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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1977 Commission file number 1-194 Philip Morris Incorporated (Exact name of registrant as specified in its charter) Virginia 13-1607658 (State or other jurisdiction of (I.R.S. Eniployer Identification No. ) incorporation or organization) 100 Park Avenue. New York, N. Y. 10017 (Address of principal executive offices) (Zip Code ) Registrant's telephone number, including area code: 212-679-1800 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class nhich registered _ Common Stock (par value $1 per share )* New York Stock Exchange 6%s o Sinking Fund Debentures Due 1993 New York Stock Exchange 8'ls% Sinking Fund Debentures Due 2004 New York Stock Exchange 8.85% Notes Due 1982 New York Stock Exchange 8',~z% Notes Due 1985 -- New York Stock Exchange * At December 31, 1977, there were 59,919,917 shares outstanding. Securities registered pursuant to Section 12(g) of the Act: Cumulative Preferred Stock, 47o Series (par value $100 per share ) f•1 Cumulative Preferred Stock, 3.90 % Series ~ (par value $100 per share ) -p, tx+ : ~ ~ Indicate by check mark whether the registrant (1) has filed all reports required to be filed bN C3 Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes 1' No ts~

Item 1. Business. Philip Morris Incorporated (the "Company") is a diversified enterprise, engaged primarily in the manufacture and sale of cigarettes and beer. The Company and its subsidiaries and affiliates (hereinafter collectively referred to as "Philip Morris") employ approximately 53,000 persons. Based on unit sales, the Company is the second largest of the six major cigarette manufacturers in the United States and, excluding two national enterprises, each of which has more unit sales than Philip Morris; the second largest cigarette company in the world. Cigarettes are sold principally to wholesalers (including distributors and government-owned organizations), vending machine operators and large retail organizations. The Company's subsidiary, Miller Brewing Company, is the second largest United States brewer. Beer products are distributed in the United States, primarily through a network of independent beer wholesalers. The principal methods of competition in the cigarette and beer industries are product quality, marketing and packaging. A wide variety of advertising and sales promotion activities is pursued. Lines of Business and Industry Segments For management purposes, Philip Morris is organized into five operating companies: Philip Morris U.S.A., Philip Morris International, Miller Brewing Company, Philip Morris Industrial and Mission Viejo Company. Tobacco (Philip Morris U.S.A. and Philip Morris International) and beer (Miller Brewing Company) represent the Company's significant industry segments. Other industry segments include industrial ,products (Philip Morris Industrial), community development operations (Mission Viejo Company) and non-tobacco operations (printing and greeting cards) of wholly-owned subsidiaries included within Philip Morris International. Operating revenues and operating profit for 1977 of the Company's industry segments (the Company and all wholly-owned subsidiaries), together with a reconciliation to consolidated operating income of operating companies (see the table on p. 2), are shown in the following table. No amounts are included in respect of operating revenues and operating profit derived from intersegment transfers, because, in the opinion of management, amounts attributable to such transfers are not material. Operating Operating Revenues Profit (in thousands of dollars) Tobacco ......................................................................... $3,493,443 $615,253 Beer ................................................................................ 1,327,619 106,456 Other .............................................................................. 380,915 49,329 $5,201,977 771,038 Equity in net earnings of unconsolidated subsidiaries and affiliates .............................................................. 11,694 Consolidated operating income .................................... $782,732 Sales of tobacco products, both within and without the United States, and sales of beer by Miller Brewing Company, as percentages of consolidated operating revenues and consolidated operating income, respectively, for the last five fiscal years are set forth in the following table. No other class of similar products accounted for as much as 10% of consolidated operating revenues in any year. Years Ended December 31 OPERATING REvENuEs Tobacco products ................................ Beer ...................................................... OPERATING INCOME Tobacco products ................................ Beer ...................................................... 1977 1976 1975 1974 1973 67% 70% 74% 77% 79% 26% 23% 18% 13% 11% 80% 83% 91% 94% 97% 14% 12% 6% 2% (1 °k ) 1

Operating revenues and income for the last five fiscal years of Philip Morris U.S.A., Philip Morris International, Miller Brewing Company, Philip Morris Industrial and Mission Viejo Company are shown in the following table. Corporate expenses, interest (other than previously capitalized interest) and items which are not directly attributable to industry segments or operating 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. Years Ended December 31 1977 1976 1975 1974 1973 (in thousands of dollars ) OPERATING 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 Philip Morris Industrial ............. 216,699 169,096 151,960 155,390 132,126 Mission Viejo Company ............ 148,017 94,762 70,635 62,676 67,976 Consolidated Operating Revenues( a ) .................. $5,201,977 $4,293,782 $3,642,414 $3,010,961 $2,602,498 OPERATING 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(a) ...................... $ 782,732 $ 634,539 $ 492,844 $ 403,585 $ 329,483 (a) Consolidated operating revenues and income include operating revenues and income of the Company and all wholly-owned subsidiaries. Consolidated operating income also includes equity in unconsolidated subsidiaries. Philip Morris U.S.A. Philip Morris U.S.A. has responsibility for the development, manufacture and marketing of cigarettes sold in the United States. Its major cigarette brands are Marlboro, Benson & Hedges 100's, Merit, Virginia Slims, Parliament and Saratoga 120's. Since the last quarter of 1975, the Company's principal cigarette brand, Marlboro, has been reported to be the largest selling brand in the United States. Merit, a low "tar" cigarette, which was introduced nationally in January 1976, is believed to be one of the most successful new cigarette introductions ever made. The following table sets forth the industry's estimated sales of cigarettes manufactured in the United States, the Company's unit sales and the Company's share of the industry (including export sales in both cases). Years Ended December 31 Industry(a) Company Company's Share of Industry (in billion units) (in billion units) (%) 1977 ...................................... 679.2 189.0 27.8 1976 ...................................... 670.4 173.8 25.9 1975 ...................................... 664.1 159.5 24.0 1974 ...................................... 651.5 150.0 23.0 1973 ...................................... 632.2 139.1 22.0 ~ (a) Source: Morgan Stanley & Co. Incorporated (John C. Maxwell, Jr. ). 0 1 4~Ca 2

Although the Company's unit volume increased by 8.7% (5.2%, excluding export sales ) in 1977 over 1976, cigarette unit volume (including export sales) for the United States industry as a whole increased by only 1.3%. Approximately 99.0% of the cigarettes sold by the Company in 1977 for consumption within the United States were filter cigarettes as compared with 89.4% for the industry as a whole. Philip Morris U.S.A. is the leader in the 100mm. sector of the United States cigarette market, which accounted for 26.2% of total United States industry sales in 1977. Philip Morris U.S.A.'s 100mm. brands accounted for 35.5% of this market in 1977. The fastest growing sector of the cigarette industry is the so-called low "tar" category, generally considered to consist of brands delivering 15 mg. or less of "tar" per cigarette. In 1977, this category accounted for approximately 26.1% of United States industry sales, and Philip Morris U.S.A.'s low "tar" brands accounted for approximately 23.2% of that total. Current prices per thousand cigarettes (except for military sales ) of the Company's principal brands within the United States, including the Federal excise tax of $4.00 per thousand, are $14.85 for 100mm. and 120mm. cigarettes and $14.35 for other cigarettes. Excise taxes, sales taxes and other taxes levied by various states and municipalities affecting cigarettes have been increasing in recent years. These taxes vary considerably and, when combined with the Federal excise tax, may be as high as 36 cents per package of twenty and may influence the sale of cigarettes. Reports and speculation with respect to the alleged harmful physical effects of cigarette smoking have been publicized for many years and, in the opinion of the Company, have had and may continue to have an adverse effect upon the industry's sales. In 1964, the Report of the Advisory Committee to the Surgeon General of the U. S. Public Health Service was released. The Report was essentially a review of the prior literature, consisting primarily of statistical association studies, and concluded that cigarette smoking was a health hazard of sufficient importance to warrant appropriate remedial action. Since then, there have been similar governmental reports on the subject of health and cigarette smoking. Since 1966, a Federal statute has required a warning statement on cigarette packaging. The current statement is: "Warning: The Surgeon General Has Determined That Cigarette Smoking Is Dangerous to Your Health." For several years prior to 1966 and continuing thereafter, the Federal Trade Commission, in annual reports to Congress, has made recommendations that Congress enact legislation requiring a stronger warning statement. When the current warning statement legislation was adopted, the Federal Trade Commission had pending a trade regulation rule proceeding that would require a stronger statement on packaging and in cigarette advertising. That legislation provides that the Federal Trade Commission must notify Congress before taking action on this rule and, if the rule is adopted, the rule cannot take effect until six months after such notification. In 1972, the Federal Trade Commission approved consent orders requiring the Company and five other cigarette manufacturers to include in specified types of advertisements and in a prescribed format the warning statement prescribed by Congress for cigarette packaging. On October 17, 1975, the Government commenced civil actions against each of the cigarette manufacturers alleging violations of the consent orders and seeking monetary penalties, an injunction against further violations and the creation of a trust fund by each of the defendants to be used for the preparation and dissemination of advertisements in order to remedy the defendants' alleged failures to comply with the consent orders. These actions are currently pending in the United States District Court for the Southern District of New York. The Company has filed an answer to the amended complaint denying the Commission's allegations and believes that it has substantial factual and legal defenses. Since 1971, television and radio advertising of cigarettes has been prohibited in the United States. Cigarette advertising in print media in the United States includes information with respect to the "tar" and nicotine content of cigarettes as well as the warning statement. From year to year, legislation has been proposed in Congress which, if passed, could be detrimental to the tobacco industry. The most significant bills relating to cigarettes which have been introduced would: eliminate all forms of Federal financial support of tobacco as administered through the U. S. Department of Agriculture; prohibit the sale of cigarettes with more than a prescribed level of "tar"; tax cigarettes on N 3

the basis of their "tar" and nicotine content; establish maximum levels of "tar" and nicotine in cigarettes; prohibit the mailing of unsolicited samples of cigarettes; and impose an additional excise tax on cigarettes with proceeds to be used for cancer research. Legislation potentially detrimental to the tobacco industry has been introduced from time to time in various state and local legislative bodies. Such measures usually relate to the taxation of cigarettes and regulation of the advertising, labeling, promotion, sale and smoking of cigarettes. Recent enactments by regulatory agencies and other governmental authorities restrict smoking areas aboard certain common carriers and in certain public places, and anti-cigarette groups are now concentrating on attempts to ban smoking in public places. In addition, the Secretary of Health, Education and Welfare announced on January 11, 1978 the formation of an Office on Smoking and Health within the Department of Health, Education and Welfare for the purpose of co-ordinating and intensifying the Federal government's efforts in the area of smoking and health. Philip Morris International Philip Morris International has responsibility for the marketing of tobacco products outside the United States (including United States territories and possessions) and for most of the Company's international subsidiaries, affiliates and licensees. Philip Morris International sells more than 160 brands of cigarettes in more than 170 countries and territories throughout the world. Cigarettes sold by Philip Morris International are manufactured in the United States by the Company and by subsidiaries and affiliates in 22 countries. In an additional 19 countries and territories, Philip Morris International's cigarette brands are manufactured and sold by licensees. World cigarette industry unit sales (excluding the United States ) were about 3.6 trillion units in 1977. Philip Morris International's share of the world market was approximately 5.2%, up from 4.9% (as adjusted) in 1976. While regional and national brands represent more than one-half of Philip Morris International's unit volume, Marlboro, the world's leading cigarette brand since 1972, accounts for more than one-third thereof. Philip Morris International has cigarette market shares of at least 15%-and in a number of cases substantially more than 15%-in at least 20 countries, including Australia, Finland, Italy, Mexico, Nigeria, Pakistan, Switzerland and Venezuela. Prices in many of Philip Morris International's markets are government controlled and excise tax increases, higher costs, and government price restraints in a number of markets have restricted the operating income margins of Philip Morris International. In recent years, a number of countries have taken steps to restrict or prohibit cigarette advertising and to discourage cigarette smoking. Philip Morris (Australia) Limited (75% owned by the Company) owns all of the outstanding shares of Lindeman (Holdings) Limited, the leading Australian wine maker. Certain wholly-owned subsidiaries of the Company are active in the greeting card and printing businesses in the United Kingdom. Miller Brewing Company Miller Brewing Company ("Miller") became the second largest brewing company in the United States in 1977, with a 31.6% increase in 1977 over 1976 in barrels shipped. Miller manufactures Miller High Life, which is believed to be the second largest selling brand in the United States, and Lite, introduced nationally in 1975 and now the leading low-calorie, premium beer in the United States. In 1975, Miller assumed full United States distribution rights for L'bwenbrku beer and, in late September 1977, introduced domestically brewed L'bwenbr'au nationally under a multi-phase agreement with Lbwenbrau MUnchen AG. 4 2048189006

The following table sets forth the industry's sales of barrels of beer in the United States, Miller's sales and Miller's share of the industry: , Miller's Years Ended Share December 31 Industry(a) Miller of Industry (in thousands of barrels) (%) 1977 ...................................... 156,948 24,110 15.4 1976 ...................................... 150,558 18,232 12.1 1975 ...........................:.......... 148,634 12,753 8.6 1974 ...................................... 145,464 9,028 6.2 1973 ...................................... 138,468 6,877 5.0 (a) Source: United States Department of the Treasury. Philip Morris Industrial Philip Morris Industrial has responsibility for the development, manufacture and marketing of Philip Morris' industrial products, both within the United States and abroad. Included in Philip Morris Industrial are: Polymer Industries-Adhesives & Liquid Coatings Division, which manufactures specialty adhesives and coatings; Polymer Industries-Textile Chemical Division, which manufactures specialty chemical products primarily for the textile industry; Wikolin Polymer Chemie GmbH, which manufactures coatings and adhesives in Germany; Armstrong Products Division, which manufactures powder coatings; Nicolet Paper Division, which manufactures dense specialty papers; Plainwell Paper Company, Inc., a maker of printing and technical papers; Surtech Coating Division, a converter which applies specialized coatings to packaging materials; the Milprint Division, which manufactures products used primarily for food packaging; Koch Label, which produces specialized labels; and Wisconsin Tissue Mills Inc., acquired in February 1977 for 314,984 shares of the Company's Common Stock and approximately $1,126,000 in cash, which manufactures disposable tissue paper products. The 1977 increase in operating revenues and income of Philip Morris Industrial (see "Lines of Business and Industry Segments") is attributable principally to Wisconsin Tissue Mills Inc., whose operating revenues and income are not included for years prior to 1977. Mission Viejo Company Mission Viejo Company is a community development and home building corporation in Southern California and Colorado. Its principal activity is the development of a new, completely pre-planned town named Mission Viejo on approximately 10,000 acres located in Orange County, California, between Los Angeles and San Diego. It should be noted that what appears to have been a "housing boom" in this area in 1976 and 1977 may be ending. A new development, Aliso Viejo, is being planned for a recently acquired 6,700 additional acres close to Mission Viejo. Mission Viejo Company is also developing a smaller residential area located near Denver, Colorado and holds an option for a 22,000 acre tract of land in the Denver area. 5 / r

