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FINANCIAL I Xat comha ny's financii~l holicy Iias ~rlhvay.s been a(fected by thc. nc ce ssity tc~ huiltl' stocks of le tf cco and increase hroclnctive c<<laacity in lina with the trc~menclc~us ~;rowth in salk~s, `i'herc~ pns• sible it has been our policy to meet expansion requirements out of income. For this reason our divi- dend payments have been a moderate proportion of net inco,ne: ln recognition of the stockholders' undistributed equity in our net earnings, we issued a stock dividend during the late Thirties, thus retaining in the business the funds which a cash dividend would have withdrawn. Our continuing rapid growth, h0wewer, was such that stockholders were givcn the opportunity to subscribe addi- tional funds through preferred stock four times during the past ten years. The first three of these issues have either been converted into common stock or refunded by the presently outstanding 4% preferred. The $3.60 preferred outstanding was issued last year. . At the pcak of the war demand when tobacco prices were making new h16hs every year, your directors found that additional funds could be used again to the interesf of the stockholders. An issue of preferred stock was planned principally to provide the increased capital funds necessary to finance the higher price of tobacco, the increase& volume of revenue stamps and the larger in- ventory requirements of the company occasioned by growing sales. The opportunity to purchase needed tobacco on favorable terms came in advance of the stock issue and funds were borrowed from banks on short term. Conditions in the tobacco industry were undergoing marked change during the long period of preparation and registration of the new preferred stock issue which was made necessary by the laws and practices governing financial markets. As it happened, the offer- ing of the preferred stock coincided with the end of purchases for the armed forces as described earlier in this letter. The income and production figures covering the period immediately preceding the offering of this stock inchided the effect of military orders. With the sudden ending of this de- mand, sales of the entire industry dropped sharply, much more than could have been expected be- cause of the season of the year. Your management believed that the stockholders should be apprised of this situation and concurrently gave them the option to cancel their subscriptions. All but 19,543 shares were cancelled. This event led your company to make its first substantial long term loan. 1•, ?100" ,-~

'Clte maltal;ement nlight well have eontimted to nrtke short term loiu-s tnasmuch as the lenders of funds to be repluced by the capital subscription were (luite happy to have the loans remain. But first, because the growth of the company had made its im•entory requirements permanently higher, and second, bccause thp! nature of Its inventory holding is long term due to the aging period; it was believed wisest to substitute a long term debt for short term notes payable to banks. A $32 million issue of debeilttires was placed with the Equitable Life Assurance Society of the United States, as described in the annual report last year. It was taken on the most favorable terms and lowest interest cost ever advanced by a large finan- cial institution to a member of the tobacco business CU1111nullity Ul) to that tlllle. MR. L. G. HANSON, the chief financial officer of the company, has been with us for twenty-three years. Treasurer and Director since 1934, he became Vice. President during the latter weeks of the war. His fellow directors rely upnn the soundness of his judq• ment in matters affecting the financial policy of your company. We entered the 1947 fiscal year in a sound condition. During that year we added over $1.4 million to the conlhtuty's pruductiive eduipment and at the same time iinproved Its working capital position. This improvement in liquid condition was accomplished through a reduction of manu- factured stocks and accounts receivable and the application of the $32 million bond issue to the reduction of bank loans and outstanding long term debt. Current assets on March 31st, 1947 were more than seven times current liabilities and our net working capital was at an all time high of $94,588,752. t' CONTINGENCY RESERVES 0 Your directors have deemed it proviclent' to set aside the sum of $500,000 out of the net~ earnings 9

