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Philip Morris Incorporated Annual Report 1977 @MIll6 YORR~S

Philip Morris Incorporated 1977 wssion Viejo Company vhiiip rnorns rndustriai In 1977, operating revenues of Philip Morris Incorporated grew 21.2% and surpassed the $5 billion mark for the first time. Each of our five operating companies contributed to our record performance. The cover of this report is a graphic represen- tation of that accomplishment and of the contribution of each operating company to the total operating revenues of Philip Morris. Philip Morris U.S A.'s operating revenues increased 10.0%, topped the $2 billion mark for the first time, and accounted for 41.5% of total Philip Morris Incorporated operating revenues. Philip Morris International's operating revenues grew 24.5%0, reaching $1,349,280,000, or 25.9% of total company revenues. Miller Brewing Company's operating revenues, up 35.1%, totaled $1,327,619,000, or 25.5% of the total. Philip Morris Industrial's operating revenues rose 28.2% and topped $200 million, for 4.2% of the total. Mission Viejo Company's operating revenues were up 56.2%, totaling $148,017,000, or 2.9% of the total. Table of Contents 1 Financial Highlights 4 Review of the Year 12 Philip Morris U.S.A. 16 Philip Morris International 20 Miller Brewing Company 24 Philip Morris Industrial 26 Mission Viejo Company 28 Financial Review 32 Fifteen-Year Financial Review 48 Directors and Officers Philip Morris Incorporated is a leading company in two large industries-cigarettes and beer- that provide simple pleasures to tens of millions of people every day. Over the past five years, Philip Morris has been the fastest-growing U.S. company in each of those industries. Founded more than a century ago and incor- porated in Virginia in 1919, the company has long been a major cigarette manufacturer. Today, it is the second-largest cigarette com- pany in the U.S. market and the largest U.S.- based international cigarette company, selling its 160 brands in more than 170 countries and territories. The corporation acquired the Miller Brewing Company in 1970. At that time, Miller was the seventh-largest brewer in the U.S. Today, Miller is the second largest. The company has also diversified into the manufacture of specialty papers, flexible pack- aging materials, and specialty chemicals as well as into community development and homebuilding. These businesses are conducted by five operating companies: Philip Morris U.S.A., Philip Morris International, Miller Brewing Company, Philip Morris Industrial, and Mission Viejo Company. I

Financial Highlights 1 1977 1976 1975 1974 1973 (dollar amounts except per-share amounts expressed in thousands) perating Revenues $5,201,977 $4,293,782 $3,642,414 $3,010,961 $2,602,498 I ~t Earnings 334,926 265,675 211.638 175,516 148,632 Earnings Per Common Share: - - Primary 5.60 4.47 3.62 3.15 2.71 Fully Diluted 5.60 4.47 3.62 3.07 2.61 Dividends Declared Per Common Share 1.563 1.150 .925 .775 .674 Percent Increase Over Prior Year Operating Revenues 21.2% 17.9% 21.0% 15.7% 22.1 % Net Earnings 26.1% 25.5% 20.6% 18.1% 19.4% Earnings Per Common Share: Primary 25.3% 23.5% 14.9% 16.2% 15.8% Fully Diluted 25.3% 23.5% 17.9% 17.6% 19.7% Operating Companies Revenues Philip Morris U.S.A. $2,160,362 $1,963,144 $1,721,549 $1,502,267 $1,303,629 Philip Morris International 1,349,280 1,083,970 1,040,002 887,077 822,907 Miller Brewing Company 1,327,619 982,810 658,268 403,551 275,860 ~hilip Morris Industrial 216,699 169,096 151,960 155,390 132,126 Iission Viejo Company 148,017 94,762 70,635 62,676 67,976 ~onsolidated Operating Revenues $5,201,977 $4,293,782 $3,642,414 $3,010,961 $2,602,498 Operating Companies Income Philip Morris U.S.A. $ 474,400 $ 401,426 $ 337,314 $ 286,225 $ 227,282 Philip Morris International 153,791 130,104 112,975 94,017 92,150 Miller Brewing Company 106,456 76,056 28,628 6,291 (2,371) Philip Morris Industrial 14,860 10,620 8,052 12,280 8,300 Mission Viejo Company 33,225 16,333 5,875 4,772 - 4,122 Consolidated Operating Income $ 782,732 $ 634,539 $ 492,844 $ 403,585 $ 329,483 Tobacco (Phil p Morris U.S.A. and Philip Morris International) and beer (Miller Brewin_g Company) represent the company's significant industry segments. Other industry segments include industrial products (Philip Morris Industrial), land development operations (Mission V eio Company) and non- tobacco operat ons (pr nt ng and greet ng cards) of Philip Morris International. Operating revenues and operating profit of the company's industry segments for 1977. together w th a reconciliation to consolidated operating income of operating companies (set forth below) in thousands of dollars are as follows: Operating Operating Revenues Profit bacco 83.493,443 8 615.253 eer 1,327,619 106.456 Other 380,915 49,329 $5,201,977 771,038 Equity in unconsolidated subsidiaries and affiliates 11,694 Consolidated operating income _ $ 782,732 Tobacco products accounted for 67°o of consolidated operating revenues in 1977. 