's Board of Directors in the third
quarter of 1996, resulting in an annualized dividend rate of $1.60 per share.

During the first six months of 1998, currency translation adjustments reduced
stockholders' equity by $221 million due to the strengthening of the U.S.
dollar versus European currencies, primarily the Swiss franc, Swedish krona,
German mark, Norwegian krone and Netherlands guilder.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents were $4.6 billion at June 30, 1998 and $2.3 billion
at December 31, 1997, the increase being largely attributable to the 1997
suspension of the Company's share repurchase program and 1998 debt issuances
discussed above.

NEW ACCOUNTING STANDARDS

During the second quarter of 1998, the Financial Accounting Standards Board
issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities", which must be adopted by the Company by January 1, 2000, with early
adoption permitted. SFAS No. 133 requires that all derivative instruments be
recorded on the consolidated balance sheet at their fair value. Changes in the

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<PAGE>

fair value of derivatives will be recorded each period in earnings or other
comprehensive earnings, depending on whether a derivative is designated as part
of a hedge transaction and, if it is, the type of hedge transaction. Gains and
losses on derivative instruments reported in other comprehensive earnings will
be reclassified as earnings in the periods in which earnings are affected by the
hedged item. The Company has not yet determined the timing of adoption or the
impact that adoption or subsequent application of SFAS No. 133 will have on its
financial position or results of operations.

In 1998, the American Institute of Certified Public Accountants' Accounting
Standards Executive Committee ("AcSEC") issued Statement of Position ("SOP")
No. 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." SOP No. 98-1 requires certain costs incurred in
connection with developing or obtaining internal-use software to be
capitalized and other costs to be expensed. The Company adopted SOP No. 98-1
effective January 1, 1998, and its application for the three and six month
periods ended June 30, 1998 had no material effect on the Company's financial
position or results of operations.

CONTINGENCIES

See Note 3 to the Condensed Consolidated Financial Statements for a discussion
of contingencies.

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

The Company and its representatives may from time to time make written or oral
forward-looking statements, including statements contained in the Company's
filings with the Securities and Exchange Commission and in its reports to
stockholders. In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, the Company is hereby identifying
important factors that could cause actual results to differ materially from
those contained in any forward-looking statement made by or on behalf of the
Company; any such statement is qualified by reference to the following
cautionary statements.

The tobacco industry continues to be subject to health concerns relating to the
use of tobacco products and exposure to ETS, legislation, including tax
increases, governmental regulation, privately imposed smoking restrictions,
governmental and grand jury investigations, litigation, and the effects of price
increases related to tobacco litigation settlements and, if implemented, federal
tobacco legislation discussed above. Each of the Company's operating
subsidiaries is subject to intense competition, changes in consumer preferences,
the effects of changing prices for its raw materials, local economic conditions
and the potential impact of the CDC issue. The performance of each of PMI and
KFI is affected by foreign economies and currency movements. Developments in any
of these areas, which are more fully described above and which descriptions are
incorporated into this section by reference, could cause the Company's results
to differ materially from results that have been or may be projected by or on
behalf of the Company. The Company cautions that the foregoing list of important
factors is not exclusive. The Company does not undertake to update any
forward-looking statement that may be made from time to time by or on behalf of
the Company.

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<PAGE>

Part II - OTHER INFORMATION

Item 1. Legal Proceedings.

Reference is made to Note 3, "Contingencies," of the Notes to the
Condensed Consolidated Financial Statements included in Part I, Item 1 of
this report, and to "Tobacco--Business Environment," of the Management's
Discussion and Analysis of Financial Condition and Results of Operations
included in Part I, Item 2 of this report.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits

10.1 Stipulation of Amendment to Settlement Agreement and For Entry
of Agreed Order, dated July 2, 1998, regarding the settlement
of the Mississippi health care cost recovery action.

10.2 Mississippi Fee Payment Agreement, dated July 2, 1998,
regarding the payment of attorneys' fees.

10.3 Mississippi MFN Escrow Agreement, dated July 2, 1998.

10.4 Stipulation of Amendment to Settlement Agreement and For Entry
of Consent Decree, dated July 24, 1998, regarding the
settlement of the Texas health care recovery action.

10.5 Texas Fee Payment Agreement, dated July 24, 1998, regarding the
payment of attorneys' fees.

12 Statement regarding computation of ratios of earnings to fixed
charges.

27 Financial Data Schedule.

99 Certain Pending Litigation Matters and Recent Developments.

(b) Reports on Form 8-K. During the quarter for which this report is
filed, the Registrant filed a Current Report on Form 8-K, dated
April 20, 1998, containing a letter to stockholders describing the
Company's view of a federal tobacco bill sponsored by Senator John
McCain.

-45-

<PAGE>

Signature

Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.

PHILIP MORRIS COMPANIES INC.

/s/ LOUIS C. CAMILLERI
---------------------------------------------
Louis C. Camilleri, Senior Vice President and
Chief Financial Officer

August 14, 1998

-46-

<PAGE>

Exhibit 10.1

IN THE CHANCERY COURT OF JACKSON COUNTY,
STATE OF MISSISSIPPI

)
IN RE MIKE MOORE, ATTORNEY GENERAL, ex. rel. ) CAUSE No. 94-1429
STATE OF MISSISSIPPI TOBACCO LITIGATION )
)

STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT
AND FOR ENTRY OF AGREED ORDER

THIS STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT AND FOR ENTRY OF
AGREED ORDER (the "Stipulation of Amendment") is made as of the date hereof, by
and among the parties hereto, as indicated by their signatures below, to amend
the Comprehensive Settlement Agreement and Release entered into by the parties
hereto with respect to this Action on October 17, 1997 (the "Settlement
Agreement").

WHEREAS, on July 2, 1997, the State of Mississippi and certain defendants
(the "Settling Defendants") entered into a Memorandum of Understanding (the
"MOU"), setting forth the terms of an agreement in principle to settle all
present and future claims relating to the subject matter of this Action, which
MOU contemplated that the parties would draft and execute a comprehensive
settlement agreement incorporating the terms of the MOU as well as other
customary terms and conditions, including releases;
<PAGE>

WHEREAS, on October 17, 1997, the State of Mississippi and Settling
Defendants entered into the Settlement Agreement to settle and resolve with
finality all present and future civil claims against all parties to this
litigation relating to the subject matter of this litigation which have been or
could have been asserted by any of the parties hereto;

WHEREAS, the Settlement Agreement was approved and adopted as an
enforceable order of the Court pursuant to Court Order dated December 29, 1997;

WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause
which provides that, in the event that Settling Defendants enter into a future
pre-verdict settlement agreement of other litigation brought by a non-federal
governmental plaintiff on terms more favorable to such governmental plaintiff
than the terms of this Settlement Agreement (after due consideration of relevant
differences in population or other appropriate factors), the terms of the
Settlement Agreement shall be revised so that the State of Mississippi will
obtain treatment at least as relatively favorable as any such non-federal
governmental entity;

WHEREAS, on May 8, 1998, Settling Defendants entered into a pre-verdict
settlement agreement with the State of Minnesota to settle the lawsuit State of
Minnesota v. Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed
Aug. 17, 1994) (the "Minnesota Settlement");

<PAGE>

WHEREAS, the State of Mississippi and Settling Defendants agree that,
pursuant to the Most Favored Nation clause of the Settlement Agreement, the
Settlement Agreement is to be revised in light of the Minnesota Settlement;

WHEREAS, the State of Mississippi and Settling Defendants have agreed on
the terms of revisions to the Settlement Agreement in light of the Minnesota
Settlement, as set forth in this Stipulation of Amendment and the Agreed Order
attached as Exhibit 1 hereto; and

WHEREAS, the parties hereto have further agreed jointly to petition the
Court for approval of the Agreed Order:

NOW, THEREFORE, BE IT KNOWN THAT, pursuant to the Most Favored Nation
clause of the Settlement Agreement and in consideration of their mutual
agreement to the terms of this Stipulation of Amendment (including, inter alia,
waiver of any further claim to revise the Settlement Agreement pursuant to the
Most Favored Nation clause, except as expressly provided herein), and such other
consideration as described herein, the sufficiency of which is hereby
acknowledged, the parties hereto, acting by and through their authorized agents,
memorialize and agree as follows:

1. Amendment of Settlement Agreement. The provisions of this Stipulation
of Amendment supplement the terms of the Settlement Agreement,

3
<PAGE>

which shall remain in full force and effect except insofar as they are expressly
revised by the provisions of this Stipulation of Amendment.

2. Voluntary Agreement of the Parties. The Court may, upon the State's
application, enter the Agreed Order attached hereto as Exhibit A. The State and
Settling Defendants understand that Congress may enact legislation dealing with
some of the issues addressed in the Settlement Agreement, this Stipulation of
Amendment or the Agreed Order. Settling Defendants and their assigns,
affiliates, agents and successors hereby voluntarily waive any right to
challenge the Settlement Agreement, this Stipulation of Amendment or the Agreed
Order, directly or through third parties, on the ground that any term thereof or
hereof is unconstitutional, outside the power or jurisdiction of the Court or
preempted by or in conflict with any current or future federal legislation
(except insofar as any terms of the Settlement Agreement (as revised hereby) or
the Agreed Order that relate to matters other than payments are irreconcilable
with any such future federal legislation).

3. Definitions. For the purposes of the Settlement Agreement, this
Stipulation of Amendment and the Agreed Order, the following terms shall have
the meanings set forth below:

(a) "Consumer Price Index" means the Consumer Price Index for All
Urban Consumers for the most recent twelve-month period for which

4
<PAGE>

such percentage information is available, as published by the Bureau of
Labor Statistics of the U.S. Department of Labor;

(b) "Market Share" means a Settling Defendant's respective share of
sales of cigarettes, by number of individual cigarettes shipped for
consumption in the United States, during (i) with respect to payments made
pursuant to paragraph 7 of this Stipulation of Amendment, the calendar
year ending on the date on which the payment at issue is due, regardless
of when such payment is made, and (ii) with respect to all other payments
made pursuant to this Stipulation of Amendment and the Settlement
Agreement, the calendar year immediately preceding the year in which the
payment at issue is due, regardless of when such payment is made;

(c) "Cigarettes" means any product which contains nicotine, is
intended to be burned or heated under ordinary conditions of use, and
consists of or contains (i) any roll of tobacco wrapped in paper or in any
substance not containing tobacco; or (ii) tobacco, in any form, that is
functional in the product, which, because of its appearance, the type of
tobacco used in the filler, or its packaging and labeling, is likely to be
offered to, or purchased by, consumers as a cigarette; or (iii) any roll
of tobacco wrapped in any substance containing tobacco which, because of
its appearance, the type of tobacco used in the filler, or its packaging
and

5
<PAGE>

labeling, is likely to be offered to, or purchased by, consumers as a
cigarette described in subparagraph (i) of this paragraph;

(d) "Smokeless Tobacco" means any powder that consists of cut,
ground, powdered or leaf tobacco that contains nicotine and that is
intended to be placed in the oral cavity;

(e) "Tobacco Products" means Cigarettes and Smokeless Tobacco; and

(f) "Children" means persons under the age of 18;

The above definitions supplement the definitions provided in the Settlement
Agreement and, insofar as they differ, supersede them.

4. Settlement Receipts. The payments to be made by Settling Defendants
under the Settlement Agreement and this Stipulation of Amendment constitute
reimbursement for public health expenditures of the State of Mississippi and the
political subdivisions and agencies of the State of Mississippi, including but
not limited to the Mississippi State Employees Health Insurance Plan, University
Medical Center and charity hospitals, as well as for Medicaid expenditures of
the State of Mississippi. Any payments made by Settling Defendants in a given
year are in settlement of claims for damages by the State in the year of payment
or earlier years related to the subject matter of this Action, including,
without limitation, claims for equitable and injunctive relief, claims for
health care

6
<PAGE>

expenditures and claims for punitive damages, except that no part of any payment
under the Settlement Agreement or this Stipulation of Amendment is made in
settlement of an actual or potential liability for a fine, penalty (civil or
criminal) or enhanced damages or as the cost of a tangible or intangible asset
or other future benefit. In consonance with the relief sought by this Action and
the Proposed Resolution, the parties hereto anticipate that the funds provided
hereunder and under the Settlement Agreement, other than funds provided pursuant
to the Settlement Agreement that are dedicated for the Mississippi Pilot Program
and legal expense reimbursement, will be used for health-related expenditures of
the State of Mississippi. This paragraph 4 supersedes paragraph 11 of the
Settlement Agreement, which is hereby rendered null, void and of no further
effect.

5. Supplemental Initial Payment. Each Settling Defendant severally shall
cause to be paid, pro rata in proportion to its Market Share and in accordance
with and subject to paragraph 17 of this Stipulation of Amendment, to an account
designated in writing by the State of Mississippi, its share of $41,738,000, to
be paid on or before January 4, 1999; its share of $145,173,000, to be paid on
or before January 3, 2000; its share of $145,173,000, to be paid on or before
January 2, 2001; its share of $145,173,000, to be paid on or before January 2,
2002; and its share of $72,743,000, to be paid on or before January 2, 2003. The
payments made by Settling Defendants pursuant to this paragraph shall be
adjusted upward

7
<PAGE>

by the greater of 3% or the actual total percent change in the Consumer Price
Index applied each year on the previous year, beginning with the payment due to
be made on or before January 3, 2000. The payments due to be made by Settling
Defendants pursuant to this paragraph on or before January 3, 2000, on or before
January 2, 2001, on or before January 2, 2002, and on or before January 2, 2003,
will also be decreased or increased, as the case may be, in accordance with the
formula for adjustment of payments set forth in Appendix A hereto. The payment
due to be made by Settling Defendants pursuant to this paragraph 5 on or before
January 4, 1999, shall not be subject to adjustment for inflation or in
accordance with the formula for adjustment of payments set forth in Appendix A
hereto.

6. Acceleration of Supplemental Initial Payment. In the event that any
Settling Defendant fails to make any payment required of it pursuant to
paragraph 5 of this Stipulation of Amendment (a "Defaulting Defendant") by the
applicable date set forth in such paragraph 5 (a "Missed Payment"), the State of
Mississippi shall provide notice to each of the Settling Defendants of such
non-payment. The Defaulting Defendant shall have 15 days after receipt of such
notice to pay the Missed Payment, together with interest accrued from the
original applicable due date at the prime rate as published in the Wall Street
Journal on the latest publication date on or before the date of default plus 3%.
If the Defaulting Defendant does not make such payment within such 15-day
period, the State of

8
<PAGE>

Mississippi shall have the option of providing notice to each of the Settling
Defendants of such continued non-payment. In the event that the State of
Mississippi elects to provide such notice, any or all of the Settling Defendants
(other than the Defaulting Defendant) shall have 15 days after receipt of such
notice to elect (in such Settling Defendant's or such Settling Defendants' sole
and absolute discretion) to pay the Missed Payment, together with interest
accrued from the original applicable due date at the prime rate as published in
the Wall Street Journal on the latest publication date on or before the date of
default plus 3%. In the event that the State of Mississippi does not receive the
Missed Payment, together with such accrued interest, within such additional
15-day period, all payments required to be made by each of the respective
Settling Defendants pursuant to paragraph 5 of this Stipulation of Amendment
that have yet to come due prior to the conclusion of such additional 15-day
period shall be accelerated and immediately become due and owing to the State of
Mississippi from each Settling Defendant, pro rata in proportion to its Market
Share; provided, however, that such accelerated payments (a) shall all be
adjusted upward by the greater of (i) the rate of 3% per annum or (ii) the
actual total percent change in the Consumer Price Index, in either instance for
the period between January 1 of the year in which the acceleration of payments
pursuant to this paragraph occurs and the date on which such accelerated
payments are made pursuant to this paragraph 6, and (b)

9
<PAGE>

shall all immediately be adjusted in accordance with the formula for adjustment
of payments set forth in Appendix A hereto.

Nothing in this paragraph 6 shall be deemed under any circumstance to
create any obligation on the part of any Settling Defendant to pay any amount
owed or payable to the State of Mississippi by any other Settling Defendant. All
obligations of the Settling Defendants pursuant to this paragraph 6 are intended
to be and shall remain several, and not joint.

7. Annual Payments. Each of the Settling Defendants agrees that, beginning
on December 31, 1998 (subject to adjustment for appropriate allocation among
Settling Defendants by January 30, 1999), and annually thereafter on December
31st of each year after 1998 (subject to final adjustment within 30 days), it
shall severally cause to be paid to an account designated in writing by the
State of Mississippi, in accordance with and subject to paragraph 17 of this
Stipulation of Amendment, pro rata in proportion to its respective Market Share,
its share of 1.7% of the following amounts (in billions):

Year 1998 1999 2000 2001 2002 2003 thereafter

1 2 3 4 5 6

Amount $4B $4.5B $5B $6.5B $6.5B $8B $8B

10
<PAGE>

annual payment due on December 31, 1999. Such payments will also be decreased or
increased, as the case may be, beginning with the annual payment due on December
31, 1999, in accordance with the formula for adjustments of payments set forth
in Appendix A. This paragraph 7 supersedes paragraph 9 of the Settlement
Agreement (and, insofar as not already superseded thereby, paragraph 3 of the
MOU), which is hereby rendered null, void and of no further effect.

8. Determination of Market Share. In the event of a disagreement between
or among any Settling Defendants as to their respective shares of any payment
due to be paid on a Market Share basis pursuant to the Settlement Agreement and
this Stipulation of Amendment, each Settling Defendant shall pay its undisputed
share of such payment promptly on or before the date on which such payment is
due, and shall, within 21 days of such date, submit copies of its federal excise
tax reports for the year in question to a third party to be selected by
agreement of Settling Defendants (the "Third Party"), who shall determine the
Market Share of each Settling Defendant within 3 business days of receipt of
such federal excise tax reports. The decision of the Third Party shall be final
and non-appealable, and shall be communicated by facsimile to each person
designated to receive notice under paragraph 23 of the Settlement Agreement.
Each Settling Defendant shall, within two business days of receipt of the Third
Party's decision, pay the State or such other Settling Defendant, as
appropriate, the difference, if any, between (1)

11
<PAGE>

the amount that such Settling Defendant has already paid with respect to the
payment in question and (2) the amount of the payment in question that
corresponds to such Settling Defendant's Market Share as determined by the Third
Party, together with interest accrued from the original date on which the
payment in question was due, at the prime rate as published in the Wall Street
Journal on the latest publication date on or before the original date on which
the payment in question was due, plus 3%.

9. Adjustments in Event of Federal Legislation. In the event that federal
tobacco legislation is enacted before November 30, 2000 that provides for
payments by tobacco companies (whether in the form of settlement payment, tax or
otherwise) ("Tobacco Legislation"):

(a) Settling Defendants shall be entitled to receive a dollar for
dollar offset against the annual payments required under paragraph 7 of
this Stipulation of Amendment of any amounts that the State of Mississippi
could elect to receive pursuant to such Tobacco Legislation ("Federal
Settlement Funds"), up to the full amount of such annual payments, except
to the extent that:

(i) such Federal Settlement Funds are required to be used for
purposes other than health care or tobacco-related purposes;

12
<PAGE>

(ii) such Tobacco Legislation does not provide for the
abrogation, settlement or relinquishment of state tobacco-related
claims; or

(iii) state receipt of such Federal Settlement Funds is
conditioned upon (A) the relinquishment of rights or benefits under
the Settlement Agreement (including this Stipulation of Amendment
and the Agreed Order) (excepting any annual payment amounts subject
to the offset); or (B) actions or expenditures by the state
unrelated to health care or tobacco (including but not limited to
tobacco education, cessation, control or enforcement).

(b) Nothing in this paragraph 9 shall reduce (i) the payments made
to the State of Mississippi pursuant to paragraphs 7 and 8 of the
Settlement Agreement and paragraphs 5 and 6 of this Stipulation of
Amendment (by offset, credit, recoupment, refund or otherwise); or (ii)
the percentage figure (1.7%) used to determine the State of Mississippi's
annual payments pursuant to paragraph 7 of this Stipulation of Amendment.
Nothing in this paragraph 9 is intended to or shall reduce the total
amounts payable by Settling Defendants to the State of Mississippi under
the Settlement Agreement (as revised hereby) by an amount greater than the
amount of

13
<PAGE>

Federal Settlement Funds that the State of Mississippi could elect to
receive.

This paragraph 9 supersedes paragraph 10 of the Settlement Agreement (and,
insofar as not already superseded thereby, paragraph 5 of the MOU), which is
hereby rendered null, void and of no further effect.

10. Clarification of Scope of State's Release. The release of claims
provided in paragraph 13 of the Settlement Agreement shall, with respect to the
Claims identified in subparagraph (2) thereof, apply only to monetary Claims
and, further, shall not operate as a release of any person, party or entity
(whether or not a signatory to the Settlement Agreement or this Stipulation of
Amendment) as to any of the obligations undertaken in the Settlement Agreement
(as revised hereby) in connection with a monetary breach or default thereof.
This paragraph 10 does not supersede but rather supplements and clarifies the
scope of the release provided in paragraph 13 of the Settlement Agreement.

11. Limited Most-Favored Nation Provision. In partial consideration for
the monetary payments to be made by Settling Defendants pursuant to this
Stipulation of Amendment, the State of Mississippi agrees that, if Settling
Defendants enter into any future pre-verdict settlement agreement of other
similar litigation brought by a non-federal governmental plaintiff, or any
amendment to any such existing settlement agreement, on terms more favorable to
such non-

15
<PAGE>

federal governmental plaintiff than the terms of the Settlement Agreement
(including this Stipulation of Amendment and the Agreed Order) (after due
consideration of relevant differences in population or other appropriate
factors), the terms of the Settlement Agreement (including this Stipulation of
Amendment and the Agreed Order) shall not be revised except as follows: to the
extent, if any, such other pre-verdict settlement agreement includes terms that
provide:

(a) for joint and several liability among Settling Defendants with
respect to monetary payments to be made pursuant to such agreement;

(b) a guarantee by the parent company of any of Settling Defendants
or other assurances of payment or creditors' remedies with respect to
monetary payments to be made pursuant to such agreement;

(c) for the implementation of non-economic tobacco-related public
health measures different from those contained in the Settlement Agreement
(including this Stipulation of Amendment and the Agreed Order);

(d) for no offset of Federal Settlement Funds against annual
settlement payments pursuant to such settlement agreement; or

(e) for an offset term more favorable to the plaintiff than the
offset provisions of paragraph 9 of this Stipulation of Amendment,

14
<PAGE>

then the Settlement Agreement shall, at the option of the Office of the Attorney
General of the State of Mississippi, be revised to include terms comparable to
such terms.

This paragraph 11 supersedes paragraph 15 of the Settlement Agreement
(and, insofar as not already superseded thereby, paragraph 7 of the MOU), which
is hereby rendered null, void and of no further effect. The State of Mississippi
hereby acknowledges that, pursuant to the terms of this paragraph 11, it has
irrevocably waived any future claim to revise the terms of the Settlement
Agreement or this Stipulation of Amendment pursuant to paragraph 15 of the
Settlement Agreement (or paragraph 7 of the MOU) (except as provided in
paragraph 23 of this Stipulation of Amendment), and it hereby further covenants
and agrees that, in consideration for Settling Defendants' agreement to the
terms of this Stipulation of Amendment, it shall not hereafter seek to revise
the Settlement Agreement or this Stipulation of Amendment, except as expressly
provided in this paragraph 11 (or pursuant to mutually agreeable amendment by
the parties hereto as provided in paragraph 22 of the Settlement Agreement and
paragraph 19 hereof).

12. Settling Defendants' Assurances. Settling Defendants agree:

16
<PAGE>

(a) to support the legislative initiatives to enact new laws and
administrative initiatives to promulgate new rules described in paragraph
6 of the Settlement Agreement; and

(b) not to support in Congress or any other forum legislation, rules
or policies which would preempt, override, abrogate or diminish the
State's rights or recoveries under the Settlement Agreement (as amended
hereby). Except as specifically provided in the foregoing sentence,
nothing in this Settlement Agreement (including this Stipulation of
Amendment and the Agreed Order) shall be deemed to restrain the parties
from advocating terms of any national settlement or taking any other
positions on issues relating to tobacco.

13. Disclosure of Payments. Each Settling Defendant shall disclose to the
Office of the Attorney General and the Office of the Governor, at the times and
in the manner provided below, information about the following payments:

(a) Any payment to a "lobbyist" within the meaning of Miss. Code
Ann. ss.ss. 5-8-3, 5-8-7 (Supp. 1997)), if the Settling Defendant knows or
has reason to know that the payment will be used, directly or indirectly,
to influence legislative or administrative action or the official action
of state or local government in Mississippi in any way relating to Tobacco
Products or their use;

17
<PAGE>

(b) Any payment to a third party, if the Settling Defendant knows
the payment is partly in consideration for the third party attending,
offering testimony at, or participating before a state or local government
hearing in Mississippi in any way relating to Tobacco Products or their
use; and

(c) Any payment (other than a "campaign contribution" under Miss.
Code Ann. ss.ss. 23-15-801 et. seq. (1972 & Supp. 1997) to, or for the
benefit of, a state or local official in Mississippi, whether made
directly by the Settling Defendant or indirectly through an employee of
the Settling Defendant acting within the scope of his employment, or
through an affiliate, lobbyist or other agent acting under the substantial
control of the Settling Defendant.

Disclosures required under this paragraph 13 shall be filed with the Office of
the Attorney General and the Office of the Governor on the first day of
February, May, August and November of each year for any and all payments made
through the first day of the previous month, and shall be transmitted in
electronic format or such format as the Attorney General may require, with the
following information:

o The name, address, telephone number and e-mail address of the
recipient;
o The amount of each payment described in this paragraph 13; and
o The aggregate amount of all payments described in this paragraph 13
to the recipient in the calendar year.

18
<PAGE>

Information disclosed pursuant to this paragraph 13 is a "public record" within
the meaning of the Mississippi Public Records Act of 1983, Miss. Code Ann.
ss.ss. 25-61-1 et seq. (1972 & Supp. 1997).

14. Prohibition of Certain Payments for Product Placement. Settling
Defendants shall not make or cause to be made, in connection with any motion
picture made in the United States, any payment, direct or indirect, to any
person to use, display, make reference to or use as a prop any cigarette,
cigarette package, advertisement for cigarettes, or any other item bearing the
brand name, logo, symbol, motto, selling message, recognizable color or pattern
of colors, or any other indicia of product identification identical or similar
to, or identifiable with, those used for any brand of domestic Tobacco Products.

15. Prohibition on Promotional Merchandise. On and after December 31,
1998, Settling Defendants shall permanently cease marketing, licensing,
distributing, selling or offering, directly or indirectly, including by
catalogue or direct mail, in the State of Mississippi, any service or item
(other than Tobacco Products or any item of which the sole function is to
advertise Tobacco Products) which bears the brand name (alone or in conjunction
with any other word), logo, symbol, motto, selling message, recognizable color
or pattern of colors, or any other indicia of product identification identical
or similar to, or identifiable with, those used for any brand of domestic
Tobacco Products.

19
<PAGE>

16. Document Production. Settling Defendants shall provide to the State of
Mississippi a copy of any CD-ROMs of documents that Settling Defendants have
agreed to produce, pursuant to the Minnesota Settlement, to the document
depository established in connection with the lawsuit State of Minnesota v.
Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed Aug. 17,
1994), with a copy of the accompanying transmittal letter provided to each
person designated to receive notice under paragraph 23 of the Settlement
Agreement.

17. Court Approval. The parties hereto agree to submit this Stipulation of
Amendment promptly to the Court for its review and approval. If the Court
refuses to approve this Stipulation of Amendment or any material provision
hereof, or if such approval is modified in any material respect or set aside on
appeal, then this Stipulation of Amendment shall be canceled and terminated and
it and all orders issued pursuant hereto (including the Agreed Order) shall
become null and void and of no further effect. Any such cancellation or
termination of this Stipulation of Amendment shall not result in the
cancellation or termination of the Settlement Agreement as approved by the Court
on December 29, 1997. All payments described in this Stipulation of Amendment
shall be paid into a special escrow account, pursuant to the terms of a mutually
acceptable escrow agreement (the "MFN Escrow Agreement"), and if so paid shall
remain in said escrow account, until such time as (1) the time for appeal or to
seek review of the Court's order

20
<PAGE>

approving this Stipulation of Amendment has expired without the filing of any
notice of appeal or petition for review; or (2) in the event of any such appeal
or petition, the appeal or the petition has been dismissed or the Court's order
has been affirmed in all material respects by the court of last resort to which
such appeal or petition has been taken and such dismissal or affirmance has
become no longer subject to further appeal or review. Any payments made into
escrow shall be disbursed from escrow only in strict accordance with the terms
of the MFN Escrow Agreement.

18. Obligations Several, Not Joint. All obligations of the Settling
Defendants pursuant to the Settlement Agreement and this Stipulation of
Amendment are intended to be and shall remain several, and not joint.

19. Applicable Provisions of Settlement Agreement. The provisions of
paragraphs 17 (Representations of Parties); 19 (Headings), 20 (No Determination
or Admission), 21 (Non-Admissibility), 22 (Amendment), 23 (Notices), 24
(Cooperation), 26 (Construction), 27 (Severability), 28 (Intended Beneficiaries)
and 29 (Counterparts) of the Settlement Agreement shall be equally applicable to
this Stipulation of Amendment as though fully set forth herein, and all
references to the Settlement Agreement in the paragraphs thereof specifically
listed in this paragraph 19 shall be construed to include this Stipulation of
Amendment.

21
<PAGE>

20. Release of Right to Additional Compensation. In consideration for the
terms hereof, including, inter alia, the provisions of paragraph 5 hereof, the
State of Mississippi hereby irrevocably releases Settling Defendants from any
claim for additional compensation pursuant to paragraph 16 of the Settlement
Agreement (and, insofar as not already superseded thereby, paragraph 8 of the
MOU), the provisions of which regarding the State's rights to additional
compensation are hereby rendered null, void and of no further effect.

21. Governing Law. The Settlement Agreement (including this Stipulation of
Amendment and the Agreed Order) shall be governed by the laws of the State of
Mississippi without regard to the conflict of law rules of such State. This
paragraph supersedes paragraph 25 of the Settlement Agreement, which is hereby
rendered null, void and of no further effect.

22. Attorneys' Fees. The parties hereto acknowledge that the entire
obligation of Settling Defendants regarding payment of private counsel's fees
pursuant to paragraph 16 of the Settlement Agreement (and, insofar as not
already superseded thereby, paragraph 8 of the MOU) is set forth in the
Mississippi Fee Payment Agreement dated July 2, 1998. The Attorney General
represents that all of the State's outside counsel that have represented the
State in connection with this action are, by and through their authorized
representatives, signatories to the Mississippi Fee Payment Agreement. Under no
circumstances shall Settling

22
<PAGE>

Defendants' entry into this Stipulation of Amendment or the Mississippi Fee
Payment Agreement be construed as, or deemed to be, evidence of or an admission
or concession that the Settlement Agreement can be revised pursuant to the Most
Favored Nations clause without incorporation of all terms of any settlement
agreement that provides the occasion for any such revision, including all terms
with respect to attorneys' fees.

23. Conditioned on Minnesota Settlement. In the event that a court order
or other judicial determination is issued on or before January 2, 2003 that
overturns, voids or invalidates the Minnesota Settlement or otherwise declares
it to be unenforceable (such that Settling Defendants are relieved from making
payments required under the Minnesota Settlement) (the "Minnesota Order"),
Settling Defendants shall have the option to elect not to make any payment
pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that becomes due
on or after the date of such Minnesota Order. In the event that Settling
Defendants make such an election:

(a) Settling Defendants shall not be obligated to make any payment
pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that
becomes due on or after the date of the Minnesota Order; provided,
however, that if the Minnesota Order is reversed on appeal or otherwise
set aside, Settling Defendants shall be obligated to make any payments

23
<PAGE>

pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that were
not made when initially due as result of the Minnesota Order;

(b) the provisions of paragraph 11 of this Stipulation of Amendment
shall not apply to preclude the application of paragraph 15 of the
Settlement Agreement with respect to any pre-verdict settlement agreement
described therein entered into after the date of the Minnesota Order; and

(c) Settling Defendants shall be entitled to a credit, in the amount
of any payments made pursuant to paragraphs 5 and 6 of this Stipulation of
Amendment, against any payments due to the State of Mississippi as a
result of application of paragraph 15 of the Settlement Agreement in
connection with any pre-verdict settlement agreement entered into after
the date of the Minnesota Order, pursuant to subparagraph (b) of this
paragraph 23.

No other provision of the Settlement Agreement, this Stipulation of Amendment or
the Consent Decree shall be affected by the Minnesota Order. Settling Defendants
will provide the State of Mississippi with notice of any filing seeking to
obtain a Minnesota Order.

24. Entire Agreement of Parties. The Settlement Agreement (including for
purposes of this paragraph 24 this Stipulation of Amendment, the Mississippi Fee
Payment Agreement and the Agreed Order) contains an entire, complete and

24
<PAGE>

integrated statement of each and every term and provision agreed to by and among
the parties hereto relating in any way to the settlement of the tobacco
litigation brought by the State of Mississippi, and is not subject to any
condition not provided for herein.

IN WITNESS WHEREOF, the parties hereto, through their fully authorized
representatives, have agreed to this Stipulation of Amendment as of this 2nd day
of July, 1998.

