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AMERICAN BRANDS, INC. 1976 ANNUAL REPORT II

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Financial highlights/=. ~.o=sa~d, o~ dollars except por ahare arnounls} 1976 Per Common share Net income Without dilution~ ......................................... $4.54 Fully diluted~'~ ............................................ 4.37 Dividends ................................................. 2.80 Net sales .................................................. $4,125,837 Income before provision for taxes on income and extraordinary gain 286,069 Net incomel~) ............................................... 121,992 Dividends Common ................................................ $71,668 Preferred ............................................... 6,611 Number of Common stockholders, December 31 ................ 126,466 Average number 01 Common shares outstanding during the year... 25,634,664 1975 $5.63 5.38 2.68 $4,055,313 302,514 148,527 $68,623 4,424 128,473 25,612,015 I1 ) Net income in 1975 includes extraordinary gain of $8,501,900, equivalent to $ 33 per share without dilution and $.31 per share tully diluted. Operating results by product line <,,, m,r~o°,/ Net sales Operating income('~ 1976 1975 1976 1975 At~ount ,% AttlOUnt % Amount % Amount % Tobacco products Domestic .............. $1,069.0 25.9 $1,051.5 International ............ 1,531.7 37.1 1,563.3 Hardware ................ 175.9 4.3 160.6 Food products ............ 455.4 11.0 457.6 Distilled beverages ........ 151.4 3.7 146.5 Office services and supplies. 111.7 2.7 98.7 Optical goods and services<2) 49.7 1.2 52.3 Toiletries ................ 71.2 1.7 65.5 Engineering(z> ............. 80.9 2.0 97.8 Golf products ............. 40.8 1.0 RetailingC2> ............... 146.5 3.6 150.1 Wholesaling~~; ............ 176.6 4.3 183.5 Other .................... 85.6 2.1 49.8 Deduct intracompany sales.. (20.6) (.6) (21.4) Total .................... $4,125.8 25.9 $206.1 54.7 $195.9 52.5 38,6 46.1 12.2 64.8 17.3 4.0 34.7 9.2 33.2 8.9 11.3 22.3 5,9 18.2 4.9 3.6 17.0 4.5 16,0 4.3 2.4 14.3 3.8 10.8 2.6 1.3 8,6 2.3 9.1 2.4 1.6 5,0 1.3 3.5 .9 2.4 4.8 1.3 11.8 3.1 3.9 1.1 3.7 2.5 .7 2.8 ,8 4.5 .9 .2 f .8 .5 1,2 10.6 2.6 5.7 1.5 (.6) lOOJ $4,055.3 100.0 $376.7 100.0 $373.6 100.0 (1) Earnings befole inte~st, uther incor le, other deductions, ~ncome taxes ~nd e×t ra, ordi~ary gain (2JForeig~

Operating income No[ttobacco products 135 72 ~0 45 30 ~5 $270 1965 1966 1967 19~B Tobaccoprodue~ 19G9 1970 1971 1972 ~973 1~74 1975 1~7G 225 195 16o 165 19~5 19~ 1967 1968 19~9 1970 1971 1972 1973 1974 1975 1976

To our stockholders Robert K. Hermann Chairman of the Board and Chief ExeCutive Officer All three o1 our management groups--domestic tobacco, nontobacco and international tobacco did thelr jobs well in 1976: 1. Operating income of the American Tobacco Division was $205,204,000, a gain o1 $10,632,000 over 1975. This is the first time American Tobacco profits exceeded the $200,090,000 mark. American Cigar's operating income o1 $6,352,000 was close to its record high. 2. Operating income of our domestic nontobacco business exceeded $10O,OO0,00O for the first time. The final figure was $104,090,000, a gain of $19,959,000. These operations include Master LOC k, Beam Distilling, Sunshine Biscuits, Swingline, Wilson Jones, Acushnet, Jergens, Acme Visible Records and Duffy-Mott. Total nontobacco operating income, including that of Gallaher Limited abroad, was $124,521,000, up 10%. 3. Our large British subsidiary, Gallaher Limited, increased tobacco operating income to a record high of £36,834,000, a gain of £5,131 ,GO0, or 16%. Despite these new highs, foreign currency translation adjustments due mainly to the decline of the British pound reduced American Brands' reported net income by $44,623,000. Net income for the year after these adjustments was $t 21,992,900, or $4.54 per Common share, compared with $148,527,000, or $5,63 per share in 1975. Excluding foreign currency adjustments, net income for 1976 was $168,6t 5,000, or $6.28 per share, compared with $154,485,000, or $8.86 per share in 1975. Domestic tobacco sales (American Tobacco and American Cigar) were $1,068,992,000, a gain of 2%. For domestic nontobacco operations the sales total was $1,040,526,000, a gain of 12%. Sales for Ga[laher Limited were £1,1 t 1,613,000, a gain of 20%. Consolidated sales after transla6ng Gallaher's results into dorlars were $4,125,837,000, compared with $4,055,313,000 in 1975.