COMPOSITION AND USE OF NET PROFITS 1946 1947 Profit fiomioperations and investments $8,006,267 S9;81],226 :. Pa6 for interest~ and prior service contribu~ i { tionito retirement fund' 558;573 1,202,141 . Providedfor taxes on income 2,550;C00 3,200,C30 Arail:`!a from usual' op,.,rati,"s for dirid~!^ds and prnis!:n for futura n~".'s of G",a busi-.:ss 4,497,694 5,409,085 But in each year, there were charges of an unusual nature whichi were paid or set aside outlof income: Losses from termination of war and reim• bursement of stockholder costs arising from subscription cancellations on 3.60 pfd $517,222 Premium paid on retirement ofi3% debentures Set aside for possible future charges , Total deductions $4]200 5001000 517,222 972;000 And, in each~ year there were credits or sums received not, in the ordinary course of business: Refund of excess Frofits taxes 1,867,528 Excess income tax provision prior years 3('0,000 Recovery under Government contracts 310,000 Profit'on sale of property 77,200 Premium received on 2s/, debentures, less expenses 133,865 Total'additions 2,167,528 521,065 Leaving, after including the unusuallitems 6,148,000 41958,150 Out of which wara pai44ri0ends 3,814,660 4,361,086 And the balance set aside for future business needs was 2,333,340 597,064 of the year just enclc•d in order to create a reserve to tirke carc of VVentualittes and leavv future carn• ings free of contitil;ent charges. Among the possible charges provided for are the expenses to the comhany which may be incurred in the settling of claims described in some detail in the pros- pectus of Jan. 16, 1946 under "pending litigation," 10

. This Is -he lost of eleven stages of mixing before the -obacco goes to the clgarefte making machines. The hot strips of tobacco which have just been pasteurized are here being treated with a cooling spray. J 11

LEAF AND BLENDING has been played by the n uiitst;mdini; part in the success of 1'hilih \1c-rris clurii-g the l rst teu years men of theleaif and blending e]ehartme--t. Mr. Hatcher„a vice-president, and Mr. Archbell, a direc- 0 tur of the con-I~,uiv, h.tVr Wurk-'cl t+-grthUn Ituclr,sr ecwl-Vrutitnt sii-ce tltrv, With 11r. Uluwiclclie, our h-huccl- hlvndiut; eslwrt, uriKiuntrtl the 11hilijt Morris E-it;lish 111cnal ili I932. lttich of our success has hevirtlhe to 1l10r itl-llitv ti- tnnlntitin ni°statul:-rtl of -IuitNtv'usvr the yatrr, Because of the vuri,chility of weather, tobacco froni the same seecl grown in the same ground by the same fanner will differ sufficiently from year to year to affect its taste. Therefore at the time of the making of a cigarette there must be on hand not only the proper amount of well aged tobacco of many types but also a duplication of these types from at least three crop years. This is necessary to instire uniformity of blend. To anticipate in the auction markets requirements for manufacturing for years ahead and to buy with unerring accuracy quatntities of aged tobacco of proper grade and dualityisahvays difl5- cult. It is even more difficult with the added problem of a large increase in sales from year to year. It is to the credit of this branch of our business that the quality of Philip Morris English Blend ciga- rettcs is just as high today as at the time of the origination of the blend. The mi•n of our leaf deparhneut have a knowledl;c of tobacco which eXtunds over more thai) two bcnerations and covers the entire world. Owing to wide experience with tobacco markets our )eaf purchasing problems clid not become acute until the complications caused by government allocations and the rising prices of rnw tobacco brought by the war years were upsetting the entire ihdustry, I)urinb 19-15 we bought a substantial portion of the tobacco which had been owned by the Axton Fishvr Tobacco Comptny. We were able to select from it large quantities of high quality and ft_ 12 I ~

TheN machines, by means of alternote application of high vacuum and -teom, nstore moiitvre to the tobacco which has previously been dried and aged, thuw giving the beil tex-ure for machine handllnq. The machines accomplish In a few hours what formerly required weeks. The vacuum is to perfect that when a machine is closed and the vacuum applied, to use the words of our foreman, "all the men in Richmond couldn't qet the hogshead out." well aged leaf to use in the immediate production of the additional cigarettes necessitated by the growth of the company's sales. Without it, inventory of aged leaf would have been dangerously reduced. Its use in the critical period just passed has made it possible for your company to achieve today an aged tobacco inventory outstanding in the industry in terms of the company's quality and production requirements. Thanks to this fortunate acquisition we came into the year 1946 with enough tobacco of Philip :1lorris quality to enable us to be selective in our purchases of raw tobacco in the crop season just concluded when prices reached an all time peuk. Our inventory costs are well below those price It^\-+4 untl tlir cunilntnv'L4inventorypotiitiun willperinit uK totukr -ttlvunt-igeof anyl-rice rrcessl«m in rnA-ing furthc'r piirchases. 13 ~ .~.......~~,,.. ~..y ...~._.....~..._._._~__....~...