STATE OF MISSISSIPPI, acting by and
through Michael C. Moore, its duly
elected and authorized Attorney General

By: /s/ Michael C. Moore
-------------------------------
Michael C. Moore
Attorney General

25
<PAGE>

PHILIP MORRIS INCORPORATED

By: /s/ Meyer G. Koplow
--------------------------------
Meyer G. Koplow
Counsel

By: /s/ Martin J. Barrington by MGK
--------------------------------
Martin J. Barrington
General Counsel

R.J. REYNOLDS TOBACCO
COMPANY

By: /s/ Arthur F. Golden
--------------------------------
Arthur F. Golden
Counsel

By: /s/ Charles A. Blixt by AFG
--------------------------------
Charles A. Blixt
General Counsel

26
<PAGE>

BROWN & WILLIAMSON TOBACCO
CORPORATION

By: /s/ Stephen R. Patton
------------------------------------
Stephen R. Patton
Counsel

By: /s/ F. Anthony Burke
------------------------------------
F. Anthony Burke
Vice President & General Counsel

LORILLARD TOBACCO COMPANY

By: Arthur J. Stevens by MGK
------------------------------------
Arthur J. Stevens
Senior Vice President and
General Counsel

27
<PAGE>

APPENDIX A

FORMULA FOR CALCULATING VOLUME ADJUSTMENTS

Any payment that by the terms of the Stipulation of Amendment is to be
adjusted pursuant to this Appendix (the "Applicable Base Payment") shall be
adjusted pursuant to this Appendix in the following manner:

(A) in the event the aggregate number of cigarettes shipped for domestic
consumption by Settling Defendants in the Applicable Year (as defined
hereinbelow) (the "Actual Volume") is greater than the aggregate number of
cigarettes shipped for domestic consumption by Settling Defendants in 1997
(the "Base Volume"), the Applicable Base Payment shall be multiplied by
the ratio of the Actual Volume to the Base Volume;

(B) in the event the Actual Volume is less than the Base Volume,

(i) the Applicable Base Payment shall be multiplied by the ratio of
the Actual Volume to the Base Volume, and the resulting product
shall be divided by 0.98; and

(ii) if a reduction of the Applicable Base Payment results from the
application of subparagraph (B)(i) of this Appendix, but the
Settling Defendants' aggregate net operating profits from domestic
sales of cigarettes for the Applicable Year (the "Actual Net
Operating Profit") is greater than the Settling Defendants'
aggregate net operating profits from domestic sales of cigarettes in
1997 (the "Base Net Operating Profit") (such Base Net Operating
Profit being adjusted upward by the greater of the rate of 3% per
annum or the actual total percent change in the Consumer Price
Index, in either instance for the period between January 1, 1998 and
the date on which the payment at issue is made), then the amount by
which the Applicable Base Payment is reduced by the application of
subparagraph (B)(i) shall be reduced (but not below zero) by 1.7% of
25% of such increase in such profits. For purposes of this Appendix,
"net operating profits from domestic sales of cigarettes" shall mean
net operating profits from domestic sales of cigarettes as reported
to the United States Securities and Exchange Commission ("SEC") for
the Applicable Year or, in the
<PAGE>

case of a Settling Defendant that does not report profits to the
SEC, as reported in financial statements prepared in accordance with
generally accepted accounting principles and audited by a nationally
recognized accounting firm. The determination of Settling
Defendants' aggregate net operating profits from domestic sales of
cigarettes shall be derived using the same methodology as was
employed in deriving such Settling Defendants' aggregate net
operating profits from domestic sales of cigarettes in 1997. Any
increase in an Applicable Base Payment pursuant to this subparagraph
B(ii) shall be payable within 120 days after the date that the
payment at issue was required to be made.

(C) "Applicable Year" means (i) with respect to the payments made pursuant
to paragraph 7 of the Stipulation of Amendment, the calendar year ending
on the date on which the payment at issue is due, regardless of when such
payment is made; and (ii) with respect to all other payments made pursuant
to the Stipulation of Amendment, the calendar year immediately preceding
the year in which the payment at issue is due, regardless of when such
payment is made.

2
<PAGE>

EXHIBIT 1

IN THE CHANCERY COURT OF JACKSON COUNTY,
STATE OF MISSISSIPPI

)
IN RE MIKE MOORE, ATTORNEY GENERAL, ex. rel. ) CAUSE No. 94-1429
STATE OF MISSISSIPPI TOBACCO LITIGATION )
)

AGREED ORDER APPROVING STIPULATION OF
AMENDMENT TO SETTLEMENT AGREEMENT
PURSUANT TO COURT ORDER OF DECEMBER 29, 1997

WHEREAS, on October 17, 1997, the State of Mississippi and certain
Defendants entered into a Comprehensive Settlement Agreement and Release (the
"Settlement Agreement") to settle and resolve with finality all present and
future claims against all parties to this litigation relating to the subject
matter of this litigation which have been or could have been asserted by any of
the parties hereto;

WHEREAS, the Settlement Agreement was approved and adopted as an
enforceable order of the Court pursuant to Court Order dated December 29, 1997;

WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause
which provides that, in the event that Settling Defendants enter into a future
pre-verdict settlement agreement of other litigation brought by a non-federal
governmental plaintiff on terms more favorable to such governmental plaintiff
than the terms of the Settlement Agreement (after due consideration of relevant
differences in population or other appropriate factors), the terms of the
Settlement

3
<PAGE>

EXHIBIT 1

Agreement shall be revised so that the State of Mississippi will obtain
treatment at least as relatively favorable as any such non-federal governmental
entity;

WHEREAS, the State of Mississippi and Settling Defendants agree that,
pursuant to the Most Favored Nations clause of the Settlement Agreement, the
Settlement Agreement is to be revised in light of the Minnesota Settlement;

WHEREAS, the State of Mississippi and Settling Defendants have agreed on
the terms of the revisions to the Settlement Agreement as set forth in a
Stipulation of Amendment to Settlement Agreement and for Entry of Agreed Order
executed on July 2, 1998 (the "Stipulation of Amendment");

WHEREAS, the Stipulation of Amendment provides for entry of this Agreed
Order and, further, provides that the Settling Defendants have waived as
specified therein their right to challenge the terms of this Agreed Order as
being superseded or preempted by future congressional enactments; and

WHEREAS, the Attorney General believes the entry of this Agreed Order is
appropriate and in the public interest;

4
<PAGE>

EXHIBIT 1

NOW, THEREFORE, the State of Mississippi and Settling Defendants having
come before the Court on their joint motion Ore Tenus for approval of a
Stipulation of Amendment to the Settlement Agreement pursuant to the Most
Favored Nations clause of the Settlement Agreement and this Court's December 29,
1997 Judgment of Dismissal and Order Approving Settlement Agreement (the
"December 29, 1997 Order"), and the Court having reviewed and considered the
Stipulation of Amendment and otherwise being fully advised in the premises, it
is hereby ORDERED, ADJUDGED and DECREED as follows:

1. Approval. Pursuant to the Settlement Agreement and this Court's
December 29, 1997 Order, this Court has continuing jurisdiction to enforce and
implement the terms of the Settlement Agreement, including the Most Favored
Nations clause of the Settlement Agreement. The Court finds that the terms of
the Stipulation of Amendment are just and in the best interests of the State of
Mississippi and Settling Defendants, and the same is hereby approved. The
parties are directed to comply with the terms of the Stipulation of Amendment.

2. Jurisdiction and Venue. In keeping with the Settlement Agreement and
this Court's December 29, 1997 Order, the Court retains jurisdiction for the
purpose of enforcement of the Settlement Agreement (as amended by the
Stipulation of Amendment) and this Agreed Order. Any party to this Agreed Order
may apply to this Court at any time for such further orders and directions as

5
<PAGE>

EXHIBIT 1

may be necessary or appropriate for the construction and enforcement of the
Settlement Agreement, the Stipulation of Amendment and this Agreed Order.

3. Definitions. The definitions set forth in the Settlement Agreement (as
supplemented or superseded by the Stipulation of Amendment) are incorporated by
reference herein.

4. Applicability. This Agreed Order applies only to Settling Defendants in
their corporate capacity acting through their respective successors and assigns,
directors, officers, employees, agents, subsidiaries, divisions or other
internal organizational units of any kind or any other entity acting in concert
or participating with them. The remedies and penalties for a violation of this
Agreed Order shall apply only to Settling Defendants, and shall not be imposed
or assessed against any employee, officer or director of Settling Defendants or
other person or entity as a consequence of such a violation, and there shall be
no jurisdiction under this Agreed Order to impose or assess a penalty against
any employee, officer or director of Settling Defendants or other person or
entity as a consequence of a violation of this Agreed Order.

5. Effect on Third Parties. This Agreed Order is not intended to and does
not vest standing in any third party with respect to the terms hereof, or create
for any person other than the parties hereto a right to enforce the terms
hereof.

6. Injunctive Relief. Settling Defendants are permanently enjoined from:

6
<PAGE>

EXHIBIT 1

(a) On and after December 31, 1998, marketing, licensing,
distributing, selling or offering, directly or indirectly, including by
catalogue or direct mail, in the State of Mississippi, any service or item
(other than Tobacco Products or any item the sole function of which is to
advertise Tobacco Products) which bears the brand name (alone or in
conjunction with any other word), logo, symbol, motto, selling message,
recognizable color or pattern of colors, or any other indicia or product
identification identical or similar to, or identifiable with, those used
for any domestic brand of Tobacco Products.

(b) Making any material misrepresentation of fact regarding the
health consequence of using any Tobacco Product, including any tobacco
additives, filters, paper or other ingredients; provided, however, that
nothing in this paragraph shall limit the exercise of any First Amendment
right or any defense or position which persons bound by this Agreed Order
may assert in any judicial, legislative or regulatory forum.

(c) Entering into any contract, combination or conspiracy between or
among themselves which has the purpose or effect of: (1) limiting
competition in the production or distribution of information about the
health hazards or other consequences of the use of Tobacco Products;

7
<PAGE>

EXHIBIT 1

(2) limiting or suppressing research into smoking and health; or (3)
limiting or suppressing research into, marketing, or development of new
products.

(d) Taking any action, directly or indirectly, to target children in
Mississippi in the advertising, promotion, or marketing of cigarettes, or
taking any action the primary purpose of which is to initiate, maintain or
increase the incidence of underage smoking in Mississippi.

7. No Determination or Admission. The Settlement Agreement having been
executed prior to the taking of any testimony, no final determination of any
violation of any provision of law has been made in this Action. This Agreed
Order is not intended to be and shall not in any event be construed as, or
deemed to be, an admission or concession or evidence of any liability or any
wrongdoing whatsoever on the part of any person covered by the releases provided
in paragraphs 12, 13 and 14 of the Settlement Agreement; nor shall this Agreed
Order be construed as, or deemed to be, an admission or concession or evidence
of personal jurisdiction by any person not a party to this Agreed Order.
Defendants specifically disclaim any liability or wrongdoing whatsoever with
respect to the claims and allegations asserted against them in this Action and
Settling Defendants have entered into the Settlement Agreement and the
Stipulation of Amendment, and have stipulated to entry of this Agreed Order,
solely to avoid the further expense, inconvenience, burden and risk of
litigation.

8
<PAGE>

EXHIBIT 1

8. Modification. This Agreed Order shall not be modified unless the party
seeking modification demonstrates, by clear and convincing evidence, that it
will suffer irreparable harm from new and unforeseen conditions; provided,
however, that the provisions of paragraph 4 of this Agreed Order shall in no
event be subject to modification. Changes in the economic conditions of the
parties shall not be grounds for modification. It is intended that Settling
Defendants will comply with this Agreed Order as originally entered, even if
Settling Defendants' obligations hereunder are greater than those imposed under
current or future law. Therefore, a change in law that results, directly or
indirectly, in more favorable or beneficial treatment of any one or more of the
Settling Defendants shall not support modification of this Agreed Order. The
provisions of this paragraph shall not be construed to limit or affect any
future modification of the Settlement Agreement (as amended by the Stipulation
of Amendment) in the manner provided in paragraphs 11 and 23 of the Stipulation
of Amendment.

9. Enforcement and Attorneys' Fees. In any proceeding which results in a
finding that a Settling Defendant violated this Agreed Order, the responsible
Settling Defendant or Settling Defendants shall pay the State's costs and
attorneys' fees incurred in such proceeding.

10. Non-Exclusivity of Remedy. The remedies in this Agreed Order are
cumulative and in addition to any other remedies the State may have at law or

9
<PAGE>

EXHIBIT 1

equity. Nothing herein shall be construed to prevent the State from bringing any
action simply because the conduct that is the basis for such action may also
violate this Agreed Order.

SO ORDERED AND ADJUDGED, this the 11th day of July, 1998.

/s/ William H. Myers
-----------------------------
WILLIAM H. MYERS,
CHANCELLOR

APPROVED:

/s/ Michael C. Moore
- ------------------------------------
MICHAEL C. MOORE, Attorney General,
for the State of Mississippi

/s/ Joe R. Colingo
- ------------------------------------
JOE R. COLINGO, for Settling Defendants

<PAGE>

Exhibit 10.2

MISSISSIPPI FEE PAYMENT AGREEMENT

This Mississippi Fee Payment Agreement (the "Agreement") is entered into
as of July 2, 1998, by and among Philip Morris Incorporated, R.J. Reynolds
Tobacco Company, Brown & Williamson Tobacco Corporation and Lorillard Tobacco
Company (collectively and severally "Settling Defendants" and each individually
a "Settling Defendant"), the State of Mississippi and private counsel retained
by the State of Mississippi in connection with the lawsuit In re Mike Moore,
Attorney General, ex rel. State of Mississippi Tobacco Litig., No. 94-1429
(Miss. Ch. Ct., Jackson County) (the "Action").

WITNESSETH:

WHEREAS, on October 17, 1997, the State of Mississippi and Settling
Defendants entered into a comprehensive settlement agreement to settle and
resolve with finality all present and future civil claims relating to the
subject matter of the Action (the "Settlement Agreement"), which Settlement
Agreement was approved by the Chancery Court for the Jackson County (the
"Court") and adopted as an enforceable order of the Court pursuant to Court
Order dated December 29, 1997;

WHEREAS, paragraph 16 of the Settlement Agreement provides that Settling
Defendants shall pay reasonable attorneys' fees to private counsel for the State
of Mississippi, in an amount set by arbitration, subject to an appropriate
annual cap on all such payments of attorneys' fees by Settling Defendants, as
well as other conditions;

WHEREAS, paragraph 16 of the Settlement Agreement did not and was not
intended to reflect the entire agreement of Settling Defendants and the State of
Mississippi as to the procedures and conditions that would govern Settling
Defendants' payment of fees to private counsel retained by the State of
Mississippi in connection with the Action ("Mississippi Counsel"), including an
agreed specific annual aggregate national cap on all payments of attorneys' fees
and certain other professional fees by Settling Defendants, as well as other
essential terms;

WHEREAS, Settling Defendants and Mississippi Counsel have entered into a
letter agreement dated October 10, 1997 (the "October 10th Letter") which
<PAGE>

describes the essential terms of Settling Defendants' agreement to pay fees to
Mississippi Counsel pursuant to paragraph 16 of the Settlement Agreement;

WHEREAS, paragraph 15 of the Settlement Agreement contains a "Most Favored
Nation" clause which provides that, in the event that Settling Defendants enter
into a future pre-verdict settlement agreement of other litigation brought by a
non-federal governmental plaintiff on terms more favorable to such governmental
plaintiff than the terms of the Settlement Agreement (after due consideration of
relevant differences in population or other appropriate factors), the terms of
the Settlement Agreement shall be revised so that the State of Mississippi will
obtain treatment at least as relatively favorable as any such non-federal
governmental entity;

WHEREAS, on January 16, 1998, Settling Defendants entered into a
pre-verdict settlement agreement with the State of Texas, which sets forth the
terms of Settling Defendants' agreement to pay attorneys' fees to private
counsel for the State of Texas and includes provisions for advances on such
attorneys' fees by Settling Defendants and the State of Texas;

WHEREAS, on May 8, 1998, certain Settling Defendants entered into a
pre-verdict settlement agreement with the State of Minnesota (the "Minnesota
Settlement"), which includes provisions for payment of attorneys' fees to
private counsel for the State of Minnesota;

WHEREAS, on July 2, 1998, Settling Defendants and the State of Mississippi
entered into a Stipulation of Amendment to Settlement Agreement and for Entry of
Agreed Order (the "Stipulation of Amendment") to resolve any disputes with
respect to the Most Favored Nation clause of the Settlement Agreement, including
any disputes regarding payment of attorneys' fees, in light of the Texas and
Minnesota Settlements; and

WHEREAS, Settling Defendants, the State of Mississippi and Mississippi
Counsel, in order to resolve any disputes with respect to paragraphs 15 and 16
of the Settlement Agreement, and to describe more fully the procedures that will
govern Settling Defendants' payment of fees to Mississippi Counsel, have agreed
to the terms of this Agreement:

NOW, THEREFORE, BE IT KNOWN THAT, in consideration of their mutual
agreement to the terms of this Agreement, the State of Mississippi's and
Settling Defendants' mutual agreement to the terms of the Stipulation of

2
<PAGE>

Amendment, and such other consideration described herein, including the release
of certain claims against Settling Defendants, the sufficiency of which is
hereby acknowledged, the parties hereto, acting by and through their authorized
agents, memorialize and agree as follows:

SECTION 1. Agreement to Pay Fees.

Settling Defendants will pay reasonable attorneys' fees to Mississippi
Counsel for their representation of the State of Mississippi in connection with
the Action. The amount of such fees will be set by a panel of three independent
arbitrators (the "Panel") whose decision as to the amount of fees for
Mississippi Counsel arbitrated in connection with this Agreement (the
"Mississippi Fee Award") shall be final and not appealable. The procedures
governing Settling Defendants' obligation to pay the Mississippi Fee Award,
including the procedures for making, and the timing of payments in satisfaction
of, the Mississippi Fee Award, shall be as provided herein.

SECTION 2. Aggregate National Caps on Payment of Certain Fees.

Settling Defendants' payment of the Mississippi Fee Award pursuant to this
Agreement shall be subject to the payment schedule and the annual and quarterly
aggregate national caps specified in sections 11, 12, 13, 14 and 15 hereof,
which shall apply to:

(a) all payments of attorneys' fees pursuant to an award arbitrated by the
Panel ("Fee Award") in connection with the settlement of any tobacco and health
cases (other than non-class action personal injury cases brought directly by or
on behalf of a single natural person or the survivor of such person or for
wrongful death, or any non-class action consolidation of two or more such cases)
("Tobacco Cases") on terms that provide for payment by Settling Defendants or
other defendants acting in agreement with Settling Defendants (collectively,
"Participating Defendants") of fees with respect to private counsel retained by
the plaintiff in connection with any such case ("Private Counsel"), subject to
an annual cap on payment of all such fees;

3
<PAGE>

enforceable obligation on Participating Defendants to pay attorneys' fees with
respect to Private Counsel (any such legislation hereinafter referred to as
"Federal Legislation"); and

(c) all payments of attorneys' fees and certain other professional fees
(other than fees for attorneys or agents of Participating Defendants) pursuant
to a Fee Award for contributions made toward enacted Federal Legislation. In the
event that Federal Legislation is enacted, the terms "Private Counsel" and
"Eligible Counsel" shall apply not only to persons otherwise falling within the
definitions of such terms herein but also to all persons granted Fee Awards for
such contributions (such persons being Eligible Counsel with respect to each
month beginning with the month the Federal Legislation was enacted).

Nothing in this Agreement shall be construed to require any Settling
Defendant to pay Fee Awards in connection with any litigation other than the
Action.

SECTION 3. Exclusive Obligation of Settling Defendants; Release.

The provisions set forth herein constitute the entire obligation of
Settling Defendants with respect to payment of attorneys' fees in connection
with the Action and the exclusive means by which Mississippi Counsel may seek
payment of fees by Settling Defendants in connection with the Action. The
parties hereto acknowledge that the provisions for payment set forth herein are
the entirety of Settling Defendants' obligations with respect to payment of
attorneys' fees pursuant to paragraph 16 of the Settlement Agreement and the
October 10th Letter. The State of Mississippi agrees that Settling Defendants
shall have no other obligation to pay fees or otherwise compensate Mississippi
Counsel, any other counsel or representative of the State of Mississippi or the
State of Mississippi itself with respect to attorneys' fees in connection with
the Action. Each Mississippi Counsel hereby irrevocably releases Settling
Defendants and their respective present and former parents, subsidiaries,
divisions, affiliates, officers, directors, employees, representatives,
insurers, agents and attorneys (as well as the predecessors, heirs, executors,
administrators, successors and assigns of each of the foregoing) from any and
all claims that such counsel ever had, now has or hereafter can, shall or may
have in any way related to the Action (including but not limited to any
negotiations related to the settlement of the Action). The foregoing shall not
be construed as a release of any person or entity as to any of the obligations
undertaken in this Agreement in connection with a breach thereof.

4
<PAGE>

SECTION 4. Composition of the Panel.

(a) The first and the second members of the Panel shall both be permanent
members of the Panel and, as such, will participate in the determination of all
Fee Awards. The third Panel member shall not be a permanent Panel member, but
instead shall be a state-specific member selected to determine Fee Awards on
behalf of Private Counsel retained in connection with litigation within a single
state. Accordingly, the third, state-specific member of the Panel for purposes
of determining Fee Awards with respect to litigation in the State of Mississippi
shall not participate in any determination as to any Fee Award with respect to
litigation in any other state (unless selected to participate in such
determinations by such persons as may be authorized to make such selections
under other agreements).

(b) The members of the Panel shall be selected as follows:

(i) The first member shall be a natural person selected by
Participating Defendants, who shall advise Mississippi Counsel of the name
of the person selected by October 8, 1998.

(ii) The second member shall be a natural person selected by
agreement of Participating Defendants and a majority of the members of a
committee composed of the following members: Joseph F. Rice, Richard F.
Scruggs, Steven W. Berman, Walter Umphrey, two representatives of the
Castano Plaintiffs' Legal Committee and, at the option of Participating
Defendants, one additional representative to serve on behalf of counsel
for any one or more states that, subsequent to the date hereof, enter into
settlement agreements with Participating Defendants that provide for
payment of such states' Private Counsel pursuant to an arbitrated award of
fees; such second member shall be selected by October 1, 1998.

(iii) The third, state-specific member for purposes of determining
Fee Awards with respect to litigation in the State of Mississippi shall be
a natural person selected by Mississippi Counsel, who shall notify
Settling Defendants of the name of the person selected by October 15,
1998.

SECTION 5. Commencement of Panel Proceedings.

No application for a Fee Award shall be presented to the Panel or any
Panel member until November 3, 1998. The Panel shall consider and render

5
<PAGE>

decisions on applications for Fee Awards in the order in which they are
submitted or pursuant to notice by counsel having priority that they have ceded
their place to others. In the event that more than one application for a Fee
Award is submitted on the same date, the Panel shall consider and render
decisions on such applications in the order in which their respective cases were
settled. Counsel may seek permission from the Panel to make combined
presentations of aspects of their respective applications. Settling Defendants
shall not oppose any request to combine presentations of applications for Fee
Awards in connection with the Action, the lawsuit State of Florida v. American
Tobacco Co., No. 95-1466AH (15th Jud. Circuit, Palm Beach County), or the
lawsuit State of Texas v. American Tobacco Co., No. 5-96CV-91 (E.D. Tex. filed
Mar. 28, 1996).

SECTION 6. Costs of Arbitration.

All costs and expenses of the arbitration proceedings held by the Panel,
including compensation of Panel members (but not including any costs, expenses
or compensation of counsel making applications to the Panel), shall be borne by
Settling Defendants in proportion to their respective Market Shares.

SECTION 7. Panel Procedures Regarding Application of Mississippi Counsel.

Mississippi Counsel shall make a collective written application to the
Panel for a Fee Award on behalf of all Mississippi Counsel not later than
November 3, 1998. All interested persons, including persons not parties hereto,
may submit to the Panel any information that they wish; but interested persons
not parties hereto may submit only written materials. The Panel shall consider
all such submissions by any party hereto and may consider any such materials
submitted by other interested persons. All written submissions relating to
applications for a Fee Award in connection with the Action shall be served on
all parties hereto by November 13, 1998. Presentations to the Panel shall, to
the extent possible, be based on affidavit rather than live testimony. The Panel
shall preserve the confidentiality of any attorney work-product materials or
other similar confidential information that may be submitted. Settling
Defendants will not take any position adverse to the amount of the Fee Award
requested by Mississippi Counsel, nor will they or their representatives express
any opinion (even upon request) as to the appropriateness or inappropriateness
of the amount of any proposed Mississippi Fee Award. The undersigned outside
counsel for Settling Defendants Philip Morris Incorporated and R.J. Reynolds
Tobacco Company will appear, if requested, to provide information as to the
nature and efficacy of the

6
<PAGE>

work of Mississippi Counsel and to advise the Panel that they support a
Mississippi Fee Award of full reasonable compensation under the circumstances.

SECTION 8. Award of Fees to Mississippi Counsel.

The members of the Panel will consider all relevant information submitted
to them in reaching a decision as to a Fee Award that fairly provides for full
reasonable compensation of Mississippi Counsel for their representation of the
State of Mississippi in connection with the Action. The Panel shall determine
the amount of fees for all Mississippi Counsel collectively no later than
December 10, 1998. Given the significance and uniqueness of the Action, the
Panel shall not be limited to an hourly-rate or lodestar analysis in determining
the amount of the Mississippi Fee Award, but shall take into account the
totality of the circumstances. In considering the amount of the Mississippi Fee
Award, the Panel shall not consider Fee Awards that already have been or yet may
be awarded to others. The Panel's decisions as to Fee Awards shall be in writing
and shall report the amount of the fee awarded (with or without explanation or
opinion, at the Panel's discretion).

SECTION 9. Allocation of Payments among Mississippi Counsel.

All payments (including advances) made by Settling Defendants in
satisfaction of the Mississippi Fee Award pursuant to this Agreement shall be
paid in the first instance to an account designated in writing by Joseph F.
Rice, Esq. Each Mississippi Counsel shall be entitled to receive a percentage of
each such payment equal to the percentage such counsel would receive of any fee
recovery in the Action, under the terms of the fee-sharing agreement among
Mississippi Counsel (such percentage being such counsel's "Fee Percentage" of
the payment in question).

SECTION 10. Advances on Payment of Fees.

Settling Defendants shall severally make two payments as an advance
against later payments of the Mississippi Fee Award pursuant to this Agreement,
to be credited as provided in section 15 hereof, as follows:

(a) On or before July 6, 1998, each Settling Defendant shall pay to
Mississippi Counsel, pro rata in proportion to its Market Share indicated on
Schedule A hereto, its respective share of $50 million.

7
<PAGE>

(b) On or before July 31, 1998, each Settling Defendant shall pay to
Mississippi Counsel, pro rata in proportion to its Market Share indicated on
Schedule A hereto, its respective share of $50 million.

SECTION 11. Annual Amount for 1997; Allocation.

(a) For 1997, Settling Defendants shall pay, in the manner described in
section 13 hereof, the unsatisfied amount of the Fee Award (the "Unpaid Fees")
of Mississippi Counsel, and those Participating Defendants so obligated shall
make payments with respect to the Unpaid Fees of Private Counsel retained in
connection with the lawsuits State of Florida v. American Tobacco Co., No.
95-1466 AH (15th Jud. Circuit, Palm Beach County), and Mangini v. R.J. Reynolds
Tobacco Co., No. 939359 (Cal. Super. Ct., San Francisco County), in an amount
not to exceed $250 million for all payments described in this subsection.

(b) In the event that the sum of the Unpaid Fees of those Private Counsel
identified in subsection (a) of this section exceeds $250 million, such amount
shall be allocated among the payments to be made with respect to such Private
Counsel in proportion to the amount of their respective Unpaid Fees (the amount
so allocated with respect to the Unpaid Fees of each such Private Counsel being
such counsel's "Allocable Share" for 1997).

SECTION 12. Annual Amount for 1998; Allocation.

(a) For 1998, Settling Defendants shall pay, in the manner described in
section 13 hereof, the Unpaid Fees of Mississippi Counsel, and those
Participating Defendants so obligated shall make payments with respect to the
Unpaid Fees of all other Private Counsel, in an amount not to exceed $500
million for all such payments described in this subsection.

(b) The amount payable to Mississippi Counsel by Settling Defendants for
1998 shall be determined as follows: The $500 million annual cap for 1998 shall
be allocated equally among each month of the year. Except as provided in section
13(b) hereof, each monthly amount shall be allocated to those Private Counsel
retained in connection with Tobacco Cases settled by Participating Defendants or
resolved by Federal Legislation before or during such month, up to the amounts
of their respective Unpaid Fees (such counsel being "Eligible Counsel" with
respect to such monthly amount). In the event that the monthly amount is less
than the sum of Eligible Counsel's Unpaid Fees, the monthly amount shall be
allocated to Eligible Counsel in proportion to the amounts of their

8
<PAGE>

respective Unpaid Fees (the amount so allocated to each Eligible Counsel for a
given month being such counsel's Allocable Share for such month, and the sum of
each Private Counsel's Allocable Shares for each month being such counsel's
Allocable Share for 1998).

SECTION 13. Payments with Respect to Annual Amounts for 1997 and 1998.

(a) On the earlier of December 15, 1998 or 15 days after the date of the
Panel's decision with respect to the Mississippi Fee Award (the "Initial
Mississippi Fee Payment Date"), each Settling Defendant shall severally pay, pro
rata in proportion to its Market Share, its share of an initial fee payment with
respect to the Mississippi Fee Award (the "Initial Mississippi Fee Payment"),
which shall include:

(i) Mississippi Counsel's Allocable Share for 1997 as provided in
section 11 hereof or, in the event that the Panel has not rendered Fee
Awards with respect to all Private Counsel described in section 11(a)
hereof as of five business days prior to the Initial Mississippi Fee
Payment Date, Settling Defendants' reasonable estimation of Mississippi
Counsel's Allocable Share for 1997; and

(ii) Mississippi Counsel's Allocable Share for 1998 as provided in
section 12 hereof for each month of 1998 except those with respect to
which Mississippi Counsel's Allocable Share could not be determined as of
five days prior to the Initial Mississippi Fee Payment Date, as a result
of there being other Eligible Counsel that, as of such date, had not yet
been granted or denied a Fee Award by the Panel (either because such
counsel's application for a Fee Award was still under consideration by the
Panel or for any other reason).

9
<PAGE>

(b) On January 15, 1999, each Settling Defendant shall severally pay, pro
rata in proportion to its Market Share, its share of Mississippi Counsel's
Allocable Share for those months of 1998 not included in the Initial Mississippi
Fee Payment. Mississippi Counsel's Allocable Share for any such month shall be
based on an allocation of the monthly amount among Eligible Counsel having Fee
Awards as of December 31, 1998, without regard to whether there may be other
Eligible Counsel that have not been granted or denied a Fee Award by the Panel
as of such date.

(c) In the event that Settling Defendants pay an estimation of Mississippi
Counsel's Allocable Share for 1997, as provided in subsection (a)(i) of this
section, subsequent payments pursuant to this Agreement shall be adjusted to
ensure that Mississippi Counsel receive their actual Allocable Share for 1997.

(d) Notwithstanding any provision of this Agreement, Mississippi Counsel
agree to defer payment of $62 million of the payment due from Settling Defendant
R.J. Reynolds Tobacco Company ("Reynolds") on the Initial Mississippi Fee
Payment Date. In the event that (i) Reynolds' share of the Initial Mississippi
Fee Payment is less than $62 million or (ii) the Mississippi Fee Award has not
been determined as of the date of any other payment by Reynolds in 1998 with
respect to Fee Awards, individual Mississippi Counsel Scruggs, Millette, Bozeman
& Dent, P.A. ("Scruggs, Millette") and Ness, Motley, Loadholt, Richardson &
Poole ("Ness, Motley") shall also defer the amounts of their respective Fee
Percentages of such other 1998 payments, until the sum of all deferred amounts
equals $62 million. Under no circumstances shall this subsection require any
increase in any payment to be made by any other Settling Defendant. On January
5, 1999, Reynolds shall pay to the appropriate persons the amounts of its 1998
payments deferred pursuant to this section.

SECTION 14. Quarterly Amounts for 1999 and Subsequent Years; Allocation.

Within 10 business days after the end of each calendar quarter beginning
with the first calendar quarter of 1999, Settling Defendants shall pay, in the
manner provided in subsection (d) of this section, the Unpaid Fees of
Mississippi Counsel, and those Participating Defendants so obligated shall make
payments with respect to the Unpaid Fees of all other Private Counsel, in an
amount not to exceed $125 million for all such payments, as follows:

10
<PAGE>

(a) In the event that Federal Legislation has been enacted by the end of
the calendar quarter with respect to which such quarterly payment is being made
(the "Applicable Quarter"):

(i) the quarterly amount shall be allocated among Private Counsel,
up to the amount of their respective Unpaid Fees. Each Private Counsel
shall be allocated an amount of each quarterly payment for the calendar
year up to (or, in the event that the sum of such Private Counsel's Unpaid
Fees exceeds the quarterly amount, in proportion to) the amount of such
Private Counsel's Unpaid Fees. Each quarterly payment shall be allocated
among Private Counsel having Unpaid Fees, without regard to whether there
are other Private Counsel that have not yet been granted or denied a Fee
Award by the Panel as of the end of the Applicable Quarter. Subsequent
quarterly payments shall be adjusted, if necessary, to account for Private
Counsel that are granted Fee Awards in a subsequent quarter of the
calendar year, as provided in paragraph (ii)(B) of this subsection.

(ii) In the event that a quarterly payment for the calendar year is
less than the sum of all Private Counsel's Unpaid Fees:

(A) in the case of the first such quarterly payment, the
quarterly amount shall be allocated among Private Counsel in
proportion to the amounts of their respective Unpaid Fees.

