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Multimodal Art Projection 267

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## Expenses The Company’s expenses wer $852,370,000 for the year ended December 31, 2002, compared to $583,002,000 in the year ended December 31, 2001, an increase of $269,368,000 of which $202,852,000 resulted from the acquisition of the remaining 66% of CESCR and the resulting consolidation of its operations. Below are the details of the increase by segment: <img src='content_image/98383.jpg'> (1) Results primarily from (i) a $9,725 increase in insurance, security and real estate taxes, largely reimbursed by tenants, and (ii) $2,639 for an allowance for straight-line rent receivables. (2) Results primarily from (i) increases in insurance costs which are reimbursed by tenants, (ii) a $402 payment of Puerto Rico taxes related to the prior year (iii) $2,280 in bad debt allowances for accounts receivable and receivables arising from the straight-lining of rents in 2002 and (iv) lease termination fees and real estate tax refunds netted against expenses in 2001, which aggregated $1,500. (3) Results primarily from the rescheduling of two trade shows from the fourth quarter in which they were previously held to the first quarter of 2003. (4) Reflects (i) increased insurance costs of $1,366, (ii) a charge of $312 from the settlement of a 1998 utility assessment, and (iii) an increase in real estate taxes of $1,725. (5) Reflects a charge of $954 in connection with the termination of a contract and the write-off of related deferred costs. (6) Reflects a charge in 2002 of $6,874 for the write-off of pre-development costs at the 20 Times Square project and a charge in 2001 of $5,223 in connection with the World Trade Center acquisition not consummated. ## Income Applicable to Alexander’s Income applicable to Alexander’s (interest income, management, leasing, development and commitment fees, and equity in income) was $29,653,000 in the year ended December 31, 2002, compared to $25,718,000 in the year ended December 31, 2001, an increase of $3,935,000. This increase resulted from (i) $6,915,000 of development and commitment fees in connec- tion with Alexander’s Lexington Avenue development project, (ii) the Company’s $3,524,000 share of Alexander’s gain on sale

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of its Third Avenue property, partially offset by (iii) the Company’s $6,298,000 share of Alexander’s gain on the sale of its Fordham Road property in the prior year. ## Income from Partially-Owned Entities Below ar the condensed statements of operations of the Company’s unconsolidated subsidiaries as well as the increase (decrease) in income from these partially-owned entities for the years ended December 31, 2002 and 2001: <img src='content_image/26803.jpg'> (1) On Januar 1, 2002, the Company acquired the remaining 66% of CESCR it did not previously own. Accordingly, CESCR is consolidated as of January 1, 2002. (2) On September 20, 2002, the Company acquired the remaining 50% of the Mall and 25% of the Kmart anchor store that it did not previously own. Accordingly Las Catalinas is consolidated for the period from September 20, 2002 to December 31, 2002. (3) On October 10, 2002, a joint venture, in which the Company has a 50% interest, acquired the Monmouth Mall. (4) Vornado’ interest in the equity in net income of the Monmouth Mall includes a preferred return of $748 for the year ended December 31, 2002. (5) The year ended December 31, 2001 includes $1,394 for the Company’ share of a gain on sale of a property. (6) The year ended December 31, 2002 excludes 570 Lexington Avenue which was sold in May 2001. (7) The year ended December 31, 2001 includes $2,000 for the Company’ share of equity in loss of its Russian Tea Room (“RTR”) investment. In the third quarter of 2001, the Company wrote-off its entire net investment in RTR based on the operating losses and an assessment of the value of the real estate.

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In 2003, Vornado’s Funds From Operations per share increased by 13.6% and FFO Adjusted for Comparability per share increased by 6.5%. EBITDA for each of our business units increased for the year and each business unit (with the exception of Washington Office (3) ) had handsome same store increases—all this performance in a challenging market. ## Financings It is a testament to Vornado’s scale and balance sheet strength that, since January 2003, we generated over $1 billion internally from the capital side of our business (not including cash flow from operations). This was accom- plished while maintaining our credit rating (which we are committed to) and maintaining virtually the same credit ratios. Here is a list of cash proceeds by transaction: <img src='content_image/53015.jpg'> ## Dispositions <img src='content_image/53016.jpg'> And we could have generated more. Vornado has substan- tial unused financial capacity that could be realized either from borrowings or from recycling existing assets. We have $10s of millions, and in some instances as much as $100 million or more, of unrealized profits in dozens and dozens of our assets. As promised at our September 2003 investor conference, in February 2004, AmeriCold completed a $254 million financing, which was the source of Vornado’s repatriating $135 million of its investment in AmeriCold. But this financing did much more—it went a long way to demon- strate the value of this business. Think about it— AmeriCold now carries $800 million of debt (recourse solely to various groups of its assets) at a weighted average interest rate of 6.1%, or about $49 million of annual interest expense, still leaving FFO of $64 million fr om actual cash rents. Mike and I believe that these facts support a value for this investment that is greater than most of our investors and analysts carry. (5)

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## Supplemental Information ## Three Months Ended December 31, 2003 and December 31, 2002 In comparing the financial results of the Company’ segments on a quarterly basis, the following should be noted: • The third quarter of the Office and Merchandise Mart segments have historically been impacted by higher net utility costs than in each other quarter of the year; • The fourth quarter of the Retail segment have historically been higher than each of the first three quarters due to the recognition of percentage rental income in that quarter; and • The second and fourth quarters of the Merchandise Mart segment have historically been higher than the first and third quarters due to major trade shows occurring in those quarters. Below is a summary of Net Income and EBITDA (1) by segment for the three months ended December 31, 2003 and 2002. For The Three Months Ended December 31, 2003 <img src='content_image/128057.jpg'> Included in EBITDA are gains on sale of real estate of $158,378, of which $156,433 and $1,945 relate to the Office and Retail segments, respectively. See notes on following page.

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## For The Three Months Ended December 31, 2002 <img src='content_image/74656.jpg'> (1) EBITDA should not be considered a substitute for net income. EBITDA may not be comparable to similarly titled measures employed by other companies. (2) Interest and debt expense and depreciation and amortization included in the reconciliation of net income to EBITDA reflects amounts which are netted in income from partially-owned entities. (3) Other EBITDA is comprised of: <img src='content_image/74660.jpg'>

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Below ar the details of the changes by segment in EBITDA for the three months ended December 31, 2003 compared to the three months ended December 31, 2002. <img src='content_image/125279.jpg'> (1) Represents operations, which were owned for the same period in each year. (2) EBITDA and same store percentage increase (decrease) was $236,952 ($80,419 excluding gains on sale of real estate of $156,533) and 7.6% (excluding such gains) for the New York City office portfolio and $73,466 and (2.1%) for the CESCR portfolio. Below ar the details of the changes by segment in EBITDA for the three months ended December 31, 2003 compared to the three months ended September 30, 2003: <img src='content_image/125280.jpg'> (1) Represents operations, which were owned for the same period in each year. (2) EBITDA and same store percentage increase was $ 236,952 ($80,419 excluding gains on sale of real estate of $156,533) and 2.8% (excluding such gains) for the New York City office portfolio and $73,466 and (.2%) for the CESCR portfolio. (3) Reflects an increase in the tenant’ gross profits, partially due to seasonality of tenant’s operations and an increase in the tenant’s cash available to pay rent in the three months ended September 30, 2003. Below is a reconciliation of net income and EBITDA for the thr ee months ended September 30, 2003. <img src='content_image/125281.jpg'>

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## Related Parties ## LOAN AND COMPENSATION AGREEMENTS At December 31, 2003, the loan due from Mr. Roth, in accordance with his employment arrangement, was $13,123,000 ($4,704,500 of which is shown as a reduction in shareholders’ equity). The loan bears interest at 4.49% per annum (based on the applicable Federal rate) and matures in January 2006. The Company also provided Mr. Roth with the right to draw up to $15,000,000 of additional loans on a revolving basis. Each additional loan will bear interest, payable quarterly, at the applicable Federal rate on the date the loan is made and will matur on the sixth anniversary of the loan. On May 29, 2002, Mr. Roth replaced common shares of the Company securing the Company’ outstanding loan to Mr. Roth with options to purchase common shares of the Company with a value of not less than two times the loan amount. In 2002, as a result of the decline in the value of the options, Mr Roth supplemented the collateral with cash and marketable securities. At December 31, 2003, loans due from Mr. Fascitelli, in accordance with his employment agreement, aggregated $8,600,000. The loans mature in December 2006 and bear interest, payable quarterly at a weighted average interest rate of 3.97% (based on the applicable Federal rate). Pursuant to Mr. Fascitelli’s 1996 employment agreement, Mr Fascitelli became entitled to a deferred payment consisting of $5 million in cash and a convertible obligation payable November 30, 2001, at the Company’s option, in either 919,540 common shares or the cash equivalent of their appreciated value, so long as such appreciated value is not less than $20 million. The Company delivered 919,540 shares to a rabbi trust upon execution of the 1996 employment agreement. The Company accounted for the stock compensation as a variable arrangement in accordance with Plan B of EITF No. 97-14 “Accounting for Deferred Compensation Arrangements Where Amounts Earned Ar Held in a Rabbi Trust and Invested” as the agreement permitted settlement in either cash or common shares. Following the guidance in EITF 97-14, the Company recorded changes in the fair value of its compensation obligation with a corresponding increase in the liability “Officer’s Deferred Compensation.” Effective as of June 7, 2001, the payment date was deferred until November 30, 2004. Effective as of December 14, 2001, the payment to Mr Fascitelli was converted into an obligation to deliver a fixed number of shares (919,540 shares), establishing a measurement date for the Company’s stock compensation obligation, accordingly the Company ceased accounting for the Rabbi Trust under Plan B of the EITF and began Plan A accounting. Under Plan A, the accumulated liability representing the value of the shares on December 14, 2001, was reclassified as a component of Shareholders’ Equity as “Deferred compensation shares earned but not yet delivered.” In addition, effective December 14, 2001 future changes in the value of the shares are no longer recognized as additional compensation expense. The fair value of this obligation was $50,345,000 at December 31, 2003. The Company has reflected this liability as Deferred Compensation Shares Not Yet Delivered in the Shareholders’ Equity section of the balance sheet. For the year ended December 31, 2001, the Company recognized approximately $4,744,000 of compensation expense of which $2,612,000 represented the appr eciation in value of the shares and $2,132,000 represented dividends paid on the shares. Effective January 1, 2002, the Company extended its employment agr eement with Mr. Fascitelli for a five-year period through December 31, 2006. Pursuant to the extended employment agreement, Mr . Fascitelli is entitled to receive a deferred payment on December 31, 2006 of 626,566 Vornado common shares which ar e valued for compensation purposes at $27,500,000 (the value of the shares on March 8, 2002, the date the extended employment agreement was executed). The shares are held in a rabbi trust for the benefit of Mr Fascitelli and vested 100% on December 31, 2002. The extended employment agreement does not permit diversification, allows settlement of the deferred compensation obligation by delivery of these shares only, and permits the deferred delivery of these shares. The value of these shares was amortized ratably over the one-year vesting period as compensation expense. Pursuant to the Company’s annual compensation review in February 2002 with Joseph Macnow, the Company’s Chief Financial Officer, the Compensation Committee approved a $2,000,000 loan to Mr. Macnow, bearing interest at the applicable federal rate of 4.65% per annum and due January 1, 2006. The loan, which was funded on July 23, 2002, was made in

