Tobacco Documents Online

a Philip Morris Companies Inc. FORM 10-K Annual Report to the Securities and Exchange Commission for the Year Ended December 31, 1989

r t f SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) 0 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1989 OR D TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE AGT OF 1934 [NO FEE REQUIRED] For the transition period from to Commission file number 1-8940 Philip Morris Companies Inc. (I'xact name of registrant aa 3pec.ified ii its cLarter) Virginia 13-3260245 (State or other jurisdiction of (I.R.S. Empioyer ldmtiflcatioi No.) incorporatios or orgaaizsbio.) 120 Park Avenue, New York, N.Y. 10017 (Address of principsd e:ecvtire o~'icea) (tig C.ode) Registrant's telephone number, 9ncluding area code: 212-880-5000 Securities registered pursuant to Section 12(b) of the Act: Name of each ezc]a'ge on Titie of eacb class which registered Common Stock, $1 par value New York Stock Exchange Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes V No At February 1, 1990, the aggregate market value of the shares of Common Stock held by non-affiliates of the registrant was approximately $35.1 billion. At such date, there were 927,265,834 shares of the registrant's Common Stock outstanding. Documents Incorporated by Reference Portions of the registrant's annual report to stockholders for the year ended December 31, 1989 are incorporated in Item 1 of Part I, Part II and Part IV hereof and made a part hereof. The registrant's definitive proxy statement in connection with its annual meeting of stockholders on April 26, 1990, filed with the Securities and Exchange Commission, is incorporated in Part III hereof and made a part hereof.

PART I Item 1. Business. General Description of Business General Philip Morris Companies Inc. is a holding company whose principal wholly-owned subsidiaries, Philip Morris Incorporated, Philip Morris International Inc., Kraft General Foods, Inc. and Miller Brewing Company, are engaged primarily in the manufacture and sale of various consumer products. A wholly-owned subsidiary of the Company, Philip Morris Capital Corporation ("PMCC"), formerly Philip Morris Credit Corporation, engages in various financing and investment activities. A wholly-owned real estate subsidiary of PMCC, Mission Viejo Company ("Mission Viejo"), formerly Mission Viejo Realty Group Inc., is engaged principally in land planning, development and sales. As used herein, unless the context indicates otherwise, the term "Company" means Philip Morris Companies Inc. and its subsidiaries. The Company is the largest consumer packaged goods company in the world. Philip Morris Incorporated ("Philip Morris U.S.A."), Philip Morris International Inc. ("Philip Morris International") and their subsidiaries and affiliates are engaged primarily in the manufacture and sale of tobacco products (mainly cigarettes). Philip Morris U.S.A. is the largest cigarette company in the United States and Philip Morris International is the leading United States exporter of cigarettes. Their principal brand, Marlboro, has been the world's largest selling cigarette brand since 1972. Through its foodd subsidiary, Kraft General Foods, Inc. ("KGF'), the Company is the largest processor and marketer of packaged grocery, coffee, cheese and processed meat products in the United States. A wide variety of similar products is manufactured and marketed by the Company in Europe, Canada, Latin America and the Asia/Pacific region. Food products are sold under more than 62 major brand names. KGF also conducts foodservice businesses and sells food ingredients. KGF resulted from the merger on December 30, 1989, of General Foods Corporation, acquired in 1985, into Kraft, Inc., acquired on December 7, 1988. From March 1, 1989, until the merger, the Company's food operations were conducted by General Foods Corporation and Kraft, Inc. under the management responsibility of the Kraft General Foods Group. Miller Brewing Company ("Miller") is the second largest brewing company in the world. Source of Funds - Dividends Because the Company is a holding company, one of its principal sources of funds is dividends from its subsidiaries. The Company's principal wholly-owned subsidiaries currently are not limited by long-term debt or other agreements in their ability to pay cash dividends or make other distributions with respect to their common stock. Industry Segments Tobacco products (of which cigarettes accounted for 40% of the Company's operating revenues in 1989 as compared with 52% in 1988), food products and beer represent the Company's significant industry segments. Operating revenues, operating profit (together with a reconciliation to operating income) and identifiable assets attributable to each such segment for each of the last three years are set forth in a note to the consolidated financial statements on page 44 of the Company's annual report to stockholders for the year ended December 31, 1989 and are incorporated herein by reference and made a part hereof. Operating profit from tobacco operations was approximately 72% of the Company's total operating profit in 1989 compared with 84% in 1988, of which Philip Morris U.S.A. and Philip Morris International contributed 51% and 21%, respectively, in 1989 and 67% and 17%, respectively, in 1988. Food products accounted for approximately 22% of the Company's operating profit in 1989 and 9% in 1988, and beer accounted for approximately 3% of operating profit in 1989 and 4% in 1988. Operating revenues and operating profit from food products reflect Kraft, Inc. results since its acquisition by the Company. 1