OPERATING EFFICIENCY he manuf!:>cturing dehartment Of your comhclnl' is under Mr. C. T. Ames, Ir., 1'ice:-1'tesident in charge of produe- tion. In 1937 this department was lo- cated in our main plant in Richmond which had 213,000 square feet of floor space. By purchase and building, (some of the building in the difficult war years) we have expanded.to our present size with two complete pro- duction units In Richmond and one each in Louisville and London, Eng- land. MR. C. T. AMES, JR., VICE-PRESIDENT in charge of monu- facturinp, come with us in 1935. Beginning forty years of experience In clyarett* mokinp as a factory worker In a large tobacco company, he started up the management ladder when he was madi packing foreman In 1910, By 1919 he was plant wperintendent and continued In a managerial capacity thenceforth. The investment in land, machinery, and buildings with 962,000 square feet of floor space now operated, stands at $6,468,421, after deduction of reserves. This compares to $1,513,914 of net prop- erty investment in 1937. Annual deductions, now aggregating $3,370,020, are made to provide for replacement of equipment when it wears out or when better, more efficient machines may be de- veloped, Finished Philip Morris products might be compared to the dishes prepared by a fine chef. Assembling the best ingredients is the starting point. Skill and! imagination are combined in the blending, flavoring and making, to reach in the end the pleasurable taste giving the greatest satis- faction. When cigarettes were made by hand, excellent quality could be achieved but only at a cost prohibitive to the general public. Our application of the science of mass production and lab- oratory cleanliness to the art of cigarette making has added uniformity to the excellence of the cigarette maker's best work and has brought vintage tobacco within the range of all smokers. Although tobacco prices on the average have risen 78% and wages have more than doubled, manufacturing efficiency and an increase in volume have made up enough of the increase in the 14

A TEN YEAR RECORD OF PHILIP MORRIS OPERATIONS Statements of Income for the fisca[years ending March 31. (000,omitted) 1938 1939 1940 1941 1942 1943 1944 19/5 1946 1947 NET SALES (including Revenue GROSS OPERATING PROFIT 14,008 16,507 16,815 19,713'! 25,390 27,365_ 25,611 26,248 16,881 21,581 SHIPPING, SELLING, GENERAL & -- - ADMINISTRATIVE EXPENSE 6,487 7,979 7,191 9,149 10,884 12,420 12,501 12,080 10,953 12,845 OPERATING _ PROFIT4_ ~_- 7,521_ 8,528 9,684 10,564 14,506 14,945 13,104 14,168 7,934 9,742 OTHER INCOME 430 _ 108 131 161 193 183 149 267 (3)2,323 (5)683 TOTAL INCONIE 7,951 8,636 9,815 10,725 1~4,699 15,128 13,253_ 14,435 10,257 _ 10,425 -- --.