Item 2. Summary of Operations ~ The following consolidated statements of earnings and stockholders' equity of Philip Morris Incorporated and Consolidated Subsidiaries for the five years ended December 31, 1977 have been examined by Coopers & Lybrand, . independent certified public accountants, whose opinion thereon is set forth in their report included on Page F-3 herein. These statements should be read in conjunction with the consolidated financial statements and notes thereto, which appear on pages F-4 to F-23, inclusive, in this report. Operating revenues ( including the amounts of federal and foreign excise taxes shown below under "Cost of sales") ..................................... $5,201,977 Cost of sales (Note 4): Cost of products sold .................................... 2,401,680 Federal and foreign excise taxes on products sold ............................................. 1,352,487 Gross profit ........................................... 1,447,810 Marketing, administration and research costs .... 676,772 771,038 Equity in net earnings of unconsolidated for- eign subsidiaries and affiliates ......................... 11,694 Operating income of operating com- panies ................................................ 782,732 Corporate expense ............................................... 38,523 Interest expense (excluding interest capitalized of $7,163,000 in 1977, $6,424,000 in 1976, $8,024,000 in 1975, $9,427,000 in 1974 and $8,872,000 in 1973) (Notes I and 9) ............. 101,584 Currency translation and hedging costs, net (Note 1) ........................................................... 11,633 Other deductions (income), net .......................... 5,476 Earnings before income taxes .............. 625,516 Provision for federal and other income taxes (Note 13) ......................................................... 290,590 Net earnings (Note 2) ......................... $ 334,926 Earnings applicable to common stock ................. $ 334,822 Earnings per common share (Note 2 and b): Primary ......................................................... $5.60 Fully diluted ................................................. 5.60 Dividends declared per common share (Note b ) ........................................................... $1.563 I $4,293,782 $3,642,414 $3,010,961 $2,602,498 1,966,871 1,656,839 1,290,319 1,060,777 1,159,286 1,078,403 968,867 893,459 1,167,625 907,172 751,775 648,262 547,287 437,196 372,804 338,978 620,338 469,976 378,971 309,284 14,201 22,868 24,614 20,199 634,539 492,844 403,585 329,483 35,229 30,270 25,292 21,016 102,834 99,045 82,741 50,993 15,520 - - - 9,028 2,719 (1,950) 1,865 471,928 360,810 297,502 255,609 206,253 149,172 121,986 106,977 $ 265,675 $ 211,638 $ 175,516 $ 148,632 $ 265,561 $ 211,521 $ 175,394 $ 148,504 $4.47 $3.62 $3.15 $2.71 4.47 3.62 3.07 2.61 $1.150 $.925 $.775 $.674 ~ ~ NoTHS: [u ~ ~ (a) Numerical references relate to Notes to Consolidated Financial Statements. ~ ~ 0 (b) The calculation has been adjusted by giving retroactive effect to the stock split in 1974. See Note 14 of Notes a to Consolidated Financial Statements. c+ Years Ended December31 (Note a) 1977 1976 1975 1974 1973 (in thousands of dollars, except per share data)

The information necessary for the calculations of earnings per share follows: I. Primary earnings per common share: (Note 1) A. Weighted average number of shares ........... 1977 1976 1975 1974 (in thousands of dollars, except per share data) B. Net earnings .................................................. Less preferred dividends ...................... Earnings applicable to commn stock ......... C. Primary earnings per common share (B -t- A) .............................................................. II. Fully diluted earnings per common share: (Note 1 ) A. Weighted average number of shares, as above ....................................................••••• Add weighted average number of shares applicable to: Convertible debentures outstanding at end of year, from beginning of year. Convertible debentures converted during the year, assumed converted from beginning of year to date of conversion ......................................... Common stock under option at end of year, less shares assumed to have been acquired (Note 2) .................... Common stock options exercised during the year to date of exercise, less shares assumed to have been acquired (Note 2) ............................. Number of shares used in fully diluted earnings per share com- putation ...................................... B. Earnings applicable to common stock, as above ..................................................•••.••• Interest expense on convertible debentures less applicable income tax benefit........ :... Earnings applicable to fully diluted com- monshares ................................................ 1973 59,822,487 59,408,484 58,442,362 55,649,417 54,804,174 $ 334,926 $ 265,675 104 114 $ 211,638 117 $ 175,516 122 S 148,632 128 $ 334,822 S 265,561 $ 211,521 $ 175,394 $ 148,504 $5.60 $4.47 $3.62 $3.15 $2.71 59,822,487 59,408,484 58,442,362 55,649,417 54,804,174 - - - - 1,821,400 - - - 1,581,430 472,542 - - - 78,711 152,628 29,697 65,040 59,822,487 59,408,484 58,442,362 57,339,255 57,315,784 $ 334,822 $ 265,561 $ 211,521 $ 175,394 $ 148,504 - -- -- 387 835 $ 334,822 $ 265,561 $ 211,521 $ 175,781 $ 149,339 C. Fully diluted earnings per common share (B + A) ................................................... $5.60 $4.47 $3.62 $3.07 $2_61 NOTES: (1) In determining 1977, 1976 and 1975 earnings per share, shares issuable upon exercise of outstanding stock options and units have not been included since the effect of such inclusion would be insignificant, and there were no other dilutive issues outstanding during these periods. (2) Funds assumed to have been received from exercise of stock options were assumed to have been used to acquire shares for the treasury at the higher of the average market price during the periods or the market price at the close of the periods. 7

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY for the five years ended December 31, 1977 (in thousands of dollars) Preferred Stock, S100 Par Value Common Stock,S1 Par Value Additional Paid-In Capital Earnings Reinvested inthe Business Cost of Treasury Stock Total Stockholders Equity Balance, January 1, 1973 ............................................. $24,773 $27,315 $179,581 $473,925 $( 10,045 ) S 695,549 Net earnings for the year 1973 .................................... 148,632 148,632 Cash dividends declared: Preferred stock ..................................................... (128) (128) Common stock, $.674 per share ........................... (37,128) (37,128) Preferred stock purchased for treasury ....................... (6,739) (6,739) Common stock issued upon conversion of deben- tures .......................................................................... 353 10,129 389 10,871 Proceeds from common stock issued upon exercise ofstockoptions ......................................................... 86 3,885 3,971 Preferred stock retired ................................................. (14,504) 3,753 10,751 - Balance, December 3 1, 1973 ................ 10,269 27,754 197,348 585,301 (5,644) 815,028 Net earnings for the year 1974 .................................... . 175,516 175,516 Two-for-one common stock split effected in the form of a 100% stock dividend ......................................... 27,886 (27,886) - Cash dividends declared: Preferred stock .................................................... _ - (122) ( 122; Common stock, $.775 per share ........................... (43,504) ( 43,504 t Preferred stock purchased for treasury ....................... (126) ( 126) Common stock issued upon conversion of deben- tures .......................................................................... 1,566 23,596 857 26,019 Proceeds from common stock issued upon exercise of stock options ......................................................... 61 1,801 1,862 Preferred stock retired ................................................. (590) 163 427 - Balance, December 31, 1974 ................ 9,679 57,267 195,022 717,191 (4,486) 974,673 Net earnings for the year 1975 .................................... 211,638 211,638 Proceeds from public issuance of two million shares of common stock ...................................................... 2,000 91,375 93,375 Cash dividends declared: Preferred stock ..................................................... (117) (117) Common stock, $.925 per share ........................... (54,419) (54,419) Preferred stock purchased for treasury ....................... (31) (31) Proceeds from common stock issued upon exercise ofstock options ......................................................... 93 2,569 2,662 Preferred stock retired ................................................. (492) 140 352 - Balance, December 31, 1975 ................ 9,187 59,360 289,106 874,293 (4,165) 1,227,781 Net earnings for the year 1976 .................................... 265,675 265,675 Cash dividends declared: Preferred stock ..................................................... (114) (114) Common stock, $ L.15 per share ........................... (68,366) (68,366) Preferred stock purchased for treasury ....................... - (121) ( 121 ; Proceeds from common stock issued upon exercise ofstockoptions ......................................................... 130 4,997 5,127 Preferred stock retired ................................................. (375) 122 253 - Balance, December 31, 1976 ................ 8,812 59,490 294,225 1,071,488 (4,033) 1,429,982 Net earnings for the year 1977 .................................... 334,926 334,926 Cash dividends declared: Preferred stock ..................................................... (l04) (I04 Common stock, $1.563 per share ......................... (93,529) (93,529 Preferred stock purchased for treasury ....................... (147) (l47 Proceeds from common stock issued upon exercise of stock options ......................................................... 117 6,138 6,255 Common stock issued for acquisition .......................... 315 12,368 12,683 Preferred stock retired ................................................. (550) 175 375 - Balance, December 31, 1977 ................ $ 8,262 $59,922 $300,538 - $1,325,149 $(3,805) $1,690,066 ( ) Denotes deduction. See Notes 3, 10, 11 and 12 of Notes to Consolidated Financial Statements. 8 20`IP,1 E9G1 r

Management's Discussion and Analysis of the Consolidated Statements of Earnings The following discussion is limited to changes between 1977-1976 and 1976-1975. Operating Rqvenues Consolidated operating revenues in 1977 were $908 million (21.2%) higher than in 1976. Revenues from worldwide sales of tobacco products were up $505 million (16.9%), of which $230 million is attributable to increased cigarette unit sales, $237 million to increases in selling prices (including increases in certain foreign excise tax rates) and $38 million to translation of foreign currencies at average rates in effect during 1977. Operating revenues from beer sales were up $345 million (35.1%), with $309 million of the increase coming from greater volume and $36 million from price increases. In 1976, consolidated operating revenues were $651 million (17.9%) higher than in 1975. Revenues from worldwide sales of tobacco products were up $284 million (10.5%), with increases of $193 million from higher unit sales and $206 million from increases in selling prices (including increases in certain foreign excise tax rates) being partially offset by translation of foreign currencies, $40 million, and deconsolidation of a foreign subsidiary, $75 million. Operating revenues from beer sales in 1976 exceeded 1975 by $325 million (49.3%), with $282 million attributable to volume and $43 million to price increases. Cost and Expenses Cost of sales, which includes cost of products sold and federal and foreign excise taxes on products sold, increased $628 million (20.1%) in 1977 over 1976 and $391 million (14.3%) in 1976 over 1975. Cost of tobacco products accounted for $291 million of the 1977 increase, of which $161 million is attributable to volume, $102 million to cost increases (including increases in certain foreign excise tax rates) and $28 million to translation of foreign currencies. The 1977 increase in cost of beer products sold was $287 million, with $262 million from greater volume and $25 million of cost increases. The increase in 1976 over 1975 includes cost increases of $113 million for tobacco products and $256 million for beer. Increases in the cost of tobacco products of $112 million from higher unit volume and $87 million of cost increases (including increases in certain foreign excise tax rates) were reduced by translation of foreign currencies, $14 million, and by deconsolidation of a foreign subsidiary, $72 million. The $256 million higher cost of beer products sold, included $247 million from higher volume and $9 million of cost increases. Marketing, administrative and research costs in 1977 were $129 million (23.7%) higher than in 1976 and $110 million (25.2%) higher in 1976 than in 1975, reflecting new cigarette and beer brand introductions, increases from growth in operations, and inflation. Currency translation and hedging costs of $12 million in 1977 were $4 million (25%) less than in 1976. Such costs were first stated in the statement of earnings in 1976 in compliance with a pronouncement of the Financial Accounting Standards Board. Equity in Unconsolidated Subsidiaries and Affiliates The decrease in 1977 compared to 1976 of $2.5 million (17.7%) in equity in net earnings of partly- owned unconsolidated subsidiaries and affiliates was principally attributable to the impact on currency translation of the Australian dollar devaluation in late 1976, a retroactive Australian corporate income tax increase in 1977, and an increase in losses from Brazilian operations, all of which were partially offset by improved results in certain other subsidiaries and affiliates. Equity in net earnings of partly-owned unconsolidated subsidiaries and affiliates decreased $8.7 million (37.9%) in 1976 from 1975 mainly due to the devaluation of the Australian dollar and the Mexican peso. Income Taxes The $84 million increase in income taxes in 1977 and $57 million increase in 1976 reflect the applicable tax on the increased income for the years. Reference is made to Note 13 of Notes to Consolidated Financial Statements for additional information. 9

