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Discount brands have also begun to grow among Blacks, and future growth is expected to resemble the trend among Whites. DISCOUNT BRAND EVOLUTION White Discount - Black Discount 9-6 of Discount Brand Smokers in the Market 14 12 10 I . s . 0 1980 1982 1984 1986 1988 1990 1992 Source: PM-USA Consumer Tracking and Consumer Research projections Segment Development The increased availability of discount brands in convenience outlets, in particular, has fueled the growth in this category. In 1988, 31% of discount sales were in convenience stores, and this percentage grew to 40.9% in 1991. This growth in convenience stores particularly affected PM-USA, since in 1991 47% of our total sales were in convenience stores. T RADE CLASS SHARE OF DISCOUNT aALES €1 Convenience ® Supermarkets ® Grocery Stores 13 Drug Store 40.9 Projected Black Discount 12

Discount brands' share is anticipated to grow 11.1 points over the plan period to 36.1% in 1996. This growth will be realized primarily in the sub-generic and black & white/private label subsegments of the discount category. MARKET SHARE OF DISCOUNT SUBSEGMENTS Difference 1991-96 Branded Generics 2.7 10.7 11.0 0.3 Price-off - 0.5 0.2 (0.3) Value 25's/30's 1.9 0.5 0.3 (0.2) Sub-Generics - 6.8 12.5 5.7 B&W/PL La 8.5 12-1 5.6 Total 8.9 25.0 36.1 Source: MSA and Market Research Estimates Historically, PM-USA's premium brands were relatively insulated from the growing discount segment due arimariiy to their younger smoker base and urban skew. In 1986, PM's JFO-'{_. 1 y,jl<':' :3y?itc~'1G~t~ ±(i:"71 i reilC! n d`J t. ~~`,'i ,~'i:`r~tr'`~f~~`~ ..,.t~;.} f' dX,; -o Ci`izcourt. In '359t, however, PM r,rernium I%,i•arrGs !j`i`otributed 93% cf thG'r fa;r share of switchers and an estimated 101 % of their fair share of alternate purchases of discount brands. PM's SHARE OF PREMIUM TO DISCOUNT SWITCHING 1986 PM Share of Premium Smokers 39.6% PM % of Fair Share 84% EI Madboro O Other Prentium 1987 39.7% 85% 1988 42.0% 94% 1989 44.6% 87% 1990 46.6% 94% 1991 48.9% 93% ~ Source: PM-USA Corsumer Tracking Batween switching and P.iternate purchasing, it is estimated that PPr9's premium brands are ;,urreni:y contftuting 4o thcir fr:ir share of vl;ilj,ne to the discount category. Du>.`no the plan p~lltiUU, aciions wiii ~:=; taken to in;;ulaie ihe srns,ictirs of yiariboro and our other ;:E•~~rnium brands from the allure of price incentives sur:h that h.4a~r[bc: o and our rth er premium trands are !d>re;asted to contribute 57"-:•'o and 43%, o` fair share to discount gro~-.vth over the 1991- 1 S.:r3 period, respectively. 13

Low/Ultra Low Tar Category The tar delivery of filter cigarettes has been an important product attribute affecting smokers' brand/packing choices since the mid-70's. The low/ultra low tar category has grown steadily and as of year-end 1991 comprised 54.1 % of the total market. 0 Non-Filter Percentage 100 80 60 40 20 1 ~ ,__.... ._. .. ._. ,.~,......~___ 19 31 r Source: MSA and Market Fiesearch Estimates INDUSTRY COMPOSITION BY TAR LEVEL 1981-1996 ® Full Flavor  Low Tar 1986 1991 13 Uftra Low Tar Low/ultra low tar cigarettes have steadily increased in popularity among adult smokers under 25 and in 1991 commanded a 47.7 share among adult smokers under 25. Among all other age groups low/ultra low tar packings are preferred by the majority. TAR PREFERENCE BY AGE GROUP % Prefering Low T^r4.lrtra Low Tar 60 ., 1 1 Under 25 25-34 Source: PM-USA Consumer Tracking 01981 01986 r•1991 35-44 45-54 55+ During tne next five years, the low tar category will continue to grow fueled primarily by the incrt,ase in the cL-,,-cent of older smokers, ln addition, as smokers who enter the market snlu-iing a low u i i7jr'czi:d iiiature, some will G:;C:lGv io switch farther down 'ale tar spectrum stimulating growth in 'he ultra !ow tar segment to 16.7% by 1998. iPM-USA will capitalize on this trend during the plan period by launching line extensions of Marlboro and Merit into the ultra low/ super ultra low tar segments and develop new filter and filler technologies which will deliver more flavor at lower tar levels. 14