Narrative Description of Business Tobacco Products Philip Morris U.S.A. is responsible for the manufacture, marketing and sale of tobacco products in the United States (including military sales) and Philip Morris International is responsible for the manufacture, marketing and sale of such products outside the United States and for tobacco product exports from the United States. Domestic Tobacco Products In 1989, Philip Morris U.S.A.'s total sales of cigarettes amounted to 219.5 billion units, an increase of 0.2 billion units over 1988. The industry's estimated cigarette sales in the United States decreased by 6.1% in 1989 as compared to 1988, following a decrease of 2.1% in 1988 as compared to 1987. The following table sets forth, based on shipments, the industry's estimated cigarette sales in the United States, Philip Morris U.S.A.'s unit sales and its share of industry sales. Export and military sales have been excluded in all cases: Philip Morris Years Ended PLffip Morris U.S.A. Share December 31 Yndnstry (a) U.S.A. .f Indnstry (a) (ia biIIios of iaita) (%) 1989 ..................................... 523.9 219.5 41.9 1988 ..................................... 558.1 219.3 39.3 1987 ..................................... 570.4 215.6 37.8 (a) Source: Wheat, First Securities, Inc. (John C. Maxwell, Jr.) Philip Morris U.S.A.'s increase in market share and the industry decline in 1989 are both partly attributable to lower customer demand as well as a decision by Philip Morris U.S.A.'s largest competitor to reduce trade inventories below year-end 1988 levels by limiting shipments. Philip Morris U.S.A.'s market share increase is attributable in part to this reduction of trade inventories and may be inflated by as much as one share point. The 1989 market share information set forth below also reflects this reduction. According to The Maxwell Consumer Report issued by Wheat, First Securities, Inc., Philip Morris U.S.A. has been the leading cigarette company in the United States market since 1983. Philip Morris U.S.A.'s major cigarette brands are Marlboro, Benson & Hedges 100's, Merit and Virginia Slims. Marlboro is the largest selling brand in the United States with unit sales of 138 billion units in 1989, approximately 26.3% of the United States market. In 1989 and 1988, the market share of low "tar" cigarettes, generally considered to consist of cigarettes delivering 15 mg or less of "tar" per cigarette, accounted for 54.7% and 56.1% of United States industry sales, respectively. Philip Morris U.S.A.'s low "tar" brands accounted for 43.6% of such market in 1989, up from 39.4% in 1988. Sales of ultra-low "tar" cigarettes, generally considered to consist of brands delivering 6 mg or less of "tar" per cigarette, accounted for 11.3% of United States industry sales in 1989 and 10.8% in 1988. Philip Morris U.S.A.'s ultra-low "tar" cigarette brands accounted for 33.1% of such market in 1989, up from 32.2% in 1988. Sales in the price-value category, which consists of "generic" and lower-priced cigarettes, have grown markedly in recent years, constituting 14.8% of United States industry sales in 1989, up from 11.1% in 1988. Philip Morris U.S.A. commenced the manufacture and sale of its lower-priced cigarette brands in 1985 with Players Lights 25s and introduced Cambridge in 1986 and Alpine in 1989. Philip Morris U.S.A.'s cigarette products accounted for 23.2% of that market segment in 1989, up from 21.0% in 1988. Excise taxes, sales taxes and other taxes levied by various states, counties and municipalities affecting cigarettes have been increasing. These taxes vary considerably and, when combined with the federal 2