(B) in the case of a quarterly payment after the first
quarterly payment that is less than the sum of all such Unpaid Fees,
the quarterly amount shall be allocated only to those Private
Counsel, if any, that were not paid a proportionate share of all
prior quarterly payments for the calendar year (either because such
Private Counsel's applications for Fee Awards were still under
consideration as of the end of the calendar quarters with respect to
which such quarterly payments were made or for any other reason),
until each such Private Counsel has been allocated a proportionate
share of all prior quarterly payments. In the event that the sum of
all such shares exceeds the amount of the quarterly payment, such
payment shall be allocated among such Private Counsel in proportion
to the amounts of their respective Unpaid Fees (without regard to
whether there are other Private Counsel that have not yet been
granted or denied a Fee Award by the Panel as of the end of the
Applicable Quarter).

11
<PAGE>

(b) In the event that Federal Legislation has not been enacted by the end
of the Applicable Quarter:

(i) the quarterly amount shall be allocated equally among each of
the three months of the calendar quarter. The amount for each such month
shall be allocated among those Private Counsel retained in connection with
Tobacco Cases settled before or during such month (such Private Counsel
being "Eligible Counsel" with respect to such monthly amount), each of
whom shall be allocated a portion of each such monthly amount up to (or,
in the event that the sum of Eligible Counsel's respective Unpaid Fees
exceeds such monthly amount, in proportion to) the amount of such Eligible
Counsel's Unpaid Fees. The monthly amount for each month of the calendar
quarter shall be allocated among Eligible Counsel having Unpaid Fees,
without regard to whether there may be Eligible Counsel that have not yet
been granted or denied a Fee Award by the Panel as of the end of the
Applicable Quarter. Subsequent quarterly payments shall be adjusted, as
necessary, to account for Eligible Counsel that are granted Fee Awards in
a subsequent quarter of the calendar year, as provided in paragraph
(ii)(B) of this subsection.

(ii) In the event that the amount for a given month is less than the
sum of all Eligible Counsel's Unpaid Fees:

(A) in the case of a first quarterly payment, such monthly
amount shall be allocated among Eligible Counsel for such month in
proportion to the amount of their respective Unpaid Fees.

(B) in the case of a quarterly payment after the first
quarterly payment, the quarterly amount shall be allocated among
only those Private Counsel, if any, that were Eligible Counsel with
respect to any monthly amount paid in a prior quarter of the
calendar year but were not allocated a proportionate share of such
monthly amount (either because such counsel's applications for Fee
Awards were still under consideration as of the end of the calendar
quarter containing the month in question or for any other reason),
until each such Eligible Counsel has been allocated a proportionate
share of all such prior monthly payments for the calendar year. In
the event that the sum of all such shares exceeds the amount of the
quarterly payment, the quarterly payment shall

12
<PAGE>

be allocated among Eligible Counsel in proportion to the amounts of
their respective Unpaid Fees (without regard to whether there may be
other Eligible Counsel with respect to such prior monthly amounts
that have not yet been granted or denied a Fee Award by the Panel as
of the end of the Applicable Quarter).

(c) Adjustments pursuant to paragraphs (a)(ii)(B) and (b)(ii)(B) of this
section shall be made separately for each calendar year. No amounts paid in any
calendar year shall be subject to refund, nor shall any payment in any given
calendar year affect the allocation of payments to be made in any subsequent
calendar year.

(d) Each Settling Defendant shall severally pay, pro rata in proportion to
its respective Market Share, its share of the amounts, if any, allocated to
Mississippi Counsel pursuant to this section.

SECTION 15. Credits and Limitations.

Notwithstanding any other provision of this Agreement, all payments by
Settling Defendants with respect to Fee Awards shall be subject to the
following:

(a) Notwithstanding any other provision of this Agreement, the advances
against future payments to Mississippi Counsel made pursuant to section 10
hereof shall be credited against and shall reduce the payments due to
Mississippi Counsel hereunder, beginning with the first quarterly payment for
1999 pursuant to section 14 hereof, in an amount equal to 50% of the payment in
question, until the advances paid by Settling Defendants are fully credited;
provided, however, that the sum of all such credits applied in any calendar year
with respect to the advances made to Mississippi Counsel pursuant to section 10
hereof shall not exceed $50 million. The amount of any credit made against any
such payment to Mississippi Counsel shall be counted in computing the annual and
quarterly aggregate national caps on all payments made with respect to Private
Counsel, in the amount of the credit applied to any such payment to Mississippi
Counsel in any quarterly or annual period.

(b) Under no circumstances shall Settling Defendants be required to make
payments that would result in aggregate national payments by Participating
Defendants with respect to Fee Awards:

(i) for 1997, totaling more than $250 million;

13
<PAGE>

(ii) during 1998, totaling more than $500 million, except insofar as
payments under the separate $250 million cap for 1997 are made in 1998
pursuant to section 13 hereof, and except insofar as advances are made in
1998 against payments due in years after 1998;

(iii) during any year beginning with 1999, totaling more than $500
million, excluding payments with respect to any Private Counsel's
Allocable Shares for 1998 that are paid in 1999; and

(iv) during any calendar quarter beginning with the first calendar
quarter of 1999, totaling more than $125 million, excluding payments with
respect to any Private Counsel's Allocable Shares for 1998 that are paid
in 1999 and except to the extent that payments with respect to any prior
quarter of the calendar year did not total $125 million.

SECTION 16. Contribution to National Legislation.

If Federal Legislation is enacted that implements the Proposed Resolution,
a three-member national panel including the two permanent members of the Panel
shall consider any application for Fee Awards on behalf of Private Counsel for
contributions made toward the enactment of such Federal Legislation, along with
all applications for Fee Awards for professional fees by any other persons who
claim to have made similar contributions (other than attorneys or agents of
Participating Defendants). No person shall make more than one application for a
Fee Award in connection with any such contributions toward enactment of such
Federal Legislation. All payments with respect to such Fee Awards, if any, shall
be paid on the payment schedule and subject to, and counted in computing, the
annual and quarterly national caps described in sections 12, 13, 14 and 15
hereof.

SECTION 17. Payments on Market Share Basis.

All payments to Mississippi Counsel pursuant to this Agreement shall be
paid by Settling Defendants pro rata in proportion to their respective Market
Shares. Each Settling Defendant shall be severally liable for its share of all
such payments. Under no circumstances shall any such payment or portion thereof
become the joint obligation of Settling Defendants or the obligation of any
party other than the Settling Defendant from which such payment is originally
due, nor shall any Settling Defendant be required to pay a portion of any such
payment greater than its respective Market Share. With respect to payment of the
advances

14
<PAGE>

described in section 10 hereof and the payment for 1997 described in section 11
hereof, the Market Share of each Settling Defendant shall be as provided in
Schedule A hereto. With respect to the payment for 1998 described in section 12
hereof, the Market Share of each Settling Defendant shall be its respective
share of sales of cigarettes, by number of individual cigarettes shipped for
consumption in the United States, for 1998. With respect to all other payments
pursuant to this Agreement, each Settling Defendant's Market Share shall be its
respective share of sales of cigarettes, by number of individual cigarettes
shipped for consumption in the United States, for the 12 month period preceding
the end of the calendar quarter with respect to which such payment is made.

SECTION 18. Determination of Market Share.

In the event of a disagreement between or among any Settling Defendants as
to their respective shares of any payment pursuant to this Agreement (except
payments for which each Settling Defendant's Market Share is expressly provided
herein), each Settling Defendant shall pay its undisputed share of such payment
promptly, on or before the date on which such payment is due, and shall within
21 days submit copies of its federal excise tax reports for the period in
question to a third party to be selected by agreement of Settling Defendants
(the "Third Party"), who shall within three days determine the Market Share of
each Settling Defendant. The decision of the Third Party shall be final and
non-appealable, and shall be communicated by facsimile to each party hereto.
Each Settling Defendant shall, within two business days of receipt of the Third
Party's decision, pay Mississippi Counsel or such other Settling Defendant, as
appropriate, the difference, if any, between (1) the amount that such Settling
Defendant has already paid with respect to the payment in question and (2) the
amount of the payment in question that corresponds to such Settling Defendant's
Market Share as determined by the Third Party, together with interest accrued
from the original date on which the payment in question was due, at the prime
rate, as published in the Wall Street Journal on the latest publication date on
or before the original date on which the payment in question was due, plus 3%.

SECTION 19. Limited Waiver as to Other Terms.

In consideration of Settling Defendants' agreement to the terms hereof,
each Mississippi Counsel hereby covenants and agrees that it will not argue in
any forum (other than in proceedings before the Panel relating to Mississippi
Counsel's application) that the arrangements made in connection with the Texas
Settlement or the Minnesota Settlement for payment of fees to private counsel
for

15
<PAGE>

the States of Texas or Minnesota give rise to any claim or entitlement on the
part of Mississippi Counsel (or any other person) in connection with this
Action.

SECTION 20. State's Identification of Mississippi Counsel.

The Attorney General represents and warrants that Schedule B hereto
contains the names of all Mississippi Counsel.

SECTION 21. Intended Beneficiaries.

No part of this Agreement creates any rights on the part of, or is
enforceable by, any person or entity that is not a party hereto or a person
covered by the release described in section 3 hereof. Nor shall any part of this
Agreement bind any non-party or determine, limit or prejudice the rights of any
such person or entity.

SECTION 22. Definitions.

Terms used herein that are defined in the Settlement Agreement or the
Stipulation of Amendment are, unless otherwise defined herein, used in this
Agreement as defined in the Settlement Agreement or the Stipulation of
Amendment, as applicable.

SECTION 23. Representations of Parties.

The parties hereto hereby represent that this Agreement has been duly
authorized and, upon execution, will constitute a valid and binding contractual
obligation, enforceable in accordance with its terms, of each of the parties
hereto.

SECTION 24. No Admission.

This Agreement is not intended to be and shall not in any event be
construed as, or deemed to be, an admission or concession or evidence of any
liability or wrongdoing whatsoever on the part of any party hereto or any person
covered by the release provided under section 3 hereof. Settling Defendants
specifically disclaim and deny any liability or wrongdoing whatsoever with
respect to the claims released under section 3 hereof and enter into this
Agreement for the sole purposes of memorializing Settling Defendants' rights and
obligations with respect to payment of attorneys' fees pursuant to the
Settlement Agreement

16
<PAGE>

and avoiding the further expense, inconvenience, burden and uncertainty of
potential litigation.

SECTION 25. Non-admissibility.

This Agreement having been undertaken by the parties hereto in good faith
and for settlement purposes only, neither this Agreement nor any evidence of
negotiations relating hereto shall be offered or received in evidence in any
action or proceeding other than an action or proceeding arising under this
Agreement.

SECTION 26. Amendment and Waiver.

This Agreement may be amended only by a written instrument executed by the
Attorney General, Mississippi Counsel and Settling Defendants. The waiver of any
rights conferred hereunder shall be effective only if made by written instrument
executed by the waiving party. The waiver by any party of any breach of this
Agreement shall not be deemed to be or construed as a waiver of any other
breach, whether prior, subsequent or contemporaneous, of this Agreement.

SECTION 27. Notices.

All notices or other communications to any party hereto shall be in
writing (including but not limited to telex, telecopy or similar writing) and
shall be given to the respective parties listed on Schedule C hereto at the
addresses therein indicated. Any party hereto may change the name and address of
the person designated to receive notice on behalf of such party by notice given
as provided in this section including an updated list conformed to Schedule C
hereto.

SECTION 28. Governing Law.

This Settlement Agreement shall be governed by the laws of the State of
Mississippi, without regard to the conflict of law rules of such State.

SECTION 29. Construction.

None of the parties hereto shall be considered to be the drafter of this
Agreement or any provision hereof for the purpose of any statute, case law or
rule of interpretation or construction that would or might cause any provision
to be construed against the drafter hereof.

17
<PAGE>

SECTION 30. Captions.

The captions of the sections of this Agreement are included for
convenience of reference only and shall be ignored in the construction and
interpretation hereof.

SECTION 31. Counterparts.

This Agreement may be executed in counterparts. Facsimile or photocopied
signatures shall be considered as valid signatures as of the date hereof,
although the original signature pages shall thereafter be appended to this
Settlement Agreement.

SECTION 32. Entire Agreement of Parties.

This Agreement contains an entire, complete and integrated statement of
each and every term and provision agreed to by and among the parties hereto with
respect to payment of attorneys' fees by Settling Defendants in connection with
the Action and is not subject to any condition not provided for herein.

IN WITNESS WHEREOF, the parties hereto, through their fully authorized
representatives, have agreed to this Mississippi Fee Payment Agreement as of
this 2nd day of July, 1998.

STATE OF MISSISSIPPI acting by and through
Michael C. Moore, its duly elected and authorized
Attorney General

By: /s/ Michael C. Moore
---------------------------------
Michael C. Moore
Attorney General

18
<PAGE>

PHILIP MORRIS INCORPORATED

By: /s/ Meyer G. Koplow
------------------------------------
Meyer G. Koplow
Counsel

By: /s/ Martin J. Barrington by MGK
------------------------------------
Martin J. Barrington
General Counsel

R.J. REYNOLDS TOBACCO COMPANY

By: /s/ Arthur F. Golden
------------------------------------
Arthur F. Golden
Counsel

By: /s/ Charles A. Blixt by A.F.G.
------------------------------------
Charles A. Blixt
General Counsel

19
<PAGE>

BROWN & WILLIAMSON TOBACCO
CORPORATION

By: /s/ Stephen R. Patton
------------------------------------
Stephen R. Patton
Counsel

By: /s/ F. Anthony Burke
------------------------------------
F. Anthony Burke
Vice President & General Counsel

LORILLARD TOBACCO COMPANY

By: /s/ Arthur J. Stevens by MGK
------------------------------------
Arthur J. Stevens
Senior Vice President & General
Counsel

MISSISSIPPI COUNSEL

By: /s/ Joseph F. Rice
------------------------------------
Joseph F. Rice
Ness, Motley, Loadholt, Richardson
& Poole

20
<PAGE>

By: /s/ Richard F. Scruggs by W.S. Bozeman
--------------------------------------
Richard F. Scruggs
Scruggs, Millette, Bozeman & Dent,
P.A

By: /s/ Don Barrett
--------------------------------------
Don Barrett
Barrett Law Offices

By: /s/ Paul T. Benton
--------------------------------------
Paul T. Benton

By: /s/ Frederick B. Clark
--------------------------------------
Frederick B. Clark

By: /s/ Michael T. Lewis
--------------------------------------
Michael T. Lewis
Lewis & Lewis

21
<PAGE>

By: /s/ David O. McCormick
------------------------------------
David O. McCormick

By: /s/ Charles Victor McTeer
------------------------------------
Charles Victor McTeer
McTeer & Associates

By: /s/ Robert H. Oswald
------------------------------------
Robert H. Oswald
Oswald & Reed

By: /s/ Crymes G. Pittman
------------------------------------
Crymes G. Pittman
Pittman, Germany, Roberts & Welsh

By: /s/ Thomas H. Rhoden
------------------------------------
Thomas H. Rhoden
Rhoden, Lacy, Downey & Colbert

22
<PAGE>

By: /s/ Paul S. Minor
------------------------------------
Paul S. Minor

23
<PAGE>

SCHEDULE A

MARKET SHARE PERCENTAGES

Settling Defendant Percentage
- ------------------ ----------

Philip Morris Incorporated ............................................ 49.9

R.J. Reynolds Tobacco Company.......................................... 24.8

Brown & Williamson Tobacco Corp........................................ 16.4

Lorillard Tobacco Company.............................................. 8.9

----------

TOTAL 100
<PAGE>

SCHEDULE B

DESIGNATION of MISSISSIPPI COUNSEL
by the Attorney General

Ness, Motley, Loadholt, Richardson & Poole (Ronald L. Motley, Joseph F. Rice,
Charles W. Patrick, Jr., Edward J. Westbrook, Ann K. Ritter, J. Anderson Berly,
III, John J. McConnell, Jr., Susan Nial, Robert J. McConnell, Richard L. Akel,
Nancy Worth Davis, Alexandra M. Wagner, Kimberly S. Vroon, Jodi W. Flowers,
Frederick C. Baker, R. Brian Johnson, Cindi Anne Solomon, Jerry Hudson Evans,
Gregory S. Lofstead, William Michael Gruenloh)

Scruggs, Millette, Bozeman & Dent, P.A. (Richard F. Scruggs, W. Steve Bozeman,
Charles J. Mikhail, Lee E. Young, Jennifer A. Coley, Ashley Hutchings Hendren)

Barrett Law Offices (Don Barrett)

Paul T. Benton

Frederick B. Clark

Lewis & Lewis (Michael T. Lewis, Pauline Shular Lewis)

David O. McCormick

McTeer & Associates (Charles Victor McTeer)

Oswald & Reed (Robert H. Oswald, William T. Reed)
<PAGE>

Pittman, Germany, Roberts & Welsh (Crymes G. Pittman, Robert G. Germany, Joseph
E. Roberts, Jr., C. Victor Welsh)

Rhoden, Lacy, Downey & Colbert (Thomas H. Rhoden)

Paul S. Minor

2
<PAGE>

SCHEDULE C

NOTICES

State of Mississippi

Hon. Michael C. Moore
Attorney General's Office
450 High Street
Post Office Box 220
Jackson, MS 39205
Fax: (601) 359-3441

With copies to:

Richard F. Scruggs
Scruggs, Millette, Bozeman & Dent, P.A.
743 Delmas Avenue
Pascagoula, MS 39568-1425
Fax: (228) 762-1207

and:

Joseph F. Rice, Esq.
Ness, Motley, Loadholt, Richardson & Poole
151 Meeting Street, Suite 600
Charleston, SC 29402
Fax: (843) 720-9290

and:

David O. McCormick
707 Watts Avenue
P.O. Box 865
Pascagoula, MS 39568-0865
Fax: (228) 762-4864

(continued)
<PAGE>

Settling Defendants

Philip Morris Incorporated: R.J. Reynolds Tobacco Company:

Martin J. Barrington, Esq. Charles A. Blixt, Esq.
Philip Morris Incorporated R.J. Reynolds Tobacco Company
120 Park Avenue 401 North Main Street
New York, NY 10017-5592 Winston-Salem, NC 27102
Fax: (212) 907-5399 Fax: (336) 741-2998

With a copy to: With a copy to:

Meyer G. Koplow, Esq. Arthur F. Golden, Esq.
Wachtell, Lipton, Rosen & Katz Davis Polk & Wardwell
51 West 52nd Street 450 Lexington Avenue
New York, NY 10019 New York, NY 10017
Fax: (212) 403-2000 Fax: (212) 450-4800

Brown & Williamson Tobacco Corp.: Lorillard Tobacco Company:

F. Anthony Burke, Esq. Arthur J. Stevens, Esq.
Brown & Williamson Tobacco Corp. Lorillard Tobacco Company
200 Brown & Williamson Tower 714 Green Valley Road
401 South Fourth Avenue Greensboro, NC 27408
Louisville, KY 40202 Fax: (336) 335-7707
Fax: (502) 568-7297

With a copy to:

Stephen R. Patton, Esq.
Kirkland & Ellis
200 East Randolph Dr.
Chicago, IL 60601
Fax: (312) 861-2200

(continued)

2
<PAGE>

Mississippi Counsel

Joseph F. Rice, Esq. Richard F. Scruggs
Ness, Motley, Loadholt, Scruggs, Millette, Bozeman & Dent, P.A.
Richardson & Poole 743 Delmas Avenue
151 Meeting Street, Suite 600 Pascagoula, MS 39568-1425
Charleston, SC 29402 Fax: (228) 762-1207
Fax: (843) 720-9290

Don Barrett, Esq. Paul T. Benton, Esq.
Barrett Law Offices Attorney At Law
P.O. Box 987 P.O. Box 1341
Lexington, Mississippi 39095 Biloxi, MS 39533-1341
Fax 1: (850) 654-4072 Fax: (228) 432-0336
Fax 2: (601) 948-6187

Frederick B. Clark, Esq. Michael T. Lewis
Attorney At Law Lewis & Lewis
P.O. Box 1806 P.O. Box 1600
Greenwood, MS 38930 Clarksdale, MS 38614
Fax: (601) 455-1282 Fax: (601) 627-2267

David O. McCormick, Esq. Charles Victor McTeer, Esq.
707 Watts Avenue McTeer & Associates
P.O. Box 865 P.O. Box 1835
Pascagoula, MS 39568-0865 Greenville, MS 38702
Fax: (228) 762-4864 Fax: (601) 334-6847

Robert H. Oswald, Esq. Crymes Pittman, Esq.
Oswald & Reed Pittman, Germany, Roberts & Welsh
3106 Canty Street 401 S. President Street
Pascagoula, MS 39567 Jackson, MS 39201
Fax: (228) 769-9019 Fax: (601) 948-6187

(continued)

3
<PAGE>

Thomas H. Rhoden, Esq. Paul S. Minor, Esq.
Rhoden, Lacy, Downey & Colbert Minor & Associates
111 Park Circle Drive 400 Main Street
Flowood, MS 39208 Biloxi, MS 39530
Fax: (601) 936-2515 Fax: (228) 374-6630

<PAGE>
Exhibit 10.3

MFN ESCROW AGREEMENT

This escrow agreement (the "MFN Escrow Agreement") is entered into as of
July 2, 1998 by and among Philip Morris Incorporated, R.J. Reynolds Tobacco
Company, Brown & Williamson Tobacco Corporation and Lorillard Tobacco Company
(collectively and severally, "Settling Defendants" and each individually a
"Settling Defendant"), the State of Mississippi and SouthTrust Bank, N.A., as
escrow agent (the "MFN Escrow Agent").

WITNESSETH:

WHEREAS, the State of Mississippi and Settling Defendants entered into a
comprehensive settlement agreement and release as of October 17, 1997 (the
"Settlement Agreement"), setting forth the terms and conditions of an agreement
to settle and resolve with finality all present and future claims relating to
the subject matter of the litigation entitled In re Mike Moore, Attorney
General, ex rel. State of Mississippi Tobacco Litig., Cause No. 94-1429 (Miss.
Ch. Ct., Jackson County) (the "Action"), in the Chancery Court of Jackson
County, Mississippi (the "Court");

WHEREAS, the State of Mississippi and Settling Defendants entered into a
Stipulation of Amendment to Settlement Agreement and for Entry of Agreed Order
(the "Stipulation of Amendment") on July 2, 1998, paragraph 17 of which provides
for Court approval of the Stipulation of Amendment;

WHEREAS, paragraph 5 of the Stipulation of Amendment provides that, on the
dates specified therein, each Settling Defendant shall severally pay to the
State of Mississippi, pro rata in proportion to its Market Share, its respective
share of the amounts indicated for each date;

WHEREAS, paragraph 17 of the Stipulation of Amendment further provides
that all payments described in the Stipulation of Amendment shall be paid into a
special escrow account (and if so paid shall remain in said escrow account)
until such time as (1) the time for appeal or to seek review of the Court's
order approving this Stipulation of Amendment has expired without the filing of
any notice of appeal or petition for review; or (2) in the event of any such
appeal or petition, the appeal or the petition has been dismissed or the Court's
order has been affirmed in all material respects by the court of last resort to
which such appeal or petition has been taken and such dismissal or affirmance
has become no longer subject to further appeal or review (the "Availability
Date"); and

<PAGE>

WHEREAS, the parties hereto believe that at least one of the payments
described in the preceding paragraphs may be made prior to the Availability
Date:

NOW, THEREFORE, the parties hereto agree as follows:

SECTION 1. Appointment of MFN Escrow Agent.

Settling Defendants and the State of Mississippi hereby appoint the MFN
Escrow Agent to act as escrow agent on the terms and conditions set forth
herein, and the MFN Escrow Agent hereby accepts such appointment on such terms
and conditions.

SECTION 2. Deposit.

In the event that any payment pursuant to paragraph 5 of the Stipulation
of Amendment becomes due on a date prior to the Availability Date, each Settling
Defendant shall severally deliver to the MFN Escrow Agent in immediately
available funds such Settling Defendant's respective share of the payment in
question (the sum of such shares being the "Initial Deposit"). Upon receipt, the
MFN Escrow Agent shall deposit the Initial Deposit into a separate escrow
account established for such purpose and governed by the terms of this MFN
Escrow Agreement (the "MFN Escrow Account"). Any subsequent payment pursuant to
the Stipulation of Amendment that becomes due prior to the Availability Date
shall be delivered to the MFN Escrow Agent and added to the Initial Deposit (the
Initial Deposit and any subsequent payments deposited into the MFN Escrow
Account, including any payments of interest or other income on investment of the
MFN Escrow Amount or any portion thereof, being the "MFN Escrow Amount") and
shall be governed by the terms of this MFN Escrow Agreement. All such deliveries
of funds are subject to the right of Settling Defendants to obtain, pursuant to
section 4(a) of this MFN Escrow Agreement, prompt return of the entire MFN
Escrow Amount (less appropriate deductions for administrative fees and expenses,
including taxes and other related costs) in the event that the Stipulation of
Amendment is cancelled and terminated pursuant to paragraph 17 of the
Stipulation of Amendment. The MFN Escrow Amount shall be maintained, invested
and disbursed by the MFN Escrow Agent strictly in accordance with this MFN
Escrow Agreement.

SECTION 3. Investment of MFN Escrow Amount.

2
<PAGE>

repurchase agreements fully collateralized by securities of the kind specified
in clause (i) above; (iii) money market accounts maturing within 30 days of the
acquisition thereof and issued by a bank or trust company organized under the
laws of the United States of America or a State thereof (a "United States Bank")
and having a combined capital surplus in excess of $250,000,000; or (iv) demand
deposits with any United States Bank or any federal savings and loan institution
having a combined capital surplus in excess of $250,000,000. Any loss on any
such investment, including, without limitation, any penalty for any liquidation
required to fund a disbursement, shall be borne pro rata by the parties in
proportion to their ultimate entitlement to the MFN Escrow Amount. The MFN
Escrow Agent's fees and all expenses, including taxes and other related costs,
shall, to the extent possible, be paid out of income earned. Whenever the MFN
Escrow Agent shall pay all or any part of the MFN Escrow Amount to any party as
provided herein, the MFN Escrow Agent shall also pay to such party all interest
and profits earned to the date of payment on such amount, less deductions for
fees and all expenses, including taxes and other related fees.

SECTION 4. Release of the MFN Escrow Amount.

After receipt, the MFN Escrow Agent shall deliver the MFN Escrow Amount as
set forth below:

(a) Following receipt of written notice signed by counsel for the
Settling Defendants certifying that such notice has been delivered by
counsel for the Settling Defendants to all parties hereto and stating that
the Stipulation of Amendment has not received court approval or has been
canceled, terminated or has otherwise become null and void for any reason,
the MFN Escrow Agent shall upon the expiration of ten (10) business days
following the MFN Escrow Agent's receipt of notice, and without an order
of the Court, disburse the entire MFN Escrow Amount (including any
interest thereon, as provided in Section 3) to the Settling Defendants on
the same pro rata basis as such funds were contributed to the MFN Escrow
Account.

(b) Upon receipt of written notice signed by counsel for the
Settling Defendants and counsel for the State of Mississippi stating that
the Availability Date has occurred, the MFN Escrow Agent shall proceed to
distribute the MFN Escrow Amount.

3
<PAGE>

Escrow Amount for any such charge until it shall have presented its
statement to and received approval by counsel for the Settling Defendants
and counsel for the State of Mississippi, which approval shall not be
unreasonably withheld. Such approval shall be deemed given if the MFN
Escrow Agent has not received written objections from either counsel for
Settling Defendants or counsel for the State of Mississippi within 14 days
after presentment of its statement. Such fees and all expenses charged
against the MFN Escrow Amount shall, to the extent possible, be paid out
of interest earned. In the event that counsel for the Settling Defendants
or counsel for the State of Mississippi objects in writing to such fees,
the MFN Escrow Agent shall not debit the MFN Escrow Amount except upon a
court order approving such fees.

SECTION 5. Substitute Form W-9; Qualified Settlement Fund.

Each of the signatories to this MFN Escrow Agreement shall provide the MFN
Escrow Agent with a correct taxpayer identification number on a substitute Form
W-9 within 90 days of the date hereof and indicate thereon that it is not
subject to backup withholding. It is anticipated that the MFN Escrow Account
established pursuant to this MFN Escrow Agreement shall be treated as a
Qualified Settlement Fund for federal tax purposes pursuant to Treas. Reg. ss.
1.468B-1.

SECTION 6. Termination of MFN Escrow Account.

This MFN Escrow Agreement (other than the MFN Escrow Agent's right to
indemnification set forth in Section 7) shall terminate when the MFN Escrow
Agent shall have released from the MFN Escrow Account all amounts pursuant to
Section 4 hereof.

SECTION 7. MFN Escrow Agent.

(a) The MFN Escrow Agent shall have no duty or obligation hereunder
other than to take such specific actions as are required of it from time
to time under the provisions hereof, and it shall incur no liability
hereunder or in connection herewith for anything whatsoever other than as
a result of its own negligence or willful misconduct. The MFN Escrow Agent
shall be fully protected if it acts in accordance with the written advice
of its counsel. In the event the MFN Escrow Agent fails to receive the
instructions contemplated by Section 4 hereof or receives conflicting
instructions, the MFN Escrow Agent shall be fully protected in refraining
from acting until such instructions are received or such conflict is
resolved by written agreement or court order.

<PAGE>

(b) Settling Defendants, on the same pro rata basis as the funds
constituting the MFN Escrow Amount were contributed to the MFN Escrow
Account, agree to indemnify, hold harmless and defend the MFN Escrow Agent
from and against any and all losses, claims, liabilities and reasonable
expenses, including the reasonable fees of its counsel, which it may
suffer or incur hereunder or in connection herewith prior to the
Availability Date, except such as shall result solely and directly from
its own negligence or willful misconduct. The MFN Escrow Agent shall not
be bound in any way by any agreement or contract between Settling
Defendants and the State of Mississippi (whether or not the MFN Escrow
Agent has knowledge thereof) and the only duties and responsibilities of
the MFN Escrow Agent shall be to hold and invest the MFN Escrow Amount
received hereunder and to release such MFN Escrow Amount in accordance
with the terms of this MFN Escrow Agreement.

(c) The MFN Escrow Agent may resign at any time by giving written
notice thereof to the other parties hereto, but such resignation shall not
become effective until a successor MFN Escrow Agent, selected by the
Settling Defendants and agreeable to the State of Mississippi, shall have
been appointed and shall have accepted such appointment in writing. If an
instrument of acceptance by a successor MFN Escrow Agent shall not have
been delivered to the MFN Escrow Agent within 30 days after the giving of
such notice of resignation, the resigning MFN Escrow Agent may, at the
expense of the Settling Defendants and the State of Mississippi (to be
shared equally between the State of Mississippi and the Settling
Defendants), petition the Court for the appointment of a successor MFN
Escrow Agent.

(d) Upon the Availability Date having occurred, provided that
Settling Defendants have performed all of their obligations required to be
performed prior to the Availability Date, all duties and obligations of
Settling Defendants hereunder shall cease, with the exception of any
indemnification obligation of Settling Defendants incurred prior to the
Availability Date.

SECTION 8. Miscellaneous.

(a) Notices. All notices or other communications to any party or
other person hereunder shall be in writing (which shall include telex,
telecopy or similar writing) and shall be given to the respective parties
or persons at the following addresses. Any party or person may change the
name and address of the person designated to receive notice on behalf of
such party or person by notice given as provided in this paragraph.

<PAGE>

State of Mississippi:

Hon. Michael C. Moore
Attorney General's Office
450 High Street
Post Office Box 220
Jackson, MS 39205
Fax: (601) 359-3441

With copies to:

Richard F. Scruggs
Scruggs, Millette, Bozeman & Dent, P.A.
P.O. Drawer 1425
743 Delmas Avenue
Pascagoula, MS 39568-1425
Fax: (228) 762-1207

and:

Joseph F. Rice, Esq.
Ness, Motley, Loadholt, Richardson & Poole
151 Meeting Street, Suite 600
Charleston, SC 29402
Fax: (843) 720-9290

and:

David O. McCormick
707 Watts Avenue
P.O. Box 865
Pascagoula, MS 39568-0865
Fax: (228) 762-4864

Settling Defendants:

For Philip Morris Incorporated:
Martin J. Barrington
Philip Morris Incorporated
120 Park Avenue
New York, NY 10017-5592
Fax: (212) 907-5399

6
<PAGE>

With a copy to:

Meyer G. Koplow
Wachtell, Lipton, Rosen & Katz
51 West 52nd Street
New York, NY 10019
Fax: (212) 403-2000

For R.J. Reynolds Tobacco Company:

Charles A. Blixt
R.J. Reynolds Tobacco Company
401 North Main Street
Winston-Salem, NC 27102
Fax: (336) 741-2998

With a copy to:

Arthur F. Golden
Davis Polk & Wardwell
450 Lexington Avenue
New York, NY 10017
Fax: (212) 450-4800

For Brown & Williamson Tobacco Corporation:

Michael Walter
Brown & Williamson Tobacco Corporation
200 Brown & Williamson Tower
401 South Fourth Avenue
Louisville, KY 40202
Fax: (502) 568-7187

With a copy to:

F. Anthony Burke
Brown & Williamson Tobacco Corporation
200 Brown & Williamson Tower
401 South Fourth Avenue
Louisville, KY 40202
Fax: (502) 568-7297

7
<PAGE>

For Lorillard Tobacco Company:
Arthur J. Stevens
Lorillard Tobacco Company
714 Green Valley Road
Greensboro, NC 27408
Fax: (336) 335-7707

MFN Escrow Agent:

SouthTrust Bank, N.A.
854 Howard Avenue
Post Office Box 1419
Biloxi, MS 39530
Phone: (228) 436-8656
Fax: (228) 436-8689

Wire Transfer Instructions:
ABA #: 062000080
Account #: 62-780173
Account Name: Mississippi MFN Escrow Account

(b) Successors and Assigns. The provisions of this MFN Escrow
Agreement shall be binding upon and inure to the benefit of the parties
hereto and their respective successors and assigns.