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conjunction with Mr. Macnow’s June 2002 exercise of options to purchase 225,000 shares of the Company’s common stock. The loan is collateralized by assets with a value of not less than two times the loan amount. In 2002, as a result of the decline in the value of the options, Mr Macnow supplemented the collateral with cash and marketable securities. One other executive officer of the Company has a loan outstanding pursuant to an employment agreement totaling $500,000 at December 31, 2003. The loan matures in April 2005 and bears interest at the applicable Federal rate provided (4.5% at December 31, 2003). Transactions with Affiliates and Officers and Trustees of the Company ## ALEXANDER’S The Company owns 33.1% of Alexander’s. Mr. Roth and Mr . Fascitelli are Officers and Directors of Alexander’s. The Company provides various services to Alexander’s in accordance with management, development and leasing agreements and the Company has made loans to Alexander’s aggregating $124,000,000 at December 31, 2003. These agreements and the loans ar described in Note 5. Investments in Partially-Owned Entities to the Company’s consolidated financial statements in this annual report. In 2002, the Company constructed a $16.3 million community facility and low-income residential housing development (the “30th Street Venture”), in order to receive 163,728 squar e feet of transferable development rights, generally referred to as “air rights”. The Company donated the building to a charitable or ganization. The Company sold 106,796 square feet of these air rights to thir parties at an average price of $120 per square foot. An additional 28,821 square feet of air rights was sold to Alexander’s at a price of $120 per squar foot for use at Alexander’s 59th Street development project (the “59th Street Project”). In each case, the Company received cash in exchange for air rights. The Company identified third party buyers for the remaining 28,111 square feet of air rights related to the 30th Street Venture. These third party buyers wanted to use the air rights for the development of two projects located in the general ar ea of 86th Street which was not within the required geographical radius of the construction site nor in the same Community Board as the low-income housing and community facility project. The 30th Street Venture asked Alexander’ to sell 28,111 square feet of the air rights it already owned to the third party buyers (who could use them) and the 30th Street Venture would r eplace them with 28,111 square feet of air rights. In October 2002, the Company sold 28,111 square feet of air rights to Alexander’ s for an aggregate sales price of $3,058,000 (an average of $109 per square foot). Alexander’ then sold an equal amount of air rights to the third party buyers for an aggregate sales price of $3,339,000 (an average of $119 per square foot). ## INTERSTATE PROPERTIES The Company manages and leases the real estate assets of Interstate Properties pursuant to a management agreement for which the Company receives an annual fee equal to 4% of base r ent and percentage rent and certain other commissions. The management agreement has a term of one year and is automatically renewable unless terminated by either of the parties on sixty days’ notice at the end of the term. Although the management agreement was not negotiated at arms length, the Company believes based upon comparable fees charged by other r eal estate companies that its terms are fair to the Company. The Company earned $703,000, $747,000 and $1,133,000 of management fees under the management agreement for the years ended December 31, 2003, 2002 and 2001. In addition, during fiscal years 2003, 2002 and 2001, as a result of a previously existing leasing arrangement with Alexander’s, Alexander’ s paid to Interstate $587,000, $703,000 and $522,000, respectively, for the leasing and other services actually rendered by the Company. Upon receipt of these payments, Interstate promptly paid them over to the Company without retaining any inter est therein. This arrangement was terminated in 2003 and all payments by Alexander’s for these leasing and other services ar made directly to the Company.

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## BUILDING MAINTENANCE SERVICE COMPANY (“BMS”) On January 1, 2003, the Company acquired BMS, a company which pr ovides cleaning and related services principally to the Company’s Manhattan office properties for $13,000,000 in cash from the estate of Bernard Mendik and certain other individuals including David Greenbaum, one of the Company’s executive officers. The Company paid BMS $53,024,000 and $51,280,000 for the years ended December 31, 2002 and 2001 for services render ed at the Company’s Manhattan office properties. Although the terms and conditions of the contracts pursuant to which these services were provided were not negotiated at arms length, the Company believes based upon comparable amounts char ged to other real estate companies that the terms and conditions of the contracts were fair to the Company. ## VORNADO OPERATING COMPANY AND AMERICOLD LOGISTICS In October 1998, Vornado Operating was spun off from the Company in order to own assets that the Company could not itself own and conduct activities that the Company could not itself conduct. The Company granted Vornado Operating a $75,000,000 unsecured revolving credit facility which expires on December 31, 2004. Borrowings under the revolving credit facility bear interest at LIBOR plus 3%. The Company receives a commitment fee equal to 1% per annum on the average daily unused portion of the facility. No amortization is required to be paid under the revolving cr edit facility during its term. The revolving credit facility prohibits Vornado Operating from incurring indebtedness to third parties (other than certain purchase money debt and certain other exceptions) and prohibits Vornado Operating from paying dividends. As of December 31, 2003, $21,989,000 was outstanding under the revolving credit facility. Vornado Operating has disclosed that ther is substantial doubt as to its ability to continue as a going concern and its ability to discharge its liabilities in the normal course of business. Vornado Operating has incurred losses since its inception and in the aggregate its investments do not, and for the foreseeable futur e are not expected to, generate sufficient cash flow to pay all of its debts and expenses. Vornado Operating estimates that it has adequate borrowing capacity under its credit facility with the Company to meet its cash needs until December 31, 2004. However, the principal, interest and fees outstanding under the line of credit come due on such date. Further, Vornado Operating states that its only investee, AmeriCold Logistics (“Tenant”), anticipates that its Landlord, a partnership 60% owned by the Company and 40% owned by Crescent Real Estate Equities, will need to restructure the leases between the Landlor and the Tenant to provide additional cash flow to the Tenant (the Landlord has previously restructured the leases to provide additional cash flow to the Tenant). Management anticipates a further lease restructuring in 2004, although it is under no obligation to do so and there can be no assurance that it will do so. Vornado Operating is expected to have a source to repay the debt under this facility from the lease restructuring or other options, although not by its original due date. Since January 1, 2002, the Company has not recognized interest income on the debt under this facility. ## OTHER On December 31, 2002, the Company and Crescent Real Estate Equities formed a joint venture to acquire the Carthage, Missouri and Kansas City, Kansas quarries from AmeriCold Logistics, the Company’s tenant at the cold storage warehouses (Temperature Controlled Logistics), for $20,000,000 in cash (appraised value). The Company contributed cash of $8,800,000 to the joint venture representing its 44% interest. AmeriCold Logistics used the proceeds from the sale to repay a portion of a loan to Vornado Operating. Vornado Operating then repaid $9,500,000 of the amount outstanding under the Company’s revolving credit facility. The Company owns preferred securities in Capital Trust, Inc. (“Capital T rust”) with a carrying amount of $29,259,000 at December 31, 2003. Mr. Roth, the Chairman and Chief Executive Of ficer of Vornado Realty Trust, is a member of the Board of Directors of Capital Trust nominated by the Company.

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Vornado has multiple assets that have substantial value, but are currently earning either no return or very low returns in relation to their value. Some examples of these are: ■ Cash balances, which at year-end were $320 million, yielding 1%. ■ Hotel Pennsylvania, which has been on a roller coaster, earning EBITDA of $13 million in 1997 when we first acquired 40% of it, peaking at $27 million in 2000, and dropping to $4.6 million last year. (6) Mike and I believe this asset could be sold for in excess of $250 million. Our to-do list for 2004 includes finalizing a plan for the Hotel Pennsylvania which may involve a sale, conversion to apartments or even razing the building for new construction. Any plan will involve realizing the site’s great retail potential. ■ Our FFO in 2003 from the Palisades apartment complex represented a 1.5% return on the $95 million of proceeds we will receive when the sale of this asset closes. ■ $25 million of Prime Group Inc. common stock for which we record no income. The totals are $690 million of capital that earned $9 million in 2003. As we harvest these values and reinvest proceeds at normalized returns, our FFO will increase. Our FFO would also increase if we refinance the $880 million por- tion of our preferred shares which are approaching their call date and are above market. On the flipside, a 100 basis point increase in LIBOR would reduce FFO by $.08 per share. (7)

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<img src='content_image/58830.jpg'> (1) In Januar 2002, when the Company acquired the remaining 66% of CESCR it did not already own, it estimated that these costs would be approximately $75.0. (2) Subject to governmental approvals. The Company is also in the pre-development phase of a number of other projects including (i) retail space in the Penn Plaza area, (ii) repositioning of the Hotel Pennsylvania, (iii) expansion and r edevelopment of the Bergen Mall, (iv) expansion of Monmouth Mall and (v) renovation of the 2101 L Street office building. There can be no assurance that any of the above projects will be ultimately completed, completed on time or completed for the budgeted amount.

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The Company plans to renovate the buildings occupied by the PTO as their leases expire over the next three years as follows: <img src='content_image/91446.jpg'> Renovations to Crystal Mall One, Crystal Park One, and Crystal Plaza Three and Four totaling 901,000 square feet will include new restrooms, lobbies, corridors and elevator modernization. In Crystal Plaza Three and Four, the renovations will also include new mechanical systems. The portions of these buildings vacated by the PTO will be taken out of service during redevelopment which is expected to be completed over a 12 to 18 month period. Renovations to the remaining buildings will consist of com- mon area and exterior renovations to upgrade the buildings that will not require the buildings to be taken out of service. The Company is also committed to fund up to $32,420,000 in connection with its initial investment in two partially-owned entities. No cash requirements have been budgeted for the capital expenditures of Alexander’s, Newkirk MLP, or any other entity that is partially owned by the Company. These investees ar expected to fund their own cash requirements. ## Financing Activities and Contractual Obligations Below is a schedule of the Company’ contractual obligations and commitments at December 31, 2003. <img src='content_image/91445.jpg'> As of March 1, 2004, the Company repaid $227,586,000 of the debt coming due during 2004. The Company has $600,000,000 available under its revolving credit facility which matures in July 2006 and a number of properties which are unencumbered. The Company’s credit facility contains customary conditions precedent to borrowing such as the bring down of customary representations and warranties as well as compliance with financial covenants such as minimum interest coverage and maxi- mum debt to market capitalization. The facility provides for higher interest rates in the event of a decline in the Company’s ratings below Baa3/BBB. This facility also contains customary events of default that could give rise to acceleration and include such items as failure to pay interest or principal and breaches of financial covenants such as maintenance of minimum capitalization and minimum interest coverage.

