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Is I I I I I I I P I I I I PHILIP MORRIS USA BUSINESS PLAN 1991-1995 TAB 1 EXECUTIVE SUMMARY TAB 2 THE ENVIRONMENT ....................................................... 1 Industry Overview ........................................................................... 1 Industry Volume Trends Pricing Product Category Trends Competitive Structure - R.J. Reynolds - Brown & Williamson - Lorillard - American - Liggett Market ............................................................................................ 20 Wholesale Community Trade Class Management Marketing Mix Co nsu me r ...................................................................................... 2 6 Age Occupation Education Product .......................................................................................... 29 Society ........................................................................................... 30 Taxation Marketing Restrictions Smoking Restrictions Discrimination in the Workplace Environmental Tobacco Smoke Pressure on Smokers TAB 3 THE COMPANY PLAN ..................................................... 3 7 Mission Statement Philip Morris USA Objectives Philip Morris Performance Strategies Macro Issues PM-USA ......................................................................................... 45 Representation in Key Industry Segments PM-USA's Role in the Corporation Long-Term Energy Requirements Philip Morris USA Departmental Issues/ Strategies/Action Plans ................................................................... 51 Operations Marketing Sales Corporate Affairs Employee Relations Legal Information Services TAB 4 FINANCIAL STATEMENTS .............................................. 140 Income Statement Balance Sheet Funds Flow Analysis TAB 5 APPENDDC............................................................... A-1 Waterfall Charts Trend Data

I I 4 I I I I PHILIP MORRIS USA 1991 • 1995 EXECUTIVE SUMMARY During the next five years, PM-USA plans to continue its profit growth, generating operating income increases of 13.2% annually. Domestic cigarettes will contribute a cumulative $17.2 billion to the corporate cash flow over the plan period. Market share will reach 49.6% in 1995, while volume will grow at a compound annual rate of half a percent. PM-USA's volume growth will occur despite a 2.7% compound annual decline in industry volume. Industry volume will be negatively affected by increasing smoking restrictions, the decreasing social acceptability of smoking and increasing excise taxes. Corporate Affairs will use direct lobbying, the media, and industry allies to minimize state and local tax increases, promote accommodation in public places and preserve the industry's freedom to advertise and promote cigarettes to adult smokers. Two federal excise tax increases have been legislated for the plan period, with a $2.00 per thousand cigarettes increase in January 1991 and a second $2.00 per thousand increase in January 1993. As a result of these increases, industry volume will decline faster in 1991 and 1993 -- 2.7% and 3.3% respectively -- than in the other years of the Plan when volume declines 2.5%. PM-USA's volume will continue to grow modestly with growth declining to an increase of 0.1% in the final year of the Plan. It is our objective to prevent any further increases in federal excise taxes during the plan period. The 1990-1994 PM-USA Plan assumed no federal excise tax increase. Within this environment, PM-USA will widen its lead as the number one cigarette manufacturer. PM-USA has scheduled up to 6 full margin line extensions during the plan period. These offerings are expected to add incremental business by appealing to competitive smokers and retaining PM-USA smokers as they age. They will enable PM-USA to increase its presence in industry segments where we are underrepresented, such as menthol and ultra low tar, while building on our leadership in growing demographic segments (25-44). Our brands' marketing mix will continue to include image advertising and retail promotions. However, retail merchandising and in-store promotions will steadily gain in importance, with consumer promotion accounting for 40% of the Company marketing budget in 1995, compared to 23% in 1990. The 1991-1995 Plan includes broad enough coverage in each of the current price/value categories for PM-USA to be aggressive. New price/value offerings will only be considered as a defensive move. While PM-USA will continue to actively participate in the price/value category, it will not fuel its growth, recognizing the market deterioration and the commodity-like status price/value brings to the industry. Additional manufacturing capacity will not be required to accommodate projected PM-USA volume growth. However, PM-USA's current capacity of 313 billion units cannot accommodate both our domestic volume and growing export volume. The total is forecasted to exceed installed capacity by 43 billion units by 1995. Consequently, the Plan includes a capital appropriation of $589 million to expand the Cabarrus Manufacturing Center. The project, which would begin early in 1991, consists of expanding the Primary, Make/Pack building and plant infrastructure. Cabarrus' capacity will rise from 78.9 billion in 1990 to 160 billion cigarettes per year in 1995, bringing total PM-USA capacity to the 408 billion unit level by the end of the plan period. PM-USA entered the decade of the nineties with considerable momentum despite the erosion of the industry. During the plan period, management will exploit PM-USA's major competitive advantage of strong trademark recognition for Marlboro, Merit, B&H and Virginia Slims. Focused line extensions, geographically targeted marketing, and trade class specific promotional programs will be used to capitalize on our trademarks. With an established young adult smoker base, PM- USA will hold smokers as they age. Recognized product quality, strong package sales, and Marlboro full margin strength will continue to deliver competitive advantage over the next five years.

