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Philip Morris Companies Inc. Annual Report 1986

er share Dividends declared p ~ Funds front operations per sliarc __- - -- ~-- Percent lncraase Over Prior Year 5.24; , ..3.62 2.475 , 2.00 l:?b ' . 9.28 -- 7.39 59.2°Ia 15.6e1r 1T.7°!o 41.3% 18.3°a 44.6% : 6.30 : 6,5°~'0 a~•  ~ ~ F~ffl a n ~ l an~la~ E{I~t'1< 1~[!tS 4,itt mtlhons of eloE[at~, except per share antountsl ~Operatirtg revenues LVet earnings ' Earnings per share _ 1)n°iclends declared per share Operating Revenues 1'ililtp Morris L~.S.A.~ ~ _--....T_............~.....__.._e.. --.._..... Philip Morris International General Foods Corporation 14lifller 73rewing Company The Seven-~Cip Companyt Philip_~lnrris 1nd_ustrial$ Consolidated operating revenues p Operating Incorrta-~ ~~ Philip_M_csrris U.S.A. ~_ ~1'Ftilip Nt<~rris International General Foods Corporation Miller Brewing Company _ Philip Morris Credit Corporation* Mission Viejo Realty Group Ino * The Seven-Up Ctanrpany°~ Philip Morris lndustrxal$ Aannrtization of goodwill Consolidated operg ating income 1986 1985 $25,409 $15,9r1 1,478 _ , 1,255 6.20 23.8% 17.6% $ 7,053 $ 6,611 ~ 5.638 3,991 ~ , 9,664 1,632 3A54 ~......_2,.914- ' 678 $25.409 $15,9&4$13,814 $ 2,369 $ 2,050 740 158 ' 18 106 $ 3,735. $ 2, 138 1984 $13,814 889 3,918 734 277 ~ _ 1983 1982 $12,976 A $11,586 2,922 650 . 237 116 227 11-..._.._..~_ 5 17 20 6 30 12 4 $ 1,946 $ 1986-1976 19.51'0 18.7°s'a 04 782 ' 12.0c'lo 8.1% (1.7%.)' 15.6% 18.5% 1.0% 151''0 18.0% 17.2% 20.8~'lc~ 20.0% $ 6,134 $ 5,520 $ 4,330 3,741 3,6473,564 2;929 530 233 $12,9 76 $11,586 $ 1,745 $ 1,338 $ 1,102 Y 421366 446 1986-1981 18.8% ~..e_ Netear.ninp. 17.5% Earnings per s1Eat~ 18.6°'0 18.7% 18.3% Operating companies' income es income before corporate expense, interest and nonoperating income and deductions. `Phe amortization of pre. ~ viously capitaliaed interest is included in operating companies' income. All per-shaew amounts have been adjusted to reflect the two-for-one coennaon stock split-up distributed on Apri110, 1986 to etoekholders of cord en March 14, 1986. General Foods Corporation was acquired in EYovember 1985. Accordingly, consolidated operating results shown above include the operating, resulte esf General Foods lr°.orporation aftr.r tJctober I986. In 198+1.; a write-down of the eomplated but inactive Miller Brewing Company facility in Trenton,.t'JhBat reduced earnings before income taxes, net earnings and earnings per share by $280 tttiElion. $146 million and x.$9, reepectively. I epra ecnta eciuity iu riet carnin~n.qsf tEQeac unconsislEdaterl4itliaidiariae '. " n F986; the company setld substantially all of the operations of The Seven-Up Cantpany to various purchasers and plans to divest the remalning ~ operrmtaons; Seven-[Up 4aas decixnsolidated cffeetive ;Tatsuat'y-1,1986< . tk flr.ctive July 1,19}44, auhstantiallp all oithe Philip Morris Industrial operations were toEdd fur $250 milli®n. The gain on these sales increarea ' exrninga beferr, inecF:rce t; xe5, net earnings antl earnings per share by $77 million, $38 million and iV.1d, respectively, fcr the year 1')85. 1986-1971 19.1~a 19.5a'o

The Components of Success Purchasing.. . only the highest ctuality agricultural products. Promotion.. . i~ffective advertising, ompelling promotion. , onsurner satis£action is our ul.tnn.ate goal. 1Vlanufacturing.. . modern facilities using advanced process technologies. assuring esthetic appeal with real consumer benefits. >Dlstrl.butlon.. . depth, market- y-market, Aore-by-store. .