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The Company carries comprehensive liability and all risk property insurance ((i) fire, (ii) flood, (iii) extended coverage, (iv) “acts of terrorism” as defined in the Terrorism Risk Insurance Act of 2002 which expires in 2004 with a possible extension through 2005 and (v) rental loss insurance) with respect to its assets. Below is a summary of the all risk property insurance and terror- ism risk insurance for each of the Company’s business segments: <img src='content_image/94248.jpg'> (1) Limited as to terrorism insurance by the sub-limit shown in the adjacent column. In addition to the coverage above, the Company carries lesser amounts of coverage for terrorist acts not covered by the Terrorism Risk Insurance Act of 2002. The Company’s debt instruments, consisting of mortgage loans secur ed by its properties (which are generally non-recourse to the Company), its senior unsecured notes due 2007 and 2010 and its r evolving credit agreement, contain customary covenants requiring the Company to maintain insurance. Although the Company believes that it has adequate insurance cov- erage under these agreements, the Company may not be able to obtain an equivalent amount of coverage at reasonable costs in the future. Further if lenders insist on greater coverage than the Company is able to obtain, it could adversely affect the Company’s ability to finance and/or refinance its properties and expand its portfolio. In conjunction with the closing of Alexander’s Lexington Avenue construction loan on July 3, 2002, the Company agreed to guarantee to the construction lender, the lien free, timely completion of the construction of the project and funding of all project costs in excess of a stated budget, as defined in the loan agreement, if not funded by Alexander’s. The Company has an effective shelf registration under which the Company can offer an aggregate of approximately $822,990,000 of equity securities and Vornado Realty L.P. can offer an aggregate of $1,800,262,000 of debt securities. ## Cash Flows for the Year Ended December 31, 2003 Cash and cash equivalents wer $320,542,000 at December 31, 2003, as compared to $208,200,000 at December 31, 2002, an increase of $112,342,000. Cash flow provided by operating activities of $528,951,000 was primarily comprised of (i) income of $460,703,000, (ii) adjustments for non-cash items of $99,985,000, partially offset by (iii) the net change in operating assets and liabilities of $31,737,000. The adjustments for non-cash items wer comprised of (i) depreciation and amortization of $219,911,000 (ii) minority interest of $178,675,000, partially offset by (iii) gains on sale of real estate of $161,789,000, (iv) gains on dispositions of wholly-owned and partially-owned assets other than r eal estate of $2,343,000, (v) the effect of straight-lining of rental income of $41,947,000, (vi) equity in net income of partially-owned entities and income applicable to Alexander’s of $83,475,000 and (vii) amortization of below market leases, net of $9,047,000. Net cash used in investing activities of $130,292,000 was primarily comprised of (i) capital expenditures of $120,593,000, (ii) devel- opment and redevelopment expenditures of $123,436,000, (iii) investment in notes and mortgages receivable of $230,375,000, (iv) investments in partially-owned entities of $15,331,000, (v) acquisitions of real estate and other of $216,361,000, (vi) cash restricted, primarily mortgage escrows of $101,292,000, (vii) purchases of marketable securities of $17,356,000 partially offset by, (viii) pro- ceeds from the sale of real estate of $299,852,000 (ix) distributions fr om partially-owned entities of $154,643,000, (x) repayments on notes receivable of $29,421,000 and (xi) proceeds from the sale of marketable securities of $7,952,000. Net cash used in financing activities of $286,317,000 was primarily comprised of (i) dividends paid on common shares of $327,877,000, (ii) dividends paid on preferred shares of $20,815,000, (iii) distributions to minority partners of $158,066,000,

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(iv) repayments of borrowings of $752,422,000, (v) redemption of perpetual preferred shares and units of $103,243,000, par- tially offset by proceeds from (vi) borrowings of $812,487,000, of which $198,500,000 was from the issuance of the Company’s senior unsecured notes due 2010, and (vii) the exercise of employee share options of $145,152,000. Below are the details of capital expenditures, leasing commissions and development and redevelopment expenditures and a reconciliation of total expenditures on an accrual basis to the cash expended in the year ended December 31, 2003. See page 5 for per square foot data. <img src='content_image/133797.jpg'> Capital expenditures are categorized as follows: Recurring—capital improvements expended to maintain a property’s competitive position within the market and tenant improvements and leasing commissions for costs to r e-lease expiring leases or renew or extend existing leases. Non-recurring—capital improvements completed in the year of acquisition and the following two years which were planned at the time of acquisition and tenant improvements and leasing commissions for space which was vacant at the time of acquisition of a property. Development and redevelopment expenditures include all har d and soft costs associated with the development or redevelop- ment of a property, including tenant improvements, leasing commissions and capitalized interest and operating costs until the property is substantially complete and ready for its intended use.

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## Bergen Mall On December 12, 2003, the Company acquired the Bergen Mall for approximately $145,000,000. This purchase was funded as part of a Section 1031 tax-free “like-kind” exchange with a portion of the proceeds from the sale of the Company’s Two Park Avenue property. The Bergen Mall is a 903,000 squar e foot shopping center located on Route 4 East in Paramus, New Jersey. The center is anchored by Macy’s, Value City Marshalls and Off Saks Fifth Avenue. The Company intends to expand, re-tenant and redevelop the center in order to reposition the asset. On January 27, 2004, the Company entered into an agree- ment to modify the Value City lease to give the Company a one-year option to terminate the lease no earlier than one year after notification and upon payment of $12,000,000 to the tenant. The present value of this option is reflected in the acquisi- tion price and is included in other liabilities in the Consolidated Balance Sheet. ## 2003 Dispositions On January 9, 2003, the Company sold its Baltimore, Maryland shopping center for $4,752,000, which resulted in a net gain after closing costs of $2,644,000. On June 13, 2003, the Company received its $5,000,000 shar e of a settlement with affiliates of Primestone Investment Partners of the amounts due under the guarantees of the Primestone loans. In connection therewith, the Company recognized a $1,388,000 loss on settlement of the guarantees. On October 10, 2003, the Company sold Two Park Avenue, a 965,000 square foot office building, for $292,000,000 to SEB Immobilien-Investment GMBH, a German capital investment company, which resulted in a net gain on the sale after closing costs of $156,433,000. On November 3, 2003, the Company sold its Hagerstown, Maryland shopping center for $3,100,000 which resulted in a net gain on sale after closing costs of $1,945,000. On February 2, 2004, the Palisades Ventur in which the Company owns a 75% interest entered into an agreement to sell its only asset, a 538 unit high-rise residential apartment tower in Fort Lee, New Jersey, for $222,500,000. On February 27, 2004, to permit a potential “like kind exchange,” the Company acquired the remaining 25% interest it did not previously own for its partner’s share of the net sales price (approximately $17,000,000). The Company’s gain on sale after closing costs will be approximately $70,000,000. The sale, which is subject to customary closing conditions, is expected to be completed by the third quarter of 2004. ## 2003 Financings On July 3, 2003, the Company entered into a new $600,000,000 unsecured revolving credit facility which has replaced its $1,000,000,000 unsecured revolving credit facility which was to mature in July 2003. The new facility has a three-year term, a one-year extension option and bears interest at LIBOR plus .65%. The Company also has the ability under the new facility to seek up to $800 million of commitments during the facility’ s term. The new facility contains financial covenants similar to the prior facility. On November 11, 2003, the Company redeemed all of its 8.5% Series D-1 Cumulative Redeemable Preferred Units issued in 1998 at a redemption price equal to the par value of $25.00 per unit or an aggregate of $87,500,000 plus accrued distributions of $849,000. This amount exceeded the carrying amount by $2,100,000, representing the original issuance costs. Upon the redemption these issuance costs were recorded as a r eduction to earnings in arriving at net income applicable to common shares in accordance with the July 2003 EITF clarification of Topic D-42. On November 17, 2003, the Company sold $40,000,000 of 7.00% Series D-10 Cumulative Redeemable Preferred Shares to an institutional investor in a registered offering. Immediately prior to that sale, Vornado Realty L.P. sold $80,000,000 of 7.00% Series D-10 Cumulative Redeemable Preferred Units to an institutional investor in a separate private offering. Both the perpetual Preferred Units and perpetual Preferred Shares may be called without penalty at the option of the Company commencing in November 2008.

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On November 25, 2003, the Company completed an offering of $200,000,000 aggregate principal amount of 4.75% senior unse- cured notes due December 1, 2010. Interest on the notes is payable semi-annually on June 1st and December 1st, commencing in 2004. The notes wer priced at 99.869% of their face amount to yield 4.772%. The notes contain the same financial covenants that are in the Company’ notes issued in June 2002, except the maximum ratio of secured debt to total assets is now 50% (pre- viously 55%). The net proceeds of approximately $198,500,000 wer e used primarily to repay existing mortgage debt. On January 6, 2004, the Company redeemed all of its 8.375% Series D-2 Cumulative Redeemable Preferred Units issued in 1999 at a redemption price equal to $50.00 per unit or an aggregate of $27,500,000 plus accrued distributions of $19,170. ## Cash Flows for the Year Ended December 31, 2002 Cash and cash equivalents wer $208,200,000 at December 31, 2002, as compared to $265,584,000 at December 31, 2001, a decrease of $57,384,000. Cash flow provided by operating activities of $499,825,000 was primarily comprised of (i) income of $232,903,000, (ii) adjust- ments for non-cash items of $303,869,000, partially offset by (iii) the net change in operating assets and liabilities of $36,947,000. The adjustments for non-cash items wer comprised of (i) a cumulative effect of change in accounting principle of $30,129,000, (ii) amortization of Officer’s deferred compensation expense of $27,500,000, (iii) depreciation and amortization of $205,826,000, (iv) minority interest of $140,933,000, (v) the write-of f of $6,874,000 of 20 Times Square pre-development costs, (vi) impairment losses on Primestone of $35,757,000, partially of fset by (vii) the effect of straight-lining of rental income of $38,119,000, (viii) equity in net income of partially-owned entities and income applicable to Alexander’s of $74,111,000 and (ix) amortization of below market leases, net of $12,634,000. Net cash used in investing activities of $24,117,000 was comprised of (i) recurring capital expenditures of $52,728,000, (ii) non-recurring capital expenditures of $42,227,000, (iii) development and redevelopment expenditures of $91,199,000, (iv) investment in notes and mortgages receivable of $56,935,000, (v) investments in partially-owned entities of $73,242,000, (vi) acquisitions of real estate of $23,665,000, (vii) cash restricted, primarily mortgage escrows of $21,471,000 partially offset by proceeds from (viii) distributions from partially-owned entities of $126,077,000, (ix) repayments on notes receivable of $124,500,000 and (x) proceeds from the sale of marketable securities of $87,896,000. Net cash used in financing activities of $533,092,000 was primarily comprised of (i) dividends paid on common shares of $314,419,000, (ii) dividends paid on preferred shares of $23,167,000, (iii) distributions to minority partners of $146,358,000, (iv) repayments of borrowings of $731,238,000, (v) redemption of perpetual preferred units of $25,000,000, partially offset by proceeds from (vi) the issuance of common shares of $56,453,000, (vii) proceeds from borrowings of $628,335,000, of which $499,280,000 was from the issuance of the Company’s senior unsecur ed notes on June 24, 2002, and (viii) the exercise of employee share options of $26,272,000. Below are the details of capital expenditures, leasing commissions and development and redevelopment expenditures for the year ended December 31, 2002. <img src='content_image/115187.jpg'>

