Tobacco Documents Online

~moruiis FIVE YEAR PLAN 1988-1992 co nfi d enti al IN= ra a ~ V ti4 -C+ LI N

I I I I I I I 4 CONFIDENTIAL ~ U.S.A. ~ I I I I I I 1988-1992 FIVE YEAR PLAN BUSINESS PLANNING & ANALYSIS MARCH 1988 NOTE I I I Discussion and analysis of competitors is based on public information and internal modeling of competition developed by the Planning Departrnent. 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.

EXECUTIVE SUMMARY 2a437743:3 (

I I I I I I I I I I I I I I I I I I PLAN OVERVIEW Philip Norris U.S.A.'s 1988-1992 Five Year Plan sets forth the business strategies which will be employed to accelerate our morcentun in the cigarette industry. To respond to the current and expected industry/competitive environrnent, PM-USA has sociopolitical, marketing and operations strategies which have as an objective continued unit volume, 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 most industry segments, superior product quality, modern infrastructure and substantial financial resources - to prosper despite this threat. These assets enable PM-USA to exploit emerging 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 smoking restrictions or unfavorable product liability rulings. Our Five Year Plan objectives 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. • Cumulative 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 niomentum 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 development opportunities with targeted consumer programs and line extensions. At the same 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 requirements within existing facilities while maintaining manufacturing flexibility, continuing to improve our superior product quality and ensuring a stable supply of quality leaf tobacco. A-1

CCVJPARIS0N OF PLAN ASSUMPTIGNS ADID PM-USA OBJDCI'IVES Industry ustry 1988-1992 1987-1991 Five Year Plan Five Year Plan • Avg. Annual Industry Voltmie Decline -2.8% -1.7% • Federal E~ccise Tax Per Thousand $8.00 $8.00 • Price/Value Category Share 21.9% (1992) 13.8% (1991) in Last 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 $13.05 per 1000 • Annual Operating Incame- Growth 13.4$(1) 12.0% • Total After Tax Cash Flow $11.6(1) $10.0 fran Operations (Billions) (1) Post-Spinoff. Pre-Spiroff volume growth ='17.9 billion, operating incane growth = 13.4%, after-tax cash flow = $11.8 billion. ATTAIrtM= OF PROFITABILITY OBJECTIVES 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. Meeting our objectives is vitally important given shareholder expectations and the impact PM-USA has on Philip Morris Companies' results. Pricing 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 volune 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 sane period Against this broader ~ . . ~ economic background and in conjunction with growing pressure from ~ , • ~ anti-smoking forces, excessive price increases may reinforce . ~ smokers' societal/perceived health concerns and provide an economic justification to reduce or stop consumption of cigarettes, or switch to lower priced alternatives. ~ w c.n I I I I I I I I I I I I I I I I I I

UK CIGARETTE SALES 1 975--1 981 140 1975 1976 1977 1978 a 1979 1980 1981 9u~arLLErbt~~

REAL RETAIL PRICE INCREASE OF UK CIGARETTES 1976-1981 1975 a 1976 1977 1978 1979 198s 1981 L,?.£tLc:CVo,:.

CHANGE IN U1K SMOKING AGE POPULATION 1976-1981 P ~ ta . 8 E R C E N •6 T C H A .4 N G E 0.2 1975 .a 1976 1977 1978 1979 1980 1981 Q S.. eM LLE W V 6r

IMPLIED PRICE E~'LA.STICITY OF UK CIGARE`ITE SALES 1975 1981 % Change Cigarette Sales (Billions) 131.1 108.3 (17.4%) Cigarette Retail Price 32.6 P 90.4 P 177.3% PDI/Capita L 431.9 L 980.5 127.0 P.eal Increase 50.3% Implied Elasticity - .2021 1975 Cigarette Sales (Billions) 131.1 Cigarette Retail Price 32.6 P PDI/Capita Real Increase Implied Elasticity L 431.9 1980 Cigarette Sales (Billions) 120.8 Cigarette Retail Price 71.3 P PDI/Capita Real Increase Implied Elasticity L 910.0 1977 % Change 124.0 (5.4%) 48.4 P 48.5% L 556.1 28.8 19.7% - .1431 1981 % Change 108.3 (10.4%) 90.4 P 26.8% L 980.5 7.8 19.0% - .4621 T m Note 1: (Change in Q) /(Q, + Q,,) r.~ (Change in P) / (Pl + P2) ~ GI •,j 14 3•J ~

ASSUMPTIONS 1975 1976 1977 1978 1979 1980 1981 Cigarette Sales1 131.1 131.7 124.0 124.4 123.3 120.8 108.3 Cigarette P2rices (Pence) 32.6 41.7 48.4 55.3 62.0 71.3 90.4 Personal ~isposable Income (Millions of Pounds) 18,501 21,237 24,075 28,351 34,201 40,205 43,623 PopulatiVn Age 15 + (000) 42,832 43,050 43,296 43,594 43,897 44,182 44,491 PDI/Capita Age 15+ (in Pounds) 431.9 493.3 556.1 650.3 779.1 910.0 980.5 Note 1: From Philip Morris International (See rnemo fran J. M. Levrat to F. Caton) Note 2: Weighted Average price based on sales and pricing data in memo above. The pricing data furnished by PMI does not reflect price discounting by retail outlets. Note 3: From UK Central Statistical Office per Chase Econometric's Data Base Note 4: Froin UK Central Statistical Office per Chase Econoretric's Data Base (Population for 1981 is estimated.) I

FRG CIGARETTE SALES 1974--1982 1SS 1 1 28 121 0 F U N I T S 114 107 100 1974 1975 1976 1977 1978 1979 1980 1981 1982 a i4E 41v- L~.c -~ tlz

REAL PRICE INCREASE OF FRG CSGARETTES 1975-19$2 20 P 1 14 E R C E N T C H A N G E , ztowEtzL.Ga tl/'.:

CHANGE IN FRG POPULATION 1975--1982 p E R C E N fd.~-1 T E -Q.8'~ 7 % 197S 1970 1977 1978 1979 1980 1981 1982 i CECVLMrQZ

IPAPLIED ELASTICITY OF FRG CIGAREIrl'E SAT,FR 1974 1982 % Change Cigarette Sales (Billions) 126.5 108.6 (14.2%) Cigarette Retail Price DM 2.30 DM 3.64 58.3% PDI/Capita DM 2,547 DM 4,273 67.8 Real Increase (9.5%) Implied Elasticity No Real Increase 1976 1977 % Change Cigarette Sales (Billions) 128.0 115.9 (9.5%) Cigarette Retail Price DM 2.40 DM 2.85 18.8% PDI/Capita DM 3,012 DM 3,196 6.1% Real Increase 12.7% Implied Elasticity - ,581(1) 1980 1981 % Change Cigarette Sales (Billions) 129.6 108.6 (16.2%) Cigarette Retail Price DM 3.00 DM 3.64 21.3% PDI/Capita DM 4,167 DM 4,273 2.5 Real Increase 18.8% Implied Elasticity - .917(1) . Note 1: (Change in Q) /(Q1 + Q,,) (Change in P)/(P1 + P2)

FRG ASStJ24PI'IONS 1974 1975 1976 1977 1978 1979 1980 1981 1982 Sales1 (Billions) 126.5 123.9 128.0 115.9 121.7 ].23.6 127.0 129.6 108.6 Retail Price2 (DM) 2.30 2.37 2.40 2.85 2.85 2.93 3.00 3.00 3.64 Disp. Inc3 158.2 174.6 185.2 196.2 209.1 226.2 243.1 256.7 263.4 (Billions of DM) Population4 (PZillions) 62.1 61.8 61.5 61.4 61.3 61.4 61.6 61.6 61.6 PDI/Capita 2,547 (DM) 2,826 3,012 3,196 3,412 3,683 3,947 4,167 4,273 Note 1: The Maxwell Report: International Tobacco Note 2: Weighted average price of Marlboro per Philip Morris International (see meno from J. M. Levrat to F. Caton). Four price categories were listed in this raem. For all price increases since 1974, the percentage increases of the four categories were virtually equal. Note 3: Deutsche Bundesbank per Chase Econometric's Data Base Note 4: Calculated from the cigarette consumption per capita ratio in the Maxwell Report. _

PHILIP MORRIS INCORPORATED INTER-OFFICE CORRESPONDENCE 120 PARK AVENUE, NEW YORK, N.Y. 10017 CONFIDENTIAL To, Mr. R. R. Millhiser DATE:March 8, 1983 FROM: suauCl: 1983-1987 Five-Year Plan Earnings J. E. Lincoln .l.l cbt` Based on the operating companies' submissions, the 1983-1987 Five-Year Plan asset and earnings growth plans would be summarized as follows: Philip Morris Incorporated Earnings Growth Rates (Based on Operating Company Submissions) % Increase vs. Earnings % Increase vs. Total Assets Previous Year Per Share Previous Year (in millions) 1982 Actual $ 9,692 5.6% $ 6.23 18.0% 1983 $10,599 9.4% $ 7.32 17.5% 1984 $11,310 6.7% $ 8.67 18.4% 1985 $11,968 5.8% $10.77 24.2% 1986 $12,707 6.2% $13.27 23.2% 1987 $13,481 6.1% $16.31 22.9% The operating companies' submissions would result in a five-year compound growth rate of 21.2% for EPS and 6.8% for total assets. Without the LIFO adjustment, the total asset growth rate would be 7.8%. The asset projections are slightly lower than those which the Corporate Finance Department included in the February Finance Committee Report. As an initial step in adjusting these figures, it is recommended that the Five-Year-Plan asset projections be conformed to the February Finance Committee Report. Additionally, Corporate Adjustments to reduce pre-tax income by $25 million in 1984, $175 million in 1985, $350 million in 1986, and $575 million in 1987 are recommended. The prevailing uncertainties appear to provide adequate justification for these adjustments. .c:. ReC?'l PM .~. w t:AR 9 1983 HL;toa CLOO&rt

The proposed Corporate Plan is summarized in the following table and in more detail in the attached schedules: Philip Morris Incorporated Earnings Growth Rates (Proposed Corporate Plan) % Increase vs. Total Assets Previous Year Earnings Per Share % Increase vs. Previous Year (in millions) 1982 Actual $ 9,692 5.6% $ 6.23 18.0% 1983 $10,563 9.0% $ 7.32 17.5% 1984 $11,263 6.6% $ 8.58 17.2% 1985 $11,963 6.2% $10.04 17.0% 1986 $12,787 6.9% $11.76 17.1% 1987 $13,766 7.7% $13.73 16.8% Average Annual Growth 1982-87 7.3% (8.2% without LIFO) 17.1% Since the recommended figures approximate our discussions with Mr. Weissman, we will proceed on the assumption that they are acceptable. Attachments JEL/V cc: Messrs. H. Cullman J. F. Cullman 3rd C. H. Goldsmith H. Maxwell J. A. Murphy S. P. Pollack H. G. Storr G. Weissman ~

B'9T T'LT 0'LT Z'LT S'LT 0'8T L'6I 0'LT T'9T £'Li 6'8T Z'LT t+'BT Z'LT 0'TZ Z'8T 9'4Z S'eT 9'OZ T'OZ 6'4T 6'£T 6'4T 8'4T 6'LT S'TZ 9'L 8'0i %I'LT %Or'LT £L'CT S ' 9L'TT S ' 40'OL S ' 85'8 S ' ZC'L S ' £Z'9 S BZ'S S 08'Z S 008 9ZT 009 9ZT 004 9ZT OOZ 9ZT OOZ 9ZT 995'SZi SZ6'4ZT 549'6iT 4 L Out TZZ7TLTT 7R7r4vrT ~Z '697 'Tf Zig zob'Zs M vz46 g L 8 9L ~f voy osy 3 B 4£ ~ - 40i - - C L ru= ~T L17 60 V t S BZ £ 8 0 rOrTM- j Z(q 19L 69 L6 4E 0'fZ •'Zi SL£ t- ' ' 9L£-tCZ`I ' ' LZS 4S0 T ' ' £SZ 0~88 ' ' L£T 969 ' ' L94 O~ZS ' ' 608- 6I~p 06Sr06Z 8'6T 8'ST 90Z C 999 S89 Z T9L £ZC SS9 Z 990 C96 T Z4Z ZZ9 T 66Z Z0£ T CBS'6L0'T 9T5'SZ9 (000'SLS) (000'0S£) (000'SLU (000'SZ) S'Z 9'TZ OS8'ZL4 LTZ'984 ZBE'ZTS ZSf'SBV Z4L'6T4 OTV'LT4 LZ4 BL' f 9TZ LTST T'64 V'ZC Z9£'V9I B69'04T ' T88'£TT ' ZLS'L9 ' 4Z9'TT ' TI£'ZZ ' 8L8'4 9L'4 S m'S (00£'L) (008 9) (009 9) (009 L) (L6f T) f60 ST TZS'TT C£9'TT aaN (8'TZ) £'iZ C66~LL L4E~Z4T LSZ~BTZ 6ZL~6SZ £6B~0LZ L9I~L9Z LIS'BSZ 495'TOi T'9T 0'4Z 66L LfZ ZL6 60Z 44B 9BT TS9 S91 ZZ9 4£T 6E8 ZTT TTS'EOT fZS'B£ 6'6T T'LT OZS'4SZ'm Z06'L6S'C L£0'TT0'C - 8ifi'fL4'Z - - 486'L£0'Z 60L'6TL'T 0T0`BS T Z£-L lBL l 6'ZI L•Z4 860TT 9iZ~lTT 6SZ 4 T 6 LT9 8 4BT~69 4CZ*69- TOOT- 469 TT T'0Z 1''9T ZZ4'LZT't 989'SBO'C BLL'9T6'Z T08'06C'Z 009'896'T ~ SLe'0S9'T 600'TTVT 8£0'ILL •'4T C'SZ SS6 S~ 9£ TSB-'4SfrC TLT~- 86S*S£9r- 0f6 I4Z 09Z- fL6- T CZL~Z49-~I CZ9 CZy 6'0T •'8i 646'S0i ' 89T'96 ' Z8S'9E ' TL8'LL ' 500'TL ' 6£Z'£9 ' 666~95 Z9 L~ L I'ZI L'LZ LZ4 9Sd ' ' 969 CTm ' ' 089 £LC ' ' SBZ BfC ' ' 49Z Z6Z ' ' 94C BSZ ' ' L46'ZCZ LIO'9L 6'4T Z'SZ 6LS C0Z C 4b8 L86 Z 606 CIS Z Z44 6TZ Z 199 8L8 T SL9 109 T LLL'ZS£'T 444'OZS Z'LT L'OZ LLC'C68'L L£S'048'9 646'06B'S 66£'9ZO'L 0£L'0LZ'm S£L'CLL'C ZfL'CSO'C T99'46£'T £'9T •'9I -rr TZ£~~LT-- 989 TZ6Z r ST - OT9~ r-£r- 68L~BL£~f i~fi ~~ r-i---6SL TT -BCS - TSZO r OT 04£~~ - S8f r-r- ~Z4i B ZZT ZCB L 9TC~L00 f %9'9I %9'LT ~ C90 STZ SZS ~ L4T fCi ZZS 8CL 69Z 6TS LL6 58L 9TS 0L0 9fZ 4TS ~ OZT 9iL TTS 45B'SB6'OTS LL6'TOL'S S L86T'Z86I ZB6T'LL6T L961 9961 S86i 4B6T C86T Z06T 1061 LL6I a7etl V7"'010 Tpn7oh/ im70Y Ten7o1f P2aelsay w (Pa77Tuj0 000) 3v0JNI j0 1N34311l1S 031U[lI"105N03 NNId W3A 3AI! £86T C86T '8 u07BH ue(d ale3odioa 031tl2i0dQi0JNI SIUWA dilINd 20437743338 (AJ-Tsd) 'S'd'3 ;OwouI 7aN saxel a.ioJag awoOUl sanuanad 6uT;elad0 (%) saseaiaul ivnL oaeyS aad s6uTuJe3 AJeuuT (a6eiany) 6uTPueasa n(I sass )M7S U--3 301 aT4BTTe sPuaPTATO Paa3aJaad aoJ Pasinb, aaN 'suoTaonPaO iatao 's7s03 (uT6PaH/'sue11 Aauaian0 asuadx3 asa3a1ul asuadx3 aje3odao:) :suoT7-P20 6uT]e3ad0-uoN saiuedwoo 6uTaeiad0 jo awoouI 6uT7BJa saiaeTPTs4^5 PaTePTlosuooa.I1 JO s6uTuae3 uI L)Tn' TTJO-ld 6uTT®i. asuadx3 Tm7ol auaudoTa^a0 PuB ypieas onT]e1TsTUTwPd Pue I®aau 15uT7o~i aTJoid aT4eiTw, PTOS sPoOO Jo as sxx»Aay 6uTaaJadb 107

Actual Res A tated ctual 1977 1981 M. U.S.A. S 474,109 S 905,120 M. INTERNATIONAL European Econ. Cormxnlty 152,641 EFTA, E. Eur./ M/E, Africa 131,477 Australia/New Zealand 29,226 Asla 40,036 Canada 5,823 Latin America/Iberia 129,160 Duty Free Sales (U.S.A.) 11,279 Rothmans International 11,442 LIFO Adjustment (43,636) Inter-Regional Adjustments a `~i~ Regional Combined 47 Headquarters & Consolidating Adj. 8) (3 2 Total Combined Less, Unconsolidated Affiliates ~ 5 iie 3~0~) (5 Total, excluding Seven-Up Int'l. Seven-Lp International ~ ~324 Total from Business 383-86b European Interest Expense (11,423) Total Consolidated P.M. International -132,f8~ 372,437 LLER BREWING COhf'ANY 105,507 110,187 VEN-lP COhPANY Franchise Division (1,754) Packaged Beverage Division 1,436 Food Products Division 5,400 Headquarters (8,564) Consolidating Adjustments • 822 I : Total Seven-Up Domestic Seven-Up International Total Less, Seven-Up International Total Seven-Lp Company '.M. IPDUSTRIAL Nicolet Plainwell wisconsin Tissue Mills Koch Colonial Heights Discontinued Operations Headquarters Consolidating Adjustments Total P.M. Industrial :ISSION VIEJO COM'ANY .M. CREDIT CORP. :ONS0.IDATING ADJUSTMENTS ,LL OPERATING COM'ANIES bRPORATE ADJUSTMENT xIRPORATE HEADt1UARTERS D1NSOLIDATEO INCOME BEFORE TAXES 14,4 7 33,065 (400) 758,880 (133,364) 1 625,516 Actual 1982 S 1,100,925 136,461 156,545 34,814 40,689 6,186 129,523 11,792 25,596 (45,944) 4 (50~~) 4 (483g9.,_99b) ,391 399,917 (7 150) 3~ 154,262 9,887 3,621 (7,680) (14,877) 62 (2,6 a) 324 391 (2,337.,) (324) (391) (2,660) 8,987) 4,020 675 (4,155) (6,047) 12,690 5,251 4,077 5,283 4 6 4 5,856 3,118 (3,675) (4,742) ~(1 34~5) - 18,112 3,538 22,534 4,107 877 (21,226) (1,222) 1,404,504 1,646,267 (324,921) (343,968) ~ 1,079.583 S 1,302.299 .. hEC•bLLEVfl%7 PHILIP MORRIS INCORPORATED 1983 FIVE YEAR PLAN PRE-TAX INCOME Om e 1983 1984 $ 1,326,024 $ 1,555,065 147,710 215,800 187,685 227,900 28,003 34,000 59,170 72,200 6,864 12,900 157,938 185,300 14,374 16,800 24,334 25,900 (52,820) (52,650) (26) ~9 ) ~3;IS . (5 s,7 2i) ~8'I b) ei 5T4 ' (45 387 ) ~(so 700) ~ ~ ~930 - ' 4 ~'y',4~ 90. 0 47F,35 4 ~ 562,370 (10,100) (7,100) 460,254 555,250 212,185 230,750 (15,377) 512 7,852 20,631 8,299 10,860 (13,766) (15,752) (1 032) (2 222) - (14:024) 14:029 930 4 900 __7t,929 (930) (4 900) 4,024) 4,02 1,700 2,361 1,354 4,044 14,219 28,630 4,600 5,440 - - - - (2,185) (2,549) (9,688) (18,000) 10,000 19,926 6,900 10,900 4,696 7,117 (10,526) (10,525) 1,995,509 2,382,512 (25,00D) (373,267) (394,446) S 1.6?2.242 S 1.963.066 1985 1986 1987 S 1,811,355 $ 2,094,662 $ 2,416,129 275,100 268,400 38,600 101,600 16,900 216,600 19,400 27,700 (49,653) 311,900 326,100 51,500 139,900 19,100 257,600 22,400 29,500 (51,662) 351,000 381,500 67,200 195,500 19,800 306,300 25,500 31,500 (56,888) (_ ~) (1~~) () ~ (66 300) - (72 800) ~ ~ ~ (79 500) 74I;647 -548;338 - ,~77;n~ (79 500) ( ) i09 ~100) (l 300) 37 14 900 _ 32 500 a _s 4-t 40 900 821;738 93I;3I2 (1,000) 7 600 1 15 200 676,047 ~29 338 986 ST2 276,950 337,060 406,452 16,411 43,144 80,989 36,110 54,385 76,453 16,581 21,587 29,645 (17,410) (19,416) (21,520) ) 9a a35) ( ) - ; -I 6I;6~3 ~14 9.0_0_ ' 32 500 ~40,~.9.0~_0 63,582 128.>35 LU1,Y/3 (14 900) ~(32 500) (40 900) 48,6 y6,u~5 7jaI,d73 i 5,504 7,454 8,520 6,712 8,113 9,108 39,283 56,646 67,051 6,646 7,503 8,514 (2,849) (3,149) (3,549) (23,000) (29,000) (29,000) 32,296 47,567 60,644 35,800 40,300 46 100 9,159 11,316 13,898 (10,525) (10,525) (10,525) 2,879,764 3,445,753 4,080,283 (175,000) (350,000) (575,000) (381,109) _ (334,068) (298,617) 3 2.323.655 S 2.761.685 S 3.206.666 Corporate Plan March 8, 1983 Growth Rate _ 8 . . I 18.4% 17.0% 20.8 19.5 14.1 36.9 26.2 18.8 16.7 .4.~ 3 f, 9.6 -I.2 24.6 - 100.0s ~.a 24.3 20.2 7.9 21.4 52.3 84.0 100.0. - 16b.N 100.0. 00~.0. 100.0. _ 00T~.0. 66.0 66.4 10.0 4.5 76.5 (34.1) 62.2 73.8 16.8 19.9 20.9 (2.8) 15,8% 19.8%

r PHILIP MORRIS INCORPORATED CONSOLIDATED BALANCE SHEET FOR YEARS ENDING DECEMBER 31 1982 ACTUAL 1983 1984 1985 •1986 1987 ASSETS CASH $ ' 53,900 $ 45,000 $ 45,000 $ 45,000 $ 45,000 $ 45,000 RECEIVABLES 691,100 834,900 907,000 1,019,600 1,145,800 1,294,900 INVENTORIES-LEAF 2,468,600 2,752,200 3,115,400 3,465,000 3,815,400 4,220,000 -OTHER 1,092,300 1,120,500 1,259,000 1,409,500 1,586,600 1,772,800 -LIFO ADJ (492,400) (668,600) (836,400) (995,600) (1,161,500) (1,340,800) 3,068,500 3,204,100 3,538,000 3,878,900 4,240,500 4,652,000 PREPAID EXPENSES 36,800 38,800 41,800 45,600 50,400 54,500 TOT CURR ASSETS 3,850,300 4,122,800 4,531,800 4,989,100 5,481,700 6,046,400 INV d ADV TO SUBS 726,700 884,000 975,200 1,065,800 1,172,700 1,294,800 INV IN BOTTLING COS 30,000 60,000 90,000 120,000 150,000 LAND & OFFTRACT 195,100 213,600 260,000 275,300 286,600 301,200 PROP, PLANT & EQU 5,309,700 5,979,500 6,450,500 6,921,600 7,494,300 8,174,900 LESS ACC DEPR 1,114,800 1,384,100 1,696,000 2,051,300 2,426,200 2,844,300 4,194,900 4,595,400 4,754,500 4,870,300 5,068,100 5,330,600 BRANDS, PATS & GW 615,800 603,300 590,200 577,400 564,700 551,900 LIT RECEIVABLES 27,300 27,400 23,700 28,400 28,400 28,500 OTHER ASSETS 81,800 86,100 67,700 66,600 64,800 62,200 TOT ASSETS $ 9,691,900 $10,562,600 $11,263,100 $11,962,900 $12,787,000 $13,765,600 LIABILITIES NOTES PAYABLE CURR L/T DEBT 166,100 202,400 105,400 A/P 5 ACC LIABS 1,243,300 1,468,400 1,639,700 1,807,600 2,013,600 2,203,700 TAXES PAYABLE 295,000 384,600 272,600 290,800 338,700 358,000 DIVS PAYABLE 75,500 91,600 117,300 141,500 170,500 204,500 TOT CURR LIABS 1,613,800 2,110,700 2,232,000 2,345,300 2,522,800 2, 766 , 200 L/T DEBT 2,687,400 2,564,400 2,318,100 1,951,500 1,663,300 1,429,700 S/T DEBT RECLASS TO L/T DEBT 853,100 542,100 520,900 511,100 391,200 204,900 IND'L REV BONDS 208,800 244,500 238,400 248,300 260,200 268,800 DEF INC TAXES 624,300 837,900 1,070,300 1,310,700 1,539,200 1,752,300 OTHER LIABS 41,600 45,300 45,100 47,300 48,400 49,800 TOT LIABS 6,029,000 6,344,900 6,424,800 6,414,200 6,425,100 6,471,700 STOCKHOLDERS' EQUITY CODL*fON STOCK 125,900 126,100 126,300 126,500 126,700 126,900 ADD'L PIC 435,900 442,400 448,600 455,100 461,500 469,400 EARNINGS REINV 3,199,700 3,757,700 4,371,900 5,075,600 5,882,200 6,806,100 TRANS ADJ -PRIOR YEARS (26,800) (98,600) (108,500) (108,500) (108,500) (108,500) -CURR YEAR (71,800) (9,900) - TOT TRANS ADJ (98,600) (108,500) (108,500) (108,500) (108,500) (108,500) TOT S/E 3,662,900 4,217,700 4,838,300 5,548,700 6,361,900 00 7,29 900 TOT LIABS & S/E S 9,691,900 $10,562,600 $11,263,100 $11,962,900 $12,787,000 $13,765,600 ~