70°o in 1976. 74°o in 1975. 77°o in 1974, and 79°-o in 1973, and 80°o of consoli- dated operating income in 1977. 83ao in 1976. 91 °ro in 1975. 94% in 1974. and 97°o in 1973. Sales of beer by Miller Brew ng Company accounted for 26°0 of consoli- dated operating revenues in 1977, 23°o in 1976. 180o in 1975. 13°a in 1974. and 11 °v in 1973. and 14°o of con- soI dated operat ng income in 1977. 12°o in 1976. 6°o in 1975, 2°o in 1974, and (10,6) in 1973. No other class of products accounted for as much as 10°-0 of consoli- dated operating revenues or operating income in any year Corporate expenses, interest expense, and items which are not directly attributable to industry segments or operat ng companies are not allocated to them. In the opinion of management. any allocation thereof would be arbitrary and would diminish the accuracy of measurement of their performances.

2 Financial Highlights Operating Revenues Operating Income Net Earnings by Operating Company by Operating Company Mdlions of Dollars 5400 5100 4800 4500 ~_~7-~ 4200 Miliions of Doliars Miliions ot Dollars 900 360 850 340 800 320 750 _ - ~ 300 700 280 ~ Philip Morris U.S.A. ~ Philip Morris International Miller Brewing Company ~ Philip Morris Industrial ~ Mission Viejo Company q

I Fully Diluted Earnings Per Share oonars 6 30 5 95 5 60 5 25 4 90 4 55 4 20 Dividends Declared Per Share Dollars 1 80 270 1 70 255 1 60 240 150 ~ 225 1 40 ~ 210 1 30 - 195 1 20 - 180 3 85 ~® 1 10 -i~ 165 3 50 3 15 I 80 1 00 -- 150 90 ~-- 135 80 --- 120 70 ---- 105 2 10 1 75 1 40 1 05 70 35 73 I 74 75 76 77 60 90 50 75 40 60 30 45 20 ----- 30 10 15 73 74 75 76 77 Capital Expenditures Millions ot OOllars 73 74 75 76 77

I 4 Review of the Year We are pleased to report that 1977 was another outstanding year for our company. Revenues and earn ngs reached new records for the 24th consecut ve year. Operating revenues increased 21.2% and surpassed the $5 billion rnark, net earnings rose 26.1 %, and earnings per share were up 25.3°ro. AII five of our operating compa- n es contributed to this growth. We paid dividends on the common stock for the 50th consecutive year. The dividend, increased for the twelfth time in the last ten years, has grown at a 16% annual rate in this period. Our latest dividend payment marked the 200th consecutive quarter of such payments. Our company has achieved compounded annual growth rates over the past ten years of 19.1 % in operating revenues and 19.2 % in fully diluted earnings per share. This record of growth attests to the ability of the company's people, in the U.S. and interna- tionally, to develop, manufacture, and market products that meet the changing preferences of consumers around the world. In meeting this demand, our company has grown to be the second-largest publicly held cigarette company in the world. Marlboro, our leading cigarette brand, is the largest-selling brand in the U.S. and internationally, and the largest ever in history. The Miller Brewing Company is now the second-largest brewer in the U.S. In 1977, the cigarette and beer industries mainta ned the traditional stability of their growth patterns. Within both product categories,, our company again substantially exceeded the industry rate of gain. Sales of cigarettes in the U.S. industry increased 0.8% in 1977 to approximately 611 billion units. Cigarette sales of Philip Morris Philip Morris U.S.A. Operating revenues of Philip Morris U.S.A. increased 10.0% and topped the $2 billion mark for the first time. Operating income rose 18.2%. Our share of the U.S. cigarette market rose from 25.1 % in 1976 to 26.2% last year as we registered the industry's largest gain in unit sales for the 11 th straight year. Marlboro strengthened its hold as the largest- selling brand in the U.S. The most significant growth was achieved by Marlboro 100's and Lights. In the full-flavor field, Marlboro Red out- performed competing full-flavor products. U.S.A. increased 5.2% to 160 billion