(c) Governing Law. This MFN Escrow Agreement shall be construed in
accordance with and governed by the laws of the State of Mississippi,
without regard to the conflicts of law rules of such state.

(d) Jurisdiction and Venue. The parties hereto irrevocably and
unconditionally submit to the jurisdiction of the Court for purposes of
any suit, action or proceeding seeking to enforce any provision of, or
based on any right arising out of, this MFN Escrow Agreement, and the
parties hereto agree not to commence any such suit, action or proceeding
except in such Court. The parties hereto hereby irrevocably and
unconditionally waive any objection to the laying of venue of any such
suit, action or proceeding in the Court and hereby further irrevocably
waive and agree not to plead or claim in such Court that any such suit,
action or proceeding has been brought in an inconvenient forum.

(e) Definitions. Terms used herein that are defined in the
Settlement Agreement or the Stipulation of Amendment are, unless otherwise
defined herein, used in this MFN Escrow Agreement as defined

8
<PAGE>

in the Settlement Agreement or the Stipulation of Amendment, as
appropriate.

(f) Amendments. This MFN Escrow Agreement may be amended only by
written instrument executed by all parties hereto. The waiver of any
rights conferred hereunder shall be effective only if made by written
instrument executed by the waiving party. The waiver by any party of any
breach of this MFN Escrow Agreement shall not be deemed to be or construed
as a waiver of any other breach, whether prior, subsequent or
contemporaneous, of this MFN Escrow Agreement.

(g) Counterparts; Effectiveness. This MFN Escrow Agreement may be
signed in any number of counterparts, each of which shall be an original,
with the same effect as if the signatures thereto and hereto were upon the
same instrument. This MFN Escrow Agreement shall become effective when
each party hereto shall have signed a counterpart hereof. Delivery by
facsimile of a signed agreement shall be deemed delivery for purposes of
acknowledging acceptance hereof; however, an original executed signature
page must promptly thereafter be appended to this MFN Escrow Agreement,
and an original executed agreement shall promptly thereafter be delivered
to each party hereto.

(h) Captions. The captions herein are included for convenience of
reference only and shall be ignored in the construction and interpretation
hereof.

IN WITNESS WHEREOF, the parties have executed this MFN Escrow Agreement as
of the day and year first hereinabove written.

STATE OF MISSISSIPPI

By: /s/ Michael C. Moore
-------------------------------
Michael C. Moore
Attorney General

<PAGE>

PHILIP MORRIS INCORPORATED

By: /s/ Meyer G. Koplow
---------------------------------------
Meyer G. Koplow
Counsel

R.J. REYNOLDS TOBACCO COMPANY

By: /s/ Arthur F. Golden
---------------------------------------
Arthur F. Golden
Counsel

BROWN & WILLIAMSON TOBACCO
CORPORATION

By: /s/ Stephen R. Patton
---------------------------------------
Stephen R. Patton
Counsel

LORILLARD TOBACCO COMPANY

By: /s/ Arthur J. Stevens by MGK
---------------------------------------
Arthur J. Stevens
Senior Vice President & General Counsel

<PAGE>

SOUTHTRUST BANK, N.A.
as MFN Escrow Agent

By: /s/ Walter H. Stuart, III
-------------------------------
Name: Walter H. Stuart, III
Title: President & CEO

<PAGE>

Exhibit 10.4

IN THE UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF TEXAS
TEXARKANA DIVISION

____________________________________
)
STATE OF TEXAS, )
)
Plaintiff, )
)
vs. ) No. 5-96CV-91
)
AMERICAN TOBACCO )
COMPANY, et al., )
)
Defendants. )
____________________________________)

STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT
AND FOR ENTRY OF CONSENT DECREE

THIS STIPULATION OF AMENDMENT TO SETTLEMENT AGREEMENT AND FOR ENTRY OF
CONSENT DECREE (the "Stipulation of Amendment") is made as of the date hereof,
by and among the parties hereto, as indicated by their signatures below, to
amend the Comprehensive Settlement Agreement and Release entered into by the
parties hereto with respect to this Action on January 16, 1998 (the "Settlement
Agreement").

WHEREAS, on January 16, 1998, the State of Texas and Settling Defendants
entered into the Settlement Agreement to settle and resolve with finality all
present and future civil claims against all parties to this litigation

<PAGE>

relating to the subject matter of this litigation which have been or could have
been asserted by any of the parties hereto;

WHEREAS, the Settlement Agreement was approved and adopted as an
enforceable order of the Court pursuant to Court Order dated January 22, 1998.

WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause
which provides that, in the event that Settling Defendants enter into a future
pre-verdict settlement agreement of other litigation brought by a non-federal
governmental plaintiff on terms more favorable to such governmental plaintiff
than the terms of the Settlement Agreement (after due consideration of relevant
differences in population or other appropriate factors), the terms of the
Settlement Agreement shall be revised so that the State of Texas will obtain
treatment at least as relatively favorable as any such non-federal governmental
entity;

WHEREAS, on May 8, 1998, Settling Defendants Philip Morris Incorporated,
R.J. Reynolds Tobacco Company, Brown & Williamson Tobacco Corporation and
Lorillard Tobacco Company (the "MFN Settling Defendants") entered into a
pre-verdict settlement agreement with the State of Minnesota (the "Minnesota
Settlement") to resolve the lawsuit State of Minnesota v. Philip Morris Inc.,
No. C1-94-8565 (Dist. Ct. Ramsey County, filed Aug. 17, 1994);

2
<PAGE>

WHEREAS, the State of Texas and MFN Settling Defendants agree that,
pursuant to the Most Favored Nation clause of the Settlement Agreement, the
Settlement Agreement is to be revised in light of the Minnesota Settlement;

WHEREAS, the State of Texas and Settling Defendants have agreed on the
terms of revisions to the Settlement Agreement, including revisions in light of
the Minnesota Settlement, as set forth in this Stipulation of Amendment and the
attached Consent Decree; and

WHEREAS, the parties hereto have further agreed jointly to petition the
Court for approval of the Consent Decree:

1. Amendment of Settlement Agreement. The provisions of this Stipulation
of Amendment supplement the terms of the Settlement Agreement, which shall
remain in full force and effect except insofar as they are expressly

3
<PAGE>

revised by the provisions of this Stipulation of Amendment. Nothing in this
Stipulation of Amendment shall be construed to release Settling Defendants from
any of the obligations assumed in paragraphs 6 (Elimination of Billboards and
Transit Advertisements), 8 (Initial Payments) and 9 (Pilot Program Payments) of
the Settlement Agreement.

2. Voluntary Agreement of the Parties. This Stipulation of Amendment is
entered into voluntarily by the parties hereto. The State and Settling
Defendants understand that Congress may enact legislation dealing with some of
the issues addressed in the Settlement Agreement, this Stipulation of Amendment
or the Consent Decree. The MFN Settling Defendants and their assigns,
affiliates, agents and successors hereby voluntarily waive any right to
challenge the Settlement Agreement, this Stipulation of Amendment or the Consent
Decree, directly or through third parties, on the ground that any term thereof
or hereof is unconstitutional, outside the power or jurisdiction of the Court or
preempted by or in conflict with any current or future federal legislation
(except insofar as the non-economic terms of the Settlement Agreement (as
revised hereby) or the Consent Decree are irreconcilable with any such future
federal legislation). The Court may, upon the State's application, enter a
Consent Decree in the form attached as Exhibit 1 hereto.

4
<PAGE>

3. Definitions. For the purposes of the Settlement Agreement, this
Stipulation of Amendment and the Consent Decree, the following terms shall have
the meanings set forth below:

(a) "Consumer Price Index" means the Consumer Price Index for All
Urban Consumers for the most recent twelve-month period for which such
percentage information is available, as published by the Bureau of Labor
Statistics of the U.S. Department of Labor;

(b) "Market Share" means a Settling Defendant's respective share of
sales of Cigarettes, by number of individual Cigarettes shipped in the
United States for domestic consumption, as measured by such Settling
Defendant's audited reports of shipments of Tobacco Products provided to
the U.S. Securities and Exchange Commission ("SEC") (or, in the case of
any Settling Defendant that does not provide such reports to the SEC,
audited reports of shipments containing the same shipment information as
contained in the reports provided to the SEC) ("Shipment Reports"), during
(i) with respect to payments made pursuant to paragraph 7 of this
Stipulation of Amendment, the calendar year ending on the date on which
the payment at issue is due (or, in the case of the payment due on
November 1, 1998, the calendar year ending December 31, 1998), regardless
of when such payment is made, and (ii) with respect to all other

5
<PAGE>

payments made pursuant to this Stipulation of Amendment and the Settlement
Agreement, the calendar year immediately preceding the year in which the
payment at issue is due, regardless of when such payment is made;

(d) "Smokeless Tobacco" means any product that consists of cut,
ground, powdered or leaf tobacco that contains nicotine and that is
intended to be placed in the oral cavity;

(e) "Tobacco Products" means Cigarettes and Smokeless Tobacco; and

6
<PAGE>

(f) "Children" means persons under the age of 18.

The above definitions supplement the definitions provided in the Settlement
Agreement and, insofar as they differ, supersede them.

4. Settlement Receipts. The payments to be made by Settling Defendants
under this Stipulation of Amendment during the year 1998 are in settlement of
the State's claims for reimbursement for public health expenditures of the State
of Texas incurred in the year of payment or earlier years related to the subject
matter of this Action, including without limitation expenditures made by the
State's Employees' Health Insurance Program and Charity Care programs. All other
payments made by Settling Defendants pursuant to this Stipulation of Amendment
are in settlement of all of the State of Texas's claims for damages incurred by
the State in the year of payment or earlier years related to the subject matter
of this Action, including claims for reimbursement of Medicaid expenditures and
punitive damages, except that no part of any payment under the Settlement
Agreement or this Stipulation of Amendment is made in settlement of an actual or
potential liability for a fine, penalty (civil or criminal) or enhanced damages
or as the cost of a tangible or intangible asset or other future benefit.

5. Supplemental Initial Payment. Each MFN Settling Defendant severally
shall cause to be paid into the registry of the court and in accordance with and
subject to paragraph 17 of this Stipulation of Amendment, pro rata in proportion
to

7
<PAGE>

its Market Share, its share of $156,530,000, to be paid on or before January 4,
1999; its share of $605,090,000, to be paid on or before January 3, 2000; its
share of $605,090,000, to be paid on or before January 2, 2001; its share of
$605,090,000, to be paid on or before January 2, 2002; and its share of
$303,200,000, to be paid on or before January 2, 2003. The payments made by MFN
Settling Defendants pursuant to this paragraph shall be adjusted upward by the
greater of 3% or the actual total percent change in the Consumer Price Index
applied each year on the previous year, beginning with the payment due to be
made on or before January 3, 2000. The payments due to be made by MFN Settling
Defendants pursuant to this paragraph 5 on or before January 3, 2000, on or
before January 2, 2001, on or before January 2, 2002, and on or before January
2, 2003, will also be decreased or increased, as the case may be, in accordance
with the formula for adjustment of payments set forth in Appendix A hereto. The
payment due to be made by MFN Settling Defendants pursuant to this paragraph 5
on or before January 4, 1999, shall not be subject to adjustment for inflation
or in accordance with the formula for adjustment of payments set forth in
Appendix A hereto.

6. Acceleration of Supplemental Initial Payment. In the event that any MFN
Settling Defendant fails to make any payment required of it pursuant to
paragraph 5 of this Stipulation of Amendment (a "Defaulting Defendant") by the

8
<PAGE>

applicable date set forth in such paragraph 5 (a "Missed Payment"), the State of
Texas shall provide notice to each of the MFN Settling Defendants of such
non-payment. The Defaulting Defendant shall have 15 days after receipt of such
notice to pay the Missed Payment, together with interest accrued from the
original applicable due date at the prime rate as published in the Wall Street
Journal on the latest publication date on or before the date of default plus 3%.
If the Defaulting Defendant does not make such payment within such 15-day
period, the State of Texas shall have the option of providing notice to each of
the MFN Settling Defendants of such continued non-payment. In the event that the
State of Texas elects to provide such notice, any or all of the MFN Settling
Defendants (other than the Defaulting Defendant) shall have 15 days after
receipt of such notice to elect (in such MFN Settling Defendant's or such MFN
Settling Defendants' sole and absolute discretion) to pay the Missed Payment,
together with interest accrued from the original applicable due date at the
prime rate as published in the Wall Street Journal on the latest publication
date on or before the date of default plus 3%. In the event that the State of
Texas does not receive the Missed Payment, together with such accrued interest,
within such additional 15-day period, all future payments required to be made by
each of the respective MFN Settling Defendants pursuant to paragraph 5 of this
Stipulation of Amendment shall at the end of such additional 15-day period be
accelerated and immediately become due and owing to

9
<PAGE>

the State of Texas from each MFN Settling Defendant, pro rata in proportion to
its Market Share; provided, however, that such accelerated payments (a) shall
all be adjusted upward by the greater of (i) the rate of 3% per annum or (ii)
the actual total percent change in the Consumer Price Index, in either instance
for the period between January 1 of the year in which the acceleration of
payments pursuant to this paragraph occurs and the date on which such
accelerated payments are made pursuant to this paragraph 6, and (b) shall all
immediately be adjusted in accordance with the formula for adjustment of
payments set forth in Appendix A hereto.

Nothing in this paragraph 6 shall be deemed under any circumstance to
create any obligation on the part of any MFN Settling Defendant to pay any
amount owed or payable to the State of Texas by any other MFN Settling
Defendant. All obligations of the MFN Settling Defendants pursuant to this
paragraph 6 are intended to be and shall remain several, and not joint.

7. Annual Payments. Each of the Settling Defendants agrees that it shall
severally cause to be paid into the registry of the Court, in accordance with
and subject to paragraph 17 of this Stipulation of Amendment, pro rata in
proportion to its Market Share, its share of the following payments (subject to
adjustment for appropriate allocation among Settling Defendants by January 30,
1999): $89

10
<PAGE>

million to be paid on or before November 1, 1998; and $201 million to be paid on
or before December 31, 1998.

Each of the Settling Defendants further agrees that, on December 31, 1999
and annually thereafter on December 31st of each year after 1999 (subject to
final adjustment within 30 days), it shall severally cause to be paid into the
registry of the Court and in accordance with and subject to paragraph 17 of this
Stipulation of Amendment, pro rata in proportion to its Market Share, its share
of 7.25% of the following amounts (in billions):

Year 1999 2000 2001 2002 2003 thereafter
----
2 3 4 5 6

Amount $4.5B $5B $6.5B $6.5B $8B $8B
------

The payments made by Settling Defendants pursuant to this paragraph 7
shall be adjusted upward by the greater of 3% or the actual total percent change
in the Consumer Price Index applied each year on the previous year, beginning
with the annual payment due on December 31, 1999. Such payments will also be
decreased or increased, as the case may be, beginning with the annual payment
due on December 31, 1999, in accordance with the formula for adjustment of
payments set forth in Appendix A hereto. Settling Defendants shall pay the
payments due pursuant to this paragraph 7 on November 1, 1998 and December 31,
1998 without adjustment for inflation or in accordance with the formula for
adjustments of payments set forth in Appendix A hereto. This paragraph 7
supersedes paragraph

11
<PAGE>

10 of the Settlement Agreement, which is hereby rendered null, void and of no
further effect.

8. Determination of Market Share. In the event of a disagreement between
or among any Settling Defendants as to their respective shares of any payment
due to be paid on a Market Share basis pursuant to the Settlement Agreement and
this Stipulation of Amendment, each Settling Defendant shall pay its undisputed
share of such payment promptly on or before the date on which such payment is
due, and shall, within 21 days of such date, submit its Shipment Reports for the
year in question to a third party to be selected by agreement of Settling
Defendants (the "Third Party"), who shall determine the Market Share of each
Settling Defendant within three business days of receipt of such Shipment
Reports. The decision of the Third Party shall be final and non-appealable, and
shall be communicated by facsimile to each person designated to receive notice
hereunder. Each Settling Defendant shall, within two business days of receipt of
the Third Party's decision, pay the State or such other Settling Defendant, as
appropriate, the difference, if any, between (1) the amount that such Settling
Defendant has already paid with respect to the payment in question and (2) the
amount of the payment in question that corresponds to such Settling Defendant's
Market Share as determined by the Third Party, together with interest accrued
from the original date on which the payment in question was due, at the prime
rate as published in the Wall Street

12
<PAGE>

Journal on the latest publication date on or before the original date on which
the payment in question was due plus 3%.

(a) MFN Settling Defendants shall be entitled to receive a dollar
for dollar offset against the annual payments required under paragraph 7
of this Stipulation of Amendment of any amounts that the State of Texas
could elect to receive pursuant to such Tobacco Legislation ("Federal
Settlement Funds"), up to the full amount of such annual payments, except
to the extent that:

(i) such Federal Settlement Funds are required to be used for
purposes other than health care or tobacco-related purposes;

(ii) such Tobacco Legislation provides the opportunity for
other states to elect to receive Federal Settlement Funds but does
not provide for the abrogation, settlement or relinquishment of any
tobacco-related claims of such states that have not previously been
resolved; or

13
<PAGE>

(iii) state receipt of such Federal Settlement Funds is
conditioned upon (A) the relinquishment of rights or benefits under
the Settlement Agreement (including this Stipulation of Amendment
and the Consent Decree) (excepting any annual payment amounts
subject to the offset); or (B) actions or expenditures by the state
unrelated to health care or tobacco (including but not limited to
tobacco education, cessation, control or enforcement).

(b) Nothing in this paragraph 9 shall reduce (i) the payments made
to the State of Texas pursuant to paragraphs 8 and 9 of the Settlement
Agreement and paragraphs 5 and 6 of this Stipulation of Amendment (by
offset, credit, recoupment, refund or otherwise); or (ii) the percentage
figure (7.25%) used to determine the State of Texas's annual payments
pursuant to paragraph 7 of this Stipulation of Amendment. Nothing in this
paragraph 9 is intended to or shall reduce the total amounts payable by
MFN Settling Defendants to the State of Texas under the Settlement
Agreement (as revised hereby) by an amount greater than the amount of
Federal Settlement Funds that the State of Texas could elect to receive.

This paragraph 9 supersedes paragraph 12 of the Settlement Agreement,
which is hereby rendered null, void and of no further effect.

14
<PAGE>

10. Clarification of Scope of State's Release. The release of claims
provided in paragraph 14 of the Settlement Agreement shall, with respect to the
Claims identified in subparagraph (2) thereof, apply only to monetary Claims.
This paragraph 10 does not supersede but rather supplements and clarifies the
scope of the release provided in paragraph 14 of the Settlement Agreement.

11. Limited Most-Favored Nation Provision. In partial consideration for
the monetary payments to be made by MFN Settling Defendants pursuant to this
Stipulation of Amendment, the State of Texas agrees that, if MFN Settling
Defendants enter into any future pre-verdict settlement agreement of other
similar litigation brought by a non-federal governmental plaintiff, or any
amendment to any such existing settlement agreement, on terms more favorable to
such non-federal governmental plaintiff than the terms of the Settlement
Agreement (including this Stipulation of Amendment and the Consent Decree)
(after due consideration of relevant differences in population or other
appropriate factors), the terms of the Settlement Agreement (including this
Stipulation of Amendment and the Consent Decree) shall not be revised except as
follows: to the extent, if any, such other pre-verdict settlement agreement
includes terms that provide:

(a) for joint and several liability among MFN Settling Defendants
with respect to monetary payments to be made pursuant to such agreement;

15
<PAGE>

(b) a guarantee by the parent company of any of MFN Settling
Defendants or other assurances of payment or creditors' remedies with
respect to monetary payments to be made pursuant to such agreement;

(d) for no offset of Federal Settlement Funds against annual
settlement payments pursuant to such settlement agreement; or

(e) for an offset term more favorable to the plaintiff than the
offset provisions of paragraph 9 of this Stipulation of Amendment,

then the Settlement Agreement shall, at the option of the Office of the Attorney
General of the State of Texas, be revised to include terms comparable to such
terms.

This paragraph 11 supersedes paragraph 16 of the Settlement Agreement,
which is hereby rendered null, void and of no further effect as to any MFN
Settling Defendant. The State of Texas hereby acknowledges that, pursuant to the
terms of this paragraph 11, it has irrevocably waived any future claim against
MFN Settling Defendants to revise the terms of the Settlement Agreement or this
Stipulation of Amendment pursuant to paragraph 16 of the Settlement Agreement
(except as

16
<PAGE>

provided in paragraph 23 of this Stipulation of Amendment), and it hereby
further covenants and agrees that, in consideration for MFN Settling Defendants'
agreement to the terms of this Stipulation of Amendment, it shall not hereafter
seek to revise the Settlement Agreement or this Stipulation of Amendment as to
MFN Settling Defendants, except as expressly provided in this paragraph 11 (or
pursuant to mutually agreeable amendment by the parties hereto as provided in
paragraph 23 of the Settlement Agreement and paragraph 19 hereof).

12. MFN Settling Defendants' Assurances. MFN Settling Defendants agree:

(a) to support the legislative initiatives to enact new laws and
administrative initiatives to promulgate new rules described in paragraph
7 of the Settlement Agreement; and

(b) not to support in Congress or any other forum legislation, rules
or policies which would preempt, override, abrogate or diminish the
State's rights or recoveries under the Settlement Agreement (as amended
hereby). Except as specifically provided in the foregoing sentence,
nothing in the Settlement Agreement (including this Stipulation of
Amendment and the Consent Decree) shall be deemed to restrain the parties
from advocating terms of any national settlement or taking any other
positions on issues relating to tobacco.

17
<PAGE>

13. Disclosure of Payments. Each MFN Settling Defendant shall disclose to
the Office of the Attorney General and the Texas Ethics Commission, at the times
and in the manner provided below, information about the following payments:

(a) Any payment to a person required to register under Tex. Gov't
Code Ann. ss.305.005 (West 1998), if the MFN Settling Defendant knows or
has reason to know that the payment will be used, directly or indirectly,
to influence legislative or administrative action or the official action
of state or local government in Texas in any way relating to Tobacco
Products or their use;

(b) Any payment to a third party, if the MFN Settling Defendant
knows the payment is partly in consideration for the third party
attending, offering testimony at, or participating before a state or local
government hearing in Texas in any way relating to Tobacco Products or
their use; and

(c) Any payment (other than a "political contribution" under 2
U.S.C. ss.431(8)(A)) to, or for the benefit of, a state or local official
in Texas, whether made directly by the MFN Settling Defendant or
indirectly through an employee of the MFN Settling Defendant acting within
the scope of his employment, or through an affiliate, lobbyist or other
agent acting under the substantial control of the MFN Settling Defendant.

18
<PAGE>

Disclosures required under this paragraph 13 shall be filed with the Office of
the Attorney General and the Texas Ethics Commission on the first day of
February, May, August and November of each year (beginning November 1, 1998) for
any and all payments made through the first day of the previous month, and shall
be transmitted in electronic format or such format as the Attorney General may
require, with the following information:

o The name, address, telephone number and e-mail address of the
recipient;

o The amount of each payment described in this paragraph 13; and

o The aggregate amount of all payments described in this paragraph 13
to the recipient in the calendar year.

Information disclosed pursuant to this paragraph is "public information" within
the meaning of Tex. Gov't Code Ann. ss. 552.002 (West 1998).

14. Prohibition of Certain Payments for Product Placement. MFN Settling
Defendants shall not make or cause to be made, in connection with any motion
picture made in the United States, any payment, direct or indirect, to any
person to use, display, make reference to or use as a prop any cigarette,
cigarette package, advertisement for cigarettes, or any other item bearing the
brand name, logo, symbol, motto, selling message, recognizable color or pattern
of colors, or any other indicia of product identification identical or similar
to, or identifiable with, those used for any brand of domestic Tobacco Products.

19
<PAGE>

15. Prohibition on Promotional Merchandise. On and after December 31,
1998, MFN Settling Defendants shall permanently cease marketing, licensing,
distributing, selling or offering, directly or indirectly, including by
catalogue or direct mail, in the State of Texas, any item (other than Tobacco
Products or any item of which the sole function is to advertise Tobacco
Products) which bears the brand name (alone or in conjunction with any other
word), logo, symbol, motto, selling message, recognizable color or pattern of
colors, or any other indicia of product identification identical or similar to,
or identifiable with, those used for any brand of domestic Tobacco Products,
except that nothing in this paragraph shall (i) require any MFN Settling
Defendant to terminate, breach or violate any licensing agreement or contract in
existence as of July 1, 1998 for the remaining term of such contract; (ii)
prohibit the distribution to any employee (18 years of age or older) of an MFN
Settling Defendant of any item described above that is intended for the personal
use of such employee by such MFN Settling Defendant; or (iii) prohibit items
necessarily incidental to or ordinarily distributed in connection with any
sponsorship described in paragraph 4(e)(2) of the Settlement Agreement.

16. Document Production. MFN Settling Defendants shall, upon request,
provide to the State of Texas a copy of any CD-ROMs of documents that MFN
Settling Defendants have agreed to produce, pursuant to the Minnesota
Settlement,

20
<PAGE>

to the document depository established in connection with the lawsuit State of
Minnesota v. Philip Morris Inc., No. C1-94-8565 (Dist. Ct. Ramsey County, filed
Aug. 17, 1994), with a copy of the accompanying transmittal letter provided to
each person designated to receive notice hereunder.

17. Court Approval. The parties hereto agree to submit this Stipulation of
Amendment promptly to the Court for its review and approval. If the Court
refuses to approve this Stipulation of Amendment and the Consent Decree in any
respect unacceptable to either of the parties hereto or to enter the Order
Granting Joint Motion for Approval of Agreement Regarding Disposition of
Settlement Proceeds and to Withdraw with Predjudice All Political Subdivisions'
Motions to Intervene (the "Political Subdivisions Order," in the form attached
as Exhibit 2 hereto), or if such approval or the Political Subdivisions Order is
modified in any respect unacceptable to either of the parties hereto or set
aside on appeal, then this Stipulation of Amendment shall be canceled and
terminated and it and all orders issued pursuant hereto (including the Consent
Decree) shall become null and void and of no further effect. Any such
cancellation or termination of this Stipulation of Amendment shall not of itself
result in the cancellation or termination of, or otherwise affect, the
Settlement Agreement as approved by the Court on January 22, 1998. All payments
described in this Stipulation of Amendment shall be paid into a special escrow
account, pursuant to the terms of a mutually acceptable

21
<PAGE>

escrow agreement (the "MFN Escrow Agreement" in the form attached as Exhibit 3
hereto), and if so paid shall remain in said escrow account, until such time as
(1) the 30-day time periods to seek review of the Court's order approving this
Stipulation of Amendment and the Political Subdivisions Order have expired
without the filing of any notice of appeal or petition for review; or (2) in the
event of a timely appeal or petition, the appeal or the petition has been
dismissed or the Court order in question has been affirmed in all material
respects by the court of last resort to which such appeal or petition has been
taken and such dismissal or affirmance has become no longer subject to further
appeal or review. Any payments made into escrow shall be disbursed from escrow
only in strict accordance with the terms of the MFN Escrow Agreement and upon
disbursement shall be transferred into the registry of the Court. All payments
described in this Stipulation of Amendment that are not required to be paid into
the MFN Escrow Account pursuant to this paragraph 17 shall be paid into the
registry of the Court.

18. Payment Responsibility. All obligations of the Settling Defendants
pursuant to the Settlement Agreement and this Stipulation of Amendment are
intended to be and shall remain several, and not joint. Due to the particular
corporate structures of Settling Defendants R.J. Reynolds Tobacco Company
("Reynolds") and Brown & Williamson Tobacco Corporation ("Brown & Williamson")
with respect to their non-domestic tobacco operations, Settling

22
<PAGE>

Defendants Reynolds and Brown & Williamson shall be severally liable for their
respective shares of each payment due pursuant to the Settlement Agreement and
this Stipulation of Amendment up to (and their liability hereunder shall not
exceed) the full extent of their assets used in, and earnings derived from, the
manufacture and sale in the United States of Tobacco Products intended for
domestic consumption, and no recourse shall be had against any of their other
assets or earnings to satisfy such obligations.

19. Applicable Provisions of Settlement Agreement. The provisions of
paragraphs 18 (Representations of Parties), 20 (Headings), 21 (No Admission), 22
(Non-Admissibility), 23 (Amendment), 25 (Cooperation), 26 (Governing Law), 27
(Construction), 28 (Severability), 29 (Intended Beneficiaries) and 30
(Counterparts) of the Settlement Agreement shall be equally applicable to this
Stipulation of Amendment as though fully set forth herein, and all references to
the Settlement Agreement in the sections thereof specifically listed in this
paragraph 19 shall be construed to include this Stipulation of Amendment.

20. Release of Right to Additional Compensation. In consideration for the
terms hereof, including, inter alia, the provisions of paragraph 5 hereof, the
State of Texas hereby irrevocably releases MFN Settling Defendants from any
claim for additional compensation pursuant to paragraphs 17(a) and (d) of the
Settlement Agreement, and the provisions of paragraphs 17(a) and (d) regarding
the State's

23
<PAGE>

rights to additional compensation are hereby rendered null, void and of no
further effect.

21. Discovery Materials. Paragraph 22 of the Settlement Agreement is
hereby modified to permit the Attorney General of the State of Texas to seek the
dissolution of any protective order in this Action governing treatment of
discovery materials during the pendency of this Action (as well as existing
confidentiality designations), but only with regard to materials that have been
made public in other litigation pursuant to a final court order, subject to any
defenses or objections as may be made by Settling Defendants. Except as
expressly provided above, the provisions of paragraph 22 of the Settlement
Agreement with respect to discovery materials shall remain in effect for the
period of time specified therein.

22. Attorneys' Fees. Settling Defendants, the State of Texas, Private
Counsel and the Law Offices of Marc D. Murr, P.C. have entered into a separate
agreement on July 24, 1998 (the "Texas Fee Payment Agreement") that sets forth
the entire obligation of Settling Defendants with respect to payment of
attorneys' fees pursuant to paragraph 17 of the Settlement Agreement. The
parties hereto agree that the Texas Fee Payment Agreement supersedes Exhibit 1
to the Settlement Agreement, which is hereby rendered null, void and of no
further effect. The parties further agree that Settling Defendants shall not be
required to perform any obligation pursuant to this Stipulation of Amendment
(excepting Settling

24
<PAGE>

Defendants' obligations with respect to the advance to be paid pursuant to
section 12 of the Texas Fee Payment Agreement) until such time as (1) the Court
issues an order confirming that amounts payable with respect to attorneys' fees
of Texas Counsel pursuant to the Texas Fee Payment Agreement are not funds of
the State of Texas and that Settling Defendants are under no obligation to pay
such amounts to the State of Texas; (2) the 30-day period to seek review of such
order has expired without the filing of any notice of appeal or petition for
review; and (3) in the event of a timely appeal or petition, such appeal or
petition has been dismissed or the order has been affirmed in all material
respects by the court of last resort to which such appeal or petition has been
taken and such dismissal or affirmance has become no longer subject to further
appeal or review. Under no circumstances shall Settling Defendants' entry into
this Stipulation of Amendment or the Texas Fee Payment Agreement be construed
as, or deemed to be, evidence of or an admission or concession that the
Settlement Agreement can be revised pursuant to the Most Favored Nation clause
without incorporation of all terms of any settlement agreement that provides the
occasion for any such revision, including all terms thereof with respect to
attorneys' fees.

25
<PAGE>

be unenforceable (such that MFN Settling Defendants are relieved from making
payments required under the Minnesota Settlement) (the "Minnesota Order"), MFN
Settling Defendants shall have the option to elect not to make any payment
pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that becomes due
on or after the date of such Minnesota Order. In the event that MFN Settling
Defendants make such an election:

(a) MFN Settling Defendants shall not be obligated to make any
payment pursuant to paragraphs 5 and 6 of this Stipulation of Amendment
that becomes due on or after the date of the Minnesota Order; provided,
however, that if the Minnesota Order is reversed on appeal or otherwise
set aside, MFN Settling Defendants shall be obligated to make any payments
pursuant to paragraphs 5 and 6 of this Stipulation of Amendment that were
not made when initially due as result of the Minnesota Order;

(b) the provisions of paragraph 11 of this Stipulation of Amendment
shall not apply to preclude the application of paragraph 16 of the
Settlement Agreement with respect to any pre-verdict settlement agreement
described therein entered into after the date of the Minnesota Order; and

(c) MFN Settling Defendants shall be entitled to a credit, in the
amount of any payments made pursuant to paragraphs 5 and 6 of this

26
<PAGE>

Stipulation of Amendment, against any payments due to the State of Texas
as a result of application of paragraph 16 of the Settlement Agreement in
connection with any pre-verdict settlement agreement entered into after
the date of the Minnesota Order, pursuant to subparagraph (b) of this
paragraph 23.

No other provision of the Settlement Agreement, this Stipulation of Amendment or
the Consent Decree shall be affected by the Minnesota Order. MFN Settling
Defendants will provide the State of Texas with notice of any filing seeking to
obtain a Minnesota Order.