II]TERNAL PLJ\IiNING 1=ING April 8-9 Five Year Plan Issues Key issues which could ir.zpact PM-USA's ability to rreet short and long-term profit objectives: 1) Industry der.tiand 2 ) Ccxpetitive actions 3) New products 4) Operations constraints 5 ) r7anageznent resources o National average price per packl#$.93; D$1.00 in several states. o International r.iarkets have experienced volume reductions when retail rise has been rapid (UK, Germany, Australia). - Relative cost of cigarettes > U.S. - Real increases have been occuring frequently o Increase factors - FEI' - further rises? I- a, - State/Local - much activity expected; plan contains xx ~ annual increase; could be more. - Manufacturers - importance of price contribution to profit. o cost inflation will be less o% increase less due to higher base cost o will others follaa or hold to build volune - Non-Financial 0 Anti-smoking - Non-smoker issue - Social cost - Youth 1. Industry Demand - Financial - consumer reaction to rising retail price of cigarettes o Real cost of smoking decreased in the inflationary 70's and early 80's. 23.3% increase in retail price in '83 in concert with 3% CPI increase reverses the trend. 0 Restrictive legislation - Smoking in public places/work places (ban/segregation). - Marketing activities - sampling, advertising, promotion. I

o Health issues - Government efforts - Lawsuits - liability o Social acceptability/lifestyle o Industry response - TI, TAP, TAN, PAC's - Political base for response - tobacco states narrowing, how to handle non-tobacco majority. 2. Cor.lpetitive Actions - Current industry situation o Low growth - softness so far, yet projected to show some growth after '83. - Smoker deriographics: Less new smokers, male/female mix, soc io-econcn-Lic /ethnic mix. o Share losses for same conzpetitors (after periods of growth); others continue to lose. o Excess capacity (plant and people) due to: - Share losses - Export softness - Capacity expansion programs o Capacity situation is further exacerbated by expansion plans by USA and RTR. o Margins are among highest in the world. - Irtportance of U.S. cigarettes to corporate parents (weakness of non-tobacco businesses). - Steady increase in margins over past decade. - Less pressure from cost inflation. , - Cor.tpetitve options o Generic/private label - gap has widened as Liggett holds back ( > $1.50 carton). - Differential (-%- wise) is above 104 brands. - Build volume opportunistically, preclude others from entering market due to low margins. rt ~ 43, ca ~ ~ ~ ~ ~ rs

o Hold/cut branded prices o Quantity in pack o Couponing o 2 for 1 o Consumer incentives o Increased marketing o New products - Line extension limitations - New product feature o ingrediant removal o filtration (a' la Barclay) o third party endorsement - Roll your own? 3. New Products (PM) - Current situation o Most new product growth in past 5 years from.line extensions (still have some options). o Tar level segmentation stabilizing - Corrpete intra segment o PM volume growth requires significant new product volume - New brands o Few successes o Product must have significant point of difference o Differentiation beyond traditional segments - Packaging - Taste - Other product features o Expensive - product and intro-marketing - Reduced margins - P.eallocation of limited marketing resources o exposure of current brands volume ,

o Offensive and defensive introductions - risk of cannibalization o Ccxnpetitive response - ability and speed 4. Operations - Less capacity, less capital o Cabarrus/20th Street 0 3rd line RL •o People imbalance - cost - Cost containment o Less inflation - constant $ closer to actual $ o Margin pressures - New products - Incr_eased quality - Flexibility o Capacity o Product mix o Product changes - External pressures o Self-extinguishing cigarette o Cigarette additives - Biological reactions - ReMoval o Label rotation - manageable o Leaf price support system 5. DZanagetnex!t DeveloMieslt - Mir!imal expansion - improved productivity/professionalism f

- Succession o Cross training (lateral) o EEOC o Key jobs - Maintain morale - Stay personal

L INTERt`1AL PLANNING MEE"TING April 8-9 Five Year Plan Issues Key issues which could impact PM-USA's ability to met our short and long-term profit objectives: 1) Industry demand 2) Competitive actions 3) New product trends 4) Operations constraints 5) Management development 1. Industry Demand - Financial - consumer reaction to rising retail price of cigarettes o Real cost of smoking decreased in the inflationary 70's and early 80's. 23.3% increase in retail price in '83 in concert with 3% CPI increase reverses the trend. chc.ti-r- Q-*4~A us cP2 / 8 3-67 9,Za/op.a. o National average price per pack $.93; $1.00 in several states. o International markets have experienced volume reductions when retail rise has been rapid (UK, Germany, Australia). v~ i nw~eS cs~ usw~. - Relative cost of cigarettes U.S. - Real increases have been occuring frequently Priee wcr.ea.-Qes vs inf o Increase factors - FET - further rises? L0.st 9-yBaV~s 4- - State/Local - much activity expected; plan contains 0O annual increase; could be more. `zz - Manufacturers - important price contribution to profit.' &' 3 o cost inflation will be less o % increase less due to higher base cost o will others follow or hold to build volume - Non-Financial o Anti-smokina - Non-smokers - Social cost - Youth o Restrictive legislation ,rf - Smoking in public places/work places (ban segregation). - Marketing activities - sampling, advertising, pronotion.

0 Health issues - Government efforts - Lawsuits - liability o Social acceptability/lifestyle o Industry response - TI, TAP, TAN, PAC's - Political base for response - tobacco states narrowing, how to handle non-tobacco majority. 2. Competitive Actions - Current industry situation o Low growth - softness so far yet projected to shcw some growth after ' 83 . , ~ g 3 -g~ 5y"O" ~~ Pc - Smoker demographics: Less new6 &okers,i le/female mix, socio-economic/ethnic mix. neede!&~~ga-'"5 'S (,V L"c.u.~~4 ~ S e/.OK7lr o Share losses for some competitors (after periods of growth); others continue to lose. C~ ~ r -1o~~y pea v-s o Excess capacity (plant and people) due to: - Share losses - Export softness - Capacity expansion programs Oue.vto-'.3 4-&(ooc,_T~ o Capacity situation is further exacerbated by expansion by USA and RJR plans.-- 3-7% ob~. o Margins are among highest in the world. - Importance of U.S. cigarettes to corporate parents (weakness of non-tobacco businesses). - Steady increase in margins over past decade. - Less pressure from cost inflation. -i ~ _ g 2, -g ~ ~C---> r 7, IF - Competitve options c'~S+_ Pf'`N 6. o Generic/private label - gap has widened as Liggett hold back ( $1.50 carton) . C~~~~3 5~„ 52.o~fo - Differential (-o-- wise) is above l0d-brands. - Build volume opportunistically, preclude others from entering market due to low margins. i~ .-,14.

o Hold/cut branded prices o Quantity in pack o Couponing - cbnsuh.e~- acA~cvj vocbwj 0 2for1 o Consumer incentives o Increased marketing - N L-E-5 e+qp ~gz o New products - Line extension limitations - New product feature o ingrediant removal o filtration (a' la Barclay) o third party endorsement - Roll your avn.? 3. New Products (PM) / K-eL., I;r Current situation --VVILs5e-a i9$z -+-ge.r- 3.(. )a, I a ~18~3 I, ~ b o Most new product growth from line extensions (still have some options). 7-,A, ,,~~ Pm -,s o Tar level segmentation stabilizing P.Q, - Compete intra secrment b--~ S ,?-- o PM volume growth required significant new product volume - New brands o -1-a-f c~ v-fl ~~ v o-w~. 3 g S`~/So o Few successes Tg-.~~ ~ p`^- N ~S. o Product must have significant point of difference o Differentiation beyond traditional segments - Packaging - ItIA - ac ~c. , P l &.L - Taste - 9 - Other product features Expensive - product and intro-marketing - Reduced margins ~ 6 4DuL- ra - Reallocation of limited marketing resources ca o exposure of volume from current brands ~ ~ ~ 133 w,~, ~, P~ ~~rs v --k-d' q v Gdlu e t a V~- 0,6 ~ . ~ .~ c,~

o Offensive and defensive introductons - risk of cannibalization c ka..,-t p . ~ ~ o Competitive response - ability and speed 4. Operations - Less capacity, less capital ('7y4 o Cabarrus/20th Street 0 3rd line RL o People imbalance - cost - Cost contairunent V~ V__ V_I!i, o Less inflation - constant $ o Margin pressures - New products - Increased quality - Flexibility o Capacity o Product mix o Product changes - External pressures o Self-extinguishing cigarette o Cigarette additives - Biological reactions - Removal o Label rotation - manageable o Leaf price support system closer to actual $ 5. Management Development - Dti.nima.l expansion - improved productivity/professionalism

- Succession o Cross training (lateral) o EEOC o Key jobs - Maintain morale - Stay personal

o Retail Cost to Consumers o Federal Excise Tax o State Excise Tax o Manufacturers Pricing o U.S. Prices vs. Other Countries - UK and Germany 1 o Non-Financial Anti-Smoking Efforts o Restrictive Legislation - S ki i P bli l o n ng n u c P aces/ work Place o Restrictions on Marketing - sampling o Health Issue --Furgeon General o Social Acceptability/Lifestyle Industry Demand o Generic/Private Label o Cut Branded prices 0 2 for 1 and/or Consumer Incentives o Couponing o Quantity in Pack o Increased Marketing Effort o New Product Introductions L..---- ~ ~3f+ 3tq P,,.z~ - h..~ o Current Industry Situation 0 o Low Growth Industry o Excess Capacity within the Industry o High Margins o Several Companies Losing VolumPe o Options Available to Competitors 0

New Products o Current Situation o PM new product grow'-h in past five_,yc5ars was o Large percent of PM future volume growthh comes from new products. o Appears that this growthh must come from New Brand Names. 0 New Brand Names l~ o Market Segments Stabilizing predominantly line extensions. Operations o Historical success of new brand names is poor. o Must have a distinctive Point of Difference. o Offensive and Defensive Introductions - Risk of Cannibalizatior_ o Expense of introductions o External Pressures 0 0 0 0 Label Rotation Self-Extinguishing Cigarette Additives Leaf Price Support System I ,%

-t j -:R 1' 14 ~0437 i~F3'.r-~

• The issue of cigarette affordability may become particularly acute for young adult srnokers, who typically have lower disposable incomes than the general population. As seen below, despite expected increases in the mirsrman 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. • The increased per unit profitability of cigarettes due to higher pricing could lead to greater full margin and price/value couponing and the energence of products priced at sub-generic levels. • The enhanced industry profitability resulting frcm these price increases could lead to the entry of new participants into the U.S. cigarette industry -- participants who would be nore 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 darestic coinpetitor. 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. Volume Growth The second component of PM-USA's long-term profitability strategy is volume growth, which will total 17.9 billion units during the Plan, substantially above the 6.3 billion conunitment 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 fron 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

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 emerge, 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) frcm 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-term volume and share momentum. 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 elevent 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 competitive trend away from advertising and provide a more forceful message for our brands. We anticipate that higher industry pricing will require a rmre aggressive defense of our brands, including,Marlboro, to ir-prove their affordability. This defense will include high quality incentives, continuity programs and targeted couponing. Sales support will be increased, in part to acconvcdate 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 comTensurate 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 manu=acturing productivity. During the plan period, PM-USA will benefit from the nbdernization of the Manufacturing Center and Cabarrus, increased utilization of Cabarrus, labor savings and improved econorties 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 cunulative productivity savings of $350 million - a substantial increase over last year's $250 million comnitment. PLAN OUZ'LINE 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 impleirented by Marketing, Corporate Affairs and Operations to achieve our unit volume, market share and profitability objectives. Projected financial statements for 1988 through 1992 are also included. These stater-ents 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 w~_- market our products and the emergence of a third price tier of sub-generic products. A-4

I I I I I I I I I I I I I I I I I I ..~ PM-USA FORECASTED VOLUME AND MA= SHARE Unit Volture (Billions) Market Share 1987 1992 Change 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) Nerit 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) Cambridge 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 Donmestic 215.6 233.5 17.9 37.8% 47.2% 9.4% Overseas Military 2.8 2.3 (0.5) TOTAL PM-USA 218.4 235.8 17.4 PM-USA FORECASTED MARKETING SPENDING (Millions) 1987 1992 Advertising/POS/Events $ 407 $ 643 Consuuner 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 MANUFACTUR.ING COSTS $8.78 $8.44 $0.34 A-5

I 1987 Performance During 1987, the industry experienced a number of events which are intpacting PM-USA's strategies. Most notably, manufacturers' 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 envirorumental tobacco smoke issue has cone to the forefront in the minds of s-nokers and non-smkers, 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 mamenttun generated in earlier years to achieve a share gain of 0.9 share points to 37.8 percent. Domestic volume growth totaled one billion units to 215.6 billion and PM-USA's year-end wholesale inventory was reduced. Operating income 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 OBJE::TIVFS (1) 1987 Actual 1987 Objective Unit Volimtie • Volture (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) • Constant Dollar Productivity $28 $39 Sw,ings (Millions) • Reduction in Constant Dollar 10G 154 Manufacturing Cost Per 1,000 • People Savings from Capital 93 66 Expenditures • Composite Cigarettes Per 16,000 16,300 Labor Hour • Efficiency 72.7% 71.3% • Critical Quality Defects Lowest in Industry Lawest in Industry (1) Caq:)arisons do not reflect spin-off impact. (2) Constant Dollar Savings and Cigarettes Per Labor. Hour were impacted by the growth of export sales beyond forecasted levels. A-6 I I I I I I I I I I I I I I I I I I

I I I I I I I I I I I I I I I I I INDUSTRY VOLUME The U.S. cigarette industry has been inpacted by several factors which have lowered smoking incidence and reduced daily consumption. Excessive taxation, restrictions on smoking in public and at work as well as adverse publicity on perceived health issues -- particularly environmental tobacco smoke (ETS) -- have largely been responsible for these trends. In recent years anti-smoking initiatives have grown more 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 volume appears dependent on maintaining the social acceptability of smoking and moderating the impact of price increases on sn-okers. 1987 INDUSTRY VOLUME U.S. cigarette shipments decreased 2.0 percent in 1987 from 581.9 billion units to 570.0 billion. This performance is a continuation of a downward trend in industry volune which began in mid-1985. Over this period, the industry has faced a growing nunber 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 General'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 snokers' families, particularly young children, have hardened this perception. INDUSTRY UNIT VOLUW CALENDAR ADJUSTED TWELVE MONTH CUKJLATIVE SALES BILLIONS QF 1 NdarS J 66M J S 6 M J S D M J S D M 11761 6 M 7S 6 4 1982 1983 5984 1985 1986 1987 I A-7

I 1988-1992 INDUSTRY FORECAST Given the current political and social environment, coupled with the projected acceleration of industry pricing, it appears likely that industry volutrne will erode at a faster rate over the next five years. During this period, PM-USA projects industry volume to decline about 2.8 percent per year, reaching 494.5 billion units in 1992. This compares to an average annual decline rate of 1.7 percent since 1984. The Plan decline rate is greater than the 1.7 percent rate in last year's Plan, reflecting a deterioration of political and social attitudes toward smoking and higher industry pricing along with the adverse demographic trends discussed in last year's Plan -- lower start rates and incidence, a drop in daily consumption and an aging population. IMUSTRY VOLUME F®RECAST THIS YEAR'S LAST YEAR'S PLAN PLAN 70 BILLIONS OF (NITS 6W 6W 550 5W 4% 570.0 44 980 i982 1984 198fi 1998 3990 '- O 524. `~ 494. i992 • Start rates for young adults are expected to remain relatively flat over the Plan period, although at a level considerably less than overall smoking incidence. During the last three years, start rates have remained fairly constant at 14 to 15 percent based on an annual study conducted by the University of Michigan. (See graph on next page.) • Smoking incidence declines are projected to continue. Based on current industry volurre and trends exhibited over the past five years, incidence airong adults is estimated to be approximately 31 percent, down from 34 percent in 1982. PM-USA's industry forecast assumes that future incidence declines will approximate those exhibited over the last five years, which would result in a 28 percent incidence level in 1992. • Average daily consumption is forecasted to decline about 2.5 cigarettes per smoker due to increased snoking restrictions, growing concern over environmental tobacco smoke and a larger share of females in the smoking population. This is down frcm the two cigarettes per day drop forecasted in last year's Plan. A-8 I I I ~ I I I I I ~ ~ I I I I I I I

• Population trends are projected to have a less favorable impact on industry volume than in the past decade. Over the next five years, the 18-34 age category is projected to decline by three million people compared to a slight gain experienced over the past five years. In addition, the overall population is aging into groups where incidence declines have traditionally accelerated. For example, over 120 million Americans will be over age 35 in 1992, compared to 109 million in 1987. Longer term, population demographics are expected to be more favorable as the current "baby bocAnlet" reaches adulthood. • Finally, pricing will have a greater impact on industry volume than in past years. As discussed in the Plan Overview, price increases are projected to be well in excess of the growth rates of overall inflation and disposable income. This level of pricing could serve to reduce cigarette affordability and contribute to consutrmtion declines and increases in quit rates. PM-USA must respond to these trends if we are to achieve our voliune and profit objectives. The projected declines in the number of young adult smokers, where we have a 64.5 percent share, mandates that we maintain our dominance in this category while retaining our current smokers as they age. At the szme time, we must step up efforts to attract additional smokers in older age groups. Marketing plans are being tailored to appeal to a smoking population which is becoming older, more female, less educated and more blue collar. Finally, the issue of cigarette affordability, especially for young adult smokers, will be addressed through a variety of incentives, continuity programs and targeted couponing.

COMPETITIVE ENVIRONN]ENT The U.S. cigarette industry possesses a number of characteristics which position it to achieve long-term profit growth. Despite aggressive pricing, cigarettes remain a low cost, repeat purchase consumer product which is not subject to a cyclical sales pattern. In addition, the industr-T does not_ encounter mearsngful foreign campetition, has high barriers to entry and has historically enjoyed an absence of product substitutes. The industry's financial strength is illustrated by its ability to maintain profit growth despite unfavorable volume trends. Total estimated operating income increased over 11 percent in 1987 to rrore than $5.7 billion and has expanded at a 13.6 percent annual rate since 1982. This performance has been a function of long-tern pricing flexibility, moderate cost inflation and productivity gains achieved through the investment in new manufacturing technologies. At the samee time, the competitive environment has changed from the 1970's, when increasing industry volume and constmer preferences for longer and lower tar cigarettes provided growth opportunities for cigarette manufacturers. PM-USA was the chief beneficiary of these trends and our success has helped move the industry toward an environment where retail presence and price competition are becoining more important than the comrcunication of brand images through traditional miedia. The following chart illustrates the major trends which are occurring in the ccnpetitive environment - a loss of young adult smokers for sorre manufacturers, a growing dependence on price/value products and the trend away from advertising. SUMMARY OF SIGNIFICANT INDUSTRY TR=S PN_USA RJR B&W Lorillard American Liggett Share of 18-24 Age Category 1982 51.8% 24.6% 11.4% 10.7% 1.0% 0.5% 1987 64.5 17.8 4.2 12.0 0.7 0.8 Manufacturer Price/Value Sales(l) 1985 0.5% 6.0% 15.0% -% -% 7,0_7% 1987 4.2 12.0 20.9 - 3.5 62.7 Media Share of Total Marketing 1984 47.8% 44.6% 31.3% 40.9% 26.5% 19.3% 1986 36.3 25.7 17.9 30.3 25.3 3.7 (1) Percent of each company's total unit voltnrre which is price/value. DIIMOGR.~PHIC POSITIONING Attaining significant representation among young adult smokers generates considerable long-term benefits for a cigarette manufacturer. Historically low switch rates among smokers, particularly older smokers, indicate that to achieve long-term share growth, a manufacturer rrmust establish a brand as a popular alternative for young adult smokers. PM-USA's success in this effort can be seen in our share of young adult smokers, which has increased 12.7 share points over the past five years to 64.5 percent. This growth is due primarily to Marlboro, which has enjoyed a-preferred status among young adult smokers for over two decades. A-10

Marlboro's dominant position among young adult smokers, coupled with Newport -- Marlboro's counterpart in the nenthol segment -- limits the growth potential of coIlpetltlve brands, including PM-USA's other products. Marlboro accounts for 52 percent of the 18-24 age category (71 percent among non-menthol smokers). Marlboro and Newport combined represent 63 percent of the total category. This strength, in conjunction with census trends showing fewer people reaching smoking age, indicates that other brands will suffer long-term erosion unless they can attract a significant number of existing smokers from conpetitive brands. COMPANY SHARES BY AGE CATEGORY PM-USA RJR B&W LORILLARD AMERICAN LIGGETT ® PERCENT 100 80 40+ 20+ m UNDER 25 25-34 ® ® 35-44 45-54 ® 55+ PRICE/VALUE DEVETAP= The increased emphasis on price/value products is indicative of the growing importance of attracting older competitive smokers. In 1987, the category grew 1.3 share points to 10.2 percent. The branded generic subsegment continued to be the category's most vibrant, accounting for 42.4 percent of total secment sales, up from 30.2 percent in 1986. RTR has the largest price/value presence (38.0 percent category share) followed by Brown & Williamson, Liggett and PM-USA (22.5, 21.7 and 15.5 categor,7 shares, respectively). As comFetitive reliance on price/value products expands, the category is being increasingly viewed as a generator of both volume and profit growth. Price/value sales, as a percent of total unit sales, grew in 1987 for virtually every category participant. At the sanp t;me, competitors adopted a more aggressive pricing strategy. In 1987, the cLmlulative manufacturer price increases for branded generic products were $1.00 per thousand higher than full margin brands. A-11

The growing 'snportance of the price/value category to most manufacturers' volume and share perfornance, coupled with the consumr trend away from "black and white" generics, could lead to a variety of cor,ipetitive actions including: • A continuation of the product proliferation seen in 1987, especially in the branded generic category, where 29 packings are now either in national distribution or test market. Fature entries could include the repositioning of marginally performing full priced brands or converting value 25's to generic 20's. • Increased emphasis on retail presence through point-of-sale competition and, for RJR in particular, leveraging their retail strength and Doral's status as the leading branded generic to achieve a competitive advantage. • The introduction of a new tier of products priced at subgeneric levels. This tier could consist of either branded products or Mre heavily discounted "black and white" generics. The emergence of a third tier will be rrore likely if Brown & Willianson and Liggett are unable to introduce successful products into the current branded generic subsegment or if the profitability of "black and white" generics increases. The future size of the price/value category wi ll be dependent on the price differential with full margin products, the degree of conpetition within the category and the type of new products introduced into the segment. Price/value growth is forecasted to be considerably greater than in last year's Plan, largely driven by the expected evolution of a third price tier (subgeneric) . Should this tier not en-erge and no major full raargin brands are repositioned, the category's growth would be only slightly greater than last year's forecast. This incremental growth is due principally to the higher forecast for industry pricing and PM-USA's aggressive goal for category penetration. FORcCASTED PRICE/VALUE GROWTH 1987-i99i 1988-1992 FIVE YEAR PLAN FIVE YEAR PLAN * 2 SHARE OF INDUSTRY 20+ 15+ 10+ 5-F * INCLUDES THIRD PRICE TIER Oa~- r- 1980 1982 10.2 e 1984 1986 1988 A-12 SHARE OF INDUSTRY 25 *21.9 ® -F5 1990 1992

MAR=ING SPED?DING Competitors continued to deemphasize traditional media during 1987, while focusing additional resources at the point-of-sale and on targeted marketing programs, including couponing. This trend, which began in the early 1980's, indicates that cornpetitors view advertising as a less effective way to influence brand choice decisions. This is due in large part to the relatively weak images of competitive brands and the difficulty in comanun:i.cating brand images through media clutter. As seen below, competitive media spending has declined since 1985 and spending on some brands has been reduced to minimal levels given their size (Kool - $12 million, Winston - $38, Kent - $8). COMPETITIVE ADV=ISING SPENDING ($ Millions) 1985 1987(E) % Change (1985 vs 1987) PM-USA $300.2 $299.0 (0.4%) PJR 318.7 205.0 (35.7%) B&W 81.8 48.1 (41.2%) Lorillard 78.1 59.1 (24.3%) American 39.5 41.7 5.6% Liggett 15.9 4.0 (74.8%) Total $834.2 $656.9 (21.3%) Source: Leo Burnett and Business Planning estimates. In 1986, media spending accounted for just 28 percent of total marketing expenditures compared to an estimated 55 percent at the start of the decade. During the same period, non-media expenditures (including merchandising payments, point-of-sale materials, sales force expenses, promotional events and product incentives) have more than doubled to about $1.7 billion while price incentives (couponing and generic trade allowances) have grown to over $500 million from virtually zero in 1980. This trend away from image-based advertising could be weakening ccxnpetitive brands to the point that they are unable to maintain a unique position in the minds of smokers and also provides PM-USA with an opportunity to reinforce our already strong brand imagery. PERCNT OF VOLUK PURCHASED WITH A COUPON PERCENT 1985 PsR VI-f= szaa3 ariY l986 ® 1987 A-13

Cornpetitors are using couponing as one neans to retain volume in the face of image erosion. As seen on the previous page, most manufacturers increased coupon levels in 1987, with nearly 20 percent of total cigarette volume sold in food stores purchased with a coupon versus 16.7 percent in 1986. RJR continued to outpace the industry with 33.8 percent of total food store volume purchased with a coupon. Coupon usage in other trade classes, particularly convenience stores, is less than in food stores because of higher pack sales and lower retailer acceptance of coupons. In the future, the expected growth in the per unit profitability of cigarettes provides an opportunity to further increase coupon levels. The following graphs illustrate the impact of RTR's couponing on their full margin brands since 1985. Based on A. C. Nielsen data, R7R's initial acceleration of couponing levels stabilized full margin share declines through first quarter 1986. R~,'R subsequently reduced full margin couponing levels and their full margin brands weakened noticeably. During this tir.e, over 40 percent of RJR's price/value volume was purchased with a coupon and other manufacturers increased full margin couponing. During 1987, RTR has increased full margin couponing and reduced couponing on Doral. This strategy has again slowed RJR's full margin share erosion, indicating that they may have sensitized their full margin smokers to look for price deals and thereby reduced brand loyalty. CHANGE IN RJR FULL MARGIN NIELSEN SHARE VS. A YEAR AGO TIfEE MONTH MOVINB AVERABE ~ , + ---t--i--Et4 ~ p 4J--i--*--St~ M 1985 H J S 1986 ~ i ~ }--* - -i --+--* 0 M PERCENT --F---~--+ b J S 1987 1.0 -1.5 A-14

Other trends impacting overall marketing spending include: • Product proliferation - Since 1981, industry packings have grown more than 30 percent to over 280, making it more difficult to communicate unique brand images and gain retail distribution. • Changing consumer buying patterns -- Aggressive industry pricing and changing consumer lifestyles have resulted in a trend toward more pack purchases. In 1986, pack sales accounted for 49 percent of industry volume compared to 34 percent in 1982. This trend benefits PM-USA, which has the highest percentage of pack sales in the industry. • Increased use of targeted and regional marketing strategies -- In an effort to maximize the efficiency of inedia spending and defend brands from competitive attacks, manufacturers have increased their use of targeted marketing strategies. FUTURE COMPETITIVE DIRECTION Although competitors appear to be deemphasizing advertising, they are expected to continue their attempts to create conpelling images and traditional new products to attract young adult snokers and erode Marlboro`s dominant position. At the sane time, it is anticipated that competitors will leverage their relatively stronger position among older srrokers through a coinbination of price competition, point-of-sale promotion and innovative new products. Future trends will likely include: • Aggressive promotion of price/value products through couponing and new introductions coupled with higher levels of full margin couponing. Manufacturer price increases will fuel this price competition. • Increased reliance on retail presence to generate brand awareness and deliver price promotions. • A growing emphasis on technologically-advanced new products which have the potential to dramatically change the industry's status quo and may offer a long-term competitive advantage. These trends, coupled with anticipated market share declines for our competitors, will* increase the likelihood that radical survival strategies may energe. Given our size and profitability, it must be assumed that competitive initiatives, either directly or indirectly, will be targeted at PM-USA. This will put a premium on our ability to retain existing smokers while expanding our position among young adult smokers. In order to achieve future vo1ume, share and profit corranitments, PM-USA must be prepared to respond quickly to increased price competition and revolutionary new products. Finally, PM-USA must also be attuned to the possible advent of growing foreign competition. Reduction in trade barriers such as the U.S./Canada Free Trade Agreement as well as the current weakness in the dollar make foreign intervention in the U.S. cigarette industry more likely than in recent years. .By building on PM-USA's current monentum through increased brand investment and an expansion of our retail presence, we are making marketing a barrier to entry and positioning PM-USA to defend against foreign attempts to intercede in the U.S. market. A-15