To Our Stockholders: Iit 1986, Philip Morris Compa- nies Inc. increased its operating revenues, net earnings, and earnings per share b,r' 59.2%, 17.7%, and 18.3%, respectively. The large revenues gain includes a full year of the operat- ing results of General Foods which was acquired in November 1985 and for which only two-month results were recorded in 1985. The inclusion of General Foods' results, together with the interest costs and amortization of goodwill associated with its acquisition, had no dilutive effects on the earnings of Philip Morris Com- panies Inc. in 1986. Your Board of Directors raised the dividend on Philip Morris common stock twice in 1986, for a combined increase of 50% over the dividend rate pre- vailing at year-end 1985. These actions reflect not only our Operating Revenues by Product Line  Other I.7 Beer  Food Products  Tobacco• Bil lions of Dollars 24.5 82 83 84 85 86 strong performance and confi- cfence in our futttre but our continuing effort to add to the value of your investment in our company. In 1986, we made real progress in each of our core businesses. • Our worldwide cigarette sales again increased by over 18 bil- lion units, and we gained share in both the U.S. and interna- tional markets. The Marlboro brand contributed substantially to these results. • At General Foods, except for coffee, food volumes increased and strong gains were realized in key categories. U.S. coffee sales volume declined as a result of much higher prices for coffee following a short crop in Brazil. Capital expenditures in support of improved technology, cost savings, and increased capacity were the highest ever. Operating Income by Product Line  Other 63 Beer  Food Products  Tobacco Bil lions of Dollars 4.2 3.6 3.0 2.4 1.8 1.2 .6 0 II 82 83 84 85 86 • Miller Brewing Company increased volume and market share, and new Miller Genuine Draft was successfully intro- duced nationally. We continued our restruc- turing of'the company in 1986. The Miller Brewing Company and Philip Morris Credit Cor- poration (PMCC) were both ntade first tier subsidiaries of Philip Morris Companies Inc. Mission Viejo Realty Group became a subsidiary of PMCC to improve focus on its financial performance and to help its competitive position in the real estate industry. We completed the divestiture of substantially all of the world- wide franchise business and other assets of The Seven-Up Company. The divestiture of Seven-Up had no impact on our 1986 results. The Administration and Net Earnings Billions of Dollars 1.4 r 1.2 ~, 1.0 ' ® .8 ® ®, .4 ® ® ®' E.Ft n ~ .2 i ® " CJ't ly 82 83 84 85 86

Congressional initiatives that resulted in the Tix Reform Act of 1986 were supported by your eompan}; which expects to benefit from a more equitable distribution of the corporate tax burden. As tax reform was debated in the Congress, we vigorously opposed proposals to increase excise taxes. These taxes are regressive and fall most heavily on those least able to pay. The doubling of the fed- eral cigarette excise tax_only four years ago reduced industry sales, lowered employment, and did much damage to farmers and the tobacco growing pro- gram. We expect pressures for increased excise taxes again in 1987, and we will work with others to oppose them and to demonstrate their detrimental effect. Jacques G. Maisonrouge, for ten years a Director of Philip Morris, resigned from the Board in 1986 in order to become the Directeur General de 1'Industrie with the government of France. We wish to thank him for his long and valuable service to our company. At year-end, Philip L. Smith was appointed Chief Executive Officer of General Foods, suc- ceeding James L. Ferguson, who had held that position since 1973. We are fortunate that Mr. Ferguson's counsel will remain available to the com- pany in his continuing position as Chairman of the Executive Committee of General Foods and as a Director of Philip Morris Companies Inc. The Outlook As we look to 1987 and the future, we are confident of pro- gressing toward our ambition to be the most successful corpora- Dividends Declared Per Share Dollars 2.45 2.10 0 1.75 1.40 .70 .35 82 83 84 85 86 tion in the world in our chosen fields. We will measure that suc- cess not only against that of our competitors but against our aim to improve on our own past performance. We plan to excel in increasing our physical volume and market shares, earnings per share, financial returns, and total return to our stockholders. In general, we aim to be the leader in product quality and in innovation as we produce, distribute, and market our products. Lastly, we intend to continue to attract and retain the highest quality people without whom our plans and ambitions could not be achieved. Our past prog- ress depended on them, and I thank them for the hard work and dedication which will help assure our future success. Hamish Maxwell Chairman of the Board and Chief Executive Officer 3 I