~ _ INCOME DEDUCTIONS 584 551 675, 594 445 515 672 (2)940 (4)1,476 (6)2,114_ NET INCO'.1E (pefore Taxes) 1,367 8;085 9,140, 10,131 14,254 14,613 12,581 13,495 8,781 8,251 FEDERAL AND, STATE TAXES 1,704 1,534 1,704 2,171 6,462 7,682 5,930 6,692 2,633 3,293 : NET INC0~,1E 5,663 6,551 7,436 7,360 7,792 6,931 6,651 6,803 6,148 4,958 OST 'Jr SALES (mc u+ng evenue Stamps) 41,605 48,088 56,469 67,639 87,175 113 682 152 290 159 051 159 799 148,319 Stamps) 555,613 $64,595 $73;344 $87,352 $112,565 $141,047 $177;901 $185,299 $178,686 $170,906 ! d' R ; TOTAL DIVIDEND PAYMENTS- CASH 3;1115 (1)4,004 4,455 4,549 5,103 5,091 5,340 5,363 3,815 4,361 NET INCO;r1E RETAINED IN THE BUSINESS (7) 2,548 2,547 2,981, 2,812 2,689 1,840 11,311 1,441 2,333 597 ' (1) Disregarding a stock dividend of one-half share of Common Stock for each share of Common Stock. Earned Surplus charged 32;597,950.001for shares of Common Stock issued4ith respect to this dividend. i(2) Inciuding provision,of $250,000;00 for post-war and other contingencies. (3) Incl'uding claim in amount of a1,867;521.76 for refund of federal excess profits taxes of prior years, arising under the carry-back provisions of the Internal Revenne Code, and excess provision of $300,000 in prioryear5 for federal income taxes. (4) Including charge of$492,22ll.95 forlosses arising from termination of war, less amount thereof chargeda8ainst provision of $250,000.00 for post•war, i and other contingencies; (See Note 2),, Also including,charge of, $275,000:00 for reimbursement of withdrawing subscribers in the purchase of , subscription rights to shares of Cumulative Preferred Stock, 3.607o,series. ;(5) Includes recnveryof $310,000 in connection with government contracts, net premium of $133,865 received in sale of 25~% Debentures, and profit of $71,200 on sale of real estate, 3) Includes premium of $472;000 paid on retirement of 370 Debentures, and provision of $500,000 for claims, litigation and contingencies, -{1) Subject to, minor, surplus adjustments. A TEN YEAR RECORD OF PHILIP MORRIS OPERATIONS Balance Sheets at March 31, (000 omitted) 1938 1939 1940 1941 1942 1943 1944 1945 1946 1941 ASSETS Cash and Marketable Securities $ 1,082 $ 1,501 $ 1,529 $ 9,524 $ 3,158 $ 3,175 $ 2;455 $ 2,320:' $ 2,486 $ 4,024 Receivables 3,093 3,705 3,854 5,172 6,255 8,219 11,017 10,063 7,914 6,391 Invytoqes 20,915 27,295 32,038 34,816 53,143 70,570 69948 87,280 112,745 98,812 Othen Current Assets -- - - -- - 102 4,290 206 1,867 -- Total Current Assets 25,090 32,501 37,421' 49,572 62,556 82,066 87,710 99;869 125,012 109227 Net Property Account 2,438 2,885 2;783 3,099 3,729 3,723 3,471 5,110 4,989 6,468 -Prepaid I(yms & Other Assets 1,713 1,157 2,051 2,044 2,534 3,286 3,304 1,929 1,391 1,049 Totat Assets 29,241 37,143 42,255 54,715 68,819 89,075 94,485 106,908 1311,392 116,144 LIABILITIES Notes Payable 850 8 7,000 9,000 52 8;000 -- 5;000 16,000, 44,000 5,500 Federal Taxes , 602 1 1,426 1,700 2;706 6,212 1,917 6,028 6,992 2,681 3,440 Accounts Payable , 121 1 877 665 31!708 3;425 5,427 6,952 5,447 2.574 3,866 OtherCurrent Liabilities , 1,134 1,206 1,298 .1,552 1,795 1,774 1,645 1,855 1,369 1,834 Total Currentliabifities 12,707 10,509 12,663 8,018 19,432 15,118 - 19,625 30,294 50,624 --- 14,640 - Long Term Debt ~ -- -- --- -- -- - 11,700 - 11,500- 11,300- 11,500~ -- ----- 32,0001 Reserves for Contingencies etc. -- - 250 - - 500~ , ~ Net Worth 16,534 26,634 29,592 46,691_49;387 62251 63,360 65,064_69,268' 69,604 ~Totat Liabilities 29 241' 37,143 42,255 54,715 68;81989,075 94,485 106,908 131,392 116,744 Net Working Capital , 12,383 21,992 24,758 41,554 43,124 66,948 68,08569,575 14,388 _ 94,587 1_'U~:333199 ,-.

