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CONFIDF'NT'TAT, U.S.A. I 1988-1992 FIVE YEAR PLAN BUSINESS PLANNING & ANALYSIS MARCH 1988 NC7I'E Discussion and analysis of competitors is based on public information and internal modeling of competition developed by the Planning Department. Projections and discussions of future actions by competitors are primarily based on extension of historical trends within the context of PM-USA's forecasted U.S. cigarette industry environment. 2030849056

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e~~~a~ PLAN OVERVIEW (',oM~ C~5 v• P 00\4 Philip Morris U.S.A.'s 1988-1992 Five Year Plan sets forth the business strategies which will be emploved to accelerate our momentum in the cigarette industry. To respond to the current and expected industry/cofnpetitive enviromrent, PM-USA has sociopolitical, marketing and operations strategies which have as an objective continued unit volune, market share and profit _. growth. While the cigarette industry as a whole continues to be impacted by anti-tobacco forces, PM-USA possesses strong internal assets -- a young smoker base, a leading position in rrost industry segr-ents, superior product quality, modern infrastructure and substantial financial resources - to prosper despite this threat. These assets enable PM-USA to exploit em,erging industry trends and position the company to achieve its volume and profit objectives unless the industry is significantly changed by external events such as large excise tax increases, a radical acceleration in smking restrictions or unfavorable product i.iabil.i y rulings. Our Five Ycai Picut objectivt'S include: • Domestic volume growth of 17.9 billion units. • Market share growth of 9.4 sharepoints. • Operating income increases averaging 13.4 percent per year. ® Cunbilative after-tax cash flow of $11.6 billion. As seen on the next page, PM-USA's five year objectives exceed those in last year's Plan and reflect our basic strategy for the future - to enhance our current momentum by aggressively investing in the cigarette business while maintaining our profitability and cash flow. To achieve these objectives, we have in place sociopolitical, marketing and operations strategies to: • Maximize industry volume potential by protecting the rights of smokers and manufacturers. • Enhance the strong brand imagery of our products through increased media support while taking advantage of brand developrcent opportunities with targeted consumer prograns and line extensions. At the satte time we will actively work to increase our penetration of the price/value category. • Improve PM-USA's retail presence, particularly in the supermarket and convenience trade classes. • Pursue technological innovation both in terms of developing new products and refining manufacturing processes. • Meet growing production requireznents within existing facilities while maintaining manufacturing flexibility, continuing to improve our superior product quality and ensuring a stable supply of quality leaf tobacco. 2030849058 A-1

CCMPARISCR3 OF PLAN ASSUMPTIONS AtID PM-USA CBJECTIVFS 1988-1992 1987-1991 Five Year Plan Five Year Plan Indust • Avg. Annual Industry Voltare Decline -2.8% -1.7% • Federal Excise Tax Per Thousand $8.00 $8.00 • Price/Value Category Share 21.9% (1992) 13.8% (1991) in Iast Year of Plan PM-USA • Total Market Share Growth 9.4 share points 4.5 sharepoints • Total Volume Growth (Billions) 17.4(1) 6.3 ~ • PM-USA Price/Value Penetration 35% (1992) 19% (1991) • Total Full Margin Price Increases $20.50 per 1000 $13.05 per 1000 • Annual Operating Incare Growth 13.4$(1) 12.0% ~ • Total After Tax Cash Flow $11.6(1) $10.0 fran Operations (Billions) (1) Post-Spiroff. Pre-Spinoff voltmie growth ='17.9 billion, operating incZne growth = 13.4%, after-tax cash flow = $11.8 billion. AZTAaTMENT OF PROFITABILI'I'Y OBJEC'iIVES Mo~c\ s . @h~~~~ An outgrowth of our business strategies will be a significant expansion of PM-USA's market share along with increases in profitability and cash flow. To achieve these objectives, PM-USA must balance four components - pricing, volume growth, marketing spending and productivity improvements. Neeting our objectives is vitally important given shareholder expectations and the impact PM-USA has on Philip Morris Companies' results. Pricin The pricing actions of other manufacturers led to an acceleration of PM-USA's price increases in 1987 beyond the levels forecasted in last year's Plan. The December increase of $2.00 per thousand on top of the $1.50 increase in June represents a significant departure from the $1.00-1.25 level of semi-annual increases the industry had instituted beginning in June 1984. This acceleration is partially the result of competitive attenpts to maintain profit growth in the face of declining unit volume and a growing proportion of price/value products in their sales mix. Manufacturer pricing appears to have reached a new level which is expected to remain essentially stable during the Plan. However, this pricing is considerably higher than in last year's Plan and creates a number of industry risks. • Full margin retail prices are forecasted to increase 8.8 percent annually during the Plan. This compares to expected yearly growth in the consumer price index and disposable income per capita of 4.4 percent and 5.2 percent over the sarre period. Against this broader economic background, and in conjunction with growing pressure from anti-smoking forces, excessive price increases may reinforce f smokers' societal/perceived health concerns and provide an economic justification to reduce or stop consumption of cigarettes, or ~ switch to lower priced alternatives. 2030849059 A-2