excise tax, may be as high as 69 cents per package of 20 cigarettes. In the opinion of the Company, such increases have an adverse effect on sales. International Tobacco Products Philip Morris International estimates that world cigarette industry unit sales (excluding the United States) were approximately 4.8 trillion units in 1989. Philip Morris International's share of the world market in 1989 was 7.5%, up from 7.2% in 1988. Unit sales of its principal brand, Marlboro, increased 9.4% in 1989 over 1988 to 182 billion units, accounting for 3.8% of the world cigarette market (excluding the United States). Philip Morris International has cigarette market shares of at least 15% - and in a number of instances substantially more than 15% - in at least 25 countries, including Argentina, Australia, Finland, France, the Federal Republic of Germany, Hong Kong, Italy, Mexico, Saudi Arabia and Switzerland. Philip Morris International is the leading United States exporter of cigarettes. It exported 78 billion units in 1989, an increase of 13.4% from 1988. Prices in many of Philip Morris International's markets are government-controlled, and excise and other tax increases, higher costs and government price restraints in a number of markets have restricted, and may continue to restrict, the sales and income of Philip Morris International. In December 1989, a subsidiary of Philip Morris International sold its ownership of approximately 29% of the equity of Rothmans International p.l.c. to a subsidiary of Compagnie Financiere Richemont AG for £610 million of 101/4% Sterling Notes maturing in 1994. These Notes were subsequently sold with recourse for approximately $850 million. Smoking and Health and Related Matters Reports with respect to the alleged harmful physical effects of cigarette smoking have been publicized for many years and, in the opinion of the Company, have had and may continue to have an adverse effect upon tobacco industry sales. Since 1964, the Surgeon General of the United States and the Secretary of Health and Human Services have released a number of reports purporting to link cigarette smoking with a broad range of health hazards, including various types of cancer, coronary heart disease and chronic lung disease, and recommending various governmental measures to reduce the incidence of smoking. The two most recent reports, released in 1988 and 1989, repeat many of the earlier conclusions regarding the alleged health hazards of smoking, recommend additional restrictions on smoking, and focus upon the purported addictive nature of cigarettes, the prevalence of smoking among different population segments and the decrease in smoking in the United States. Federal legislation requires cigarette manufacturers and importers to include the following warning statements in rotating sequence on cigarette packages and in advertisements: SURGEON GENERAL'S WARNING: Smoking Causes Lung Cancer, Heart Disease, Emphysema, And May Complicate Pregnancy; SURGEON GENERAL'S WARNING: Quitting Smoking Now Greatly Reduces Serious Risks to Your Health; SURGEON GENERAL'S WARNING: Smoking By Pregnant Women May Result in Fetal Injury, Premature Birth, And Low Birth Weight; and SURGEON GENERAL'S WARNING: Cigarette Smoke Contains Carbon Monoxide. Such legislation also covers the size and format of warnings in cigarette advertising and prescribes a modified version of the warnings for outdoor billboard advertisements. In addition to the warning statements, cigarette advertising in the United States includes a disclosure of the average "tar" and nicotine deliveries of the advertised brand or variety. Cigarette manufacturers and importers are also required to provide annually to the Secretary of Health and Human Services a list of ingredients added to tobacco in the manufacture of cigarettes, and the Secretary is directed to report to Congress concerning the health effects, if any, of such ingredients. A majority of Philip Morris International's cigarettes are sold in countries where warning statement requirements for cigarette packages have been adopted. 3

Another federal statute established the Interagency Committee on Cigarette and Little Cigar Fire Safety to direct the work of a Technical Study Group created by the same statute and to make policy recommendations to Congress. The Technical Study Group, which consisted of representatives of designated government agencies, the tobacco and furniture industries and various other organizations, studied the feasibility and consequences of developing cigarettes and little cigars that would have a minimum propensity to ignite upholstered furniture or mattresses. Based on this research, the Interagency Committee submitted its final technical report to Congress in December 1987, which contained the conclusion of the Technical Study Group that it is technically feasible and may be commercially feasible to develop cigarettes that will have a significantly reduced propensity to ignite upholstered furniture and mattresses. The Interagency Committee recommended that legislation be adopted to facilitate additional research guided by a new scientific Advisory Committee. Since 1971, television and radio advertising of cigarettes has been prohibited in the United States. Enactments by regulatory agencies and other governmental authorities have restricted or prohibited smoking areas aboard certain common carriers, in certain public places and in places of employment. As of February 25, 1990, smoking was banned on all commercial airline flights within the 48 contiguous states and all domestic flights to or from Alaska and Hawaii scheduled for more than six hours. Numerous other legislative and regulatory