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The PM-USA Five Year Plan provides an explanation of the business envirornnent and a set of proposed programs and strategies to chart the canpany's course within this envirormient. The financial results estimated on pages I-1 through 1-4 reflect realization of the forecasted ccmpetitive, social and political envirornnent and implenentation of the brand, retail and~ pricing,strategies explained in the body of the Plan. Industry trends and the potential consequences of manufacturers' volume and pricing strategies pose a number of threats to attaining this forecast. Recent data suggest that some of the negative trends reviewed in the Plan are accelerating or have a higher probability of occurrence. To the extent possible, PM-USA is taking action to minimize the impact of these risks. However, a second set of financial statements is provided on pages J-4 through J-6 which reflects these recent trends and PM-USA's financial prospects if they continue. These revised statements should be used by Corporate for financial planning purposes.

CONFIDIIVTIAL BUSINESS'PLANNING & ANALYSIS NARCH 1986 NO'IE Discussion and analysis of ccanpetitors is based on public information and internal modeling of canpetition developed by the Planning Department. Projections and discussions of future actions by canpetitors are primarily based on extension of historical trends within the context of PM-USA's forecasted U.S. cigarette industry environment. I

PM-USA FIVE YEAR PLAN HIGHLIGHTS (Millions of Dollars) 1985 1990 Conpound Annual Growth • Sales (Billions of Units)' U.S. Cigarette Industry Volume 594.7 560.6 (1.2%) PM-USA Unit Volume 213.6 230.9 1.6% PM-USA Market Share 35.9% 41.2% 1.1$(1) Operating Revenues $6,610.9 $9,807.2 8.2% • Profits Before Tax Pre-Tax Inccane $2,047.3 $4,029.6 14.5% Pre-Tax Margin 31.0% 41.1$ 2.001) • Profits After Tax Net Incane $1,053.5 $2,051.4 14.3$ ~ After~ax Margin 15.9% , 20.9% 1.0$(1) • Assets Leaf Inventory $1,268.9 $1,461.4 2.9% Other Assets 1,761.8 1,522.2 (2.9%) Total Assets $3,030.7 $2,983.6 (0.3%) Net Return on Assets 36.0% 69.2% • Other 1986-1990 Total Capital Expenditures $ 621.0 After-Tax Funds Flow $7,962.7 (1) Average Annual Growth

PLAN OVERVIEW The U.S. cigarette industry begins the plan period with a number of enviable strengths. Despite showing signs of volume maturity, 1985 industry operating revenues were nearly $18 billion and profit margins for cigarette manufacturers averaged~25 percent. In 1985, industry operating income increased 13 percent to $4.5 billion. The industry's non-cyclical sales pattern, long product life cycles, absence of foreign~ caripetition, barriers to entry and greater return on investment position it favorably c:cmpared to other industries. The characteristics of the cigarette industry disproportionately benefit a growing ccripany such as PM-USA. Within this strong industry, PM-USA is the marketing and technology leader with formidable assets - a young dsnographic profile, dominant positioning in the most important industry categories, superior product quality, modern infrastructure and the expertise and financial resources to exploit future trends. Of PM-USA's five ecccrpetitors, RJR has formidable` domestic marketing and~ product assets and B&W is potentially well-financed due to the strength of its foreign operations. Lorillard is ccmpetitive, but vulnerable, due to declining! brands and uncertain Corporate comnitment. Two competitors -- American and~ Liggett - are currently "milking" their brand franchises. The lack of strength of these three canpetitors and B&W"s weakening position provide a significant opportunity for PM-USA to increase market share and profits. This plan reviews PM-USA's positioning in the industry and outlines thee strategies that will be implemented to attain the 1990 objectives. While internal and external pressure continue to present challenges, PM-USA possesses the initiative, mcmentum and resources to achieve the performance that the Corporation and Philip Morris' shareholders require. Major objectives for the planning period are: • Volume growth of 17.3 billion units. • Market share growth~of 5.3 share points. • Pre-tax profit growth of 14.5 percent per year. • Aggregate after-tax cash flow to Corporate of $7.9 billion. The broad strategies to attain these goals were outlined in last year's Five Year Plan. In this document, these strategies have been updated for new information. However, in the following areas, there are significant changes: • Industry sales are projected to decline about one percent annually. • Aggressive programs are being implemented to penetrate the N price/value category and develop high technology entries. ~; • Retail strategies are improving PM-USA''s shelf space and putting, rp ccnipetitors on the defensive. N • New quality and productivity programs are being implemented to support PM-USA's volume strategy and profit objectives. • Expansion of the price/value category and declining industry sales are putting pressure on PM-USA's profit and pricing plans. A-2' f;

