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Beer Miller Brewing Company's operating revenues were up 4.8% and operating income was up 16.7% in 1986. Shipments of 38.7 million barrels were up 4.4%, the first significant gain in four years, and our barrelage increase resulted in a gain in market share. Miller Lite, the second best- selling brand in the United States, increased volume and continued to lead the low calorie segment. New Miller Genuine Draft was successfully intro- duced nationally and very sig- nificantly slowed the volume decline of the Miller High Life brand family. Lowenbrau had a decline in volume but held its share of the super-premium segment. Meister Brau and U.S. Beer Industry Barrel Shipments Fedlral Tax Paid W ithdrawah ^ U.S. Beer Industry Barrel Shipner,ts r. Miller Share of U.S. Industry (%) MdldonsofBarrels % 175 ~ 28 15Q~. 24 ~~ 125 reEre~e~ 77.7879 80 81 82 83848586 Milwaukee's Best, our entries in the popular-price category, both strongly increased their volume with resulting,share gains. During 1986, we introduced new products into test market in the United States and suc- cessfully began selling Miller Lite under license in the United Kingdom. Financial Services and Real Estate Operations In 1986, Philip Morris Credit Corporation's (PMCC) financ- ing revenues rose 74% to $162 million, and net earnings rose over 100% to $70.9 million. These results include the equity income since July 1986 of Mis- sion Viejo Realty Group Inc. (MVRG), PMCC's real estate subsidiary. Our after-tax return on invested capital was 25% in 1986, up from 16% in the prior year. PMCC's growth resulted pri- marily from customer financing operations and leveraged lease investments. In addition, cumu- lative gains on PMCC's lever- aged lease portfolio, resulting principally from the Tax Reform Act of 1986, and the inclusion of General Foods Credit Corporation and MVRG, also contributed to increased earnings. In 1986. we invested $343 million in leveraged leases,, bringing the total equipment value of our portfolio to over $3 billion. We also continued to provide financing services to customers of Philip Morris' subsidiaries. Operating revenues for MVRG rose significantly in 1986, and net earnings were 45% higher than in the prior year. MVRG's performance was based on strong demand for land from builders and a good residential housing market that reacted to lower mortgage interest rates. We continued to fund PMCC's operations through the issuance of commercial paper and long- term debt in domestic and international capital markets. In sum, PJu1ip Morris Compa- nies Inc.'s pr ogrrss in 1986 gives us eonjidenee that we can con- tiwute to build upon our strong base to achieve superior results in the futiu+e. 9

Purchasing... only the highest quality agricultural products. 10 . . . .~s, . Our purchasing systems assure the acquisition of adequate supplies of the finest raw materials. Quality control personnel, using the most advanced testing equipment and stringent control procedures, are an integral part of our manufacturing processes. The highest standards are maintained from raw materials to finished goods. Philip Morris begins with quality to deliver quality. A"

12 Manufacturing. •1 modern facilities using advanced process technologies.

]\1]1jflg or exceeding standards for speed and costs while increasing quality levels is efficient manufactur- ing. To keep costs down, we design or acquire the most advanced process technologies. Combined with effec- tive systems engineering and a posi- tive personnel environment, these factors are key to Philip Morris' success- fui manufacturing operations. At Philip Morris, machinery counts but more important are the people who run it.

14 Packaging... assuring esthetic appeal with real consumer benefits. Serviceable package design is far more than skin deep. Although appearance is of paramount impor- tance to effective marketing, the design must guarantee the delivery of quality to the consumer. Cartons and cans, cases and packages must meet the rigorous tests of transit, storage, and shelf life. The most modern and exhaustive testing is applied to insure consumer satisfaction while the finest designers are engaged to assure visual appeal. At Philip Morris, package design begins with the consumer in mind.

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16 in depth, market- by-market, store-by-store. he distribution process begins as goods move out of our plants. Our shipment of products is carefully managed in order to eliminate exces- sive inventories or, worse yet, out-of- stock conditions. The flow of our products is overseen through every stage of the system-from ware- house to retail, from the back room to the shelf. Philip Morris people work to guarantee a fair share of exposure, thus assuring availability and visibility in every retail outlet. At Philip Morris, distribution is the delivery of consumer satisfaction. 0

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18 Promotion... effective advertising, compelling promotion. Successful marketing is the effective use of every element of the marketing mix in order to induce consumer awareness, comprehension, trial, and repeat sales. The tools are varied and conditions differ from product to product, but one rule is an imperative at Philip Morris: only the best...advertising that's compelling and promotions that fit the interests of our consumers. At Philip Morris, effective marketing balanced with quality products leads to our ultimate goal-consumer satisfaction.