Item 3. Properties. Philip Morris' principal United States plants are: five manufacturing facilities for tobacco products- four in the Richmond, Virginia area, and one in Louisville, Kentucky; and two stemmeries-one located near Louisville and the other located in Richmond. The Philip Morris U.S.A. Operations Center in Richmond is believed to be the most modern cigarette factory in the world and is currently producing cigarettes at an annual rate of 100 billion units, approximately 70% of its planned production capacity. All of the foregoing are owned by the Company. Additional cigarette manufacturing facilities of Philip Morris are located in 22 countries outside of the United States. Philip Morris owns or leases other premises, including a research and development facility and an operations and data processing center in Richmond, warehouses, paper mills, converting plants and other manufacturing facilities. At present, Miller has breweries located in Milwaukee, Wisconsin; Fulton, New York; Azusa, California; and Fort Worth, Texas. Miller has embarked on a major capital expansion program. As part of this program, capacity at the Fulton brewery, at which production commenced in 1976, is being expanded; a new brewery, in Eden, North Carolina, is under construction with production scheduled to begin in 1978, and ground was broken in November 1977 for a new brewery in Irwindale, California to replace the smaller nearby Azusa facility. In addition, Miller is expanding and modernizing its facilities in Milwaukee and Fort Worth. Miller has three can-making facilities in operation, capable of an annual production of 1.5 billion cans, and an additional plant is planned for use in connection with the Eden Brewery. A glass making plant in Sennett, New York, is under construction. When completed, it will supply the Fulton Brewery with a portion of its glass bottle needs. Reference is made to the description of Mission Viejo Company under Item 1 for additional information. In 1977, capital expenditures amounted to $280,000,000 and are estimated at $500,000,000 in 1978. For the period 1978 through 1982, the Company estimates that total capital expenditures will exceed $2,250,000,000. Of this amount, more than one-half will be used for the expansion and modernization of beer operations and the rest largely for world-wide tobacco operations. Capital expenditures in the five year period 1973-1977 were $1,135,000,000. Of this amount, $484,000,000 was spent on the expansion and modernization of cigarette manufacturing facilities and $567,000,000 was spent on beer production facilities. Philip Morris' plants and properties are maintained in good condition and are believed to be suitable and adequate for present needs. As a result of recent capital expenditures, approximately 70% of Philip Morris' property, plant and equipment was less than five years old at December 31, 1977. Item 4. Parents and Subsidiaries. The active subsidiaries of the Company and their subsidiaries as of December 31, 1977 are listed below. The names of certain subsidiaries, which considered in the aggregate would not constitute a significant subsidiary, have been omitted. The consolidated financial statements included herein include the accounts of the Company and all subsidiaries whose common stock is wholly owned. Investments in and advances to unconsolidated subsidiaries are stated at cost plus equity in undistributed earnings since the dates of acquisition. Financial statements of unconsolidated foreign subsidiaries and affiliates included in the following list are omitted in accordance with the Instructions as to Financial Statements for Form 10-K. There are no parents of the Company. Name State or Country of Organization Percent of Voting Power Philip Morris Incorporated ......................................................... Virginia (the Company) Abdulla of Bond Street Ltd . ............................................... Delaware 100 Aliso Viejo Company .......................................................... California 100 Benson & Hedges (Canada) Limited ................................ Canada 100 B & H Retail Limited .................................................. Canada 100 C. A. Tabacalera Nacional ................................................. Venezuela 48 C. A. Cigarrera Doble Aguila y Sport ......................... Venezuela 100 10 204B1894f2

Name State or Country of Organization Percent of Voting Power Fabrica de Filtros C. A ................................................ Venezuela 100 Investigaciones Agricoles C. A .................................... Venezuela 100 Mendiola y Compania, S.A . ............................................... Costa Rica 51 Miller Brewing Company .................................................... Wisconsin 100 Crescent Distributing Company .................................. Louisiana 100 Star Distributing Company ......................................... Utah 100 Waterloo Malting Company, Inc ................................ Wisconsin 100 Mission Viejo Company ..................................................:... California 100 Mission Viejo Realty ................................................... California 100 MVC Escrow Corporation ........................................... California 100 MVC Financial Corporation ....................................... California 100 Park Avenue Export Corporation ....................................... Delaware 100 Philip Morris Asia-Pacific Inc ............................................. Delaware 100 Philip Morris ( Australia ) Limited ...................................... Australia 74.81(1) GPM Cigarette Distributors Limited .......................... Australia 100 Lindeman ( Holdings ) Limited ................................... Australia 100 Leo Buring Pty. Limited ...................................... Australia 100 Lindemans Wines Pty. Limited ........................... Australia 100 M. Moss & Co. Pty. Limited ................................ Australia 100 Crawford & Co. (Australasia) Pty. Limit- ed .............................................................. Australia 100 Philip Morris Limited .................................................. Australia 100 Philip Morris (New Zealand ) Limited ...................... New Zealand 100 Philip Morris Brasileira S.A. de Cigarros ........................... Brazil 81.33 Companhia de Fumos Santa Cruz .............................. Brazil 99.88 Philip Morris Export Corporation ...................................... Delaware 100 Philip Morris France S.A . ................................................... France 100 Philip Morris GmbH ........................................................... West Germany 100 Philip Morris Industrial Incorporated ................................ Delaware 100 Plainwell Paper Company, Inc . ................................. Michigan 100 Philip Morris International Capital N.V ............................ Netherlands Antilles 100 Philip Morris International Finance Corporation .............. Delaware 100 Fabriques de Tabac Reunies S.A ................................ Switzerland 100 Orecla S. A . .......................................................... Switzerland 100 Orienta S. A .......................................................... Switzerland 100 Philip Morris Espana S.A . ................................... Spain 45 Philip Morris Holland B.V . ................................. Netherlands 100 Philip Morris Iberica S.A ..................................... Spain 45 Philip Morris AB ......................................................... Sweden 100 Philip Morris Europe S.A ............................................ Switzerland 100 Philip Morris Limited .................................................. Delaware 100 Anniversary House Limited ................................. United Kingdom 100 Celebration Arts Group Limited ......................... United Kingdom 100 Charles Stewart & Company (Kirkcaldy) Lim- ited .................................................................... United Kingdom 100 Cohen Weenen & Company Limited .................. United Kingdom 100 Day & Wilkins Limited ....................................... United Kingdom 100 Godfrey Phillips Limited ..................................... United Kingdom 100 11

Name State or Country of Organization Percent of Voting Power J. Millhoff& Company Limited .......................... United Kingdom 100 The United Kingdom Tobacco Company Lim- ited .................................................................... United Kingdom 100 Philip Morris Nigeria Limited ............................................ Nigeria 90 Philip Morris Overseas, Inc ................................................. Delaware 100 Tabacalera Costarricense S.A . ............................................ Costa Rica 51 Tabacalera Nacional S.A .................................................... Panama 80 Weltab S.A . ......................................................................... Belgium 100 Distalux Luxembourg S.A ........................................... Luxembourg 100 Wikoln-Polymer Chemie GmbH ........................................ West Germany 100 Wisconsin Tissue Mills Inc Delaware 100 (1) 44.64% owned by the Company and 30.17% owned by Philip Morris International Finance Corporation. Item 5. Legal Proceedings. Three purported class actions by tobacco growers are pending against the six major United States cigarette manufacturers, including the Company, and others alleging violations of the United States antitrust laws. In these actions, it is alleged, among other things, that the Company conspired with other named defendants to fix prices at which tobacco is purchased from the plaintiffs and the growers allegedly represented by the plaintiffs. In two of the actions, the plaintiffs originally sought damages for the years 1970-1974 of approximately $2,500,000,000 in the aggregate. In April 1976, plaintiffs in one of these cases filed a proposed amended complaint which would reduce the size of the purported class, so that the aggregate damages claimed in both actions would be approximately $400,000,000. No specific amount of damages is claimed in the third action. The Company has denied any violation of law, is vigorously contesting the actions and has been advised by its counsel, Messrs. Arnold & Porter, Washington, D. C., that in their opinion these actions are not proper class actions. Furthermore, based on the investigation made to date, counsel is of the opinion that the Company has substantial factual and legal defenses to each of the alleged charges. The District Court in one of the three actions determined that the action could not be maintained as a class action. On October 11, 1977, that determination was affirmed by the United States Court of Appeals. A petition for a writ of certiorari has been filed but not yet acted upon by the Supreme Court. The District Courts in the other two cases have not as yet determined whether those cases may be maintained as class actions. After service of subpoenas duces tecum, three employees of the Company testified before a United States Grand Jury in March, 1978 concerning the operations and record keeping of a Company waste water treatment facility. The Company does not believe the outcome of the matter will have a material effect on its operations. For additional information, reference is made to the litigation described herein under Item 1. Item 6. Increases and Decreases in Outstanding Securities and Indebtedness. (a) Increases and Decreases in Equity Securities: The following increases and decreases in the amounts of the Company's equity securities outstanding took place during the year ended December 31, 1977: Date or Description Increase Period of Transaction (Decrease) No. of Shares(*) Outstanding I. CohnMoN STOCK (par value $1 per share): Balance at December 31, 1976 .............................................. 59,487,393 January 1-December 31 ............... Issued upon exercise of stock options ....................... 117,540 February 2, 1977 ........................... Acquisition of Wisconsin Tissue Mills...................... 314,984 Balance at December 31, 1977 .............................................. 59,919,917 12 . 204a1$q014

II. CUIvIULATIVE PREFERRED STOCK, 4% SERIES (par value $100 per share): Balance at December 31, 1976 .............................................. 18,016 January .......................................... February ........................................ March .............:.............................. April .............................................. May ............................................... June ............................................... July ................................................ August ........................................... September ..................................... December ...................................... Open market purchases ...................... (570) Open market purchases ...................... (152) Open market purchases ...................... (113) Open market purchases ...................... (56) Open market purchases ...................... (175) Open market purchases ...................... (8) Open market purchases ...................... (20) Open market purchases ...................... (100) Open market purchases ...................... (40) Open market purchases ...................... (30) Total decrease ................................. (1,264) Balance at December 31, 1977 .............................................. 16,752 III. CUMULATIVE PREFERRED STOCK, 3.90% SERIES (par value $100 per share) : Balance at December 31, 1976 .............................................. 9,944 January .......................................... Fe bruary ........................................ April .............................................. May ............................................... June ............................................... July ................................................ August ........................................... S eptember ..................................... Open market purchases ...................... (10) Open market purchases ...................... (100) Open market purchases ...................... (111) Open market purchases ...................... (60) Open market purchases ...................... (5) Open market purchases ...................... (32) Open market purchases ...................... (52) Open market purchases ...................... (385) Total decrease ................................. (755) Balance at December 31, 1977 .............................................. 9,189 IV. OPTIONS TO PURCHASE COMMON STOCK: See Note 11 of Notes to Consolidated Financial Statements. * Amounts are stated net of shares held by or for the account of the Company. (b) Increases and Decreases in Debt Securities and Indebtedness. See Item 5 of the Company's Quarterly Report on Form 10-Q for the Quarter ended June 30, 1977, which is incorporated herein by reference, for a description of: the sale by the Company on April 1, 1977 of its 8'/a% Promissory Note due April 1, 1997 in the principal amount of $100,000,000; the prepayment by the Company of all of its outstanding 10% Subordinated Notes due August 1, 1982 at par plus accrued interest and the redemption by the Company's subsidiary, Philip Morris International Capital N.V., of all of its 8% Guaranteed Notes due 1978 at par plus accrued interest, both on June 1, 1977; the borrowing by the Company on May 1, 1977 of $50,000,000 from Continental Illinois National Bank and Trust Company of Chicago pursuant to a Term Loan Agreement dated as of April 28, 1977; the issuance by the Company on May 10, 1977 of its 6% Promissory Note in the principal amount of $2,600,000 due May 1, 1997 to the Industrial Development Authority of the County of Chesterfield, Virginia, and the simultaneous issuance by such Authority of a corresponding principal amount of Pollution Control Revenue Bonds. During the fourth quarter of 1977 the Company entered into the following transactions involving an increase in its indebtedness: (i) On October 4, 1977, the Company gave its Guaranty, dated as of October 1, 1977, of the principal of, premium if any, and interest on, $1,000,000 Industrial Facilities Revenue Bonds, Series A 13

(Miller Brewing Company Project) due October 1, 2002, of The Rockingham County Industrial Facilities and Pollution Control Financing Authority (the "Authority"), a political subdivision of the State of North Carolina, and its Guaranty, also dated as of October 1, 1977, of the principal of, premium, if any, and interest on, the Authority's $16,000,000 Pollution Control Revenue Bonds, Series A (Miller Brewing Company Project). The Industrial Facilities Revenue Bonds and the Pollution Control Revenue Bonds were sold on October 4, 1977 to The Aetna Casualty and Surety Company at 100% of par, the proceeds being used by the Authority to finance the acquisition, construction, and installation of certain machinery and pollution control equipment at the Eden, North Carolina, brewery of Miller. The Company's Guaranties, the Industrial Facilities Revenue Bonds and the Pollution Control Revenue Bonds were not registered under the Securities Act of 1933, as amended, because each is exempt from registration pursuant to Section 3(a)(2) of that Act. (ii) On October 26, 1977, the Company gave its Guaranty, dated as of October 1, 1977, of the principal of, premium, if any, and interest on, $4,500,000 aggregate principal amount of Industrial Revenue Bonds (Philip Morris Industrial Incorporated Project) due October 1, 1997 of the City of Fort Atkinson, an incorporated municipality of the State of Wisconsin ("Municipality"). Such Bonds were sold on October 26, 1977 to United States Fidelity and Guaranty Company at 100% of par, the proceeds being loaned by the Municipality to Philip Morris Industrial Incorporated ("Industrial"), a wholly-owned subsidiary of the Company, to finance the acquisition, construction, and equipping of a new industrial plant for Industrial's Koch Label Division located in the Municipality. The Guaranty and the Municipality's Industrial Revenue Bonds were not registered under the Securities Act of 1933, as amended, because they are exempt from registration pursuant to Section 3(a)(2) of that Act. (iii) The Company entered into a Credit Agreement dated as of December 1, 1977 with a group of U. S. and foreign banks, arranged through Bank of Boston International, pursuant to which the banks have agreed that, until November 30, 1982, they will make Eurodollar loans to the Company up to an aggregate principal amount of U. S. $250,000,000. Such loans will bear interest at a rate of'/a of 1% above the average London interbank rate offered by certain of the banks. This Credit Agreement replaces a Credit Agreement dated as of July 31, 1975 pursuant to which the Company had the right to borrow up to U. S. $180,000,000. As of December 1, 1977, the Company had no borrowings outstanding under the 1975 Credit Agreement, and no borrowings were made under the new Credit Agreement during the period to which this report applies. Item 7. Changes in Securities and Changes in Security for Registered Securities. Not applicable. Item 8. Defaults Upon Senior Securities. Not applicable. Item 9. Approximate Number of Equity Security Holders. The following table shows, as of January 31, 1978, the number of holders of record of each class of equity securities of the Company. Title of Class Number of Holders of Record Common Stock (par value $1 per share ) ................................................ 27,735 Cumulative Preferred Stock, 4% Series (par value $100 per share )...... 288 Cumulative Preferred Stock, 3.90% Series (par value $100 per share ). 151 Item 10. Submission of Matters to a Vote of Security Holders. Not applicable. 14