24. Entire Agreement of Parties. The Settlement Agreement (including this
Stipulation of Amendment, the Texas Fee Payment Agreement and the Consent Decree
but excluding Exhibit 1 to the Settlement Agreement, which is hereby rendered
null, void and of no further effect) contains an entire, complete and integrated
statement of each and every term and provision agreed to by and among the
parties hereto relating in any way to the settlement of the tobacco litigation
brought by the State of Texas, and is not subject to any condition not provided
for herein.

27
<PAGE>

IN WITNESS WHEREOF, the parties hereto, through their fully authorized
representatives, have agreed to this Stipulation of Amendment as of this 24th
day of July, 1998.

STATE OF TEXAS, acting by and through
Dan Morales, its duly elected and
authorized Attorney General

By: /s/ Dan Morales
----------------------------------
Dan Morales
Attorney General

COUNSEL TO THE STATE OF TEXAS

By: /s/ Walter Umphrey
----------------------------------
Walter Umphrey
Provost & Umphrey

By: /s/ John M. O'Quinn
----------------------------------
John M. O'Quinn

By: /s/ John Eddie Williams, Jr.
----------------------------------
John Eddie Williams, Jr.

28
<PAGE>

By: /s/ Wayne A. Reaud
----------------------------------
Wayne A. Reaud
Reaud, Morgan & Quinn, Inc.

By: /s/ Harold W. Nix
----------------------------------
Harold W. Nix
The Nix Law Firm

By: /s/ Cary Patterson
----------------------------------
Cary Patterson
The Nix Law Firm

By: /s/ Marc D. Murr
----------------------------------
Marc D. Murr
Law Offices of Marc D. Murr, P.C.

By: /s/ Grant Kaiser
----------------------------------
Grant Kaiser
Kaiser & Morrison

By: /s/ T. Richardson, Jr.
----------------------------------
For Joseph F. Rice
Ness, Motley, Loadholt,
Richardson & Poole

29
<PAGE>

PHILIP MORRIS INCORPORATED

By: /s/ Meyer G. Koplow
----------------------------------
Meyer G. Koplow
Counsel

By: /s/ Martin J. Barrington by MGK
----------------------------------
Martin J. Barrington
General Counsel

R.J. REYNOLDS TOBACCO COMPANY

By: /s/ Arthur F. Golden
----------------------------------
Arthur F. Golden
Counsel

By: /s/ Charles A. Blixt
----------------------------------
Charles A. Blixt
General Counsel

30
<PAGE>

BROWN & WILLIAMSON TOBACCO CORPORATION

By: /s/ Stephen R. Patton
----------------------------------
Stephen R. Patton
Counsel

By: /s/ F. Anthony Burke
----------------------------------
F. Anthony Burke
Vice President & General Counsel

LORILLARD TOBACCO COMPANY

By: /s/ Arthur J. Stevens by MGK
----------------------------------
Arthur J. Stevens
Senior Vice President & General
Counsel

UNITED STATES TOBACCO COMPANY

By: /s/ Richard H. Verheij
----------------------------------
Richard H. Verheij
Executive Vice President &
General Counsel

31
<PAGE>

APPENDIX A

FORMULA FOR CALCULATING VOLUME ADJUSTMENTS

(B) in the event the Actual Volume is less than the Base Volume,

(i) the Applicable Base Payment shall be multiplied by the ratio of
the Actual Volume to the Base Volume, and the resulting product
shall be divided by 0.98; and

(ii) if a reduction of the Applicable Base Payment results from the
application of subparagraph (B)(i) of this Appendix, but the
Settling Defendants' aggregate net operating profits from domestic
sales of cigarettes for the Applicable Year (the "Actual Net
Operating Profit") is greater than the Settling Defendants'
aggregate net operating profits from domestic sales of cigarettes in
1997 (the "Base Net Operating Profit") (such Base Net Operating
Profit being adjusted upward by the greater of the rate of 3% per
annum or the actual total percent change in the Consumer Price
Index, in either instance for the period between January 1, 1998 and
the date on which the payment at issue is made), then the amount by
which the Applicable Base Payment is reduced by the application of
subparagraph (B)(i) shall be reduced (but not below zero) by 7.25%
of 25% of such increase in such profits. For purposes of this
Appendix, "net operating profits from domestic sales of cigarettes"
shall mean net operating profits from domestic sales of cigarettes
as reported to the United States Securities and Exchange Commission
("SEC") for the Applicable Year or, in the case of a Settling
Defendant that does not report profits to the SEC, as reported in
<PAGE>

financial statements prepared in accordance with generally accepted
accounting principles and audited by a nationally recognized
accounting firm. The determination of Settling Defendants' aggregate
net operating profits from domestic sales of cigarettes shall be
derived using the same methodology as was employed in deriving such
Settling Defendants' aggregate net operating profits from domestic
sales of cigarettes in 1997. Any increase in an Applicable Base
Payment pursuant to this subparagraph B(ii) shall be payable within
120 days after the date that the payment at issue was required to be
made.

2
<PAGE>

EXHIBIT 1

IN THE UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF TEXAS
TEXARKANA DIVISION

____________________________________
)
STATE OF TEXAS, )
)
Plaintiff, )
)
vs. ) No. 5-96CV-91
)
AMERICAN TOBACCO )
COMPANY, et al., )
)
Defendants. )
____________________________________)

CONSENT DECREE

WHEREAS, on January 16, 1998, the State of Texas and certain defendants
entered into a Comprehensive Settlement Agreement and Release (the "Settlement
Agreement") to settle and resolve with finality all present and future claims
against all parties to this litigation relating to the subject matter of this
litigation which have been or could have been asserted by any of the parties
hereto;

WHEREAS, the Settlement Agreement was approved and adopted as an
enforceable order of the Court pursuant to Court Order dated January 22, 1998,
in which the Court expressly retained continuing jurisdiction to enforce and
implement the terms of the Settlement Agreement, including the Most Favored
Nation clause of the Settlement Agreement;
<PAGE>

WHEREAS, the Settlement Agreement contains a "Most Favored Nation" clause
which provides that, in the event that Settling Defendants enter into a future
pre-verdict settlement agreement of other litigation brought by a non-federal
governmental plaintiff on terms more favorable to such governmental plaintiff
than the terms of the Settlement Agreement (after due consideration of relevant
differences in population or other appropriate factors), the terms of the
Settlement Agreement shall be revised so that the State of Texas will obtain
treatment at least as relatively favorable as any such non-federal governmental
entity;

WHEREAS, the State of Texas and Settling Defendants have agreed on the
terms of the revisions to the Settlement Agreement as set forth in a Stipulation

2
<PAGE>

of Amendment to Settlement Agreement and for Entry of Consent Decree executed on
July 24, 1998 (the "Stipulation of Amendment");

WHEREAS, the Stipulation of Amendment provides for entry of this Consent
Decree, which sets forth certain terms of injunctive relief, and further,
provides that the MFN Settling Defendants have waived as specified therein their
right to challenge the terms of this Consent Decree as being superseded or
preempted by future congressional enactments; and

WHEREAS, the Attorney General believes the entry of this Consent Decree is
appropriate and in the public interest;

NOW, THEREFORE, the State of Texas and MFN Settling Defendants having come
before the Court on their joint motion for approval of a Stipulation of
Amendment to the Settlement Agreement, and the Court having reviewed and
considered the Stipulation of Amendment and otherwise being fully advised in the
premises, it is hereby ORDERED, ADJUDGED and DECREED as follows:

1. Approval. The Court finds that the terms of the Stipulation of
Amendment are just and in the best interests of the State of Texas and Settling
Defendants, and the same is hereby approved. The Court further finds that the
Texas Fee Payment Agreement referred to in paragraph 22 of the Stipulation of
Amendment sets forth the entire obligation of Settling Defendants with respect
to payment of attorneys' fees pursuant to paragraph 17 of the Settlement
Agreement and supersedes Exhibit 1 to the Settlement Agreement, which is hereby
declared

3
<PAGE>

to be null, void and of no further effect, that amounts payable with respect to
attorneys' fees of Texas Counsel pursuant to the Texas Fee Payment Agreement are
not funds of the State of Texas and that Settling Defendants are under no
obligation to pay such amounts to the State of Texas.

2. Jurisdiction and Venue. In keeping with the Settlement Agreement and
this Court's January 22, 1998 Order, the Court expressly retains jurisdiction
for the purpose of enforcement of the Settlement Agreement (as amended by the
Stipulation of Amendment) and this Consent Decree, as well as other issues
relating to the settlement of this Action that are currently pending before the
Court. Any party to this Consent Decree may apply to this Court at any time for
such further orders and directions as may be necessary or appropriate for the
construction and enforcement of the Settlement Agreement, the Stipulation of
Amendment and this Consent Decree.

3. Definitions. The definitions set forth in the Settlement Agreement (as
supplemented or superseded by the Stipulation of Amendment) are incorporated by
reference herein.

4. Applicability. This Consent Decree applies only to MFN Settling
Defendants in their corporate capacity acting through their respective
successors and assigns, directors, officers, employees, agents, subsidiaries,
divisions or other internal organizational units of any kind or any other entity
acting in concert or participating with them, and only with respect to
activities in connection with the

4
<PAGE>

manufacture and sale in the United States of Tobacco Products intended for
domestic consumption. The remedies and penalties for a violation of this Consent
Decree shall apply only to MFN Settling Defendants, and shall not be imposed or
assessed against any employee, officer or director of MFN Settling Defendants or
other person or entity as a consequence of such a violation, and there shall be
no jurisdiction under this Consent Decree to impose or assess a penalty against
any employee, officer or director of MFN Settling Defendants or other person or
entity as a consequence of a violation of this Consent Decree.

5. Effect on Third Parties. This Consent Decree is not intended to and
does not vest standing in any third party with respect to the terms hereof, or
create for any person other than the parties hereto a right to enforce the terms
hereof.

6. Injunctive Relief. MFN Settling Defendants are permanently enjoined
from:

(a) On and after December 31, 1998, marketing, licensing,
distributing, selling or offering, directly or indirectly, including by
catalogue or direct mail, in the State of Texas, any item (other than
Tobacco Products or any item the sole function of which is to advertise
Tobacco Products) which bears the brand name (alone or in conjunction with
any other word), logo, symbol, motto, selling message, recognizable color
or pattern of colors, or any other indicia or product identification
identical or similar to, or identifiable with, those used for any domestic

5
<PAGE>

brand of Tobacco Products, except that nothing in this paragraph shall (i)
require any MFN Settling Defendant to terminate, breach or violate any
licensing agreement or contract in existence as of July 1, 1998 for the
remaining term of such contract; (ii) prohibit the distribution to any
employee (18 years of age or older) of an MFN Settling Defendant of any
item described above that is intended for the personal use of such
employee by such MFN Settling Defendant; or (iii) prohibit items
necessarily incidental to or ordinarily distributed in connection with any
sponsorship described in paragraph 4(e)(2) of the Settlement Agreement.

(b) Making any material misrepresentation of fact regarding the
health consequence of using any Tobacco Product, including any tobacco
additives, filters, paper or other ingredients; provided, however, that
nothing in this paragraph shall limit the exercise of any First Amendment
right or any defense or position which persons bound by this Consent
Decree may assert in any judicial, legislative or regulatory forum.

6
<PAGE>

(3) limiting or suppressing research into, marketing, or development of
new products.

(d) Taking any action, directly or indirectly, to target children in
Texas in the advertising, promotion, or marketing of cigarettes, or taking
any action the primary purpose of which is to initiate, maintain or
increase the incidence of underage smoking in Texas.

7. No Determination or Admission. The Settlement Agreement having been
executed prior to the taking of any testimony, no final determination of any
violation of any provision of law has been made in this Action. This Consent
Decree is not intended to be and shall not in any event be construed as, or
deemed to be, an admission or concession or evidence of any liability or any
wrongdoing whatsoever on the part of any person covered by the releases provided
in paragraphs 14 and 15 of the Settlement Agreement; nor shall this Consent
Decree be construed as, or deemed to be, an admission or concession or evidence
of personal jurisdiction by any person not a party to this Consent Decree.
Defendants specifically disclaim any liability or wrongdoing whatsoever with
respect to the claims and allegations asserted against them in this Action and
MFN Settling Defendants have entered into the Settlement Agreement and the
Stipulation of Amendment, and have stipulated to entry of this Consent Decree,
solely to avoid the further expense, inconvenience, burden and risk of
litigation.

7
<PAGE>

8. Modification. This Consent Decree shall not be modified unless the
party seeking modification demonstrates, by clear and convincing evidence, that
it will suffer irreparable harm from new and unforeseen conditions; provided,
however, that the provisions of paragraph 4 of this Consent Decree shall in no
event be subject to modification. Changes in the economic conditions of the
parties shall not be grounds for modification. It is intended that MFN Settling
Defendants will comply with this Consent Decree as originally entered, even if
MFN Settling Defendants' obligations hereunder are greater than those imposed
under current or future law. Therefore, a change in law that results, directly
or indirectly, in more favorable or beneficial treatment of any one or more of
the MFN Settling Defendants shall not support modification of this Consent
Decree. The provisions of this paragraph shall not be construed to limit or
affect any future modification of the Settlement Agreement (as amended by the
Stipulation of Amendment) in the manner provided in paragraphs 11 and 23 of the
Stipulation of Amendment.

9. Enforcement and Attorneys' Fees. In any proceeding which results in a
finding that a MFN Settling Defendant violated this Consent Decree, the
responsible MFN Settling Defendant or MFN Settling Defendants shall pay the
State's costs and attorneys' fees incurred in such proceeding.

10. Non-Exclusivity of Remedy. The remedies in this Consent Decree are
cumulative and in addition to any other remedies the State may have at law or

8
<PAGE>

equity. Nothing herein shall be construed to prevent the State from bringing any
action simply because the conduct that is the basis for such action may also
violate this Consent Decree.

DONE AND ORDERED at Texarkana, Texas, this the 24th day of July, 1998.

/s/ David Folsom
--------------------------------------
DAVID FOLSOM
JUDGE, UNITED STATES DISTRICT COURT

APPROVED:

/s/ Dan Morales
- -----------------------------------
Dan Morales, Attorney General,
For the State of Texas

Howard Waldrop

By: /s/ Josh R. Morriss, III
- -----------------------------------
Howard Waldrop
For MFN Settling Defendants

9
<PAGE>

EXHIBIT 2

IN THE UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF TEXAS
TEXARKANA DIVISION

THE STATE OF TEXAS, ) CIVIL NO.: 5:96-CV-0091
PLAINTIFF, )
)
VS. ) JUDGE: DAVID FOLSOM
)
THE AMERICAN TOBACCO ) MAGISTRATE JUDGE:
COMPANY, ET AL, ) WENDELL C. RADFORD
DEFENDANTS. )

ORDER GRANTING JOINT MOTION FOR
APPROVAL OF SETTLEMENT AGREEMENT REGARDING DISPOSITION OF
SETTLEMENT PROCEEDS AND TO WITHDRAW WITH PREJUDICE
POLITICAL SUBDIVISIONS' MOTIONS TO INTERVENE

Before the Court is a Joint Motion for Approval of Settlement Agreement
Regarding Disposition of Settlement Proceeds and to Withdraw with Prejudice
Political Subdivisions(1) Motions to Intervene. After considering the filings
related to this motion, the evidence, and the applicable law, the Court is of
the opinion the Motion should be granted. The Court therefore makes the
following findings of fact and conclusions of law.

1. The Court finds that the Agreement Regarding Disposition of Settlement
Proceeds ("Disposition Agreement") is in the public interest and
should be approved. The benefits of this agreement include certainty
for the parties and movants as well as judicial economy.

2. Therefore, the Court approves and adopts the Disposition Agreement,
attached hereto and incorporated herein, as an enforceable judgment of
this Court. The parties and movants are ordered to comply with all
terms and conditions contained in the Disposition Agreement.

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(1)Dallas County, Dallas County Hospital District, El Paso County, El Paso
County Hospital District, Harris County, Harris County Hospital District,
Montgomery County Hospital District, Nueces County, Nueces County Hospital
District, and Tarrant County Hospital District.

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3. The Court further finds, as it has previously found, that the Attorney
General brought this suit on behalf of the State in its
quasi-sovereign capacity. SEE MEMORANDUM OPINION AND ORDER RE:
DEFENDANTS' MOTION TO DISMISS COUNTS 1-3 AND COUNTS 4-17 OF THE
STATE'S SECOND AMENDED COMPLAINT at 5 (Sept. 8, 1997).

4. The January 16, 1998, Comprehensive Settlement Agreement and
Release (the "CSA") negotiated by the parties and approved by the
Court defines the "State of Texas" to include "all of its officers
acting in their official capacities and any department, subdivision
or agency of the State, regardless of whether a named plaintiff".
Paragraph 14 of the CSA further provides that the Waiver and Release
given pursuant to paragraph 14 of the CSA constitutes a release of
claims of "the State of Texas (including any of its past, present or
future agents, officials acting in their official capacities, legal
representatives, agencies, departments, commissions, divisions,
subdivisions (political and otherwise), public entities,
corporations, instrumentalities and educational institutions, and
whether or not any such person or entity participates in the
settlement)".

5. The Court further finds and declares that during the litigation of
this action and the negotiation of the CSA, the Attorney General,
acting on behalf of the State in its quasi-sovereign capacity, had the
authority to and did adequately represent the State of Texas and the
persons and entities enumerated in paragraph 14 of the CSA (as quoted
in the preceding paragraph of this Order) (the "Releasing Parties"),
including, without limitation, all political subdivisions and hospital
districts of the State of Texas. Accordingly, the Court further finds
and declares that all Releasing Parties are encompassed within and
bound by the release provided pursuant to the CSA, that all Releasing
Parties are further encompassed within and bound by the Court's
January 22, 1998 Final Judgment approving and incorporating the CSA,
and that all Released Claims (as defined in paragraph 14 of the CSA)
of the Releasing Parties were fully and finally compromised, settled
and released by the CSA.

6. The Court also grants the Movants' request that the Political
Subdivisions withdraw their motions to intervene and all other motions
with prejudice to refiling. All motions filed by the Political
Subdivisions are hereby dismissed with prejudice.

7. It is further ordered that this Court shall have exclusive
jurisdiction over the provisions of this Order and the Final Judgment
in this case. All persons in privity with the parties, including all
persons represented by the parties, who seek to raise any objections
or challenges in any forum to any provision of this Judgment are
hereby enjoined from proceeding in any other state or federal court.
SEE, E.G., IN RE CORRUGATED CONTAINER ANTITRUST LITIGATION, 659 F.2d
1332, 1334-35 (5th Cir. 1981), CERT. DENIED, 456 U.S. 936 (1982);
SOUTHWEST AIRLINES CO. V. TEXAS INTERNATIONAL AIRLINES, INC., 546 F.2d
84, 91 (5th Cir.), CERT. DENIED, 434 U.S. 832 (1977)

<PAGE>

8. The Political Subdivisions' withdrawal of all their motions with
prejudice leaves undisturbed the entirety of the merits of the January
22, 1998, Final Judgment in this cause. The Court's January 22, 1998,
Final Judgment disposed of all claims in the underlying suit. It is
therefore is a "final decision" as a matter of federal law under 28
U.S.C. Section 1291.

SIGNED JULY 24, 1998.

/s/ David Folsom
------------------------------
DAVID FOLSOM
UNITED STATES DISTRICT JUDGE

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EXHIBIT 3

MFN ESCROW AGREEMENT

This escrow agreement (the "MFN Escrow Agreement") is entered into as of
July __, 1998 by and among Philip Morris Incorporated, R.J. Reynolds Tobacco
Company, Brown & Williamson Tobacco Corporation and Lorillard Tobacco Company
(collectively and severally, "MFN Settling Defendants" and each individually a
"MFN Settling Defendant"), the State of Texas and __________ Bank, N.A., as
escrow agent (the "MFN Escrow Agent").

WITNESSETH:

WHEREAS, the State of Texas and Settling Defendants entered into a
comprehensive settlement agreement and release as of January 16, 1998 (the
"Settlement Agreement"), setting forth the terms and conditions of an agreement
to settle and resolve with finality all present and future claims relating to
the subject matter of the litigation entitled State of Texas v. American Tobacco
Co., No. 5-96CV-91 (E.D. Tex. filed Mar. 28, 1996) (the "Action"), in the United
States District Court for the Eastern District of Texas (the "Court");

WHEREAS, the State of Texas and Settling Defendants entered into a
Stipulation of Amendment to Settlement Agreement and for Entry of Consent Decree
(the "Stipulation of Amendment") on July 24, 1998, paragraph 17 of which
provides for Court approval of the Stipulation of Amendment and the entry by the
Court of the Political Subdivisions Order attached to the Stipulation of
Amendment as Exhibit 2 thereto;

WHEREAS, the Stipulation of Amendment provides that, on the dates
specified therein, each MFN Settling Defendant shall severally pay to the State
of Texas, pro rata in proportion to its Market Share, its respective share of
the amounts indicated for each date;

WHEREAS, paragraph 17 of the Stipulation of Amendment further provides
that all payments described in the Stipulation of Amendment shall be paid into a
special escrow account (and if so paid shall remain in said escrow account)
until such time as (1) the 30 day periods for appeal or to seek review of the
Court's order approving this Stipulation of Amendment and the Court's entry of
the Political Subdivisions Order have expired without the filing of any notice
of appeal or petition for review; or (2) in the event of any such appeal or
petition, the appeal or the petition has been dismissed or the order in question
has been affirmed in all material respects by the court of last resort to which
such appeal or
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EXHIBIT 3

petition has been taken and such dismissal or affirmance has become no longer
subject to further appeal or review (the "Availability Date"); and

WHEREAS, the parties hereto believe that at least one of the payments
described in the preceding paragraphs may be made prior to the Availability
Date:

NOW, THEREFORE, the parties hereto agree as follows:

SECTION 1. Appointment of MFN Escrow Agent.

MFN Settling Defendants and the State of Texas hereby appoint the MFN
Escrow Agent to act as escrow agent on the terms and conditions set forth
herein, and the MFN Escrow Agent hereby accepts such appointment on such terms
and conditions.

SECTION 2. Deposit.

In the event that any payment pursuant to the Stipulation of Amendment
becomes due on a date prior to the Availability Date, each MFN Settling
Defendant shall severally deliver to the MFN Escrow Agent in immediately
available funds such MFN Settling Defendant's respective share of the payment in
question (the sum of such shares being the "Initial Deposit"). Upon receipt, the
MFN Escrow Agent shall deposit the Initial Deposit into a separate escrow
account established for such purpose and governed by the terms of this MFN
Escrow Agreement (the "MFN Escrow Account"). Any subsequent payment pursuant to
the Stipulation of Amendment that becomes due prior to the Availability Date
shall be delivered to the MFN Escrow Agent and added to the Initial Deposit (the
Initial Deposit and any subsequent payments deposited into the MFN Escrow
Account, including any payments of interest or other income on investment of the
MFN Escrow Amount or any portion thereof, being the "MFN Escrow Amount") and
shall be governed by the terms of this MFN Escrow Agreement. All such deliveries
of funds are subject to the right of MFN Settling Defendants to obtain, pursuant
to section 4(a) of this MFN Escrow Agreement, prompt return of the entire MFN
Escrow Amount (less appropriate deductions for administrative fees and expenses,
including taxes and other related costs) in the event that the Stipulation of
Amendment is cancelled and terminated pursuant to paragraph 17 of the
Stipulation of Amendment. The MFN Escrow Amount shall be maintained, invested
and disbursed by the MFN Escrow Agent strictly in accordance with this MFN
Escrow Agreement.

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EXHIBIT 3

SECTION 3. Investment of MFN Escrow Amount.

The MFN Escrow Agent shall invest and reinvest the MFN Escrow Amount in
either (i) direct obligations of, or obligations the principal and interest on
which are unconditionally guaranteed by, the United States of America (including
government-sponsored agencies) or the State of Texas; (ii) repurchase agreements
fully collateralized by securities of the kind specified in clause (i) above;
(iii) money market accounts maturing within 30 days of the acquisition thereof
and issued by a bank or trust company organized under the laws of the United
States of America or a State thereof (a "United States Bank") and having a
combined capital surplus in excess of $250,000,000; or (iv) demand deposits with
any United States Bank or any federal savings and loan institution having a
combined capital surplus in excess of $250,000,000. Any loss on any such
investment, including, without limitation, any penalty for any liquidation
required to fund a disbursement, shall be borne pro rata by the parties in
proportion to their ultimate entitlement to the MFN Escrow Amount. The MFN
Escrow Agent's fees and all expenses, including taxes and other related costs,
shall, to the extent possible, be paid out of income earned. Whenever the MFN
Escrow Agent shall pay all or any part of the MFN Escrow Amount to any party as
provided herein, the MFN Escrow Agent shall also pay to such party all interest
and profits earned to the date of payment on such amount, less deductions for
fees and all expenses, including taxes and other related fees.

SECTION 4. Release of the MFN Escrow Amount.

After receipt, the MFN Escrow Agent shall deliver the MFN Escrow Amount as
set forth below:

(a) Following receipt of written notice signed by counsel for the
MFN Settling Defendants certifying that such notice has been delivered by
counsel for the MFN Settling Defendants to all parties hereto and stating
that the Stipulation of Amendment has not received court approval or has
been canceled, terminated or has otherwise become null and void for any
reason, the MFN Escrow Agent shall upon the expiration of ten (10)
business days following the MFN Escrow Agent's receipt of notice, and
without an order of the Court, disburse the entire MFN Escrow Amount
(including any interest thereon, as provided in Section 3) to the MFN
Settling Defendants on the same pro rata basis as such funds were
contributed to the MFN Escrow Account.

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EXHIBIT 3

(b) Upon receipt of (i) written notice signed by counsel for the MFN
Settling Defendants and counsel for the State of Texas stating that the
Availability Date has occurred and (ii) an order of the Court so
directing, the MFN Escrow Agent shall proceed to distribute the MFN Escrow
Amount in accordance with such Court order.

(c) For its services, the MFN Escrow Agent shall receive fees in
accordance with the MFN Escrow Agent's customary fees in similar matters.
All such fees shall constitute a direct charge against the MFN Escrow
Amount, but the MFN Escrow Agent shall not debit the MFN Escrow Amount for
any such charge until it shall have presented its statement to and
received approval by counsel for the MFN Settling Defendants and counsel
for the State of Texas, which approval shall not be unreasonably withheld.
Such approval shall be deemed given if the MFN Escrow Agent has not
received written objections from either counsel for MFN Settling
Defendants or counsel for the State of Texas within 30 days after
presentment of its statement. Such fees and all expenses charged against
the MFN Escrow Amount shall, to the extent possible, be paid out of
interest earned. In the event that counsel for MFN Settling Defendants or
counsel for the State of Texas objects in writing to such fees, the MFN
Escrow Agent shall not debit the MFN Escrow Amount except upon a court
order approving such fees.

SECTION 5. Substitute Form W-9; Qualified Settlement Fund.

SECTION 6. Termination of MFN Escrow Account.

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EXHIBIT 3

SECTION 7. MFN Escrow Agent.

(a) The MFN Escrow Agent shall have no duty or obligation hereunder
other than to take such specific actions as are required of it from time
to time under the provisions hereof, and it shall incur no liability
hereunder or in connection herewith for anything whatsoever other than as
a result of its own negligence or willful misconduct. In the event the MFN
Escrow Agent fails to receive the instructions contemplated by Section 4
hereof or receives conflicting instructions, the MFN Escrow Agent shall be
fully protected in refraining from acting until such instructions are
received or such conflict is resolved by written agreement or court order.

(b) MFN Settling Defendants, on the same pro rata basis as the funds
constituting the MFN Escrow Amount were contributed to the MFN Escrow
Account, agree to indemnify, hold harmless and defend the MFN Escrow Agent
from and against any and all losses, claims, liabilities and reasonable
expenses, including the reasonable fees of its counsel, which it may
suffer or incur hereunder or in connection herewith prior to the
Availability Date, except such as shall result solely and directly from
its own negligence or willful misconduct. The MFN Escrow Agent shall not
be bound in any way by any agreement or contract between MFN Settling
Defendants and the State of Texas (whether or not the MFN Escrow Agent has
knowledge thereof) and the only duties and responsibilities of the MFN
Escrow Agent shall be to hold and invest the MFN Escrow Amount received
hereunder and to release such MFN Escrow Amount in accordance with the
terms of this MFN Escrow Agreement.

(c) The MFN Escrow Agent may resign at any time by giving written
notice thereof to the other parties hereto, but such resignation shall not
become effective until a successor MFN Escrow Agent, selected by the MFN
Settling Defendants and agreeable to the State of Texas, shall have been
appointed and shall have accepted such appointment in writing. If an
instrument of acceptance by a successor MFN Escrow Agent shall not have
been delivered to the MFN Escrow Agent within 30 days after the giving of
such notice of resignation, the resigning MFN Escrow Agent may, at the
expense of MFN Settling Defendants and the State of Texas (to be shared
equally between the State of Texas and the MFN Settling Defendants),
petition the Court for the appointment of a successor MFN Escrow Agent.

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EXHIBIT 3

(d) Upon the Availability Date having occurred, provided that MFN
Settling Defendants have performed all of their obligations required to be
performed prior to the Availability Date, all duties and obligations of
MFN Settling Defendants hereunder shall cease, with the exception of any
indemnification obligation of MFN Settling Defendants incurred prior to
the Availability Date.

SECTION 8. Miscellaneous.

State of Texas:

Hon. Dan Morales
Office of the Attorney General

P.O. Box 12548
Capitol Station
Austin, TX 78711
(512) 463-2063

With a copy to:

Walter Umphrey
Provost & Umphrey
490 Park Street
P.O. Box 4905
Beaumont, TX 77704
Fax: (409) 838-8888

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EXHIBIT 3

Settling Defendants:

Philip Morris Incorporated: R.J. Reynolds Tobacco Company:

With a copy to: With a copy to:

For Brown & Williamson Tobacco Lorillard Tobacco Company:
Corporation:

Michael Walter Arthur J. Stevens, Esq.
Brown & Williamson Tobacco Corp. Lorillard Tobacco Company
200 Brown & Williamson Tower 714 Green Valley Road
401 South Fourth Avenue Greensboro, NC 27408
Louisville, KY 40202 Fax: (336) 335-7707
Fax: (502) 568-7187

With a copy to:

F. Anthony Burke
Brown & Williamson Tobacco Corporation
200 Brown & Williamson Tower
401 South Fourth Avenue
Louisville, KY 40202
Fax: (502) 568-7187

MFN Escrow Agent:

_________________ Bank, N.A.
Phone:
Fax:
Wire Transfer Instructions:
ABA #:
Account #:
Account Name:

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EXHIBIT 3

(b) Successors and Assigns. The provisions of this MFN Escrow
Agreement shall be binding upon and inure to the benefit of the parties
hereto and their respective successors and assigns.

(c) Governing Law. This MFN Escrow Agreement shall be construed in
accordance with and governed by the laws of the State of Texas, without
regard to the conflicts of law rules of such state.

(d) Jurisdiction and Venue. The parties hereto irrevocably and
unconditionally submit to the jurisdiction of the United States District
Court for the Eastern District of Texas for purposes of any suit, action
or proceeding seeking to enforce any provision of, or based on any right
arising out of, this MFN Escrow Agreement, and the parties hereto agree
not to commence any such suit, action or proceeding except in such Court.
The parties hereto hereby irrevocably and unconditionally waive any
objection to the laying of venue of any such suit, action or proceeding in
the Court and hereby further irrevocably waive and agree not to plead or
claim in such Court that any such suit, action or proceeding has been
brought in an inconvenient forum.

(e) Definitions. Terms used herein that are defined in the
Settlement Agreement or the Stipulation of Amendment are, unless otherwise
defined herein, used in this MFN Escrow Agreement as defined in the
Settlement Agreement or the Stipulation of Amendment, as appropriate.

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EXHIBIT 3

purposes of acknowledging acceptance hereof; however, an original executed
signature page must promptly thereafter be appended to this MFN Escrow
Agreement, and an original executed agreement shall promptly thereafter be
delivered to each party hereto.

(h) Captions. The captions herein are included for convenience of
reference only and shall be ignored in the construction and interpretation
hereof.

IN WITNESS WHEREOF, the parties have executed this MFN Escrow Agreement as
of the day and year first hereinabove written.

STATE OF TEXAS

By:
-------------------------------
Dan Morales
Attorney General

PHILIP MORRIS INCORPORATED

By:
-------------------------------
Meyer G. Koplow
Counsel

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EXHIBIT 3

R.J. REYNOLDS TOBACCO COMPANY

By:
-------------------------------
Arthur F. Golden
Counsel

BROWN & WILLIAMSON TOBACCO
CORPORATION

By:
-------------------------------
Stephen R. Patton
Counsel

LORILLARD TOBACCO COMPANY

By:
-------------------------------
Arthur J. Stevens
Senior Vice President & General Counsel

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EXHIBIT 3

_____________________ BANK, N.A.
as MFN Escrow Agent

By:
-------------------------------
Name:
Title:

<PAGE>

Exhibit 10.5

TEXAS FEE PAYMENT AGREEMENT

This Texas Fee Payment Agreement (the "Agreement") is entered into as of
July 24, 1998, by and among Philip Morris Incorporated, R.J. Reynolds Tobacco
Company, Brown & Williamson Tobacco Corporation, Lorillard Tobacco Company and
United States Tobacco Company (collectively and severally "Settling Defendants"
and each individually a "Settling Defendant"), Walter Umphrey, John M. O'Quinn,
P.C., John Eddie Williams, Jr., Reaud, Morgan & Quinn, Inc., The Nix Law Firm
and Ness, Motley, Loadholt, Richardson & Poole (collectively, "Private
Counsel"), the Law Offices of Marc D. Murr, P.C. ("Other Texas Counsel") and the
State of Texas, in connection with the lawsuit State of Texas v. American
Tobacco Co., No. 5-96CV-91 (E.D. Tex. filed Mar. 28, 1996) (the "Action").