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PHIUP MORRIS USA 11191 -1 siD5 INDUSTRY OVERVIEW In 1990, the U.S. cigarette industry achieved record revenues and operating income, totalling an estimated $24 billion and $8.5 billion, respectively. Higher prices and operating efficiencies continued to more than offset unfavorable mix changes and volume declines. INDUSTRY VOLUME TRENDS Industry volume of 521.8 billion in 1990 was down 0.3% versus 1989, continuing a downward trend which began in 1981/1982. However, a two year comparison is more meaningful because of RJR's and Lorillard's decision to "de-load" in 1989. Since 1988, Industry volume has declined an average of 3.3% per year, exceeding the industry's decline over the past decade. Since reaching Its peak of 626.5 billion units In 1981, U.S. cigarette consumption has declined at a compound annual rate of 2.0%. Factors negatively influencing volume inciude the health controversy, the declining social acceptability of smoking, more smoking restrictions, and rising excise taxes and prices. Over the next five years, we expect cigarette consumption to continue declining given the Increasingly hostile smoking environment and the effect of two federal excise tax Increases. There were no federal excise tax increases during the last five years. Sales of cigarettes in the U.S. are projected to decrease an average of 2.7% per year between 1990 and 1995, reaching 455.5 billion in 1995. This is a slight acceleration of the trend of the last five years when industry volume declined 2.6% per year. Full margin brands will fuel this decline, decreasing an estimated 6.3% per year, while price/vaiue brands will help keep consumers in the marketplace. INDUSTRY VOLUME TRENDS 1980 1982 -Total 1984 -Full Margin ••Price/Value 1986 1988 1990 1992 COMPOUNDED ANNUAL VOLUME GROWTH (%) 3985-1990 1990-1995 Total Industry (2.8) (2.7) Full Margin (5.2) (6.3) PriceyNalue 18.3 8.5 1994 I 1

PHILIP MORRIS USA 1991 - 1995 Price/Value Price/value will continue to be the most dynamic segment in the tobacco industry, fueled by aggressive full margin pricing, brand/packing proliferation and higher availability at retail. PRICE/VALUE PROLIFERATION # Brands # Packinas 1989 25 152 1990 30_ 182 1995 34 196 Over the next five years, price/value's share of the industry is expected to rise approximately 2.8 share points per year, from 19.2% in 1990 to 33.2% in 1995. Over the past five years, the price/value category grew approximately 2.4 share points per year. Price/value volume is expected to grow at an annual rate of 8.5%, reaching 151.2 billion units in 1995 compared to 100.4 billion in 1990. New competitive entries are likely to be introduced to meet the increasing consumer preference for lower priced cigarettes. MARKET SHARE OF PRICE/VALUE SUBSEGMENTS I r 1981 1985 1990 1995 Difference 1990-95 Black & Whites 0.5 4.6 3.6 4.1 0.5 Branded Generics - 1.4 10.4 16.0 5.6 Value 25's/30's - 1.3 0.7 0.4 (0.3) Price-off - - 1.0 1.4 0.4 Sub-generics : _ 2-5 11.3 7 $ Total 0.5 7.3 19.2 33.2 14.0 Assumptions This industry forecast is based on the following assumptions: • The federal excise tax will rise $2.00/M in January 1991 to $10.00/M and again in January 1993 to $12.00/M, per the budget accord reached in November. There are no further increases in federal excise taxes planned. • State excise taxes will rise approximately 10.0% per year, increasing from almost $0.24 per pack in 1990 to $0.38 per pack in 1995. This represents a slight increase in the trend of the past five years when state excise taxes increased 8.7% annually. The state excise tax increases are higher in the earlier years of the Plan as many states currently have large budget deficits. • The industry remains relatively price inelastic due partially to the availability of lower priced alternatives, such as Bristol, which had an average retail carton price (85mm) of $8.48 in 1990, compared to $15.27 for a full margin brand. Elasticity is assumed to be -.37. This means that for every 10% increase in price, industry volume will decline 3.7%, or approximately 19 billion units (based on 1990 volume). 2