Item 11. Executive Ojfficers of the Registrant. The following are the executive officers of the Company: Name Office Age (1) Joseph F. Cullman 3rd (2)(3) .............. Chairman of the Board and Chief Executive Officer 65 George Weissman .................................. Vice Chairman of the Board 58 Ross R. Millhiser .................................... President 57 Hugh Cullman (2) ................................. Executive Vice President 55 Clifford H. Goldsmith ............................ Executive Vice President 58 John A. Murphy ..................................... Executive Vice President 48 Thomas F. Ahrensfeld ........................... Senior Vice President and General Counsel 54 James C. Bowling ................................... Senior Vice President 49 John T. Landry ....................................... Senior Vice President 53 Hamish Maxwell .................................... Senior Vice President 51 Albert E. Bellot ...................................... Vice President 57 Russell N. Freund ............................... :.. Vice President 50 William K. Howell ................................. Vice President 47 Jetson E. Lincoln .................................... Vice President 56 William D. McCoy ................................. Vice President 48 W. Wallace McDowell ........................... Vice President 41 James J. Morgan .................................... Vice President 35 R. William Murray ................................. Vice President 41 William J. O'Connor .............................. Vice President 47 Shepard P. Pollack ................................. Vice President and Chief Financial Officer 49 Philip J. Reilly ........................................ Vice President 48 Carlos E. Salguero .................................. Vice President 48 Edward M. Schaaf, Jr . ........................... Vice President 63 Benjamin A. Soyars ................................ Vice President 59 Walter F. Sperber .................................. Vice President and Controller 60 Helmut R. R. Wakeham ........................ Vice President 61 Lauren S. Williams ................................ Vice President 40 Eugene J. T. Flanagan ........................... Associate General Counsel, Secretary 54 Alexander Holtzman .............................. Associate General Counsel 53 F. Harrison Poole ................................... Treasurer 57 George P. Hibbard ................................. Assistant Treasurer 36 Edward G. Silcock ................................. Assistant Treasurer 46 Norman J. Treisman (3) ....................... Assistant Treasurer 40 John C. Lino ........................................... Assistant Controller 46 Horace W. Pierpoint .............................. Assistant Controller 48 Robert H. Souther .................................. Assistant Controller 54 Robert A. White ..................................... Assistant Controller 50 Mary E. Russell ...................................... Assistant Secretary 62 Anthony W. Giraldi ............................... Assistant Secretary 53 ( 1) As of January 31, 1978. (2) Messrs. Joseph F. Cullman 3rd and Hugh Cullman are first cousins. (3) Mr. Cullman is the father-in-law of Mr. Treisman. All of the above mentioned officers have been employed by Philip Morris in various capacities during 15

the past five years with the exception of George P. Hibbard who earned his M.B.A. degree in finance at the Harvard University Graduate School of Business Administration in 1971 and was associated with Smith Barney, Harris Upham & Co. from September 1971 until February 1974. From March 1974 until December 1974, when he joined the Company, Mr. Hibbard was an independent consultant. Item 12. Indemnification of Officers and Directors. The Virginia Stock Corporation Act (§ 13.1-3.1) grants corporations the power to indemnify their directors and officers in connection with actions, suits and proceedings and provides that directors and officers shall be indemnified when successful in defense thereof. The Act further provides that any corporation shall have power to make any other or further indemnity authorized by the articles of incorporation or stockholder adopted by-law except an indemnity against gross negligence or wilful misconduct. The Company's articles of incorporation provide that a director or officer of the Company shall be indemnified except in relation to matters as to which he shall have been finally adjudged to be liable by reason of having been guilty of gross negligence or wilful misconduct in the performance of his duties. The Company has purchased directors' and officers' liability insurance. Item 13. Financial Statements, Exhibits Filed and Reports on Form 8-K. (a) The following financial statements and exhibits are filed as part of this report: (i) Financial statements: See Index to Financial Statements and Schedules on page F-1. (ii) Exhibits: 1. Consent of Independent Public Accountants. 2. Copy of Credit Agreement dated as of December 1, 1977. (b) The Company filed no reports on Form 8-K during the last quarter of the period covered by this report. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PHILIP MORRIS INCORPORATED (Registrant) By SHEPARD P. POLLACK Shepard P. Pollack Vice President and Chief Financial Officer Date: March 28, 1978 16

PHILIP MORRIS INCORPORATED INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES Report of Independent Public Accountants ................................................. F-3 Financial Statements: Balance Sheets ....................................................................................... F-4 Statements of Earnings .......................................................................... 6 Statements of Stockholders' Equity ...................................................... 8 Statements of Changes in Financial Position ....................................... F-6 Notes to Financial Statements .............................................................. F-8 Schedules: III-Investments in, Equity in Earnings of, and Dividends Re- ceived from Affiliates and Other Persons ............................... F-24 IV-Indebtedness of Affiliates and Other Persons-Not Current.... F-26 V-Property, Plant and Equipment .................................................. F-28 VI-Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment ...........:............:..................:.. F-29 VII-Intangible Assets, Preoperating Expenses and Similar Defer- rals ........................................................................................... F-30 VIII-Accumulated Depreciation and Amortization of Intangible Assets ....................................................................................... F-31 IX-Bonds, Mortgages and Similar Debt .......................................... F-32 XII-Valuation and Qualifying Accounts and Reserves .................... F-34 XIII-Capital Shares ............................................................................. F-36 Schedules other than those listed above have been omitted either because the required information is ,,,wained in notes to the consolidated financial statements or because such schedules are not required or ,Ii r not applicable. Separate financial statements of the Company are omitted since the Company is primarily an ,,1)rrating company and all subsidiaries included in the consolidated financial statements are wholly ,,~N, iied. The long-term indebtedness of two unconsolidated subsidiaries is guaranteed by the Company. Financial statements of unconsolidated subsidiaries and affiliates are not filed for the reason that no ;,iiI»idiary or affiliate individually constitutes a significant subsidiary.

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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of PHILIP MOEtRIS INCORPORATED: We have examined the consolidated balance sheets of PHILIP MORRIS INCORPORATED and Consoli- dated Subsidiaries as of December 31, 1977 and 1976, and the related consolidated statements of earnings, stockholders' equity and changes in financial position for each of the five years in the period ended December 31, 1977 and the supporting schedules. Our examinations were made in accordance with generally accepted auditing standards and, accordingly, included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances. In our opinion, the financial statements mentioned above (pages 6 to 8 and F-4 to F-23, inclusive ) present fairly the financial position of Philip Morris Incorporated' and consolidated subsidiaries at December 31, 1977 and 1976, and the results of their operations and the changes in their financial position for each of the five years in the period ended December 31, 1977, and the supporting schedules (pages F- 24 to F-37, inclusive) present fairly the information required to be included therein, all in conformity with generally accepted accounting principles applied on a consistent basis. COOPERS & LYBRAND 1251 Avenue of the Americas New York, N. Y. January 24, 1978 F-3

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries CONSOLIDATED BALANCE SHEETS December 31, 1977 and 1976 (in thousands of dollars) ASSETS: 1977 1976 Cash and cash equivalents (Note 7) ............................................................ Accounts receivable from customers ............................................................. Less, Allowances for discounts and doubtful accounts (Note 1 and Schedule XII ) .................................................................................... $ 72,231 279,733 14,214 $ 64,353 233,187 14,417 Accounts receivable from others ................................................................... 265,519 51,204 218,770 49,173 Inventories (Notes 1 and 4) ......................................................................... Prepaid expenses ........................................................................................... 316,723 1,817,561 14,505 267,943 1,657,504 15,945 Total current assets ................................................................. 2,221,020 2,005,745 Investments in and advances to unconsolidated foreign subsidiaries and affiliates (Notes I and 3): Investments (Schedule III ) ................................................................... 222,182 200,237 Advances (Schedule IV ) ....................................................................... 7,326 19,910 229,508 220,147 Land and offtract improvements (Note 1) .................................................. 69,576 58,766 Property, plant and equipment, at cost (Notes 1 and 5 and Schedule V).. 1,594,910 1,323,923 Less, Accumulated depreciation (Notes I and 5 and Schedule VI) ... 392,478 330,044 1,202,432 993,879 Brands, trademarks, patents and goodwill, at cost (Notes 1 and 6 and Schedule VII), less amortization of $4,060,000 and $3,437,000, respec- tively (Schedule VIII ) ......................................................................:........ 222,492 211,570 Long-term receivables ................................................................................... 64,762 66,463 Other assets .................................................................................................... 38,249 25,639 $4,048,039 ' $3,582,209 See notes to consolidated financial statements. F-4

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries CONSOLIDATED BALANCE SHEETS December 31, 1977 and 1976 (in thousands of dollars) LIABILITIES: Notes payable (Note 7 ) ................................................................................ Current portion of long-term debt ................................................................ Accounts payable: 1977 1976 $ 121,139 $ 260,131 15,740 17,729 Trade creditors ....................................................................................... 139,326 114,768 Other .................................................................................................... .. 50,738 33,568 Accrued liabilities: Taxes, other than income taxes ............................................................. 149,315 144,444 Interest ......................................:............................................................ 20,826 17,368 Employees' retirement and profit-sharing plans .................................. 22,834 17,578 Salaries, wages and commissions .......................................................... 17,589 13,734 Other .................................................................................................... .. 103,139 61,315 Federal and other income taxes .................................................................... 139,766 103,527 Dividends payable ......................................................................................... 24,741 19,359 Total current liabilities ........................................................... 805,153 803,521 Long-term debt, less amount due within one year (Note 8 and Schedule IX ) .................................................................................................... ......... 1,426,619 1,247,778 Deferred income taxes (Note 1) .................................................................. 104,429 77,714 Other liabilities .............................................................................................. 21,772 23,214 Total liabilities ........................................................................ 2,357,973 2,152,227 STOCKHOLDERS' EQUITY: Stockholders' equity (Note 10, consolidated statements of stockholders' equity and Schedule XIII), represented by: Cumulative preferred stock, par value $100 per share ......................... 8,262 8,812 Common stock, par value $1 per share (Note 11) ............................... 59,922 59,490 Additional paid-in capital ........................................ ............................. 300,538 294,225 Earnings reinvested in the business (Notes 3 and 12) ......................... 1,325,149 1,071,488 1,693,871 1,434,015 Less, Cost of treasury stock ............................................................ 3,805 4,033 1,690,066 1,429,982 $4,048,039 $3,582,209 See notes to consolidated financial statements. F-5

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION for the five years ended December 31, 1977 (in thousands of doliars) SOURCES OF WORKING CAPITAL: 1977 1976 1975 1974 1973 Net earnings ............................................................. $334,926 $265,675 $211,638 $175,516 $1 48,632 Add (deduct) items not requiring current use of working capital: Depreciation and amortization ................. 81,604 67,663 52,474 39,858 31,947 Deferred income taxes .............................. 28,015 20,306 12,870 13,128 6,360 Provision for reserve applicable to inter- national operations ................................ 2,500 3,000 Equity in net earnings of unconsolidated foreign subsidiaries and affiliates.......... (11,694) (14,201) (22,868) (24,614) (20,199) Dividends from unconsolidated foreign sub- sidiaries and affiliates ........................................... 10,985 8,636 7,270 4,429 8,612 From operations ...........:..............:..... 443,836 348,079 261,384 210,817 178,352 Long-term debt issued .............................................. 258,550 340,000 177,923 302,032 28,639 Sale of common stock ............................................... - - 93,375 - - Common stock issued under stock options .............. 6,255 5,127 2,662 1,862 3,971 Land and offtract improvements transferred to housing programs under construction .................. 3,822 9,226 2,934 2,513 2,528 Disposal of property, plant and equipment ............. 9,563 4,266 3,041 7,025 7,798 Additions to working capital ............. $722,026 $706,698 $541,319 $524,249 $221,288 See notes to consolidated financial statements. F-6

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION for the five years ended December 31, 1977 (in thousands of dollars) USES OF WORKING CAPITAL: 1977 1976 Dividends .................................................................. $ 93,633 $ 68,480 Expansion and modernization of property, plant and equipment ...................................................... 279,818 220,173 Capitalized lease obligations .................................... 6,260 - Land and offtract improvements .............................. 14,632 21,769 Long-term receivables .............................................. (4,611) 34,045 Investments in and advances to unconsolidated foreign subsidiaries and affiliates ......................... 8,652 - 25,059 Investments in consolidated subsidiaries ................. 11,884 6,415 Decrease in long-term debt ...................................... 92,647 18,267 Net unrealized exchange losses ( gains ), resulting from translation of working capital ..................... - - Preferred stock purchased for treasury .................... 147 121 Other, net .................................................................. 5,321 942 Working capital used ................. $508,383 $395,271 Increase ( decrease ) in working capital ..................................... $213,643 $311,427 Changes in components of working capital: Cash and receivables ........................................ $ 56,658 $ 544 Inventories ......................................................... 160,057 209,076 Notes payable and long-term debt currently payable ......................................................... 140,981 247,540 Accrued liabilities and other payables ............. (137,231) ( 149,282) Other, net .......................................................... (6,822) 3,549 $213,643 $311,427 Other significant changes in financial position not affecting working capital: Increase ( decrease ) in foreign currency long- term liabilities resulting from translation at year-end rates with a corresponding de- crease ( increase ) in other liabilities and deferred taxes where applicable ................... Increase in common stock and additional paid-in capital resulting from conversions of debentures with a corresponding de- crease in long-term debt ............................... Sale of net noncurrent assets of a consoli- dated subsidiary in exchange for a long- term note ....................................................... 1975 1974 1973 S 54,536 244,477 - $ 43,626 215,770 - $ 37,256 174,665 - 7,944 16,849 3,711 3,827 831 (109) 27,486 22,552 (316) 2,322 1,768 2,053 22,640 20,359 7,776 13,205 (11,065) (2,798) 31 126 6,739 (946) 3,780 1,755 $375,522 $314,596 $230,732 $165,797 $209,653 $ (9,444) $ 53,565 $ 50,440 $ 44,341 179,216 259,798 208,269 (54,391) (23,480) (246,329) (6,603) ( 77,081) (18,560) (5,990) (24) 2,835 $165,797 $209,653 $ (9,444) $(7,167) $ 21,667 $ 14,657 $ 26,634 $ 11,018 $ 21,505 See notes to consolidated financial statements. F-7