measures have been proposed at the federal, state and local levels which, if implemented, could adversely affect Philip Morris U.S.A.'s cigarette business. The most significant of such measures would increase federal, state or local taxes on cigarettes, further restrict cigarette advertising and promotion, and further restrict or prohibit smoking aboard common carriers or in public places or places of employment. A number of foreign countries have also taken steps to restrict or prohibit cigarette advertising and promotion, to increase taxes on cigarettes and to discourage cigarette smoking. In some cases, such restrictions are more onerous than those in the United States. Litigation is pending against the leading United States cigarette manufacturers seeking compensatory and, in some cases, punitive damages for cancer and other health effects alleged to have resulted from cigarette smoking. Philip Morris U.S.A. is a defendant in some of these actions. It is not possible to predict the outcome of this litigation. Litigation is subject to many uncertainties and it is possible that some of these actions could be decided unfavorably to Philip Morris U.S.A. An adverse development in pending litigation could encourage the commencement of additional similar litigation. All such actions are and will be vigorously defended. However, management does not believe that this litigation will have a material adverse effect upon the financial condition of the Company. As of March 1, 1990, 57 such actiQns against the leading United States cigarette manufacturers were pending, as compared to 61 such actions pending as of December 31, 1989 and 80 such actions pending as of December 31, 1988. Philip Morris U.S.A. was a defendant in 28 of such actions pending as of March 1, 1990, as compared to 31 such actions as of December 31, 1989 and 39 such actions pending as of December 31, 1988. Distribution, Competition and Raw Materials Philip Morris U.S.A. sells its tobacco products principally to wholesalers (including distributors and government-owned organizations), large retail organizations and vending machine operators. Philip Morris International markets cigarettes and other tobacco products worldwide through subsidiaries, affiliates, export sales organizations, licensees and other entities with which it has contractual arrangements. The market for tobacco products is highly competitive, with product quality, marketing and packaging constituting the principal methods of competition. Philip Morris U.S.A. and Philip Morris International extensively advertise and promote their tobacco products through various media, although television and radio advertising of cigarettes is prohibited or restricted in many countries, including the United States. Promotional activities include, in certain instances, price reductions, allowances and other discounts. Philip Morris U.S.A. and Philip Morris International purchase leaf tobacco of various grades and types each year, primarily at auction. The tobacco is then graded, cleaned, stemmed and redried prior to its storage for aging up to three years. Large quantities of leaf tobacco inventory are maintained to support cigarette manufacturing requirements. 4

Tobacco is an agricultural commodity subject to United States government controls, including the tobacco price support and production adjustment programs administered by the United States Department of Agriculture (the "USDA"). Under a federal price support program enacted in 1986, tobacco production quotas were adjusted and Philip Morris U.S.A. and three other United States cigarette manufacturers agreed to buy over a period of several years more than 1.1 billion pounds of surplus tobacco accumulated by tobacco grower cooperatives from 1976 to 1984. Philip Morris U.S.A. has substantially fulfilled its obligations under the program. The effect of the program was a moderate reduction in prices paid by Philip Morris U.S.A. for leaf tobacco and a moderate and temporary increase in its leaf tobacco inventory, which has been subsequently adjusted to appropriate levels. Food Products KGF consists of seven operating units: (i) General Foods USA, responsible for General Foods domestic packaged grocery products and coffee businesses; (ii) Kraft USA, responsible for Kraft domestic dry grocery foods and refrigerated foods businesses; (iii) Kraft General Foods International, responsible for all General Foods and Kraft businesses outside the United States and Canada; (iv) Kraft General Foods Canada, responsible for all General Foods and Kraft Canadian businesses; (v) Oscar Mayer Foods, responsible for domestic processed meat and poultry products businesses; (vi) Kraft General Foods Frozen Products, responsible for domestic frozen foods and cultured dairy products businesses; and (vii) Kraft General Foods Commercial Products, responsible for domestic foodservice and food ingredients businesses. GErrFRAL FooDs USA. General Foods USA is one of the largest processors and marketers