MA=ING STPATEGY During the next five years, PM-USA intends to significantly outperform the industrv and achieve record levels of market share and unit volume. Our market share is projected to increase 9.4 share points to 47.2 percent by 1992 with dcx-Ly---stic volume growth totaling 17.9 billion units. These corrnitrnents are considerably higher than in last year's Plan. Achieving these volume and share targets will depend largely on PM-USA's ability to maintain our dominant share among young adult smokers, while retainina older smokers and broadening our demographic profile. We must do this in the context of an industry environiTent which is characterized by a declining number of new smokers and a campetitive envirorunent which is attaching greater importance to various forms of price competition at the expense of image advertising. PM-USA has been successful in competing in this changing environment with market share increases and volume growth totaling 5.0 share points and 11.2 billion units since 1982. As shown below, strong advertising, progress at retail, line extensions and new products targeted to specific groups have enabled PM-USA to retain smokers as they age while increasing our democrraphic penetration by attracting competitive snokers. We have also increased our share of young adult smokers by over 70 percent during the past ten years. To accelerate PM-USA's growth, we must address several priorities during the plan period: 1) maximize r':ar.lboro' s strength, 2) conti nue to support other established brands, 3) strengthen our price/value position, 4) pursue technological innovation, and 5) improve our retail presence. The remainder of the Marketing Strategy section will sturmarize PM-USA's strategies for each of these priorities. A-16

I I I I I I I I I I I I I I I I I MARLBORO Marlboro continued its record of impressive growth in 1987 as volisne advanced 0.4 billion units to 134.6 billion and market share grew 0.5 points to 23.6 percent. During the plan period, Marlboro's share growth is projected to total 4.1 share points and reach 27.7 percent in 1992. This would make Marlboro the largest brand in terms of market share since Lucky Strike in 1948. While this is an aggressive objective for Marlboro, it is achievable if the brand continues its current momentum. Since 1985, Marlboro has increased its share across virtually all age categories, including a 5.0 share point gain among young adult smokers. It has also improved its market share to at least 20 percent in every region of the country and strengthened its number one ranking among males, females, whites and Hispanics while maintaining its 5.9 percent share among blacks. In the future, three principal risks facing Marlboro are the projected decline in the number of young smokers, accelerated industry pricing which could disproportionately affect brands with young demographic profiles, and the gap between Marlboro's market share and retail inventory levels. To achieve Marlboro's objectives during the plan period, PM-USA will employ a combination of high profile advertising and promotions, base-broadening line extensions and aggressive retail programs, while experimenting with ways to defend Marlboro against ccxnpetitive price initiatives. •Imaqe -- Marlboro will leverage the competitive trend away from advertising by continuing active media and outdoor support around the "Marlboro Country" theme to reinforce its premium image. Emphasis will be placed on Marlboro Red without sacrificing support for the Lights packings. Additional resources will be - placed on event promotions such as Marlboro County Music, Auto - ---- Racing and Soccer. A-17

• Retail Programs - A concentrated effort will be made to improve the brand's retail visibility and inventory depth by increasing shelf space and employing supplemental racks. High quality consumer incentives will be used to reward current smokers and differentiate the brand's premiun image. Programs will be implemented to capitalize on Marlboro's stmmier seasonality and, where possible, linked with Marlboro event promotions. • Line Extensions -- Menthol line extensions were introduced in February 1988 to broaden Marlboro's appeal. LongLr term, PM-USA will consider an ultra lights extension to provide a Marlboro alternative for smokers who switch down the tar spectrnuri and high technology products to defend Marlboro if new categories emerge. • Price Defense -- PM-USA will experiment with ways to defend Marlboro against price competition and increase its affordability, particularly for young adult smokers. Possible options include new packaging configurations such as 10's or 14's packs, continuity programs and targeted promotions. . 0'I'HER ESTABLISHID BRANDS Another marketing priority is to continue supporting our other established brands such as Benson & Hedges, Merit and Virginia Slims. These products are an iinportant part of PM-USA's brand family and had a combined market share of 11.2 percent in 1987, larger than any competitor except RJR. This portfolio of brands broadens PM-USA's appeal beyond Marlboro's traditional younger adult, male-oriented demographic base. B&H is PM-USA's leading nenthol brand and the industry's largest free-standing 100 nm brand. Merit Ultra Lights is the fastest growing ultra lights and Merit remains the leading free-standing low tar brand. Virginia Slims remains the leading brand in the female cigarette segment and was one of only three of the top twenty -full margin brands to gain market share in 1987. To meet PM-USA's volume and share objectives for Benson & Hedges, Merit and Virginia Slims, we will utilize a variety of strategies which include: • Focusing efforts to strengthen the performance of parent packings. • Pursuing image-oriented advertising which stresses quality and product uniqueness to reduce price/value cann.ibalization. • Placing additional emphasis on consumer incentives and event promotions to reinforce brand images. • Adopting regional marketing strategies for areas offering growth potential. • Introducing line extensions, where appropriate, to broaden the demographic appeal of each brand. Specific strategies for each brand are sturnmarized in the following chart.

SLMMRY OF BRAND OPPOR'iiBJITIES AND STRATEGIES Benson & Hedges • Cpportunity - Minimize share decline by improving perfosmance of parent and lights. - Reverse erosion among young adult smokers. - Maximize ultra lights performance. Merit Virginia Slims Revitalize parent. - Stabilize performance of Maximize potential of Merit parent and lights. Ultra Lights. - Expand derographic appeal - to younger adults and older smokers. • Strategies Image - Reinforce quality - Launch new ad campaign - Expand the brand's proven perception through establishing Merit as the advertising theme. current advertising and „smast alternative". erphasize added-value in packaging and prosmtions. Consurrer - B&H Conmand Performance Programs - Quality Choices Catalog - Direct marketing targeted at high potential areas. Blind Taste Challenge - Virginia Slims Tennis Direct marketing against - Book of Days canpetitive low tar smkers. - Direct mail which capitalizes on brand's feanale profile. Line Extension - Select Thins fran B&H - Ultra Lights Box - Elan from Virginia S1ims Options - Kings - Technology products (ultra slim) - 120's - 85mn Slims - Premiun flanker - Luxury Slims - Technology products - Flanker options PRICE/VALUE PM-USA increased its penetration of the price/value segment in 1987 by capturing 41 percent of the segment's 1.3 sharepoint growth. Our category share increased 3.8 percentage points to 15.5 percent in 1987, fueled by Cambridge and, to a lesser extent, Famous Value Brands. In order to achieve our volume and share targets, we must accelerate this category penetration. Accordingly, we have targeted a 35 percent segment share by the end of the P lan period. TOTAL PRICE/VALUE MARCET SHARE OF PAI[E/VALIJE SE94ENT THREE MONTH MOVING AVERAGE BAANDED BLACt< & WHITE GENERICS GENEAICS VALUE 25'S 1 PEACENT OF MAAKET PERCENT OF MAAKETI2 SO 2+ _~ _.r--•- 0 c- JFMAMJJASONDJFMAMJJASONDJFMAMJJASONDJFMAMJJASOND 1984 1985 1986 1987 A-19

We can accomplish this objective by implementing the following strategies: • Maintaining competitive pricing offers to consuners and taking advantage of opportunities to be pre-enptive. In addition, we will quickly respond to a new tier of subgeneric products, should this category energe. • Improving distribution and retail presence through the placement of additional price/value fixtures. • Maintaining superior product quality. • Introducing new products. Cambridge Fueled in part by the introduction of CaTnbridge Full Flavor, Carnbridge achieved a market share of 1.1 percent and volume of 6.4 billion units in 1987. Cambridge's share of the branded generic subsegmeent grew from 21 percent in 1986 to 25 percent in 1987. During the plan period, the brand's market share is forecasted to reach 3.4 percent with vo1ume of 16.9 billion units. Strategies to achieve these targets include: • Couponing -- In 1987, couponing for Cambridge outpaced Doral as 44 percent of Cambridge's volume in food stores was couponed versus 36 percent for Doral. Our strategy is to expand this level of couponing while periodically increasing coupon values to attract competitive smokers. • Distribution -- Cambridge's current distribution lags Doral (79 versus 87 percent). During the plan period, we will seek to improve distribution for all Cambridge packings. An important element of this strategy will be to convince retailers that they should carry more than one branded generic option. • Retail Presence - By leveraging its strength in the retail envirornrent, RTR has placed approximately 20,000 (72 percent) more supplemental price/value fixtures than PN USA. This offers RJR a major advantage in terms of in-store presence and visibility for Doral. PN'~-USA will work to substantially narrow this fixture differential over the next five years. Famous Value Brands AIarketing efforts for PM-USA's black and white generics during the plan period will be focused in four areas: increasing distribution, primarily to direct chain accounts which offer high volurne potential; maintaining competitive rebates with other manufacturers in the subsegrrent (B&W, Liggett and RJR); maintaining the high quality of Famous Value Brands; and finally, testing our ability to use the PM-USA sales force to support FVB like other PM-USA brands. The latter strategy could provide PM-USA with a competitive advantage in servicing accounts which are currently supplied by either Liggett or Brown & Williamson. In addition, we will seek to leverage the inroads made by FVB to increase the distribution of PM-USA's branded generic products. A-20

I I I I I I I I I I I I I I I I I I I Players Lights 25's Players Lights 25's 1987 performance mirrored the lack of consumer interest in the value 25's subsegment. During 1988, a regional marketing strategy ained at strengthening the brand in areas where value 25's are strongest will be implemented. Marketing efforts will concentrate on couponing and ccoimznicating product attributes which are meaningful to value 25's smokers. During the plan period, PM-USA may also test various line extension and repositioning options for Players Lights. Under consideration are a full flavor line extension and conversion of the brand to a generic 20's proposition. Price/Value New Products The final ingredient in PM-USA's price/value growth strategy is the introduction of new products. In 1988, we are planning to launch Alpine as the first free-standing price/value menthol. This entry will enable PM-USA to exploit the underrepresentation of nenthols in the price/value segment, particularly in the 85's and full flavor categories. The repositioning of Alpine provides an opportunity for PM--USA to attract competitive menthol snokers, especially Salem smokers. In addition to Alpine, we are planning to launch other free-standing price/value products to establish a pre-emptive position in potential develogmnt areas of the price/value category. FULL MARGIN NEW PRODUCTS PM-USA's fourth marketing priority is to develop both traditional and technologically-advanced new full margin products. A successful implenentation of this strategy offers PM-USA with an opportunity to help achieve our volume and share targets with products which broaden our demographic profile, increase our participation in segments where PM-USA is underrepresented and respond to changing consumer desires. In late 1987, RTR announced that they are developing a "clean" cigarette which will be ready for test market during 1988. This development indicates that RJR is willing to implement a radical strategy in hopes of changing the industry's status quo and regaining market share frccn PM-USA and other competitors. If this product neets mioker demands for taste and smoking experience while addressing non-smoker concerns, it could pose a significant threat to PM-USA's brands, especially Merit and Benson & Hedges. While PM-USA is developing a product similar to R7R's, we are also pursuing a number of additional concepts which fall into two broad classifications -- high technology and traditional new products. • Our high technology efforts are designed to provide smokers with real or perceived product benefits, to address consunmer concern over health and social issues and to respond to possible product requirements mandated by government legislation. R&D, in conjunction with Marketing and Manufacturing is developing a number of product concepts for these areas. • In addition to line extensions, our traditional product developnment efforts will focus on providing PM-USA with new menthol entries and luxury/upscale products, such as Dunhill and possibly Cartier, targeted toward affluent, upwardly mobile and young adult smokers. A-21

RETAIL STRATEGY A key element of PM-USA's marketing strategy is to develop a retail presence comsnensurate with our market share. This is of vital importance if we are to achieve our five year volLme and share objectives. By expanding our retail presence, we can increase the visibility and availability of existing brands while also providing the necessary retail space to support new products. In addition, a strong retail presence will be critical to our success if an advertising ban occurs. In recent years, PM-USA's sales organization has initiated a number of programs to improve our retail positioning. Future programs will build upon this progress. As seen below, PM USA made considerable retail gains in 1987. Carton rows increased ten percent to over 3.2 million, fueled in part by the doubling of PM-USA carton fixtures at retail during the year. Our aggressive fixture policy forced RJR to defend their presence through fixture upgrading and we captured additional rows in the process. Our carton merchandising efforts were supplemented by a significant increase in the nunber of free-standing rack placements. We also succeeded in i«<Nroving Pr.1-USA' s pack outlet presence by upgrading existing pack displays and installing additional overhead merchandisers. These gains in carton and pack outlets contributed to increases in Nielsen market share and share of retail inventory of 1.4 and 1.2 percent, respectively, in 1987. PM-USA 1987 RETAIL ACCOMPLISHMIIQTS 1986 1987 % Change Carton Merchandising Carton Rows (000's) 2,960 3,250 9.8% Carton Fixtures 5,000 11,200 124.0% Free-Standing Fixtures 15,000 29,200 94.7% Pack Merchandising - Counter Pack Displays 88,000 90,800 3.2% - Price/Value Pack Displays 35,000 56,700 62.0% - Front-End Merchandisers (stores) - 2,200 N.M. - Overhead Merchandisers 28,000 36,500 30.4% Retail Universe During the 1980's, two trade classes -- supermarkets and convenience stores -- have become increasingly important. Together, these trade classes account for 56 percent of industry volume versus 42 percent in 1980. Supermarkets are typically high volume, self-service carton outlets with patrons tending to be older and female. Conversely, convenience outlets are often low volume, non-self-service pack stores frequented by young males. RJR enjoys a dominant retail presence in supermarkets due in part to their conmazding lead in carton fixtures which was achieved when they were the market leader during the 1960's and 1970's. Convenience store growth has been more recent and PM-USA has a relatively stronger retail position in this pack-oriented trade class. A-22 I I I I I I I I ~ I I I I I I I

SHARE OF IPDIlSTRY YOLIN£ BY TRADE CLASS 1980 1987 AC ENT ACENT ~ 60 ® ® 30 CONVENIENCE CQNV./BAS, GAS SIPERIARI<ETS OTHER Trade Class Characteristics Supermarkets Convenience % Self Service 71% 29% % Carton/Pack 70/30% 33/67% % High Volume 82% 14% Demcgraphics Male 44% 60% Female 56% 40% 18-34 year olds 34% 62% 35+ 66% 38% While PM-USA has retail strategies for all trade classes, the remainder of this section will focus on our plans for supermarkets and convenience stores as well as our sales force. Supermarkets An important priority in PM-USA's retail programs is to improve the availability and visibility of our products in supermarkets. RJR's long-standing position as the principal fixture supplier to these outlets has provided their products with an advantage in terms of inventory and in-store presence. RTR currently controls over 65 percent of the carton fixture universe. Over the past two years, PM-USA's fixture programs and accelerated merchandising plans have provided a first step toward "leveling the playing field" and improving PM-USA's positioning in supermarkets. During the plan period, PM-USA will seek to further erode R7R's presence with a variety of merchandising options. • Achieve adequate shelf space for existing and future PM-USA products: Field sales incentive programs and pre-emptive payment plans have greatly narrowed the gap between actual PM-USA carton rows and the rows needed to effectively merchandise our brands. An ongoing priority for the sales force will be to keep future row gains in line with PM-USA's share growth and new product introductions. By the end of the Plan we intend to have 40 percent more rows than today. • Expand the size of cigarette departnents and supplement capacity needs by placing PM-USA carton fixtures and free-standing carton racks: Our objective is to continue our steady growth in share of retail fixtures while forcing RTR to defend their larger, and to themselves, more strategically critical fixture position. PM-USA will also reduce RJR's fixture advantage by placing free-standing carton racks which will be principally devoted to Marlboro or our price/value products. Our goal is to more than double the number of PM-USA carton fixtures and triple our free-standing racks over the next five years. A-23

• Utilize front-end pack merchandisers and in-store P.O.S. to further diffuse RJR's retail advantage in high volume accounts: These merchandisers will enable PM-USA to capitalize on the growth of pack sales in carton outlets, help spur impulse buying, provide a "home" for new introductions and offer a highly visible P.O.S. option. Other in-store P.O.S. vehicles such as clocks, deparfarent markers and electronic message centers will also be used. We intend to place front-end merchandisers in 18,000 stores and achieve a broad coverage of in-store P.O.S. during the plan period. • Implement a payment plan for a limited number of non-self-service supermarkets: This program is targeted towards high volume outlets where conversion to self-service cannot be achieved and is designed to improve the merchandising of PM-USA's brands by gaining placerrent of PM-USA signage, adequate in-store inventories and preferential placement on the top shelves of a retailer' s fixture -- where products are often visible to consumers. The program was successfully tested in 1987 and will be expanded nationally in 1988. PN-•USA CARTON R&S VS. R0W GAP REGUIRED ROWS ACTUAL ROWS 6/85 12/65 6/86 12/66 6/87 12/87 6/88 12/88 Convenience Outlets PM-USA has an opportunity to build upon its market leader position in the convenience trade class. Based on Nielsen data, PNrUSA's market share in small chains (a proxy for convenience stores) is nearly 60 percent higher than RJR's and Marlboro's 30.4 percent share is over three times that of Winston. Our future strategies leverage this superior position through programs which foster an ongoing working relationship with major convenience chains while improving inventory depth and product visibility and increasing PM-USA's P.O.S. presence. o PM-USA's pack merchandising capabilities will be improved through the introduction of a new pack display and the continued upgrading of existing displays. These new generation Maxi displays provide greater inventory depth and additional P.O.S. options. Our newest display, the M-5, allows for an enhanced merchandising of brand families and has been designed to attain a better location on increasingly cluttered convenience store check-out counters. A-24

• We will also utilize other merchandising vehicles such as overhead pack merchandisers, customized promotions and permanent P.O.S. Overhead msrchandisers not only increase PM-USA's pack inventory, but also serve as an excellent P.O.S. option. We intend to increase our placement of overhead merchandisers by over 80 percent during the plarn period. Customiz ed prorrotions and P. 0. S. wi ll be employed to maximize Marlboro's in-store presence. Examples of these efforts include chain-specific coffee and ciaarette tie-ins, Marlboro clocks for Circle K stores and permanentJ P. 0. S. such as Marlboro ash trays and shopping baskets. • Carton merchandising in convenience stores will be improved through the placement of specialized fixtures tailored to the small size of individual outlets. These fixtures will also provide for increased in-store inventories of PM-USA brands, especially Marlboro. • Finally, we will aggressively promote PM-USA's price/value brands in convenience stores by increasing place.rrients of price/value counter displays and smaller versions of the free-standing carton fixtures being used in supermarkets. In both supermarkets and convenience stores, an important element of our retail efforts will be to educate, train and assist store personnel on the proper merchandising of the cigarette departsnent. The sales organization will use a variety of tools to ccnnunicate cigarette profitability and ways to maximize those profits. This is a crucial facet of PM-USA's overall retail strategy since our gains in other areas will not be maximized if retailers do not effectively manage their cigarette business. A-25

Sales Organization The sales organization is ultimately responsible for ensuring that the sales portion of PM-USA's marketing plan is successfully implemented. During 1987, we began changing the focus of the sales force's key operating unit, the Section Sales Office, from one of merely implementing sales programs to becoming a discreet business developnent unit responsible for selling, merchandising and targeted consumer efforts. The use of supplemental non-selling personnel such as Retail Merchandisers increased the flexibility of Sales Representatives, allowing them to cc~ncentrate on selling activities. Senior Account Managers were also added to improve our ability, at the section level, to form merchandising partnerships with key retailers through a consultative selling approach. PM-USA's aggressive retail programs and new product strategies for the next five years will require a further enhancement of our sale force to ensure that bottlenecks to growth do not develop. During 1988, we will continue to emphasize localized business development through key account selling at the section level and targeted merchandising and promotional programs. In addition, PM-USA will test a number of redeployment options in 1988 to expand sales force capabilities. These include using additional supplesnental personnel to handle non-selling activities and adjusting sales territory boundaries to enhance sales force flexibility and improve call coverage. These tests represent a significant change in PM-USA's sales organization and will be studied extensively before a national redeployment is implemented. PM-USA's goal is to modify our sales organization in a manner which is both cost efficient and enhances our flexibility to respond to a changing marketing environment. lie believe that a redeployment based on some combination of these tests will lead to a significant improvement in our sales force's ability to carry out PM-USA's Five Year Plan strategy. It is anticipated that a national redeployment will begin during late 1988.

SOCIOPOLITICAL STRATEGY I I I I I I I I I I I I I I I I PM-LTSA's sociopolitical goal is to maximize industry volume by protecting the rights of smokers while also preserving the rights of manufacturers to market cigarettes. PM-USA is taking a major role in defending the cigarette industry since our leadership position in terms of market share and profitability implies that we have the most to lose if the industry is radically altered by the aggressive attacks of anti-srroking forces. The industry currently faces a number of threats, of which one of the most serious is the growing concern -- anong snokers and non-sawkers -- regarding environmental tobacco smoke (ETS). Despite the lack of definitive scientific evidence, ETS is being linked to health problems in non-smokers, including the families of smokers. By blowing the ETS issue out of proportion, anti-smoking advocates are succeeding in increasing the ostracism of smokers and heightening the uneasiness smokers feel when smoking around others. The ongoing risk of federal excise tax increases as well as an acceleration of state and local excise tax hikes also effect industry volume potential. While excise taxes at all levels of goverrunent have an impact on the industry, a federal excise tax increase represents a significant threat to both industry volume and PM-USA's ability to meet our Five Year Plan objectives for volume and profitability. Other risks to the industry include: • A growing trend towards restricting or banning smoking in both public places and in the work place -- at the federal, state and local level. • A continued desire among some legislators to impose marketing restrictions on the industry, even to the point of a conplete ban on advertising. • A renewed drive at the federal and state level to enact product requirements such as "fire-safe" cigarettes and the disclosure of cigarette ingredients. Corporate Affairs has established a number of objectives designed to minimize the impact of these threats. We are planning to blunt the ETS issue by stressing accomnodation and compromise between swkers and non-smokers while working longer term to allay consumer fears through additional research. While excise taxes, particularly at the state and local level, will remain a cost of doing business, our objective is to keep these increases, in aggregate, below the level of inflation. Corporate Affairs will seek to limit the number and severity of smoking restrictions and, where necessary, push for compromises which segregate smoking instead of banning smoking entirely. By linking cigarette advertising to the First Amendnent right to free speech, we will strive to prevent any additional restrictions on advertising, sampling and promotions. Finally, we will work to ensure that no compulsory requirements regarding ingredient disclosure or "fire-safe" cigarettes become law. A-27

I PM-USA's strategies to achieve these objectives target three groups whose actions help'determine the long-term viability of the industry -- politicians, smokers and other allies and the mass media. • Politicians - Corporate Affairs will build upon our regional public affairs network and work with the Tobacco Institute to monitor and combat legislation unfavorable to PM-USA. In doing so, we will take a more proactive role by making anti-smoking forces defend past gains, increase the activity of state Political Action Committees, leverage the revitalized tobacco coalition to strengthen our Congressional political base and educate smkers on how their politicians stand on smoking issues. • Srokers And Other Potential Allies -- PM-USA will increasingly utilize our mass mobilization database, which now numbers eight million smokers. We will also recruit other allies such as retailers, wholesalers and vendors to work on our behalf. Once identified, mnokers and other allies will participate in a comprehensive communication program whose capabilities are being enhanced to better target individual and group concerns. PM Magazine and state-oriented Smokers' Newsletters will continue to be major communication vehicles. During 1988, Corporate Affairs will spearhead the developrrent of a nationwide Smokers' Rights Association to monitor smoking issues, voice opinions and concerns and serve as a grass roots promoter for smokers' rights. • Mass Media -- We will use our computer-based monitoring system to track and analyze articles and editorials on snoking. By doing so, we can detect emerging issues and unbalanced reporting in order to respond appropriately. Our responses will continue to include rebuttal pieces, advocacy advertising, letters to editors and special press briefings. In addition, we will undertake newsworthy activities such as the PM Magazine essay competition on conanercial free speech, PM Magazine editorial services and sponsorship of third party economic and public opinion research. An important program to combat the ETS issue, growing smking restrictions and increasing social pressures will be Operation Downunder. This program is predicated on the assumptions that although science has not established a health risk to non-smokers fresn ETS, it remains an annoyance to some people. Therefore, it is proper policy to acconamdate the preferences of smokers and non-sn-okers with governnent intervention only as a last resort. In Operation Downunder we will restate the industry's position on smoking accommd.ation to gain credibility and popular support and will create and push private initiatives for this accomurodation. When government involvement is unavoidable, we will use the legislative process to conpel accomrodation as opposed to outright bans. Finally, we will continue the scientific battle over the effects of ETS through the Center for Indoor Air Research. I I I I 1 I I I I I I I I I t,a 0 I -~. w ~ I ~ .~ A-28 w ~a .0 I

I I I I I I I ~ I I I I I I I I I OPERATIONS STRATEGY Efficient production of the industry's highest quality cigarettes is an essential component of PNr-USA's volume and profit strategies. An industry environn,ent characterized by aggressive pricing, growing price/value sales, and mounting social pressures makes it imperative that PM-USA provide smokers with products which are demonstrably better than the competition. To accomplish this objective, PM-USA has an operations philosophy which recognizes the importance of maintaining our quality leadership, investing in new technology, creating new products, managing assets as efficiently as possible and developing a workforce which has a commitment to excellence. During the plan period, domestic and export sales forecasts are projected to increase 12.0 percent to 318.3 billion units in 1992. As seen below, these forecasts are significantly higher than in last year's Plan due primarily to our conanitment to faster donestic volume growth and greater export sales to Japan. A number of events could result in a deviation of donestic and export sales from this forecast and contingency plans have been developed to ensure such situations are manageable. SALES FORECAST COMPARISONS (Billions of Units) DOMESTIC Current Year's Plan Last Year's Plan Difference EXPORT Current Year's Plan* Last Year' s Plan Difference TOTAL SALES Current Year's Plan Last Year's Plan Difference 1988 1989 1990 1991 1992 218.9 222.5 226.2 230.1 233.5 217.4 218.7 219.8 220.9 1.5 3.8 6.4 9.2 69.9 73.7 77.8 81.0 84.8 55.8 48.1 48.8 49.9 14.1 25.6 29.0 31.1 288.8 296.2 304.0 311.1 318.3 273.2 266.8 268.6 270.8 15.6 29.4 35.4 40.3 Includes overseas military sales. The increase in PM-USA's projection for both donestic and export sales highlights two of the major issues which Operations will face during the plan period -- production capacity and overall manufacturing flexibility. From 1982 through 1986, PM-USA's export volume averaged 43.2 billion units annually. The combination of a weaker dollar and the opening up of Asian markets resulted in explosive export growth in 1987 and, over the next five years, average export production is expected to be almost 80 percent higher than in the 1982 to 1986 period. At the same time, the complexity of our brand mix has increased. In 1987, the number of packings manufactured by PM-USA (dcxnestic and export) totaled 222, up 51 percent versus 1982. A-29