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<img src='content_image/35968.jpg'> Cash Flows for the Year Ended December 31, 2001 Cash flow provided by operating activities of $387,685,000 was primarily comprised of (i) income of $263,738,000, (ii) adjust- ments for non-cash items of $104,393,000, and (iii) the net change in operating assets and liabilities of $19,554,000. The adjustments for non-cash items wer primarily comprised of (i) a cumulative effect of change in accounting principle of $4,110,000, (ii) the write-off of the Company’s remaining equity investments in technology companies of $16,513,000, (iii) the write-off of its entir net investment of $7,374,000 in the Russian Tea Room, (iv) depreciation and amortization of $123,682,000, (v) minority interest of $112,363,000, partially offset by (vi) the effect of straight-lining of rental income of $27,230,000, and (vii) equity in net income of partially-owned entities and income applicable to Alexander’s of $106,330,000. Net cash used in investing activities of $79,722,000 was primarily comprised of (i) recurring capital expenditures of $41,093,000, (ii) non-recurring capital expenditures of $25,997,000, (iii) development and redevelopment expenditures of $145,817,000, (iv) investment in notes and mortgages r eceivable of $83,879,000, (v) investments in partially-owned entities of $109,332,000, (vi) acquisitions of real estate of $11,574,000, offset by, (vii) proceeds from the sale of real estate of $162,045,000, and (viii) distributions from partially-owned entities of $114,218,000. Net cash used in financing activities of $179,368,000 was primarily comprised of (i) proceeds from borrowings of $554,115,000, (ii) proceeds from the issuance of common shares of $377,193,000, (iii) proceeds from the issuance of preferred units of $52,673,000, offset by, (iv) repayments of borrowings of $835,257,000, (v) dividends paid on common shares of $201,813,000, (vi) dividends paid on preferred shares of $35,547,000, and (vii) distributions to minority partners of $98,594,000. Below are the details of capital expenditures, leasing commissions and development and redevelopment expenditures. <img src='content_image/35974.jpg'>

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<img src='content_image/131810.jpg'> ## Funds From Operations Applicable to Common Shares (“FFO”) FFO does not represent cash generated from operating activities in accordance with accounting principles generally accepted in the United States of America and is not necessarily indicative of cash available to fund cash needs which is disclosed in the Consolidated Statements of Cash Flows for the applicable periods. FFO should not be considered as an alternative to net income as an indicator of the Company’ operating performance or as an alternative to cash flows as a measure of liquidity. Management considers FFO a relevant supplemental measur of operating performance because it provides a basis for com- parison among REITs. FFO is computed in accordance with NAREIT’ s definition, which may not be comparable to FFO report- ed by other REITs that do not compute FFO in accordance with NAREIT’s definition. Year Ended December 31, 2003 vs. December 31, 2002 FFO was $518,242,000, or $4.44 per diluted shar for the year ended December 31, 2003, compared to $439,775,000, or $3.91 per diluted share for the year ended December 31, 2002, an incr ease of $78,467,000 or $.53 per share. Income from the straight-lining of rents included in FFO amounted to $34,023,000, or $.24 per diluted share for the year ended December 31, 2003, and $27,295,000, or $.24 per diluted shar for the year ended December 31, 2002. Income from the amortization of acquired below market leases net of above market leases included in FFO amounted to $9,047,000, or $.06 per diluted share for the year ended December 31, 2003 and $12,634,000, or $.11 per diluted share for the year ended December 31, 2002. Also included in FFO are certain items that affect comparability as detailed below. Before these items, the year ended December 31, 2003 FFO is 6.5% higher than the year ended December 31, 2002 on a per share basis. For The Year Ended <img src='content_image/131811.jpg'>

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<img src='content_image/129036.jpg'> ## Fourth Quarter 2003 vs. Fourth Quarter 2002 FFO was $130,729,000, or $1.08 per diluted share for the thr ee months ended December 31, 2003, compared to $93,507,000, or $.83 per diluted share for the three months ended December 31, 2002, an increase of $37,222,000 or $.25 per share. Income from the straight-lining of rents included in FFO, amounted to $8,204,000, or $.06 per diluted share for the three months ended December 31, 2003, and $7,794,000, or $.06 per diluted share for the three months ended December 31, 2002. Income from the amortization of acquired below market leases net of above market leases included in FFO, amounted to $2,133,000, or $.01 per diluted share for the three months ended December 31, 2003 and $12,662,000, or $.09 per diluted share for the three months ended December 31, 2002. Also included in FFO are certain items that affect comparability as detailed below. Before these items, the three months ended December 31, 2003 FFO is 8.7% higher than the year ended December 31, 2002 on a per share basis. For The Three Months Ended <img src='content_image/129035.jpg'> The following table reconciles FFO and net income: <img src='content_image/129034.jpg'>

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## Lease, Lease, Lease The mission of our business is to create value for our shareholders by growing our asset base through the addition of carefully selected properties and by adding value through intensive and efficient management. As in past years, Mike and I are pleased to present leasing statistics for our businesses. In our business, leasing is what it’s all about. <img src='content_image/97065.jpg'> * Percentage increase over expiring escalated rent. Mike and I congratulate David Greenbaum, Mitchell Schear, Sandeep Mathrani and Chris Kennedy for a superb 2003. Generally speaking, most times we can only get rents that the market offers, but each of these franchise players, through aggressiveness and ability, do a marvelous job of achieving above-market occupancy, year in and year out. David Greenbaum reports that in New York activity is increasing, occupancy rates are rising and rental rates have stabilized. David, ever measured, continues to be cautious and aggressively defensive—focusing on leasing. Sandeep Mathrani and team give us superb skills in devel- oping, leasing, and managing strip shopping centers, malls and New York street retail. After all, these retail businesses are our heritage. We continue to seek retail investment opportunities. In December, we acquired the Bergen Mall for $145 million, a 900,000 square foot fixer-upper on 80 acres in Paramus, New Jersey. We plan to redevelop this property into a lifestyle center and will invest at least an additional $100 million. We have owned Green Acres, a super regional mall, in Valley Stream, Long Island, New York for six years. Sandeep is now working hard on plans for a renovation and expansion of this productive property. Chris Kennedy’s Mart team is also a leasing machine. Chris keeps our showroom space at a very respectable 95% occupancy and in 2003 leased 1,157,000 square feet of showroom space in 465 separate transactions. Also in 2003, our trade show personnel rented thousands of booths to exhibitors in 29 trade shows. Importantly, Chris is also working on several large office leasing deals for our Chicago assets.

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## CONSOLIDATED BALANCE SHEETS ## December 31, <img src='content_image/129103.jpg'> See notes to consolidated financial statements.

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## CONSOLIDATED STATEMENTS OF INCOME <img src='content_image/41327.jpg'> See notes to consolidated financial statements.

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## CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY <img src='content_image/52.jpg'> See notes to consolidated financial statements.

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## CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY <img src='content_image/83930.jpg'> See notes to consolidated financial statements.

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## CONSOLIDATED STATEMENTS OF CASH FLOWS <img src='content_image/84983.jpg'> See notes to consolidated financial statements.

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## VORNADO REALTY TRUST ## NOTES TO CONSOLIDATED FINANCIAL STA TEMENTS ## 1. Organization and Business Vornado Realty Trust is a fully-integrated real estate investment trust (“REIT”). Vornado conducts its business through Vornado Realty L.P., (“the Operating Partnership”). Vornado is the sole general partner of, and owned approximately 82% of the common limited partnership interest in, the Operating Partnership at February 16, 2004. All references to the “Company” and “Vornado” refer to Vornado Realty Trust and its consolidated subsidiaries, including the Operating Partnership. The Company currently owns directly or indirectly: ## Office Properties: (i) all or portions of 83 office properties aggregating approximately 27.3 million square feet in the New York City metropoli- tan area (primarily Manhattan) and in the Washington D.C. and Northern Virginia area; ## Retail Properties: (ii) 60 retail properties in six states and Puerto Rico aggregating appr oximately 12.9 million square feet, including 2.7 million square feet built by tenants on land leased from the Company; ## Merchandise Mart Properties: (iii) 8.6 million square feet of showroom and office space, including the 3.4 million square foot Merchandise Mart in Chicago; ## Temperature Controlled Logistics: (iv) a 60% interest in the Vornado Crescent Portland Partnership that owns 87 cold storage warehouses nationwide with an aggregate of approximately 440.7 million cubic feet of r efrigerated space leased to AmeriCold Logistics; ## Other Real Estate Investments: (v) 33.1% of the outstanding common stock of Alexander’s, Inc. (“Alexander’s”); (vi) the Hotel Pennsylvania in New York City consisting of a hotel portion containing 1.0 million square feet with 1,700 rooms and a commercial portion containing .4 million square feet of r etail and office space; (vii) a 22.6% interest in The Newkirk Master Limited Partnership (“Newkirk MLP”) which owns office, retail and industrial properties net leased primarily to credit rated tenants, and various debt interests in such properties; (viii) eight dry warehouse/industrial properties in New Jersey containing approximately 2.0 million square feet; and (ix) other investments, including interests in other real estate, marketable securities and loans and notes receivable.