• The issue of cigarette affordability may become particularly acute for young adult smokers, who typically have lower disposable incomes than the general population. As seen below, despite expected increases in the minimtun wage, the minutes of work required to purchase a pack of cigarettes is projected to increase for minimum wage workers (which may include a significant number of young adult smokers) at a faster rate than for other employment groups. •'Ihe increased per unit profitability of cigarettes due to higher pricing could lead to greater full margin and price/value couponing and the emrgence of products priced at sub-generic levels. • The enhanced industry profitability resulting from these price increases could lead to the entry of new participants into the U.S. cigarette industry -- participants who would be more willing to dramatically change the industry's pricing structure in hopes of building share. A continued weak dollar further heightens the risk of foreign intervention through the acquisition of a don-estic competitor. J PM-USA and the industry are responding to the issue of cigarette affordability by offering consumers a variety of lower priced and value enhanced alternatives. These alternatives include numerous price/value options, full margin and price/value couponing and, for PM-USA in particular, a broad menu of product incentives to reinforce the premium image and value of our brands. We will continue to explore new ways to improve cigarette affordability, especially for young adults, where PM-USA has a dominant share. Volune Growth The second component of PM-USA's long-tersn profitability strategy is volume growth, which will total 17.9 billion units during the Plan, substantially above the 6.3 billion arounitment in last year's Plan. This will occur despite an accelerated decline in industry volume and will result in a market share increase of 9.4 sharepoints to 47.2 percent in 1992. Volume growth will occur principally fran Marlboro, new products and our price/value entries. At the same time, PM-USA will strive to slow the volume declines of our other brands. A-3 20308420b0

Confidential Philip Morris v. ABC As mentioned earlier, one of the risks of the industry's aggressive pricing will be increased price/value development -- perhaps led by the advent of a new tier of products priced at sub-generic levels. Should this segment energe, PM-USA will become an active participant and this new category would accelerate the decline of both the industry's and PM-USA's full margin business. We have projected a third price tier into our financial forecast and have estimated that by 1992 it would result in an additional shift of nine billion units (versus the top chart on the next page) fresn PM-USA's full margin business to our price/value entries. Marketing Strategy PM-USA intends to invest the additional resources generated by anticipated industry price increases to accelerate our long-tern volume and share mcirentum. During the plan period, total marketing expenditures are projected to increase at a rate of 18.1 percent annually to nearly $2.5 billion by 1992. This compares to a nine percent rate in last year's Plan. An important element of this increase will be to enhance the flexibility of our marketing expenditures so that a portion of these resources can be reallocated as necessary to respond to external factors. PM-USA's level of marketing spending reflects our planned response to current and expected industry trends, including the possibility of an advertising ban. Additional image support can leverage the recent ccmpetitive trend away from advertising and provide a nmore forceful message for our brands. We anticipate that higher industry pricing will require amore aggressive defense of our brands, including Marlboro, to improve their affordability. This defense will include high quality incentives, continuity programs and targeted couponing. Sales support will be increased, in part to acconanadate a planned redeployment beginning in 1988. Finally, merchandising spending will accelerate as we continue to expand our retail presence to a point where it is con4rensurate with our market share.. This will be particularly important if an advertising ban occurs. Productivity A key component of our long-term profitability strategy is to increase manufacturing productivity. During the plan period, Pri USA will benefit from the modernization of the Manufacturing Center and Cabarrus, increased utilization of Cabarrus, labor savings and improved economies of scale. Our efficient use of production facilities, raw materials and human resources will enable PM-USA to realize constant dollar variable and fixed cost savings of $0.26 and $0.08 per thousand, providing our domestic and export sales targets are achieved. This translates into a cumulative productivity savings of $350 million -- a substantial increase over last year's $250 million cominitment. PLAN OUTLINE The remainder of this Plan will review PM-USA's 1987 performance, our forecast of the industry's future direction and the strategies which will be inplemented by Marketing, Corporate Affairs and Operations to achieve our.unit volume, market share and profitability objectives. Projected financial state;nents for 1988 through 1992 are also included. These statements reflect the spin-off impact on PM-USA. Major assumptions in'the statements include a continuance of the $8.00 per thousand federal excise tax on cigarettes, no additional restrictions on the manner in which we market our products and the emergence of a third price tier of sub-generic products. 2030849061 A- 4