Menthol Category The menthol category will continue to decline, primarily due to two factors: its lack of appeal among White young adult smokers and the rapid decline in smoking incidence among Blacks (36.9% in 1986 vs 29.7% in 1991), over 70% of whom smoke a menthol. WHITE SMOKERS M1981 ®1986  1991 % Who Smoke Menthol MENTHOL CHOICE BY RACE BLACK SMOKERS ®1981 ®1986  1991 % Who Smoke Menthol 100.0 .. 32.1 89.0 88.1 836824 84.7 78.6 Under 25 25-34 35-44 75.1 The menthol category is projected to decline 2.1 share points to 23.8 in 1996. This loss of 26.4 billion units of menthol volume over the plan period is expected to cause competition among B&W, RJR and Lorillard to intensify since these three companies have an 72.1 share of the menthol category. Since PM-USA has only 21.6 share of menthol, our sales overall will be less affected. However, because B&H and Virginia Slims sales are 32.2% menthol, this trend will impact their sales performance. To offset the effect on B&H, we are scheduled fin 'atanch B&H ,fl-~? Size in 1992. Product Cf~tcgcri w~s In support of our strategy to extend the equity of our premium trademarks, PM-USA will be developing innovative products that provide tangible added value for consumers. This will help deliver insulation from the discount category for our premium brands by offering unique attributes that lower price products can't match. In 1991, there were no major new product developments tested by industry firms. Discount and reduced tar cigarettes continue to dominate the new product segment with 71% of the new packings introduced in 1991 being low tar or ultra low tar, Out of the 31 new packings introduced, 23 packings or 74% were discount brands. Product concepts and research that may lead to new products include: •Low T;?r,/-b.jghFlav_o_r_: PM-USA's objective is to develop efficient 4-6 mg products with aouiv3lent consumer taste perception to flavor low tar products. Products that have y r "A from r:-,dn.xc1,h ir7 this area are 'V;e;it #Jltima, Cambridge n.nd Br~Aol LowV:>t, and frlu7;horo Ultra Lights. • Redummd NicQ ine• PM-USA has been testing de-nicotinized cigarettes in several markets since 1990 under the brand name Next and as line extensions of Merit and B&H. Currently, we are test marketing B&H De-Nic only in Arizona, where results have been disappointing. in general, tests have revealed that consumers are interested in the 15

I I I I I I I I I I I I concept of a de-nicotinized cigarette, but are frequently dissatisfied with the product's taste. To address the taste issue, PM-USA is currently investigating the potential of a reduced nicotine cigarette or "Haif-Nic", rather than de-nicotinized. • Low Smoke: The product is designed to produce less visible smoke from the lit end than a standard cigarette. Products tested by RJR and PM-USA have relied on paper technology and reductions in tobacco content to achieve the desired results. PM-USA is using the concept in Virginia Slims' Super Slims, which offers two unusual product characteristics: reduced side stream smoke and a smaller cigarette circumference. RJR test marketed Vantage Excel 100's (a low side stream smoke product) in 1989, but the cigarette was withdrawn after lack of consumer interest. The future viability of this concept is dependent on its ability to deliver satisfying taste and the successful communication of the product's benefits to smokers. • Scented Smoke Aroma: The concept of a scented cigarette is to minimize or eliminate the discomfort of smoking to others, which could lead to it becoming more socially acceptable. RJR has been test marketing since 1990, a brand named Horizon, a vanilla scented product with advertising claiming it to be "The First Cigarette That Smells Good". Horizon has reported a shipment share in its test markets of 0.1% to 0.2%. In 1991, RJR discontinued the testing of another scented brand, Chelsea, a smaller circumference cigarette similar to VS Super Slims. PM-USA is investigating the potential of scented cigarettes through project Ambrosia. • Flavored Cigarettes: Menthol's appeal among young adult smokers has been declining in recent years. Flavored cigarettes may present an opportunity to gain trial and conversion from smokers that may want additional flavor but find Menthol too harsh. Lorillard has resurrected a lemon flavored cigarette, Spring Lemon Lights, which began testing as a non-menthol in 1989 and was discontinued in late 1990. The brand is currently being test marketed as a menthol mixed with lemon flavorings. • New Devices: Since the introduction and subsequent withdrawal of RJR's Premier, no new smoking articles have been introduced. Development activity on these type of products continues by PM-USA, RJR and BAT. It is anticipated that pharmaceutical and biotechnology companies will continue developing products that are designed to aid a smoker in quitting. Currently, Marion Merril Dow markets Nicorette, a prescription nicotine chewing gum and Alza Corp., Ciba-Geigy and Cygnus/Warner Lambert have gained FDA approval for a nicotine delivery skin patch. The market for skin patches has been estimated by pharmaceutical industry analysts to reach approximately $1 billion dollars by 1995. Packaging As premium cigarette prices continue to increase and competition from discount brands intensifies, some companies will consider new packaging concepts to make premium brands more affordable or to add value to justify the premium price. Examples of these two concepts were evident in 1991 as, Lorillard tested the Newport half pack (sold at half the price of a 20 pack) in two southern states and RJR unveiled "The Wrap" for Winston and Salem. RJR is actively using new packaging concepts to create "product news" in an attempt to enhance brand equity and build smoker loyalty for their premium brands which have been suffering double digit volume and share declines in recent years. In July 1991, RJR introduced Winston in a new aluminized foil wrap packaging and claimed that it maintained freshness longer than traditional cellophane packaging. In November, Salem was also introduced with "The Wrap". It is too early to tell if these packaging innovations have had an impact on Winston and Salem's performance. 16