I Fulfilling PM-USA's production require.ments, while supporting our strategies for both volume and profit growth, will largely be a function of Operations' ability to achieve higher levels of production within existing facilities and enhancing the flexibility of our processing and cigarette manufacturing equipment to acconmodate a growing rnanber of packings and leaf blends. To accomplish these objectives, Operations will build upon our quality leadership, develop new products and manufacturing processes to respond to changing constuner desires and competitive initiatives, maximize the benefits of new technology through the use of faster machinery and employ training programs which keep pace with this technology. Finally, we must ensure that adequate stocks of quality leaf tobacco exist to meet our production needs. Quality A major component of PM-USA's volLUne strategy is to manufacture cigarettes that deliver consistent consuner satisfaction with quality superior to our competition. Product quality is vital to protect the strong brand imagery of our full margin products as competitive marketing strategies shift toward couponing and the price/value segment grows. Quality enhancenent programs are integrated throughout Operations from procurement of tobacco, machinery and materials to manufacturing and distribution. PM-USA continues to achieve improvements in product quality. The quality of our brands versus competitive products is measured quarterly through internal competitive audits. Information frctn snokers is also an important gauge in measuring our performance. As seen in the graphs on the next page, PM-USA achieved positive results in both our audits and.consumer feedback in 1987. • PM-USA's critical domestic cigarette defects decreased over 20 percent versus 1986. We continued to outperform the industry despite quality improvements by competitors. • Domestic consumer complaints decreased 4.2 percent in 1987 to 45.2 complaints per billion sales, the lowest level since we began tracking these complaints. Contributing to this performance was the progress made since 1984 toward reducing, by 50 percent, consumer complaints in four major areas. • Case shortages are the primary complaint of distributors. Shortages have been reduced 40 percent since 1985 and a conmi.tment is being made in this year's Plan to reduce shortages another 50 percent to four shortages per billion sales by 1992. Research and Development The innovative research and development of products and processes are essential elements in supporting PM-USA's current business and positioning the company to maintain industry leadership. Short-term, PM-USA's strategy is to develop products which broaden our demographic profile and capitalize on existing market opportunities. Advanced process technologies are also being developed to enhance productivity, material utilization and manufacturing flexibility. In addition, R&D is developing products and processes to enable PM-USA to assist PM-International in providing competitive products for world markets. Long-term, R&D will work to provide a broad foundation of basic research that will generate new product concepts beyond the plan period. A-30 I I I I ~ I ~ I t I I I I I i I I

CONSUMER COMPLAINTS PROGRESS VS. i984 COMMITMENTS 20 X CHANGE IN CONSUMER COMPLAINTS 10} TORN ROD/ FILTER FOREIGN MATTER I BROKEN CIGT. FALLS OFF IN FILLER TASTE/ODOR/STALE -36.7 .~ .r.= -x ..-. A-31

PM-USA's work in new technology products is of critical importance given RJR' s recent announcement concerning the introduction of a "clean" cigarette. R&D is developing concepts which address perceived health issues and environmental tobacco smoke. To be successful, these products must deliver consumer benefits without sacrificing other product qualities. Historically, filter cigarettes and reduced tar products provided substantial growth opportunities. R&D is currently developing a nunber of products which have the potential to generate similar opportunities for the future. Manufacturing I Improving operational flexibility is an important component of PM-USA's strategy to efficiently manufacture our products and maximize the use of existing assets. PM-USA allocates the production of our brands to the most appropriate plants, utilizing each facility's unique characteristics. As such, the Manufacturing Center and Cabarrus produce large volume brands with long production runs. Louisville, and to a greater extent, Stockton Street, handle smaller volume brands to take advantage of their greater flexibility. Factory support systems are being modified to enhance blending flexibility, material handling, cut filler and filter delivery and machinery changeovers. At the sane tizre, each of our products is being reviewed in order to standardize components which do not impact each brand's unique attributes. To improve the capacity of our existing plants, PM-USA began embarking in 1986 on a factor_y modernization program. In the Manufacturing Center, every maker and packer will be replaced or upgraded with machine speeds accelerating from 5,000 to 6,000 cigarettes per minute to speeds ranging from 8,000 cFan to 9,000 or greater. Twelve production nodules will be added to Cabarrus (six at 9,000 cpn) and existing equipment will be upgraded from 6,000 to 8,000 cpm. This modernization program, in conjunction with inzprovements to Louisville and Stockton Street, will allow PM-USA to fulfill the production requirements in the Five Year Plan without additional bricks and mrtar. Attaining the full benefit of PM-USA's modernization program requires upgrading work force skills to keep pace with new technology. Our training programs focus on supervisors, operators, fixers and craft enployees. We will use more stringent competency-based selection for training on new equ_ipment and we will continually assess the skills of our work force for retraining where necessary. Significant consolidation of existing job classifications has been achieved via negotiations with our unions. Our future plans call for further consolidation in non-operator classifications. Leaf Since the early 1980's PM-USA has supplen-ented our leaf inventories during poor crop years with stocks from the U.S. Goverrucent pool and purchases of offshore tobacco. These sources are becoming limited due to PM-USA's voluntary reduction in offshore leaf purchases and the reform of the Federal Tobacco Program which reduced governrneant pool stocks and brought crop production in line wi'-,h demand. Due to our growing domestic and export sales, PM-USA will need to purchase approximately 40 percent of the U.S. flue-cured and 50 percent of the U.S. burley crops by the end of the plan period. To assure that adequate quantities_of quality tobaccos remain available, the Leaf Department will pursue the following strategies: A-32

I I I I I I I I I I I I I I I I I I • Increase flue-cured and burley tobacco durations by two months. This will return PM-USA's durations to pre-1980 levels. • Analyze the physical and subjective characteristics of each lot of purchased tobacco and work with R&D and Manufacturing to optimize the usage of various blend components. • Encourage the developn-ent of advanced farming technologies and maintain a strong relationship with the U.S. agricultural commluzity and major tobacco dealers. Productivity Con¢nitment To support PM-USA's profit objectives, Operations has accelerated its productivity comni_tments in comparison to last year's Plan. The benefits from PM-USA's modernization program and other productivity plans are expected to provide a savings in constant dollar manufacturing costs of $0.34 per thousand and increase cigarettes per labor hour (CPLH) by 1,200 versus last year's Plan. These savings are expected to result in a c-u-mulative constant dollar productivity savings of $350 million. The following chart stmarizes PM-USA's productivity comnitnents for the 1988-1992 Plan. COMPARISON OF PM-USA PRODUCTIVITY COMNIITMENTS Performance in Last 1988-1992 1987-1991 Year of the Plan Plan Plan • Constant Dollar Productivity Savings $350 million $250 million • Total Reduction in Constant Dollar Manufacturing Costs 34G per 1,000 30G per 1,000 • People Savings from Capital Expenditures 1,016 positions .864 positions • Composite CPLH 19,400 (1992) 18,200 (1991) • Efficiency 75.8% 75% I A-33

FINANCIAL STATEMENTS :=0g3r74325

I I I INCOME FROM OPERATIONS FORECAST (Dollar Amounts in Millions) I Actual y 1987 1988 1989 1990 1991 1992 I Operating Revenues Variable Cost $7,640.6 $8,510.8 $9,460.7 $3,187.2 $3,291.2 $3,417.2 $10,429.9 $ 3,532.4 $11,335.3 $ 3,637.7 $12,328.2 $ 3,751.7 Shipping 63.5 69.9 74.7 79.7 85.0 90.6 LIFO Adjustment 15.3 14.4 29.2- 35.3 39.1 41.1 Fixed Cost 403.4 435.7 452.6,,- 475.8 511.3 540.9 ~ I Available Profit j $3,971.2 $4,699.6 $5,487.0~ $ 6,306.7 $7,062.2 $7,903.9 % of Sales 52.0% 55.2% 58.0% 60.5% 62.3% 64.1% Marketing $1,075.4 $1,314.9 ~$1,715.2 $2,054.3 $2,262.8 $2,470.4 I General & Administrative 137.1 198.0 ~Z1~5 229.6 248.5 269.2 Research & Development 51.3 56.8 65.0 72.0 77.4 84.5 Other Deductions/(Income) (6.4) 49.0 (10.5) (10.8) (10.1) (11.2) I Income From Operations $2,713.8 $3,080.9 $3,505.8 $3,961.6 $4,483.6 $5,091.0 % of Sales 35.5% 36.2% 37.1% 38.0% 39.6% 41.3% I Change Over Prior Year 13.5% 13.5% 13.8% 13.0% 13.2% 13.5% I AFTER-TAX INCOME FORECAST I (Dollar Amounts in Millions) Actual 1987 1988 1989 1990 1991 1992 I Income from Operations $2,713.8 $3,080.9 $3,505.8 $3,961.6 $4,483.6 $5,091.0 I Corporate Assessments Interest Exp./(Inc.) - Net 135.1 4.4 (24.7) (36.0) (34.1) (40.1) Corp. Assessment - G&A 85.1 67.2 71.8 76.6 81.6 87.2 Corp. Assessment - Interest 6.6 0.7 - - - - I Earnings Before Income Tax $2,487.0 $3,008.6 $3,458.7 $3,921.0 $4,436.1 $5,043.9 Income Tax 1,084.1 1,142.0 1,312.9 1,488.4 1,684.0 1,914.6 I After-Tax Income $1,402.9 $1,866.6 $2,145.8 $2,432.6 $2,752.1 $3,129.3 P Y 21 9% 15 0% 7 2 13 4% 13 1% 7% 13 I Change Over ear rior . . . 2 % . . . I I B-1

I INCOME STATEMENT FORECAST (Dollars Per Thousand) I Actual 1987 1988 1989 1990 1991 1992 I 35 45 40 $ 42 03 $ 38 $ 45 61 77 $ 48 $ 52 29 Operating Revenues Variable Cost . $ $ 14.79 . . $ 14.85 $ 15.18 . $ 15.45 . $ 15.65 . $ 15.91 I Shipping 0.30 0.32 0.33 0.35 0.37 0.38 LIFO Adjustment 0.07 0.06 0.1~ 0.15 0.17 0.17 Fixed Cost 1.87 1.96 2.01 2.08 2.19 2.30 I ~. Available Profit $ 18.42 $ 21.21 $ 24.38 $ 27.58 $ 30.39 $ 33.53 % of Sales 52.0% 55.2% 58.0% 60.5% 62.3% 64.1% I Marketing $ 4.99 $ 5.93 $ 7.62 $ 8.98 $ 9.74 $ 10.48 General & Administrative 0.64 0.89 0.94 1.00 1.07 1.14 Research & Development 0.24 0.26 0.29 0.31 0.33 0.36 I Other Deductions/(Income) (0.04) 0.23 (0.05) (0.03) (0.04) (0.04) Income From Operations $ 12.59 $ 13.90 $ 15.58 $ 17.32 $ 19.29 $ 21.59 % of Sales 35.5% 36.2% 37.1% 38.0% 39.6% 41.3% I AFTER-TAX FORECAST (Dollars Per Thousand) I I Actual 1987 1988 1989 1990 1991 1992 Income from Operations $ 12.59 $ 13.90 $ 15.58 $ 17.32 $ 19.29 S 21.59 Corporate Assessments Interest Exp./(Inc.) - Net Corp. Assessment - G&A Corp. Assessment - Interest Earnings Before Income Tax Income Tax After-Tax Income % of Sales 0.63 0.02 (0.11) (0.16) (0.15) (0.17) 0.39 0.30 0.32 0.33 0.35 0.37 0.03 - - - - - $ 11.54 $ 13.58 $ 15.37 $ 17.15 $ 19.09 $ 21.39 5.03 5.16 5.84 6.51 7.25 8.12 $ 6.51 $ 8.42 $ 9.53 $ 10.64 $ 11.84 $ 13.27 18.4% 21.9% 22.7% 23.3% 24.3% 25.4% I I I I I B-2 -i~ k.3 .,d V 1 4*-

I I I INCOME FROM OPERATIONS FORECAST I 1987 CONSTANT DOLLARS (Dollar Amounts in Millions) Actual 1987 1988 1989 1990 1991 1992 I Operating Revenues $7,640.6 $7,723.0 $7,783.3 $7,852.9 $7,853.5 $7,849.2 Variable Cost $3,187.2 $3,233.7 $3,300.7 $3,349.8 $3,396.0 $3,438.0 I Shi in 5 65.1 66.0 63 67.1 68.1 69.1 pp g LIFO Adjustment . 15.3 15.2 15.3 15.3 15.3 15.3 Fi d C t 4 402 9 4 410 403 402 1 412.4 415.5 I xe os Available Profit . . . $3,971.2 $3,998.6 $3,998.4 . $4,018.6 $3,961.7 $3,911.3 % of Sales 52.0% 51.8% 51.4% 51.2% 50.4% 49.8% Marketing $1,075.4 $1,243.5 $1,534.4 $1,738.6 $1,811.9 $1,871.8 General & Administrative 137.1 188.5 191.1 197.7 204.2 210.8 Research & Development 51.3 52.8 56.6 58.9 60.5 62.6 Other Deductions/(Income) (6.4) 48.7 (9.5) (9.3) (8.5) (8.8) I Income From Operations $2,713.8 $2,465.1 $2,225.8 $2,032.7 $1,893.6 $1,774.9 % of Sales 35.5% 31.9% 28.6% 25.9% 24.1% 22.6% I Change Over Prior Year (9.2%) (9.7%) (8.7%) (6.3%) I , INCOME FROM OPERATIONS FORECAST I 1987 CONSTANT DOLLARS (Dollars Per Thousand) I Actual 1987 1988 1989 1990 1991 1992 Operating Revenues $ 35.45 $ 34.85 $ 34.58 $ 34.34 $ 33.79 $ 33.29 I Variable Cost $ 14.79 $ 14.59 $ 14.67 $ 14.65 $ 14.61 $ 14.58 Shipping 0.30 0.29 0.29 0.29 0.29 0.29 I LIFO Adjustment Fixed Cost 0.07 0.07 0.07 1.87 1.86 1.78 0.07 1.76 0.07 1.77 0.06 1.77 Available Profit $ 18.42 $ 18.04 $ 17.77 $ 17.57 $ 17.05 $ 16.59 % of Sales 52.0% 51.8% 51.4% 51.2% 50.4% 49.8% Marketing $ 4.99 $ 5.61 $ 6.82 $ 7.60 $ 7.80 $ 7.94 General & Administrative 0.64 0.85 0.85 0.86 0.88 0.89 Research & Development 0.24 0.24 , 0.25 0.26 0.26 0.27 t•.1 Other Deductions/(Income) (0.04) 0.22 (0.04) (0.04) (0.04) (0.04) .~ I I Income from Operations % of Sales $ 12.59 $ 11.12 $ 9.89 35.5% 31.9% 28.6% $ 8.89 25.9% $ 8.15 24.1% $ 7.53 22.6€ W ~.! ~.i -~ C.1 Qa Cu

I I ASSETS: Cash Receivables Inventories: Leaf Finished Goods All Other LIFO Reserve Total Inventories Prepaid Expenses Total Current Assets Property, Plant & Equipment Accumulated Depreciation Net Property, Plant & Equipment Patents, Trademarks & Goodwill Miscellaneous Assets Total Assets LIABILITIES & CAPITAL: Current Portion Long-Term Debt Accounts Payable & Accrued Liabilities Federal Excise & Other Taxes Total Current Liabilities Long-Term Debt Other Liabilities Net Income-Current Year Intra-Company Balance BALANCE SHEET FORECAST DECEMBER 31, 1987 - 1992 (Dollar Amounts in Millions) Actual 1987 1988 1989 1990 1991 1992 $ 0.1 $ 0.1 $ 0.1 $ 0.1 $ 0.1 $ 0.1 392.7 427.1 461.9 503.6 542.8 585.2 1,762.0 1,950.3 2,221.8 2,377.2 2,499.5 2,607.3 199.3 192.7 202.3 211.4 221.4 231.5 162.8 151.1 159.8 167.9 173.3 182.9 (643.3) (635.2) (679.0) (732.3) (791.9) (855.1) $1,480.8 $1,658.9 $1,904.9 $2,024.2 $2,102.3 $2,166.6 26.7 26.5 28.3 30.2 31.5 33.5 $1,900.3 $2,112.6 $2,395.2 $2,558.1 $2,676.7 $2,785.4 $2,365.7 $2,712.7 $2,896.9 $2,982.3 $3,060.7 $3,086.0 (777.6) (891.5) (1,003.3) (1,133.6) (1,268.6) (1,420.0) $1,588.1 $1,821.2 $1,893.6 $1,848.7 $1,792.1 $1,666.0 0.4 0.3 0.3 0.3 2.5 - - - 0.3 0.2 $3,491.3 $3,934.1 $4,289.1 $4,407.1 $4,469.1 $4,451.6 $ 1.1 $ 0.1 $ 0.1 $ 0.1 $ 0.1 $ 0.1 300.0 313.0 325.1 338.2 351.0 365.5 101.1 85.4 78.8 86.8 87.6 87.9 $ 402.2 $ 398.5 $ 404.0 $ 425.1 $ 438.7 $ 453.5 $ 10.3 $ 10.3 $ 10.3 $ 10.3 $ 10.3 $ 10.3 6.1 6.2 6.2 6.2 6.2 6.2 1,530.9 1,866.6 2,145.8 2,432.6 2,752.1 3,129.3 1,541.8 1,652.5 1,722.8 1,532.9 1,261.8 852.3 Total Liabilities & Capital . $3,491.3 $3,934.1 $4,289.1 $4,407.1 $4,469.1 $4,451.6 I I I U I I I I I I I I I I I B-4 I

I I I I I I I I I I I I I I I I I I FUNDS FLOW ANALYSIS FOR THE YEARS 1987-1992 (Dollar Amounts in Millions) Actual 1987 1988 1989 1990 1991 1992 SOURCES: Income from Operations $ 2,713.8 $ 3,080.9 $ 3,505.8 $ 3,961.6 $ 4,483.6 $ 5,091,0 After-Tax Income from Operations $ 1,530.9 $ 1,911.4 $ 2,175.0 S 2,457.8 $ 2,781.6 $ 3,158.4 Add: Depreciation 144.4 154.2 171.2 178.0 185.1 193.0 Total From Operations $ 1,675.3 $ 2,065.6 $ 2,346.2 $ 2,635.8 $ 2,966.7 $ 3,351.4 Change in Other Liabilities $ (i.i) S 0.1 $ 0.1 $ - $ ° $ - Disposal of Fixed Assets 5.9 2.8 2.8 3.0 3.1 3.1 Total Sources $ 1,680.1 $ 2,068.5 $ 2,349.1 $ 2,638.8 $ 2,969.8 $ 3,354.5 USES: Change in Working Capital $ '53.2 $ 215.9 $ 277.2 $ 141.7 $ 105.1 $ 93.8 Expansion & Modernization 135.0 390.1 246.4 136.2 131.5 70.0 Change in Other Assets 1.6 (2.4) - - - - Total Uses $ 189.8 $ 603.6 $523.6 $ 277.9 $ 236.6 $ 163.8 Net Funds Generated $ 1,490.3 $ 1,464.9 $ 1,825.5 $ 2,360.9 $ 2,733.2 $ 3,190.7 B-5

FULL MARGIN STRATEGY 2Q43.'74391

FULL MARGIN STRATEGY PM-USA's ability to provide the Corporation with planned profit growth is largely dependent on achieving unit volume and market share targets for our full margin brands. In 1987, PM-USA's full margin products grew 0.4 share points to a 36.2 percent market share. How-aver, PM-USA's share of the full margin segment grew 1.1 share points to 40.4 percent. During the plan period, PM-USA's full margin products are expected to grow a total of 5.1 share points to an industry share of 41.3 percent. Conpetitive and environmental trends including a larger price/value category, increased couponing, more aggressive pricing and continued social pressures on snokers are increasing the difficulty of corRpeting in the full margin segment. To further our full margin growth in this environment, PM-USA must continue to maintain strong brand images and enhance the value and affordability of our products. Advertising and an improved retail presence will be used to comrnulicate our brands' unique advantages to consumers while high quality incentives, continuity programs and targeted couponing will convey PM-USA's added value and superior product quality to price-sensitive consumers. In the Executive Suimaty of this Plan, PM-USA's plans for our major full margin brands were briefly discussed. This section describes in greater detail both the current positioning and the strategic plans being implemented for Marlboro, Benson & Hedges, Merit, Virginia Slims and Parliament as well as PM-USA's anticipated new product activities in the full margin segment. MARLBORo Marlboro continued to grow in 1987 with volume advancing 0.4 billion units to 134.6 billion. Market share growth of 0.5 points to 23.6 percent was the largest gain recorded by a full margin brand during the year. The brand's market share is the highest since Camel achieved a 25.6 percent market share in 1953. Marlboro Lights fueled the brand's growth (+0.6 share points) while the market shares of Red and 100's remained essentially unchanged. During the plan period, Marlboro's market share is projected to grow 4.1 percentage points to 27.7 percent with unit volume increasing approximately 2.2 billion to 136.8 billion. C-1

Attaining Marlboro's voltme and share targets are dependent on achieving the following objectives: • Maintai _n; ng Marlboro' s premiun image through advertising and high quality promQtions. • Retaining current smokers as they age. • Sxpanding Marlboro's appeal beyond traditional denographic strengths. • Developing geographic opportunities. • Optimizing the brand's retail presence. Since Marlboro has already achieved dominant positioning in most major industry and demographic categories, attaining future voltmie gains will be challenging. Marlboro is the leading brand in the 85 nan, 100 n¢n, full flavor, low tar and box categories, as well as the most popular brand arrong mzn, wasren, whites, Hispanics and smokers aged 18 to 34. Marlboro's strong positioning makes the brand a target for competitors who are attempting to reverse declining voltune trends and eroding shares among young adult smokers. MARLBORO DII~lCJGRP>PEiIC PRCFILE VS. PRT=AL COMPEI'IZURS Brand Ranking Demaraahic Group First Second Third Overa?.). Males Femaies Wfiites Blacks* Marlboro (23.3%) Marlboro (28.3%) na.r iboro (18 . 4 %) Marlboro (24.5%) Newport (18.8%) Winston (11.5%) Winston 113.5%) Salgn (10.4%) Winston (11.7%) Y.ool (18.6%) Sa.1en (8.7%) Salem (7.0%) Winston (9.5%) Salem (8.2%) Sa1an (15.0%) Hisp?nics 18-24's Marlboro (29.8%) Marlboro (52.1%) Winston (11.5%) Newport (11. 0 $ ) Salem (8.3%) Salem (5.6%) 25-34's Marlboro (30.4%) Salem (9.7%) Winston (9.1%) * Marlboro (5.9%) is the nLmlber six brand arong Blacks. Source: 1987 Tracking Study. C-2

Advertising Marlboro's ongoing success is in part attributable to a broad-based advertising cmrpaign which has created and maintained the industry's most recognizable brand image. The Marlboro Country theme continues to be relevant for both young and old adult smokers as evidenced by recent share gains among all age groups. The advertising campaign is designed to portray a leadership position - by reinforcing consumers' perception of Marlboro as the industry's premium brand. During the plan period, Marlboro's goal is to continue its- leadership position in non-retail media. Marlboro has an opportunity to further solidify its image dominance due to competitive movement away from advertising. Slightly more advertising emphasis will be placed on full flavor packings during the plan period. Unlike the past, when Marlboro Lights received disproportionate support to fuel their growth, future support for these non-menthol packings will be brought more in line with their relative volume contribution. In 1988, all Marlboro Lights packings are expected to benefit from the high level of introductory advertising for Marlboro Lights Menthol. While magazines and outdoor will continue to be cornerstones of Marlboro's media plan, there will be a shift in spending between the two. In 1988, outdoor is budgeted for approximately 36 percent of Marlboro's media spending compared to 29 percent in 1987. Marlboro's strength arrong males will be reinforced by heavier advertising in targeted male publications. Promotions During the next five years, PM-USA's promotional objectives will be to differentiate Marlboro as the industry's premium brand and heighten Marlboro's leadership presence nationally and in local communities. Retail-delivered consumer incentives and event promotions will be used to this end, as follows: • On-product incentives, such as lighters, road atlases and belt buckles which are planned for 1988. • Marlboro Auto Racing. ' • A Marlboro Country Music Tour focused in the South and Southeast. • An expanded Marlboro Soccer Cup targeted toward Hispanics. • Marlboro Ski Challenge. • Marlboro Target Marketing, geared toward maximizing the franchise's growth in potential high vollmie markets.

Smoker Retention Retention of current Marlboro smkers is one of PM-USA's main objectives during the plan period. Marlboro has an estimated 52.1 percent share airong adult smokers below age 24 (up from 47.1 percent in 1985) and an estimated 71.1 percent share among non-menthol smokers in this age category. Retaining these ~rokers as they age will become increasingly inmortant because projected demographic trends, including the decline in the number of young adults and low start rates among young adults, indicate that future volume gains from attracting additional young adult smokers will be limited. Between 1987 and 1992, the 18 to 24 age category is forecasted to decline by 2.4 million people to 24.9 million. In contrast, the 35 to 44 age group is expected to grow from 34.4 to 39.7 million. In 1987, Marlboro achieved its goal of retaining current smokers, gaining share in virtually all age categories compared to 1986. If Marlboro can replicate this performance, while attracting almost 60 percent of the youngest adult smokers (18 to 21 year olds) as it did in 1987, its voluire target is achievable. Ho4ever, ultra low tar and price/value cigarettes, with their strong appeal among older smokers, could adversely affect future retention patterns as Marlboro's current smokers age. One strategy to retain smokers which may be employed during the plan period will be to defend Marlboro against competitive price initiatives. This strategy wtiuld have a dual purpose: 1) stem the erosion of older smokers to price/value products, and 2) increase the affordability of Marlboro for young adults. Price defenses for these two groups wvuld probably take different forms with targeted, direct mail programs focusing on higher quality incentives receiving greater eiTphasis for older smokers and continuity programs and 10's or 14's packs being directed toward young adults. Impleznenting this strategy will be a function of future industry pricing, competitive couponing and the impact the growing price/value category has on Marlboro's sales. C-4

Line Extensions The development of successful line extensions could help Marlboro retain srrokers as they age as well as expand the brand's appeal beyond its traditional derrographic strengths. PM-USA's Switching Study indicates that 30 percent of Marlboro outswitchers leave Marlboro for either a menthol (18 percent) or ultra low tar brand (12 percent). As shown below, the introduction of Marlboro Menthol will allow the brand to corpete for an additional 26.6 percent of the 18 to 24 age category, while a Marlboro Ultra Lights could increase Marlboro's penetration among older age groups. Consequently, efforts will be made during the plan period to expand the franchise into the mainstream menthol category and possibly into the ultra lights category. Marlboro is underrepresented in the menthol segment, having a 0.8 percent share of the category. As a result, three new products have been developed -- Marlboro Lights Menthol Kings and 100's and a reformulated Marlboro Menthol full flavor. These packings are targeted toward white smokers under age 35 whose preferred brand is principally Salem. Marlboro Menthol will be positioned as the new menthol, one made especially for nenthol smokers by Marlboro. The Marlboro Menthol line extensions were nationally introduced in February 1988. Ultra Light versions of Marlboro are currently being developed for a possible test market in 1988 or 1989. This extension, while providing an opportunity to retain snokers and broaden Marlboro's age profile, could impact the brand's strong flavor perceptions aznong consumers. Extensive testing will be done to evaluate the impact an ultra light extension would have on the total franchise before it is introduced. High technology line extensions may also be considered for Marlboro during the Plan. While Marlboro would not be the first entry into a new segment, its later presence in an emerging segment would serve to validate the category and protect Marlboro froin a broad change in smoker preferences. PM-USA would first assess the viability of any new category before introducing a Marlboro extension.