PM-USA FORECASTED VOLUME AND MARKE~T SHARE Unit Volume (Billions) Market Share 1987 1992 Change hange 1987 1992 Change Marlboro 134.6 136.8 2.2 23.6% 27.7% 4.1% Benson & Hedges 24.1 20.1 (4.0) 4.2 4.1 (0.1) Merit 22.2 19.8 (2.4) 3.9 4.0 0.1 Virginia Slims 17.5 16.4 (1.1) 3.1 3.3 0.2 Parliament 5.1 4.0 (1.1) 0.9 0.8 (0.1) Cc-ubridge 6.4 16.9 10.5 1.1 3.4 2.3 Famous Brands 0.9 3.2 2.3 0.2 0.7 0.5 Other 4.8 2.7 (2.1) 0.8 0.5 (0.3) New Products - 13.6 13.6 - 2.7 2.7 TOTAL Domestic 215.6 233.5 17.9 37.80 47.2% 9.4% Overseas Military 2.8 2.3 (0.5) TOTAL PM-USA 218.4 235.8 17.4 PM-USA FORECASTED MA~'~I~tING SPENDING (Millions) I j 1987 1992 Advertising/POS/Events $ 407 $ 643 Consumer Spending 201 812 Sales Support 237 434 Merchandising 195 451 Other 35 130 TOTAL $1,075 $2,470 CONSTANT DOLLAR MANUFACTURING COST PER THOUSAND 1987 Actual 1992 Estimate Change Variable Cost Leaf $3.60 $3.58 $0.02 Conversion 1.36 1.06 0.30 Other Direct Materials 1.97 2.03 (0.06) Total Variable Costs $6.93 $6.67 $0.26 Fixed Costs 1.85 1.77 0.08 TOTAL MANUFACTURING COSTS $8.78 $8.44 $0.34 A-5 2030849062

1987 Performance During 1987, the industry experienced a number of events which are impacting PM-USA's strategies. Most notably, nanufacturers' pricing reached an unprecedented level in a year without an FET hike. RJR announced that they are developing an alternative smoking product -- a product which has the potential to dramatically change the industry's status quo, especially for smaller competitors who have limited R&D resources. The envirorunental tobacco smoke issue has come to the forefront in the minds of smokers and non-smokers, resulting in an increase in smoking restrictions and growing pressure on smokers. Finally, the price/value category continued to expand, fueled by branded generic products. This occurred despite a narrowing of the price gap with full margin products. Nevertheless, in 1987 PM-USA continued to build upon the momenttun generated in earlier years to achieve a share gain of 0.9 share points to 37.8 percent. Domestic voltune growth totaled one billion units to 215.6 billion and PM-USA's year-end wholesale inventory was reduced. Operating incone- of $2.7 billion was 13.4 percent above 1986 and after tax cash flow totaled nearly $1.7 billion. The chart below compares our 1987 performance versus the objectives in last year's Plan. 1987 PERFORMANCE VERSUS OBJEC•TIVFS (1) Unit Volume 1987 Actual 1987 Objective • Volure (Billions) 215.6 216.0 • Market Share 37.8$ 37.8% Profitability • operating Revenues +7.4% +7.2% • Operating Income Growth +13.4% +13.4% • Return on Assets 55.1% 41.1% • After-Tax Cash Flow (Millions) $1,658 $1,513 operations(2) rN ~~~`~er~,P~'~ 01105 • Constant Do11ar Productivity $28 $39 Sa%ings (Millions) • Reduction in Constant Dollar 10C 15C Manufacturing Cost Per 1,000 • People Savings from Capital 93 66 Expenditures • Conr-osite Cigarettes Per 16,000 16,300 Labor Hour • Efficiency 72.7% 71.3% • Critical Quality Defects Iowestt in Industry Irwest in Industry (1) Comgsrisons do not reflect spin-off =,pact. (2) Constant Do11ar Savings and Cigarettes Per Labor Hour growth of export sales beyond forecasted levels. were impacted by the A-6 2E9330849063 1

f906fs0c0z The U.S. cigarette industry has been itnpacted by several factors which have lowered snoking incidence and reduced daily consumption. Excessive taxation, restrictions on snoking in public and at work as well as adverse publicity on perceived health issues -- particularly environmental tobacco siroke (ETS) -- have largely been responsible for these trends. In recent years anti-smoking initiatives have grown iTere visible and threatening, while at the same time declining volume has made competitors increasingly reliant on pricing to achieve profit growth. Maximizing long-term industry voltune appears dependent on maintaining the social acceptability of smoking and moderating the impact of price increases on smokers. 1987 INDUSTRY VOLUME U.S. cigarette shipirents decreased 2.0 percent in '987 from 581.9 billion units to 570.0 billion. This performance is a continuation of a downward trend in industry volLUne which began in mid-1985. Over this period, the industry has faced a growing r.unber of threats in the political, business and social arenas. Excise taxes have increased at the state and local levels. Legislation to restrict smoking has been more prevalent at all levels of government and businesses continue to seek to segregate smokers or ban smoking entirely. The ambient smoke issue, fueled by the 1986 Surgeon C-ener_al's Report, has intensified the anti-smoking movement despite a lack of definitive scientific evidence. Anti-smoking advocates have successfully created a negative public perception of ETS and recent studies proclaiming the effects of ETS on sar:okers' families, particularly young children, have hardened this perception. INDUSTRY lNIfi VOLUME CALENDAR ADJUSTED TWELVE MONTH CUMULATIVE SAL%~' 5~.~--_ c~~? ~~ -( 6i0 540f IrIDUSTRY VOLUME 574-}. M J S D M S D 1982 M J S D 1983 J 1984 M J 1985 S D M J S 1986 D M J 1987 'F570 S D ~ A-7