I I* I I I I I I I N I I I I PHILIP MORRIS USA 1991-1995 • Population trends, while favorable (+7.6 million smoking age people between 1990 and 1995), will not provide as much potential volume as in the past five years when the smoking age population grew 10.6 million. Growth will occur mainly in older age categories where smoking incidence has historically declined, partially offsetting the benefits of population gains. The 35-54 age group will show the largest growth (+16.2%) and will comprise the largest share of the population (21.8%). The over age 55 population will also grow (+4.1%). These trends highlight the desirability of retaining smokers as they age. ADULT POPULATION GROWTH BY AGE GROUP 1Sli4-1995 18-24 25-34 35-44 45-54 55+ Longer term, industry volume will be negatively affected by a decline in the number of potential new smokers, adults under 25 are forecasted to decline 5.5% - while the 25-34 cohort will decline 5.9%. This trend is of particular concern to PM-USA because of our historical strength among these cohorts. • Smoking incidence is forecasted to decline 2.6 share points to 26.5% in 1995. Average daily consumption will also decline, although to a lesser extent, averaging 25.4 cigarettes per day in 1995. As shown in the following chart, average daily consumption and smoking incidence are expected to decline the most among 45-54 year olds. Average Daily ConsumptionW 1990 1995 Difference Under 25 23.3 22.9 (0.4) 25-34 25.3 24.0 (1.3) 35-44 27.5 25.3 (2.2) 45-54 27.8 25.4 (2.4) 55-64 27.9 26.4 (1.5) 65+ 2U 232 41J,1 Total 25.9 25.4 (0.5) Incidence t%l 1990 199 5 Difference 31.2% 28.3% (2.9) 35.2 31.7 (3.5) 33.4 29.5 (3.9) 30.3 24.1 (6.2) 26.3 23.5 (2.8) 1&4 1.]_.fi ~34 29.1 26.5 (2.6) (1) Roper consumption data has been adjusted to reflect industry volume. Source: Roper (1990 Incidence) and PM-USA Market Research Demographic Model (1995) 3

PHILIP MORRIS USA 1991-1995 PRICING Pricing will continue to be a major contributor to PM-USA's profitability during the plan period. PM- USA is faced with the challenge of balancing operating income growth goals with the objective of unit volume growth. It is critical that PM-USA's pricing strategy, particularly in an environment of high taxation, does not accelerate the decline of industry volume or encourage consumer switching from PM-USA's full margin products to less profitable price/vaiue brands. PM-USA's pricing strategy for 1991 through 1995 inciudes the following actions: • Utilizing price increases to supplement volume increases and productivity gains to achieve operating Income growth goals. • Structuring frequency and amount of price increases to minimize impact on PM-USA full margin brands. • Reducing net retail price pressure on high margin segment of the business through price increases: - Reduce the gap between Bristol and Full Margin prices from 44% in 1990 to 32% In 1995. - Reduce the gap between sub-generic and branded generic prices to less than $3.00 per carton and maintain during plan period. • Maintaining retail price competitiveness using on-carton coupons for branded generic products. Do not lead new discount levels. • Recognizing that there may be competitive entries introduced at lower price levels during the plan period. Manufacturer List Prices The combination of manufacturers' price increases and rising state excise taxes during the 1980's caused full margin cigarette prices to increase in excess of inflation. The graph below illustrates the rate of growth for cigarette prices (excluding FET) versus the consumer price index for the same period. Manufacturers' list prices increased a compound annual average of 10.9% from 1980 through 1990, while the Inflation rate of other goods and services as measured by the CPI increased 4.5%. 4

PHILJP MORRI8 USA 1991-1995 The rapid growth rate for full margin cigarette prices is the driving force behind the emergence and growth of the price/value category. The widening retail price gap between the lowest priced brands (such as Liggett's Pyramid) and full margin brands and the competitive activity it has encouraged has further accelerated the growth of the category. PM-USA's large share of industry full margin unit volume puts the company's profitability at risk if the price,kalue category continues to grow rapidly. A new PM-USA pricing strategy is to lead upward pricing pressure in the low price categories, while stabilizing full margin pricing. Our objective is to reduce the price gap between full margin and discount brands. The Plan assumes that the industry practice of semi-annual price increases will be maintained. Annual price increases on full margin brands are projected to be $5.00 in 1991 and 1992, rising to $6.00 in 1993, 1994 and 1995. PM-USA will start by taking an additional $2.50 per thousand increase on branded generics and $3.00 per thousand increase on sub- generics out of cycle in March 1991. In addition, annual price increases on branded generics and sub-generics are projected to be $6.00 in 1991 and 1992, rising to $7.00 in 1993, 1994 and 1995. Pricing actions for FVB will be structured to ensure that the retail price of our black and white/private label products is comparable to the lowest priced branded products in the industry. PM-USA AVERAGE LIST PRICES 1991-1995 $ Per Thousand 100 80 60 40 20 57.00 _.... 47.60 0  Full Margin  Branded Generic  Bristol 85MM 81.75 75.85 75.75 69.75 68.85 62.00 61.85 _,__ 53.60 32.85 1991 1992 Source: PM-USA Market Research 54.10 1995 1993 47.10 1994 Our goal is to reduce the retail price gap to the following levels by 1995: ESTIMATED RETAIL CARTON PRICE DIFFERENTIAL 85m m b 1990 Full Margin $15.27 1995 $24.94 Branded Generics $10.01 $18.93 vs. FM $5.26(34%) $6.01 (24%) Bristol $8.48 $16.84 vs. FM $6.79 (44aYo) $8.10 (32%) vs. BG $1.53(15°Y6) $2.09(11%) 38.85 5