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## Capital Expenditures Managing capital expenditures is an important part of our business. The table below presents capital expenditures* since 2000, in dollars on a segment basis. <img src='content_image/128317.jpg'> * This data excludes expenditures for acquisitions, developments and expansions. Since leasing activity varies year-to-year and the term of leases fluctuate, we think per square foot numbers tell a meaningful story. In the table below, the Expenditures to Maintain Assets are presented based on total square feet in the segment. Tenant Improvements Leasing Commissions are presented based on square feet leased in the year on per annum basis based upon the average term of leases. <img src='content_image/128320.jpg'>

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with a fair value of $25,780,000 at December 31, 2003, which is included in Other Assets on the Company’s consolidated balance sheet. Accounting for these swaps also requires the Company to recognize changes in the fair value of the debt during each reporting period. At December 31, 2003, the fair value adjustment of $25,780,000, based on the fair value of the swaps, is included in the balance of the Senior Unsecured Notes. Because the hedging relationship qualifies for the “short-cut” method, no hedge ineffectiveness on these fair value hedges was r ecognized during 2003 and 2002. REVENUE RECOGNITION: The Company has the following revenue sources and revenue recognition policies: Base Rents—income arising from tenant leases. These rents are r ecognized over the non-cancelable term of the related leases on a straight-line basis which includes the effects of rent steps and r ent abatements under the leases. Percentage Rents—income arising from retail tenant leases which ar e contingent upon the sales of the tenant exceeding a defined threshold. These rents are recognized in accordance with SAB 104, which states that this income is to be recognized only after the contingency has been removed (i.e., sales thresholds have been achieved). Hotel Revenues—income arising from the operation of the Hotel Pennsylvania which consists of rooms revenue, food and beverage revenue, and banquet revenue. Income is recognized when r ooms are occupied. Food and beverage and banquet revenue are recognized when the services have been rendered. Trade Show Revenues—income arising from the operation of trade shows, including rentals of booths. This revenue is recognized in accordance with the booth rental contracts when the trade shows have occurred. Expense Reimbursements—revenue arising from tenant leases which pr ovide for the recovery of all or a portion of the operating expenses and real estate taxes of the respective property . This revenue is accrued in the same periods as the expenses are incurred. Contingent rents are not recognized until r ealized. INCOME TAXES: The Company operates in a manner intended to enable it to continue to qualify as a REIT under Sections 856-860 of the Internal Revenue Code of 1986, as amended. Under those sections, a REIT which distributes at least 90% of its REIT taxable income as a dividend to its shareholders each year and which meets certain other conditions will not be taxed on that portion of its taxable income which is distributed to its shareholders. The Company will distribute to its shareholders 100% of its taxable income and therefore, no provision for Federal income taxes is required. Dividend distributions for the year ended December 31, 2003, wer characterized for Federal income tax purposes as 94.4% ordinary income and 5.6% long-term capital gain income. Dividend distributions for the year ended December 31, 2002 and 2001 were characterized as ordinary income. The Company owns stock in corporations that have elected to be tr eated for Federal income tax purposes, as taxable REIT subsidiaries (“TRS”). The value of the combined TRS stock cannot and does not exceed 20% of the value of the Company’s total assets. A TRS is taxable on its net income at regular corporate tax rates. The total income tax paid for the 2003 and 2002 tax years was $2,486,000 and $1,430,000. The following table reconciles net income to estimated taxable income for the year ended December 31, 2003. <img src='content_image/893.jpg'>

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The net basis of the Company’ assets and liabilities for tax purposes is approximately $2,857,619,000 lower than the amount reported for financial statement purposes. At December 31, 2003, the Company had a capital loss carryover of zero. INCOME PER SHARE: Basic income per shar is computed based on weighted average shares outstanding. Diluted income per share considers the effect of outstanding options, r estricted shares warrants and convertible or redeemable securities. STOCK-BASED COMPENSATION: In 2002 and prior years, the Company accounted for employee stock options using the intrinsic value method. Under the intrinsic value method compensation cost is measured as the excess, if any, of the quoted market price of the Company’ stock at the date of grant over the exercise price of the option granted. Compensation cost for stock options, if any, is recognized ratably over the vesting period. The Company’s policy is to grant options with an exercise price equal to 100% of the market price of the Company’ stock on the grant date. Accordingly, no compensation cost has been recognized for the Company’s stock option grants. Effective January 1, 2003, the Company adopted SFAS No. 123 “Accounting for Stock Based Compensation” as amended by SFAS No. 148 “Accounting for Stock—Based Compensation—Transition and Disclosure.” The Company adopted SFAS No. 123 pr ospectively by valuing and accounting for employee stock options granted in 2003 and thereafter The Company utilizes a binomial valuation model and appropriate market assumptions to determine the value of each grant. Stock-based compensation expense is recognized on a straight-line basis over the vesting period for all grants subsequent to 2002. See Note 9. Stock-Based Compensation, for pro forma net income and pro forma net income per shar for the years ended December 31, 2003, 2002 and 2001, assuming compensation costs for grants prior to 2003 were recognized as compensation expense based on the fair value at the grant dates. In addition to employee stock option grants, the Company has also granted restricted shares to certain of its employees that vest over a three to five year period. The Company recor ds the value of each restricted share award as stock-based compensation expense based on the Company’ closing stock price on the NYSE on the date of grant on a straight-line basis over the vesting period. As of December 31, 2003, the Company has 246,030 restricted shares or rights to receive restricted shares outstanding to employees of the Company excluding 626,566 shares issued to the Company’s President in connection with his employment agreement. The Company recognized $1,898,000 and $1,868,000 of stock-based compensation expense in 2003 and 2002 for the portion of these shares that vested during each year. Dividends on both vested and unvested shares are charged to retained earnings and amounted to $777,700 and $210,100 for 2003 and 2002, respectively. Dividends on shares that are canceled or terminated prior to vesting ar e charged to compensation expense in the period they are cancelled or terminated. ## Recently Issued Accounting Standards ## FASB INTERPRETATION NO. 46—CONSOLIDATION OF VARIABLE INTEREST ENTITIES (“FIN 46”) In January 2003, the FASB issued FIN 46, as amended in December 2003 by FIN 46R, which deferred the effective date until the first interim or annual reporting period ending after Mar ch 15, 2004. FIN 46R requires the consolidation of an entity by an enterprise known as a “primary beneficiary,” (i) if that enterprise has a variable interest that will absorb a majority of the entity’s expected losses, if they occur, receive a majority of the entity’ s expected residual returns, if they occur, or both and (ii) if the entity is a variable interest entity (“VIE”), as defined. An entity qualifies as a variable interest entity if (i) the total equity investment at risk in the entity is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) the equity investors do not have the characteristics of a controlling financial interest in the entity. The initial determination of whether an entity is a variable interest entity shall be made as of the date at which an enterprise becomes involved with the entity and re-evaluated as of the date of triggering events, as defined. The Company has evaluated each partially-owned entity to determine whether any qualify as a VIE, and if so, whether the Company is the primary beneficiary, as defined. The Company has determined that its investment in Newkirk MLP, in which it owns a 22.6% equity interest (see Note 5—Investments in Partially-Owned Entities), qualifies as a VIE. The Company has determined that it is not considered the primary beneficiary and, accordingly, consolidation is not r equired. The Company’s maximum exposure to loss as a result of its involvement in Newkirk is limited to its equity investment of approximately $138,762,000, as of December 31, 2003. In addition,

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the Company has variable interests in certain other entities which ar e primarily financing arrangements. The Company has evaluated these entities in accordance with FIN 46R and has determined that they are not VIEs. Based on the Company’s evaluations, it does not believe that the adoption of FIN 46R will have a material effect on its consolidated financial statements. SFAS NO. 150—ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY In May 2003, the FASB issued SFAS No. 150 which establishes standar ds for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. The adoption of SFAS No. 150 on July 1, 2003 caused the Company to reclassify all of its Series F-1 Preferred Units ($10 million liquidation value) from minority interest to a liability on its consolidated balance sheet, as those units may be settled by the issuance of a variable number of the Company’s common shares. In connection therewith, the Company also reclassified $225,000 of payments made to the holders of these units in the three months ended December 31, 2003 as interest expense. On November 7, 2003, the FASB deferred, indefinitely the application of paragraphs 9 and 10 of SFAS No. 150 as it relates to mandatory redeemable non-controlling interests in consolidated subsidiaries in order to address a number of interpretation and implementation issues. The Company has determined that one of its consolidated, finite-life joint ventures qualifies as a mandatory redeemable non-controlling interest. If the Company were r equired to adopt the provisions of paragraphs 9 and 10 as currently written, the Company would have to reclassify as a liability , amounts included in minority interest of approximately $1.6 million and record the minority partner’s interest as a liability at its estimated settlement value which would result in a cumulative effect of change in accounting principle of approximately $15.6 million. This liability would be required to be reviewed each quarter and any changes in its settlement value would be recor ded as interest expense. ## 3. Acquisitions and Dispositions ## ACQUISITIONS: The Company completed approximately $530,400,000 of real estate acquisitions and investments in 2003 and $1,834,000,000 in 2002. These acquisitions were consummated through subsidiaries or preferred stock affiliates of the Company. Related net assets and results of operations have been included in these financial statements since their respective dates of acquisition. The pro forma effect of the individual acquisitions and in the aggregate other than Charles E. Smith Commercial Realty, were not material to the Company’s historical results of operations. Acquisitions of individual properties are recorded as acquisitions of r eal estate assets. Acquisitions of businesses are accounted for under the purchase method of accounting. The purchase price for pr operty acquisitions and businesses acquired is allocated to acquired assets and assumed liabilities using their relative fair values as of the acquisition date based on valuations and other studies. Initial valuations ar subject to change until such information is finalized no later than 12 months from the acquisition date. ## CHARLES E. SMITH COMMERCIAL REALTY INVESTMENT (“CESCR”) On January 1, 2002, the Company completed the combination of CESCR with Vornado. Prior to the combination, Vornado owned a 34% interest in CESCR. The consideration for the remaining 66% of CESCR was approximately $1,600,000,000, consisting of 15.6 million newly issued Operating Partnership units and approximately $1 billion of debt (66% of CESCR’s total debt). The purchase price paid by the Company was determined based on the weighted average closing price of the equity issued to CESCR unit holders for the period beginning two business days before and ending two business days after the date the acquisition was agreed to and announced on October 19, 2001. The Company also capitalized approximately $32,000,000 of acquisition related costs, including advisory, legal and other pr ofessional fees that were incurred in connection with the acquisition. The following table summarizes the estimated fair value of assets acquired and liabilities assumed at January 1, 2002, the date of acquisition.

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(AMOUNTS IN THOUSANDS) <img src='content_image/97720.jpg'> The Company’ estimate of the weighted average useful life of acquired intangibles is approximately three years. This acquisition was recorded as a business combination under the purchase method of accounting. The purchase price was allocated to acquired assets and assumed liabilities using their relative fair values as of January 1, 2002 based on valuations and other studies. The operations of CESCR ar consolidated into the accounts of the Company beginning January 1, 2002. Prior to this date the Company accounted for its 34% interest on the equity method. The unaudited pro forma information set forth below presents the Company’s condensed consolidated statement of income for the year ended December 31, 2001 as if the following transactions had occurred on January 1, 2001, (i) the acquisition of CESCR described above and (ii) the Company’ November 21, 2001 sale of 9,775,000 common shares and the use of proceeds to repay indebtedness. (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <img src='content_image/97719.jpg'> ## CRYSTAL GATEWAY ONE On July 1, 2002, the Company acquired a 360,000 square foot of fice building from a limited partnership, which was approximately 50% owned by Mr. Robert H. Smith and Mr. Robert P. Kogod, trustees of the Company, and members of the Smith and Kogod families, in exchange for approximately 325,700 newly issued Vornado Operating Partnership units (valued at $13,679,000) and the assumption of $58,500,000 of debt. The building is located in the Crystal City complex in Arlington, Vir ginia. The operations of Crystal Gateway One are consolidated into the accounts of the Company from the date of acquisition. ## BUILDING MAINTENANCE SERVICE COMPANY (“BMS”) On January 1, 2003, the Company acquired for $13,000,000 in cash BMS, which provides cleaning, security and engineering services principally to the Company’s Manhattan office pr operties. This company was previously owned by the estate of Bernar Mendik and certain other individuals including David R. Greenbaum, one of the Company’s executive officers. This acquisition was recorded as a business combination under the purchase method of accounting. Accordingly, the operations of BMS ar consolidated into the accounts of the Company beginning January 1, 2003.