of packaged grocery products and is the largest processor and marketer of coffee in the United States. Its principal brands include Maxwell House, Yuban, Sanka, Brim, Maxim and General Foods International coffees, Jell-O and D- Zerta desserts, Post cereals, Log Cabin syrups, Kool Aid, Tang; Crystal Light and Country Hme beverages, Entenmann's and Freihofer's bakery products, Oroweat specialty breads, Minute rice, Stove Top stuffing, Shake'n Bake coatings, Good Seasons salad dressings and Dream Whip topping. KxaFr USA. Kraft USA's principal products include cheese and related products; vegetable oil-based products, such as salad dressings and related products; margarine and margarine-type spreads; barbecue sauce; confections; fruit spreads, jellies and preserves; packaged pasta dinners; and dips. In addition to Kraft, its principal brands include Velveeta, Cracker Barrel and Churny cheeses, Miracle Whip salad dressing, Philadelphia Brand cream cheese, Cheez Whiz pasteurized process cheese spread, Seven Seas pourable dressings, Parkay and Chiffon margarines and Bull's-Eye barbecue sauce. KxAFr GnsrEx.A,t. FOODS IrrrsxxA'noxat,. Kraft General Foods International is responsible for manufacturing and marketing a wide variety of packaged grocery, coffee, cheese and processed meat products in Europe, Latin America and the Asia/Pacific region, and for the Company's international foodservice business. International brands include a wide variety of the products sold by General Foods USA and Kraft USA, as well as Gevalia, Hag and Saimaza coffees, Simmenthal meats, Mato Mato ketchup, Mirbcoli pasta dinners, Dairylea processed cheese, Hollywood chewing gum and Kibon ice cream. The international foodservice business markets coffee and grocery products to restaurants, airlines, schools and other institutions. KxAFr GENERALFoons CANADA. Kraft General Foods Canada is responsible for manufacturing and marketing packaged grocery, coffee and cheese products. Major brands include Kraft, Philadelphia Brand, Jell-O, Post, Kool-Aid, Baker's, Tang: Miracle Whip, Parkay, Cool Whip, Sanka, Maxwell House and Chase & Sanborn. In addition, Hostess and Frito-Lay products are manufactured and sold pursuant to a joint venture with another company. The Canadian foodservice business markets coffee, salad dressings and food condiments to restaurants and other institutions. OSCAR MAYER FooDS. Oscar Mayer Foods is one of the largest processors and marketers of processed meat and poultry products sold in the United States. Its principal brands include Oscar Mayer luncheon meats, hot dogs, bacon, ham and other meat products; Louis Rich turkey cuts, luncheon meats and other products; Louis Kemp Seafood Company surimi products; and Claussen pickles. 5

Ky-uz'r GErrERAt Foons FRozEN PROnuc'rs. Kraft General Foods Frozen Products is responsible for the manufacture and marketing of a variety of products, including the following brands: The Budget Gourmet frozen entrees, side dishes and dinners, Lender's frozen bagels, Breyers ice cream and yogurt, Sealtest frozen desserts and cultured dairy products, Light n' Lively ice milk and cultured dairy products, Knudsen cultured dairy products, Frusen GTddje super-premium ice cream products, Birds Eye frozen foods, Tombstone frozen pizza, Jell-O frozen novelties, Cool Whip toppings and Breakstone's cultured dairy products. KRAFr GENExAi Foons CoMMmtciAi. PRODUCrs. Kraft General Foods Commercial Products consists of domestic Foodservice and Food Ingredients business groups. Kraft Foodservice is the second largest broadline distributor of food service products, including food products and supplies manufactured by others, in the United States. Kraft Food Ingredients manufactures certain private label products as well as a variety of industrial food products for sale to other food processors, which products include edible oils, shortenings, whey products, non-dairy creamers, confection products, cheese flavorings, seasonings and cheese analogs. Distribution, Competition and Raw Materials Sales of products of the General Foods USA, Kraft USA, Kraft General Foods Canada, Oscar Mayer Foods and Kraft General Foods Frozen Products operating units are generally made on the basis of orders by supermarket chains, wholesalers, buying cooperatives, distributors and individual stores. Substantially all products are distributed through retail food outlets. Dry grocery products are shipped to, or picked up by, customers from plants and distribution centers. Products are also shipped to customers from a number of satellite warehouses and other facilities. Frozen and refrigerated products are shipped from manufacturing locations and from intermediate public cold storage facilities. Fresh baked goods are delivered daily to depots where they are then distributed to the retail trade. Selling efforts are assisted by national and regional advertising on television and radio, and in magazines and newspapers, as well as by sales promotions, product