PHIUP MORRIS USA 1991-1995 The accelerated pricing of price/value products will improve the profitability of the category. Projected net margins are forecasted to increase substantially over the plan period. PROJECTED NET CONTRIBUTION PER THOUSAND 1990-95 Full Margin 1990 1991 1992 1993 ]99 4 1995 S ASz Marlboro $29.63 $33.77 $37.66 $42.28 $47.74 $52.75 12.2% B&H 26.63 30.18 33.82 38.87 46.03 51.05 13.9 Merit 28.58 32.81 34.42 41.75 44.91 51.80 12.6 V S 23.90 29.43 33.87 36.58 42.38 48.20 15.1 Parliament 24.49 30.57 34.42 39.19 44.35 49.38 15.0 Price/Value 1991-95 CAG Cambridge $2.63 $9.19 $11.00 $13.77 $15.66 $18.60 19.3% Alpine (1.23) 4.42 6.77 12.55 14.34 18.02 42.1 Bristol 1.25 10.88 10.60 13.60 16.61 19.80 16.1 Bucks (47.00) 6.06 5.58 10.06 13.87 16.83 29.1 The profitability of the price/value category is ultimately dependent on the level of marketing support. Competitive marketing efforts including escalating coupon rates and values, increased retail promotion and new brand introductions are slowing the increase in net margins for the category. PM-USA must remain competitive in this category and minimize the possibility that competitors will see their volume potential being greater than the risk to their profitability. Competitors who are using full margin brand profits to finance price/value marketing efforts must be pressured into defending their full margin brands or risk accelerated volume decline rates, further impairing their profitability. PM-USA's strategy is to leverage full margin brands to relieve competitive pressure in the price/value category. Pricing assumptions for the plan period create the possibility of the emergence of a fourth price tier. As price/value margins increase, the opportunity to introduce a marginally profitable product could become appealing to competitors, who are willing to postpone profitability in the hope of gaining volume. PM-USA will defend against new entries of this nature by matching competitive price efforts through couponing and other promotional efforts. Although this pricing strategy enables PM-USA to meet projected income growth targets, it is possible that other manufacturers will seek to accelerate pricing. While estimates of RJR's forecasted profits indicate that cash flow is more than adequate to cover debt obligations under current pricing assumptions, RJR's parent, KKR, may seek to improve operating income growth performance to improve the market for its high yield debt and recent equity issues. In addition, PM-USA's pricing strategy is forecasted to yield RJR a compound average operating income growth rate of 5.8% (1990-1995), below the pre-KKR average growth rate of 11.9% (1983-1988). Retail Pricing PM-USA price increases over the plan period will increase retail cigarette prices at a higher rate than both the consumer price index and disposable income per capita. In the current recessionary economy, PM-USA must achieve its income goals without increasing prices to a level that leads to the acceleration of industry volume decline. 6

PHILIP MORRIS USA 1ti91 -1tifi5 RETAIL PRICE COMPOUND AVERAGE GROWTH 1990-1995 DIPC CPI Fuli Margin Source: WEFAVPbIdJSA Merket Research-85MM Carton Brand Generic Bristol The average retail carton and pack prices for full margin, branded generics and Bristol are forecasted to increase annually an average of 10.3%, 13.6% and 14.7%, respectively. Excluding 1990, Bristol has a compound growth rate of 11.0%. This compares with a 5.0% increase for general inflation and a 1.1% increase in disposable income. Average retail pack prices are projected to near the $3.00 mark by 1995 for full margin. ESTIMATED AVERAGE RETAIL PACK PRICES Full Margin Branded Generic Source: PM-USA Market Research-85MM 7 Bristol