As illustrated by the chart on page 2, the heavy foreign currency adjustments which reduced net income did nor prevent total operating income from setting a new record at $376,692,009. Furthermore, cash flow continued strong and resulted in a $91,609,000 reduction of total debt by the end of 1976 compared with the December 31, t 975 level. The Board of Directors therefore again increased your cash dividend on the Common stock at the January 1977 meeting. The new rate of $2.92 per year, or 73¢ per quarter, takes effect with the March 1977 pay- ment. That compares with $2.80 per year, or 70¢ per quarter, paid in 1976. This year's i nc rease was the 13th In the last 13 years. Domestic tobacco operating ]ncome, as the chart on page 2 shows, has shown steady progress over the last three years. Both American Tobacco and American Cigar contributed to fhe 1976 improvement. The upper por6on of the chart also shows steady profit progress over fhe years for our nontobacco diversification effort, starting in 1966. Progress continued in 1976: Master Lock operating income exceeded $20,600,009 for the first time on higher sales volume. Master Lock has increased operating income by over 100% in the six years since it was acquired in 1970. Beam Distilling rebounded from the 1975 recession year with higher case sales of Bourbon and a 4% increase in operating income. Sunshine Biscuits operating income reached an all-time high at $18,402,000, a 22% gain over 1975. Swingline operating income was down 3% to $16,483,000 owing to the cost of reorganizing and resfaffing its newest subsidiary, Man/el Lighting Corporation.The other principal Swingline divisions showed excellent gains. Operating profits from Swing][no staplers increased $1,288,000, or 20% ; from Case Cutlery $1,188,000, or 68% ; from Marson automotive and fastener products $253,000, or 16% ; and from Spotnai]s $1,142,000, or 181%. Wilson Jones in its first fug year as a first-tier subsidiary showed the most dramatic increase, with operating income up 58%, or $4,191,00O, to a record $11,43t ,0O0. Acush net increased operating income by 8% to a record $10,408,000 for calendar 1976. Of this total $7,729,000 was consoli- dated in American Brands" results since the acquisition of Acushnet took place in the second quarter of 1976. The Andrew Jergens Company turned in its highest operating income since its acquisition in 1979, $5,896,000. Acme Visibte Records showed a dip of 18% in operating income to $2,899,000. This traced to a loss year for its business forms opera- tion. However, Acme's principal business, record retrieval and storage, which accounts for fwo-thirds of the company's sales, showed a profit increase of more than 11%, to $3,254,000. Duffy-Mott rebounded from a depressed 1975 with a 63% operating income increase to $2,546,009. At the same time, Duffy-Mott achieved near nabonal distribution for its own Super Mott's Prune

Juice and discontinued sell[ng and marketfng prune product brands owned by others. The third major phase of our operations, Gallaher Limited, had a successful year in terms of pounds sterling, with operating income up 7% on a sales gain of 20%. Gallaher increased its share of the cigarette market in the U.K., in the Irish Republic and in The Nether- lands. It reduced its debt in pounds sterling by 28% and furnished a cash dividend to the Parent Company which translated into $20,108,00(3. However, the decline of the British pound from $2.02 to $t .70 during 1976 gave rise to charges of $42,922,g00 which reduced American Brands' net income. Part of this, $20,575,000, was charged against Gallaher's operating income in dollars as reflected on the chart, page 2 (International Tobacco 1976). These heavy foreign currency translation adjustments should not obscure Gallaher's excellent performance in reducing its debt, contributing to American Brands' cash flow and increasing its share of market in cigarettes, cigars and smoking tobacco and in its optics and retailing operations. Detailed discussion of subsidiary results appears on the pages that follow, while operating results by product line for 1976 and 1975 are shown on page 1. Effective January 1, 1977, the Board of Directors elected Mr. John F. Walrath President and Chief Operating Officer and changed the title of the undersigned to Chairman and Chief Executive Officer. In August, Richard B. Young, President of Aoushnet, was elected to American's Board. Effective March 1,1977, two new Directors join the Board: Edward J. Jennings, Jr., President of Sunshine Biscuits, Inc., and Edward W. Whittemore, President of Swingline inc. They assume seats vacated by the retirement of Julien B. McCarthy, Executive Vice President of American Tobacco, and Daniel F. Cahalane, Director of Corporate Insurance and Real Estate of American Brands. The Board thanks Messrs. McCarthy and Cahalane for their contributions during careers of 44 years and 50 years, respectively, and wishBs them well in their retirement. We describe our Company as a diversified manufacturer of consumer products. In this relatively new role we still hold to American Tobacco's old credo: "Quality of Product Is Essential to Continuing Success." We believe it is the combinat{on of outstanding people and quality products that produces quality profits. We appreciate the loyalty and support of the stockholders and welcome your inquiries about our business. Submitted on behalf of the Board of Directors, Robert K. Heimann Chairman of the Board and Chief Executive Officer February 22, 1977