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Consolidation: The consolidated financial statements include the accounts of the Company and all wholly owned subsidiaries. Investments in and advances to unconsolidated subsidiaries and affiliates are stated at cost adjusted for equity in undistributed earnings or losses since the dates of acquisition. Foreign operations: Foreign currency accounts are translated into U.S. dollars as follows: (1) current assets (except inventories ), current liabilities, long-term receivables and long-term debt at year-end rates; (2) in- ventories, other assets and liabilities generally at historical rates; and (3) revenues, costs and expenses at average rates during the year except for the cost of inventories sold and depreciation and amortization which are based upon the historical dollar cost. The Company enters into forward exchange contracts and other hedging activities to minimize the effect of currency fluctuations on net earnings. Gains and losses on such transactions and other currency gains and losses are included in income in the period in which they occur. Receivables: Current earnings are charged and an allowance is credited with a provision for doubtful accounts based on experience and on any unusual circumstances which may affect the ability of customers to meet their obligations. Accounts deemed uncollectible are charged against this allowance. Inventories: Inventories are valued at the lower of cost or market. The cost of leaf tobacco is determined on an average cost basis and the cost of other inventories is determined generally on a first-in, first-out basis. It is a generally recognized industry practice to classify the total amount of leaf tobacco inventory as a current asset although part of such inventory, because of the duration of the aging process, ordinarily would not be utilized within one year. The cost of housing programs under construction represents the cost of land, including offtract improvements, interest and property taxes and housing construction costs on sites currently under development. Real estate operations: The cost of land, including offtract improvements, interest and property taxes, is reported as a noncurrent asset until a designated area is placed into development. Interest is capitalized in accordance with the general industry practice. The amount of interest capitalized is determined by the average short- and long-term borrowing rates applicable to loans incurred for use in these operations. Offtract improvements are access roads, utilities, etc., which are essential to the development of a community, but which are not directly attributable to the development of a particular tract or area. The cost of these improvements is allocated to the saleable acreage remaining in each project and is charEed to cost of sales when such acreage is sold. Revenue and profit from real estate sales are recognized only as cash is received. ~ . ,~ ca Continued 2 ta -t3 F-8 ° ~

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Brands, trademarks,'patents and goodwill: Cost in excess of net assets of companies acquired after November 1, 1970 is being amortized over a period of no more than 40 years. Other goodwill is not amortized unless there has been a diminution in its value. Income taxes: The provisions for federal and foreign income taxes are calculated on reported pre-tax earnings. Certain items of income and expense included in the financial statements, such as depreciation, are reported in different years in the tax returns in accordance with applicable income tax laws. The resulting difference between the financial statement income tax provision and income taxes currently payable is reported in the financial statements as deferred income taxes. Investment tax credits are recognized currently as a reduction in the provision for income taxes. Provision is also made for federal income taxes on the portion of undistributed earnings of foreign subsidiaries and affiliates that is expected to be remitted to the United States. Property, plant and equipment: Maintenance and repairs are charged to income, and expenditures for renewals and improvements are capitalized. In order to present more realistically the economic cost of a constructed facility, whenever the construction period of a facility exceeds one year, the capitalized cost of the facility includes interest and .real estate taxes incurred during the construction period. The interest capitalized on construction of facilities is determined by applying the Company's average short-term borroWing rates to the outstanding construction balance. Provision for depreciation of assets is recorded by a charge against income at rates considered adequate to amortize the cost of such assets over their useful lives computed on the straight-line method. Pension plans: The Company and certain of its subsidiaries have pension plans covering substantially all their employees. Prior service costs, which are being amortized over periods of up to 30 years, and accrued pension costs are funded with independent trustees. 2. TRANSLATION OF FOREIGN CURRENCY: Effective January 1, 1976, in accordance with the Financial Accounting Standards Board statement on translation of foreign currency transactions and foreign currency financial statements (FASB 8), the Company changed its method of translating inventories denominated in foreign currencies to use historical rather than current exchange rates and also began to include exchange gains and losses in income in the period in which they occur. As a result of the Company's policy of minimizing the impact of foreign currency fluctuations on its operations by entering various hedging activities, it has been concluded that it is not practicable to restate the financial statements for 1975 and earlier years because no reasonable estimates can be made of the hedging costs and exchange gains and losses that the Company would have incurred in such years under its established hedging policy. Accordingly, the cumulative effect as of January 1, 1976 of restatement of the inventory and other accounts pursuant to FASB 8, which is not significant, has been reflected in 1976 earnings. Had the Company reported prior period data reflecting the impact of FASB 8 on its inventory and other accounts without giving effect to the hedging program that would have been followed had the new accounting rules been known at the time, reported net earnings and primary and fully diluted earnings per share for the year ended December 31, 1975, would have increased by $4,315,000, $.07 and $.07, respectively; decreased $14,923,000, $.27 and S.26, respectively, in 1974; and increased $3,321,000, $.06 and $.05, respectively, in 1973. Continued F-9

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. FOREIGN SUBSIDIARIES: All significant intercompany accounts and profits have been eliminated. For U.S. reporting purposes, the fiscal years of foreign subsidiaries and affiliates end on either October 31, November 30 or December 31. Summarized financial data of the Company's unconsolidated foreign subsidiaries and affiliates, none of which is individually significant, and its consolidated foreign subsidiaries are presented below. Consolidated (Wholly Owned) 1977 1976 (in thousands) Assets ............................................................................................. $ 741,761 $635,715 Liabilities ....................................................................................... 430,976 359,102 Net assets ....................................................................................... 310,785 276,613 Operating revenues ....................................................................... 1,017,780 860,011 Net earnings .................................................................................. 37,723 33,095 Unconsolidated (Partially Owned) Affiliates 1977 1976 1977 1976 (in thousands) (in thousands) Operating revenues .................:.. ::...:::.: .......:.................:.......... $569,287 $612,051 $396,104 $415,571 Gross profit ................................................................................ 110,448 122,148 54,097 43,799 Operating income ...................................................................... 40,502 49,756 27,413 9,233 Pre-tax earnings ......................................................................... 32,088 46,328 16,861 (4,315) Net earnings .............................................................................. 11,563 21,095 13,717 (7,529) Company's equity ...................................................................... 6,168 15,040 5,526 (839) Inventories ................................................................................. 160,495 152,775 164,486 131,338 Total current assets .................................................................... 219,354 224,042 188,821 155,544 Property, plant and equipment, net ........................................................................................... 103,995 97,055 45,346 39,034 Total assets ................................................................................ 359,999 359,336 242,604 201,991 Total current liabilities .............................................................. 119,451 133,380 125,813 I00,319 Stockholders' equity .................................................................. 227,689 202,083 76,814 64,000 Company's equity and advances ............................................... 178,205 171,180 35,022 31,766 At December 31, 1977, investments in unconsolidated foreign subsidiaries and affiliates exceeded equity in net assets by approximately $16,000,000, including $11,000,000 which arose subsequent to November 1, 1970 and is being amortized. Consolidated earnings reinvested in the business at December 31, 1977 includes approximately $101,000,000 of undistributed earnings of unconsolidated subsidiaries and affiliates. Federal income tax has not been provided on approximately $360,000,000 of undistributed earnings of foreign subsidiaries and affiliates, accumulated since inception of such investments, which are expected to be permanently invested abroad. Continued F-10 2fl4818-r`i0cP

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. INVENTORIES: The inventories used in the computation of cost of products sold are as follows: December 31 1977 1976 (in thousands) Raw materials: Leaf tobacco ...................................................................................... $1,271,235 $1,089,301 Other .................................................................................................. 142,231 125,620 Finished goods .......................................................................................... 278,492 346,181 Work in process ........................................................................................ .. 36,027 33,265 Housing programs under construction ..................................................... 89,576 63,137 $1,817,561 $1,657,504 December 31, 1975 ................... $1,448,428 December 31, 1974 ................... $1,269,212 December 31, 1973 ................... $1,009,414 December 31, 1972 ................... $ 801,145 5. PROPERTY, PLANT, EQUIPMENT AND RELATED DEPRECIATION: The major classes of fixed assets, which are stated at cost, are as follows: December 31 Land and land improvements .................................................................. Buildings and building equipment ........................................................... Machinery and equipment ....................................................................... Construction in progress ...............................................................:........... 1977 1976 (in thousands) $ 55,246 $ 53,230 398,479 391,341 931,042 755,310 210,143 124,042 $1,594,910 $1,323,923 Commitments for plant, equipment and machinery at all locations approximated $290,000,000 at December 31, 1977. The principal depreciation rates used are as follows: Class of Property Rates ( Percent ) per Annum Land improvements .................................................................................. 2-6 Buildings and building equipment ........................................................... 2-635 Machinery and equipment ....................................................................... 4-62h When items of machinery and equipment subject to composite rate depreciation are retired or otherwise disposed of, the acquisition costs of such items are charged to accumulated depreciation which is also credited with the proceeds received from disposition, if any. Consequently, no profit or loss on such retirement or disposal is recognized. Generally, when items other than machinery and equipment subject to composite rate depreciation are retired or otherwise disposed of the depreciation account is charged with the accumulated amount of depreciation applicable thereto and any profit or loss on such retirement or disposal is credited or charged to income. Continued F-11

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 6. BRANDS, TRADEMARKS, PATENTS AND GOODWILL: At December 31, 1977, this amount included approximately $35,000,000 of goodwill which is being amortized. Cost in excess of net assets of companies acquired prior to November 1, 1970 is not being amortized because, in the opinion of management, the related investments have not experienced any diminution in value. 7. SHORT-TERM BORROWING ARRANGEMENTS: In addition to the domestic and foreign bank loans and commercial paper obligations included in current liabilities, the information presented below also includes short-term notes payable classified as long-term debt in accordance with Financial Accounting Standards Board Statement No. 6. At December 31, 1977, $500,000,000 of short-term notes were included in long-term debt. Average bank loans and commercial paper obligations outstanding during 1977 were $127,049,000 and $401,612,000, respectively, on which the weighted average interest rates were 7.5% and 5.6%, respectively. At December 31, 1977, short-term notes payable consisted of bank loans of $309,967,000 and commercial paper obligations of $311,172,000 on which the average rates of interest were 8.1% and 6.4%, respectively. At that date, lines of credit amounted to approximately $1,200,000,000 of which $600,000,000 remained unused. During 1977, the Company and its consolidated subsidiaries maintained average demand deposit book balances of approximately $54,000,000 with a number of banks, principally in the United States, while average actual collected fund balances held by the banks approximated $88,000,000, to compensate the banks for account handling and other important services and to support lines of credit. Cash and cash equivalents include $52,549,000 and $5,664,000 of time deposits at December 31, 1977 and 1976, respectively. 8. LONG-TERM DEBT: Outstanding at December 31, exclusive of amounts due within one year: December 31 1977 1976 (in thousands) 8'/a% Notes, payable $6,665,000 annually from 1983 to 1996 and $6,690,000 in 1997 ................................................................................ $ 100,000 Bank Term Loan Agreement, payable $33,000,000 in 1981 and $17,000,000 in 1982. Interest is at 7%s% to April 30, 1979 and 8'k% thereafter ............................................................................................... 50,000 Notes payable (see below) ..................................................................... 500,000 $ 430,000 8'h% Notes, payable in 1985 .................................................................... 150,000 150,000 8%a% Sinking Fund Debentures, payable $6,250,000 annually from 1984 to 2003 and $25,000,000 in 2004 ................................................. 150,000 150,000 Bank Term Loan Agreement, payable in 1980. Interest is at 'Fi% above the bank prime rate, but not more than an average effective rate of 7.9% per annum if outstanding to maturity .............................. 150,000 150,000 6~/s% Sinking Fund Debentures, payable $3,500,000 annually to 1992 and $15,500,000 in 1993 ....................................................................... 64,500 68,000 8.85% Notes, payable in 1982 .................................................................. 50,000 50,000 4.90% Notes, payable $2,600,000 annually to 1988 and $16,000,000 in 1989 ................................................................................................... 42,000 44,600 6'/,% Loan, 100,000,000 German marks, payable from 1978 to 1987.... 41,861 41,667 6'fz% Loan, 80,000,000 Swiss francs, payable 1988 ................................. 39,024 32,653 Purchase money obligations ..................................................................... 62,306 32,847 Other .................................................................................................... ..... 26,928 42,571 t 3 10% Subordinated Notes .......................................................................... 55 440 Ct , # Total long-term debt .......................................................... $1,426,619 $1,247,778 Co ~. C~+ ~ Continued ~ C2 G F-12