I RJR is also testing a sliding box package for Dakota and is test marketing a new dual use packaging on Vantage Ultra Lights. The dual use package is similar to a conventional box packaging, but will also convert to a soft pack type access by tearing off part of the pack's top. PM-USA tested a similar packaging concept on B&H in the early 1980's that generated little consumer interest. As part of our strategy to create economies of scale, we plan to use SKU's to our strategic advantage. New packaging, like the 5 pack carton and B&H Kings rounded corner box, provide consumer value and help put pressure on our competitors slow moving packings. Marlboro will be launching in August 1992, a 5 pack carton that provides the consumer with an alternative to the large cash outlay of a traditional pack carton. Another potential packaging concepts is the twin pack configuration. In addition, PM-USA is exploring new pack material textures and graphics to update brand packaging. Environmental concerns and possible future ecological legislation may require manufacturers and suppliers to develop packaging and cigarette filters that are biodegradable and include a specified percentage of recycled material. Any packaging changes will be evaluated meticulously for consumer acceptability and quality assurance. I I I I I I I I I I I I

TRADE CHANNELS Wholesale Community Competitive pressures, rising costs and thin profit margins have brought about an increasing number of consolidations, mergers and liquidations of tobacco wholesalers. In many cases, a tobacco distributor's profitability does not generate enough working capital to make necessary investments in warehousing, technology, processing equipment and delivery vehicles to remain competitive with larger food wholesalers. The consolidation trend is evident in a review of PM-USA's top 100 customers over the last ten years. Comparing 1981 with today, 60% of the accounts remain in the top 100 (includes corporate structural changes and the military), 25% have been acquired or been involved in a merger and 15% are no longer in the top 100 or have gone out of business. • Since 1985, the number of wholesale tobacco distributors has decreased 17% to 1,257. If this trend continues, by 1996 there will be approximately 1,000 tobacco wholesalers remaining. Wholesale grocers have also declined 18% to 540. Combined, these channels represented about 78°'0 of direct sales. • Direct retailers, representing 22% of direct sales, have increased steadily since 1985 and now total about 500 accounts. Helping to expand this category is the increased popularity c ' -iholesale price ciubs such as Sam's and Price Chopper, which snr»ioA many small ~ ~~ur-ts and --etailers. We expect this trend to continue since smaller tobacco distributors are under increasing economic strain. Brand proliferation, manufacturers price increases and growing receivables have diluted wholesaler working capital. This problem is compounded by a 13% decline in inventory turns since 1985. Those that remain in the business will need to focus on improving their financial position and capital structure, increase technological applications, increase efficiency to reduce overhead, diversify into more profitable product lines, expand into new markets and increase value added services. Another factor working against the financial health of tobacco wholesalers is the current US banking crisis. Wholesalers have traditionally been dependent on bank financing to respond to cigarette manufacturers' trade programs. There is a possibility that some distributors may t;~~d ;t d:fficult to obtain credit ^s bankers become increasingly conservative in their lending ~,w:t:c; s. This cou'd accelerate consolidation vf the industry in tt3e near future. Coe of ihe most notauie consolidations in the d;stribut'ron carraifiunity was the acquisition :r' the McLane Company, PM's largest customer, by Wal-Mart Stores, Inc. This increased McLane's average weekly volume by 23% to approximately 265 million units or 6.3% of PM's average weekly volume and assured McLane retail distribution to approximately 1,600 Wal- Mart and 150 Sam's Wholesale Club retail locations. 18