WITNESSETH:

WHEREAS, on January 16, 1998, the State of Texas and Settling Defendants
entered into a comprehensive settlement agreement to settle and resolve with
finality all present and future civil claims relating to the subject matter of
the Action (the "Settlement Agreement"), which Settlement Agreement was approved
by the United States District Court for the Eastern District of Texas (the
"Court") and adopted as an enforceable order of the Court pursuant to Court
Order dated January 22, 1998.

WHEREAS, paragraph 17 of the Settlement Agreement and Exhibit 1 thereto
provide that Settling Defendants shall pay reasonable attorneys' fees to Private
Counsel and Other Texas Counsel (collectively "Texas Counsel"), in an amount set
by arbitration, subject to an appropriate annual cap on all such payments of
attorneys' fees by Settling Defendants, as well as other conditions set forth
therein;

WHEREAS, paragraph 16 of the Settlement Agreement contains a "Most Favored
Nation" clause which provides that, in the event that Settling Defendants enter
into a future pre-verdict settlement agreement of other litigation brought by a
non-federal governmental plaintiff on terms more favorable to such governmental
plaintiff than the terms of the Settlement Agreement (after due consideration of
relevant differences in population or other appropriate factors), the terms of
the Settlement Agreement shall be revised so that the State of Texas will obtain
treatment at least as relatively favorable as any such non-federal governmental
entity;
<PAGE>

WHEREAS, on July 24, 1998, Settling Defendants and the State of Texas
entered into a Stipulation of Amendment to Settlement Agreement and for Entry of
Consent Decree (the "Stipulation of Amendment") to resolve any disputes with
respect to the Most Favored Nation clause of the Settlement Agreement, including
any disputes regarding payment of attorneys' fees, in light of the Minnesota
Settlement; and

WHEREAS, Settling Defendants, the State of Texas and Texas Counsel, in
order to resolve any disputes with respect to paragraphs 16 and 17 of the
Settlement Agreement, and to describe more fully the procedures that will govern
Settling Defendants' payment of fees to Texas Counsel, have agreed to the terms
of this Agreement:

NOW, THEREFORE, BE IT KNOWN THAT, in consideration of their mutual
agreement to the terms of this Agreement, the State of Texas's and Settling
Defendants' mutual agreement to the terms of the Stipulation of Amendment, and
such other consideration described herein, including the release of certain
claims against Settling Defendants, the sufficiency of which is hereby
acknowledged, the parties hereto, acting by and through their authorized agents,
memorialize and agree as follows:

SECTION 1. Agreement to Pay Fees.

Settling Defendants will pay reasonable attorneys' fees to Texas Counsel
(as identified by the Attorney General pursuant to section 21 hereof) for their
representation of the State of Texas in connection with the Action. The amount
of such fees will be set by a panel of three independent arbitrators (the
"Panel") whose decisions as to the amount of fees to be paid in connection with
this Agreement ("Fee Award(s)") shall be final and not appealable. The
procedures governing Settling Defendants' obligation to pay any such Fee Awards,
including the procedures for making, and the timing of payments in satisfaction
of, such Fee Awards shall be as provided herein.

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<PAGE>

SECTION 2. Aggregate National Caps on Payment of Certain Fees.

Settling Defendants' payment of any Fee Award pursuant to this Agreement
shall be subject to the payment schedule and the annual and quarterly aggregate
national caps specified in sections 13, 14, 15 and 16 hereof, which shall apply
to:

(a) all payments of attorneys' fees pursuant to an award arbitrated by the
Panel ("Fee Award") in connection with the settlement of any tobacco and health
cases (other than non-class action personal injury cases brought directly by or
on behalf of a single natural person or the survivor of such person or for
wrongful death, or any non-class action consolidation of two or more such cases)
("Tobacco Cases") on terms that provide for payment by Settling Defendants or
other defendants acting in agreement with Settling Defendants (collectively,
"Participating Defendants") of fees with respect to private counsel retained by
the plaintiff in connection with any such case ("Outside Counsel"), subject to
an annual cap on payment of all such fees;

(b) all payments of attorneys' fees (other than fees for attorneys of
Participating Defendants) pursuant to a Fee Award for activities in connection
with Tobacco Cases resolved by operation of federal legislation that either (i)
implements the terms of the June 20, 1997 Proposed Resolution (or a
substantially equivalent federal program) (the "Proposed Resolution") or (ii)
imposes an enforceable obligation on Participating Defendants to pay attorneys'
fees with respect to Outside Counsel (any such legislation hereinafter referred
to as "Federal Legislation"); and

(c) all payments of attorneys' fees and certain other professional fees
(other than fees for attorneys or agents of Participating Defendants) pursuant
to a Fee Award for contributions made toward enacted Federal Legislation. In the
event that Federal Legislation is enacted, the terms "Outside Counsel" and
"Eligible Counsel" shall apply not only to persons otherwise falling within the
definitions of such terms herein but also to all persons granted Fee Awards for
such contributions (such persons being Eligible Counsel with respect to each
month beginning with the month the Federal Legislation was enacted).

Nothing in this Agreement shall be construed to require any Settling
Defendant to pay Fee Awards in connection with any litigation other than the
Action.

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<PAGE>

SECTION 3. Exclusive Obligation of Settling Defendants; Release.

The provisions set forth herein constitute the entire obligation of
Settling Defendants with respect to payment of attorneys' fees in connection
with the Action and the exclusive means by which Texas Counsel may seek payment
of fees by Settling Defendants in connection with the Action. The parties hereto
acknowledge that the provisions for payment set forth herein are the entirety of
Settling Defendants' obligations with respect to payment of attorneys' fees
pursuant to paragraph 17 of the Settlement Agreement. The State of Texas agrees
that Settling Defendants have no obligation to pay attorneys' fees pursuant to
paragraph 17 of the Settlement Agreement with respect to any counsel other than
Texas Counsel (as identified by the Attorney General pursuant to section 21
hereof), and that Settling Defendants have no other obligation to pay fees or
otherwise compensate Texas Counsel, any other counsel or representative of the
State of Texas or the State of Texas itself with respect to attorneys' fees in
connection with the Action. Each Texas Counsel hereby irrevocably releases
Settling Defendants and their respective present and former parents,
subsidiaries, divisions, affiliates, officers, directors, employees,
representatives, insurers, agents and attorneys (as well as the predecessors,
heirs, executors, administrators, successors and assigns of each of the
foregoing) from any and all claims that such counsel ever had, now has or
hereafter can, shall or may have in any way related to the Action (including but
not limited to any negotiations related to the settlement of the Action). The
foregoing shall not be construed as a release of any person or entity as to any
of the obligations undertaken in this Agreement in connection with a breach
thereof.

SECTION 4. No Effect on Texas Counsel's Fee Contracts.

The State of Texas has entered into a contingent-fee contract with certain
Private Counsel ("Private Counsel's Contract") and has entered into a fee
contract with Other Texas Counsel ("Other Texas Counsel's Contract"). The rights
and obligations, if any, of the parties to Private Counsel's Contract and Other
Texas Counsel's Contract shall be unaffected by this Agreement. Those Private
Counsel that are parties to Private Counsel's Contract shall not be deemed to
have waived any rights under Private Counsel's Contract, nor shall Other Texas
Counsel be deemed to have waived any rights under Other Texas Counsel's
Contract, as a result of their acceptance of payments made pursuant to this
Agreement. However, any Private Counsel Payments made in connection with this
Action shall be credited against any amounts that may be due to Private Counsel
that are parties to Private Counsel's Contract from the State of Texas under
Private

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<PAGE>

Counsel's Contract, and any payments received pursuant to this Agreement by
Other Texas Counsel shall be credited against any amounts that may be due to
Other Texas Counsel from the State of Texas under Other Texas Counsel's
Contract.

SECTION 5. Composition of the Panel.

(a) The first and the second members of the Panel shall both be permanent
members of the Panel and, as such, will participate in the determination of all
Fee Awards. The third Panel member shall not be a permanent Panel member, but
instead shall be a state-specific member selected to determine Fee Awards on
behalf of Outside Counsel retained in connection with litigation within a single
state. Accordingly, the third, state-specific member of the Panel for purposes
of determining Fee Awards with respect to litigation in the State of Texas shall
not participate in any determination as to any Fee Award with respect to
litigation in any other state (unless selected to participate in such
determinations by such persons as may be authorized to make such selections
under other agreements).

(b) The members of the Panel shall be selected as follows:

(i) The first member shall be a natural person selected by
Participating Defendants, who shall advise Texas Counsel of the name of
the person selected by October 8, 1998.

(ii) The second member shall be a natural person selected by
agreement of Participating Defendants and a majority of the members of a
committee composed of the following members: Joseph F. Rice, Richard F.
Scruggs, Steven W. Berman, Walter Umphrey, two representatives of the
Castano Plaintiffs' Legal Committee and, at the option of Participating
Defendants, one additional representative to serve on behalf of counsel
for any one or more states that, subsequent to the date hereof, enter into
settlement agreements with Participating Defendants that provide for
payment of such states' Outside Counsel pursuant to an arbitrated award of
fees. Such second member shall be selected by October 1, 1998.

(iii) The third, state-specific member for purposes of determining
Fee Awards with respect to litigation in the State of Texas shall be a
natural person selected by Private Counsel, who shall notify Settling

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<PAGE>

Defendants and Other Texas Counsel of the name of the person selected by
October 15, 1998.

SECTION 6. Commencement of Panel Proceedings.

No application for a Fee Award shall be presented to the Panel or any
Panel member until November 3, 1998. The Panel shall consider and render
decisions on applications for Fee Awards in the order in which they are
submitted or pursuant to notice by counsel having priority that they have ceded
their place to others. In the event that more than one application for a Fee
Award is submitted on the same date, the Panel shall consider and render
decisions on such applications in the order in which their respective cases were
settled. Private Counsel may seek permission from the Panel to make combined
presentations of aspects of their respective applications. Settling Defendants
shall not oppose any request to combine presentations of applications for Fee
Awards in connection with the Action, the lawsuit In re Mike Moore, Attorney
General, ex rel. State of Mississippi Tobacco Litig., No. 94-1429 (Miss. Ch.
Ct., Jackson County), or the lawsuit State of Florida v. American Tobacco Co.,
No. 95-1466 AH (15th Jud. Circuit, Palm Beach County).

SECTION 7. Costs of Arbitration.

SECTION 8. Application of Private Counsel.

Private Counsel shall make a collective written application to the Panel
for a single Fee Award (the "Private Counsel Fee Award") on November 3, 1998.
All interested persons, including persons not parties hereto, may submit to the
Panel any information that they wish; but interested persons not parties hereto
may submit only written materials. The Panel shall consider all such submissions
by any party hereto and may consider any such materials submitted by other
interested persons. All written submissions relating to applications for a Fee
Award in connection with the Action shall be served on all parties hereto by
November 13, 1998. Presentations to the Panel shall, to the extent possible, be
based on affidavit or video presentation rather than live testimony. The Panel
shall preserve the confidentiality of any attorney work-product materials or
other

6
<PAGE>

similar confidential information that may be submitted. Settling Defendants will
not take any position adverse to the amount of the Fee Award requested by
Private Counsel, nor will they or their representatives express any opinion
(even upon request) as to the appropriateness or inappropriateness of the amount
of any proposed Private Counsel Fee Award. The undersigned outside counsel for
Settling Defendants Philip Morris Incorporated and R.J. Reynolds Tobacco Company
will appear, if requested, to provide information as to the nature and efficacy
of the work of Private Counsel and to advise the Panel that they support a
Private Counsel Fee Award of full reasonable compensation under the
circumstances.

SECTION 9. Award of Fees to Private Counsel.

The members of the Panel will consider all relevant information submitted
to them in reaching a decision as to a Fee Award that fairly provides for full
reasonable compensation of Private Counsel for their representation of the State
of Texas in connection with the Action. The Panel shall determine the amount of
the Private Counsel Fee Award for all Private Counsel collectively no later than
December 10, 1998. Given the significance and uniqueness of the Action, the
Panel shall not be limited to an hourly-rate or lodestar analysis in determining
the amount of the Private Counsel Fee Award, but shall take into account the
totality of the circumstances. In considering the amount of the Private Counsel
Fee Award, the Panel shall not consider Fee Awards that already have been or yet
may be awarded in connection with any other Tobacco Case. The Panel's decisions
as to Fee Awards shall be in writing and shall report the amount of the fee
awarded (with or without explanation or opinion, at the Panel's discretion).

SECTION 10. Application of Other Texas Counsel.

Other Texas Counsel may submit an application for a Fee Award separate
from Private Counsel. The procedures, schedule and process with respect to such
application on behalf of Other Texas Counsel shall be the same as the
procedures, schedule and process set forth in sections 6, 7, 8 and 9 hereof with
respect to the fee application on behalf of Private Counsel, except that
Settling Defendants shall be in no way constrained from contesting Other Texas
Counsel's entitlement to receive a Fee Award or the amount of the Fee Award
requested by Other Texas Counsel.

7
<PAGE>

SECTION 11. Allocation of Payments among Private Counsel.

All payments (including advances) made by Settling Defendants with respect
to the Private Counsel Fee Award pursuant to this Agreement ("Private Counsel
Payments") shall be paid in the first instance to Walter Umphrey, Esq. (or such
other person designated in writing by Private Counsel), on behalf of Private
Counsel. Each Private Counsel shall be entitled to receive a percentage of such
payment equal to the percentage of any fee recovery allocated to such Private
Counsel under the terms of the fee-sharing agreement among Private Counsel (or
any written amendment thereto). Settling Defendants shall have no obligation,
responsibility or liability with respect to the allocation among Private
Counsel, or with respect to any claim of misallocation, of any amounts of any
Private Counsel Payment.

SECTION 12. Advances on Payment of Fees.

Each Settling Defendant has paid to Walter Umphrey, Esq., on behalf of
Private Counsel, its respective share of $50 million, as listed in Rider B to
Exhibit 1 to the Settlement Agreement, as an advance against later Private
Counsel Payments. On or before the later of July 31, 1998 or the fifth business
day following entry by the Court of an order approving the Stipulation of
Amendment, each Settling Defendant shall severally pay to Private Counsel, pro
rata in proportion to its Market Share indicated on Schedule A hereto, its
respective share of $50 million, as a further advance against later Private
Counsel Payments. Each of the advances described in this section shall be
credited as provided in section 16 hereof.

SECTION 13. Annual Amount for 1998; Allocation.

(a) For 1998, Settling Defendants shall pay, in the manner described in
section 14 hereof, the unsatisfied amount of the Fee Awards (the "Unpaid Fees")
of Texas Counsel, and those Participating Defendants so obligated shall make
payments with respect to the Unpaid Fees of all other Outside Counsel, in an
amount not to exceed $500 million for all such payments described in this
subsection.

(b) The amount payable by Settling Defendants with respect to each Fee
Award for 1998 shall be determined as follows: The $500 million annual cap for
1998 shall be allocated equally among each month of the year. Except as provided
in section 14(b) hereof, each monthly amount shall be allocated to those

8
<PAGE>

Outside Counsel retained in connection with Tobacco Cases settled by
Participating Defendants or resolved by Federal Legislation before or during
such month, up to the amounts of their respective Unpaid Fees (such counsel
being "Eligible Counsel" with respect to such monthly amount). In the event that
the monthly amount is less than the sum of Eligible Counsel's Unpaid Fees, the
monthly amount shall be allocated to Eligible Counsel in proportion to the
amounts of their respective Unpaid Fees (the amount so allocated to each
Eligible Counsel for a given month being such counsel's Allocable Share for such
month, and the sum of each Outside Counsel's Allocable Shares for each month
being such counsel's Allocable Share for 1998).

(c) Settling Defendants represent that, as of the date of this Agreement,
the only Tobacco Cases (other than the Action) that have been settled by
Participating Defendants on terms that allow for Outside Counsel retained in
connection with such cases to seek a Fee Award from the Panel are In re Mike
Moore, Attorney General, ex rel. State of Mississippi Tobacco Litig., No.
94-1429 (Miss. Ch. Ct., Jackson County), State of Florida v. American Tobacco
Co., No. 95-1466 AH (15th Jud. Cir., Palm Beach County), and Mangini v. R.J.
Reynolds Tobacco Co., No. 939359 (Cal. Super. Ct., San Francisco County). In
addition, Outside Counsel retained in connection with Mangini v. Brown &
Williamson Tobacco Corp., No. 993893 (Cal. Super. Ct., San Francisco County),
may under the terms of the settlement in that action "apply to participate in
any national, reasonable, 'public benefit' fee award or arbitration process
created by a 'national settlement' or 'Congressional Resolution.'"

SECTION 14. Payments with Respect to Annual Amount for 1998.

(a) On December 15, 1998, each Settling Defendant shall severally pay, pro
rata in proportion to its Market Share, its share of an initial fee payment with
respect to the Private Counsel Award and the Fee Award, if any, on behalf of
Other Texas Counsel (the "Initial Texas Fee Payment"), which shall include Texas
Counsel's Allocable Share for 1998 as provided in section 13 hereof for each
month of 1998 except those with respect to which Texas Counsel's Allocable Share
could not be determined as of December 8, 1998, as a result of there being other
Eligible Counsel that, as of such date, had not yet been granted or denied a Fee
Award by the Panel (either because such counsel's application for a Fee Award
was still under consideration by the Panel or for any other reason).

(b) On January 15, 1999, each Settling Defendant shall severally pay, pro
rata in proportion to its Market Share, its share of Texas Counsel's Allocable

9
<PAGE>

Share for those months of 1998 not included in the Initial Texas Fee Payment.
Texas Counsel's Allocable Share for any such month shall be based on an
allocation of the monthly amount among Eligible Counsel having Fee Awards as of
December 31, 1998, without regard to whether there may be other Eligible Counsel
that have not been granted or denied a Fee Award by the Panel as of such date.

(c) Notwithstanding any provision of this Agreement, Private Counsel shall
defer payment of the Private Counsel Payment due from Settling Defendant R.J.
Reynolds Tobacco Company ("Reynolds") on December 15, 1998, insofar as necessary
for the sum of all deferred amounts of any payments by Reynolds in 1998 with
respect to Fee Awards to equal $62 million. Under no circumstances shall this
subsection require any increase in any payment to be made by any other Settling
Defendant. On January 5, 1999, Reynolds shall pay to Private Counsel the amount,
if any, of the Initial Texas Fee Payment deferred pursuant to this subsection.

SECTION 15. Quarterly Amounts for 1999 and Subsequent Years; Allocation.

Within 10 business days after the end of each calendar quarter beginning
with the first calendar quarter of 1999, Settling Defendants shall pay, in the
manner provided in subsection (d) of this section, the Unpaid Fees of Texas
Counsel, and those Participating Defendants so obligated shall make payments
with respect to the Unpaid Fees of all other Outside Counsel, in an amount not
to exceed $125 million for all such payments, as follows:

(a) In the event that Federal Legislation has been enacted by the end of
the calendar quarter with respect to which such quarterly payment is being made
(the "Applicable Quarter"):

(i) the quarterly amount shall be allocated among Outside Counsel,
up to the amount of their respective Unpaid Fees. Each Outside Counsel
shall be allocated an amount of each quarterly payment for the calendar
year up to (or, in the event that the sum of such Outside Counsel's Unpaid
Fees exceeds the quarterly amount, in proportion to) the amount of such
Outside Counsel's Unpaid Fees. Each quarterly payment shall be allocated
among Outside Counsel having Unpaid Fees, without regard to whether there
are other Outside Counsel that have not yet been granted or denied a Fee
Award by the Panel as of the end of the Applicable Quarter. Subsequent
quarterly payments shall be adjusted, if

10
<PAGE>

necessary, to account for Outside Counsel that are granted Fee Awards in a
subsequent quarter of the calendar year, as provided in paragraph (ii)(B)
of this subsection.

(ii) In the event that a quarterly payment for the calendar year is
less than the sum of all Outside Counsel's Unpaid Fees:

(A) in the case of the first such quarterly payment, the
quarterly amount shall be allocated among Outside Counsel in
proportion to the amounts of their respective Unpaid Fees.

(B) in the case of a quarterly payment after the first
quarterly payment that is less than the sum of all such Unpaid Fees,
the quarterly amount shall be allocated only to those Outside
Counsel, if any, that were not paid a proportionate share of all
prior quarterly payments for the calendar year (either because such
Outside Counsel's applications for Fee Awards were still under
consideration as of the end of the calendar quarters with respect to
which such quarterly payments were made or for any other reason),
until each such Outside Counsel has been allocated a proportionate
share of all prior quarterly payments. In the event that the sum of
all such shares exceeds the amount of the quarterly payment, such
payment shall be allocated among such Outside Counsel in proportion
to the amounts of their respective Unpaid Fees (without regard to
whether there are other Outside Counsel that have not yet been
granted or denied a Fee Award by the Panel as of the end of the
Applicable Quarter).

(b) In the event that Federal Legislation has not been enacted by the end
of the Applicable Quarter:

(i) the quarterly amount shall be allocated equally among each of
the three months of the calendar quarter. The amount for each such month
shall be allocated among those Outside Counsel retained in connection with
Tobacco Cases settled before or during such month (such Outside Counsel
being "Eligible Counsel" with respect to such monthly amount), each of
whom shall be allocated a portion of each such monthly amount up to (or,
in the event that the sum of Eligible Counsel's respective Unpaid Fees
exceeds such monthly amount, in proportion to) the amount of such Eligible
Counsel's Unpaid Fees. The monthly amount

11
<PAGE>

for each month of the calendar quarter shall be allocated among Eligible
Counsel having Unpaid Fees, without regard to whether there may be
Eligible Counsel that have not yet been granted or denied a Fee Award by
the Panel as of the end of the Applicable Quarter. Subsequent quarterly
payments shall be adjusted, as necessary, to account for Eligible Counsel
that are granted Fee Awards in a subsequent quarter of the calendar year,
as provided in paragraph (ii)(B) of this subsection.

(ii) In the event that the amount for a given month is less than the
sum of all Eligible Counsel's Unpaid Fees:

(A) in the case of a first quarterly payment, such monthly
amount shall be allocated among Eligible Counsel for such month in
proportion to the amount of their respective Unpaid Fees.

(B) in the case of a quarterly payment after the first
quarterly payment, the quarterly amount shall be allocated among
only those Outside Counsel, if any, that were Eligible Counsel with
respect to any monthly amount paid in a prior quarter of the
calendar year but were not allocated a proportionate share of such
monthly amount (either because such counsel's applications for Fee
Awards were still under consideration as of the end of the calendar
quarter containing the month in question or for any other reason),
until each such Eligible Counsel has been allocated a proportionate
share of all such prior monthly payments for the calendar year. In
the event that the sum of all such shares exceeds the amount of the
quarterly payment, the quarterly payment shall be allocated among
Eligible Counsel in proportion to the amounts of their respective
Unpaid Fees (without regard to whether there may be other Eligible
Counsel with respect to such prior monthly amounts that have not yet
been granted or denied a Fee Award by the Panel as of the end of the
Applicable Quarter).

12
<PAGE>

(d) Each Settling Defendant shall severally pay, pro rata in proportion to
its respective Market Share, its share of the amounts, if any, allocated to
Texas Counsel pursuant to this section.

SECTION 16. Credits and Limitations.

Notwithstanding any other provision of this Agreement, all payments by
Settling Defendants with respect to Fee Awards shall be subject to the
following:

(a) The advances against future Private Counsel Payments described in
section 12 hereof shall be credited against and shall reduce subsequent Private
Counsel Payments, beginning with the first quarterly payment for 1999 pursuant
to section 15 hereof, in an amount equal to 50% of the Private Counsel Payment
in question, until the advances paid by Settling Defendants are fully credited;
provided, however, that the sum of all such credits applied in any calendar year
with respect to the advances made to Private Counsel described in section 12
hereof shall not exceed $50 million. The amount of any credit made against any
such Private Counsel Payment shall be counted toward the annual and quarterly
aggregate national caps on all payments made with respect to Outside Counsel, in
the amount of the credit applied to any such Private Counsel Payment in any
quarterly or annual period. All credits against Private Counsel Payments
pursuant to this section shall be allocated among Settling Defendants in
proportion to their respective contributions toward the amounts of the advances
described in section 12 hereof.

(b) Under no circumstances shall Settling Defendants be required to make
payments that would result in aggregate national payments and credits by
Participating Defendants with respect to Fee Awards:

(i) during 1998, totaling more than $500 million, except insofar as
payments to certain Outside Counsel with respect to 1997 are made in 1998,
and except insofar as advances are made in 1998 against payments due in
years after 1998;

(ii) during any year beginning with 1999, totaling more than $500
million, excluding payments with respect to any Outside Counsel's
Allocable Shares for 1998 that are paid in 1999; and

(iii) during any calendar quarter beginning with the first calendar
quarter of 1999, totaling more than $125 million, excluding payments with

13
<PAGE>

respect to any Outside Counsel's Allocable Shares for 1998 that are paid
in 1999 and except to the extent that payments and credits with respect to
any prior quarter of the calendar year did not total $125 million.

SECTION 17. Contribution to National Legislation.

If Federal Legislation is enacted that implements the Proposed Resolution,
a three-member national panel including the two permanent members of the Panel
shall consider any application for Fee Awards on behalf of Outside Counsel for
contributions made toward the enactment of such Federal Legislation, along with
all applications for Fee Awards for professional fees by any other persons who
claim to have made similar contributions (other than attorneys or agents of
Participating Defendants). No person shall make more than one application for a
Fee Award in connection with any such contributions toward enactment of such
Federal Legislation. All payments with respect to such Fee Awards, if any, shall
be paid on the payment schedule and subject to, and counted in computing, the
annual and quarterly national caps described in sections 13, 14, 15 and 16
hereof.

SECTION 18. Payments on Market Share Basis.

All payments due hereunder shall be paid by Settling Defendants pro rata
in proportion to their respective Market Shares as provided herein, and each
Settling Defendant shall be severally liable for its share of all such payments.
Due to the particular corporate structures of Settling Defendants R.J. Reynolds
Tobacco Company ("Reynolds") and Brown & Williamson Tobacco Corporation ("Brown
& Williamson") with respect to their non-domestic tobacco operations, Settling
Defendants Reynolds and Brown & Williamson shall be severally liable for their
repsective shares of each payment due pursuant to this Agreement up to (and
their liability hereunder shall not exceed) the full extent of their assets used
in, and earnings and revenues derived from, their manufacture and sale in the
United States of Tobacco Products intended for domestic consumption, and no
recourse shall be had against any of their other assets or earnings to satisfy
such obligations. Under no circumstances shall any payment due hereunder or any
portion thereof become the joint obligation of Settling Defendants or the
obligation of any party other than the Settling Defendant from which such
payment is originally due, nor shall any Settling Defendant be required to pay a
portion of any such payment greater than its respective Market Share. With
respect to the advance to be paid pursuant to section 12 hereof, the Market
Share of each Settling Defendant shall be as provided in Schedule A hereto. With
respect to the amount for 1998 described in section 13 hereof, the Market Share
of

14
<PAGE>

each Settling Defendant shall be its respective share pursuant to Appendix A
hereto for 1998. With respect to all other payments pursuant to this Agreement,
each Settling Defendant's Market Share shall be its respective share pursuant to
Appendix A hereto for the 12 month period ending on the last day of the calendar
quarter immediately preceding the calendar quarter with respect to which such
payment is made.

SECTION 19. Determination of Market Share.

In the event of a disagreement between or among any Settling Defendants as
to their respective shares of any payment pursuant to this Agreement (except
payments for which each Settling Defendant's Market Share is expressly provided
herein), each Settling Defendant shall pay its undisputed share of such payment
promptly, on or before the date on which such payment is due, and shall within
21 days submit copies of its audited reports of shipments of Tobacco Products
provided to the U.S. Securities and Exchange Commission ("SEC") for the period
in question (or, in the case of any Settling Defendant that does not provide
such reports to the SEC, audited reports of shipments containing the same
shipment information as contained in the reports provided to the SEC) ("Shipment
Reports") to a third party to be selected by agreement of Settling Defendants
(the "Third Party"), who shall within three business days determine the Market
Share of each Settling Defendant. The decision of the Third Party shall be final
and non-appealable, and shall be communicated by facsimile to each party hereto.
Each Settling Defendant shall, within two business days of receipt of the Third
Party's decision, pay Texas Counsel or such other Settling Defendant, as
appropriate, the difference, if any, between (1) the amount that such Settling
Defendant has already paid with respect to the payment in question and (2) the
amount of the payment in question that corresponds to such Settling Defendant's
Market Share as determined by the Third Party, together with interest accrued
from the original date on which the payment in question was due, at the prime
rate as published in the Wall Street Journal on the latest publication date on
or before the original date on which the payment in question was due plus 3%.

SECTION 20. Limited Waiver as to Other Terms.

In consideration of Settling Defendants' agreement to the terms hereof,
each Texas Counsel hereby covenants and agrees that it will not argue in any
forum (other than in proceedings before the Panel relating to their Fee Award
application) that the arrangements made in connection with the Florida
Settlement, the Mississippi Settlement or the Minnesota Settlement for payment

15
<PAGE>

of fees to Outside Counsel for the States of Florida, Mississippi or Minnesota
give rise to any claim or entitlement on the part of Texas Counsel (or any other
person) in connection with this Action.

SECTION 21. State's Identification of Texas Counsel.

The Attorney General represents and warrants that Schedule B hereto
identifies all Texas Counsel.

SECTION 22. Private Counsel's Costs.

Settling Defendants have agreed to reimburse Private Counsel for
reasonable costs and expenses incurred in connection with the Action, provided
that such costs and expenses are of the same nature as costs and expenses for
which Settling Defendants would reimburse their own counsel or agents. To this
end, each Settling Defendant has paid to Walter Umphrey, Esq., on behalf of
Private Counsel, the respective amount listed for such Settling Defendant in
Rider A to Exhibit 1 to the Settlement Agreement, the sum of such payments being
$40 million, which equals Private Counsel's best estimate as of the date of the
Settlement Agreement of such costs and expenses. Private Counsel shall provide
Settling Defendants with an appropriately documented statement of their costs
and expenses consistent with the criteria set forth above. Settling Defendants
shall promptly pay the amounts of such costs and expenses in excess of $40
million, or shall receive a refund if the total of such costs and expenses is
less than $40 million. Any dispute as to the nature or amount of reimbursable
costs and expenses shall be decided with finality by the Panel.

SECTION 23. Intended Beneficiaries.

SECTION 24. Definitions.

16
<PAGE>

SECTION 25. Representations of Parties.

SECTION 26. No Admission.

SECTION 27. Non-admissibility.

SECTION 28. Amendment and Waiver.

This Agreement may be amended only by a written instrument executed by the
Attorney General, Texas Counsel and Settling Defendants. The waiver of any
rights conferred hereunder shall be effective only if made by written instrument
executed by the waiving party. The waiver by any party of any breach of this
Agreement shall not be deemed to be or construed as a waiver of any other
breach, whether prior, subsequent or contemporaneous, of this Agreement.

SECTION 29. Notices.

17
<PAGE>

indicated. Any party hereto may change the name and address of the person
designated to receive notice on behalf of such party by notice given as provided
in this section including an updated list conformed to Schedule C hereto.

SECTION 30. Governing Law.

This Settlement Agreement shall be governed by the laws of the State of
Texas, without regard to the conflict of law rules of such State.

SECTION 31. Construction.

SECTION 32. Captions.

The captions of the sections of this Agreement are included for
convenience of reference only and shall be ignored in the construction and
interpretation hereof.

SECTION 33. Execution of Agreement.

This Agreement may be executed in counterparts. Facsimile or photocopied
signatures shall be considered valid signatures as of the date hereof, although
the original signature pages shall thereafter be appended to this Agreement.

SECTION 34. Certain Court Orders Conditions Precedent.

The terms of this Agreement shall supersede the terms of Exhibit 1 to the
Settlement Agreement, and the parties hereto will promptly file a joint motion
requesting that the Court approve this Agreement. The parties further agree that
Settling Defendants shall not be required to perform any obligation hereunder
(excepting Settling Defendants' obligations with respect to the advance to be
paid pursuant to section 12 hereof) until such time as (1) the Court issues an
order declaring Exhibit 1 to the Settlement Agreement to be null, void and of no
further effect; (2) the Court issues an order approving the Stipulation of
Amendment; (3) the Court issues the Political Subdivisions Order in the form
attached to the

18
<PAGE>

Stipulation of Amendment as Exhibit 2 thereto; (4) the Court issues an order
confirming that amounts payable to Texas Counsel pursuant to this Agreement are
not funds of the State of Texas and are not subject to appropriation by the
State of Texas and that Settling Defendants are under no obligation to pay such
amounts to the State of Texas; (5) the 30-day periods to seek review of such
orders have expired without the filing of any notice of appeal or petition for
review; and (6) in the event of a timely appeal or petition, such appeal or
petition has been dismissed or the order in question has been affirmed in all
material respects by the court of last resort to which such appeal or petition
has been taken and such dismissal or affirmance has become no longer subject to
further appeal or review.

SECTION 35. Entire Agreement of Parties.

IN WITNESS WHEREOF, the parties hereto, through their fully authorized
representatives, have agreed to this Texas Fee Payment Agreement as of this 24th
day of July, 1998.