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company has entered into a $250,000,000 revolving credit and term loan agreement, maturing in 1984, and a $250,000,000 Eurodollar revolving credit agreement maturing in 1982, both of which can be used to refinance short-term notes payable. Management intends to exercise its rights under these agreements in the event that it becomes advisable. Accordingly, at December 31, 1977, $500,000,000 of short-term notes payable have been classified as long-term debt in accordance with Financial Accounting Standards Board Statement No. 6. Generally, long-term debt is callable, at annually decreasing premiums. Expenses incurred in securing long-term loans are included in other assets and are being amortized on the straight-line method over the respective lives of the issues giving rise thereto. Aggregate maturities of long-term debt in each of the following years are: 1978, $15,740,000; 1979, $16,162,000; 1980, $166,276,000; 1981, $46,964,000; 1982, $330,326,000. 9. CAPITALIZED INTEREST: The effect of the policy to capitalize interest relating to major facilities was an increase in pre-tax income of $513,000 in 1977, $643,000 in 1976, $2,928,000 in 1975, $4,842,000 in 1974 and $5,794,000 in 1973; the effect relating to real estate operations was an increase in pre-tax income of $2,037,000 in 1977, $1,959,000 in 1976, $1,577,000 in 1975, $2,398,000 in 1974 and $1,434,000 in 1973. The combined effect on net income was an increase of $1,228,000 in 1977, $1,257,000 in 1976, $2,176,000 in 1975, $3,499,000 in 1974 and $3,522,000 in 1973. 10. CAPITAL SHARES: Authorized Issued Treasury Outstanding Preferred: At December 31, 1976 ........................................................... 88,119 88,119 (60,159) 27,960 Purchased ............................................................................... (2,019) (2,019) Retired ................................................................................... (5,503) (5,503) 5,503 At December 31, 1977 ........................................................... 82,616 82,616 (56,675) 25,941 Common, $1 par value: At December 31, 1976 ........................................................... 100,000,000 59,489,617 (2,224) 59,487,393 Shares issued for acquisition ................................................. 314,984 314,984 Exercise of stock options ....................................................... 117,540 117,540 At December 31, 1977 ........................................................... 100,000,000 59,922,141 (2,224) 59,919,91 7 As of December 31, 1977, 1,672,775 shares are reserved for the exercise of stock options and units. On February 2, 1977, the Company issued 314,984 shares of its common stock in connection with the acquisition of Wisconsin Tissue Mills, a transaction accounted for as a pooling of interests. Financial statements for periods prior to January 1, 1977 have not been restated due to the immateriality of the amounts involved. 11. STOCK PLANS: Under the stockholder-approved 1977 Stock Unit Plan, units with respect to 1,000,000 shares of common stock of the Company may be granted to employees of the Company or its affiliates. A stock unit entitles the holder to purchase one share of common stock at the market price at the date of grant, or to receive the appreciation value (the excess of the market price at the date of exercise over the market price at the date of grant) in the form of stock or stock and cash. Appreciation value may be received with respect to no more than 50% of the units granted. At December 31, 1977, units with respect to 298,700 Continued ~ F-13

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) shares had been granted at a price of $60.06 per share and become exercisable over a four year period beginning on the first anniversary of the date of grant. Appropriate appreciation value currently as compensation expense. With the adoption of the 1977 Stock Unit Plan, options no longer can previously approved stock option plan. is recognized be granted under any Pursuant to previously approved stock option plans, common stock of the Company has been made available for option to officers and other key employees at market prices on the dates granted. Other data regarding activity under the stock option plan, after giving effect to stock splits, follows: Option Price Market Value Number of Shares Per Share(A) Total Per Share Total 1977: Under option, beginning of year .........:......:... 825,376 Options granted .............................................. 4,000 Options exercised ............................................ (117,540) $ 50.50 to $ 6,144,275 $ 54.13 to $ 6,941,049 $ 59.72 S 64.38(B) Options canceled ............................................. (39,061) Under option, end of year .............................. 672,775 $ 44.44 to $35,044,161 $ 61.94 Options becoming exercisable ........................ 169,399 $ 44.44 to $ 8,511,300 $ 55.38 to $ 9,620,033 Available for option, end of year ................... $ 61.94 $ 61.13(C) 1976: Under option, beginning of year .................... 811,291 Options granted .............................................. 171,800 Options exercised ............................................ (130,157) $ 29.75 to $ 4,753,750 $ 51.50 to $ 7,325,119 $ 55.69 $ 62.75(B) Options canceled ............................................. (27,558) Under option, end of year .............................. 825,376 $ 44.44 to $43,023,561 $ 61.94 Options becoming exercisable ........................ 177,264 $ 44.44 to $ 8,927,948 $ 51.00 to $ 9,412,313 Available for option, end of year ................... 101,023 $ 61.94 $ 61.88(C) 1975: Options granted .............................................. 203,000 Options exercised ............................................ (92,650) $ 17.88 to $ 2,216,309 $ 42.50 to $ 4,737,100 $ 50.50 $ 55.38(B) Options becoming exercisable ........................ 205,962 $ 44.44 to $11,119,939 $ 47.00 to $10,740,888 1974: $ 59.72 $ 54.00(C) Options granted .............................................. 181,000 Options exercised ............................................ (77,528) $ 14.50 to S 1,457,969 $ 38.25 to $ 3,901,157 $ 55.69 $ 60.00(B) Options becoming exercisable ........................ 173,595 $ 50.50 to $ 9,414,491 S 36.00 to S 9,253,457 1973: $ 59.72 $ 55.50(C) Options granted .............................................. 280,600 Options exercised ............................................ (172,420) $ 11.78 to $ 3,271,478 S 51.38 to $10,380,131 $ 55.69 $ 68.13(B) Options becoming exercisable ........................ 166,966 $ 26.94 to $ 6,405,059 $ 52.82 to $ 9,791,604 $ 59.72 S 64.25(C) (A) Market value on dates options were granted. (B) On dates options were exercised. (C) On dates options were exercisable. There have been no charges to income under the stock option plans. value of common stock has been credited to additional paid-in capital. Continued The excess of proceeds over par F-14 2048 189032

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. RESTRICTIONS: Certain of the agreements covering long-term debt contain restrictions with respect to the payment of cash dividends on common stock and to the purchase, redemption or retirement of capital shares. At December 31, 1977, approximately $400,000,000 of consolidated earnings reinvested in the business was free of such restrictions. Other debt agreements specify minimum amounts of working capital and limit the amount of senior debt which may be issued. At December 31, 1977, the Company was in compliance with these agreements. 13. PROVISION FOR FEDERAL AND OTHER INCOME TAXES: Years Ended December 31 1977 1976 1975 1974 1973 (in thousands) Federal: Current ..................................... $211,620 $143,383 $100,889 $ 79,274 $ 74,660 Deferred ................................... 18,513 18,060 13,325 17,568 3,839 Foreign: Current ..................................... 16,591 18,196 17,483 17,036 13,576 Deferred ................................... 9,502 2,246 (455) (4,440) 2,521 State and local ................................. 34,364 24,368 17,930 12,548 12,381 $290,590 $206,253 $149,172 $121,986 $106,977 Deferred tax expense results from timing differences in the recognition of certain items of revenue and expense for tax and financial statement purposes. The source of such differences and the tax effect of each are as follows: Excess of tax over book deprecia- tion ............................................... Provisions charged to expense, de- ductible in other years for tax purposes, net ................................ Additional taxes provided on unre- mitted earnings of foreign subsi- diaries and affiliates ..................... Carrying costs of real estate oper- ations deferred which are de- ductible currently for tax pur- poses ............................................ Other .................... :........................... 1977 1976 1975 1974 1973 (in thousands) $24,597 $22,444 $13,200 $ 6,852 $8,686 1,187 (4,352) (3,260) 2,114 (4,551) 1,600 2,133 2,142 2,200 1,600 855 884 813 1,594 1,061 (224) (803) (25) 368 (436) $28,015 $20,306 $12,870 $13,128 $6,360 Continued F-15

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The effective income tax rate on consolidated pre-tax earnings differs from the U.S. federal income'tax rate of 48% for the following reasons: 1977 Percent to Amount Pre-tax ision computed at 48% of report- pre-tax pre-tax earnings ............................ $300,248 48.0% :ases ( decreases ) in the provision suiting from: Inclusion of equity in net earnings of unconsolidated subsidiaries and affiliates in pre-tax eam- ings ............................................ (5,613) (.9) Investment tax credit ..................... (16,768) (2.7) Foreign income taxed at other than 48% and not expected to be subject to U.S. tax in the foreseeable future ...................... (5,257) (.8) State and local income taxes, net offederal tax benefit ................. 17,872 2.9 Other .............................................. 108 rision as reported ............................ $290,590 46.5% 14. EARNINGS PER SHARE: 1976 1975 1974 1973 Amount Percent to Pre-tax Percent to Amount Pre-tax Amount Percent to Pre-tax Amount Percent to Pre-tax (inthousands) $226,525 48.0% $173,189 48.0% $142,801 48.0% $122,692 48.0% (6,816) (1.5) (10,976) (3.0) (11,815) (4.0) (9,696) (3.8) (18,756) (4.0) (17,136) (4.8) (9,863) (3.3) (4,841) (1.9) (3,423) (.7) (4,560) (1.3) (3,479) (1.2) (6,305) (2.5) 12,671 2.7 9,324 2.6 6,525 2.2 6,438 2.5 (3,948) (.8) (669) (.2) (2,183) (.7) (1,311) (.4) $206,253 43.7% $149,172 41.3% $121,986 41.0% $106,977 41.9% Primary earnings per common share is calculated on the weighted average number of shares of common stock outstanding during each year, which was 59,822,487 in 1977; 59,408,484 in 1976; 58,442,362 in 1975; 55,649,417 in 1974 and 54,804,174 in 1973. In determining 1977, 1976 and 1975 primary earnings per share, shares issuable upon exercise of outstanding stock options have not been included since the effect of such inclusion would be insignificant, and there were no other dilutive issues outstanding during such years. Fully diluted earnings per common share in 1974 and 1973 gives effect to the reduction in earnings per share which would result from the conversion of all outstanding convertible securities and the exercise of stock options. Convertible securities were assumed to have been converted from the beginning of the period and net earnings were adjusted for related interest net of tax. Funds assumed to have been received from exercise of stock options were assumed to have been used to acquire shares for the treasury at the higher of the average market price during the periods or the market price at the close of the periods. In determining 1977, 1976 and 1975 fully diluted earnings per share, shares issuable upon exercise of outstanding stock options have not been included since the effect of such inclusion would be insignificant, and there were no other dilutive issues outstanding during such years. The number of shares of common stock used in this computation was: 1977, 59,822,487; 1976, 59,408,484; 1975, 58,442,362; 1974, 57,339,255 and 1973, 57,315,784. Continued F-16 ~

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Co.ooued) 15. PENSION AND RETIREMENT PLANS: The Company's retirement plan (noncontributory) covers substantially all domestic employees of tobacco operations. The plan provides that after five years of service employees may retire at the age of 60 or at certain optional earlier retirement ages at reduced retirement allowances. The plan also provides that after 30 years of service employees may retire at age 55 with an early retirement allowance equal to a portion of a full retirement allowance and provides retirement allowances starting at age 65 for employees with six years of service who are terminated for any reason. Retirement allowances are based on the average amount of annual compensation received during the 60 highest paid consecutive months of the last 120 months of an employee's accredited service. Retirement allowances are now computed at an amount equal to 1 i/a% of the applicable social security integration level plus 1'l.% of the balance of the five- year average compensation, multiplied by the number of years of accredited service. Other retirement plans provide benefits for substantially all other employees. Charges to income for these plans for the years 1977, 1976, 1975, 1974 and 1973 were $34,015,000, $29,739,000, $24,812,000, $19,549,000 and $14,805,000, respectively, which includes amortization of prior service costs over a period of 30 years. Unfunded prior service costs at December 31, 1977 amounted to approximately $26,900,000. The Company's policy is to fund accrued pension costs. 16. INCENTIVE COMPENSATION PLAN: In accordance with the stockholder-approved Incentive Compensation Plan, a provision is made against current earnings for awards that may be made subsequent to the close of the year to officers and other key employees. The amounts provided were as follows: 1977, $5,612,000; 1976, $3,940,000; 1975, $3,100,000; 1974, $2,400,000 and 1973, $2,200,000. 17. LITIGATION: Three purported class actions by tobacco growers are pending against the six major United States cigarette manufacturers, including the Company, and others alleging violations of the United States antitrust laws. In two of the actions, the plaintiffs originally sought damages for the years 1970-1974 of approximately $2,500,000,000 in the aggregate. In April 1976, plaintiffs in one of these cases filed a proposed amended complaint which would reduce the size of the purported class, so that the aggregate damages claimed in both actions would be approximately $400,000,000. No specific amount of damages is claimed in the third action. The Company has denied any violation of law, is vigorously contesting the actions and has been advised by counsel that in their opinion the actions are not proper class actions. Furthermore, based on the investigation made to date, counsel is of the opinion that the Company has substantial factual and legal defenses to each of the alleged charges. The District Court in one of the three actions determined that the action could not be maintained as a class action and on October 11, 1977, the Fourth Circuit Court of Appeals affirmed that decision. The plaintiffs are asking for review by the United States Supreme Court. The District Courts in the other two cases have not as yet determined whether those cases may be maintained as class actions. No adjustments or provisions have been made on account of the litigation. Continued

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 18. ADDITIONAL INFORMATION: 1977 Working capital at year end .......................................................... $1,415,867 Maintenance and repairs ............................................................... $ 102,016 Depreciation of property, plant and equipment .......................... $ 78,466 Taxes, other than income taxes: Federal and foreign excise taxes on tobacco and beer products sold ...................................................................... $1,352,487 Other taxes (none in excess of 1% of consolidated reve- nues) .................................................................................. 61,206 $1,413,693 Adverdsingcosts .........................................::..:...:.............:............ $ 277,138 Rental expense .............................................................................. $ 24,678 December 31 1976 1975 1974 1973 (in thousands) $1,202,224 $ 890,797 $ 725 000 $515 347 - - , , $ 83,551 $ 56,199 $ 48,125 $ 39,359 $ 64,856 $ 49,853 $ 38,006 $ 30,245 - $1,159,286 $1,078,403 $ 968,867 $893,459 53,416 41,758 34,365 30,470 $1,212,702 $1,120,161 $1,003,232 $923,929 $ 211,316 $ 152,662 S 122,839 $107,777 $ 20,639 $ 17,982 S 14,590 $ 12,166 19. REPLACEMENT COST (UNAUDITED ): Estimated replacement cost data are presented pursuant to Rule 3-17 of Regulation S-X. The amounts reported are the result of calculations described below and are not necessarily indicative of either the amounts for which the assets could be sold or management's intention to replace such assets, nor are they necessarily representative of costs that might be incurred in a future period. Inventories and Cost of Sales Leaf tobacco held for use in the production of tobacco products is by far the most significant component of the Company's inventories, accounting for over 70% of the historical cost of the inventories on hand at December 31, 1977. The Company's tobacco products contain blends of many different grades and types of tobacco. Leaf tobacco is principally purchased at auction at the conclusion of each growing season. Following purchase of the tobacco, the production process commences when the leaf tobacco arrives at the stemmeries. In the stemmeries, the tobacco is cleaned, stemmed, redried in strips, graded and conditioned to the correct moisture level for storage. The redried, graded tobacco is then aged for periods up to three years. The Company maintains large quantities of leaf tobacco inventory to support production requirements for aged tobacco. The manufacture of tobacco products requires only small amounts of tobacco and direct materials in work in process at any given time. Generally, finished products are sold promptly and inventory is maintained only in quantities sufficient to assure continued availability of product. The Company's beer products are produced with commodities that are generally available on the open market and can be readied for production in a matter of days. The process of brewing, fermenting and aging beer products is completed in a number of weeks and the finished product is sold to distributors in a few days. The Company produces a variety of industrial products including printed and processed flexible packaging material, printing papers, disposable tissue paper, textile and other specialty chemicals and coatings. Many of these products are produced for specific orders and production involves the use of a variety of raw materials including pulp, chemicals, paper, plastics and inks. Continued F-18