THE RETAIL UNIVERSE IN THE 1990's Trade Class Management: During the 1980's, consumers began to alter their cigarette purchase patterns in response to their lifestyle and economic circumstances. This has contributed to the growth of cigarette volume in trade classes such as convenience and gas stores, which have aggressively promoted the cigarette category and as a result have increased their share of industry sales from 26% in 1984 to 34% in 1991. There has been a corresponding decline in the grocery and drug categories. INDUSTRY RETAIL SALES BY TRADE CLASS (%) 12 34 3ource: PM-USA SPACE 1984 1991 Associated with the growth in the convenience store trade class has been the shift in consumer purchase patterns toward packs. Since 1984, pack purchases have increased to 59; of ;.' o'. ~~. Civ iding trade ciasses into pack ari ^arton `;y .,.~ ~~ ,. :s ~j s ~ ~d ~'ir;g: Carton Qutlets E&GIS Carton Pack gutlets i gnd= Supermarkets 30% 70% Convenience 85% 15% Mass Merch. 15% 85% Grocery 60% 40% Drua Stores 60% 40% T he proliferation of cigarette packings, along with the general increase in new consumer products and line extensions, has created intense competition for limited retail space in all trade classes. PM-USA is competing not only with other cigarette manufacturers for retail space and visibility but with all consumer product companies. In tha current business :,erironment, PM-USA will focus efforts on stores with similar merci^??n.ndising cheracteristics, operating policies and customer bases because each provides ,in opportunity to tailor marketing prograrr,s that provide our brands a competitive advantage. in ctrdr:r `v fccus r: taiier`s :L:nntion on pr ,muting P,%4-tJSA's brands, we are implementing 'Retaii be.6-,,-j rnwt'chart0a.isg t:ir.;n iiia.t r::wards rotaile.s for t;'.-.'!.1ing r2 s,;- USA volume thr.avr:h total st:1';: ~ pv rticipaticn. The pian features financial inci-intives for retailers to emont<size PM's Premium brands, captu, e prirne real estate, reduce out-of- stocks, support r1ew items and develop private label partnerships. In supermarkets and mass merchandisers, PM will continue to pursue improvements in retail v.3ibility and inventory levels, through carton merchandising programs and fixture placement. In addition, there will be increased emphasis on improving premium brand pack sales in 19 I ij