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LIBOR floor of 2.50% on $35,000,000, a three year term and two one-year extension options. The Company accounts for its investment on the equity method. ## BERGEN MALL On December 12, 2003, the Company acquired the Bergen Mall for approximately $145,000,000. This purchase was funded as part of a Section 1031 tax-free “like-kind” exchange with a portion of the proceeds from the sale of the Company’s Two Park Avenue property. The Bergen Mall is a 903,000 square foot shopping center located on Route 4 East in Paramus, New Jersey. The center is anchored by Macy’s, Value City , Marshalls and Off Saks Fifth Avenue. The Company intends to expand, re-tenant and redevelop the center in order to r eposition the asset. On January 27, 2004, the Company entered into an agreement to modify the Value City lease to give the Company a one-year option to terminate the lease no earlier than one year after notification and upon payment of $12,000,000 to the tenant. The present value of this option is reflected in the acquisition price and is included in other liabilities in the consolidated balance sheet. ## GENERAL MOTORS BUILDING MEZZANINE LOANS On October 20, 2003 the Company made a $200 million mezzanine loan secured by partnership interests in the General Motors Building. The General Motors Building was acquir ed by Macklowe Properties in September 2003 for approximately $1.4 billion. Vornado’s loan is subordinate to $900 million of other debt. The loan is based on a rate of LIBOR plus 8.685% (with a LIBOR floor of 1.5%) and currently yields 10.185%. Further, on October 30, 2003, the Company made an additional $25 million loan, as part of a $50 million loan, the balance of which was funded by an affiliate of Soros Fund Management LLC. This loan, which is junior to the $1.1 billion of loans noted above, is based on a rate of LIBOR plus 12.81% (with a LIBOR floor of 1.5%) and currently yields 14.31%. These loans matur e in October 2005, with three one-year extensions. ## FOREST PLAZA SHOPPING CENTER On February 3, 2004, the Company acquired the Forest Plaza Shopping Center for approximately $32,500,000, of which $14,000,000 was paid in cash, and $18,500,000 was debt assumed. The purchase was funded as part of Section 1031 tax-free “like kind” exchange with the remaining portion of the proceeds from the sale of the Company’s Two Park Avenue property. Forest Plaza is a 165,000 squar foot shopping center located in Staten Island, New York, anchored by a Waldbaum’s Supermarket. ## OTHER On December 31, 2002, the Company and Crescent Real Estate Equities formed a joint venture to acquire the Carthage, Missouri and Kansas City, Kansas quarries from AmeriCold Logistics, the Company’s tenant at the cold storage warehouses (Temperature Controlled Logistics) facilities for $20,000,000 in cash (appraised value). The Company contributed cash of $8,800,000 to the joint venture representing its 44% inter est. The Company accounts for its investment in the venture on the equity method. The Company entered into an agreement to acquire a 62,000 square foot free-standing retail building located at 25 W. 14th Street in Manhattan for $40,000,000. The building, which was r ecently renovated, is 87% occupied as of December 31, 2003. The acquisition is expected to be completed in the second quarter of 2004. ## Dispositions: The following sets forth the details of sales, dispositions, write-offs and other similar transactions for the years ended December 31, 2003, 2002 and 2001:

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GAINS ON SALES OF REAL ESTATE (DISCONTINUED OPERATIONS IN 2003): On November 3, 2003, the Company sold its Hagerstown, Maryland shopping center property for $3,100,000, which resulted in a net gain on sale after closing costs of $1,945,000. On October 10, 2003, the Company sold Two Park Avenue, a 965,000 square foot office building, for $292,000,000 to SEB Immobilien-Investment GmbH, a German capital investment company , which resulted in a net gain on the sale after closing costs of $156,433,000. On January 9, 2003, the Company sold its Baltimore, Maryland shopping center for $4,752,000, which resulted in a net gain on the sale after closing costs of $2,644,000. On August 6, 2001, the Company sold its leasehold interest in 550/600 Mamaroneck Avenue for $22,500,000, which approximated book value. On May 17, 2001, the Company sold its 50% interest in 570 Lexington Avenue for $60,000,000, which resulted in a net gain on sale after closing costs of $12,445,000. In September 1998, Atlantic City condemned the Company’s property . In the third quarter of 1998, the Company recorded a gain of $1,694,000, which reflected the condemnation awar of $3,100,000, net of the carrying value of the property of $1,406,000. The Company appealed the amount and on June 27, 2001, was awarded an additional $3,050,000. On February 2, 2004, the Palisades Ventur in which the Company owns a 75% interest entered into an agreement to sell its only asset, a 538 unit high-rise residential apartment tower in Fort Lee, New Jersey, for $222,500,000. On February 27, 2004, the Company acquired the remaining 25% interest it did not previously own for approximately $17,000,000. The Company’s gain on sale after closing costs will be approximately $70,000,000. The sale, which is subject to customary closing conditions, is expected to be completed by the third quarter of 2004. Net gains (losses) on disposition of wholly-owned and partially-owned assets other than depreciable real estate: For the Years Ended December 31, <img src='content_image/120450.jpg'> ## PRIMESTONE SETTLEMENT OF GUARANTEES (2003) AND FORECLOSURE AND IMP AIRMENT LOSSES (2002) On September 28, 2000, the Company made a $62,000,000 loan to Primestone Investment Partners, L.P. (“Primestone”). The Company received a 1% up-front fee and was entitled to receive certain other fees aggregating approximately 3% upon repay- ment of the loan. The loan bore interest at 16% per annum. Primestone defaulted on the repayment of this loan on October 25, 2001. The loan was subordinate to $37,957,000 of other debt of the borr ower that liened the Company’s collateral. On October 31, 2001, the Company purchased the other debt for its face amount. The loans were secured by 7,944,893 partnership units in Prime Group Realty, L.P., the operating partnership of Prime Group Realty Trust (NYSE:PGE) and the partnership units are exchangeable for the same number of common shares of PGE. The loans are also guaranteed by affiliates of Primestone.

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Assets related to discontinued operations consist primarily of real estate, net of accumulated depreciation. The following table sets forth the balances of the assets related to discontinued operations as of December 31, 2003 and 2002: <img src='content_image/114979.jpg'> Liabilities related to discontinued operations represent the Palisades mortgage payable of $120,000,000 and $100,000,000 as of December 31, 2003 and 2002, respectively. The combined results of operations of the assets related to discontinued operations for the years ended December 31, 2003, 2002 and 2001 are as follows: <img src='content_image/114982.jpg'> See Note 3. Acquisitions and Dispositions for details of gains on sale of real estate related to discontinued operations in the year ended December 31, 2003. ## 5. Investments in Partially-Owned Entities The Company’ investments in partially-owned entities and income recognized from such investments are as follows: ## Balance Sheet Data: <img src='content_image/114987.jpg'> (1) On February 5, 2004, AmeriCold Realty Trust completed a $254,400 mortgage financing for 21 of its owned and 7 of its leased temperature-controlled warehouses. The loan bears interest at LIBOR plus 2.95% (with a LIBOR floor of 1.5% with respect to $54,400 of the loan) and requires principal payments of $5,000 annually The loan matures in April 2009 and is pre-payable without penalty after Februar 5, 2006. The net proceeds were approximately $225,000 after providing for usual escrows, closing costs and the repayment of $12,900 of existing mortgages on two of the warehouses, of which $135,000 was distributed to the Company and the remainder was distributed to its partner.

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## Washington Office Vornado’s Charles E. Smith Division is the largest owner of office space in the Washington, DC area and is the largest landlord to the Federal Government. Vornado made minor- ity investments in Smith in 1997, and then again in 1999, and acquired the remainder on January 1, 2002, so that we now own 100%. Smith today owns 14.0 million square feet, about half of which is located in 26 buildings in Crystal City, Arlington, VA, adjacent to Reagan National Airport, overlooking the Capitol. (8) Mitchell Schear has now completed his first full year as President of Charles E. Smith. He has finished the integration of Smith and Kaempfer and is fully focused on leasing—our Washington office team leased 2,848,000 squar e feet in 2003. He and David have become quite a team. Mike and I are delighted. When we acquired Smith our underwriting accounted for the fact that its largest tenant, the Patent and Trademark Of fice (PTO), would be relocating in late 2004 and 2005, vacating approximately 1.9 million square feet in Crystal City . Our underwriting accounted for this both in terms of price (9) —we acquired the portfolio at an above market 10.3% cap rate—and by mentally allocating $75 million for capital expenditures to re-lease these buildings. The table below shows the move-out schedule of PTO. <img src='content_image/105995.jpg'> (8) Smith also owns 4.8 million square feet inside the Beltway including 2.5 million square feet in the I-395 Corridor (Skyline), 1.5 million square feet in the District of Columbia and .8 million square feet in Rosslyn/Ballston and 1.7 million square feet outside the Beltway in Tysons Corner Reston and Bethesda. (9) Our purchase price for 100% of Smith was $2.45 billion based on a 10.3% cap rate on EBITDA. Same store EBITDA grew at the rate of 5% per annum to $278.7 million in 2003, which we believe would be valued in the current market at a cap rate in the 7s. But even at an 8% cap rate, we have a mark-to-market profit in this investment of approximately $1 billion. It’s not that simple, however In this acquisition we issued a security convertible into 5.7 million common shares at $44 and issued 15.6 million operating partnership units at $39. In effect, the sellers who took our shares instead of cash participated to the tune of 14% in the increase in value of the Smith assets and the Vornado assets as well.