displays, informative material offered to customers and other promotional activities. Regional foodservice distribution centers support the operations of the Foodservice Group of Kraft General Foods Commercial Products. Each Foodservice Group distribution center has a warehouse, sales office and fleet of trucks to distribute products to customers in its district. The products of the Food Ingredients Group of Kraft General Foods Commercial Products are distributed to food processors, foodservice operators and distributors and retail food stores. Sales are made primarily through the Food Ingredients Group sales force, but also to independent brokers. The Food Ingredients Group maintains warehouse and distribution centers at each of its main manufacturing facilities. Advertising is primarily through promotional programs, including price reductions, allowances and functional discounts. Products of Kraft General Foods International are sold primarily through sales offices and agents abroad. Europe represents the majority of the sales of this operating unit. European regional distribution is coordinated from a headquarters office located in Munich, Germany and through facilities located throughout Europe. The Asia/Pacific area operations are headquartered in Melbourne, Australia. Latin American and world trade operations are directed from the Kraft General Foods International headquarters in White Plains, New York. Advertising is tailored by product and country to reach targeted audiences. KGF is subject to highly competitive conditions in virtually all aspects of its business. Competitors include large national and international companies and numerous local and regional companies. Its food products also compete with generic products and private label products of food retailers, wholesalers and cooperatives. In the United States, KGF is the leading or a leading seller of cheese, viscous salad products, coffee, luncheon meats and other processed meat and poultry products, pourable dressings, barbecue sauce, 6 ZZ

packaged dinners, bakery products, frozen bagels, mayonnaise, margarine, jellies and preserves, syrups, ice cream, powdered beverages, frozen pizza and entrees, cottage cheese, sour cream, yogurt and refined oils. KGF competes primarily with respect to price, quality and service. KGF is a major purchaser of green coffee beans, milk, cheese, wheat, cocoa, rice, eggs, livestock, poultry, meat cuts, shortening, vegetable oil, aspartame, flour, fruits and berries, sugar, corn syrup, herbs and spices, and tomato products. KGF continuously monitors worldwide supply and cost trends of these commodities to enable it to take appropriate action to obtain ingredients needed for production. KGF purchases from outside sources all of its milk requirements and a substantial part of its cheddar cheese requirements. Such purchases are made principally from cooperatives and individual producers, pursuant to both contractual relationships and informal arrangements. The prices for United States milk purchases are based upon or substantially influencedd by the floor prices established by the milk price support program administered by the USDA and/or state government agencies. The prices paid for cheese in the United States are based upon or substantially influenced by weekly quotations on the National Cheese Exchange in Green Bay, Wisconsin. Such quotations generally reflect the USDA-set support price at which the Commodity Credit Corporation ("CCC"), an arm of the USDA, will purchase cheese, which price, in turn, is based upon the floor prices established by the milk price support program. See "Regulation" below. The most significant cost item in coffee products is green coffee beans, which are purchased on world markets. Green coffee bean prices are affected by the quality and availability of supply, trade agreements among producing and consuming nations, the unilateral policies of the producing nations, changes in the value of the United States dollar in relation to certain other currencies, and consumer demand for coffee products. In mid-1989, green coffee bean prices had moderated as a result of the July 3, 1989 expiration of the International Coffee Agreement. Governmental discussions between producer and consumer nations are taking place on an informal basis. These discussions may result in a formal agreement which could affect current prices. Livestock (hogs), poultry (turkey) and meat cuts (pork, beef, turkey and chicken) represent the principal raw materials used in manufacturing Oscar Mayer and Louis Rich branded products. The price paid for these raw materials is the major factor in the cost of these products. Livestock and meat cut prices are affected by market demand and supply. Poultry prices are principally affected by the cost of turkey-growing operations. In 1989, Oscar Mayer obtained 70% of the meats for its Louis Rich processed products and 13% of the meats for its Oscar Mayer processed products from its own slaughtering