A COMPARISON OF PHILIP MORRIS OPERATIONS WITH nHE AGGREGATE FIGURES OF ITS FOUR MAJOR COMPETITORS The fiscal year of Philip Morris & Co. Ltd., Inc. ends March 31. The figures of the four major competitors are on a calendar year b;,~Uq emapA the 1937 comparison is between the March 31, 1938 fiscal year dt Philip Morris and the 1937 calendar year for the other companies. 1931 1938 1939 1940 1941 1942 1943 1944 1945 1946 ET SALES (including Revenue Stamps) P. M. Co, 000 omitted $55,613 4 Compeling Companies 000 omitted $864,056 P. M. Ca 000 emitted $64,595 4 Competint P. M. Ca, Companies ON emitul 000 omltted $841,009 .=73,344 4 Competing F. M. Co, 4 Compsunt Companles Comp~niq 000 omitted 000 omitted 000 aninw $851,838 ~$81,352 $902,967 p. M. Co. qfo eoihed $112,565 4 Compotlnl Compeniss 000 omitted $1,045,506 P. M. Co. 000 omitted $141,047 4 Compelln~ Companles 000 omitted $1,206,242 F. M. Co, 000 omitted $177,901 4 Compotln(< Companies NO omitted $1,408,276 P. M. Co. ON omitted $185,299 4 C 0 $ Competln ompanies 00 omllled 1,419,195 F. M. Co. 4 CCO omItled O $178,686 $ Conqennt ComNeNs M omitted 1,514,167 F. M. Cs. ON ommed $110,906 4 $ Conqonn Campanlss NO omlttd 1,965,829 NET Smt E< (including Revenue Stamps) per $1,000,000 of net property 22,810 16,063 22,390 15,530 26,354 14,925 28,187 15,815 30,186 17,459 37,885 21,375 51,253 27,199 36,262 29,542 35,815 32,771 26,423 33,908 ANALYSIS OF Ui'4RAI1uris t -- -- - ` --- --- •-- ---- --- -- , , . 00.00% 100.00% ' 100.00% 100;00~0 •100.0070 100.0070 100.00% 100,00 a 100,0070 100.00% Cost of Sales (Excluding Revenue Stamps) 48.36 (1)61.20 48.07 62.32 62.55 60.65 51.61 j 59,71 50,97 59,17 58.65 62.15 68.54 68.16 72.52 75.09 77.43 78.76 73.70 ]1.13 Gross Operating Profit 51.64 38.80 51.93 37.68 1~` 41.45 39.35 48.39 40,29 49.03 40.23 41.35 37.85 31.46 31.84 27.48 2431 22.57 21.24 26.30 22.27 Shipping, Selling, General & Administrative Expense 23 91 16 65 25 10 29 16 ' 20.22 16.60 22 46 ` 15 92 21 02 i 15 19 18 ]1 12 54 15 36 ~ 46 10 12 65 7 86 13 09 5 77 14 95 6 18 . . . . . . . . , . . . . . . . . . Net Operating Profit 21,13 22.15 26.83 21.39 27.23 22.75 25.93 $ 24.37 28.01 25.04 22.58 25.31 16.10 ~ 21.38 14.83 11,05 9.48 15.47 11.35 16.09 Other Income 1.58 1,18 .34 1.15 .37 .63 .40 1 .42 .37 .57 .28 .45 .18 .32 .28 30 2.78 i .35 .80 .23 Total Income 29.31 - 23,33 21,11- 22.54 21.60 23.38 26.33 ~ 24.79 28.38 25.61 i 22.86 25.76 16.28 21.10 15.11 17.35 12.26 16,82 . 12.15 16.32 Income Deductions 215 1.98 173 1.43 1,90 1,54 1,46 1.58 ~ 18 1.58 i 83 ~ 1 40 ..98 1.44 ' 1.76 N 1.94 ; 2.54 `. 1.80 ~{ , . Net Income before Taxes 27.16 21.35 25.44 21.11 25.70 ; 21.84 24,81 4 ) + f:;2 24.03 22.08 24.18 i 15.45 20.30 14,13 15.91 10.50 13.88 9.61 14.52 Federal and State Taxes 6.28 3.97 4.83 4.08 4.79 4.32 ,~. 