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## Income Statement Data: <img src='content_image/86502.jpg'> (1) 2003 includes the Company’s $14,868 share of Alexander’ stock appreciation rights compensation expense. 2002 includes the Company’s $3,431 share of Alexander’s gain on sale of its Third Avenue property. Equity in income in 2001 includes (i) the Company’s $6,298 share of Alexander’ gain on sale of its Fordham Road property, (ii) a charge of $1,684 representing the Company’ share of abandoned development costs and (iii) $1,170 representing the Company’s share of Alexander’s gain on the early extinguishment of debt on its Fordham Road property Management and leasing fee income include $350 and $520 paid to the Company in 2002 and 2001 in connection with sales of real estate. (2) Alexander’s capitalizes the fees and interest charged by the Company Because the Company owns 33.1% of Alexander’s, the Company recognizes 66.9% of such amounts as income and the remainder is reflected as a reduction of the Company’s carrying amount of the investment in Alexander’s. (3) The Company owned a 34% interest in CESCR. On Januar 1, 2002, the Company acquired the remaining 66% of CESCR it did not previously own. Accordingly, CESCR is consolidated as of January 1, 2002. (4) Represents the Company’s interests in 330 Madison Avenue (24.8%), 825 Seventh Avenue (50%), Fairfax Square (20%), Kaempfer equity interests in six office buildings (.1% to 10%) and 570 Lexington Avenue (50%). On May 17, 2001, the Company sold its 50% interest in 570 Lexington Avenue for $60,000, resulting in a gain of $12,445 which is not included in income in the table above. (5) On June 11, 2003, the Company exercised its right to exchange the 3,972,447 units it owned in Prime Group Realty L.P. for 3,972,447 common shares in Prime Group Realty Trust (NYSE:PGE). Prior to the exchange, the Company accounted for its investment in the partnership on the equity method. Subsequent to the exchange, the Company is accounting for its investment in PGE as a marketable equity security-available for sale. ## Alexander’s The Company owns 1,655,000 common shares or 33.1% of the outstanding common stock of Alexander’s at December 31, 2003. Alexander’s is managed by and its properties ar leased and developed by the Company pursuant to management, leasing and development agreements with one-year terms expiring in March of each year, which are automatically renewable. In conjunction with the closing of the Alexander’s Lexington A venue construction loan on July 3, 2002, these agreements were revised to cover the Alexander’s Lexington Avenue property separately. Further, the Lexington Avenue management and development agreements were amended to provide for a term lasting until substantial completion of the development of the property, with automatic renewals, and for the payment of the development fee upon the earlier of January 3, 2006, or the payment in full of the construction loan encumbering the pr operty. The Company is entitled to a development fee estimated to

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## 6. Notes and Mortgage Loans Receivable ## GENERAL MOTORS BUILDING MEZZANINE LOANS On October 20, 2003, the Company made a $200,000,000 mezzanine loan secured by partnership interests in the General Motors Building. The Company’s loan is subordinate to $900,000,000 of other debt. The loan is based on a rate of LIBOR plus 8.685% (with a LIBOR floor of 1.5%) and currently yields 10.185%. On October 30, 2003, the Company made an additional $25,000,000 loan, as part of a $50,000,000 loan, the balance of which was funded by an affiliate of Soros Fund Management LLC. This loan, which is junior to the $1,100,000,000 of loans noted above, is based on a rate of LIBOR plus 12.81% (with a LIBOR floor of 1.5%) and currently yields 14.31%. The loans mature in October 2005, with three one-year extensions. ## LOAN TO COMMONWEALTH ATLANTIC PROPERTIES (“CAPI”) On March 4, 1999, the Company made an additional $242,000,000 investment in CESCR by contributing to CESCR the land under certain CESCR office properties in Crystal City Arlington, Virginia and partnership interests in certain CESCR subsidiaries. The Company acquired these assets from CAPI, an affiliate of Lazard Freres Real Estate Investors L.L.C., for $242,000,000, immediately prior to the contribution to CESCR. In addition, the Company acquired from CAPI for $8,000,000 the land under a Marriott Hotel located in Crystal City The Company paid the $250,000,000 purchase price to CAPI by issuing 4,998,000 of the Company’s Series E-1 convertible preferred units. In connection with these transactions, the Company agreed to make a five-year $41,200,000 loan to CAPI with interest at 8%, increasing to 9% ratably over the term. The loan is secured by approximately 1.1 million of the Company’ Series E-1 convertible preferred units issued to CAPI. Each Series E-1 convertible preferred unit is convertible into 1.1364 of the Company’ s common shares. As of December 31, 2003, the balance of the loan was $38,500,000. In February 2004, CAPI converted all of its Series E-1 units into 5,679,727 Vornado common shares. Subsequent to the conversion the loan is secured by 1,250,000 Vornado common shares. ## LOAN TO VORNADO OPERATING COMPANY (“VORNADO OPERATING”) At December 31, 2003, the amount outstanding under the r evolving credit agreement with Vornado Operating was $21,989,000. Vornado Operating has disclosed that ther is substantial doubt as to its ability to continue as a going concern and its ability to discharge its liabilities in the normal course of business. Vo rnado Operating has incurred losses since its inception and in the aggregate its investments do not, and for the foreseeable future are not expected to, generate sufficient cash flow to pay all of its debts and expenses. Vornado Operating estimates that it has adequate borrowing capacity under its credit facility with the Company to meet its cash needs until December 31, 2004. However, the principal, interest and fees outstanding under the line of credit come due on such date. Further, Vor nado Operating states that its only investee, AmeriCold Logistics (“Tenant”), anticipates that its Landlord, a partnership 60% owned by the Company and 40% owned by Crescent Real Estate Equities, will need to restructur the leases between the Landlord and the Tenant to provide additional cash flow to the Tenant (the Landlord has previously restructured the leases to pr ovide additional cash flow to the Tenant). Management anticipates a further lease restructuring in 2004, although the Landlor d is under no obligation to do so and there can be no assurance that it will do so. Vornado Operating is expected to have a sour ce to repay the debt under this facility from the lease restructuring or other options, although not by its original due date. Since January 1, 2002, the Company has not recognized interest income on the debt under this facility The Company has assessed the collectibility of this loan as of December 31, 2003 and determined that it is not impaired. ## DEARBORN CENTER MEZZANINE CONSTRUCTION LOAN On March 19, 2003, the outstanding amount of $29,401,000 was received from Dearborn representing the full satisfaction of the mezzanine construction loan. The loan bore interest at 12% per annum plus additional interest of $5,655,000 which was received upon repayment.

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OTHER On September 11, 2003, the Company made a loan of $7,300,000 to a non-affiliated party. The loan was collateralized by the borrower’s ownership of the 150,067 shares of Vornado Series C-1 convertible preferred operating partnership units and 202,411 Vornado Class A operating partnership units. On November 18, 2003, the Company acquired the units for $15,998,000 (equivalent to 373,952 Class A at $42.78 per unit) fr om the borrower for $8,698,000 in cash and the balance through the repayment of the loan. ## 7. Debt Following is a summary of the Company’s debt: <img src='content_image/110774.jpg'> See notes on following page

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<img src='content_image/39039.jpg'> (1) On February 5, 2004, the Company completed a $300,000 refinancing of Tw o Penn Plaza. The loan bears interest at 4.97% and matures in Februar 2011. The Company retained net proceeds of $39,000 after repaying the existing $151,000 loan, $75,000 of the $275,000 mortgage loan on its One Penn Plaza property and the $33,000 mortgage loan on 866 U.N. Plaza. (2) On June 9, 2003, the Company completed a $170,000 mortgage of its 770 Broadway property. The loan bears interest at LIBOR plus 1.05% is pre-payable after one year without penalty and matures in June 2006 with two-one year extension options. The pro- ceeds of the new loan were used primarily to repay (i) a $18,926 mortgage loan on 33 North Dearborn, (ii) a $69,507 mortgage loan on Tysons Dulles Plaza, and (iii) $40,000 of borrowing under the Company’ s unsecured revolving credit facility. In connection with the closing of the 770 Broadway loan, the Company purchased an interest rate cap, and simultaneously sold an interest rate cap with the same terms. Since these instruments do not reduce the Company’ s net interest rate risk exposure, they do not qualify as hedges and changes in their respective values are charged to earnings. As the significant terms of these arrangements are the same, the effects of a revaluation of these instruments is expected to substantially offset one another. Simultaneously with the com- pletion of the 770 Broadway loan, the Company used cash from its mortgage escrow account to repay $133,659 of the $153,659 of debt previously cross-collateralized by its 770 Broadway and 595 Madison A venue properties. (3) On August 4, 2003, the Company completed a refinancing of its 909 Third A venue mortgage loan. The new $125,000 mortgage loan is for a term of three years and bears interest at LIBOR plus .70% and has two one-year extension options. Simultaneously with the completion of the 909 Third Avenue loan, the Company used cash from its mortgage escrow account to repay the balance of $20,000 of debt previously cross-collateralized by its 770 Broadway and 595 Madison Avenue properties. In connection with the closing of the 909 Third Avenue loan, the Company purchased an interest rate cap and simultaneously sold an interest rate cap with the same terms. Since these instruments do not reduce the Company’ s net interest rate risk exposure, they do not qualify as hedges and changes in their respective values are charged to earnings. As the significant terms of these arrangements are the same, the effects of a revaluation of these instruments is expected to substantially offset one another. (4) On July 31, 2003, the Company replaced the mortgage on the Commerce Executive property with (i) a new $43,000 non-recourse mortgage loan at LIBOR plus 1.50% with a two-year term and one-year extension option and (ii) a $10,000 unsecured loan for three years at LIBOR plus .65% with a one-year extension option. (5) On June 24, 2002, the Company completed an offering of $500,000 aggregate principal amount of 5.625% senior unsecured notes due June 15, 2007. Interest on the notes is payable semi-annually on June 15th and December 15th, commencing December 15, 2002. The notes were priced at 99.856% of their face amount to yield 5.659%. The net proceeds of approximately $496,300 were used to repay the mortgages payable on 350 North Orleans, T wo Park Avenue, the Merchandise Mart and Seven Skyline. On June 27, 2002, the Company entered into interest rate swaps that effectively converted the interest rate on the $500,000 senior unsecured notes due 2007 from a fixed rate of 5.625% to a floating rate of LIBOR plus .7725%, based upon the trailing 3 month LIBOR rate (2.15% if set on December 31, 2002). As a result of the hedge accounting for the interest rate swap on the Company’ senior unsecured debt, the Company recorded a fair value adjustment of $34,245, as of December 31, 2002 which is equal to the fair value of the interest rate swap asset. The fair value of the swap was $25,780 on December 31, 2003.