Review of the Year Tobacco Philip Morris U.S.A. cigarette uuit sales were up 0.5% to 214.6 billion units in 1986 while oper- ating income rose 15.6% to $2.4 billion and operating revenues increased 6.7%. Total industry volume declined 2.1% to 582 billion units. Philip Morris U.S.A:s share of the market rose to 36.9%. Marlboro, whose volume grew to 134.2 billion units, was again the nation's largest selling brand, a position it has held for 12 years. Virginia Slims Lights 120's helped the total Virginia Slims brand grow by 1.6%. The value category-generic and lower price name brands- increased to 8.9% of the industry in 1986. Philip Morris U.S.A. entered that segment in 1986 with Cambridge Lights and Players Lights 25's and, by year-end, had built an 11.6% share of the category. Despite the growth of this segment and our participation in it, we remain committed to the high- margin segment of the industry which represented 97% of our unit sa es: Our brands continued to benefit from improved visibility and availability at retail. We have redeployed our sales force, implemented new merchandis- ing and promotion programs, and strengthened distribution channels. As a result, we gained greater share of retail inventory, increased our display space in supermarkets and other high- volume outlets, and substan- tially improved the placement of our display fixtures in all other retail categories. We continue to invest in facility and equipment improvements consistent with the corporation's capital expen- diture programs to insure that our cigarette manufacturing facilities remain the best in the industry. As has been true historically, American-grown leaf tobacco is responsible for the superior U.S. Cigarette Industry Unit Sales  U.S. Cigarette Industry Unit Sales . Philip Morris Share of the U.S. Industry (%) Billion Units % 630 42 oiulllu 36 alli 360 taste and quality of our ciga- rette blends. A new federal price support program, The Tobacco Program Improvement Act, was signed into law in 1986. As provided in the Act, Philip Morris and three other U.S. cigarette manufac- turers made commitments to buy more than 1.1 billion pounds of surplus tobacco which had accumulated in the growers' cooperatives from 1976 to 1984. The purchase of these tobaccos by Philip Morris and others relieves growers of the considerable expense of carry- ing these surplus inventories and should clear the way for the program to operate more efficiently. Early indications from the 1986 flue-cured and burley auc- World Cigarette Industry Unit Sales Excluding U.S.A.  World Cigarette Industry Unit Sales (Excluding U.S.A ) . Philip Mortis Share of the World Market (4'0) Billion Units % 4900 10.5 4200 - 19.0 4

~ tion markets arc in line with the expectations for the new pro- gram. «nly 55 million pounds of the Rue-cured.crop were unsold and taken by the coop- eratives compared with 132 mil- lion pouiiels in the prior year. Burley marl.et results were similar. Despite our major commit- nucnt to lutrchase part of the grow~~rs' surplus stocks, we bought actively in the 1986 crop auction tnarkets. In 1986, there were calls for a national ban on the advertising and promotion of cigarettes. We believe that such proposals ignore the constitutional rights of our industry. Further, they seek to establish a precedent that could have very damaging consequences for many other products which are also legally sold but which periodically attract public or legislative criticism. We have spoken out vigor- ously against such prohibition, stressing the protection of com- mercial free speech under the First Amendment. And to focus attention on this crucial issue, Philip Morris Magazine spon- sored a nationally-advertised essay competition which drew thousands of entries. With regard to another issue, anti-smoking forces continued to push for workplace and pub- lic smoking restrictions based on claims of health hazards from cigarette smoke in the air. These claims are made despite deficiencies in the scientific data and a need for more research which are acknowledged even by our critics. We continue to believe that the weight of scien- tific evidence indicates that exposure to cigarette smoke causes no health impairment to a healthy nonsmoker. Philip Morris International's 1986 volume of 292.3 billion units was its highest ever, a gain of 6.3% over 1985. In addition, our cigarette export volume was extremely strong with unit vol- ume up 14%, and we increased our total share of the profitable cigarette export market to a record 64%. Our exports of cigarettes and tobacco made a gross contribution of $1.2 billion to the U.S. balance of payments in 1986. International's operating revenues increased 41.2% over 1985, and operating income was $501 million, up 15.2% over 1985. International's volume improvement, together with favorable currency movements, would have produced a higher earnings gain had it not been for the decision to increase marketing spending in several high-potential markets. Marlboro accelerated its his- torical pattern of growth during 1986. It is a strong brand entry in most international markets and is one of the world's best- known trademarks. In many markets, the successful intro- duction of Marlboro Lights has added momentum as well as volume and market share to the Marlboro brand family. In addition, our other inter- national brands continue to perform well, notably Merit in Italy, Chesterfield in Spain and Argentina, L&M in Lebanon, and Lark and Parliament in Japan. The Philip Morris brand family continues to make prog- ress in Western Europe and in Japan. Regional and national brands such as Peter Jackson in Australia, Lider in Ecuador, 5