INCxJSTRY FNUIROTIIMF7VT PM-USA's volume objective for the five year plan period' is to grow 17.3 billion units and achieve a market share of 41.2 percent by 1990. This objective is in line with share projections in last year's Plan, however, volume gains are lower because we are forecasting a one percent annual decline in industry volume. As detailed in the next section of this document, the previous forecast of flat industry volume has been modified to reflect a decrease in average daily consumption per smoker, less favorable trends in sme,king incidence and lower "start" rates for young adults. Incidence During the last ten years, the incidence of cigarette smoking,declined'fro,m 39 percent of the adult population in 1975 to 33 percent in 1985. (Surrena,rized~ by age category below.) Contributing to this decrease were a number of external factors - adverse publicity on the health effects of smoking, unfair taxation and laws that prohibit or restrict smoking in public places. Attacks on the industry have becaitie more visible and threatening in recent years, fueling a hardening of attitudes by non-smokers and growing self-consciousness imung smokers. PM-USA is responding aggressively to this threat by counteracting legislative infringements and minimizing sociopolitic~~ l implications for industry sales. The strategies that PM-USA is utilizing to counterattack the anti-smoking lobby and influence political decision makers, potential allies and the media are reviewed in the sociopolitical section of this Plan. A-3

Competitive Environment The cecrtpetitive environment within the U.S. cigarette industry has experienced a fundamental change during the last five years. To a large extent, this change resulted~frcm two factors - the past success of PM-USA brands and Newport among young!smokers and the appeal of Liggett's generic products to blue collar and older ssrokers in the early 1980's. As a result of these trends, RJR and B&W were pressured at both ends of their demographic profiles and faced long term volume erosion unless they altered their strategies to strike a new ccxnpetitive balance. In response, ccntpetitors invigorated their strategies to capture new young, scmkers and switchers in the 18 to 34 age category by repositioning their brands against Marlboro, Virginia Slims and Newport. These brands have growing shares a¢nong young scmkers. RJR ccmplemented this strategy in 1984 and 1985 with an aggressive couponing campaign to protect the middle and upper ends of their demographic profile. Of greater consequence, RJR and B&W entered the price/value category with products designed to ccaipete against both generics and full margin brands, and backed them~ with aggressive price strategies. These actions served to accelerate the growth of the price/value segment, which currently accounts for about eight percent of the market. Paralleling these develoFments was a stabilization of constmier tar preferences. This trend significantly reduced the acnount of switching between brands. In an attempt to generate incremental volume, manufacturers probed the market with a number of new brand names -- such as Players, Sterling, Bright and Satin - and launched deluxe packaging and; 25's line extensions. This market segmentation strategy, in canbination with the proliferation of prioe/value products, contributed to a 35 percent increase in the number of packings frcm 198 in 1980 to 267 in 1985. The resulting "clutter" in the media and retail environment has significantly increased the difficulty of cxcmmunicating a brand image to consumers and maintaining adequate retail availability. Another result of proliferation is a more ccnplex mix of products to be manufactured. A-4

SUNA7ARY OF CHANGES IN THE C'(XMPE,TITIVE IIMRCMM Industry Volume Tar Segments Switching New Product Opportunities New Packings Per Share Point Price/Value Segment Product Proliferation PM-USA Share Growth PM-USA Volume Growth Rate (1976-1980) Marlboro B&H Merit (1977-1980) Virginia Slims PM-USA VOLUME'STRATF.,G1" 1980 Siow Growth Dynamic 18% Line Extensions into Majpr Growing Segments 4.1 (1978-1980) 08' 198 Packings 11.4 Share Points Annually 6.3% Annually 3.8% 3.1% 33.L$ 110.8% Line Extensions into Smaller Segments; New Brand Names; High Technology Products 8.5 (1983-1985) 10% to 15$ 260+ Packings 1.11 Share Points Annually 1.6% Annually In last year's Five Year Plan, PM-USA outlined a four point strategy to achieve historic volume and market share levels. The first phase of this plan was implemented in 1985 with~ the launching of four products -- Marlboro 25's, Merit 85's box, Virginia Slims 120's and Players Lights 25's -- and through testing and developing a number of new product concepts. PM-USA also introduced a new advertising campaign~ for Benson & Hedges and inplemented programs to improve the retail availability and visibility of our brands. Given PNf USA"s category positioning and~the aforementioned industry trends, two priorities in the Plan are to penetrate the menthol market with new products and to capture a representative share of the price/value category with repositioned brands -- Players and Cambridge. Bothl of these categories offer a significant opportunity to increase volume with minimal cannibalization of PM-USA brands. An opportunity also exists to develop a high technology product -- possibly marketed as a Merit line extension -- that gives PM-USA a long, term campetitive advantage while addressing social concerns.