Ceographic Development Although Marlboro continued to lead the industry with over a 20 percent narket share in all regions of the U.S. in 1987, opportunities exist to develop geographic areas where the brand is less dominant. As shown below, Marlboro's strongest markets are west of the Mississippi River (Regions 6 and 7) and in the Northeast (Region 1). MARLBORO SHARE PERFORMANCE BY REGION 1985 1987 To capitalize on these opportunities, PM-USA will supplenent Marlboro's nationwide advertising support by allocating additional resources to geographic areas with high growth potential. PM-USA has identified 27 markets where Marlboro has enjoyed above average share growth and are large enough to warrant receiving incremental support. In addition, Region 3, where PJR has its greatest retail presence, will be targeted because Marlboro has the best opportunity to increase its geographical penetration in this region. Media, event sponsorship, local event promotions and intensified retail efforts will be utilized to secure additional shelf space, inventory and visibility for Marlboro in these areas. PM-USA will also work to develop marketing strategies for Marlboro to defend against competitive regional marketing initiatives and the growing popularity of the price/value segrrent. In 1987, PM-USA tested the M.I.S.T. program which indicated that increasing retail display/promotion spending in target areas could help defend Marlboro against price/value inroads and competitive full margin products. Defending Marlboro will becorre especially important given the increase in regional marketing programs used by competitors to attack the brand. Can-el, which RJR has identified as Marlboro's key competitor, is showing regional strength as a result of RTR's recent focus on Regions 6 and 7. C-6

Retail Marlboro is PM-USA's only major brand with a significant gap between market share and retail inventory share (23.6 vs 11.9 percent, respectively). Consequently, a major goal of Marlboro is to increase the brand's availability nationwide while achieving continuous leadership presence in pack and carton outlets. This will be accornplished through the extensive use of special displays, ter,tporary and permanent point-of-sale materials, and programs which encourage the trade to merchandise the brand effectively. Over the past twU years, Marlboro has placed additional marketing support behind retail activities dedicated to the brand. As a result, Marlboro's share of both total and visual inventory has improved since 1985. Innovative P.O.S. such as Marlboro ash trays and neon signs have increased the brand's visibility in important trade classes. Enlarged pack displays have also succeeded in expanding inventories in pack outlets and contributed to increased brand awareness. Future retail efforts will continue this strategy while seeking to further leverage Marlboro's sumrer popularity. BENSON & FEDGES Benson & Hedges' market share totaled 4.2 percent in 1987, 0.1 share point below the previous year. This represents a moderation in B&H's share decline which decreased 0.3 share points in 1986. The brand's unit volune totaled 24.1 billion in 1987, down 3.8 percent from 1986. The full flavor packings contributed to the decline, as volume decreased 7.0 percent to 10.7 billion units. B&H's ultra lights packings continued to exhibit stability with flat unit volune and market share in 1987. C-7

During the plan period, B&H's market share is forecasted to decline slightly to 4.1 percent in 1992 with voluire falling to 20.1 billion units. Yloderating B&H's share decline over the next five years is dependent on achieving the following objectives: • Slowing the downward trend for B&H full flavor and lights packings while maximizing ultra lights potential. • Reversing the erosion of B&H's appeal among young adult smokers. • Comnunicating the brand's quality image. • Improving the brand's share in strong B&H markets. As shown below, a major problem for B&H is its declining performance in the low tar 100 mm category. The brand' s share of the reduced tar category has fallen to approximately 4.7 percent fron 5.0 percent in 1985. B&H Lights has not captured a substantial number of s_mokers from full flavor B&H as they switched down the tar spectrum. Forty-one percent of B&H outswitchers choose either Virginia Slims (21 percent) or price/value products (20 percent). BENSON 6~ HEDGES CATE60RY PQSITIONING 1985 1987 :1....L ... RREGULAR MENTHOL REGULAR MENTHOL REGULAR MENTHOL FULL FLAVOR LOW TAR ULTRA LOW TAR A second major problem for B&H is the erosion of its young adult sn1oker base. Since 1985, B&H has lost 20 percent of its =kers with young adult smokers declining by one-third. The percent of smokers aged 18 to 24 who choose B&H has declined from 3.9 percent in 1985 to 2.4 percent in 1987. As a result, B&H has the oldest demographic profile of any major PM-USA brand. B&H has also lost share among all demographic groups since 1985, particularly among blacks (-1.2 share points), females (-1.1 share points) and Hispanics (-1.0 share points). C-8

Advertising The key objective of B&H's advertising campaign is to communicate B&H's status as the quality brand for people who enjoy smoking. We will continue to employ B&H's current advertising, which was introduced in January 1987 ("For people who like to smoke ... Benson & Hedges because quality matters."). The campaign effectively portrays snoking and nonsmoking people in spontaneous natural situations which reinforce the social acceptabilit,r of the brand and the people who choose it. The goal of the campaign is to broaden B&H's demographic profile (without alienating current smokers) by making the brand appear rrore mainstream. B&H currently has a relatively affluent, higher educated snoker profile. Survey data indicates that these groups have lower start rates and higher quit rates than blue collar amokers. While we intend to maintain broad media support to B&H's core smokers, targeted efforts will be directed at younger adults, blacks and Hispanics. In addition, spending will be weighted toward 20 geographic areas identified as high potential markets. Prorrotions Increased emphasis will be placed on B&H promtions during the plan period to enhance B&H's image as the quality brand in the minds of consumers. In 1988, B&H's promotional programs will be focused on supporting the B&H Command Performance Music series, which is designed to target specific market segments by offering jazz, contemporary and classic performances. Other proposed prcxnotional programs include: • Quality Choices catalogue. • Quality Matters club.

• Audin cassette with carton purchase. • Graduated incentive luggage offer with pack and carton purchases. • S~noker friendly restaurant program. Geographic Developrent B&H's sales are concentrated in the southern rim of the U.S from California to Florida, Northeastern urban areas and in Chicago -- largely areas where 100 rmn cigarett.es are most strongly developed. However, the total brand has declined in all reg,ions since 1985. A primary opportunity to stabilize B&H's volum is to focus media and prornotional spending on the brand's top 20 trading areas. These markets, which are concentrated in urban areas primarily in the West and Southwest (Regions 5 and 7), account for over 65 percent of the brand's voltune. During 1988, marketing programs targeted to these areas will be employed for the first time. BENSON C tED6ES SH/lE BY RE6ION 1985 087 ® 8+ 6t a III IV VI VII Line Fxtensions During the plan period, B&H will focus on defending the existing franchise against competitors with line extensions being a secondary concern. This strategy is based on the belief that B&H's parent packings must be revitalized before successful line extensions can be launched. Consequently, while several B&H line extension options are available, it is important to first solidify the bras!d's quality image in the consumers mind and stabilize the parent packings. Once this is accomplished, possible line extensions include king size packings in full flavor and lights, ultra thins and 120's. in addition, high technology line extensions could work well with B&H's smoker friendlv orientation. C-10

NERIT Merit's 1987 market share totaled 3.9 percent, down 0.1 share point from the previous year with volur.e of 22.2 billion units. Continued growth of Merit Ultra Lights -- unit volume was up 8.5 percent over 1986 -- partially offset an 8.9 percent decline in the parent's volume. Nerit's ultra lights packings now account for 34.2 percent of total brand sales, up from 20.2 percent in 1982. By 1992, Merit's market share is forecasted to increase slightly to 4.0 percent while volume declines to 19.8 billion units. Merit Ultra Lights market share is projected to increase 0.8 share points to 2.1 percent and is projected to comprise approximately 53 percent of Merit's volume in 1992. This will offset a forecasted decline in the parent packings of 0.7 share points. ' Ef~2lT PAFIENT MEAIT MAAK ET SFME tL7AA LOW TAR 4.a !. 4.4 !. 4.s i.! 4.! 4.0 3.9 rrri- h3d. 'rrY~r~ ~~J ~X 2 S~. .,, 4V-Nr4'7 4 rI-. r .+. ~ ~ F ' 1982 l983 1981 l966 !96@ 1987 During the plan period, Merit's two major goals are to stabilize the parent packings and maximize the growth potential of Merit Ultra Lights, currently the fastest growing product in the ultra low tar segment. Attaining these goals will be dependent on achieving the following objectives: • Reversing the perception of Merit as a low tar brand that corm~romises on taste. • Improving the brand's performance among young adult male mmkers. • Encouraging con7petitive switching to Merit. • Leveraging Merit's technology heritage with new products. Merit has a strong appeal among higher educated, higher income 25 to 44 year old siokers -- who also have relatively low and declining incidence levels. Merit has been unable to attract an increasing number of young adult smokers to compensate for this shrinking `noker base. Since 1985, Merit's share of young adult smokers has declined 1.0 share point to 2.9 percent. Because of its inability to attract young adult male smokers, who prefer Marlboro Red and Lights, the brand's demographic profile is skewing more towards older females.

Advertising Merit must address its poor flavor perception among smokers. Research indicates that as a free-standing low tar brand, Merit is perceived to deliver less smoker satisfaction than the low tar line extensions of full flavor products. Merit's advertising goal is to refocus consutrer attention on the brand's low tar/high taste heritage and position it favorably against brands such as Winston Lights, Camel Lights and Kent. The message will be conamuzicated through a new advertising campaign and a continuation of the successful Merit Blind Taste Challenge. The new "A Solution with Merit" advertising campaign, which is being launched in 1988, will position Merit as the "smart" alternative to the leading lights. The campaign will employ a clear message which states that Merit has "all the taste of the leading lights...but less tar". It will seek to convince potential downswitchers and remind current sttiokers that Merit is a "better way to smQke" compared to higher tar cigarettes. The advertising utilizes a rrnre rational, intellectual approach similar to the original Merit campaign, as opposed to the Sea Campaign which used lifestyle imagery to comnunicate the brand' s story. The new advertising will also incorporate an element of htmor into the Merit message. Prorrotions The objective of Merit's 1988 promtional activities is to maximize reach and awareness among competitive smokers in order to generate a high level of trial and conversion to the brand. Based on the success of the Blind Taste Challenge in 1987, the key element of this strategy will be another media and direct mail-based product trial program. Approximately one million competitive smokers will receive two unidentified packs matched to each smoker's brand preference and a letter which explains the blind taste-test format. A subsequent mailing reveals that the product was Merit, provides a rationale for switching and includes carton coupons to mctivate conversion. PM-USA is also considering expanding the Nlerit blind challenge format to support either its ultra low tar or menthol business. C-12

Event sponsorships and on-carton incentives -- two areas which have traditionally been included in previous Merit marketing plans -- are not included for 1988 so that Merit's resources can be focused on the blind taste test which has proven to be very effective in generating competitive trial. Pack prorrotions will be continued and other promotional vehicles will be considered in later years of the Plan. Line Extensions Line extensions incorporating technological innovations will be an important way to revitalize Merit. High technology line extensions could infuse the brand with the same sense of innovation and real product news it had when it was first introduced in 1976. They are also critical elements of the new overall "solution" positioning and wou1d help diffuse the threat that RRTR's "clean" cigarette could pose to Merit if it is able to meet srrtoker demands for taste and smoking experience while addressing non-smoker concerns. R&D is researching a variety of high technology products to support this strategy including nicotine-free, super ultra low tar, low sidestream, and self-extinguishing cigarettes. Merit Ultra Lights Box (kings and 100's regular) are scheduled for launch in 1988. These extensions will capitalize on the growing popularity of box packings and should help strengthen the brand's share anong younger male smokers (kings) as well as retain Merit Ultra Lights older female smokers (100's). Geographical Developnent Merit is strongest in Regions 1, 4 and 6, while Regions 3, 5 and 7 are underdeveloped. By packing group, there is an opportunity to accelerate the parent's growth in Regions 3 and 5, which are above average low tar markets and strong Vantage markets. For Merit Ultra Lights, Region 7 represents an area of opportunity since it is a strong ultra low tar market. During the plan period, PM-USA will continue to leverage these regional disparities by targeting coapetitive weaknesses. C-13

VIRGINIA SLIMS Virginia Slims' growth accelerated in 1987 with market share and unit volume up 0.2 share points and.3.3 percent, respectively. Market share totaled 3.1 percent and unit volume 17.5 billion units. This performance was fueled by recent line extensions -- 120's and the newly introduced ultra lights -- which offset, and to some extent contributed to, declines in both the parent and lights packings. During the plan period, the brand's market share is forecasted to reach 3.3 percent while unit volune decreases 1.1 billion units to 16.4 billion due to declining industry volume. Continued growth of ultra lights and 120's is expected to compensate for declines in the brand's full flavor and lights packings. Key objectives for Virginia Slims during the plan period include: • Stabilizing the performance of the parent and lights packings. • Improving the brand's performance among young adult female smokers. • Reducing the threat of Capri and other ultra thin products to Virginia Slims' "thinness" positioning. • Improving the penetration of targeted geographic areas and ethnic groups. Virginia Slims remained the leading brand in the female cigarette segment in 1987 and the fourth best selling brand overall among women with a 7.6 percent share. Despite new entries into the female cigarette segment, the brand increased its share of this category from almost 54 percent in 1985 to more than 56 percent in 1987. However, the brand lost market share airong young adult female smokers, particularly among 18 to 21 year olds. In this age group, Virginia Slims' market share decreased 1.9 share points to 8.0 percent over the past year, while remaining essentially stable arrong 22 to 24 year old females. This decline highlights the brand's increasing inability to attract younger smokers who typically prefer full flavor packings, particularly Marlboro Red. C-14

Advertising A large part of Virginia Slims success can be attributed to its consistent, yet innovative, advertising campaign. During the plan period, the brand will continue its appeal to wmen with a historical humor/modern fashion message in modern and contemporary formats. Consumer research indicates that the can-paign continues to have the highest claimed advertising awareness of any cigarette brand among women and that it is still effective in clearly =rtunicating the Virginia Slims concept. Over the next five years, advertising will be increasingly focused on targeted audiences and geographic areas as opposed to broad, national marketing programs. While maintaining support directed at all women, advertisements will be designed to appeal to specific smoker groups, particularly young adult female smokers, ethnic female smokers and female sirokers in major U.S. cities. Promtions PM-USA will continue to utilize promotional programs and on-product incentives to supplement Virginia Slims' broad msdia visibility and induce trial. Prorrntions which will offer high perceived value to female snmkers include a mail-in offer for a rugby shirt, the Book of Days calendar as an on-carton promotion and notecards with a two-pack purchase. PM-USA's sponsorship of Virginia Slims World Championship Tennis continues to extend the brand's image and gain broad awareness. In 1988, there will be a slight shift in the tennis budget away from general funding and toward retail promotions in support of the event. A month prior to each event, on-carton incentives offering a Virginia Slims baseball cap will be placed in tournament cities.

Other promotional events and direct mail programs scheduled for 1988 include testing a Virginia Slims Resort program in three markets. This program, which is airced at attracting young adult female smokers, includes sampling, point-of-sale materials and a redemption center. The direct mail programs will target both potential inswitchers and outswitchers and include mailing coupons to smokers already identified as having used or expressed an interest in Virginia Slims from prior promotions. Geographic Development Virginia Slims will conduct a special marketing effort to increase trial and awareness of Virginia Slims 120's in the Southwest (Region 7). As shown below, 120's are strongest in this region while Virginia Slims 120's share is below its national average (0.45 versus 0.52 percent nationally). The marketing program will include a two-for-one promotion, an on-product incentive and a direct mail campaign targeting competitive 120's smokers with free pack coupons. YIR6INIA S.IMS i20' S SWAIE VS THE CATE60RY BY FSION VIRGINIA SLIMS TOTAL i20'S 120'S RPERCENT .rr ® V.5 SFAFE OF CATE60HY 1 16 5% V 26 5% 4+ II . 22.4% VI . 19.4Z III 25.3% VII 11.9% IV 21.9% TOTAL 20.6% 3.02 3+ ~ 2.83 2+ i+ 0.43 0.58 0.52 2.38 0.80 0.55 0.45 3.78 Line Extensions With the introduction of the 120's and Ultra Lights line extensions, Virginia Slims is now represented in all longer length and tar level segments. Consequently, future line extension efforts will be primarily of a defensive nature. In response to Brown & Williamson's Capri introduction, the brand plans to test market Elan from Virginia Slims in 1988 to compete in the emerging ultra slim cigarette category. Capri was introduced on a regional basis beginning in January 1987 and has achieved' a 0.6 percent share in the areas in which it is marketed. This brand poses a threat to Virginia Slims' image and slimness proposition. Besides Elan, the most imnediate project for Virginia Slims is the development of an 85 rrmn product which could help attract younger smokers who prefer shorter cigarettes. 2.29 C-16

PARLIAMETIT Parliament's volune totaled 5.1 billion units in 1987, down 6.2 percent from 1986. Market share remained essentially unchanged at 0.9 percent. Small share gains in the brand's strongest markets -- New York and Boston -- partially offset declines in other geographic areas. By 1992, ParliamPnt's market share is forecasted to decline slightly to 0.8 percent while volume is projected to total 3.8 billion units. Ihiring 1988, the primary objective for Parliament is to aggressively support the brand in the Northeast (Region 1). Longer term, if this targeted marketing program proves effective, Parliament support could be expanded geographically. This strategy is similar to the one successfully ezrployed by Newport during the 1970's. As shown below, Parliament's regional market share disparity is extreme. The brand's share in Region 1 in 1987 was 2.9 percent, almost four times higher than in its second strongest region (Region 7). Region 1 accounted for approximately 50 percent of Parliament's total volume with metro New York (a part of Section 14) accounting for about 32 percent. PARLIAMENT SHARE PERFOFMANCE 1986 1987 :$ ~~~W-4: NATIONAL REGION I REGION VII SECTION 14 SECTION 15 PM-USA will maintain a targeted marketing strategy for Parliament in 1988 and will focus the brand's resources on young adult snokers in key geographic areas of Region 1. The "Perfect Recess" advertising campaign will be continued as it presents an effective, memorable message while leveraging the brand's uniaue recessed filter. Outdoor spending will be increased significantly and is budgeted to comprise approximately 36 percent of Parliament's media spending in 1988 versus 19 percent in 1987. Retail efforts will target pack outlets to generate trial among young adult smokers and will include two pronotions offering lighters with a twn-pack purchase in 1988. In addition, an on-carton calendar incentive is planned to reward current Parliament 100's smokers, particularly females over age 35. If the brand's regional strategy proves successful, two possible line extensions include Parliament Menthol and Super Lights. C-17

FL'LL MARGIN NEW PRODUCTS Another area of vital importance in achieving PN-USA's volutne and share objectives is the development of new products for the full margin segment. Traditional new products such as length, reduced tar and box line extensions and products targeted tcrvrard existing segnents help PM-USA to broaden its derngraphic profile and penetrate markets where we are underrepresented. Technologically-advanced products will enable us to initiate or participate in er.rexging categories and position us to respond to campetitive attempts to alter the industry's status quo with radically new products. Traditional Products Many of PM-USA's recent traditional new product efforts in the full margin segment have been directed at increasing our representation in certain industr_v catecories. In 1984, four full margin segnents were identified where PNr-USA's category share was significantly below our overall market share - ultra low tars, king size nmenthols, 120's and non-filters. In the ultra low tar and 120's segr.ients, PM-USA has made progress in increasing our penetration. The king size m.enthol category remains an area where PNrUSA has the opportunity to generate uncannibalized volture growth. The king size rrenthol category is don.inated by three brands - Salem, Newport and Kool -- which together account for 83 percent of the segment. Their strong positioning across various demographic segrrents has made it difficult for new free-standing brands to penetrate the menthol category. Since 1970, no new =ree-standing menthol has been able to sustain a market share in excess of 0.1 share points. C-18

I I I I I I I I I t 1 I I I I I I I I During the plan period, PM-USA will continue to actively pursue the king size menthol category. Marlboro Lights Menthol and a reformulated full flavor Marlboro Menthol, discussed earlier in this section, represent PM-USA's initial effort during the 1988 to 1992 planning horizon. At the sane time, we will work to develop other concepts offering compelling images to menthol smokers and products with unique attributes which will appeal to these smokers. In addition to our raenthol efforts, PM-USA will continue to target affluent, upwardly mobile and young adult smokers with products offering premitun quality, packaging and image. Products of this nature could help PM-USA broaden its demographic profile, protect our strong positioning among 18 to 34 year olds and pre-empt competitive initiatives. Marketing, Manufacturing and R&D are working in concert to develop products which possess these characteristics and offer considerable market potential. Concepts currently being pursued include Dunhill, Cartier, and longer term, Ferrari. Technologically-Advanced Products While developing high technology products has been a priority for PM-USA, RJR's announcement in September 1987 that they are developing a "clean" cigarette increases the importance of this activity. RJR's "clean" cigarette is claimed to provide smoker satisfaction comparable to traditional cigarettes by using a carbon heat source to warm, but not burn, both tobacco and a flavor capsule. The product supposedly gives off little snoke after the initial puffs, is not likely to ignite other materials if laid on them and produces no odor or ash. In addition, since the tobacco is heated instead of burned, RJR states that a nunber of compounds inherent in cigarette srcoke are reduced or eliminated. This new cigarette has a number of implications for the industry if it is successfully introduced. Smaller competitors could be at risk since they may not have the R&D resources to develop comparable products. RJR's marketing strategy for the product could create the perception that conventional cigarettes are somehow flawed or "unclean". On the other hand, it could possibly be used in some areas where snoking is currently restricted, thus providing a positive impetus to industry volune. PM-USA is responding to this threat by developing a comparable, alternative product using technologies from a variety of ongoing R&D projects. The introduction of this alternative will be a function of RJR's actions. PM-USA's current plans are to allow RJR to test market their product first so that we can evaluate consumer response as well as the best way to educate smokers on how to use the product. By doing so, we can refine our alternative and position it as superior to RJR's. RJR has recently stated that they'intend to have the "clean" cigarette ready for market in late 1988. PM-USA will also continue extensive development work on several concepts which are designed to provide snokers with real or perceived product benefits, address smoker and non-smoker concerns over health and social issues and respond to possible product requirements mandated by government legislation. These concepts include: C-19

I • A low sidestream cigarette which would significantly reduce sidestream smoke visibility and thus respond to concerns regarding environmental tobacco smoke. • A denicotinized product which also offers acceptable smoker satisfaction. This product has the potential to create broad smoker interest similar to that accorded to filter cigarettes in the 1950's and low tar cigarettes in the 1970's. • A self-extinguishing, or low ignition propensity, cigarette which addresses renewed governmental efforts to require the manufacture of "fire-safe" cigarettes. • An ultra low tar product with superior taste which could provide a significant opportunity to increase PNf-USA's penetration of the ultra low tar category. • A tobacco blend with no additives which could be utilized if governmental initiatives to require product labeling or ingredient disclosure becon-e law. While sone of these concepts may be incorporated into PM-USA's "clean" cigarette alternative, each offers its own advantages which may be appropriate for new brand names or line extensions of existing brands such as Merit. R&D, Marketing and Manufacturing continue to make progress in developing viable products using these concepts and our intention is to have products either ready for test or in test market by the end of 1988. The aggressive pursuit of technologically-advanced cigarettes offers significant opportunities to achieve long-term competitive advantages and remains an integral part of PN-USA's marketing strategy to achieve our five year objectives. C-20 I I I I I I I I ~ ~ I I I I I I I I

PRICE/VALUE STRATEGY 2G43774412'

PRICE/VALUE STRATEGY PM-USA has targeted the price/value category -- along with Marlboro and full margin new products -- as an area where future unit volume and market share growth can be achieved. To this end, a number of strategies have been developed to increase PM-USA's price/value penetration to the point where we have a share of the category comrensurate with our position in the industry. These strategies are tailored for the differing characteristics of the price/value segnent whose smokers, in addition to being price conscious, tend to be older and less brand loyal. The price/value category was initiated by Liggett in 1980 with "black and white" generic products which carried a price differential versus full margin products of about $1.00 per carton at retail. The segment experienced slow growth until the Federal Excise Tax was increased in January 1983 when Liggett decided to leverage heightened smoker price consciousness by more than doubling the generic price differential. To defend against Liggett's inroads, RJR (Century) and Brown & Williamson (Richland) introduced value 25's products. These were. followed in 1984 by PJR's Doral, the industry's first branded generic, and Brown's "black and white" generics. During this period, the price/value category grew rapidly. After studying a number of options, PM-USA introduced Players Lights 25's in late 1985. This was followed in 1986 with the repositioning of Cambridge as a branded generic and the introduction of PM-USA's "black and white" alternative - Fanous Value Brands. With these products, PM-USA now competes in all three of the category's subsegments -- branded generics, "black and white" generics and value 25's. During 1987, the price/value segment grew 1.3 share points and accounted for 10.2 percent of the industry. This growth was fueled by the branded generic subsegment which increased 1.9 share points. Category expansion is expected to accelerate during the plan period given continued aggressive full margin pricing, PM-USA's price/value initiatives and corresponding competitive actions including new price/value introductions. By 1992, the category's market share is projected to be at least 16.9 percent and as high as 21.9 percent if a new tier of sub-generic products emerges. PM-USA increased its penetration of the price/value segment in 1987 by capturing 41 percent of the segment's growth during the year. Our category share increased 3.8 percentage points to 15.5 percent, fueled by Cambridge and, to a lesser extent, Famous Value Brands. PM-USA's price/value unit voltate totaled 9.1 billion in 1987, up over 50 percent from 1986. Over the next five years, PM-USA intends to accelerate its penetration of the category and reach a 35 percent segment share in 1992. This aggressive target is necessary if PM-USA is to attain its overall volume and market share objectives for the five year period.