Multifilter in Italy, Mistura Fina in Brazil, and Nacional in the Dominican Republic maintained or improved their positions. We continue to increase sales and gain share in the European Economic Community (EEC). Unit volume was up 6.5%, and our aggregate share increased to approximately 19% of the total EEC market. In Germany and France, our market shares rose to 23.6% and 18.7%, respectively, on strong volume gains. Our share of the Italian market increased. We added volume and gained market share in Spain. Elsewhere in Europe, we improved in both volume and share in the important Swiss market and increased share in Finland and Sweden. Our export business to Tur- key achieved superior results. Volume was up 79% over the previous year, and our share of total market increased by 3.7 percentage points. The industry was down in the Gulf countries of the Midcllc East ilueto the deteriorating <~couoinic clinnate. Despite this, PhiLip 1lorris brands increased share in the major markets within the region. In Canada, our subsidiary, Benson & Hedges (Canada) Inc., merged with Rothmans of Pall Mall Limited. The new company, Rothmans, Benson & Hedges Inc. (in which our direct holding is 40%), has a 30% share of the market and is well positioned to meet the future challenges of the highly compet- itive Canadian environment. Trading was difficult through- out Latin America due to depressed economic conditions. We achieved sales and share increases in most markets in which we operate, which will enhance earnings as the econo- mies in the region improve. We made particularly good progress in Argentina, Mexico, Ecuador, and the Dominican Republic. Marlboro and several of our other international brands performed well throughout the region. Cigarette volume increased in Australia, and our market share improved by more than two share points. We are restructuring Lindemans, our wine business, and consolidating our operations at the Karadoc Winery in Victoria. This restruc- turing will place Lindemans on better financial footing and improve its profit performance in the future. The strong and expanding economies in Asia offer espe- cially attractive growth oppor- tunities. In Japan, our four brand families command a 75% share of the import segment. We are well positioned to take advantage of the expansion of the imported segment of the Japanese market which will result from the suspension of tariffs on imported cigarettes as of April 1987. In Hong Kong, our brands continued to gain volume and market share, and we increased volume in the Philippines. The suspension of the tariffs in Japan and the recent opening of the market in Taiwan are the direct result of effective negotiations by the Office of the U.S. Trade Representative. 6