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company's real estate operations consist principally of the sale of residential houses and commercial and industrial sites. Inventories related to these operations consist of land and related carrying costs, unamortized offtract improvements and the cost of houses under construction which for the most part are the subject of sales agreements with purchasers. Leaf tobacco inventory is valued in the Company's financial statements at average cost by grade. Its replacement cost has been estimated by valuing the year-end inventory quantities by grade at the latest crop year average stemmed purchase price. Because of the quantities in inventory, there is no assurance that total replacement could be achieved at this price, nor does this statistical calculation reflect the importance of, or the value added by, the aging process. The current replacement cost of other raw materials, including packaging materials, industrial raw materials and operating supplies, was determined by pricing year-end inventory quantities at current purchase prices. Inventory of land retained in real estate operations is sufficient to satisfy current levels of home construction activity for more than ten years. Therefore, historical cost is deemed to represent replacement cost. Housing programs under construction reflect costs under current subcontracts and so are the equivalent of current replacement costs. The current replacement cost of finished goods and work in process inventories was calculated by applying the percentage increase of replacement cost over historical cost in raw materials inventory to the related raw material component of these inventories. Depreciation included in the historical valuation of finished goods was adjusted to reflect the current replacement cost basis of productive capacity. The current replacement cost of leaf tobacco in cost of sales was determined by accumulating, by type, the pounds of tobacco used in finished products sold during the year and applying the average purchase price, by type, of the latest crop year in inventory when the sales were made. Current replacement cost of raw materials and direct materials in cost of sales was determined generally by applying the average percentage cost increase for such materials during the year. Fixed manufacturing expense and direct labor in cost of sales approximate current replacement cost except for depreciation expense which was revalued based on the average replacement cost of productive capacity available during the year. Productive Capacity and Depreciation The Company's tobacco manufacturing facilities include some recently constructed facilities contain- ing the most modern highly efficient equipment and utilizing the latest production methods. Other tobacco manufacturing facilities, while generally utilizing highly efficient equipment, are housed in structures that, if replacement were to be considered, would be replaced with structures designed to provide more efficient production. Brewing and related manufacturing facilities include one new and two expanded breweries and three container plants constructed during the last three years. Certain of the facilities at the older breweries, if replaced, would be replaced with facilities incorporating recent developments. Other properties include paper mills, converting plants and other manufacturing facilities utilized in the Company's industrial products operations and warehouses, research, office and other support facilities located both in the United States and abroad. The historical cost of recently constructed and purchased domestic tobacco manufacturing and brewing and related manufacturing productive capacity was indexed, where necessary, to reflect the current replacement cost at December 31, 1977. The current replacement cost of older domestic tobacco manufacturing and brewing productive capacity was based on the cost per unit of productive capacity of the recently constructed facilities. The replacement cost of certain tobacco manufacturing productive capacity outside of the United States was developed by using engineering estimates of the cost of replacing Continued F-19

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NO:ES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) selected facilities with a new facility upgraded for technological improvements and deriving a cost per unit of productive capacity therefrom. The cost per unit of productive capacity, thus derived was applied to the total existing productive capacity of tobacco manufacturing facilities in the geographical area to determine their estimated replacement cost. Tobacco manufacturing and brewing and related manufacturing productive capacity thus revalued comprise over 80% of the historical cost of productive capacity for which replacement cost data are provided. The current replacement cost of other manufacturing and support facilities was determined in a variety of ways. Generally, published construction and other indexes were used to estimate the current replacement cost of buildings. Productive and other equipment utilized in such facilities were revalued either by obtaining vendor quotes for new equipment of equivalent productive capacity or by applying appropriate indexes to historical cost. While it is believed that the indexes applied are reasonably representative of changes in prices for the assets, the Company is not responsible for the accuracy, consistency, weighting and other factors which may affect such indexes. Accumulated depreciation and amortization related to the replacement cost of existing productive capacity was computed by applying ratios of historical accumulated depreciation to historical cost to the estimated replacement cost of productive capacity. Replacement cost depreciation and amortization were calculated on the straight-line method using the historical depreciation and amortization rates for existing facilities applied to the average estimated replacement cost of productive capacity. In making the replacement cost depreciation calculations, no changes were made in the periods used for historical cost depreciation purposes as a result of technological improvements included in calculations of the replacement cost of productive capacity. All replacement cost amounts related to foreign assets were initially calculated in the relevant foreign currency and then translated to U.S. dollars using year-end rates of exchange. Replacement cost amounts related to foreign cost of sales and depreciation expense were also initially calculated in the local foreign currency and then translated into U.S. dollars using average annual rates of exchange. The estimated current replacement cost amounts presented below do not reflect any of the cost savings that might result from replacing existing productive capacity with improved technology, facilities and equipment. It should be noted that replacement of productive capacity in the manner assumed for the calculation of current replacement cost would alter the current level of many operating costs other than depreciation, such as direct labor, direct material usage, maintenance and repairs, utility and other indirect costs. The impractibility of determining the current replacement cost of all of the Company's productive capacity on an improved technology basis precludes quantifying the current level of operating costs that would result from the assumed hypothetical replacement. However, operating cost efficiencies quantified with respect to the assumed replacement of certain of the Company's existing productive capacity lead management to believe that such operating cost efficiencies would substantially offset the additional depreciation on a replacement cost basis. Additionally, this replacement cost information does not reflect all of the effects of inflation and other economic factors on the Company's operations. The Company has not attempted to quantify the impact of financing the "instant" replacement of inventories and productive facilities assumed by Rule 3-17 and of inflation on other assets and liabilities because of the many unresolved problems in doing so. Nor does the replacement cost information recognize the customary relationship between changes in costs and selling prices. Condnued F-20 204$189{}3$

~ ,:~ , .. . T PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Selling prices of the Company's products are dictated to a great extent by competitive conditions, and in some instances by governmental regulation. In the past, the Company has generally been able to adjust selling •prices to compensate for cost increases. Competitive conditions and governmental regulations permitting, the Company may be able to continue to modify selling prices in recognition of cost changes. The current replacement cost data required by Rule 3-17, and related historical costs reconciled to related totals shown in the consolidated financial statements are as follows: Estimated Replacement Cost Comparable Other Historical Historical Cost Cost* Total Historical Cost At December 31, 1977: (in millions) Inventories ......................................................... $1,940 $1,818 $1,818 Property, plant and equipment ........................ $2,574 $1,566 $ 29 $1,595 Less, Accumulated depreciation and amorti- zation ............................................................. 693 393 - 393 $1,881 $1,173 $ 29 $1,202 For the year ended December 31, 1977: Total depreciation expense ............................... $ 138 $ 78 $ 78 Amount included in costs other than cost of products sold ..................................... 12 7 7 Amount included in cost of products sold 126 71 71 Cost of products sold, excluding depreciation. 2,396 2,331 2,331 Cost of products sold, including depreciation.. $2,522 $2,402 $2,402 At December 31, 1976: Inventories ......................................................... $1,617 $1,528 $130 $1,658 Property, plant and equipment ........................ $2,048 $1,239 $ 85 $1,324 Less, Accumulated depreciation and amorti- zation ............................................................. 533 308 22 330 $1,515 $ 931 $ 63 $ 994 For the year ended December 31, 1976: Total depreciation expense ............................... $ 102 $ 60 $ 5 $ 65 Amount included in costs other than cost of products sold ..................................... 9 5 1 6 . Amount included in cost of products sold 93 55 4 59 Cost of products sold, excluding depreciation. 1,876 1,839 69 1,908 Cost of products sold, including depreciation.. $1,969 $1,894 $ 73 $1,967 * 1977 Other Historical Cost includes the cost of land not held for resale, for which replacement cost data are not required. 1976 Other Historical Cost includes the cost of inventories and productive capacity in operations located outside North America and the European Economic Community and the cost of land not held for resale, for which replacement cost data are not required. Continued F-21

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 20. QUARTERLY FINANCIAL RESULTS (UNAUDITED): 1977 Year ................................................................. Quarter Ended: March 31 ........................................................... June 30 .............................................................. September 30 .................................................... December 31 ..................................................... 1976 Year ................................................................. Quarter Ended: March 31 ........................................................... June 30 .............................................................. September 30 .................................................... December 31 ..................................................... Operating Gross Net Earnings Revenues Profit Earnings Per Share* (in thousands, except per share data) $5,201,977 $1,447,810 $334,926 $5.60 1,142,617 319,380 71,417 1.19 1,329,319 365,001 85,147 1.42 1,376,106 388,307 94,147 1.57 1,353,935 375,122 84,215 1.41 4,293,782 1,167,625 265,675 4.47 942,813 253,750 1,069,921 291,943 1,122,584 1,158,464 56,903 .96 67,204 1.13 302,567 74,542 1.25 319,365 67,026 1.13 * The sum of quarterly amounts may not equal the yearly amount due to rounding. 21. SEGMENT REPORTING: Worldwide tobacco and domestic beer represent the primary segments of the Company's operations. Other products include industrial products and land development operations. The Company's foreign operations which are predominantly in the tobacco business are organized into geographic regions for management responsibility with Europe being the most significant. Intersegment transactions are not reported separately since they are not material. Operating profit is total operating revenues less operating expenses. In computing operating profit, none of the following has been allocated: equity in net earnings of unconsolidated foreign subsidiaries and affiliates, corporate expense, interest expense and miscellaneous income and expense items, including currency translation and hedging costs. Identifiable assets by segment are those assets that are used in the Company's operations in each segment. Corporate assets consist primarily of long-term receivables and fixed assets. Continued t•} ~ -~ tri ~ C4~ F-22 ^rJ 3a 0

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded) The reportable segments together with a reconciliation to the consolidated statements are presented below. Data by Product Line for Year Ended December 31, 1977 Consolidated (inthousands) Operating Revenues: Tobacco .................................................................................................... .............................. $3,493,443 Beer .................................................................................................... ..................................... 1,327,619 Other Products .................................................................................................... ................... 380,915 $5,201,977 Operating Profit: Tobacco .................................................................................................... .............................. $ 615,253 Beer .................................................................................................... ..................................... 106,456 Other Products .....................................:.............................................................. ................... 49,329 771,038 Equity in net earnings of unconsolidated foreign subsidiaries and affiliates ............................... 11,694 Operating Income of Operating Companies ................................................................................. $ 782,732 Depreciation Expense: Tobacco .................................................................................................... .............................. $ 42,442 Beer .................................................................................................... ..................................... 27,299 Identifiable Assets: Tobacco .................................................................................................... .............................. $2,509,878 Beer .................................................................................................... ..................................... 819,413 Other Products .................................................................................................... ................... 406,837 3,736,128 Investments in and advances to unconsolidated foreign subsidiaries and affiliates .................... 229,508 Corporate Assets .................................................................................................... ........................ 82,403 Total Assets .................................................................................................... ................ $4,048,039 Capital Expenditures: Tobacco .................................................................................................... .............................. $ 77,568 Beer .................................................................................................... ..................................... 182,899 Data by Geographical Region for Year Ended December 31, 1977 Operating Revenues: United States .................................................................................................... ...................... $4,184,197 Europe .................................................................................................... ................................ 893,600 Other Foreign .................................................................................................... ..................... 124,180 $5,201,977 Operating Profit: United States .................................................................................................... ...................... $ 711,549 Europe .................................................................................................... ................................ 49,681 Other Foreign .................................................................................................... ..................... 9,808 771,038 Equity in net earnings of unconsolidated foreign subsidiaries and affiliates ........................•••••.• 11,694 Operating Income of Operating Companies ................................................................................. $ 782,732 Identifiable Assets: United States .................................................................................................... ...................... $3,061,761 Europe .................................................................................................... ................................ 579,674 Other Foreign .................................................................................................... ..................... 94,693 3,736,128 Investments in and advances to unconsolidated foreign subsidiaries and affiliates .................... 229,508 Corporate Assets .................................................................................................... ........................ 82,403 Total Assets .................................................................................................... ................ $4,048,039 F-23

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries SCHEDULE III-INVESTMENTS IN, EQUITY IN EARNINGS OF, AND DIVIDENDS RECEIVED FROM AFFILIATES AND OTHER PERSONS for the years ended December 31, 1977 and 1976 (in thousands) Col. A . Col. B Col. C Balance at Beginning of Period Additions ame of Issuer and Description of Investment (1) Number of Shares or Units Principal Amount of Bonds and Notes (2) mount in Dollars (1) Equity Taken Up in Earnings (Losses) of Affiliates and Other Persons for the Period (2) ther 1977: 50% or more ownership ............................................. Various $168,929 $ 6,168 $21,536 Less than 50% ownership ........................................... Various 31,308 5,526 - $200,237 $11,694 $21,536(i) Unconsolidated foreign subsidiaries and affiliates ( 16 at beginning and end of period ) ..................... 1976: 50% or more ownership ............................................. Various $146,288 $15,040 $14,182 Less than 50% ownership ........................................... Various 34,752 (839) (16) Unconsolidated foreign subsidiaries and affiliates (16 at beginning and end of period ) ..................... $181,040 $14,201 $14,166(L) NoTES: (1) This amount primarily reflects additional investment in unconsolidated subsidiaries in 1976 and includes the capitalization of advances in 1977. (2) This represents amortization of excess cost over investment in certain subsidiaries. The amount shown for 1976 includes a reduction of ownership interest in an affiliate. .- cn ~ 0 F-24 ~