The American Tobacco Company For the first time American Tobacco's operating income exceeded $200,000,000. The 1976 figure was $205,204,000, up 6% from 1975's $194,572,000. Sales were $1.053,230,000, compared with St ,098,848,000 in 1975. Sales include $14,675,000 from smoking tobacco and $16,555,090 for the outside business of Golden Belt, American's printing and foil-laminating subsTdiary. Sales of the division's cigarette brands were $1,021,556,000. During the last three years American Tobacco's operating income has increased from $172,581,000 to $205,204,000. a gain of 19%. During the same period advertising expenditures have doubled and selJing expenditures have increased by more than a third. This is in keeping with the company's objective of increasing its filter cigarette business to compensate for the decline in nonfilter cigarette sales, a decline which has continued for many years and which is expected to continue. Over the last three years unit filter sales have increased from 43% of the total to 50% at present. The fastest-growing segment of today's cigarette market is the low-tar category, which now accounts for an estimated 16% of industry sales. Sales of Carlton cigarettes, the pioneer low-tar brand, and the first to carry tar and nicotine numbers on the pack, showed a sub- stantial increase last year on top ot a sharp gain in 1975. Car/ten offers a filter king and rnenthol king lower in tar than any competitive brand (less than 1 rag. per cigarette). In addition, the company's line includes Lucky lO9's and Iceberg lOg's, which deJiver less tar than any competitive 100's or menthol lO0's (4 rag. per cigarette). In 1976 the swing to low-tar cigarettes came at the expense of con- ventional filter brands, including the company's ]argest filter brand, Tareyton. In unit sales Pall Mail's85 and 100 mm fi]ter cigarettes were about even with 1975, while Carlton's unit increase roughly corn- 6 i .........

pensated for the dip in Tareyton. During the second haIf of 1976, added promotional weight was placed behind Pall Mall Extra Mild which, at 7 rag. of tar, is lower than all the advertised "lights." The brand responded to the increased promotion, which is being con- tinued. In addition, Tareyton lights were developed and will be introduced nationally during the first quarter of 1977. Tareyton lights offer in addition to a low-tar level of 8 rag. per cigarette the well- known "Tareyton plus" in the form of Tareyton's activated charcoal filter, which the brand pioneered in 1954. Pall Mall and Lucky Strike nonf]lters are still substantial in size, reflecting American Tobacco's long-time dorn]nance of this segment of the market. However, these brands have been declining since 1964 and 1949, respectively. In 1976 they again declined, reflecting the industrywide downtrend for nonfi[ter products. Nevertheless, inde- pendent analysts estimate American Tobacco has nearly 60% of all U.S. nonfilter cigarette sales, with Pall Mall King far and away the leader in the nonfi]ter category. American Tobacco's advertising agencies are compensated on an incentive fee system instead of the conventional 15% commission on billings. Savings to the company from this system were $2,493,000 for 1976, bringing total savings since 1965 to $20,172,000. Industry sales of smoking tobaccos again declined. American Tobacco's total poundage sales were down in line with the trend. Our principal brands--Half and Half, Paladin Blackcherry and Bourbon Blen~he[d their share of market. Average market prices for Feat tobacco increased sharply in 1976. Flue-cu red tobacco sold at an average of $1.11 per pound, compared with $1.0g in 1975. Burley leaf increased from $1.05 last year to $1.15. Higher leaf costs and cost increases for labor and packaging materials led to a cigarette price increase of 75¢ per thousand in October.

Gallaher Limited 20/2o0 L, F. G. Pritchard MaNaging D]r@ctor Gallaher's operating income in 1976 reached a new high of £46,427,000, an increase of £2,908,000 over 1975. Sales reached a record high of £1,111,613,090, up 20% over the prior year. About 24% of the company's sales is derived from its nontobacco busF nesses: engineering, optical, who[esaling and retailing. The remainder represents tobacco products. Operating income from tobacco in pounds sterling was up 16% as a result of an increase in home trade and overseas business. In the U.K. the company increased its share of market, with its Silk Cut low-tar brands and Benson and Hedges Special Filter gaining. AS the United Kingdom shifts from a duty levied on tobacco weight to an end product tax (to be completed by January 1978), price dif- ferences between king-size cigarettes and smaller cigarettes will lessen. The reduced price differential is expected to shift sales to king-size brands at the expense of shorter cigarettes. Benson and Hedges Special Filter is the leading brand in the klng-size market and increased in volume during 1976 despite severe price cutting by new competitive brands. Silk Cut increased unit vo]ume and is now Gallaher's largest-serling cigarette. Silk Cut is recognized as Britain's leading low-tar brand. Hamlet remains the leading cigar in the U.K. and posted a unit increase in 1976, whi]e the industry declined 1%. Gallaher's cigar sales were up slightly and the Cigar Division enlarged its market share from 33% to 34%. Old Holborn made gains in the roll-your-own market and Gallaher's two major pipe tobacco brands, Condor and Meflow Virginia, increased their volume. Gallaher's Niemeyer operations in The Netherlands contributed £3,075,000 to operating income, more than double the 1975 figure. In the growing low-tar category, Roxy Duel Filter more than doubled ils