Management's Discussion and Analysis of Financial Condition and Results of Operations Financial Review General Net earnings for 1986 increased 17.7% to $1.5 billion. The 1986 results include the first full year of operating,results of General Footi, Corporation ("General Foods") which was acquired in \o%ember 1985. The capital structure of the company reflects the two-for-one common stock split-up distributed in April 1986. Except as otherwise noted, all per-share amounts have been restated to reflect the ~Itlit-up. Earnings per share reached $6.20 in 1986, up 1813/c from 1985. Dividends declared in 1986 increased 23.8`7c to ~2.1 75 per share ($590 million) from $2.00 per share ($479 millionl) in 1985. The quarterly dividend declared in DVoveulber 1986 was at an annual rate of $3.00 per share, an increase trfi.illc'o over November 1985. Return on average stockholrl'rr,* equity was 28.4% in both 1986 and 1985. The compan%'s return on average assets was 10.6% in 1986, down from 17.8('c in 1985 due principally to the inclusion of General Foods for a fitll year. In 1986. 1.9 million shares of common stock were repur- chased after the common stock split-up at an average cost of $72.53 per share. In 1985 and 1984, the company repurchased 6.6 million 4tares of its common stock at a pre-split average cost of S79,35 per share (13.2 million shares at 539.68 per share after giving effect to the common stock split-up). Sub- stantiall-v, all of the shares repurchased in 1985 and 1984 were retired prior to the common stock split-up. ^ Stockholders' Equity (vear-End) - Net Return on Average Stockhoiden'Equity (%) 01 numm uuuuu 77 78 7980 81 82 83 84185 86 28 4 0 ^ Total Assets (Year.End)'. - Not Return (Before Net Irrterest) on Average Total Assets (%) Billlions of polPars 17,5 125 ~~~ / ^ ^ 10 10.0 B 7:5 6 50 ^ll IIIIII4 25~IIIIII1112 0111111111101 77 78 79 80'81182 83 94 85 86 Debt and Interest At December 31, 1986, the company's debt-to-equity ratio was 1.22 to 1.00, down from 1.69 to 1.00 at December 31, 1985. In 1986, the company reduced total debt by $1.1 billion to G6.9 billion with funds generated from operations and from the sale of The Seven-Up Company ("Seven-Up"). At December 31, 1986, approximately $1.2 billion (17%) of the company's total debt was sensitive to interest rate fluctua- tions, compared with 39% at December 31, 1985. The com- pany's average interest rate on total debt during 1986 was 9.3% versus 9.9%during 1985. At year-end 1986, the average interest rate on total debt was 8.8°1a: Credit facilities totaling $7.8 billion are maintained with var- ious lenders to support commercial paper borrowings for sea- sonal and other needs of the company's operations. Substantially all of these facilities have maturities beyond one year. Of these facilities, 56.8billion were unused at December 31, 1986. Interest expense more than doubled in 1986 to $7,79 million. The increase was due primarily to the first full year of interest on the General Foods acquisition debt. Interest coverage (earnings before interest and taxes divided by interest) was 4.61 in 1986 compared with 7.76 in 1985. The company maintains an `A-1fP-1" rating in the commer- cial paper market and a strong "A" credit rating for long-term obligations. Total debt increased by $5.4 billion in 1985 due principally to financing of the General Foods acquisition and $1.0 billion of outstanding General Foods debt. The acquisition financing consisted principally of a$3.6 billion borrowingunder a ^ Total Debt (Year-End) ~ Ratio of Total Debt to Stockholders' Equity (vea.-End) Billions of DoNrs Ratio 8.4 3.5 7.2 ' 3:0 6.0 1125 4.8 3.6 77 78 79 80 8182 83 84 85 86 ^lnterest Expense r. Interest Coverage (Earnings Before Interest and Raxes Divided DyJnterest) Mlilloonsof Dollars Coverage 840 10.5 720 190 175 1601 1 4.5. 360 240 all ^ 3-0 120 0 77 78 79 80 81 82'83848586 20