General Foods Corporata®n General Foods' operating income increased 7.2% to $740 million from the full year 1985 on higher revenues of $9.7 bil- lion in 1986. Overall unit volume declined slightly in 1986 due to a decrease in the U.S. coffee mar- ket. Several key franchises in the United States, however, posted important gains and, internationally, volume growth was strong across most product lines and markets. New product activity contin- ued strong, particularly in ineals, beverages, desserts, baked goods, and coffee. U.S. Grocery Business Volumes in this sector, which contributes approximately half General Foods Corporation Operating Revenues 1982• 1984 data are for 1983•1985 fiscal years, ended approximately March 31. 8ii0ons of Dollars 10.5 9.0 7.5 s.0 4.5 3.0 1.5 0 82 83 84 85 86 of General Foods' operating income, were about even with those of 1985. Our bakery business had an excellent year. Volumes, sales, and earnings moved ahead in all principal markets. New products contributed to the renewed growth of Entenmann's business in the Northeast. Expansion into the Southeast, Midwest, and, most recently, California continues to be vig- orous, keeping Entenmann's the clear national leader in fresh sweet baked goods. Oroweat specialty breads also lead their markets and likewise increased market strength in 1986. Post cereals achieved gains in both volume and earnings. Sev- eral key brands-Natural Raisin Bran, Grape-Nuts, Fruit & Fibre, Pebbles, and Super Gold- General Foods Corporation Operating Income 1982-1984 data are for 1983•1985 fiscal years, ended approximately March 31. Millions of Dollars 840 82 83 84 85 86 en Crisp-increased or main- tained market share. We are committed to continued product development in this market where the potential for growth is good. We made significant progress in the development of new pre- pared convenience meals, one of the fastest growing segments in the food industry. Following a successful test market, Birds Eye Fresh Creations premium frozen dinners are expanding to a number of new markets. Culinova, a unique line of refrigerated gourmet entrees, and Impromptu, a line of shelf- stable meals that require no freezing or refrigeration, are also in test market. In addition, as part of a pro- gram to create a broad line of Italian foods, Ronzoni's new frozen entrees were expanded into the New York market fol- lowing a successful test in Florida. General Foods' position in the dessert business continued to benefit from the strength of the Jell-O brand name. Jell-O Fruit Bars were intro- duced nationally and, together with Jell-O Pudding Pops and Gelatin Pops, helped us main- 7

tain share leaderslril) in the vrowin, frozen uovelty business. New Jell-O ready-to-eat des- serts continue to do well in test market. Worldwide Coffee & International Products This sector accounts for approximately one-third of General Foods' operating income. It increased its earnings and posted good volume gains in key international businesses despite a decline in its coffee volume caused by price volatil- ity which disrupted normal consumer and trade buying patterns, especially in the United States. We introduced Maxwell House Private Collection, a line of premium coffees offered in whole bean and ground forms. Offered last year in selected markets, Private Collection is the first nationally distributed product in the gourmet coffee category, the fastest growing segment of the U.S. market. New programs are contribut- ing to share growth in interna- tional markets. We introduced preiuiutn instaut coffees in C<uia(la, the Unitecl Kinrdont, and ['rance. And in Korea, where the coffee market has been developing rapidly, our volume continues its double- digit annual growth. Our other international busi- nesses, including Hostess snack foods in Canada, Simmenthal meats in Italy, and Hollywood chewing gum in France, per- formed well in 1986. In Brazil, both our Kibon ice cream fran- chise and our joint venture in the powdered beverage business were exceptionally strong. General Foods also enhanced its international business through acquisition and joint ventures. Early in 1987, we pur- chased Kenco Coffee Company Limited, a well-established sup- plier of ground coffee in the United Kingdom. In Denmark, General Foods and Karat Kaf- fee A/S have formed a joint venture to produce and market a variety of coffee products. In Ireland, we acquired Cressett Foods, a manufacturer of con- venience meals, our first such venture in Europe. In Canada, we purchased Laurentide, a Quebec-based snack food company, to complement our Hostess business. We had a very good year in our food service businesses based largely on gains in insti- tutioual coffee sales. In addition to coffee, we sell desserts, bev- erages, and a variety of other grocery items to hotels, restau- rants, schools, hospitals, and other institutions. Processed Meats The company's processed meat business, primarily the Oscar Mayer and Louis Rich brands, contributed approximately 17% of General Foods' operating income in 1986. Volumes, sales, and earnings increased despite some disruption in produc- tion due to temporary plant shutdowns during labor negotiations. However, these negotiations resulted in the conclusion of satisfactory long-term labor contracts. Louis Rich processed turkey products achieved good volume growth across most product lines. These results reflect the trend to white meat consump- tion and the increased national recognition of the Louis Rich brand. Oscar Mayer brand bacon, hot dogs, and luncheon meats continue to rank as best sellers nationally.