units, and accounted for 26.2% of the industry. In the past ten years, our share of the U.S. cigarette market has almost doubled. The cigarette market outside the U.S. expanded at more than four times the rate of the U.S. market. Cigarette sales in the international market increased 3.7% to an estimated 3.6 tril- lion units. Philip Morris International's unit sales outpaced that growth with a gain of 9.3% and totaled 186 billion units. We enlarged our share of the international market to 5.2%. The U.S. brewing industry sold a record total of approximately 157 million barrels, a gain of 4.4% over sales in 1976. Miller Brewing Company was again the fastest-growing major brewer in the U.S. Miller's barrel shipments totaled 24.2 million, a 31.6% increase over 1976, and its market share reached 15.4%. Since 1973, when Miller's resurgence began, the company's market share has nearly quadrupled. Increasingly, corporate earnings are reflecting the capacity additions and production efficien- cies made possible by our investment in the most advanced technology for new plants and equipment for both cigarettes and beer. In 1977, our capital expenditures totaled $280 million. Our upward momentum in sales and profit now leads us to increase our plans for capital expenditures for the 1978 through 1982 period to over $2.25 billion. Of this amount, some $500 million is expected to be spent in 1978. These plans are a further indication of our confidence in the future of the cigarette, beer, and our other businesses and in our determina- tion to maintain growth and technological leadership. - Benson & Hedges 100's improved its position as the leading 100 millimeter brand with the suc- cessful introduction of Benson & Hedges 100's Lights in September, 1977. The growth of Merit continued in 1977. Since its introduction in early 1976, Merit has moved into the rank of the top ten brands in the industry. During 1977, Virginia Slims grew and consoli- dated its position as the leading cigarette for women. Parliament was more aggressively posi- tioned last year as a leading low-tar entry. With Marlboro Lights, Benson & Hedges 100's I,

i Lights, Merit, and Parliament. Philip Morris has chieved broad and substantial representation 9 the fast-growing low-tar segment of the arket. Vital to our 1977 market ng effort were our enlarged sales force. our expanded merchan- dising programs, and our unique advertising. Consumer satisfact on w th the taste of our brands, espec ally our new low-tar brands, is a tribute to our extensive research and develop- ment capabilities and to our research scientists, who have achieved a breakthrough in the ability to deliver flavor at low-tar levels. Our Operations Center in Richmond has Philip Morris International Philip Morr s International attained a 24 5°o increase in operat ng revenues last year and an 18.2°'o increase in operating income. Our 9.3°% gain in unit volume was two and one-half times the growth rate of the cigarette industry outside the U.S., and our share of the international cigarette market rose to about 5.2% last year. Our 1976 share was adjusted to 4.9% following a revision of estimated total orld industry sales by the U.S. Department :)f Agriculture. We sell more than 160 brands in more than 170 countries and terr tories through 25 manu- facturing and marketing affiliates. 19 licensees, and regional export sales organizations. Regional and national brands, ta lored to the many different preferences around the world, contributed significantly to our growth and account for more than one-half of our unit vol- ume. Marlboro continues to grow and accounts for more than one-third of our units. Our exports of c garettes from the U.S. and elsewhere, led by Marlboro, increased sharply last year. The Europe%Middle East; Africa region achieved record unit sales and market share despite excise tax increases and expanding restrictions on the marketing of cigarettes. Sales of Marlboro rose sharply in many mar- kets, including Italy, Switzerland, France, Poland, the United Kingdom, the Benelux, and the Mid- dle East. In the important West German market, where total industry sales declined, Marlboro ales and market share continued to increase. Merit was introduced in a number of markets, d low-tar line extensions of existing brands were launched in several countries. In the Australia/New Zealand region, Philip Morris Limited continued as one of the leading cigarette companies in Australia with its steadily