PM-USA PRICE/VALLE GROWTH PLAYERS LTS 25'S CAMBRIDGE FVB ® 9.1 i.0 0 6.0 11.1..........•+. ..•1:..11.••...1...... • 1..11.1.11..1...f11.. r..~.•.1..1..........• .111...+..7,...1..• .+...+......•.......• • ~r.~ .1...........1... •..1.......+..... •~1 . . . + , 1 .. . . . . . . r. . . . . ..................... ..................... ..................... • .. ................... ~..-.~~.-fi.~ .....,..,..., ...................... .... ., .r+.r..,s.,++... :r,r.,....,,...+++.,.. 1985 1986 . .. -:.f•....• ;o~ ~~a,..~ r ~~.~.tr_. a .--r.~ •'_ .. ...................... ...................... ...•.1...+.•...+.+...1• ....1.•.....1.+f..... L 1.1..+..1.1....1.1.1. 1......•..1.......1.1• ..1.1.11•.,.+...1.+. ~.~:1.i•. i•..1.....1... f. +.•.•....+1.++..1... ..•1..1.1.11+...1. •..11.+,.....•......+ ~..+111..I.Ir,.11....1. :+ 087 The category's future growth is expected to be concentrated in the branded generic subsegment. Consequently, PM-USA will focus most of its efforts toward improving our performance in, and penetration of, this subsegr.ent. We will strive to minimize the cannibalization of PM-USA's full margin brands by targeting competitive srrokers to the extent possible. We can accomplish this objective by implenenting the following strategies: • Maintaining competitive pricing offers to consuners and taking advantage of opportunities to pre-empt other manufacturers. • Improving distribution and retail presence. • Introducing new products. • Developing a measure of brand loyalty by maintaining superior packaging and product quality. CAMBRIDGE In its first full year at retail, Cambridge achieved market share of 1.1 percent, doubling its share from the prior year with unit volume of 6.4 billion. The successful introduction of Cambridge Full Flavor in June 1987 contributed 0.2 share points to this growth. Cambridge's share of the branded generic subsegment grew to 25 percent in 1987 from 21 percent the previous year. During the plan period, the brand is forecasted to reach a 3.4 share, with unit volutre totaling 16.9 billion. In order to achieve these targets, Cambridge rnust improve its performance relative to Doral. In 1987, Doral grew 0.9 share points to 3.0 percent -- and is nearly three times larger than Cambridge. However, in the second half of 1987, Cambridge succeeded in narrowing the share gap with Doral in food stores (1.9 percent share gap in June versus 1.6 percent in Dece;nber). Over the next five years, PM-USA must continue to erode Dora1's advantageous position while also defending Cambridge against new branded generic entries. D-2

MARKET SHARE OF BFiMDED 6ETFAIC SEGMENT T}REE MONTH MOVING AVERAGE TOTAL BAAAOED DORAL CAMBRIDGE ALL GENEAICS A PERCENT OF MApCET *INCLl1DES MALIM FALCON I LIGHTS AND7/N~ (TfFiDU6H 3+ 2+ i+ OTHERS* 6 +5 +4 +2 .~-~-- - - ~----- --J ~ ~ 1 _~ M J J A S 0 N D J F M A M J J A S 0 N D J F M A M J J A S 0 N D J F M A M J J A S 0 N 0 1984 1985 1986 1987 During the plan period, Cambridge's couponing strategy will be structured to take advantage of opportunities to be pre-emptive. Cambridge's couponing outpaced Doral in 1987 as 44 percent of the brand's volums in food stores was couponed versus 36 percent for Doral. We will expand this level of couponing over the next five years while periodically increasing coupon values -- even though this action may accelerate the category's growth. This strategy will also enable PM-USA to take advantage of an apparent decision by RJR during 1987 to increase Doral's profit contribution by reducing marketing investrent behind the brand. D-3

PM-USA will also work to improve Cambridge's retail availability and visibility. Efforts will be directed at placing additional price/value merchandising vehicles -- both carton fixtures and pack displays. As shown below, RJR has leveraged its retail strength to place approximately 27,900 (72 percent) rrore value centers than PM-USA. This gives Doral a major advantage, particularly in supermarkets, since these carton fixtures provide the brand with greater inventory and visibility versus Cambridge. It is critical that PM-USA narrow this fixture differential so that Cambridge can compete on a mre equal footing with Doral. In addition, we will seek to increase Cambridge's presence in convenience stores by installing smaller versions of the value centers used in supermarkets and placing pack displays dedicated to PM-USA's price/value products. An important objective of these retail efforts is to educate price/value smokers that there is Mre than one branded generic alternative. Longer term, PM-USA's goal is to convince these smokers that Cambridge is the deznonstrably better alternative. Doral's market share advantage is in part due to its greater distri•bution. Although Cambridge has attained a higher distribution than Doral did at ccnparable points since introduction, the brand's current distribution lags Doral (79 versus 87 percent, respectively). During the plan period, we will seek to increase distribution for every Cambridge packing to a level at least as great as Doral. An important element of this strategy will be to convince retailers that thev should offer consumers more than one branded generic option. ~ D-4

IETAIL. OISIAIBUTIad S?1CE INTRMUCTYON DORAL CAMBRID6E ~T F~cFxr a7 7s -90 7 73 70 .60 2 4 6 8 10 12 iA 16 i8 20 22 2A 26 28 30 32 34 36 38 40 MONTFL4 In Cambridge's marketing efforts will be focused in strong generic markets and areas where the brand is underdeveloped. The Southeast and Midwest will represent the brand's primary geographic thrust. Ehzphasis will also be placed on underdeveloped markets in the FTestern U.S., primarily California, Texas and ;r'ashi.ngton. FANOUS VALUE BRANDS During 1987, the "black and white" subsegment's market share continued to decline, falling to less than four percent versus 4.3 percent in 1986. Since its peak of about 4.8 percent in October 1985, the subsegment has declined by nearly one fifth due to the increasing popularity of branded generics. Over the next five years, this decline is forecasted to continue, spurred by the high couponing levels and increased visibility for branded generics. Famous Value Brands achieved unit vollune of 0.9 billion and market share of almost 0.2 percent in 1987. During the plan period, PM-USA's "black and white" generic products are projected to reach a unit volture of 3.2 billion and a market share of nearly 0.7 percent. MVM SHAFE OF SLACK C IHITE GENE= SE8MW ThREE MONTH MOVING AVERAGE TOTAL BLApC & Lam B&W pk-{1SA WHITE GENERICS GENERICS GENERICS GENERICS PERCENT OF MARCET -~ 3 2 JFMAMJJA80MDJFMAMJJASONDJFMAMJJASOMDJFMAMJJASOND 1984 1985 i9B6 1987 D-5

Ccxnpetition for private label business is expected to remain fierce during the next five years. This is due to the unique nature of the private label market. Since retailers tend to carry only one private label product, manufacturers are competing for these customers as opposed to actual smokers of "black and white" cigarettes. Signing or losing private label contracts can have a material impact on a manufacturer' s unit volume and market share since some contracts can amount to several billion units annually. Liggett and Brown & Williamson continue to be the principal participants in the "black and white" subsegment with subsegnent shares of 52 percent and 43 percent, respectively (fourth quarter 1987). PM-USA has made steady progress in signing retail custcmers and now has a five percent_subsegmentI share. PJR's entry into the private label business in 1987 will, in all likelihood, further increase subsegrfent canpetition given their retail leverage and strong branded generic presence. For example, PJR's private label contract with K-Mart contains a provision which attempts to exclude other generic products, including branded generics such as Cambridge. To achieve the targets which have been set for Famus Value Brands, PM-USA will seek to: • Increase private label distribution, primarily annng high volume, direct chain accounts. • Maintain incentive packages which are competitive with other manufacturers. • Continue the high quality of our private label products. • Test using the field sales force to market FVB like other PM-USA brands. Marketing efforts for FVB will continue to be directed at increasing distribution by securing additional private label contracts, primarily in direct chain accounts which offer high volume potential. In 1987, we signed contracts with Pathmark, A&P and Southland and we are currently negotiating with a number of customers which offer considerable volune opportunities. Since competition for distributors and direct retailers is mainly price driven, PM-USA will continue to offer incentive packages which are ccxnparable to those of other manufacturers. These incentives have grown in recent years as manufacturer price increases on "black and white" products have accelerated and now include allowances of up to $5.75 per thousand and as much as eight weeks of free product. We will work to develop incentive programs which are creative and attractive to retailers. In-store promotions, such as couponing, will be anployed as needed to respond to conpetitive initiatives. These activities will be supplemented with merchandising programs such as carton fixtures and pack displays as appropriate.

Continuing the high quality of FVB will also serve as a competitive weapon given the concern among distributors and private label smokers that the cruality of these cigarettes is not equal to branded products. Finally, testing our ability to use the PM-USA sales force to support FVB like other PM-USA brands could provide us with a coinpetitive advantage in servicing accounts which are currently supplied by either Liggett or Brcwn & Williamson. We will also seek to leverage inroads made by FVB to increase the distribution of PM-USA's branded generic products. Players Lights 25's The value 25's subsegnent did not participate in the growth of the overall price/value category during 1987, declining 0.2 share points to a 1.7 percent market share. Players Lights 25's and Century exhibited the largest declines while Richland's share remained essentially unchanged. During the plan period, the subsegcrsnt's decline is forecasted to continue since consumers appear to define "value" in terms of lower price rather than more cigarettes. M ARCET SHAM OF VALUE 25' S SEGhENT THREE MONTH MOVING AVERAC-E TOTAL CENTURY RICHLAND PLAYERS VALUE 25'S 25'S PERCENT OF MARKE7 ~ 3 2 '- ~ ~ ~ ~' -- --' " 0 "'- - --- --- ~- --- ~ J F M A M J J A S 0 N D J F M A M J J A S 0 N D J F M A M J J A S 0 N D J F M A M J J A S 0 N D l984 198<i 1986 1987 In 1987, Players Lights 25's market share fell to 0.3 percent from 0.4 percent the prior year and volume declined to 1.7 billion units. However, the brand's share appeared to stabilize soirewhat toward the end of the year. During the plan period, Players Lights 25's performance is expected to mirror that of the entire 25's subsegment. By 1992, the brand's market share is forecasted to be 0.26 percent with unit volume at 1.3 billion. During 1988, a regional marketing strategy aimed at strengthening the brand in areas where value 25's are strongest -- Regions 4 and 6 -- will be implemented. The goal of this program is to determine if the brand can be stabilized in these markets to provide a base for future expansion. Marketing efforts will be concentrated on couponi.ng and value center placements to improve retail visibility, stimulate trial and encourage repeat purchases. Players Lights 25's couponing trend versus Century and Richland is seen on the following page.

A new advertising campaign will also be developed to communicate product attributes such as quality and smker satisfaction which are important to value 25's snokers. Prorrotional incentives, such as the Lotto personall computer and 2 for 1 pack offers which were used in 1987, will be employed as appropriate to encourage trial and appeal to the price-consciousness of value 25's smokers. During the plan period, PM-USA rnay also test various line extension and repositioning options for Players Lights 25's to determine the best direction the brand should take to achieve long-term growth. Under consideration are a full flavor line extension and conversion of the brand to a generic 20's proposition. NEW PRODUCTS In addition to the expansion of existing brands, future price/value growth could come from two sources -- new products in the category's current subsegments or entirely new subsegments such as a third tier of products priced at sub-generic levels. In order to achieve our 35 percent penetration target by the end of the plan period, PM-USA will participate in any new subsegments which appear viable, including a third price tier. PM-USA will not initiate the higher level of price competition such a tier would engender, however, we will also not allow the lower price tier to develop without early PM-USA representation. PM-USA is also developing new products to enhance our performance in the price/value category•as it is currently structured. Our initial thrust will be the introduction of Alpine, the industry's first free-standing price/value nenthol. This launch is currently scheduled for mid-year 1988. Alpine will enable PM-USA to exploit menthol underrepresentation in the price/value segment. While menthols accounted for 27.7 percent of industry volume in 1987, they corimrised only 22.8 percent of the price/value category. D-8

I I I I I I I I I I I I I I I I I I I Alpine also provides an opportunity to attract competitive nmenthol smokers. Research indicates that sawkers switching to generic menthols are skeaed toward women and whites. Salem, with its comparable demographic profile, appears to be particularly vulnerable to a free-standing generic menthol product. Longer term, PM-USA is planning to launch other free-standing price/value products. Such entries will either be mainstream products like Cambridge or brands targeted at specific segments along the lines of Alpine. Our objective will be to establish a pre-emptive position in potential development areas of the price/value category and provide PM-USA with an array of products to neet our five year price/value objectives. D-9

RETAIL STRATEGY 2 0 437 74 42 :_

In 1987, PM-USA continued to implement programs to capitalize on growth opportunities in the retail environment. These programs are designed to maximize PM-USA's retail presence and heighten the availability and visibility of PM-USA's existing brands and new product introductions by increasing shelf space, accelerating placement of full service and supplemental carton fixtures, and placing high profile pack displays and point-of-sale (POS) materials. In addition, PM-USA continued to refine the structure of the sales force to enhance its key account selling and analytical/logistical capabilities through actions such as the creation and staffing of the Senior Account Manager position in each Sales Section. This provided a first step toward achieving PM-USA's long-term strategy of transferring more business development responsibilities to individual section offices. These programs significantly improved PM-USA's retail position during the year. A combination of field sales incentive programs and a coinpetitive carton merchandising plan increased PM-USA's shelf space by nearly ten percent (300,000 rows). We continued to provide a viable carton fixture option for retailers and doubled our share of fixtures placed at retail. This progress forced RJR to defend their retail position and install larger racks in high volume stores, on which PM-USA captured additional space. PN-USA's carton fixture_efforts were supplemen-ted by the placement of over 14,000 additional supplemental - racks principally for price/value products. In pack''merchandising outlets, PM-USA's focus on installing larger displays and overhead pack merchandisers provided increased visibility for PNI--USA's existing packings and new products and improved inventory depth. As a result of these accomplislhments, PM-USA increased its share of retail inventory as measured by Nielsen by 1.2 share points to 29.4 percent. However, our market share in the Nielsen universe climbed 1.4 share points to 36.2 percent and is now 6.8 percentage points greater than our inventory share. Given our aggressive share targets for the future, the forecasted growth of Marlboro and the probability that we will introduce several new products during the plan period, we rmust continue our efforts to obtain shelf space and enhance PM-USA's retail positioning. i987 CHANGE IN NIELSEN SHARE PM-USA RJR ALL OTHER ® ~ ~ 0 3 RCENT PE ~ . 2.0+ 1 4 . 1.2 1.0 0.9 0 4 0 0 . -1.0 N -2.0 ~ -2.1 .A -3.0 w ~ MARKET TOTAL SHARE INVENTORY ~ .~. W E-1

PM-USA's principal goal during the plan period is to develop a retail presence conuensurate with our market share leadership. Our retail plan is to build on the strategic framework established in recent years and introduce new programs which complement PM-USA's retail objectives and provide added value for retailers and distributors. Specific issues underlying this retail strategy include the following. • Maximizing retail presence is vitally important, particularly in light of industry trends towards couponing and other retail initiatives and the threat of a possible ad ban. An important element of PI+-USA's strategies is to view each trade class as a separate opportunity requiring programs structured to fit their individual needs. • Retail cigarette departsnents should be expanded to ensure optimum availability and visibility of PM-USA's established brands and facilitate new product introductions. • In order to achieve PM-USA's penetration targets for the price/value category, special retail programs are necessary to counteract RJR's current advantage in the segirent. • In conjunction with the expansion of cigarette departrtent size, product availability must be improved, particularly for PM-USA's growth brands. To help reach this goal, retailers need to be educated on proper cigarette merchandising, inventory rnanagement and category profitability. •'IYade relations should be enhanced with programs which both strengthen the trade and enlist their support in implementing PM-USA's retail programs. SHARE OF INDUSTRY VOLUME BY RETAIL TRADE CLASS 1982 1987 1992 SUPERMARKETS CONVENIENCE GROCERY OTHER 25 E-2

I I I I I I I I I I I I I I I I I I I RETAIL UNIVERSE The retail universe consists of several trade classes, each with its own unique characteristics. To be most effective, PM-USA's retail programs must be tailored to incorporate these differences. Significant changes have occurred in the retail universe since the start of the decade, including the substantial growth of convenience stores, fueled in part by the expansion of gas stations into the convenience store business, the concurrent decline of the traditional "corner store" grocery outlet, and the more recent energence of price clubs as cigarette outlets. • Supermarkets -- Comprised primarily of large food outlets, the supermarket trade class has grown during the 1980's, albeit at a slower rate than convenience stores. Supermarkets represent the industry's second largest retail trade class and are usually high volume stores with patrons tending to be older and female. While primarily self-service carton outlets, pack volunes in supermarkets are often as great as in a typical convenience store. Historically, PM-USA's retail presence tends to be underrepresented in these outlets due in part to R7R's long-standing display position as the primary supplier of carton and pack merchandising fixtures to this trade class. • Convenience; Convenience/Gas; Gas -- These outlets now comprise the largest single trade class in terms of unit volume, accounting for 30 percent of industry volume. While convenience stores tend to be lower volurce, non-self-service pack outlets, PM-USA is pursuing programs to stimulate carton sales in these stores. The growth of convenience stores is indicative of changing consumer lifestyles, with typical patrons being younger, male and less price sensitive than those of supermarkets. Price/value products, for example, have about a 7 percent share in convenience outlets as opposed to over 13 percent in supermarkets. Marlboro's growth coincided with the emergence of the category, and PM-USA has a relatively stronger retail position in the trade class. • Grocery -- Grocery outlets have decreased slightly due primarily to the growt.h of large supermarkets and the emergence of chain convenience stores. The trade class is expected to continue to decline as grocery outlets are either converted to convenience franchises or are unable to complete against larger chains. • Mass Merchandisers/Chain Drug -- Although cigarette volume in these outlets has remained fairly stable, the trade class has recently received rrore attention froin manufacturers in terms of retail merchandising. These efforts have focused primarily on signing self-service carton contracts with large chains such as K-Mart, Zayre's and Target. In general, this trade class has been underdeveloped in terms of other presence-building vehicles at the point-of-sale. • Wholesale Price Clubs -- While wholesale price clubs currently account for only two percent of industry volume, aggressive industry pricing could stimulate growth in these outlets. These stores are typically wholesale outlets which also sell directly to consuners, competing for business primarily on price. A key issue for PM-USA is to capitalize on potential retail opportunities in wholesale price clubs without giving these outlets a competitive advantage over distributors and retailers. E-3

• Other Outlets -- Other trade classes, including independent drug stores, liquor stores, vending and military, have generally exhibited declining shares of retail cigarette volume. The vending trade class has suffered the most severe decline. This is due to the growing number of convenience stores, higher vending pack prices and the concurrent need for vending machine patrons to carry enough change to make vending purchases. Drug store volume has remained relatively stable. These stores are primarily pack outlets and tend to be less receptive to programs which promote cigarettes than convenience outlets. The following sections will discuss PM-USA's retail strategies for supermarkets and convenience stores as well as distributor relations and the sales force. It should be noted that many of the programs discussed will be applied to other trade classes where appropriate. SUPEP14A=S Improving the availability and visibility of Marlboro and other PM-USA brands are key objectives in our retail stratecPy for supermarkets. RTR's long-standing position as the principal fixture supplier to these outlets has provided their products an advantage in terms of inventory and in-store presence. Over the past two years, PM-USA has begun to reduce this advantage. We will continue to employ a variety of merchandising options to increase shelf space, heighten in-store presence and ensure sufficient distribution for our products. A secondary goal is to further erode RTR's supermarket presence and force them to allocate substantial resources to defend their position. y is to secure sufficent shelf An important ele.ment of our retail stratew space for existing brands and new product introductions. In the past, PM-USA's consistent growth outpaced retail shelf space gains. If this situation were to to remain uncorrected, it could prove to be a future bottleneck to growth. This is particularly true for Marlboro, which currently has an 18.2 percent market share in supermarkets but only 10.5 percent share of visual inventory. PM-USA has initiated accelerated merchandising payment plans (Plan A's) and field sales incentive programs to narrow the row gap between contracted rows and the space necessary to effectively merchandise our products. An important feature of these incentive programs is the requirement that Marlboro be the primary beneficiary of shelf space gains. PM-USA has narrowed this row differential by 850,000 since June 1985. During this time PM-USA's visual inventory has increased from 22.6 to 26.4 percent. PM-USA ROW 6AP 6/85 12/85 6/86 12/86 6/87 12/87 6/88 I I I I I I I I I I I I I I I I I I I E-4

COMPETITIVE CARTON MERCHANDISING CONTRACTS i985 1987 . An aggressive new product strategy and Marlboro's continued growth mandates that PM-USA maintain its mrxnentum in acquiring additional shelf space. PM-USA's sales force will continue to focus on expanding the size of conventional cigarette departrments, particularly in high volutre outlets. In addition, PM-USA will utilize end aisle pack merchandisers, supplemental promotional displays and free-standing carton fixtures to further enhance retail presence and depth of inventory in supermarkets. Through these programs, PM-USA is expected to increase contracted carton rows to 4,550,000 by 1992, 40 percent above current levels. These shelf space gains will also provide substantial product visibility opportunities for PM-USA's brands. PM-USA will continue a fixture placement strategy aimed at providing retailers with viable alternatives to RJR racks. This strategy focuses on expanding cigarette departnent size through the installation of larger fixtures in high voltune accounts, offering competitive merchandising payments and convincing retailers to accept PM-USA fixtures. Past experience indicates that this strategy forces RJR to allocate additional resources to defend its retail position by installing its own larger fixture, on which PM-USA receives a large share of incranental space. Therefore, PM-USA can achieve a substantial portion of its shelf space objectives without refixturing the entire carton rack universe. As seen on the following page, PM-USA made significant progress in 1987 by rrore than doubling our share of carton racks to 14.5 percent. We intend to have about 30 percent (22,000 fixtures) of the fixture universe by the end of the plan period. E-5

A major elemen.t of PM-USA's supermarket strategy is to capitalize on the growing trend toward pack sales in supermarkets. Pack sales currently account for 30 percent of cigarette volume in these outlets and, in a typical supermarket, are approximately equal to total sales in a convenience store. Packs generally carry higher mark-ups than cartons, providing greater profits to retailers on a per unit basis. Combined with PM-USA's strong share armng pack purchasers relative to RJR, the higher profitability of packs versus cartons provides a strong selling point for the sales force to use in convincing retailers to more aggressively promote pack sales. PM-USA has introduced a new generation of front-end pack merchandisers to leverage this situation. The merchandisers provide increased in-store inventory and offer a highly visible P.O.S. opportunity at the point of purchase. In addition, these fixtures provide an excellent means to feature new brand introductions, especially in supermarkets which usually do not have counter pack displays. Over the plan period, PN-USA's objective is to equip 18,000 high volurre stores with our front-end merchandisers. Another option for expanding the size of cigarette departments and supplenenting PM-USA's in-store inventory in both supermarkets and convenience stores is the placement of free-standing carton racks. These fixtures offer an excellent visibility vehicle for established brands and, in the future, could also facilitate the distribution of new products. PNI-USA's free-standing carton racks are currently targeted towards products experiencing growth, principally Marlboro and our price/value products. PM-USA's supermarket strategy also calls for a significant increase in high profile, in-store P.O.S. as a means to build retail presence. In the past, supenTarkets have been reluctant to place conventional P.O.S. materials for fear of increasing in-store clutter and limiting their ability to promote a variety of grocery products. PM-USA has responded to this concern by developing customized P.O.S. items such as electronic message centers, clocks and departztent markers which retailers find desireable and provide PM-USA with a greater presence in the store. During the plan period, the sales organization will accelerate efforts to both develop innovative P.O.S. vehicles and gain their placement in supermarkets. E-6

I I I I I I I I I I I I I I I I I I During 1987, PM-USA tested a program to enhance the merchandising and visibility of our brands in non-self-service stores. The primary thrust in these outlets remains conversion to self-service. However, situations such as in-store pilferage in inner city accounts makes such a move impractical in a small percentage of stores. This very targeted program will be expanded in 1988. To qualify, a retailer must allow PM-USA signage, maintain adequate inventories and place our products in a position where they are visible to consumers. To optimize PM-USA's various supermarket efforts, the sales organization will continue its consultative selling approach to educate, train and assist retailers on the proper management of their cigarette departments. This approach encourages retailers to focus on increasing cigarette sales instead of merchandising payments as the way to maximize their profits. A key objective of these efforts is to encourage retailers to adjust ordering and stocking patterns to accamx>date growing brands and increasing fixture size. CONVENIII3CE; CONVENIENCE/GAS; GAS STORES PM-USA's convenience strategy is to leverage our dom.inant market share in these outlets with programs which further enhance our retail presence. PM-USA's share of convenience store volume is approximately 49 percent versus 30 percent in supermarkets. Marlboro's growth has paralleled the developsnent of the trade class, enabling PM-USA to establish a strong retail position in terms of displays, fixtures and P.O.S. PM-USA's challenge over the plan period is to expand this retail presence in convenience stores and the developing gas/oil trade class with programs which enhance display capacity, increase price/value distribution, place additional carton fixtures and overhead pack merchandisers, and provide extensive P.O.S. visibility. An important elgrent of PM-USA's convenience strategy involves expanding the versatility of our pack merchandising vehicles (Plan B's) through continued migration to larger displays, additional value displays and new flexible display options such as displays which attach to our overhead merchandisers and modules which can be configured to mset individual store needs. Traditionally, B-displays have provided an opportunity to profile established packings, attain visibility and distribution for new products and stimulate impulse purchases. PM-USA currently has pack displays in most eligible outlets. As our market share grows and new products are introduced, a challenge will be to place larger displays so that new products can be featured without sacrificing opportunities to pronnte existing brands. This must be accomplished despite growing competition for limited retail counter space. E-7

I Over the last two years, PM-USA has increased the size of pack displays in convenience outlets. PM-USA currently has 61,500 of our largest pack displays (B-3 maxis, B-4's, B-4 maxis) at retail versus 28,400 in 1985, increasing total display capacity by over 60 percent. In addition, we have placed nearly 57,000 price/value pack displays to provide greater visibility and distribution for our price/value products without sacrificing exposure of full margin brands. During 1988, PM-USA will introduce a new generation of pack displays (M-5's) which can accomanodate up to five brands. The new M-5 will provide for improved mechandising of brand families and has been designed to obtain better positioning on check-out counters. PACK CAPACITY OF PM-USA RETAIL DISPLAYS MILLIONS OF PACKS 15 6.2 10.2 I I I I I I I I The sales organization will continue to work to place larger pack displays and gain the optimum counter position in convenience stores. PM-USA's goal is to maintain display penetration in eligible stores as close to 100 percent as possible by signing newly built outlets to display contracts and securing contracts with the few existing eligible stores which do not have a PM-USA display. Longer term, PM-USA will also investigate the feasibility of developing merchandising displays which feature cigarettes and other product categories. While pack displays will continue to be a major merchandising vehicle in the convenience and gas/oil trade classes, PM-USA has developed a variety of additional high profile, value-added retail programs to enhance in-store presence and service the needs of retailers. These programs include: • Overhead pack merchandisers • Specialized carton fixtures • P.O.S. and customized promotions I I I I I I E-8 M.NBER OF DISPLAYS(000'g) 1985 086 087 B-2 7.2 5.3 4.4 B-3 47.3 32.1 24.9 8-4 28.4 19.7 15.4 M-3 - 11.5 13.8 M-4 - 17.2 32.3 TOTAL 82.9 85.8 90.8 I

I I I I I I I I I I I I I I I I I p During 1987, PM-USA increased the placement of overhead pack merchandisers (OPM's), bringing to 36,500 the total number of these fixtures at retail. These fixtures provide an excellent P.O.S. vehicle at the point of purchase and expand inventory depth due to their large storage capacity. Currently, PM-USA has roughly an equivalent number of OPM's as RJR and, over the plan period, our objective is to establish a leadership position by placing approximately 30,000 additional merchandisers. PM-USA will also vxork to increase the utility of our overheads with items such as bz-ck-lit graphics and a new pack display which can be attached to the OPM, increasing the flexibility of PM-USA retail package programs. PM-USA has also developed carton fixtures specifically designed for convenience outlets, which typically have limited floor space relative to supermarkets. These fixtures address the growing need to improve Marlboro's in-store inventory as well as make it possible for convenience stores to build carton business, which currently accounts for about 30 percent of their total cigarette sales. PM-USA is supplementing this fixture strategy with smaller versions of free-standing value centers to provide our price/value products added awareness in convenience outlets. The visibility provided by high profile P.O.S. as well as national and customized promtions allows PM-USA to leverage the benefits of other merchandising programs and comnunicate with smokers where they make their purchase decisions. We will continue to utilize national promotions such as on-product incentives offering belt buckles, lighters and cassettes. PM-USA has developed a wide variety of traditional and customized P.O.S. materials such as clocks, ashtrays and shopping baskets. In many cases, PM-USA has created P.O.S. materials specifically for large convenience chains. During 1987, PM-USA integrated merchandising and visibility programs with large store operators such as 7-Eleven, Circle K, Mobil, and Texaco. During the plan period, the sales organization will expand these efforts and, where possible, incorporate other PM Companies' products into our promotions as a method of supporting the strong single and multiple product merchandising strategies of this trade class. As with supermarkets, the sales organization will continue its consultative selling approach with convenience and gas/oil chains to educate retailers and form merchandising partnerships. This is particularly important given PM-USA's dominant share in convenience-type stores and the opportunity we have to fully capitalize on future growth in these trade classes. SALES ORGANIZATION The sales organization is ultimately responsible for the successful implen-entation of the sales portion of PM-USA's marketing strategy. In recent _years, PM-USA has invested significant resources in improving the sales force's capability to support our marketing initiatives. For example, over the last two years, supplemental merchandisers have been added to assist with non-selling activities (such as couponing, placing P.O.S. materials and installing carton fixtures), thereby enhancing the flexibility of Sales Representatives to concentrate on their primary selling responsibilities. E-9