The challenge of executing this strategy is significant because it is dependent on successfully repositioning old brands or establishing new brands and developing technological breakthroughs. PM-USA will continue to utilize line extensions to strengthen.existing brands and target underdeveloped markets. However, unless a new category develops -- such as the low tar or 100's category in the 1970's - it will be difficult to achieve substantial share gains in the full margin segment with PM-USA's remaining line extension options. While tactical adjustments have been made based on our experiences in 1985, the overall strategic direction of PM-USA's volume growth plan is the same as last year's Five Year Plan. • Continue growth of Marlboro. • Defend current volume positions for Benson & Hedges and Merit and maintain Virginia Slims' mcanentun. • Penetrate underrepresented categories, especially menthol and price/value. • Develop new products that satisfy strongly perceived consumer needs. Underlying PM-USA's volume plan is a strategy to maximize overall unit volume by positioning our brands as a portfolio of selling propositions which have wide demographic appeal. In the 1970's this strategy was executed through the successful launch of Merit and law tar line extensions of PM-USA's full flavor brands. As indicated below, the success of this strategy enabled PM-USA to capture an overwhelming share of young smokers and increase sales to all age cohorts. During the last ten years, mst of PM-USA's growth among smokers currently over age 24 was due to brands other than Marlboro. PM-USA RETENTION OF SMDKERS BY AGE CATEGORY orHS orta wNteoAO PM-M eRMos NutAWo PM-USA eaArwS 1875 1975 !m i985 ® 80PEflCENT OF /16E CATE60RY e2.8 \ ~ l6-a4 ffi-34 ® ® A-G

In contrast to previous years when PM-USA had four growing brands, only Marlboro and Virginia Slims achieved unit volume increases in 1984 and 1985. Volume trends for Merit and Benson & Hedges have been affected by declining incidence among upscale smokers, the growth of Marlboro Lights and the price/value category - and proliferation of competitive products. These trends underscore the need to broaden PM-USA's demographic appea]l to achieve volume targets. Successful entry into the price/value category will inprove PM-USA's positioning among older, less urban and blue collar smokers while penetration of the menthol category will increase our share of female and black smokers. MARKFTING A major goal during the five year plan period is to significantly increase the availability and visibility of PM-USA brands at retail. Successful programs in this area are perhaps PM}USA's greatest opportunity to accelerate volume gains in the future. The foundation for future volume growth must be built through a combination of new product launches and retail programs that provide adequate shelf space for both new and existing products. In conjunction with this strategy, PM-USA is developing programs that reinforce brand images by camrnin,icating, with consumers outside the media environment. As discussed in last year's Plan, a more broad-based marketing program has been inplemented to execute this strategy. Major aspects of this program include expanded sponsorship of events, increased use of promotional incentives and development of innovative point-of-sale materials. PM-USA is also developing a plan~ to use direct marketing to improve the volume trends of Benson & Hedges and Merit. For a number of years, PM-USA has been the industry leader in creating strong brand images through advertising. The success of this strategy is reflected in the positioning attained'by our brand franchises in the industry's most important categories. • Marlboro is the number one brand in the full flavor and low tar categories, the leadYng seller among men, wanen, young, smokers and Hispanics and was the fastest growing branded cigarette in 1985. • Benson & Hedges is the leading free-standing 100 mn brand. • Merit is the leading free-standing brand in the low tar segment. • Virginia Slims is the most popular wxrnel's cigarette. PM-USA will continue utilizing a high level of intrusive advertising to maintain~ broad brand exposure, achieve rapid awareness of new products and improve the positioning of declining, brands. However, the opportunities to increase the exposure of PM-USA products through significantly larger expenditures in print and outdoor media are now more limited. There are presently fifty cigarette brand families canpeting with each other and all other consumer products in the media environment. This competition for brand recognition has contributed to a substantial increase in the number of advertisements in magazines and newspapers at a time when per capita reading,of print media is declining. Concurrently, the number of available billboards has decreased because of environmental concerns. N O N ~ N ~ CA CA ~ ~ A-7

Therefore, improving PM-USA's retail presence is a major objective during the plan period. Our retail strategy, as outlined in this Plan, is expected to provoke a formidable counterattack frcen RJR, who currently dcminates cigarette merchandising,in many retail outlets. Frcin 1958 through 1982, RJR leveraged its position as the largest cigarette manufacturer to take a leading role in developing, retaill programs and establishing thenselves as the major carton and pack fixture supplier to the trade. As a result of this strategy, RJR owns approximately 70 percent of the carton racks and 64 percent of the pack racks in the retail universe. PM-USA's share of inventory on RJR racks is significantly below our market share, which has led to an unacceptable level of out-of-stockss and inadequate inventory depth for Marlboro. (See graphs below.) SELECTED OUT-OF-STOCK COMPARISONS IN FOOD STORES (NIELSEN DATA) PM-USA RJR