increased its daily production rate. The efficiencies inherent in the Operat ons Center, which opened in 1973. made a s gnif cant contr but on to ga ns in prof tab l ty for Phil p Morr s U.S_A Further eff c enc es are antic pated w th the replacement of some of the initial equip- ment w th the newest. most advanced cigarette- making and pack ng mach nes. In accord with our prolected long-term needs and our confidence in our future in the cigarette business, we are now in the planning stages for another major new cigarette manufacturing facility. successful Marlboro and Alpine brands. T ghter cost controls helped offset continuing effects of the Austral an currency devaluat on and a cor- porate tax ncrease. New marketing strateg,es were implemented to counteract significant competitive price-cutting, Our wine affiliate, Lindeman (Holdings) Lirnited, posted new sales records and aga n increased its share of the Austral an market In the Asia Canada region. Benson & Hedges (Canada) Limited's sales were lower last year than in 1976 but recovered in the latter half of 1977. The company's leading low-tar product. V scount. again recorded higher sales. In Asia, our affiliate in Pakistan achieved improved sales. and our licensee in the Ph l p- p nes posted record sales for Marlboro. a lead- ing brand in this large market. Our U.S. exports to Asia also made strong sales gains. The Latin America Iberia reg on again increased unit sales to record levels and enlarged its share of the market. In Argentina, Venezuela, and El Salvador. new brands and line extensions were introduced successfully. Marlboro increased its market share in Mexico, the Dominican Republic. Pan- ama, and Spain. Our affiliate in Brazil, established in 1973, again recorded a significant loss as substantial marketing investment was provided to exist ng and new brands in this important and highly competitive market. We continue to be confident that profitability will be achieved over the long term. Geographic diversity is a continuing strength of our international operations. It enables us to maintain overall stability and growth in times of fluctuating currencies and at diverse levels of economic activity. 5

6 Miller Brewing Company Operating revenues of the Miller Brewing Company increased 35.1 % in 1977. Operating income rose 40.0%, continuing the upward momentum of the past few years. Our shipments of 24.2 million barrels of beer represented an increase of 5,8 million barrels, or 31.6% over 1976, and maintained the growth that has been leading the brewing industry. Miller's gain greatly exceeded the industry increase of 4.4% last year, and the company moved into second place in the U.S. industry. Our share of the market in the U.S. increased to about 15.4% from 12.2% in 1976. Strong gains were posted by premium-priced Miller High Life, Miller's largest-selling brand, and Lite, by far the country's leading low-calorie beer. Lite continued its impressive growth despite heavily promoted low-calorie entries by a number of our competitors. In September, 1977, Miller introduced domes- tically brewed Lowenbrau with a substantial advertas ng program. Its encouragirrg early reception indicates that Miller may have a potentially strong entry in the expanding super- premium segment of the market. Despite the accelerated capital expansion program, Miller's brands continue to be on allo- cation. Since 1973, Miller has invested more than $500 million in expansion and moderniza- tion. The modernized brewery in Milwaukee is now the largest in that brewing capital of the world. Philip Morris Industrial In 1977, Philip Morris Industrial achieved a 28.2% increase in operating revenues and a 39.9% increase in operating income. These increases were due to the acquisition of Wisconsin Tissue Mills in February, 1977, and its outstanding performance since then. The company produces disposable napkins for the institutional food market and generated a 37.3% increase in profits over 1976. Despite a difficult year in their respective The new brewery in Fulton, in upstate New York, which began commercial production in April, 1976, has been expanded to a capacity of 8 million barrels a year. Annual capacity in the Fort Worth, Texas, brewery was increased to 7 million barrels by year-end and will reach 8 million by 1979. In 1977, it was decided to increase the planned annual capacity of the new Eden, North Carolina, brewery, which will begin production early this year, from 3 million to 