I In addition, PM-USA's took steps to improve the analytical and selling capabilities of the sales force's key operating unit, the Section Sales Office. The Senior Account Manager and Manager of Planning Analysis positions were created and staffed to handle business development responsibilities for the largest accounts in each Sales Section. These changes helped establish a support infrastructure which positions PM-USA to modify the future role of the Section Sales Office from one of implenenting sales programs to becoming more of a business development unit responsible for selling, merchandising and targeted consumer efforts. The reorganization strengthens the foundation for achieving PN-USA's sales force mission of improving distribution for new and existing products, enhancing in-store presence and increasing the use of business development techniques while maintaining the flexibility to tailor programs for individual customer and regional needs. Nevertheless, the ability of the sales force to comprehensively fulfill PM-USA's numerous retail objectives has become strained over time. SALFS FORCE MISSICN 1981 1987 I. Retail Presence Pack Display Brands New Products Introduced Piromtions (National/Local) 2-3 Featured Brands 2-5 Brands plus Price/Value 1 Brand With 4 Packings 3 Brands with 8 Packings 4 Pack, 5 Carton, 16 Special 37 Pack, 29 Carton, 67 Special P.O.S. Zerq-ra.tiy Permanent II. Fixtures Carton Pack Overheads III. Merchandising Carton Plans 12 Items/Sales Period 7 Items/Sales Period 14 Items/Sales Period 4 Items/Sales Period None 9'lypes in 11,000 Outlets 7'Iypes in 14,500 Outlets 18 Types in 17,500 Outlets None 5'Iypes in 36,500 Outlets 2 Plans in 38,000 Stores 3 Plans in 47,600 Stores (Plan A) and 16,400 (Plan AV/FG) Pack Display 2 Plans in 73,300 Stores 7 Plans - 140,000 Contracts IV. Consurer Interaction On-Carton Couponing None 800,000 Ccupons Placed/bbnth Consumer Intercept None 4 Major Brands plus Price/Value and New Products Special Events Msrlboro Cup 35 Special Events Sanpling 25 Per Rep Per Day 10 Per Rep Per Day As seen above, the niaznber of national pronotions and new product introductions has remained at a higher level compared to the early 1980's. At the sane time, the sales force has been called upon to accelerate shelf space gains, place new generations of carton and pack fixtures, conduct intensified consumer selling efforts, place coupons and participate in a growing rnunber of activities such as brand-related event pron,otions and public affairs drives to protect the industry. The role of the sales force will expand even further in the future as PM-USA pursues an increasing number of national and targeted retail programs. E-10 I I I I I I I a I I I I I I I r~3 41h I ~ ~ ~ ~ CJ P•.t I

To respond to this situation, PM-USA has begun testing a variety of fu11-time and part-time manning options to more efficiently allocate our sales resources and ensure that the sales force has the capability to achieve our marketing objectives. These tests include using additional supplemental personnel to alleviate the Sales Reps of non-selling activities and adjusting sales territory boundaries and manning to enhance sales force flexibility and improve call coverage. PM-USA's sales organization will study the results of these tests extensively before a national redeployment is implemented. It is believed that a redeployment based on some combination of the tests will lead to a significant enhancement of sales force's capabilities. it is anticipated that a national redeployment will begin during late 1988. The anticipated reorganization will enable PM-USA to better use the sales force as a strategic weapon against our competitors. Some companies appear unwilling to make substantial investnents in their sales forces in light of eroding voltmie bases and their general milking posture towards the industry. This situation provides an opportunity for PM-USA to provide value-added services to the retail community relative to other manufacturers. PM USA will employ the following strategies to capitalize on this opportunity and facilitate the implementation of our retail programs. • Key account selling will continue to be emphasized. Over the plan period, PM-USA's sales force will continue its consultative selling approach to forge merchandising partnerships with key retailers. This approach incorporates advanced profit analyses and space management tools to enhance retailer profitability. • PM-USA will work to improve the sales.force's logistical ability to service retailers and forestall competitive initiatives. The sales force has utilized the resources of the Infornation Systems department to assist in the creation of an electronic ordering capability, thus facilitating the timely placement of fixtures, P.O.S. materials and promtional incentives. In addition, conversion of the sales force vehicle fleet to more versatile miri-vans was completed in 1987. • Performance-based incentive programs are being developed as a tool to enhance the sales force's influence in the distribution community. As discussed on the next section, these programs provide a means to strengthen relationships with decision makers in key accounts. The capabilities of both the sales force and PM-USA's broader marketing organization will also be enhanced by drawing upon the resources of the Information Systems department to assist in the developmnt of operating systems identified by Marketing as important to fulfilling our business objectives. The sales force's consultative selling approach can be expanded by providing graphics and mQdelling capabilities to Section offices and developing a Rapid Information System for the field and headquarters sales. An information system is also being developed to improve both P.O.S. and fixture inventory management and distribution.

I.S. can also assist in improving the marketing orgars.zation's ability to simultaneously conduct a variety of progrm-ns. An important part of this effort will be to support decision making and analysis through the implementation of a Marketing Information System for brand managers as well as personnel in other areas of Marketing. Finally, I.S. will work with Marketing to expand the size, quality and utility of PM-USA's direct marketing database. WHOhESAIER SUPPORT A long-term PM-USA objective is to enlist the direct support of the wholesale trade to assist the sales force in implementing retail programs. Wholesalers can potentially serve as merchandising consultants to retailers in areas such as brand distribution and inventory, cigarette depart~nent layout, ordering and stocking techniques and P.O.S. placement. To date, cigarette manufacturers have not fully utilized the trade to perform these functions. However, trends within the distribution network provide PM-USA an opportunity to develop programs which provide incentives to wholesalers to strengthen the distribution network while supporting our retail objectives. Wholesalers have generally responded to increasing competitive pressures from within the distribution corrurnanity in two ways - consolidation and diversification. The number of wholesaler tobacco distributors has decreased 9 percent since 1981 to 1,400 and wholesaler grocers have decreased 21 percent to 565. In 1987, almost 34 percent of PM-USA's volume was sold to our top 25 accounts (including direct retailers) compared to 25 percent in 1980. In addition, tobacco distributors are diversifying into new product lines such as grocery items to remain competitive with wholesalers grocers and reduce their business risk in the face of declining cigarette volume. E-12

I I I I I I I I I I I I I I I I r These actions have placed additional financial strains on the distribution network. Consolidations, particularly those involving leveraged buy-outs, have resulted in a larger number of undercapitalized distributors. This is expected to continue as the financial investnent required to operate efficiently increases. This situation is compounded by product line diversification since many non-tobacco items have longer turnover rates than cigarettes and require substantial up-front capital investment. By responding to these issues of consolidation and diversification, PM-USA has an opportunity to strengthen working relationships with distributors. We are considering programs to both expand the impact of our Incentive Distribution Plan and ensure a stronger distribution network. Such programs could offer a menu of valuable incentives to distributors, including business and financial expertise, training programs and access to PM-USA's purchasing and financial resources. The primary intent of any future program will be to both facilitate PM-USA's retail objectives and strengthen the internal operations (and thus the continued viability) of individual distributors. RETAIL OBJECTIVES PM-USA's carton and pack merchandising objectives for 1988 and the next five years are sum-narized in the following chart. PM-USA RETAIL OBJECTIVES Change Carton Merchandising 1987 1988 1992 1987 to 1992 Carton Rows (000's) 3,250 3,750 4,550 + 1,300 Carton Fixtures 11,200 14,000 22,000 +10,800 Free-standing Fixtures 29,200 46,000 83,000 +53,800 Pack Merchandising Counter Pack Displays 90,800 92,000 100,000 + 9,200 Price/Value Pack Displays 56,700 64,000 72,000 +15,300 Front-End Nerchandisers(1) 2,200 10,000 20,000 +17,800 Overhead Merchandisers 36,500 46,000 66,000 +29,500 (1) Stores E-13

SOCIOPOLITICAL STRATEGY 2043774436

SOCIOPOLITICAL STRATEGY In the next five years the assault on cigarettes and smoking is expected to intensify. Led by Surgeon General Koop, virtually all public health associations and various politicians, the anti-smoking movement has three main goals: • Make smoking an unacceptable behavior in any social context. • Make cigarette prarotion and advertising illegal. • Make cigarettes themselves more expensive through heavier taxation. During the plan period, the cigarette industry will face legislation to increase excise taxes, to ban print and outdoor advertising, to prohibit sampling and promotion, and to forbid smoking in any public place, office, common carrier, restaurant or accomrcdation. These legislative initiatives represent the most visible element of the anti-smoking force's coordinated strategy to ostracize smokers - both in the general public and even in their homes, where'they are accused of perpetrating health problems on their spouses and children. The rmvement against smoking and smokers enjoys sanction from the media, business leaders and governmsnt akin to that accorded Prohibition and McCarthyism. Scientists are ridiculed if they differ from the party line of the health bureaucracy. The continuing fallout fran the 1986 Surgeon General's Report on environmental tobacco smoke has demonstrated that the anti-sttoking forces are willing to distort science in their single-minded quest to alienate smokers. 1987 REVIEW In 1987, PM-USA's efforts helped hold excise taxes and marketing restrictions in check, but the anti-smoking movement was successful in expanding public and private restrictions on smoking: • Since 1983, the federal excise tax has remained at $8.00 per thousand and the growth of aggregate cigarette excise taxes has been kept below the inflation rate. Cigarette taxes continue to decline as a percent of retail price. Of the 31 states that considered cigarette tax increases in 1987, only 12 raised cigarette taxes. GROWI'H IN FEDERAL AND STATE ExCISE TAXES Cents Per Pack Fiscal Year* Federal Excise Average State Excise % Increase in Aggregate Federal/State 1982 8, 13.5,, --- 1983 16~ 14.7(,4 +42.8% 1984 16~ 15.3~ +1.9% 1985 16~ 15.9~ +1.9% 1986 16(~ 16.2~ +0.9% 1987 16~ 16.9G +2.8% 1988 Est. 16~ 18.3~ +4.3% * July 1 of previous year through June 30 of year indicated.

F-2

I I t I I I I I I I I I I I I I I • Forty-five states considered swking restrictions and 17 enacted some form of restriction. Because of their sheer number, localities remain a problem: 260 cities and counties considered such restrictions last year and 140 adopted some form of restriction. These ni.umbers are up significantly from 1986 and do not include the numerous restrictions and bans imposed by private entities. California enacted a ban on all smoking on public transportation. Congress voted to ban smoking on all comrercial flights of less than two hours duration. • Although 22 states and the federal governnent considered legislation to restrict tobacco marketing, none enacted restrictions on cigarette advertising or promtions. Minnesota, however, did ban cigarette product sampling while still permitting sampling by coupon. • Legislation to require the manufacture of "fire-safe" cigarettes is pending Massachusetts in Congress, California, New York, and Minnesota. This issue will Neta Jersey, be a major • challenge to the industry in the foreseeable future. New Jersey, California, Texas and Ohio reformed their product liability laws. We began reform efforts in Louisiana and Wisconsin which will continue in 1988 and are pursuing stronger legislation in Texas. Overall, the reform efforts are proceeding according to plan. Unless we continue to act forcefully against our opponents, the cigarette market will be fundanentally changed. Since PN~-USA ccmmands 37.9 percent of industry sales, nearly half of estimated industry profits and continues to grow, we have the mst to lose frcin that change. Thus, we must continue to lead the fight against the anti-smoking mvement and devote considerable resources to defeat or mitigate their initiatives. OBJECTIVES FOR THE PLAN PERIOD History offers some reason for hope since the pendulum of public sentiment swung back against Prohibition and the McCarthyism. Our strategy then needs to be a sustained holding action with aggressive counterattacks whenever we have the opportunity to demonstrate weakness or fanaticism in our opponents. In the U.S. particularly, we also have powerful traditions operating in our favor: • Americans do not like taxes on anything though some taxes are less objectionable than others. • Americans do not like government interference in an individual's life though what is acceptable in practice is often at variance with the overall principle. • Americans value free speech even for those they dislike though they would rather have those they dislike speak quietly. • Americans tend to come to the defense of the oppressed and support the underdog. F-3

I Our strategic objective is to leverage these sentiments and maximize industry volume by aggressively blunting attacks from anti-smoking advocates and improving public perceptions of smoking. We intend to maintain and expand our principal programs to influence political decision-makers, smokers and non-smokers and the mass media. We have identified four primary fields of battle: • The social ostracism of smokers and consequent inhibitions about when and where to smoke caused by health-risk perceptions, effective lobbying by anti-smoking groups, restrictive smoking policies (public and private) and biased media coverage. • Restrictions on the type of cigarettes sold, how they are sold, and where they are sold, including advertising bans, sampling restrictions, content regulations and "fire-safe" cigarette bills. • Pressure for higher excise taxes by federal, state and local goverruaents . • Legislation on product liability. The short-term and long-term objectives for PN-USA's sociopolitical strategy are summarized below: SOCIOPOLITICAL oBJECIIVEs Issue 1988 Objectives Long Range Objectives Excise Tax No federal excise tax increase, average Aggregate federal/state tax increases Increases aggregate state increases at or below kept below inflation rate. inflation rate. Smoking Prevent enactnent of new restrictions Restrictions/ and weaken those restrictions which do Environmental pass. Diffuse tte conflict between Tobacco &mke smokers and non-smokers by stressing accanmdation and private initiatives over laws. Advertising Prevent any further restriction on Restrictions advertising, samplizig or promotions. Product Prevent ccYnpulsory requi•-ements Requirements regarding ingredient disclosure or. "fire safe" cigarettes. Ad Valorem Replace Hawaii's ad valorem cigarette Taxation tax with a specific excise tax. Social Continue effort to support smokers Acceptability against anti-smoking activities via PM Magazine, Smokers' Newsletters and aggressive media relations. Product Press ahead with refoan of product Liability liability laws in Louisiana, Wisconsin Pennsylvania, Hawaii and other states as appropriate. Limit restrictions to segregating smokers, not banning smoking. Force restrictive laws to include provisions which prevent individual businesses fran banning smoking or discriminating against smokers in hiring or promotion. Blunt the inpact of ETS with continued research. Link cigarette advertising and promotion to the First Amesdnent to prevent restrictions. Insure that any product reauirements imposed by law do not have an adverse effect on consume.r perceptions of cigarettes or cause significant production problems. Piavent passage of any ad valorem cigarette tax. Establish a politically powpxful coalition of smoker's to blunt assaults against smoking and cause problems for the instigators of such assaults. Work toward a legal environment in which product liability suits are no longer brought against us. I I r I I I I I I I I I I I I I I F-4

I I I V I I I I ~ I I I I I I I STRATEGIES To combat the well-organized, well-funded anti-snoking nnvenent in this country and abroad we have put into place programs that target three groups whose decisions and actions ultimately determine the long-term viability of the cigarette industry. Our overall goal is to preserve the industry by protecting smokers' rights and improving the perception of smokers and snoking in society. Political Decision-Makers We have improved our ability to participate directly in the political process. To communicate more effectively with federal, state and local politicians, a regional public affairs network has been established to monitor and combat (in conjunction with the Tobacco Institute) legislation unfavorable to PM-USA interests and coordinate our activities with the field sales force and other allies. Specifically we plan to do the following: • To go beyond simply defending ourselves, we intend to fashion proactive groups led by the regional managers of the public affairs network. These groups will campaign for repeal of anti-smoking legislation and enactment of legislation to protect srnokers from discrimination in employment. This offensive strategy is intended not only to change existing laws, but to force anti-smoking advocates to defend their gains rather than seeking to expand them. • State political action comni.ttees will expand to make contributions to key political decision-makers in states where direct corporate contributions are not permitted. • At the federal level, the revised tobacco program and an aggressive "buy-domestic" program have dramatically improved farmer-manufacturer relations. We intend to reinforce the renewed tobacco coalition to strengthen our political base in Congress through a continuing outreach program. • We will begin telling smokers how their representatives stand on cigarette taxes, smoking restrictions and related smoking issues in order to help them cast an informed vote at election time. NYoreover, we will make sure the elected officials know their smoking constituents are watching them. • We will extend our "Grass Tops" leadership program to twenty key states where congressional leaders and tax canrnittee members reside. The purpose of this program is to organize local political, business and labor '_eaders into groups opposed to federal excise tax increases. These groups will be modelled on the Washington-based Coalition Against Regressive Taxation (CART) and will also serve as a bulwark against state excise tax increases. F-5

I I Development/Enhancement of Selected Co rate Affairs' Programs Grass Tops Program* 1985 None 1986 None 1987 Vendors and Customers in Albright Program; Mini Coalitions Against Regressive Taxation (CART) in two states 1988 Mini-CARTs in 20 key states, including major PM-USA markets and Tax Committee states, CARTs will include tobacco business community and general business community with strong connection to target legislators Reward/Inform Legislator Program 1985 None 1986 None 1987 Special thank you mailing to smoker- constituants of one non-tobacco Congressman who publicly opposed FET increase 1988 Expansion of thank you mailings and beginning of select "your representative wants to raise your taxes" mailings to smoker-constituants of strong anti-tobacco legislators * Note: Grass Tops Program stresses personal contacts between participant and legislator: phone call, personal letter, office visits, social interaction (at fundraisers, etc.) I I i I I I Snnkers and Other Potential Allies Direct lobbying alone cannot stop the anti-smoking nbvement or influence an indifferent public and media who tolerate fanatical anti-smoking activities. To enlist public support, we will take our program of identification, recruitment, education, camanunication and nobilization of smokers to a new level of organization. This constituency developnent program now targets: • Smokers we have identified through PM-USA's direct marketing, promotional activities and mailing list acquisitions. • Consumers who conmunicate directly with PM-USA through Philip Morris Magazine and the Snxokers' Newsletters. • Retailers, wholesalers and vendors who sell or profit from tobacco products. • Organizations that support or should support the industry. • Smokers and non-smokers identified through special political mobilizations and promotions such as inserts in cigarette cartons. In total, the constituency development database now includes more than eight million smokers and will expand in 1988 to twelve million of the estimated 25 million households with smokers in the U.S. As shown on the following page, we plan to continue our enhancement of the Mass Mobilization System. F-6 I I I I I I ~1 r..~ -~ 42~ ~ .~ I I

I I I I I I I ~ I I I I I I I I I I I Source of Names (Number)* Year (Volunteers) 1985 Commercial Listing (200,000) (47,000) 1986 Self-identi- fied smokers in vendor data base (2.5 million) (221,000) 1987 Self-identi- fied smokers in Mass Mo- bilization System (7 million) (634,000) Development/Enhancement of Mass Mobilization System, 1985-1988 Number of Variations Educational in Lobby Vehicles Letter Text Other Vehicles for Co®unication News media Letters to Editor Activist Volunteers/ Smokers Associations Political District Identification 50 Mailgrams _ _ Federal only PM Magazine to 100 Mailgrams and _ _ Federal and half of smokers handwritten letters 25 states PM Magazine to 2700 Mailgrams, hand- Yes by Elite vols Federal, all all smokers plus written letters, employees first identi- states and Smoker Newsletter petitions, phone fied; major local- to activists in calls, attend New Hampshire ities 26 states hearings Smokers Caucus 1988 Self-identi- PM Magazine to fied smokers all smokers and in Mass Mo- Smoker News- bile Cluster letters to based develop- activists in ment of activ- 50 states ists (11 million) (1 million+) 3000+ Mailgrams, hand- Yes by Major block Federal, all written letters, employees Captain/ states and phone calls, peti- tions, attend and elite volunteers Activists Program; major localities hearings, personal visits to legisla- tors, toll-free legislation call Smokers Rights Association to be organized * Note: Not included on this chart are the numerous improvements in the quality of the names, addresses and phone numbers of the data themselves. Once constituents are identified, they participate in a casnprehensive caYmunication program on smoking issues designed to appeal to each individual's or group's concerns. The most visible conmmnication vehicle is Philip Nbrris Magazine, the winter issue of which went to more than eight million households. We intend to solicit paid advertising for the Magazine in 1988. In 1987, we also launched state 8moker Newsletters in 26 states. Each Newsletter is state specific in content and requests smokers to take action on legislative and snokers' rights issues by writing, phoning or visiting decision-makers. The subscribers represent an activist core. In 1988, we will expand the Newsletter into all fifty states and develop one specifically targeted on the military. In 1988, we intend to create local smokers' rights associations throughout the U.S. The basis for these associations will be a network of 50,000 "block captains" who will monitor local smoking issues, write or visit political decision-n-akers, write letters to local newspapers and generally serve as a grass roots voice for smokers' rights. We intend to link these "captains" to local, state and ultimately a national rights organization. Once the national organization is established and funded, we will spin the Smokers Newsletters into it and create a self-sustaining membership organization similar to the National Rifle Association. F-7

I As we gather names through the constituency development program, they are entered into our computerized political mobilization system to identify voting districts and elected representatives. When political threats arise, we mobilize individuals and groups to communicate with political decision-makers. More than 625,000 persons have actively supported us in political battles over taxes and smo king restrictions since 1985 by writing or phoning their elected officials. 1987 MOBILIZATION SYSTEM UTILIZATION Issue Increase federal excise tax on cigarettes by 16~ per pack. outcome No increase in FET. Ban smoking on commercial air flights of twv hours or less. State excise taxes increases in six states. Restrict smoking in 17 states or localities. Mass Media Ban enacted.but limited to two years. Excise taxes raised in four states and defeated in two. Restriction enacted in six locations, defeated in seven and pending in four. The mass media, like political decision-makers, require special programs to achieve a more balanced presentation of snoking issues. PN-USA's target audience consists of print and broadcast editors, who influence the general public. We have created a camprehensive, computer-based monitoring system to track and analyze articles and editorials on smoking in daily newspapers and periodicals throughout the U.S. This system allows us to detect eznerging issues and unbalanced reporting in order to respond accordingly. We have done so in several ways: • Forceful responces to press inquires, knowing that if we do not speak out on our side of the issues, no one else will. • Rebuttal pieces and advocacy advertising by both PM-USA and non-industry allies. • Letters to the editor from allies and PM-USA employees targeted to specific issues (e.g., airline smoking ban.). • Dissemination of issues materials, both in print and broadcast, directly to news media. • Mretings with editorial boards, special press briefings and media events. F-8 I I i I I I I I I I I I I I I I I

I I I I I I I I I I I I I I I I In 1987, we concluded the PM Magazine Essay Competition on comnercial free speech and the First Amendment. The published volume of winning essays has been sent to all members of Congress and news publications. We launched PM Magazine editorial services to disseminate news articles and features to more than 8,000 local newspapers and demonstrate there is another side of the smoking issue. We began PM Broadcast Services to provide short radio features to 350 radio stations throughout the country. The features have general interest content fran PM Magazine, but also include issues materials. We intend to expand these services in 1988. As long as the news media fails to provide balance, we will continue to do so through other means. In order to produce a better news base for the media to draw from, we plan to expand our sponsorship of econcanic and public opinion research. Such third party research reports serve to balance the anti-smoking propaganda and generate more favorable coverage of our issues. In 1987, we focused on tobacco's role in international trade, state finances (especially in the Southeast) and public opinion surveys on smoking restriction issues. We will pursue these areas in 1988 and sponsor research into employee absenteeism, business attitudes towards eniployee lifestyles, and social engineering movements in American history. We have made progress with the media in forcing at least sone attention to our side of the smoking debate. in doing so, reporters are beginning to show the sanme degree to skepticism toward our antagonists as they show toward us. Operation Downunder To deal with growth of smoking restrictions and increasing social pressure against smoking in public, we intend to launch a comprehensive scientific, political and public relations program -- Operation Downunder. Operation Downunder is predicated on four assumptions: 1) Science has not established a health risk to non-smokers from envirorurental tobacco smoke (ETS). 2) ETS is nonetheless an annoyance to some non-smokers. 3) It is therefore proper policy for businesses, restaurants and other public places to accomnodate the preferences of smokers and non-smokers even through designated smoking areas where necessary and appropriate. 4) Goverrm-ent intervention in this matter should only be as a last resort and should place maximum responsibility on proprietors to assure smokers and non-smokers are acconmodated in all public places. In implenenting Operation Downunder, PM-USA will address the three key decision-making groups and all smoking restriction fronts. We will begin with ~ a public restatement of the cigarette industry's position on smoking accoimbdation to capture popular support. The key to this restatement is to ,{~' present the industry as a reasonable one that wants to resolve the differences 4:* ~ between smokers and non-snokers. -a ...~ 4:% ~ ~

I PM-USA will create and support private initiatives on smoking accommodation in private businesses to denonstrate that governrnent intervention is an unwanted and unnecessary intrusion in the public snoking issue. Where government action is unavoidable, we intend to use the legislative process to compel the accomnodation of smoking in all public places. Finally, we will continue the scientific battle over the effects of ETS through the Center for Indoor Air Research (CIAR). The CIAR is an industry-sponsored scientific funding organization designed to obtain better scientific research on ETS and the overall indoor air quality issue. We believe there are several benefits to the industry in pursuing this strategy. It will: 1) Increase the industry's leverage in legislatures by showing a more reasonable approach to the issue. 2) Provide an acceptable smoking environment for smokers in all social contexts by demanding at least a designated smoking area. 3) Provide a statutory basis for snokers to assert their right to smoke by inserting in legislation the requirement that smokers be acconnodated. 4) Isolate the anti-smoking forces by making the industry appear reasonable on the issue while they are irrational in their demands. 5) Allow the industry to claim victory for sawkers when accoarmodation legislation is passed thus reversing the perception that all snoking legislation is anti-smoking. This final benefit is of particular significance because the laws theznsel,ves are generally mild in their restrictive provisions, but the media reporting of their passage often drives businesses to institute policies far more severe than the minimLUn required by law. Like all new programs, a degree of risk is involved. Operation Downunder will raise the visibility of the ETS issue, but it is already a highly visible controversy. It could also be construed as conceding that smoking can be legitimately limited and pramte government intervention. However, the fact that 45 states and 260 localities debated restrictive smoking legislation in 1987 clearly demonstrates that government intervention is already a part of political life in the U.S. SOCIOPOLITICAL PRIORITIES FOR THE PLAN PERIOD 1) Keep 1he federal excise tax a specific levy at the present level. 2) Control growth of state excise taxes. 3) Reform product liability laws. 4) Prevent the enactment of marketing restrictions. 5) Prevent smoking restrictions from becoming public or private snoking bans. F-10 I I I I I I I I I I I I I I I I I I