operations and augmented its supply with bulk market purchases. KGF is also a major user of packaging materials. Outside purchases of packaging materials are made from many suppliers. The prices paid for other food product raw materials generally reflect external forces, among which weather conditions and commodity market activities are significant. Although the prices of the principal raw materials required by KGF can be expected to fluctuate as a result of government actions and/or market forces (which would directly affect the cost of products and value of inventories), such materials are generally in adequate supply and available from numerous sources. Regulation Almost all of KGF's domestic food products (and packaging materials therefor) are subject to regulations administered by the Food and Drug Administration ("FDA"), with the exception of products containing meat and poultry products, which are regulated by the USDA. Among other things, the FDA enforces the statutory prohibitions against misbranded and adulterated foods, establishes ingredients and/or manufacturing procedures for certain standard foods, establishes standards of identity for food, and 7

determines the safety of food substances. FDA regulations may, in certain instances, affect the ability of KGF's domestic operating units to develop and market new products and to utilize technological innovations in the processing of existing products. In addition, various states regulate the business of KGFs domestic operating units by licensing dairy plants, enforcing federal and state standards of identity for food, enforcing federal standards and their own standards for fluid milk products, grading food products, inspecting plants, regulating certain trade practices in connection with the sale of dairy products, and imposing their own labeling requirements on food products. The prices paid for grade-A raw milk in the United States are controlled in most areas by Federal Milk Marketing Orders or state regulatory agencies. Such orders and agencies establish basic minimum prices, with adjustments based upon usage and geographic location. In some areas, the prices for raw milk also include additional premiums charged by suppliers. In certain states, governmental agencies affect the wholesale price of dairy products. In addition, the USDA sets a support price, which serves as a floor for the price of cheese, butter and milk powder at which the CCC will purchase such products. Under a United States Government program administered by the various states, cheese previously purchased by the CCC is distributed to certain individuals and organizations free of charge, with a primary objective being to decrease the inventories of such cheese. From time to time, KGF (as well as other cheese producers) sells excess cheese production to the CCC. Almost all of the activities of Kraft General Foods International and Kraft General Foods Canada are subject to the same kinds of regulation as the domestic businesses. Each of the operations and locations of these units is subject to local and national, and in some cases, international (such as by the European Economic Community) regulatory provisions. The rules and regulations, which relate to labeling, food content, pricing, marketing and advertising and related areas, are not deemed to present a significant impediment to the operations affected thereby. Beer Products Miller's major products are Lite, the largest selling reduced-calorie beer and second largest selling brand in the United States; Miller High Life; Miller Genuine Draft, which was introduced in 1986 and is one of the fastest growing premium beers in the United States; Meister Brau and Milwaukee's Best, introduced in the "popular price" segment of the United States market in 1983 and 1984, respectively; and Lowenbrau, brewed and sold in the United States under a license agreement with Lowenbrau Munchen AG and the second largest selling super-premium beer in the United States. Lite, Miller High Life, Miller Genuine Draft and Milwaukee's Best are among the top ten selling beers in the United States. Miller beer sales increased 3.7% in 1989 (3.3% excluding export sales) compared with 1988. This increase resulted principally from increased barrel sales of Miller Genuine Draf t and Milwaukee's Best. The growth of Miller Genuine Draft has significantly slowed the volume decline of the Miller High Life brand family. Beer sales accounted for 7.7% of the Company's total revenues in 1989. The following table sets forth, based on domestic shipments, the industry's sales of beer, Miller's unit sales and its share of industry sales: Yem's Ended Milkr's Share December 31 Indnstr (n) MiIler of Indushy(a) (in thousanck of barreis) (%) 1989 ............................... 179,506 41,355 23.0 1988 ............................... 178,227 40,026 22.5 1987 ............................... 177,849 38,887 21.9 (a) Source: United States Department of the Treasury (federal tax paid withdrawals). 8