6.80 6.59 -12.48 10.77 11.61 13.46 7.28 11.37 7.00 8.23 i 3.15 .; 6.22 3.83 5.92 Net Income as % of Net Sales (Excluding Revenue Stamps) 20.88 ~ 11.38 20.61 17.03 20.91 17.52 18.07 I6.64 15.04 13 26 10.47 10.72 8.17 8.93 ~°. 7.13 7.68 7.35 + 7.66 5.78 ! 8.60 Net Income as % of Net Worth 34.25 14.14 24.60 13.43 25.13 13.75 15.16 ± 13.10 15.11 12.00 11.13 10.12 , 10.50 10.15 10.45 9.34 8.88 8.82 1.12 11.68 Net Income er sh re of Commo St k 10 91 94 5 4 67 3)2 04 2 p a n oc . hU.50 , 8.33 8.14 , 8.01 ,6.10 5.81 . ( . . CAP!TAt SiIA!TUk( % Long term debt 9.65 11.89, 11.18 46 10 9.88 15.82 20.24 16.36 , 20.89 14.79 28:21 14.24 28.97 31.49 43.63 ~~. . % Preferred Stock 14.92 10.04 13.44 2.86 13.37 31.91' 13.28 130•11 i 13.37 26.66 , 11.53 26.07 11.11 26.11 9.99 27.16 14.36 . 21.40 10.93 % Common Stock' and Surplus 100.00 15.43 89,96 74.67 97.14 75.45 68.09 16.26 69.83 76.75 57.52 68,23 58,5] 68.00 59.04 61.80 58.60 56.67 47.11 45.44 ASSET PO,Iil;" '! ~ ~ k i w Net tangible assets per $1000 of debt 10,263 7,787 8,493 9033 9,510 ; 6,321 4,582 6,509 4,457 ° 6,758 3,328 7,019 3,259 3,191 1,939 Net tangible assets per common share 31.85 (2)28,02 32.58 35.51 38.58 42.58 43.87 45.11 (3)23.66 24.20 Net current assets per $1000 of debt 8,418 6,404 6,994 7,407 7,842 5,]22 3,936 5,920 3,860 6,157 2,943 6,469 2,984 2,956 1,7]4 Net current assets per common share 23.85 (2)22.59 27.10 29.81 31.57 35.56 37.09 38.32 (3)20.49 20.44 (1) Partially estimated, (2) after 50% stock dividend, (3) after exchange of 2 shares $5 par value for each share of $10 Par Value Stock, 17 lt?

``... . _. To insure against the presence of porticles of tobacco stem in the finished cigarettes, the soft part, of the leaf Is removed from the dem at an early stage of manufoctu-e. Theie machlnn each do in one day the work which would' require weeks of tedious application for a man. 11ltilih Jlurris costs to lot-rmit us tu sell the tn-v;tryiitg I'lulip Morris quality at present prices, only 18q higher than in 1937. Cre;tt progress has brcn marlh in iinhroveci rnntrol and recluction c-f costs, llurinb the past cit;hhecn InotttllS Ilnllrtwctnvnts il- metltc-cl and ntcl-inery tleveluhccl In coping with the actttr war• thile tlilfictiltivs have luet- nl-pliet3 with sloleticliil rt-snlts. Costs of tnakii-I; each thousand cigat- rcttes lra%•c been reduced and the titiic re<lnircd to gt•t freshly l-ackrcl cib,uettes from the factory to the tobacco ctnnitcr•in -Iuuntities to tneet rurrcl-t ttnmttntl has been ftlrtht-r HlturtenrtL '1'1Lr cloauges til.-nnecl by yonr co-npany, nnclrr great strain iii mceti--g hnge demantls, reachetl lidl ;rplriii•aFion cliiring tL4• N'r•ur ji-st I-ar•xccl --rnti' luwi,r operaling cn" t.-4 are nntiuil-atecl nt~xt )'i-c-r. is