STATE OF TEXAS, acting by and through Dan
Morales, its duly elected and authorized Attorney
General

By: /s/ Dan Morales
-----------------------------------------
Dan Morales
Attorney General

19
<PAGE>

PHILIP MORRIS INCORPORATED

By: /s/ Meyer G. Koplow
--------------------------------
Meyer G. Koplow
Counsel

By: /s/ Martin J. Barrington by MGK
--------------------------------
Martin J. Barrington
General Counsel

R.J. REYNOLDS TOBACCO COMPANY

By: /s/ Arthur F. Golden
--------------------------------
Arthur F. Golden
Counsel

By: /s/ Charles A. Blixt
--------------------------------
Charles A. Blixt
General Counsel

20
<PAGE>

BROWN & WILLIAMSON TOBACCO
CORPORATION

By: /s/ Stephen R. Patton
------------------------------------
Stephen R. Patton
Counsel

By: /s/ F. Anthony Burke
------------------------------------
F. Anthony Burke
Vice President & General Counsel

LORILLARD TOBACCO COMPANY

By: /s/ Arthur J. Stevens by MGK
------------------------------------
Arthur J. Stevens
Senior Vice President & General Counsel

UNITED STATES TOBACCO COMPANY

By: /s/ Richard H. Verheij
-----------------------------------
Richard H. Verheij
Executive Vice President & General Counsel

21
<PAGE>

TEXAS COUNSEL

By: /s/ Walter Umphrey
------------------------------------
Walter Umphrey
Provost & Umphrey

By: /s/ John M. O'Quinn, P.C.
------------------------------------
John M. O'Quinn, P.C.

By: /s/ John Eddie Williams, Jr.
------------------------------------
John Eddie Williams, Jr.

By: /s/ Wayne A. Reaud
------------------------------------
Wayne A. Reaud
Reaud, Morgan & Quinn, Inc.

By: /s/ Harold W. Nix
------------------------------------
Harold W. Nix
The Nix Law Firm

22
<PAGE>

By: /s/ Cary Patterson
------------------------------------
Cary Patterson
The Nix Law Firm

By: /s/ Marc D. Murr by Roy Q. Minton with permission
------------------------------------
Marc D. Murr
Law Offices of Marc D. Murr, P.C.

By: /s/ T. Richardson, Jr.
------------------------------------
For Joseph F. Rice
Ness, Motley, Loadholt, Richardson & Poole

1
<PAGE>

APPENDIX A

MARKET SHARE CALCULATION

The Market Share of each Settling Defendant for purposes of any payment
required hereunder shall be equal to the proportion of (1) such Settling
Defendant's Aggregate Sales Volume for the period in question to (2) the sum of
all Settling Defendants' Aggregate Sales Volumes for the period in question. For
purposes of the foregoing:

(a) Each Settling Defendant's Aggregate Sales Volume shall be the sum of
such Settling Defendant's Sales Volumes with respect to each type of Tobacco
Product.

(b) Each Settling Defendant's Sales Volume with respect to each type of
Tobacco Product shall be the number of Units of such type of Tobacco Product
sold within the United States by such Settling Defendant during the period in
question, as measured by such Settling Defendant's applicable Shipment Reports.

(1) one Cigarette;

(2) .12 ounces of Moist Snuff;

(3) .3 ounces of Loose Leaf, Plug, Twist, Roll or other form of
chewing tobacco;

(4) .25 ounces of Dry Snuff; and

(5) .16 ounces of Loose Leaf tobacco suitable for user preparation
of cigarettes.
<PAGE>

SCHEDULE A

MARKET SHARE PERCENTAGES

Settling Defendant Percentage
- ------------------ --------------

Philip Morris Incorporated .................................49.26

R.J. Reynolds Tobacco Company...............................24.49

Brown & Williamson Tobacco Corp.............................16.20

Lorillard Tobacco Company....................................8.77

United States Tobacco Company................................1.28

----------
TOTAL 100.00
<PAGE>

SCHEDULE B

DESIGNATION OF TEXAS COUNSEL
by the Attorney General

Pursuant to section 21 of the Texas Fee Payment Agreement, I hereby
identify as Texas Counsel: (1) Walter Umphrey, John M. O'Quinn, P.C., John Eddie
Williams, Jr., Reaud, Morgan & Quinn, Inc., The Nix Law Firm and Ness, Motley,
Loadholt, Richardson & Poole ("Private Counsel") and (2) the Law Offices of Marc
D. Murr, P.C. ("Other Texas Counsel").

There are no other Texas Counsel entitled to seek any payment of
attorneys' fees by Settling Defendants under the Settlement Agreement or the
Texas Fee Payment Agreement.

/s/ Dan Morales
-----------------------------
Dan Morales
Attorney General
<PAGE>

SCHEDULE C

NOTICES

State of Texas

Hon. Dan Morales
Attorney General
P.O. Box 12548
Capitol Station
Austin, TX 78711
Fax: (512) 463-2063

With copies to:
Harold W. Nix
Walter Umphrey Cary Patterson
Provost & Umphrey The Nix Law Firm
490 Park Street 205 Linda Drive
P.O. Box 4905 P.O. Box 679
Beaumont, TX 77704 Daingerfield, TX 75638
Fax: (409) 838-8888 Fax: (903) 645-5389

John M. O'Quinn John Eddie Williams, Jr.
440 Louisiana Street, Suite 2300 8441 Gulf Freeway, Suite 600
Houston, TX 77002 Houston, TX 77017
Fax: (713) 222-6903 Fax: (713) 649-0126

Wayne A. Reaud Marc D. Murr
Reaud, Morgan & Quinn, Inc. Law Offices of Marc D. Murr, P.C
801 Laurel 1001 Texas Avenue, Suite 1250
Beaumont, TX 77701 Houston, TX 77002-3131
Fax: (409) 833-8236 Fax: (713) 229-8003

Joseph F. Rice
Ness, Motley, Loadholt, Richardson & Poole
151 Meeting Street, Suite 600
Charleston, SC 29402
Fax: (803) 720-9290 (continued)
<PAGE>

Settling Defendants

Philip Morris Incorporated: R.J. Reynolds Tobacco Company:

With a copy to: With a copy to:

Brown & Williamson Tobacco Corp.: Lorillard Tobacco Company:

With a copy to: United States Tobacco Company:

Stephen R. Patton, Esq. Richard H. Verheij
Kirkland & Ellis UST Inc.
200 East Randolph Dr. 100 West Putnam Avenue
Chicago, IL 60601 Greenwich, CT 06830
Fax: (312) 861-2200 Fax: (203) 863-7233

(continued)

2
<PAGE>

Texas Counsel

Walter Umphrey Wayne A. Reaud
Provost & Umphrey Reaud, Morgan & Quinn, Inc.
490 Park Street 801 Laurel
P.O. Box 4905 Beaumont, TX 77701
Beaumont, TX 77704 Fax: (409) 833-8236
Fax: (409) 838-8888

John Eddie Williams, Jr. John M. O'Quinn
8441 Gulf Freeway, Suite 600 440 Louisiana Street, Suite 2300
Houston, TX 77017 Houston, TX 77002
Fax: (713) 649-0126 Fax: (713) 222-6903

Harold W. Nix Marc D. Murr
Cary Patterson Law Offices of Marc D. Murr, P.C.
The Nix Law Firm 1001 Texas Avenue, Suite 1250
205 Linda Drive Houston, TX 77002-3131
P.O. Box 679 Fax: (713) 229-8003
Daingerfield, TX 75638
Fax: (903) 645-5389

Joseph F. Rice
Ness, Motley, Loadholt, Richardson & Poole
151 Meeting Street, Suite 600
Charleston, SC 29402
Fax: (803) 720-9290

<PAGE>

EXHIBIT 12

PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES
Computation of Ratios of Earnings to Fixed Charges
(in millions of dollars)
--------------------

Six Months Ended Three Months Ended
June 30, 1998 June 30, 1998
---------------- ------------------
<S> <C> <C>
Earnings before income taxes $5,221 $2,902

Add (Deduct):
Equity in net earnings of less than 50% owned
affiliates (104) (55)
Dividends from less than 50% owned
affiliates 71 43
Fixed charges 688 342
Interest capitalized, net of amortization (2) (1)
------ ------

Earnings available for fixed charges $5,874 $3,231
====== ======
Fixed charges:
Interest incurred:
Consumer products $ 577 $ 286
Financial services 37 19
------ ------

614 305
Portion of rent expense deemed to represent
interest factor 74 37
------ ------

Fixed charges $ 688 $ 342
====== ======

Ratio of earnings to fixed charges 8.5 9.4
====== ======

</TABLE>

<PAGE>

EXHIBIT 12

PHILIP MORRIS COMPANIES INC. AND SUBSIDIARIES
Computation of Ratios of Earnings to Fixed Charges
(in millions of dollars)
--------------------

Years Ended December 31,
------------------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- ------
<S> <C> <C> <C> <C> <C>
Earnings before income
taxes and cumulative
effect of accounting
changes $10,611 $10,683 $ 9,347 $ 8,216 $ 6,196

Add (Deduct):
Equity in net earnings
of less than 50%
owned affiliates (207) (227) (246) (184) (164)
Dividends from less
than 50% owned
affiliates 138 160 202 165 151
Fixed charges 1,438 1,421 1,495 1,537 1,716
Interest capitalized,
net of amortization (16) 13 2 (1) (13)
------- ------- ------- ------- -------
Earnings available for
fixed charges $11,964 $12,050 $10,800 $ 9,733 $ 7,886
======= ======= ======= ======= =======
Fixed charges:
Interest incurred:
Consumer products $ 1,224 $ 1,197 $ 1,281 $ 1,317 $ 1,502
Financial services
and real estate 67 81 84 78 87
------- ------- ------- ------- -------

1,291 1,278 1,365 1,395 1,589
Portion of rent expense
deemed to represent
interest factor 147 143 130 142 127
------- ------- ------- ------- -------

Fixed charges $ 1,438 $ 1,421 $ 1,495 $ 1,537 $ 1,716
======= ======= ======= ======= =======
Ratio of earnings to
fixed charges 8.3 8.5 7.2 6.3 4.6
======= ======= ======= ======= =======

</TABLE>

<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary information extracted from Pages 3-5 of the
Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30,
1998 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000

<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 4,605
<SECURITIES> 0
<RECEIVABLES> 5,466
<ALLOWANCES> 173
<INVENTORY> 9,119
<CURRENT-ASSETS> 20,857
<PP&E> 20,595
<DEPRECIATION> 8,740
<TOTAL-ASSETS> 59,363
<CURRENT-LIABILITIES> 15,976
<BONDS> 13,127
0
0
<COMMON> 935
<OTHER-SE> 15,087
<TOTAL-LIABILITY-AND-EQUITY> 59,363
<SALES> 37,361
<TOTAL-REVENUES> 37,361
<CGS> 13,590
<TOTAL-COSTS> 22,009
<OTHER-EXPENSES> 9,649
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 482
<INCOME-PRETAX> 5,221
<INCOME-TAX> 2,103
<INCOME-CONTINUING> 3,118
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,118
<EPS-PRIMARY> 1.28
<EPS-DILUTED> 1.28

</TABLE>

<PAGE>

EXHIBIT 99

CERTAIN PENDING LITIGATION MATTERS AND RECENT DEVELOPMENTS

As described in Note 3 ("Note 3") to the Condensed Consolidated Financial
Statements included in Part I, Item 1, of this Quarterly Report on Form 10-Q,
there are legal proceedings covering a wide range of matters pending in
various U.S. and foreign jurisdictions against the Company, its subsidiaries
and affiliates, including PM Inc. and PMI, and their respective indemnitees.
Various types of claims are raised in these proceedings, including products
liability, consumer protection, antitrust, securities law, tax, patent
infringement, employment matters and claims for contribution. Pending claims
related to tobacco products generally fall within three categories: (i)
smoking and health cases alleging personal injury brought on behalf of
individual plaintiffs, (ii) smoking and health cases alleging personal injury
and purporting to be brought on behalf of a class of individual plaintiffs,
and (iii) health care cost recovery cases brought by state and local
governments seeking reimbursement for Medicaid and/or other health care
expenditures allegedly caused by cigarette smoking, as well as similar cases,
including class actions, brought by non-governmental plaintiffs such as
unions, HMOs, federal and state taxpayers, native American tribes and others.
The following lists the pending claims included in the latter two of these
categories. Certain developments in these cases since April 1, 1998 are also
described.

SMOKING AND HEALTH LITIGATION

The following lists the smoking and health class actions pending against PM
Inc. and, in some cases, the Company and/or its other subsidiaries and
affiliates, including PMI, as of August 1, 1998, and describes certain
developments since April 1, 1998.

ENGLE, ET AL. V. R.J. REYNOLDS TOBACCO CO., ET AL., CIRCUIT COURT, DADE
COUNTY, FLORIDA, FILED MAY 5, 1994. Jury selection began in July 1998. In May
1998, the court denied defendants' motions for summary judgment as to
plaintiffs' express and implied warranty claims, and defendants' motion for
summary judgment against certain named plaintiffs.

GRANIER, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES
DISTRICT COURT, EASTERN DISTRICT, LOUISIANA, FILED SEPTEMBER 26, 1994.

CAPUTO (formerly LETOURNEAU) V. IMPERIAL TOBACCO LIMITED, ET AL., ONTARIO
COURT OF JUSTICE, TORONTO, CANADA, FILED JANUARY 13, 1995.

THE SMOKER HEALTH DEFENSE ASSOCIATION, ET AL. V. SOUZA CRUZ, S.A. AND PHILIP
MORRIS MARKETING, S.A., 19TH LOWER CIVIL COURT OF THE CENTRAL COURTS OF THE
JUDICIARY DISTRICT OF SAO PAULO, BRAZIL, FILED JULY 25, 1995.

NORTON, ET AL. V. RJR NABISCO HOLDINGS CORPORATION, ET AL., SUPERIOR COURT,
MADISON COUNTY, INDIANA, FILED MAY 3, 1996.

RICHARDSON, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT COURT,
BALTIMORE CITY, MARYLAND, FILED MAY 24, 1996. Trial is scheduled for
September 1999.

SCOTT, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., DISTRICT COURT,
ORLEANS PARISH, LOUISIANA, FILED MAY 24, 1996.

FROSINA, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPREME COURT, NEW
YORK COUNTY, NEW YORK, FILED JUNE 19, 1996. In July 1998, a New York appeals
court
1
<PAGE>

EXHIBIT 99

overturned the trial court's certification of the class, and dismissed the
underlying claims, thus dismissing this case in its entirety.

REED, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, DISTRICT
OF COLUMBIA, FILED JUNE 21, 1996.

BARNES (formerly ARCH), ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL.,
UNITED STATES DISTRICT COURT, EASTERN DISTRICT, PENNSYLVANIA, FILED AUGUST 8,
1996.

LYONS, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT
COURT, SOUTHERN DISTRICT, ALABAMA, FILED AUGUST 8, 1996.

HOLMES (formerly CROZIER) V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT
COURT, MONTGOMERY COUNTY, ALABAMA, FILED AUGUST 8, 1996. In April 1998, the
court denied defendants' motion to dismiss in most respects, but required
plaintiffs to file an amended complaint to address certain deficiencies.
Plaintiffs subsequently filed an amended complaint that deletes their health
care cost reimbursement claims. The amended complaint seeks class
certification on behalf of two subclasses, one directed to claims concerning
youth smoking and to comprise minors and parents, and the second directed to
antitrust claims and to comprise Alabama residents who have purchased tobacco
products in Alabama during a period to be set by the court. Trial has been
scheduled for August 1999.

CHAMBERLAIN, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES
DISTRICT COURT, NORTHERN DISTRICT, OHIO, FILED AUGUST 14, 1996.

THOMPSON, ET AL. V. AMERICAN TOBACCO COMPANY, INC., ET AL., UNITED STATES
DISTRICT COURT, MINNESOTA, FILED SEPTEMBER 4, 1996.

PERRY/CHAMPION, ET AL. V. AMERICAN TOBACCO CO., INC., ET AL., CIRCUIT COURT
FOR COFFEE COUNTY, TENNESSEE, AT MANCHESTER, FILED SEPTEMBER 6, 1996.

CONNOR, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., SECOND JUDICIAL
DISTRICT COURT, BERNALILLO COUNTY, NEW MEXICO, FILED OCTOBER 10, 1996.

RUIZ, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT
COURT, PUERTO RICO, FILED OCTOBER 23, 1996.

HANSEN, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES
DISTRICT COURT, EASTERN DISTRICT, ARKANSAS, FILED NOVEMBER 4, 1996.

MCCUNE, ET AL. V. AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT OF KANAWHA
COUNTY, WEST VIRGINIA, FILED JANUARY 31, 1997.

BAKER, ET AL. V. AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, WAYNE
COUNTY, MICHIGAN, FILED FEBRUARY 4, 1997.

WOODS (formerly INGLE), ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT
COURT, MCDOWELL COUNTY, WEST VIRGINIA, FILED FEBRUARY 4, 1997.

GREEN (formerly EMIG), ET AL. V. AMERICAN TOBACCO COMPANY, ET AL., UNITED
STATES DISTRICT COURT, KANSAS, FILED FEBRUARY 6, 1997.

PETERSON, ET AL. V. AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT
COURT, HAWAII, FILED FEBRUARY 6, 1997.
2
<PAGE>

EXHIBIT 99

WALLS, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT
COURT, NORTHERN DISTRICT, OKLAHOMA, FILED FEBRUARY 6, 1997. In July 1998, the
court ruled that plaintiffs' claims for breach of implied warranty are
inappropriate for class treatment.

SELCER, ET AL. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., UNITED STATES
DISTRICT COURT, NEVADA, FILED MARCH 3, 1997.

INSOLIA, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT
COURT, WESTERN DISTRICT, WISCONSIN, FILED APRIL 21, 1997. Trial is scheduled
for May 1999.

WHITE, ET AL. V. PHILIP MORRIS, INC., ET AL., CHANCERY COURT, JEFFERSON
COUNTY, MISSISSIPPI, FILED APRIL 18, 1997.

GEIGER, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPREME COURT, QUEENS
COUNTY, NEW YORK, FILED APRIL 30, 1997. In July 1998, the appellate court
decertified the class and remanded the case back to the trial court for
further proceedings on whether plaintiffs meet the requirements for class
certification. The appellate court also dismissed plaintiffs' claims of
negligent misrepresentation and implied warranties of merchantability and
fitness to the extent based on a failure to warn after 1969.

COLE, ET AL. V. THE TOBACCO INSTITUTE, INC., ET AL., UNITED STATES DISTRICT
COURT, EASTERN DISTRICT, TEXAS, TEXARKANA DIVISION, FILED MAY 5, 1997.

COSENTINO, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT,
MIDDLESEX COUNTY, NEW JERSEY, FILED MAY 21, 1997.

CLAY, ET AL. V. THE AMERICAN TOBACCO COMPANY, INC., ET AL., UNITED STATES
DISTRICT COURT, SOUTHERN DISTRICT, ILLINOIS, BENTON DIVISION, FILED MAY 22,
1997. In April 1998, the court vacated the August 1998 trial date, and
scheduled the trial to begin during August 1999.

ANDERSON, ET AL. V. THE AMERICAN TOBACCO COMPANY, INC., ET AL., UNITED STATES
DISTRICT COURT, EASTERN DISTRICT, TENNESSEE, FILED MAY 23, 1997.

TAYLOR, ET AL. V. THE AMERICAN TOBACCO COMPANY, INC., ET AL., CIRCUIT COURT,
WAYNE COUNTY, MICHIGAN, FILED MAY 23, 1997.

LYONS, ET AL. V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., UNITED
STATES DISTRICT COURT, NORTHERN DISTRICT, GEORGIA, FILED MAY 27, 1997.

KIRSTEIN (formerly ENRIGHT), ET AL. V. AMERICAN TOBACCO COMPANY, INC., ET
AL., SUPERIOR COURT, CAMDEN COUNTY, NEW JERSEY, FILED MAY 28, 1997.

TEPPER, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT, BERGEN
COUNTY, NEW JERSEY, FILED MAY 28, 1997.

BROWN, ET AL. V. THE AMERICAN TOBACCO COMPANY, INC., ET AL., SUPERIOR COURT,
SAN DIEGO COUNTY, CALIFORNIA, FILED JUNE 10, 1997.

LIPPINCOTT, ET AL. V. AMERICAN TOBACCO COMPANY, INC., ET AL., SUPERIOR COURT,
CAMDEN COUNTY, NEW JERSEY, FILED JUNE 13, 1997.

BRAMMER, ET AL. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., UNITED STATES
DISTRICT COURT, SOUTHERN DISTRICT, IOWA, FILED JUNE 20, 1997.
3
<PAGE>

EXHIBIT 99

KNOWLES, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES
DISTRICT COURT, EASTERN DISTRICT, LOUISIANA, FILED JUNE 30, 1997.

DALEY, ET AL. V. AMERICAN BRANDS, INC., ET AL., UNITED STATES DISTRICT COURT,
NORTHERN DISTRICT, ILLINOIS, FILED JULY 7, 1997.

PISCITELLO, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT,
MIDDLESEX COUNTY, NEW JERSEY, FILED JULY 28, 1997.

MCCAULEY, ET AL. V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., UNITED
STATES DISTRICT COURT, NORTHERN DISTRICT, GEORGIA, FILED AUGUST 20, 1997.

DASILVA, ET AL. V. NIGERIAN TOBACCO COMPANY, ET AL., HIGH COURT OF LAGOS
STATE, NIGERIA, FILED SEPTEMBER 8, 1997.

BUSH, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT
COURT, EASTERN DISTRICT, TEXAS, FILED SEPTEMBER 10, 1997.

NWANZE, ET AL. V. PHILIP MORRIS COMPANIES INC., ET AL., UNITED STATES
DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED SEPTEMBER 29, 1997.

BADILLO, ET AL. V. AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT
COURT, NEVADA, FILED OCTOBER 8, 1997.

NEWBORN, ET AL. V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., UNITED
STATES DISTRICT COURT, WESTERN DISTRICT, TENNESSEE, FILED OCTOBER 9, 1997.

YOUNG, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., CIVIL DISTRICT COURT,
ORLEANS PARISH, STATE OF LOUISIANA, FILED NOVEMBER 12, 1997.

AKSAMIT, ET AL. V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., UNITED
STATES DISTRICT COURT, SOUTH CAROLINA, FILED NOVEMBER 20, 1997.

DIENNO, ET AL. V. LIGGETT GROUP, INC., ET AL., UNITED STATES DISTRICT COURT,
NEVADA, FILED DECEMBER 22, 1997.

HERRERA, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES
DISTRICT COURT, CENTRAL DISTRICT, UTAH, FILED JANUARY 28, 1998.

JACKSON, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES DISTRICT
COURT, CENTRAL DISTRICT, UTAH, FILED FEBRUARY 13, 1998.

PARSONS, ET AL. V. A C & S, INC., ET AL. CIRCUIT COURT, KANAWHA COUNTY, WEST
VIRGINIA, FILED FEBRUARY 27, 1998.

NATIONAL ASSOCIATION FOR ASSISTANCE TO CONSUMERS AND WORKERS V. SOUZA CRUZ
S.A. AND PHILIP MORRIS BRASIL S.A., THE FIFTH COURT OF BANKRUPTCIES AND
REORGANIZATIONS OF THE CAPITAL DISTRICT OF THE STATE OF RIO DE JANEIRO,
BRAZIL, FILED MARCH 16, 1998.

BASIK (formerly MENDYS), ET AL. V. LORILLARD TOBACCO COMPANY, ET AL., CIRCUIT
COURT OF COOK COUNTY, ILLINOIS, FILED MARCH 17, 1998.

DANIELS, ET AL. V. PHILIP MORRIS COMPANIES, INC., ET AL., UNITED STATES
DISTRICT COURT, SOUTHERN DISTRICT, CALIFORNIA, FILED APRIL 2, 1998.
4
<PAGE>

EXHIBIT 99

CHRISTIANSON, ET AL. V. PHILIP MORRIS COMPANIES, INC., ET AL., UNITED STATES
DISTRICT COURT, NEVADA, FILED APRIL 3, 1998.

AVALLONE, ET AL. V. THE AMERICAN TOBACCO COMPANY, INC., ET AL., NEW JERSEY
SUPERIOR COURT, ATLANTIC COUNTY LAW DIVISION, FILED APRIL 23, 1998.

COLLIER, ET AL. V. PHILIP MORRIS INCORPORATED, UNITED STATES DISTRICT COURT,
SOUTHERN DISTRICT OF MISSISSIPPI, FILED MAY 26, 1998.

CLEARY, ET AL. V. PM INC., ET AL., CIRCUIT COURT, COOK COUNTY ILLINOIS,
COUNTY LAW DEPARTMENT, LAW DIVISION, FILED JUNE 3, 1998.

VAUGHAN, ET AL. V. PHILIP MORRIS INC., ET AL., UNITED STATES DISTRICT COURT,
WESTERN DISTRICT OF VIRGINIA, FILED JULY 30, 1998.

------------------------------------------------------------------------

HEALTH CARE COST RECOVERY LITIGATION

The following lists the health care cost recovery actions pending against PM
Inc. and, in some cases, the Company and/or its other subsidiaries and
affiliates as of August 1, 1998, and describes certain developments since
April 1, 1998.

MOORE V. THE AMERICAN TOBACCO COMPANY, ET AL., CHANCERY COURT, JACKSON
COUNTY, MISSISSIPPI, FILED MAY 23, 1994. The parties entered into a
settlement agreement in July 1997 (see the Company's 1997 Form 10-K). In July
1998, the parties amended the settlement agreement (see Note 3. Contingencies
hereto).

STATE OF MINNESOTA, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., DISTRICT
COURT, RAMSEY COUNTY, MINNESOTA, FILED AUGUST 17, 1994. The parties entered
into a settlement agreement in May 1998 (see the Company's Quarterly Report
on Form 10-Q for the quarter ended March 31, 1998).

MCGRAW V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, KANAWHA
COUNTY, WEST VIRGINIA, FILED SEPTEMBER 20, 1994.

THE STATE OF FLORIDA, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT
COURT, PALM BEACH COUNTY, FLORIDA, FILED FEBRUARY 21, 1995. The parties
entered into a settlement agreement in September 1997 (see the Company's 1997
Form 10-K). In April 1998, the court issued an order incorporating additional
provisions into the settlement agreement pursuant to its "most favored
nation" clause. The court order provides that the settling defendants are
required to pay $50 million to the state's contingency fee counsel as an
advance on attorneys' fees to be awarded in arbitration proceedings that will
commence in November 1998. The court's order is under appeal. Also in April
1998, the court dismissed the remaining equitable claims without prejudice.

COMMONWEALTH OF MASSACHUSETTS V. PHILIP MORRIS INC., ET AL., SUPERIOR COURT,
MIDDLESEX COUNTY, MASSACHUSETTS, FILED DECEMBER 19, 1995. In June 1998, the
court ruled that a three-year statute of limitations applies to all of
plaintiff's claims, except for those asserted under the Massachusetts Trade
Practices Act, which are limited to four years. Trial is scheduled for
February 1999.

IEYOUB V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT,
WESTERN DISTRICT, LOUISIANA, FILED MARCH 13, 1996.
5
<PAGE>

EXHIBIT 99

THE STATE OF TEXAS V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES
DISTRICT COURT, EASTERN DISTRICT, TEXAS, FILED MARCH 28, 1996. The parties
entered into a settlement agreement in January 1998 (see the Company's 1997
Form 10-K). In July 1998, the parties amended the settlement agreement (see
Note 3. Contingencies hereto).

STATE OF MARYLAND V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT COURT,
BALTIMORE CITY, MARYLAND, FILED MAY 1, 1996. Trial is scheduled for April
1999. In April 1998, the Maryland legislature amended the statute governing
recovery for health care costs to permit the state to pursue claims for
health care costs without proceeding via subrogation. The statute also
permits the state to use a statistical model to prove causation and the
amount of medical assistance expenditures attributable to the use of a
tobacco product. The amendment took effect on July 1, 1998.

STATE OF WASHINGTON V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPERIOR COURT,
KING COUNTY, WASHINGTON, FILED JUNE 5, 1996. In July 1998, the court
dismissed plaintiff's claim for restitution. The court denied defendants'
motions seeking dismissal of plaintiff's other claims, including plaintiff's
conspiracy claim, but it invited defendants to address the scope of
permissible relief under the conspiracy claim by further motion at trial. The
court also ordered that defendants may seek a damages offset for plaintiff's
tobacco-related tax revenues and that defendants are entitled to challenge
the methodology used by plaintiff in estimating its damages and to present
alternate methodologies. The court also granted plaintiff's motion for
summary judgment as to defendants' defenses that subrogation is plaintiff's
exclusive remedy, but denied the motion as to defendants' defenses based on
the comparative fault of individual smokers, holding that defendants must be
permitted to meet plaintiff's allegations of misrepresentation, deception,
and fraud by showing that individual smokers were not misled. Trial is
scheduled for September 1998.

CITY AND COUNTY OF SAN FRANCISCO, ET AL. V. PHILIP MORRIS INCORPORATED, ET
AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, CALIFORNIA, FILED
JUNE 6, 1996.

STATE OF CONNECTICUT V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT,
LITCHFIELD DISTRICT, CONNECTICUT, FILED JULY 18, 1996. In July 1998,
plaintiff filed a motion that seeks prejudgment orders of attachment that
attach assets in the amount of $2 billion of each tobacco company defendant,
excluding Liggett, in order to secure the state's potential recovery.
Plaintiff also filed a motion to bifurcate the case as to its claims under
the Connecticut Unfair Trade Practices Act ("CUPTA"), and to set the case
immediately for trial as to the injunctive relief claims under CUPTA.
Defendants' motion to dismiss the CUPTA claims was denied in July 1998.

COUNTY OF LOS ANGELES V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., SUPERIOR
COURT, SAN DIEGO COUNTY, CALIFORNIA, FILED AUGUST 5, 1996. A trial on certain
issues is scheduled for February 1999. In July 1998, the San Diego Superior
Court recommended that this case be consolidated with certain other pending
California cases.

STATE OF ARIZONA V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPERIOR COURT,
MARICOPA COUNTY, ARIZONA, FILED AUGUST 20, 1996. In June 1998, the court
denied defendants' motion to dismiss a claim of negligent entrustment
relating to the alleged sale of tobacco products to minors. Trial is
scheduled for March 1999.
6
<PAGE>

EXHIBIT 99

STATE OF KANSAS V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., DISTRICT COURT,
SHAWNEE COUNTY, KANSAS, FILED AUGUST 20, 1996.

KELLEY V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT COURT, INGHAM COUNTY,
MICHIGAN, FILED AUGUST 21, 1996, BY THE ATTORNEY GENERAL OF MICHIGAN. In July
1998, the court granted defendants' motion to dismiss plaintiff's claim of
breach of voluntary duty undertaken and plaintiff's exemplary damages claim,
and denied the motion with respect to unjust enrichment as untimely.

STATE OF OKLAHOMA, ET AL. V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., DISTRICT
COURT, CLEVELAND COUNTY, OKLAHOMA, FILED AUGUST 22, 1996. In June 1998, the
court granted defendants' motion for partial summary judgment on the state's
unjust enrichment claim. The court also granted the state's motion for
partial summary judgment against defendants' affirmative defenses of statute
of limitations, unclean hands, estoppel and statute of repose. In July 1998,
the court granted in part and denied in part defendants' motion for summary
judgment on the state's public nuisance claim. The motion was granted to the
extent the state's public nuisance claim was based on the lawful sale of
cigarettes; it was denied to the extent the state's claim was based on
defendants' alleged unlawful conduct. Also in July, the court denied
defendants' motion for summary judgment on the state's claims for
reimbursement of health care costs. The grounds for defendants' motion were
(i) subrogation is the exclusive method of recovering the state's health care
costs and (ii) the state is too remote a plaintiff. In August 1998, the court
granted defendants' motion for partial summary judgment on the state's
voluntary undertaking claim. Trial is scheduled for January 1999.

PEOPLE OF THE STATE OF CALIFORNIA V. PHILIP MORRIS INCORPORATED, ET AL.,
SUPERIOR COURT, SAN FRANCISCO COUNTY, CALIFORNIA, FILED SEPTEMBER 5, 1996.
This action, based on state law consumer protection theories, is scheduled
for trial in March 1999. In April 1998, the court issued an order striking
defendants' equitable defenses and the defense of discriminatory prosecution.
In July 1998, the San Diego Superior Court recommended that this case be
consolidated with certain other pending California cases.

STATE OF NEW JERSEY V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., SUPERIOR COURT,
MIDDLESEX COUNTY, NEW JERSEY, FILED SEPTEMBER 10, 1996. Trial is scheduled
for May 1999.

COYNE, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT
COURT, NORTHERN DISTRICT, OHIO, FILED SEPTEMBER 17, 1996.

PERRY, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT, COFFEE
COUNTY, TENNESSEE, FILED SEPTEMBER 30, 1996.

STATE OF UTAH V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., UNITED STATES
DISTRICT COURT, CENTRAL DIVISION, UTAH, FILED SEPTEMBER 30, 1996.

CITY OF NEW YORK, ET AL. V. THE TOBACCO INSTITUTE, ET AL., SUPREME COURT, NEW
YORK COUNTY, NEW YORK, FILED OCTOBER 17, 1996.

PEOPLE OF THE STATE OF ILLINOIS V. PHILIP MORRIS, INC., ET AL., CIRCUIT
COURT, COOK COUNTY, ILLINOIS, FILED NOVEMBER 12, 1996.