ASSET UTILIZATION 2043774447 f

I I I I I I I I I I I I I I I I ASSET UTILIZATION Effectively utilizing PM-USA's assets continues to be challenging given an increasingly complex brand mix and our growing domestic and export business. Expanding capacity and improving manufacturing flexibility are important elen-ents of PM-USA's strategy to efficiently fulfill its production requirements, quickly respond to changing market conditions and achieve productivity conunitments. A long-term facility modernization program will allow PM-USA to increase overall capacity and operational flexibility within existing plants while enabling Operations to maintain its ability to manufacture cigarettes whose quality is superior to the competition. CAPACITY STRATEGY PM-USA's domestic and export production requirements are projected to increase 34.4 billion units (12.0 percent) to 318.5 billion by 1992. The domestic forecast asstmles industry vo'luane will decrease 2.8 percent per year to 494.5 billion units in 1992 and that PM-USA's market share increases 9.4 share points to 47.2 percent. The export forecast reflects continued growth in Asian markets offset somewhat by a phased transfer of twelve billion units of export production to manufacturing facilities in Turkey beginning in 1989. PM-USA will supply cut filler initially, then blended strips for this production once it is transferred to Turkey. PROJECTED PM-USA PRODUCTION REQUIRIIMENTS (Billions of Units) 1988 1989 1990 1991 1992 • Sales Forecast Domestic 218.9 222.5 226.2 230.1 233.5 Overseas Military 2.7 2.6 2.5 2.4 2.3 Export 67.2 71.1 75.3 78.6 82.5 TC7I'AL * 288.8 296.2 304.0 311.1 318.3 • Production Allocation Manufacturing Center 120.6 126.4 129.6 126.8 136.8 Cabarrus 68.0 79.5 81.5 83.0 83.0 Louisville 67.3 64.7 65.8 69.9 67.6 Stockton Street 30.4 25.8 27.3 31.6 31.1 TOTAL* 286.3 296.4 304.2 311.3 318.5 * Sales do not match production due to inventory adjustments. I I G-1

I PM-USA's production allocation strategy takes advantage of each cigarette plant's unique characteristics to maximize productivity and overall manufacturing flexibility: • The Manufacturing Center utilizes rows of linked machinery (modules) and is designed for large and moderate volurre domestic and export production. Utilization of high speed equipment on high volume brands a11ow:- the plant to achieve low costs per unit of production and a high cigarettes per labor hour (CPLH). New brand introductions and promotional programs are allocated sparingly to the Manufacturing Center to minimize disruptions in the manufacturing process. The Manufacturing Center produces the majority of PM-USA's export vo1ume including the charcoal-filtered Lark brand for Japan. • Louisville is a multi-storied facility which manufactures moderate to large volume brands and some specialty brands. The cigarette mairufact-uritig process is flexible with stand-alone making and packing equipment. Some makers and packers are linked by a unique cigarette handling system that increases machinery utilization and flexibility. The use of this system will be expanded during the plan period. Shipping economies are realized by producing some brands at Louisville that are also manufactured at other factories. The plant produces over 60 percent of PM-USA's menthol production. • Cabarrus is PM-USA's newest and most efficient facility, utilizing high speed equipment in a mdular floor layout similar to the Manufacturing Center. The factory primarily manufactures high volume domestic brands and this contributes to its highest CPLH of any PM-USA plant. Currently, less than 10 percent of Cabarrus production is for export. Cabarrus will continue to provide the added capacity to acconm-cdate a portion of PM-USA's future sales growth. • Stockton Street is PM-USA's most flexible plant with respect to blending and production capabilities. The plant utilizes stand-alone making and packing equipment and has the capability to produce non-DBC tobacco blends. Stockton Street is best suited to manufacture small volume domestic and export brands, specialty packings, test market reauirements and new brand factory tests. Allocation of these more difficult production runs to Stockton Street enables the other plants to operate more efficiently, which contributes to a higher overall CPLH for PM-USA. G-2 I I I I I I I I I I I I I I I I I I

1987 PLANT CHARAC=STICS Manufacturing Center Cabarrus Louisville Stockton Street % of Total PM-USA Production 46.6% 19.9% 23.6% 9.9% % of Total PM-USA Export 64.1% 7.4% 11.7% 16.8% Number of Export Packi.ngs , Manufactured 201 57 197 392 Average Units Per Export Packing (Millions) 217.6 89.4 40.5 29.2 % of Total PM-USA Menthol 30.0% -% 62.5% 7.5% % of Total PM-USA Charcoal 52.1% 9.2% -% 38.7% % of Total PM-USA Box 49.8% 15.9% 21.8% 12.5% Percent of Making Speed 5,000 CPM or less 74% -% 100% 100% 6,000 CPM or greater 26% 100% -% -% CPM - Cigarettes Per Minute During the 1988-1992 Five Year Plan, each plant's allocation will be adjusted in concert with changing production requirements and enhancements in facility characteristics resulting from PM-USA's expansion and modernization program. Adjustments will be made to maximize efficiency and productivity, reduce the impact of increased manufacturing complexity and enhance overall flexibility. • The Manufacturing Center will continue to operate at full capacity with about 30 percent of the plant's production on large export orders. The number of brands produced at the Manufacturing Center will be reduced to maximize plant efficiency, CPLH and the length of production runs as new generation high speed equipmnt is installed. • Cabarrus' production allocation strategy will be similar to the Manufacturing Center's with a minimal number of brands produced in the plant. The facility is scheduled to reach full capacity during 1990. Export production, primarily large volume orders, will increase during the Plan to about 20 percent of the plant's capacity. • Louisville will continue to manufacture the majority of PM-USA's menthol products. Export volume will be reduced to about five percent of plant production (from the current 12 percent) and the number of donestic packings will be increased to leverage the plant's flexibility. Some reserve capacity will exist at Louisville.

• Stockton Street's production will continue to be weighted toward smaller export orders (about 50 percent of plant production), small volwne danestic brands, specialty packings and test market requirements. Reserve capacity will be used to respond to marketing opportunities arid balance incremental production scheduling requirements. Production Sensitivities The dynamics of the domestic and international cigarette markets could lead to significant deviations fran PM-USA's sales and production forecast. Events which could impact our forecast include excise tax increases, successful new product introductions, exchange rate fluctuations and the opening of new foreign markets. Operations has developed upside and downside scenarios to ensure that PM-USA can efficiently accmucdate deviations fran the Five Year Plan forecast. PRODUCTION SCENARIOS lPBIDE SCEliWIO BASE CA8E DOIfiBIDE StOaiAR20 350 BILLIONS OF UtiITB 930 910 301 270 + 284.1 288.8 288.8 324.3 304.0 280.2 334.0 311.! 343.3 318.3 270.6 289.8 2501 1887 19S i989 1D90 1991 1992 The upside scenario reflects a 2.0 percent annual decline in the domestic market ccnipared to a 2.8 percent decline in the Plan forecast. PM-USA's market share growth is the sane as the Plan forecast, reaching 47.2 percent by 1992. Export sales are assumed to increase due to greater penetration of Asian markets, a weak dollar and continued export production to Turkey. 314.6 296.2 289.8 G-4

In the upside scenario, PN-USA's total domestic and export sales increase to 343.3 billion units by 1992, eight percent higher than the Five Year Plan forecast. Alternatives are being developed to meet this higher production including opportunities to free-up floor space for additional production at Louisville and Stockton Street as well as additional module installations and alternative work schedules at Cabarrus. Overtime would also be used, as necessary, to fulfill production requirements. The downside scenario reflects a downward adjustment in domestic industr,,T volume due to a Federal Excise Tax increase in 1989 and a slight reduction in PM-USA' s market share growth. Export requirements decline due to the shift of production to Turkey, unfavorable exchange rates and the opening of manufacturing facilities in Japan. In the downside scenario, total domestic and export sales decrease to 269.8 billion units in 1992, down fifteen percent from the base forecast. Initially, this scenario would result in a production cutback at all manufacturing facilities and a reduction in planned production days. Further declines would be handled by reducing the number of shifts at Stockton Street and reallocating the plant's production to other facilities. As the volume shortfall approached Stockton Street's capacity (35 billion units per year), the plant would probably be closed and with rrodifications required at other facilities to accommodate Stockton Street's small volutne brand allocation. Flexibility In addition to our growing production, PM-USA rrrast acconmcdate an increasing number of packings as our presence expands in both the price/value category and export markets and new market segnents emerge. Achieving PM-USA's volume goals may require products targeted for small segments, technologically-advanced cigarettes and innovative packaging -- all of which place a premium on manufacturing flexibility. This strategy, in combination with the implementation of PM-USA's modernization plans, will result in a more complicated production environment, requiring greater sophistication in machingery changeovers, material handling and tobacco blending as well as cut filler storage and delivery. The growing importance of smaller volume domestic and export products results in shorter production runs and has led to an increasing amount of machinery downtime to perform brand changeovers. PM-USA is working to reduce changeover dawntime by increasing machine part interchangeability, improving material and product handling systems, and standardizing product specifications which do not impact each brand's unique attributes. Some new products utilize unique (non-DBC) leaf blends that often require dedicated processing equipment, special processing parameters and reduced throughput speeds. PM-USA is working to standardize these blends where possible without sacrificing taste, quality or the unique characteristics desired by consuners. As a result, standard leaf blends have been developed for products in the Japanese markets and for mentholated brands.

Other strategies that will be pursued to increase overall production flexibility include: • Cross-training production workers to increase their knowledge and skills and make them nmore responsive to changes in machinery configuration. •Enhancing in house expertise to modify cigarette fabrication equipment for different brands and specifications and facilitate brand changeovers. • Consolidating job classifications and improving work rules through labor negotiations. •Encouraging participation in employee involvement programs to strengthen this source of problem solving and creativity. PRODUCTIVI'I'i' STRATEGY PM-USA's historical commitment to modernization has led to continued advances in manufacturing productivity. Investments in new manufacturing technology during the mid-1970's to early 1980's have increased PM-USA's productivity by 65 percent since the opening of the Manufacturing Center in 1973 -- as measured by cigarettes per labor hour. These advances resulted in equipment which operates at production speeds of 5,000 to 7,200 cigarettes per minute (cpn) cantpared to production speeds of 2,500 to 4,000 cpm for the previous eauipment generation. PM-USA began embarking on an expansion and modernization program in 1986 to further increase the capacity and productivity of our manufacturing facilities. PM-USA has worked with several equipment suppliers to develop a new generation of equipment that satisfies our stringent recrn,;rements for safety, quality, speed, flexibility and efficiency. As a result, PM-USA can now buy new equipment in a ccxrtpetitive environment with additional leverage obtained through the combined procurement of Philip Morris' worldwide equipanent needs. The moddernization program will be implemented during the entire Five Year Plan period and will result in substantial changes to PM-USA's cigarette plants -- particularly the Manufacturing Center and Cabarrus. G-6

I I I I I I I I I I I I I I I I I I I PM-USA's modernization strategy calls for each of the Manufacturing Center's five manufacturing bays to be modernized during the Plan (one bay per year). All modules in Bays One through Four will be replaced with new generation (9,000 cgn or higher) equipment. Utilities distribution and support systems for cut filler delivery, filter making and delivery, material handling and carton handling will also be upgraded. Bay Five modernization (the Manufacturing Center's charcoal production bay) will be achieved by iwdifying existing modules to operate at higher speeds and by improving manufacturing support systems. This modernization will result in increased capacity at the Manufacturing Center to about 140 billion units from the current 125 billion. At Cabarrus, an additional six modules (formerly Manufacturing Center modules rebuilt and upgraded to 8,000 cpm) will be installed in floor space available in the plant's two manufacturing bays and six 9,000 cpm modules will be installed in the filter making area. In subsequent years, all existing modules will be accelerated to 8,000 cpm to increase production capacity to 85.0 billion units per year. (Cabarrus produced 56.5 billion cigarettes in 1987.) Factory support systems will be upgraded as required. Louisville and Stockton Street will increase packing speeds by upgrading existing equipment or replacing equipment with 8,000 cpm G.D packers upgraded during the normal rebuiid/replace.na--nt cycle. The Manufacturing Center modernization will provide additional machinery to allow these plants to continue improving productivity beyond the planning period by replacing older generation equipment with upgraded makers and packers. Primaries and support systems will be improved in accordance with changes in production mix and additional capacity and flexibility needs. PM-USA will implenment several projects during the Plan to improve productivity in our tobacco processing operations. Expanded tobacco production has begun at Cabarrus allowing Richmond's Westab ET plant to be closed. This move provided additional employees for Stockton Street to increase production in 1988. The Louisville Stemnery has been closed to reduce overall stemming costs and provide additional employees for the Louisville cigarette facility to maintain production at about 65 billion units per year. The Oriental processing lines at the Richmond Stenvery will be reconfigured to reduce processing costs. Additional floor space provided from the reconfiguration could be used to increase stenining capacity in the future. Finally, alternatives are being evaluated to eliminate weekend production at the Blended Leaf plant in Richmond. It is currently projected that PM-USA's modernization program will require a total capital investment of ~415 million during the Plan. The modernization will lead to growth in cigarettes per labor hour and labor savings which exceed the comnitments in last year's Plan. Composite CPLH is forecasted to increase 21.3 percent to 19,400 in 1992. CPLH growth will be most dramatic at the Manufacturing Center, where this productivity measure is expected to increase 42 percent above the 1987 level. PM-USA's projected CPLH growth for each plant is shown on the following page. This growth is based on the current production allocation and the achievement of planned labor savings and efficiency goals. G-7

CIGARETTES PER LABOR HOUR 1980-1992 35 TNO NS 30+ ~---~ 25 ' 20+ 15+ 10 5+ de 10 ` .00, ~ / -_r •\. .~-. ~ ~ cABAFFtjs Ws. CENTER COMPOSITE LOUISVILLE STOCKTON STREET ( i I i i 1 F -1 -i 1 i 1 F- i ~980 1982 1984 1986 1988 1990 1992 Labor Savings The medernization program will contribute to a planned five year labor savings of 1,115 people, 23 percent above the level forecasted in last year's Plan. These savings result from Manufacturing and Engineering wmrking to accelerate productivity gains while integrating new processes to improve quality, safety and flexibility. Other major labor savings projects during the plan period include: • Improved filter handling at the Manufacturing Center and Louisville. • Installation of additional maker/packer tray handling linkups at Louisville. • Installation of G.D carton overwrappers at Louisville to enhance export flexibility and modernize a labor intensive overwrapping operation. PZANNED FIVE YEAR LABOR SAVIlNGS Approved Projects People N.edernization 228 Cigarette Handling 21 Filter Handling and Delivery 126 I G.D Overwrappers 21 Planned Projects 719 Total Labor Savings 1,115 G-8 ... ~._.. I I I I I I I I I I I I I I I I

I I I I I I I I I I I I I I I I I I PM-USA will work with our unions, including the Bakery, Confectionery and Tobacco Workers International Union, to build a foundation for future negotiations based on the spirit of cooperation fostered by the Long-Term Agreenlent. These efforts will allow us to expand upon the labor savings derived from the r:bdernization program and other projects. We will work to achieve labor's support for improved manufacturing productivity and flexibility while securing favorable labor complements, fewer job classifications, work rule improvements and modified benefit plans. EFFICIENCY Meeting PM-USA' s increased production requirements and productivity goals are also dependent on attaining optiirnun machinery efficiency for both new and existing equipment. Despite the disruptions resulting from the modernization program, Operations' five year objective is to increase coniposite production efficiency by at least three percentage points above the 72.7 percent level achieved in 1987. Reducing the number of, and the tine required for, brand changeovers is an important element of increasing manufacturing efficiency. Strategies being used to minimize the impact of brand changeovers include consolidation of PM-USA's largest volume brands at the Manufacturing Center and Cabarrus, predicting demand for small volume domestic and export brands so that Manufacturing can produce sufficient quantities for inventory and standardizing specifications that do not affect unique brand attributes. Engineering and Manufacturing work with equipment suppliers to improve the safety, quality and efficiency of existing equipment and to define and conm=icate design improvements needed for new generation equipment. Ectuipment modifications are evaluated in the plants and incorporated on existing machinery through the in-house standardization program and the cyclical rebuild/replacement program. One important goal during the Plan will be to produce charcoal filtered brands at the same speeds and efficiencies as standard filtered brands. The ability of employees to properly operate and maintain increasingly sophisticated equipnpant is critical to achieving efficiency objectives. A new generation production nodule will be installed in the Training Center to facilitate instruction and competency evaluation prior to assigning production employees to new equipment. Advanced training programs for fixers and craft employees are of particular importance since the new generation equipment requires precise mechanical adjustnients and incorporates state-of-the-art computerized electronics. Programs designed to enhance the technical knowledge of production supervisors will be continued for all generations of equipment. In addition, new generation equipment incorporates more efficient devices for loading and splicing materials and enhanced diagnostics to increase efficiency through proactive operator responses and improved trouble-shooting information. Other strategies that will continue to be employed to increase machinery efficiency include: • Maintaining a proactive quality assurance program to identify and correct problems that create defects and downtime. • Improving in-house preventive maintenance programs.

I • Iinproving cigarette and carton handling equipnv--nt to reduce module doumtime. • Negotiating more favorable qualification and competency standards for key job classifications. An important elenent in maximizing PM-USA's manufacturing efficiency, productivity and flexibility while achieving our five year objectives for Operations will be the increasing utilization ~-)f the resources provided by the Information Systems area. During the plan period, I.S. will work with Operations to: • Increase our application off new technologies such as magnetic encoding, electronic message systems, bar code scanning, artificial intelligence and computer-aided software engineering. • Improve manufacturing quality and productivity through increased integration of production information systems in the areas of materials managenent, production forecasting and product specifications. • Provide a work-in-progress information system for the processing plants. • Optimize direct materials inventory levels through improved on-line access to production and product distribution data. • Support Operations' efforts in plant modernization and new process developmnt. G-10 I I I I I I I I I I I I I I I I I I

HUMAN RESOURCES 2043774458

I I I I I I I I I I I I I I I I I I I HUMAN RESOURCES OPERATING ENVIRON= PM-USA's operating environnent, and the company's responses to it, have a direct and significant impact on our work force. The continuous flow of adverse publicity regarding cigarettes, restrictive legislation, litigation activities and attempts to increase excise taxes have created uncertainty regarding the future of the industry. One impact already felt is an increased difficulty in recruiting top quality talent with the primary candidate concerns being working for a cigarette company and doubts as to the future of tobacco. As perceptions about the cigarette industry evolve and our organizational growth slows, we are also faced with the challenge of maintaining current employee morale and effort at levels necessary to maximize productivity. PM-USA's historical reputation as a growth company was responsible for attracting much of our current talent. This, in combination with our prior ability to provide more rapid advancement, has led to employee expectations which will be nbre difficult to satisfy in the future. We must, however, continue to provide our younger talent with the growth opportunities and career nobility necessary to identify and broaden the next generation of senior managers. It is important that senior management throughout the organization communicate regularly with employees as to the state of the industry and our business results. These commanications go a long way toward enhancing job performance by making employees feel that they are part of an organization with considerable upside potential. Furthermore, enthusiasm and motivation are increased when employees understand the direction of our business strategies and how their individual contributions play a role in these strategies. Employees also need positive reinforcerrent to counter-balance negative attacks froin outside groups. Meetings, such as those periodically held for the sales force, serve to bring our people together, place them in a position to receive encouragerrent, and allow them to feel important and appreciated by the company. Similar neetings should be utilized to provide positive reinforcement and communications at the regional, local, functional and departnental levels. Within the sales force, changes have been implemented to give new hires greater knowledge and enthusiasm about the company. Sales force orientations are now conducted in Richmond rather than at regional sales offices. By providing in4rediate exposure to the scope, size and professionalism of our company and employees, these new hires can draw on this knowledge and pride while on the job and when they encounter negative attitudes and comments from the outside conxnunity. H-1

We also need to provide our work force with more education and information regarding smoking and tobacco issues, particularly the environmental tobacco smoke controversy. Frequent dissemination of factual materials enables employees to feel more canfortable as individuals, and also allows them to respond intelligently and effectively to external attacks they encounter. In addition, broader corcnnunication of available facts in the smoking controversy serves to improve employee confidence about the challenges facing our business. Within PM-USA, we must continue our efforts to redeploy our wrk force. Redeployment and transfer of employees within PM-USA has proven to be an important source of talent to the company and a key avenue for individual career progression. In recent years, the frequency of transfers between Richmond and New York for positions in Finance, Employee Relations, Marketing and Operations has been increasing. Our efforts in these areas should be strengthened to continue this resource pool as well as provide talented, younger employees with the message that career opportunities will continue to exist. One obstacle to th is approach is the high cost of relocation. Moves to the New York Office are particularly problematic because of the cost of housing in the area. Rejection rates for these moves are increasing because many middle management and professional employees are financially excluded from the housing market within a 50 to 60 mile radius of the city. We have, however, developed alternatives for special housing assistance for employees being relocated to New York City to make this career option more viable. COMPETITIVE RESPONSES The evolution of PM-USA's business strategies requires changes in the way our employees perform their jobs. For example, increases in the number of packings we market leads to a more complex operational mix for Manufacturing, with shorter, more frequent production runs becoming more conmon. Research and Development carries a heavier burden for product and technological development, while Engineering must develop the technological capability to accomnod.ate an ever-growing rnunber of unique production requirements. As PN-USA's retail mission expands, the sales organization is being called upon to perform an increasing variety of activities. While technological improvements enable us to manufacture nbre cigarettes with the same or fewer employees, many of our strategies require that we increase our efforts in some people-intensive activities. Over the past five years, we have increased the number of our packings by over 50 percent, our event promotions have dramatically increased and the number of product incentives has more than doubled. Couponing, which we did not do five years ago, has become an important marketing tool, especially for price/value products. PM-USA's price/value efforts have also led to an entirely new class of inerchandising vehicles for this segment. Finally, brand introductions and test markets -- also labor intensive -- have increased, and it is projected that this trend will continue. H-2 I I I I I I I I I I I I I I I I I I

I I I I I I I I I I I I I I I I I I I Given these strategies, the co=nly heard perspective of "more with less" does not apply to all facets of our business. The recent reorganization and expansion of the sales force -- which included the creation of the Senior Account Manager position to focus on our larger accounts and the Manager of Planning Analysis position in each Sales Section -- reflects the need for more intensified field efforts. Recognizing the greater -lemands being placed on Marketing and Sales -- while trying to improve productivity and control costs -- has led to the exploration of staffing alternatives in the sales force. One of the options under study is the use of more part-time employees to perform some of the non-selling activities currently handled by sales representatives. For example, stock rotations and point-of-sale placements could be handled by part-timers, which would give our professional sales people more time to work with customers. TRAIr1ING AND MANPOWER DEVE.L.,OPMENT Competitive pressures dictate that we increase productivity throughout the organization to support profit objectives. While capital expenditures on facilities and equipment provide the foundation to achieve productivity improveme.nts, these gains are optimized through better human resource management. PM-USA management has negotiated an extension of the Long-Term Agreement with all bargaining units through 1994. This positions us to continue using new high speed equiFnent as it becomes available and upgrade employee skills through intensive training, while avoiding costs and other disruptions associated with labor strikes. Our comnitment to manufacture even higher quality cigarettes and reduce production costs will continue to be supported by the integration of state-of-the-art technology throughout the manufacturing process. Introduction of new technology -- whether it is designed to improve quality, productivity, customer service or managenent information systems -- requires that we direct resources to provide employees with the skills necessary to fully utilize that technology. The ability of employees to properly operate and maintain sophisticated equipmsnt will play a crucial role in achieving quality and productivity targets. A Labor Relations Strategic Plan has been developed to define how PM-USA's long-term strategies will impact the hourly wc~rk force during the next two rounds of basic contract bargaining. Specific strategies included in this Plan incorporate changes which support PM-USA's long-term objectives. Major issues addressed in the Plan include: 1) upgrading the skill level of the current work force, to accounod.ate the introduction of new technology and to maximize operating efficiencies; 2) achieving productivity savings through both reduced labor hours per unit of production and containnent of cost per labor hour; and 3) securing greater flexibility to enhance manufacturing responsiveness within the plant environment. H-3

I PM-USA is developing intensive training programs to enhance the technical competency of key employees throughout the manufacturing process. Current efforts are focused on first-line supervisors, machinery fixers and operators. Working together, Employee Relations and Manufacturing have designed a structured approach to determine critical job skills, evaluate competency levels and develop training programs which correct deficiencies. Management recognizes the tine conmi.tment required for these technical programs and is developing schedules ':o accontrlodate them. The following steps have been taken to improve the technical skills of key manufacturing employees: • An assessaTient of supervisors in Richmond and Louisville during 1985 identified critical training needs in the areas of equipment knowledge and people management. Training programs were initiated in 1987 to address these needs. • rollow-up training for fixers, initiated in 1986, focuses on the critical tasks to repair the fixer's primary machine. Longer-term, fixers will be trained on additional machine types to enhance overall operational flexibility. • Operator follow-up training, begun in 1985, utilizes on-line observation to assess machine knowledge and training needs. • Extensive efforts are underway to develop technical training programs for supervisors, operators and fixers selected to staff each bay of the Manufacturing Center as new high speed making and packing equipment is installed. The complexity of this new equipment dictates that extensive changes be made in how we select and prepare employees to operate and maintain it. • A multicraft concept, implemented in late 1986, provides additional flexibility in assigning craft employees. This concept combines the electrician and instri.mient servicemen crafts into "instrLurent electricians" and the machinist, welder and millwright crafts into "maintenance mechanics". Extensive cross-training, begun in 1987, will ensure that PM-USA realizes the full benefit of this negotiated change. • A $4. 8 million technical train; _ng facility was constructed at the James River Center complex to accomnodate PM-USA's expanded training requirements. This facility contains training machinery, classrooms and office space to support instruction on a wide variety of new and old generation equipnent. The new facility provides twice the space previously available for technical training in Richmond. H-4 I I I I I I I I I I I I I I I I I I

I ' We are also continuing to improve our training, development and management succession programs within Sales, Marketing and Operations, with the following ' initiatives under way: I I I I I I I I I I I I I I • Use of an assessrrent center process to identify candidates for Senior Account Manager positions in the sales force. The assessment process provides objective information upon which to base candidate selection and also provides feedback as to critical individual needs around which tailored training programs can be structured. In the future, the assessment process will be used to assist in filling manager level positions. • Implenentation of a Htunan Resource Planning and Evaluation System throughout the sales force. In combination with the assessment process discussed above, this system will be used to identify high potential employees, establish development plans and plan possible next assignments. • Implementation of a revised performance appraisal process in which specific job objectives, accanplishments versus objectives, work skills and job-related traits are specifically cammunicated. • Development of a middle management training program in Operations. A three-tiered task force (incLunbent, supervisors and subordinates) was used to identify the skills and abilities critical to managerial success. Smpleatientation will begin in early 1988. • Development of a cross-functional job rotation program for mid-level supervisors and professionals to broaden their knowledge and provide a foundation for future advancement. These neasures serve to enhance caryrnanication with employees regarding expectations, strengths, weaknesses and avenues for improvement. Additional training programs targeted for specific positions or skills will also be continued during the plan period. ~ 4~ s'a 4 .,~ 4W H-5 ~ ~