8.8 million barrels. In November, construction began on a new $170 million brewery in Irwindale, Southern Cali- fornia. When in operation in early 1980, it will have a capacity of 5 million barrels a year and will replace the production capacity of the smaller Azusa, California, brewery nearby. Philip Morris began construction of a $34.1 million glass bottle manufacturing plant in Sen- nett, in upstate New York, to supply Miller's Ful- ton brewery with some of its glass bottle needs. The new headquarters office building in Milwaukee is now occupied. Projections of Miller's growth indicate that it may well be required to invest more than S1 bil- lion to expand the company's facilities over the next five years. The present facilities are the most modern in the brewing industry, and their efficiency in producing high-quality beer will increasingly become a factor in Miller's operat- ing performance. markets, the Chemical, Paper, and Packaging Groups were profitable and increased their revenues over 1976. The Chemical Group makes specialty chemi- cals for the textile and packaging industries. The Paper Group produces specialty and technical papers. The Packaging Group makes flexible packag- ing materials primarily for the food industry. ~ ~ .a

Mission Viejo Company Operating revenues at Mission Viejo Company, r community development and homebuilding pany, increased 56.2% in 1977, while rating income more than doubled over the exceptionally y high 1976 level. In Orange County, California, Mission Viejo's record sales of 1,649 homes represented an increase of 30.5% over1976. The company's increased sales volume in California was co- incident with unusually strong demand for its homes in all price ranges. A record was also achieved in Denver, Colorado, where in 1977 its unit sales of 209 homes resulted in a 67.2% increase over 1976. Housing sales surrounding Lake Mission Viejo Cigarette and Beer Excise Taxes Consumers of cigarettes and beer have been increasingly required to bear an excessive tax burden. Excise taxes placed on these products are regressive and discriminate directly against lower- income consumers. Total excise taxes on cigarettes in the U.S. amounted to $6.0 billion last year. These excise taxes accounted for 37% of the average retail I ce of a pack of cigarettes on a national basis. Total excise taxes on beer in the U.S. in 1977 re $2.2 billion and accounted for about 15% of the retail price. Cigarette bootlegging has become a wide- spread crime in states with the highest taxes, and there is mounting pressure for corrective action. There has been growing sympathy, particu- larly in New York, for a reduction in state and local taxes to reduce tax disparities and thus the profit margin for bootleggers. This is a reason- Smoking and Health In the 14 years since the U.S. Surgeon General's report, the activities of anti-cigarette groups have not encouraged efforts in the area of sci- entific research. Although there is no conclusive clinical evidence that cigarettes cause disease in smokers, or nonsmokers, some volunteer health agencies are proceeding as if the case were closed. This attitude discourages further research and is a disservice to science. Major new anti-cigarette publicity efforts, sup- :~rted by multimillion-dollar budgets, have been nched by Joseph A. Califano, Secretary of e e Department of Health, Education, and Wel- fare, and the American Cancer Society. At the same time, the federal health agencies are devoting more attention to the broad spec- have proceeded at a strong pace and will accel- erate with the completion of programs currently in design. As development of the 10.000-acre Mission Viejo project nears the halfway mark, master planning for the newly acquired 6.700-acre Aliso Viejo property has proceeded on schedule with the recent completion of the preliminary design. At its Mission Viejo-Aurora prolect in Colo- rado, Mission Viejo Company has an option for additional land in the Denver area that could provide the basis for long-term major participa- tion in this growing market. able approach because it would increase the amount of taxes collected while relieving the smokers of legally taxed cigarettes of an unfair tax burden. Another proposal is for a uniform rate, imposed nationally. In effect, that would mean higher taxes in many states, including tobacco- growing states, where the proposal has met strong resistance, just as Maine farmers would resist taxes on potatoes and Texas