I I I I I I I I ~ I I I I I I carton outlets through a number of marketing and merchandising fixture initiatives. In pack outlets, PM is working to become the first tier supplier with large convenience, gas and drug store chains. We are increasing our premium brand retail presence through the development of account specific promotional and merchandising programs for high volume chain stores. Although PM will attempt to maintain our fair share of discount brand volume, we will work to position all low price brands in a secondary retail position to our premium brands. Carton Outlets Supermarkets: Current trends in the supermarket trade class include: • Although many large supermarket chains continue to expand the size of their stores, this trend among intermediate size supermarkets appears to have slowed. • Generic products are regaining strength due to economic conditions. • Margins on key categories, some of which have historically subsidized other categories (health and beauty care), are being reduced by competition from non-supermarkets. • Labor and related costs are increasing at significant rates and are reducing profitability faster than margins. Cigarettes continue to be considered one of the best performing products in supermarkets and are consistently ranked each year in the top 10 largest selling product groups. Cigarette inventory turns of 22X outperform the supermarket average of 15X. In 1991 Marlboro continues to be the leading brand in the trade class with a share of 19.5%, up 0.3 points versus 1990. Highlighting the strong performance of discount brands in supermarkets is Doral, which is the 4th largest selling brand in the trade class with a share of 5.8%, an increase of 0.5 points versus year-ago. Cambridge is also doing well in the trade class with a share of 3.6%. The discount category has grown rapidly in this trade class in 1991, increasing 4.6 points over year-ago to a current market share of 26.5%. Supermarket shopper demographics are similar to discount smokers, with both skewing older (35+) and female. Supermarkets, which has a high number of deal oriented consumers, provide manufacturers a perfect environment for implementing aggressive coupon and retail price promotion programs. % Share 1991 PM-USA B,Zg B&W Lorillard Amer Ltggett Chain 38.3% 32.3% 8.2% 6.9% 8.1% 6.2% Change vs. 1990 1.1 (0.8) (0.2) (0.2) (0.3) 0.4 Independent 36.4% 29.5% 9.5% 6.3% 10.5% 7.8% Change vs. 1990 1.4 (1.9) (0.3) (0.4) 0.6 0.6 Supermarket cigarette sales are predominantly cartons (68%). However, in recent years the emphasis has switched to the front-end of the store as pack sales comprise a growing portion of volume (32% in 1991 versus 24% in 1985). Presence at the front end offers an advantage in terms of impulse buying, new product introductions, availability of packings, and strong point of sale visibility. For the retailer, pack sales are more profitable on a per unit basis than carton sales with an average margin of 24% compared to 14% for cartons. 20

Total merchandising spending for the industry in supermarkets has increased 17% annually since 1984. Pack spending has taken on greater significance in this trade class and now represents 21% of total payments. Merchandising Spending Estimates Supermarket Trade Ciass $ in Millions im PIVI-USA BstB B$c1~C 1~4111hLS! 9m€i: Ltqqett IstW Carton $63.9 $51.1 $29.1 $17.3 $16.4 $11.0 $188.0 Pack 28.5 J3,2 1¢ DA Q,g Q,Q 49.1 Total $92.4 $71.0 $29.5 $17.4 $16.6 $11.0 $237.9 1984 Carton $21.7 $22.2 $15.3 $9.2 $7.0 $3.4 $78.8 Pack Total $21.7 $22.2 $15.3 $9.2 $7.0 $3.4 $78.8 Pack Outlets Convenience and Gas Stores: Convenience and gas stores combined represent the largest trade class for industry cigarette volume. With total sales in 1991 of $8.1 billion, cigarettes were the number one ranked in- store category. Cigarette sales in the trade class increased by 9.5% over 1990. Pack sales continue to gain share in convenience stores, accounting for 85% of sales in 1991 vs 70% in 1986. In addition, discount brands are increasing their share of convenience stores' business, increasing 6.4 points versus 1990 to 24% in 1991. In general, changing consumer lifestyles will continue to favor the growth of this trade class. The convenience store's average shopper demographic profile is very similar to cigarette purchasers. Cigarette Purchasers Daily C-Store ShoRpers In C-Stores Sex 2-to-1 male 61% male Age 60% adults under 34 62% adults under 34 Education 75% no college 60% no college Over the last five years, the total number of stores in the trade class has grown 11% to 84,500. This is comprised of a 30% increase in gas stores to 32,500 outlets and relatively no growth among traditional convenience stores, which have been flat at about 52,000. As the number of stores and customers have grown, the percent of industry cigarette volume sold in convenience outlets has increased from 23% in 1985 to 38% in 1990. PM-USA is substantially ahead of the competition in this trade class with a 1991 share of 47%. % Share 1991 PM-USA g,jg B&W Lorillard gp1g~ Ligaett Total Convenience 46.9% 28.2% 8.5% 6.3% 6.1 % 4.0% Change vs. 1990 0.6 (1.3) (0.4) (0.6)_ __ 0.9 0.6 Recently, several major convenience store chains have reported financial difficulties that could further reduce the number of stores. Circle K, which is currently operating under Chapter 11 bankruptcy proceedings, has announced plans to shut or sell 1,500 of its 3,700 stores over the next 12 to 18 months. Southland Corporation (7-11) emerged from Chapter 11 in March 1991 and is now largely controlled by its Japanese affiliates. . Total merchandising spending for the industry in the convenience and gas trade class has increased 20% annually since 1984. Pack spending in 1991 represents 74% of total payments versus 60% in 1984. PM-USA accounts for 44% of total merchandising spending in this trade class. 21 I I I I I I ~ I I I I I I I I I