STATE OF IOWA V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., DISTRICT COURT, FIFTH
JUDICIAL DISTRICT, POLK COUNTY, IOWA, FILED NOVEMBER 27, 1996. In April 1998,
the Iowa Supreme Court affirmed the trial court's dismissal of plaintiff's
claims for deception, breach of assumed duty and indemnity.
7
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EXHIBIT 99

COUNTY OF ERIE V. THE TOBACCO INSTITUTE, INC., ET AL., SUPREME COURT, ERIE
COUNTY, NEW YORK, FILED JANUARY 14, 1997.

STATE OF NEW YORK V. THE AMERICAN TOBACCO COMPANY, ET AL., SUPREME COURT, NEW
YORK COUNTY, NEW YORK, FILED JANUARY 21, 1997. Trial is scheduled for May
1999.

STATE OF HAWAII V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., CIRCUIT
COURT, FIRST CIRCUIT, HAWAII, FILED JANUARY 31, 1997. Trial is scheduled for
September 1999.

STATE OF WISCONSIN V. PHILIP MORRIS INCORPORATED, ET AL., CIRCUIT COURT, DANE
COUNTY, WISCONSIN, FILED FEBRUARY 5, 1997. Trial is scheduled for September
1999.

STATE OF INDIANA V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT,
MARION COUNTY, INDIANA, FILED FEBRUARY 19, 1997. In July 1998, the trial
court dismissed this case in its entirety.

STATE OF ALASKA V. PHILIP MORRIS, INCORPORATED, ET AL., SUPERIOR COURT, FIRST
JUDICIAL DISTRICT, ALASKA, FILED APRIL 14, 1997. In April 1998, the court
granted defendants' motion to dismiss plaintiff's claims for public nuisance
(with leave to amend), unjust enrichment, restitution and breach of special
duty. Defendants' motion was denied with respect to claims for violations of
antitrust and consumer protection statutes, negligence PER SE and conspiracy.
Trial is scheduled for February 2000.

COUNTY OF COOK V. PHILIP MORRIS, INCORPORATED, ET AL., CIRCUIT COURT, COOK
COUNTY, ILLINOIS, FILED APRIL 18, 1997.

COMMONWEALTH OF PENNSYLVANIA V. PHILIP MORRIS, INC., ET AL., COURT OF COMMON
PLEAS, PHILADELPHIA COUNTY, PENNSYLVANIA, FILED APRIL 23, 1997.

STATIONARY ENGINEERS LOCAL 39 HEALTH AND WELFARE TRUST FUND V. PHILIP MORRIS,
INC., ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, CALIFORNIA,
FILED APRIL 25, 1997. In April 1998, the court granted defendants' motion to
dismiss with prejudice the RICO claims, the state and federal antitrust
claims, the intentional breach of special duty claim, the unfair business
practices claim, and the restitution and unjust enrichment claim. The court
dismissed without prejudice plaintiff's claim for fraud and
misrepresentation. The court denied defendants' motion to dismiss plaintiff's
claim for negligent breach of special duty.

STATE OF ARKANSAS V. THE AMERICAN TOBACCO COMPANY, ET AL., CHANCERY COURT,
SIXTH DIVISION, PULASKI COUNTY, ARKANSAS, FILED MAY 5, 1997.

STATE OF MONTANA V. PHILIP MORRIS, INCORPORATED, ET AL., FIRST JUDICIAL
COURT, LEWIS AND CLARK COUNTY, MONTANA, FILED MAY 5, 1997.

STATE OF OHIO V. PHILIP MORRIS, INCORPORATED, ET AL., COURT OF COMMON PLEAS,
FRANKLIN COUNTY, OHIO, FILED MAY 8, 1997. Trial is scheduled for May 2000.

STATE OF TENNESSEE ET AL., EX. REL. BECKOM, ET AL. V. THE AMERICAN TOBACCO
COMPANY, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, TENNESSEE,
FILED MAY 8, 1997.

STATE OF MISSOURI V. AMERICAN TOBACCO COMPANY, INC., ET AL., CIRCUIT COURT,
CITY OF ST. LOUIS, MISSOURI, FILED MAY 12, 1997. Trial is scheduled for
January 2000.
8
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EXHIBIT 99

STATE OF SOUTH CAROLINA V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL.,
COURT OF COMMON PLEAS, RICHLAND COUNTY, SOUTH CAROLINA, FILED MAY 12, 1997.

IRON WORKERS LOCAL UNION NO. 17 INSURANCE FUND, ET AL. V. PHILIP MORRIS,
INC., ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, OHIO, EASTERN
DIVISION, FILED MAY 20, 1997. Trial is scheduled for February 1999.

NORTHWEST LABORERS-EMPLOYERS HEALTH AND SECURITY TRUST FUND, ET AL. V. PHILIP
MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, WESTERN DISTRICT,
WASHINGTON, FILED MAY 21, 1997. Trial is scheduled for September 1999.

STATE OF NEVADA V. PHILIP MORRIS, INCORPORATED, ET AL., SECOND JUDICIAL
DISTRICT, WASHOE COUNTY, NEVADA, FILED MAY 21, 1997. In April 1998, the court
granted defendants' motion to dismiss plaintiff's claims for targeting minors
in violation of the Nevada Deceptive Trade Practices Act,
negligent/intentional breach of a special duty, public nuisance, negligence,
negligence PER SE, strict products liability and breach of express or implied
warranties. Trial is scheduled for June 2000.

UNIVERSITY OF SOUTH ALABAMA V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED
STATES DISTRICT COURT, SOUTHERN DISTRICT, ALABAMA, FILED MAY 23, 1997.

STATE OF NEW MEXICO V. THE AMERICAN TOBACCO COMPANY, ET AL., FIRST JUDICIAL
DISTRICT COURT, SANTA FE COUNTY, NEW MEXICO, FILED MAY 27, 1997.

CITY OF BIRMINGHAM, ALABAMA, AND THE GREENE COUNTY RACING COMMISSION V. THE
AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT COURT, NORTHERN
DISTRICT, ALABAMA, FILED MAY 28, 1997.

STATE OF VERMONT V. PHILIP MORRIS, INCORPORATED, ET AL., SUPERIOR COURT,
CHITTENDEN COUNTY, VERMONT, FILED MAY 29, 1997. Trial is scheduled for
November 1999.

CENTRAL LABORERS WELFARE FUND, ET AL. V. PHILIP MORRIS INC., ET AL., UNITED
STATES DISTRICT COURT, SOUTHERN DISTRICT, ILLINOIS, FILED MAY 30, 1997.

MASSACHUSETTS LABORERS HEALTH AND WELFARE FUND V. PHILIP MORRIS INC., ET AL.,
UNITED STATES DISTRICT COURT, MASSACHUSETTS, FILED JUNE 2, 1997.

STATE OF NEW HAMPSHIRE V. R.J. REYNOLDS TOBACCO COMPANY, ET AL., SUPERIOR
COURT, MERRIMACK COUNTY, NEW HAMPSHIRE, FILED JUNE 4, 1997.

THE LOWER BRULE SIOUX TRIBE V. THE AMERICAN TOBACCO COMPANY, ET AL., TRIBAL
COURT, LOWER BRULE SIOUX TRIBE, FILED JUNE 4, 1997.

STATE OF COLORADO V. R.J. REYNOLDS TOBACCO CO., ET AL., DISTRICT COURT, CITY
AND COUNTY OF DENVER, COLORADO, FILED JUNE 5, 1997.

STATE OF OREGON V. THE AMERICAN TOBACCO COMPANY, ET AL., CIRCUIT COURT,
MULTNOMAH COUNTY, OREGON, FILED JUNE 9, 1997. In July 1998, the court
dismissed with prejudice plaintiff's unjust enrichment claim. The court
denied defendants' motion to dismiss plaintiff's public nuisance claim but
struck with prejudice that portion of the claim based on defendants' alleged
interference with the "right to health care." Trial is scheduled for April
1999.
9
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EXHIBIT 99

THE CROW TRIBE V. THE AMERICAN TOBACCO COMPANY, ET AL., TRIBAL COURT, CROW
TRIBE, FILED JUNE 10, 1997. In April 1998, plaintiff voluntarily dismissed
the case without prejudice.

STATE OF IDAHO V. PHILIP MORRIS, INC., ET AL., DISTRICT COURT, FOURTH
JUDICIAL DISTRICT, ADA COUNTY, IDAHO, FILED JUNE 11, 1997.

PEOPLE OF THE STATE OF CALIFORNIA V. PHILIP MORRIS, INC., ET AL., SUPERIOR
COURT, SACRAMENTO COUNTY, CALIFORNIA, FILED JUNE 12, 1997. In May 1998, the
court held that the state's reimbursement claims, which were based on a
product liability theory, were barred by a California statute, which, until
amended in 1997, did not permit product liability claims to be asserted with
respect to tobacco products. The court held that the 1997 amendment of the
law could not be applied retroactively. In addition, the court held that the
statute, as enacted in 1987, did not permit claims that arose from pre-1987
conduct. However, the court further held that the statute did not apply to
fraud claims, and granted the state leave to amend the complaint to assert a
fraud claim. The court also dismissed without leave to amend the state's
request for punitive damages and the cause of action alleging numerous
violations of California's False Claims Act. In July 1998, the San Diego
Superior Court recommended that this case be consolidated with certain other
pending California cases.

HAWAII HEALTH AND WELFARE TRUST FUND FOR OPERATING ENGINEERS V. PHILIP
MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, HAWAII, FILED JUNE 13,
1997.

STATE OF MAINE V. PHILIP MORRIS, INCORPORATED, ET AL., SUPERIOR COURT,
KENNEBEC COUNTY, MAINE, FILED JUNE 17, 1997.

ROSSELLO, ET AL. V. BROWN & WILLIAMSON TOBACCO CORPORATION, ET AL., UNITED
STATES DISTRICT COURT, PUERTO RICO, FILED JUNE 17, 1997. In June 1998, the
court denied defendants' motion to dismiss the Commonwealth of Puerto Rico's
racketeering claims, and a motion to dismiss certain defendant parent
companies. The court also ruled that the Commonwealth has standing to pursue
claims for health care costs without having to proceed via subrogation. The
court dismissed plaintiff's claims of unjust enrichment, indemnity, voluntary
assumption of a special duty, and a claim for injunctive relief. Trial is
scheduled for September 1999.

STATE OF RHODE ISLAND V. AMERICAN TOBACCO COMPANY, INC., ET AL., SUPERIOR
COURT, PROVIDENCE, RHODE ISLAND, FILED JUNE 17, 1997.

LABORERS LOCAL 17 HEALTH AND BENEFIT FUND, ET AL. V. PHILIP MORRIS, INC., ET
AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED JUNE
19, 1997. In April 1998, the court denied defendants' motion to dismiss for
failure to join necessary parties.

THE MUSCOGEE CREEK NATION, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL.,
DISTRICT COURT, MUSCOGEE CREEK NATION, OKMULGEE DISTRICT, FILED JUNE 20,
1997. In July 1998, the appellate court dismissed defendants' appeal from the
lower court's denial of a motion to dismiss based on lack of jurisdiction.

KENTUCKY LABORERS DISTRICT COUNCIL HEALTH AND WELFARE TRUST FUND, ET AL. V.
HILL & KNOWLTON, INC., ET AL., UNITED STATES DISTRICT COURT, WESTERN
DISTRICT, KENTUCKY, LOUISVILLE DIVISION, FILED JUNE 20, 1997.

OREGON LABORERS -- EMPLOYERS HEALTH AND WELFARE TRUST FUND, ET AL. V. PHILIP
MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, OREGON, FILED JUNE 20,
1997. In August 1998, the court dismissed this case in its entirety against
PM Inc. and certain other defendants.
10
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EXHIBIT 99

UNITED FEDERATION OF TEACHERS WELFARE FUND, ET AL. V. PHILIP MORRIS, INC., ET
AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, NEW YORK, FILED JUNE
25, 1997. In April 1998, the court denied defendants' motion to dismiss for
failure to join necessary parties.

CONNECTICUT PIPE TRADES HEALTH FUND, ET AL. V. PHILIP MORRIS, INC., ET AL.,
UNITED STATES DISTRICT COURT, CONNECTICUT, FILED JULY 1, 1997.

SEAFARERS WELFARE PLAN AND UNITED INDUSTRIAL WORKERS WELFARE PLAN V. PHILIP
MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, MARYLAND, SOUTHERN
DIVISION, FILED JULY 2, 1997. In July 1998, the court dismissed all claims
with prejudice.

LABORERS AND OPERATING ENGINEERS UTILITY AGREEMENT HEALTH AND WELFARE TRUST
FUND FOR ARIZONA V. PHILIP MORRIS INCORPORATED, ET AL., UNITED STATES
DISTRICT COURT, ARIZONA, FILED JULY 7, 1997.

WEST VIRGINIA LABORERS' PENSION FUND, ET AL. V. PHILIP MORRIS, INC., ET AL.,
UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT, WEST VIRGINIA, HUNTINGTON
DIVISION, FILED JULY 11, 1997. In August 1998, the court denied defendants'
motion to dismiss. Trial is scheduled for June 2000.

RHODE ISLAND LABORERS HEALTH AND WELFARE FUND V. PHILIP MORRIS INCORPORATED,
ET AL., UNITED STATES DISTRICT COURT, RHODE ISLAND, FILED JULY 20, 1997.

EASTERN STATES HEALTH AND WELFARE FUND, ET AL. V. PHILIP MORRIS, INC., ET
AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED JULY 28,
1997.

ASBESTOS WORKERS LOCAL 53 HEALTH AND WELFARE FUND, ET AL. V. PHILIP MORRIS,
INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, LOUISIANA,
FILED AUGUST 15, 1997.

STEAMFITTERS LOCAL UNION NO. 420 WELFARE FUND, ET AL. V. PHILIP MORRIS, INC.,
ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, PENNSYLVANIA, FILED
AUGUST 21, 1997. In April 1998, the court granted defendants' motion to
dismiss this case and ordered the class allegations stricken.

STATE OF GEORGIA V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, FULTON
COUNTY, GEORGIA, FILED AUGUST 29, 1997.

CONSTRUCTION LABORERS OF GREATER ST. LOUIS WELFARE FUND, ET AL. V. PHILIP
MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT,
MISSOURI, FILED SEPTEMBER 2, 1997.

THE ARKANSAS CARPENTERS HEALTH & WELFARE FUND, ET AL. V. PHILIP MORRIS, INC.,
ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, ARKANSAS, FILED
SEPTEMBER 4, 1997.

SOUTHEAST FLORIDA LABORERS DISTRICT COUNCIL HEALTH AND WELFARE TRUST FUND V.
PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT,
FLORIDA, FILED SEPTEMBER 11, 1997. In April 1998, the court granted
defendants' motion to dismiss this case.

WEST VIRGINIA--OHIO VALLEY AREA INTERNATIONAL BROTHERHOOD OF ELECTRICAL
WORKERS WELFARE FUND V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES
DISTRICT COURT, SOUTHERN DISTRICT, WEST VIRGINIA, FILED SEPTEMBER 11, 1997.
In August 1998, the court denied defendants' motion to dismiss. Trial is
scheduled for March 2000.
11
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EXHIBIT 99

TEAMSTERS UNION NO. 142 HEALTH AND WELFARE TRUST FUND AND SHEET METAL WORKERS
LOCAL UNION NO. 20 WELFARE AND BENEFIT FUND V. PHILIP MORRIS INCORPORATED, ET
AL., CIRCUIT COURT OF ST. JOSEPH COUNTY, INDIANA, FILED SEPTEMBER 12, 1997.

CROW CREEK SIOUX TRIBE V. THE AMERICAN TOBACCO COMPANY, ET AL., TRIBAL COURT,
CROW CREEK SIOUX TRIBE, FILED SEPTEMBER 14, 1997.

OPERATING ENGINEERS LOCAL 12 HEALTH AND WELFARE TRUST V. AMERICAN TOBACCO
COMPANY, ET AL., SUPERIOR COURT OF CALIFORNIA, LOS ANGELES COUNTY, FILED
SEPTEMBER 16, 1997. In July 1998, the court dismissed, without leave to
amend, plaintiffs' claims for strict products liability, negligent breach of
special duty, breach of express and implied warranties, restitution, unjust
enrichment, violation of California antitrust law and intentional breach of
special duty. The court dismissed, with leave to amend, plaintiffs' claims
for fraud and misrepresentation, civil conspiracy and unfair business
practices.

PUERTO RICAN ILGWU HEALTH & WELFARE FUND, ET AL. V. PHILIP MORRIS INC., ET
AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED
SEPTEMBER 17, 1997.

NEW JERSEY CARPENTERS' HEALTH FUND, ET AL. V. PHILIP MORRIS, INC., ET AL.,
UNITED STATES DISTRICT COURT, NEW JERSEY, FILED SEPTEMBER 25, 1997.

NEW MEXICO AND WEST TEXAS MULTI-CRAFT HEALTH AND WELFARE TRUST FUND, ET AL.
V. PHILIP MORRIS, INC., ET AL., SECOND JUDICIAL DISTRICT COURT, BERNALILLO
COUNTY, NEW MEXICO, FILED OCTOBER 10, 1997.

REPUBLIC OF THE MARSHALL ISLANDS V. THE AMERICAN TOBACCO COMPANY, ET AL.,
HIGH COURT, REPUBLIC OF THE MARSHALL ISLANDS, FILED OCTOBER 20, 1997.

CENTRAL STATES JOINT BOARD V. PHILIP MORRIS, INC., ET AL., UNITED STATES
DISTRICT COURT, NORTHERN DISTRICT, ILLINOIS, FILED OCTOBER 20, 1997.

INTERNATIONAL BROTHERHOOD OF TEAMSTERS, LOCAL 734 V. PHILIP MORRIS, INC., ET
AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, ILLINOIS, FILED OCTOBER
20, 1997.

TEXAS CARPENTERS HEALTH BENEFIT FUND, ET AL. V. PHILIP MORRIS, INC., ET AL.,
UNITED STATES DISTRICT COURT, EASTERN DISTRICT, TEXAS, BEAUMONT DIVISION,
FILED OCTOBER 31, 1997.

UNITED FOOD AND COMMERCIAL WORKERS UNION AND EMPLOYERS HEALTH AND WELFARE
FUND, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT,
NORTHERN DISTRICT, ALABAMA, FILED NOVEMBER 13, 1997.

B.A.C. LOCAL 32 INSURANCE TRUST FUND, ET AL. V. PHILIP MORRIS, INCORPORATED,
ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, MICHIGAN, FILED
NOVEMBER 14, 1997.

SCREEN ACTORS GUILD-PRODUCERS HEALTH PLAN, ET AL. V. PHILIP MORRIS, INC., ET
AL., SUPERIOR COURT, LOS ANGELES COUNTY, CALIFORNIA, FILED NOVEMBER 20, 1997.
In June 1998, the court dismissed, without leave to amend, plaintiffs' claims
of intentional breach of special duty, negligent breach of special duty,
indemnity and unjust enrichment, and dismissed, with leave to amend,
plaintiffs' fraud and negligence claims. The court declined to dismiss
plaintiffs' unfair business practices claim. In July 1998, the court
dismissed, without leave to amend, plaintiffs' antitrust claim.
12
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EXHIBIT 99

IBEW LOCAL 25 HEALTH AND BENEFIT FUND V. PHILIP MORRIS, INC., ET AL., SUPREME
COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED NOVEMBER 25, 1997.

IBEW LOCAL 363 WELFARE FUND V. PHILIP MORRIS, INC., ET AL., SUPREME COURT,
STATE OF NEW YORK, COUNTY OF NEW YORK, FILED NOVEMBER 25, 1997.

LOCAL 138, 138A AND 138B INTERNATIONAL UNION OF OPERATING ENGINEERS WELFARE
FUND V. PHILIP MORRIS, INC., ET AL., SUPREME COURT, STATE OF NEW YORK, COUNTY
OF NEW YORK, FILED NOVEMBER 25, 1997.

LOCAL 840, INTERNATIONAL BROTHERHOOD OF TEAMSTERS HEALTH AND INSURANCE FUND
V. PHILIP MORRIS, INC., ET AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF
NEW YORK, FILED NOVEMBER 25, 1997.

LONG ISLAND REGIONAL COUNCIL OF CARPENTERS WELFARE FUND V. PHILIP MORRIS,
INC., SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED NOVEMBER 25,
1997.

DAY CARE COUNCIL - LOCAL 205 D.C. 1707 WELFARE FUND V. PHILIP MORRIS, INC.,
ET AL., SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED
DECEMBER 8, 1997.

LOCAL 1199 HOME CARE INDUSTRY BENEFIT FUND V. PHILIP MORRIS, INC., ET AL.,
SUPREME COURT, STATE OF NEW YORK, COUNTY OF NEW YORK, FILED DECEMBER 8, 1997.

LOCAL 1199 NATIONAL BENEFIT FUND FOR HEALTH AND HUMAN SERVICES EMPLOYEES V.
PHILIP MORRIS, INC., ET AL., SUPREME COURT, NEW YORK COUNTY, NEW YORK, FILED
DECEMBER 8, 1997.

MASON, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT
COURT, NORTHERN DISTRICT, TEXAS, FILED DECEMBER 23, 1997.

OPERATING ENGINEERS LOCAL 324 HEALTH CARE FUND, ET AL. V. PHILIP MORRIS, INC.,
ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, MICHIGAN, FILED
DECEMBER 30, 1997.

CARPENTERS & JOINERS WELFARE FUND, ET AL. V. PHILIP MORRIS INCORPORATED, ET
AL., UNITED STATES DISTRICT COURT, MINNESOTA, FILED DECEMBER 31, 1997. Trial is
scheduled for March 2000.

STEAMFITTERS LOCAL UNION NO. 614 HEALTH & WELFARE FUND, ET AL. V. PHILIP
MORRIS, INC., ET AL., CIRCUIT COURT, THIRTEENTH JUDICIAL DISTRICT, TENNESSEE,
FILED JANUARY 7, 1998.

WOODS, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL., UNITED STATES DISTRICT
COURT, MIDDLE DISTRICT, NORTH CAROLINA, FILED FEBRUARY 13, 1998.

STATE OF SOUTH DAKOTA, ET AL. V. PHILIP MORRIS, INC., ET AL., CIRCUIT COURT,
HUGHES COUNTY, SOUTH DAKOTA, FILED FEBRUARY 19, 1998.

BELK, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES DISTRICT COURT,
SOUTHERN DISTRICT, ALABAMA, FILED FEBRUARY 20, 1998. In August 1998, this
case was voluntarily dismissed.

NATIONAL ASBESTOS WORKERS MEDICAL FUND, ET AL. V. PHILIP MORRIS INCORPORATED,
ET AL., UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF NEW YORK,
FILED FEBRUARY 27, 1998.
13
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EXHIBIT 99

MILWAUKEE CARPENTERS, ET AL. V. PHILIP MORRIS INCORPORATED, ET AL., UNITED
STATES DISTRICT COURT, EASTERN DISTRICT, WISCONSIN, FILED MARCH 4, 1998.

GROUP HEALTH PLAN, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES
DISTRICT COURT, MINNESOTA, FILED MARCH 11, 1998. Trial is scheduled for March
2000.

WILLIAMS & DRAKE COMPANY, ET AL. V. THE AMERICAN TOBACCO COMPANY, ET AL.,
UNITED STATES DISTRICT COURT, WESTERN DISTRICT, PENNSYLVANIA, FILED MARCH 23,
1998.

MANGINI, ON BEHALF OF THE GENERAL PUBLIC OF THE STATE OF CALIFORNIA V. BROWN
& WILLIAMSON TOBACCO CORPORATION, ET AL., SUPERIOR COURT, SAN FRANCISCO
COUNTY, CALIFORNIA, FILED MARCH 26, 1998. This action sought injunctive and
other relief regarding the advertising of tobacco products on outdoor
billboards in California allegedly in violation of a recently-enacted statute
that prohibits the placement of such billboards within 1000 feet of certain
schools and "public playgrounds." In July 1998, this case was dismissed with
prejudice in exchange for defendants' agreement to take certain actions with
respect to its billboard advertising in California, including the removal of
certain billboards.

UNITED ASSOCIATION OF PLUMBING AND PIPEFITTING INDUSTRY LOCAL 467 V. PHILIP
MORRIS INCORPORATED, ET AL., SUPERIOR COURT, SAN MATEO, CALIFORNIA, FILED
MARCH 31, 1998.

UNITED ASSOCIATION LOCAL NO. 467 HEALTH AND WELFARE TRUST FUND V. PHILIP
MORRIS, INC., ET AL., SUPERIOR COURT, SAN MATEO COUNTY, CALIFORNIA, FILED
MARCH 31, 1998.

CONWED CORPORATION AND LEUCADIA, INC. V. RJ REYNOLDS TOBACCO COMPANY, ET AL.,
UNITED STATES DISTRICT COURT, MINNESOTA, FILED APRIL 10, 1998.

TEAMSTERS BENEFIT TRUST V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT,
ALAMEDA COUNTY, CALIFORNIA, FILED APRIL 15, 1998.

UNITED ASSOCIATION LOCAL NO. 159 HEALTH AND WELFARE TRUST FUND V. PHILIP
MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED APRIL
15, 1998.

NEWSPAPER PERIODICAL DRIVERS LOCAL 921 SAN FRANCISCO NEWSPAPER AGENCY HEALTH
& WELFARE FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, SAN MATEO
COUNTY, CALIFORNIA, FILED APRIL 15, 1998.

UNITED ASSOCIATION LOCAL NO. 343 HEALTH AND WELFARE TRUST FUND V. PHILIP
MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED
APRIL 16, 1998.

BAY AREA AUTOMOTIVE GROUP WELFARE FUND V. PHILIP MORRIS, INC., ET AL.,
SUPERIOR COURT, SAN FRANCISCO COUNTY, CALIFORNIA, FILED APRIL 16, 1998.

PIPE TRADES DISTRICT COUNCIL NO. 36 HEALTH & WELFARE TRUST FUND V. PHILIP
MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED APRIL
16, 1998.

SIGN, PICTORIAL AND DISPLAY INDUSTRY WELFARE FUND V. PHILIP MORRIS, INC., ET
AL., SUPERIOR COURT, SAN FRANCISCO COUNTY, CALIFORNIA, FILED APRIL 16, 1998.

SAN FRANCISCO NEWSPAPER PUBLISHERS AND NORTHERN CALIFORNIA NEWSPAPER GUILD
HEALTH & WELFARE TRUST V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, SAN
FRANCISCO COUNTY, CALIFORNIA, FILED APRIL 17, 1998.

NORTH COAST TRUST FUND V. PHILIP MORRIS, INC., ET AL., SUPERIOR COURT, SAN
FRANCISCO COUNTY, CALIFORNIA, FILED APRIL 24, 1998.
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EXHIBIT 99

NORTHERN CALIFORNIA BAKERY DRIVERS SECURITY FUND V. PHILIP MORRIS, INC., ET
AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED APRIL 24, 1998.

ARKANSAS BLUE CROSS AND BLUE SHIELD, ET AL. V. PHILIP MORRIS INCORPORATED, ET
AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT, ILLINOIS, FILED
APRIL 29, 1998.

BLUE CROSS AND BLUE SHIELD OF NEW JERSEY, INC., ET AL. V. PHILIP MORRIS,
INCORPORATED, ET AL., UNITED STATES DISTRICT COURT, EASTERN DISTRICT, NEW
YORK, FILED APRIL 29, 1998.

REGENCE BLUESHIELD, ET AL. V. PHILIP MORRIS, INC., ET AL., UNITED STATES
DISTRICT COURT, WESTERN DISTRICT, WASHINGTON, FILED APRIL 29, 1998.

BAY AREA DELIVERY DRIVERS SECURITY FUND V. PHILIP MORRIS, INC., ET AL.,
SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED APRIL 30, 1998.

SISSETON-WAHPETON SIOUX TRIBE V. PHILIP MORRIS INCORPORATED, ET AL., TRIBAL
COURT OF THE SISSETON-WAHPETON SIOUX TRIBE, FILED MAY 8, 1998.

STANDING ROCK SIOUX TRIBE V. PHILIP MORRIS INCORPORATED, ET AL., TRIBAL COURT
OF THE STANDING ROCK SIOUX INDIAN RESERVATION, FILED MAY 8, 1998.

THE REPUBLIC OF GUATEMALA V. THE TOBACCO INSTITUTE, INC., ET AL., UNITED
STATES DISTRICT COURT, DISTRICT OF COLUMBIA, FILED MAY 11, 1998.

LANDRY, ET AL. V. LOUISIANA HEALTH SERVICE AND INDEMNITY CO., INC., ET AL.,
19TH JUDICIAL COURT, EAST BATON ROUGE, LOUISIANA, FILED MAY 18, 1998.

NORTHERN CALIFORNIA PLASTERERS HEALTH & WELFARE TRUST FUND V. PHILIP MORRIS,
INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED MAY 21, 1998.

UNITED ASSOCIATION LOCAL NO. 393 HEALTH AND WELFARE TRUST FUND V. PHILIP
MORRIS, INC., ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED
MAY 21, 1998.

SERVICE EMPLOYEES INTERNATIONAL UNION HEALTH & WELFARE FUND, ET AL. V. PHILIP
MORRIS, ET AL., UNITED STATES DISTRICT COURT, DISTRICT OF COLUMBIA, FILED
MAY 21, 1998.

NORTHERN CALIFORNIA GENERAL TEAMSTERS SECURITY FUND V. PHILIP MORRIS, INC.,
ET AL., SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED MAY 22, 1998.

UTAH LABORERS' HEALTH AND WELFARE FUND, ET AL. V. PHILIP MORRIS INCORPORATED,
ET AL., UNITED STATES DISTRICT COURT, UTAH, FILED JUNE 13, 1998.

JOINT BENEFIT TRUST V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT,
ALAMEDA COUNTY, CALIFORNIA, FILED JUNE 15, 1998.

NORTHERN CALIFORNIA PIPE TRADES V. PHILIP MORRIS INCORPORATED, ET AL.,
SUPERIOR COURT, ALAMEDA COUNTY, CALIFORNIA, FILED JUNE 16, 1998.

S.E.I.U. LOCAL 74 WELFARE FUND, ET AL. V. PHILIP MORRIS, ET AL., UNITED
STATES DISTRICT COURT, DISTRICT OF COLUMBIA, FILED JUNE 22, 1998.

PLASTERING INDUSTRY WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL., SAN
FRANCISCO COUNTY SUPERIOR COURT, CALIFORNIA, FILED JULY 1, 1998.
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<PAGE>

EXHIBIT 99

CENTRAL VALLEY PAINTING & DECORATING HEALTH & WELFARE TRUST FUND V. PHILIP
MORRIS, INC., ET AL., SAN FRANCISCO COUNTY SUPERIOR COURT, CALIFORNIA, FILED
JULY 6, 1998.

STATE OF VERMONT V. PHILIP MORRIS INCORPORATED, ET AL., SUPERIOR COURT,
BURLINGTON, VERMONT, FILED JULY 7, 1998. Effective April 23, 1998, Vermont
enacted a statute permitting the state to seek recovery from a "tobacco
manufacturer" for the amount paid or likely to be paid in Medicaid benefits
for tobacco-related health conditions, and for punitive damages, costs,
reasonable attorneys' fees, and other relief. Among other things, the statute
abrogated certain affirmative defenses, listed elements of the state's new
direct cause of action, and authorized the use of statistical analysis to
prove damages. PM Inc. and four other domestic cigarette manufacturers
brought suit in federal court in Vermont against state officials for
declaratory and injunctive relief on the grounds that enforcement of the
statute would violate the United States Constitution and federal law. In July
1998, the State of Vermont brought a state court action under the new statute
seeking damages in an amount sufficient to reimburse the state for
expenditures made or to be made after the effective date of the statute for
health conditions allegedly caused by the tobacco companies' tobacco
products, for punitive damages, and certain other relief.

MICHAEL H. HOLLAND, ET AL. V. PHILIP MORRIS, ET AL., UNITED STATES DISTRICT
COURT, DISTRICT OF COLUMBIA, FILED JULY 9, 1998.

PEOPLE OF THE STATE OF CALIFORNIA, ET AL. V. PHILIP MORRIS INC., ET AL.,
SUPERIOR COURT, LOS ANGELES COUNTY, CALIFORNIA, FILED ON JULY 14, 1998.

NORTHERN CALIFORNIA TILE INDUSTRY HEALTH & WELFARE TRUST FUND V. PHILIP
MORRIS, INC., ET AL., SAN FRANCISCO COUNTY SUPERIOR COURT, CALIFORNIA, FILED
JULY 29, 1998.

SAN FRANCISCO CULINARY, BARTENDERS AND SERVICE EMPLOYEES WELFARE FUND V.
PHILIP MORRIS, INC., ET AL., SAN FRANCISCO COUNTY SUPERIOR COURT, CALIFORNIA,
FILED JULY 30, 1998.

IBEW LOCAL 595 HEALTH AND WELFARE TRUST FUND V. PHILIP MORRIS, INC., ET AL.,
ALAMEDA COUNTY SUPERIOR COURT, CALIFORNIA, FILED JULY 30, 1998.

SHOP IRONWORKERS LOCAL 790 WELFARE PLAN V. PHILIP MORRIS, INC., ET AL.,
ALAMEDA COUNTY SUPERIOR COURT, CALIFORNIA, FILED JULY 31, 1998.

In addition to the foregoing actions, other foreign, state and local
government entities and others, including unions, have announced they are
considering filing health care cost recovery actions.
16