ranchers, taxes on beef. - The U.S. Treasury Department, the agency that would administer such a uniform tax, has said: "We have serious reservations about sup- porting legislation which would be aimed at rec- tifying a regional problem. It is our belief that federal intrusion into traditional state areas of responsibility can only be justified if the problem is national in scope: " trum of possible carcinogens in the environ- ment. In November, Dr. Peter G. Bourne, Special Assistant to the President for Health Issues, said that federal efforts should be concentrated "on the acquisition of basic knowledge" concerning disease and research "should not be centered on tobacco alone." We believe the President's top health advisor has taken a sensible and realistic approach to the government's dealing with tobacco prod- ucts. His advocacy of basic research parallels the position long held by the tobacco industry, which itself has granted more than $70 million for independent scientific investigation into the diseases blamed on smoking. 7

a The Public Interest We expect our bus ness activities to make social sense and our social act vities to make business sense. - Our company has enjoyed extraordinary growth A respons ble corporation must manage such growth in a manner responsive to the needs of soc ety That mandate has become ncreas ngly urgent because we live in a time when fa th in all inst tutions has declined and when the bus ness sector in particular is regarded by many as a rig d relic of a bygone era. Sensitivity to change is a hallmark of our company. We need to be as responsive in the soc al arena as we are in our corporate deci- sions, and we are wili ng to undergo social scrutiny Our cigarettes are manufactured and mar- keted today by affiliates in 25 countries and licensees in 19 countries and territories. We employ 27,000 persons in the U.S., and Philip Morris International and its affiliates now employ 26,000 persons abroad. These are not jobs taken from the American labor market. We do not manufacture c garettes abroad for import into the U S. If we did not manufacture abroad for sale abroad, that demand would be met by competit ve companies of other nations. The cont nuing growth of our exports of ciga- rettes from the U.S. generates higher export income and strengthens employment in our U.S. manufacturing locations and in supplier indus- tries. The continued sales growth of cigarettes produced by our l censees and affiliates also contr butes to larger exports of U.S. cigarettes. tobacco. and other manufacturing components produced in the U.S. Philip Morr s U.S A.'s pulverized coal-fired boiler at the Operat ons Center in R chmond. Virg nia, saves oil while it meets all appl cable air pollut on standards. Proposals to lower or eliminate U.S. tax cred- its and tax deferrals affecting foreign-source income will receive greater attention this year when the U.S. government considers changes in the federal tax laws. As most other countries provide these or similar benefits to their multi- national companies, an additional tax burden on overseas income would seriously restrict the ability of U.S. companies to compete effectively overseas and would therefore jeopardize the jobs created by the production of U.S. exports, including the jobs of the production workers in U.S. plants, jobs of suppliers, and jobs of those in service industries. Through the export of cigarettes and tobacco, Philip Morris and the other tobacco companies make a substantial favorable contribution to the balance of trade for the U.S. Total U.S. exports of tobacco and tobacco products in 1977 accounted for a net positive contribution of more than $1.3 billion to the U.S. trade balance, an increase of 19% over 1976. A major factor in the record trade deficit experienced by the U.S. in 1977 was the high price of imported oil. In comparison with many other industries, the production of cigarettes and beer consumes remarkably little energy. Never- theless, we have in place an intensive, cor- porate-wide program of energy conservation. Philip Morris engineers at our cigarette plants are constantly exploring ways to conserve energy. We receive a monthly computer printout of energy consumption in every phase of our U.S. cigarette operations. We therefore have a good reading on our conservation efforts. Since Wisconsin Tissue Mills waste water treatment facility returns cleaner water to the river than the water already present in the river. k-7