Col. D Col. E Col. F Balance at Deductions End of Period (1) Distribution of Earnings by Persons in Which Earnings (Losses) Were Taken Up (2) ther (1) Number of Shares or Units Principal Amount of Bonds and Notes (2) Dividends Received During the Period from Investments Amount Not Accounted in for by the Dollars Equity Method (Note 2) $ 8,729 $232 Various $187,672 2,256 68 Various 34,510 $10,985 $300 $222,182 $ 6,364 $217 Various $168,929 2,272 317 Various 31,308 $ 8,636 $534 $200,237

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries SCHEDULE IV-INDEBTEDNESS OF AFFILIATES AND OTHER PERSONS-NOT CURRENT for the years ended December 31, 1977 and 1976 (in thousands) Col. A Col. B Col. C Col. D Col. E Name of Person Balance at Beginning of Period Additions Deductions Balance End of Perio 1977.• ( Note ) 50% or more ownership .......................................................................„ $16,910 $ 407 $12,991 $ 4,32 Less than 50% ownership ...................................................................... 3,000 - - 3,0C Unconsolidated foreign subsidiaries and affiliates (6 at beginning and 3 at end of period ) ....................................... $19,910 $ 407 $12,991 $ 7,32 1976: 50% or more ownership ......................................................................... $ 8,483 $ 8,749 $ 322 $16,91 Less than 50% ownership ...................................................................... - 3,000 - 3,0C Unconsolidated foreign subsidiaries and affiliates (5 at beginning and 6 at end of period ) ....................................... $ 8,483 $11,749 $ 322 $19,91 NOTE: Represents additional advances. F-26

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PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries SCHEDULE V-PROPERTY, PLANT AND EQUIPMENT for the years ended December 31, 1977 and 1976 (in thousands) Col. A Col. B Col. C Col. D Col. E Col. F Additions (1) (2) Assets of Company Balance at Acquired, Other Balance at Beginning Additions at Book Changes- End of Classification of Period at Cost Value Retirements Add (Deduct) Period (Note 1) (Note 2) (Note 3) (Note 4) 1977: Land and land improvements ........ $ 53,230 $ 3,453 $ 238 $ 681 $ (994) $ 55,246 Buildings and building equipment. 391,341 27,972 1,985 4,008 (18,811) 398,479 Machinery and equipment .............. 755,310 169,711 14,301 27,116 18,836 931,042 Construction in progress ................. 124,042 84,942 754 564 969 210,143 $1,323,923 $286,078 $17,278 $32,369 $ - $1,594,910 1976: Land and land improvements ........ $ 46,326 $ 7,315 $ 11 $ (400) $ 53,230 Buildings and building equipment. 330,460 65,218 285 (4,052) 391,341 Machinery and equipment .............. 611,451 165,018 12,812 (8,347) 755,310 Construction in progress ................. 141,601 (17,378) - (181) 124,042 $1,129,838 $220,173 $13,108 $(12,980) $1,323,923 NOTES: (1) A significant portion of the additions are due to expansion and modernization of Miller Brewing Company facilities and modernization of domestic cigarette manufacturing facilities. (2) Represents balances of Wisconsin Tissue Mills at January 1, 1977. (3) The 1977 retirements are primarily from the disposition of razor blade operations. (4) Represents deconsolidation of a foreign subsidiary in 1976 and reclassifications among categories in 1977.

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries SCHEDULE VI-ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT for the years ended December 31, 1977 and 1976 (in thousands) Col. A Col. B Col. C Col. D Col. E Col. F Additions escription alance at Beginning of Period (1) Additions Charged to Costs and Expenses (2) Accumulated Depreciation of Company Acquired, at Book Value etirements ther Changes- Add (Deduct) Balance at End of Period 1977: (Note 1) (Note 2) (Note 3) Land improvements ................... $ 4,488 $ 1,073 $ 52 $ 173 $ (34) $ 5,406 Buildings and building equip- ment ........................................ 80,060 14,847 955 2,783 5 93,084 Machinery and equipment ........ 245,496 62,546 5,767 19,850 29 293,988 $330,044 $78,466 $6,774 $22,806 $ - $392,478 1976: Land improvements ................... $ 3,459 $ 1,030 $ 1 $ 4,488 Buildings and building equip- ment ........................................ 68,390 13,052 137 $ (1,245) 80,060 Machinery and equipment ........ 206,886 50,774 8,704 (3,460) 245,496 $278,735 $64,856 $ 8,842 $ (4,705) $330,044 NOTES: ( 1) Represents balances of Wisconsin Tissue Mills at January 1, 1977. (2) The 1977 retirements are primarily from the disposition of razor blade operations. (3) Represents deconsolidation of a foreign subsidiary in 1976 and reclassifications among categories in 1977. F-29

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries SCHEDULE VII-INTANGIBLE ASSETS, PREOPERATING EXPENSES AND SIMILAR DEFERRALS for the years ended December 31, 1977 and 1976 (in thousands) Col. A Col. B Col. C Description Balance at Beginning of Period Balance at End of Period 1977: Part A-Intangible assets: Patents .............................................................. $ 854 $ 440 Brands, trademarks and goodwill .................... 214,153 226,112 $215,007 $226,552 1976: Part A-Intangible assets: Patents ............................................................... $ 654 $ 854 Brands, trademarks and goodwill .................... 208,094 214,153 $208,748 $215,007 NOTE: Neither total additions nor total deductions exceed 10% of closing balances for the periods covered. F-30

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries SCHEDULE VIII-ACCUMULATED DEPRECIATION AND AMORTIZATION OF INTANGIBLE ASSETS for the years ended December 31, 1977 and 1976 (in thousands) Col. A Col. B Col. C Col. D Col E Additions Balance at Charged to Balance at Beginning Costs and End of Description of Period Expenses Deductions Period (Note) 1977: Part A-Intangible assets: Patents ............................................:.................. $ 483 $ 30 $374(l) $ 139 Brands, trademarks and goodwill .................... 2,954 1,068 101(2) 3,921 $3,437 $1,098 $475 $4,060 1976: Part A-Intangible assets: Patents ............................................................... $ 446 $ 37 $ 483 Brands, trademarks and goodwill .................... 2,209 745 2,954 $2,655 $ 782 $3,437 NOTES: (1) Represents the disposition of razor blade operations. (2) Represents write-off of fully amortized brands, trademarks 3nd goodwill. F-31

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries SCHEDULE IX-BONDS, MORTGAGES AND SIMILAR DEBT as at December 31, 1977 (in thousands) Col. A Col. B Col. C Col. D Amount Included in Col. C Which is ame of Issuer and Title of Each Issue Amount Authorized by Indenture Amount Issued and Not Retired or Canceled (1) Held by or for Account of Issuer Thereof (2) Not Held by or for Account of Issuer Thereof Philip Morris Incorporated: 8'/a% Notes, payable $6,665,000 annually from 1983 to 1996 and $6,690,000 in 1997 .................................................................................... $100,000 $100,000 None $100,000 Bank Term Loan Agreement, payable $33,000,000 in 1981 and $17,000,000 in 1982. Interest is at 7%s% to April 30, 1979 and 8'h% thereafter ................................................................................................... 50,000 50,000 None 50,000 Notes Payable (Note I) ............................................................................... 500,000 500,000 None 500,000 8/z%Notes,payablein 1985 ........................................................................ 150,000 150,000 None 150,00 0 8%a%Sinking Fund Debentures, payable $6,250,000 annually from 1984 to 2003 and $25,000,000 in 2004 ............................................................. 150,000 150,000 None 150,000 Bank Term Loan Agreement, payable in 1980. Interest is at 'h% above the bank prime rate, but not more than an average effective rate of 7.9% per annum if outstanding to maturity ............................................. 150,000 150,000 None 150,000 6~/s%Sinking Fund Debentures, payable $3,500,000 annually from 1978 to 1992 and $15,500,000 in 1993 ............................................................. 75,000 68,000 None 68,000 8.85% Notes, payable in 1982 ...................................................................... 50,000 50,000 None 50,000 4.90% Notes, payable $2,600,000 annually to 1988 and $16,000,000 in 1989 .................................................................................................... ....... 55,000 44,600 None 44,600 6'/a% Loan, 100,000,000 German marks, payable from 1978 to 1987 ....... 46,512 46,512 None 46,512 6'k% Loan, 80,000,000 Swiss francs, payable 1988 .................................... 39,024 39,024 None 39,024 Purchase money obligations ......................................................................... 16,100 16,100 None 16,100 Philip Morris International Capital N. V. (Note 2): 8'h% Guaranteed Sinking Fund Debentures, payable $600,000 annually to 1979, $1,500,000 annually 1980 through 1985 and $3,000,000 in 1986 .................................................................................................... ....... 15,000 13,200 None 13,200 Miller Brewing Company (Note 2): Purchase money obligations ......................................................................... 36,000 36,000 None 36,000 Mission Viejo Company: Purchase money obligations ......................................................................... 9,130 6,847 None 6,847 Philip Morris Industrial Incorporated (Note 2): Purchase money obligations ......................................................................... 4,500 4,500 None 4,500 Philip Morris International Finance Corporation (Note 2): 4h%Subordinated Guaranteed Debentures ............................................... 25,000 24,977 None 24,977 43/.%oSubordinated Guaranteed Debentures ............................................:.. 40,000 39,893 None 39,893 Other long-term debt of subsidiaries ................................................................... 11,869 11,869 None 11,869 Capitalized lease obligations ............................................................................... 5,707 5,707 None 5,7 07 NOTES: (1) The Company has entered into a $250,000,000 revolving credit and term loan agreement, maturing in 1984, and a $250,000,000 Eurodollar revolving credit agreement maturing in 1982, both of which can be used to refinance short-term notes payable. Management intends to exercise its rights under these agreements in the event that it becomes advisable. Accordingly, at December 31, 1977, $500,000,000 of short-term notes payable have been classified as long-term debt in accordance with Financial Accounting Standards Board Statement No. 6. (2) The purchase money obligations of Miller Brewing Company and Philip Morris Industrial Incorporated, the Philip Morris International Finance Corporation debentures and the Philip Morris International Capital N.V. debentures are guaranteed as to principal and interest by Philip Morris Incorporated. (3) The differences in the amount shown in Column E from the amounts shown in Columns C and D(2 ) are due to eliminations in consolidation and amounts classified as current portion of long-term debt. F-32

Col. E Col. F Col. G Col. H Amount Included in Sum Extended Under Caption "Bonds, mount Amount Held by Affiliates For Which Statements Are Filed Herewith Mortgages and Similar Debt" in Related Balance Sheet in Sinking And Other Special Funds of Issuer Thereof Amount Pledged by Issuer Thereof (1) Persons Included in Consolidated Statement (2) thers (3) $ 100,000 None None None None 50,000 None None None None 500,000 None None None None 150,000 None None None None 150,000 None None None None 150,000 None None None None 64,500 None None None None 50,000 None None_ None None 42,000 None None None None 41,861 None None None None 39,024 None None None None 16,100 None None None None 12,600 None None None None 36,000 None None None None 5,706 None None None None 4,500 None None None None - None None 24,977 None - None None 39,893 None 9,896 None None None None 4,432 None None None None $1,426,619 F-33

PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries SCHEDULE XII-VALUATION AND QUALIFYING ACCOUNTS AND RESERVES for the years ended December 31, 1977 and 1976 (in thousands) Col. A Col. B Col. C Co1. D Col. E escription Balance at Beginning of Period Additions Charged to Costs and Expenses eductions Balance at End of Period (Note ) 1977: Allowance for discounts ....................................... $ 2,946 $76,908 $76,881 $ 2,973 Allowance for doubtful accounts ......................... 11,471 2,248 2,478 11,241 $14,417 $79,156 $79,359 $14,214 1976: Allowance for discounts ....................................... $ 2,297 $68,741 $68,092 $ 2,946 Allowance for doubtful accounts ......................... 10,608 1,690 827 11,471 $ 12,905 $70,431 $68,919 $14,417 NOTE: - Represents charges for which the reserves were created.

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PHILIP MORRIS INCORPORATED and Consolidated Subsidiaries SCHEDULE XIII-CAPITAL SHARES as at December 31, 1977 Col. A Col. B Col. C Col. D Number of Shares Included in Column C Which Are (1) (2) Number of Held by Not Held Number of Shares Issued or for by or for Shares and not Account Account Name of Issuer Authorized Retired or of Issuer of Issuer and Title of Issue by Charter Canceled Thereof Thereof Philip Morris Incorporated (Note 1): Cumulative Preferred Stock, par value $100 per share: 4% Series ............................................................. 39,996 39,996 23,244 16,752 3.90% Series ........................................................ 42,620 42,620 33,431 9,189 Common Stock, par value $1 per share .................... 100,000,000 59,922,141 2,224 59,919,917 NoTES: (1) Certain subsidiaries of Philip Morris Incorporated are omitted from this schedule for the reason th%{' such subsidiaries are wholly owned and the answers to Column G in respect to such subsidiaries would be- "None." (2) See Notes 10 and 11 of notes to consolidated financial statements. F-36

Col. E Col. F Col. G Shares Issued or Outstanding as Shown on or Included in Related Balance Sheet Under Caption "Capital Shares" Number of Shares Held by Affiliates for Which Statements Are Filed Herewith Number of Shares Reserved for Options, Warrants, Conversions and Other Rights (1) umber (2) Amount at Which Shown (1) Persons Included in Consolidated Statements (2) thers (1) Directors, Officers and Employees (2) thers 39,996 $ 4,000,000 None None None None 42,620 4,262,000 None None None None $ 8,262,000 59,922,141 $59,922,000 None None ( Note 2) ( Note 2)

Exhibit I CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS We consent to the incorporation by reference in the Prospectus prepared in compliance with the requirements of Form S-16 pursuant to the Securities Act of 1933 and included in registration statement No. 2-60014 of our report dated January 24, 1978 accompanying the financial statements of Philip Morri: Incorporated and consolidated subsidiaries as of December 31, 1977 and 1976 and for each of the five years in the period ended December 31, 1977 and appearing in the Annual Report on Form 10-K for the year ended December 31, 1977. COOPERS & LYBRAND New York, N. Y. March 29, 1978