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These costs will be recorded as a reduction to earnings in arriving at net income applicable to common shares, in accordance with the July 2003 EITF clarification of Topic D-42. ## SERIES C PREFERRED SHARES OF BENEFICIAL INTEREST Holders of Series C Preferred Shares of beneficial interest ar e entitled to receive dividends at an annual rate of 8.5% of the liquidation preference, or $2.125 per Series C Preferred Share per annum. These dividends are cumulative and payable quarterly in arrears. The Series C Preferred Shares ar not convertible into or exchangeable for any other property or any other securities of the Company at the election of the holders. However, subject to certain limitations relating to the source of funds used in connection with any such redemption, on or after May 17, 2004 (or sooner under limited circumstances), the Company, at its option, may redeem Series C Preferred Shares at a r edemption price of $25.00 per share, plus any accrued and unpaid dividends through the date of redemption. The Series C Pr eferred Shares have no maturity date and will remain outstanding indefinitely unless redeemed by the Company. ## SERIES D-10 PREFERRED SHARES OF BENEFICIAL INTEREST Holders of Series D-10 Preferred Shares of beneficial inter est are entitled to receive dividends at an annual rate of 7.0% of the liquidation preference, or $1.75 per Series D-10 Preferr ed Share per annum. These dividends are cumulative and payable quarterly in arrears. The Series D-10 Preferred Shares ar e not convertible into or exchangeable for any other property or any other securities of the Company at the election of the holders. On or after November 17, 2008 (or sooner under limited circumstances), the Company, at its option, may redeem Series D-10 Preferred Shares at a redemption price of $25.00 per share, plus any accrued and unpaid dividends through the date of redemption. The Series D-10 Preferred Shares have no maturity date and will remain outstanding indefinitely unless redeemed by the Company. ## 9. Stock-based Compensation The Company’s Share Option Plan (the “Plan”) provides for grants of incentive and non-qualified stock options, restricted stock, stock appreciation rights and performance shares to certain employees and officers of the Company. Restricted stock awards ar granted at the market price on the date of grant and vest over a 3 to 5 year period. The Company recognizes the value of restricted stock as compensation expense based on the Company’s closing stock price on the NYSE on the date of grant on a straight-line basis over the vesting period. As of December 31, 2003, there are 246,030 restricted shares outstanding, excluding 626,566 shares issued to the Company’s President in connection with his employment agreement. The Company recognized $2,599,000 and $1,868,000 of compensation expense in 2003 and 2002 for the portion of these shares that vested during each year Dividends paid on both vested and unvested shares are charged directly to retained earnings and amounted to $777,700 and $210,100 for 2003 and 2002, respectively. Dividends on shares that are cancelled or terminated prior to vesting are charged to compensation expense in the period of the cancellation or termination. Stock options are granted at an exercise price equal to 100% of the market price of the Company’s stock on the date of grant, vest pro-rata over three years and expire 10 years from the date of grant. As of December 31, 2003 there are 14,153,587 options outstanding, of which 125,000 wer granted during 2003. On January 1, 2003, the Company elected to adopted SFAS 123—Accounting for Stock Based Compensation, on a pr ospective basis covering all grants subsequent to 2002. Under SFAS 123, the Company recognizes compensation expense for the fair value of options granted on a straight-line basis over the vesting period. For the year ended December 31, 2003, the Company recognized $77,200 of compensation expense related to the options granted during 2003. Grants prior to 2003 are accounted for under the intrinsic value method under which compensation expense is measured as the excess, if any , of the quoted market price of the Company’s stock at the date of grant over the exercise price of the option granted. As the Company’s policy is to grant options with an exercise price equal to 100% of the quoted market price on the grant date, no compensation expense has been recognized for options granted prior to 2003. If compensation cost for grants prior to 2003 were recognized as compensation expense based on the fair value at the grant dates, net income and income per shar would have been reduced to the pro-forma amounts below:

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<img src='content_image/88538.jpg'> The fair value of each option grant is estimated on the date of grant using an option-pricing model with the following weighted-average assumptions used for grants in the periods ending December 31, 2003, 2002 and 2001. December 31, <img src='content_image/88545.jpg'> A summary of the Plan’ status and changes during the years then ended, is presented below: <img src='content_image/88544.jpg'> The following table summarizes information about options outstanding under the Plan at December 31, 2003: <img src='content_image/88543.jpg'> Shares available for futur grant under the Plan at December 31, 2003 were 9,728,792, of which 2,500,000 are subject to shareholder approval.

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## 10. Retirement Plan The Company has two defined benefit pension plans (the “Plans”), a Vornado Realty Trust Retirement Plan (“Vornado Plan”) and a Merchandise Mart Properties Pension Plan (“Mart Plan”). Benefits under the Plans were primarily based on the employee’s years of service and compensation during employment. The Company’s funding policy for the Plans is based on contributions at the minimal amounts required by law The benefits under the Vornado Plan and the Mart Plan were frozen in December 1997 and June 1999, respectively. The Company uses a December 31 measurement date for the Vornado Plan and the Mart Plan. OBLIGATIONS AND FUNDED STATUS The following table sets forth the Plans’ funded status and amounts recognized in the Company’s balance sheets: <img src='content_image/129626.jpg'>

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# INDISPENSABLE GLOBAL INFORMATION 2 5 Besäfkimie m] Heil Heil ## SCIENCE & MEDICAL LIFE SCIENCES > NEUROSCIENCE > CHEMISTRY > MATHEMATICS > PHYSICS > DECISION SCIENCES > SOCIAL AND BEHAVIOURAL SCIENCES > MEDICINE > NURSING > DENTISTRY > VETERINARY SCIENCE STATUTES > CASE LAW > COMMENTARIES > CITATIONS > TAX INFORMATION> DIRECTORIES > COURT RECORDS > LEGAL DISCOVERY > BUSINESS INFORMATION> RISK SOLUTIONS > CONGRESSIONAL INFORMATION <img src='content_image/1417.jpg'> ## LEGAL ANNUAL REPORTS AND FINANCIAL STATEMENTS 2003 For the Reed Elsevier Combined Businesses, Reed Elsevier PLC and Reed Elsevier NV ELEMENTARY > SECONDARY > SUPPLEMENTAL > ASSESSMENT > E-LEARNING > PROFESSIONAL DEVELOPMENT > TEACHING SUPPORT > LIBRARY MATERIALS > CLINICAL TESTING Bea ## EDUCATION AEROSPACE > COMMUNICATIONS > MEDIA AND ENTERTAINMENT > IT > BUILDING AND CONSTRUCTION > LOGISTICS AND DISTRIBUTION > SOCIAL CARE > SPORT AND LEISURE > FOOD AND HOSPITALITY > AGRICULTURE > MANUFACTURING ## BUSINESS

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## Contents 01 Financial highlights 03 Operating and financial review 22 Structure and corporate governance 27 Report of the audit committees 29 Directors’ remuneration report ## Reed Elsevier combined financial statements 40 Accounting policies 42 Combined financial statements 46 Notes to the combined financial statements 70 Independent auditors’ report ## Reed Elsevier PLC annual report and financial statements 72 Financial highlights 73 Directors’ report 76 Accounting policies 77 Financial statements 81 Notes to the financial statements 88 Independent auditors’ report ## Reed Elsevier NV annual report and financial statements 90 Financial highlights 91 The Supervisory Board’s report 91 The Executive Board’s report 92 Accounting policies 94 Financial statements 97 Notes to the financial statements 104 Independent auditors’ report 104 Other information ## Additional information for US investors 106 Reed Elsevier combined businesses 111 Reed Elsevier PLC 113 Reed Elsevier NV 115 Principal operating locations This document contains Annual Reports information and the Financial Statements in respect of the Reed Elsevier combined businesses and the two parent companies, Reed Elsevier PLC and Reed Elsevier NV. This, together with the separate summary document Reed Elsevier Annual Review and Summary Financial Statements 2003, forms the Annual Reports and Financial Statements of Reed Elsevier PLC and Reed Elsevier NV for the year ended 31 December 2003 and the two documents should be read together.

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<img src='content_image/66465.jpg'> revenues continue to grow strongly, albeit from a much smaller base than in Science & Technology, from the expansion of online services in addition to migration from print subscriptions. Demand from the pharmaceutical industry for projects and conferences was however weaker leading to consolidation of these activities. The International business was expanded in the year through more aggressive versioning and distribution of international content in local markets and the acquisition of the Holtzbrinck STM publishing business, adding high quality German language medical publishing and strong local market and distribution channels for other international content. Significant investments continue to be made in ScienceDirect, most particularly in new navigation services, and in web platforms to support the launch of new online products within Health Sciences. Continued action on costs, including further benefits of integration of the Harcourt STM businesses, funded increases in investment and improved the adjusted overall margin, i.e. before exceptional items and the amortisation of goodwill and intangible assets, by 0.7 percentage points. The outlook for the Science & Medical business is good. Although academic institutional and corporate budgets remain under pressure, Elsevier continues to see strong subscription renewals and take up of its electronic products. Investment in content and new online services is being increased to address further market opportunities.

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## Cash flow statement 10 ## Reconciliation of operating loss to net cash outflow from operating activities <img src='content_image/115096.jpg'> ## Reconciliation of net funding balances with joint ventures <img src='content_image/115097.jpg'> ## Fixed asset investments – group 11 ## Gross equity accounted investments in joint ventures <img src='content_image/115098.jpg'> The investment in joint ventures comprises the group share at the following amounts of: <img src='content_image/115099.jpg'> Included within share of current assets and creditors are cash and short term investments of € 446m (2002: € 421m) and borrowings of € 2,130m (2002: € 2,520m) respectively.

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## Fixed asset investments – parent company 12 <img src='content_image/61.jpg'> ## Debtors 13 <img src='content_image/60.jpg'> Amounts falling due after more than one year are € nil (2002: € nil). ## Creditors: amounts falling due within one year 14 <img src='content_image/59.jpg'> ## Creditors: amounts falling due after more than one year 15 <img src='content_image/57.jpg'> Debenture loans comprise four convertible personnel debenture loans with a weighted average interest rate of 5.2%. Depending on the conversion terms, the surrender of € 227 or € 200 par value debenture loans qualifies for the acquisition of 20-50 Reed Elsevier NV ordinary shares.

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## Share option schemes 16 During the year a total of 405,812 ordinary shares in the company, having a nominal value of € 0.02m, were allotted in connection with the exercise of share options. The net consideration received by the company was € 3m. Share options are granted under the Reed Elsevier Group plc Executive Share Option Scheme, the Reed Elsevier Group plc Senior Executive Long Term Incentive Scheme, and, prior to 1999, under the Reed Elsevier NV share option scheme. In addition nil cost options were granted to certain senior executives. Share options will generally be met by the issue of new Reed Elsevier NV shares. Certain share options will be met by the Reed Elsevier Employee Benefit Trust ("EBT") from shares purchased in the market. A summary of the movement in share options is presented in the table below: <img src='content_image/6330.jpg'> The average exercise price of share options outstanding at the end of the year was € 11.62 (2002: € 12.36) and the average term of these options is four years (2002: four years). ## Called up share capital 17 <img src='content_image/6328.jpg'> The R-shares are held by a subsidiary company of Reed Elsevier PLC. The R-shares are convertible at the election of the holder into ten ordinary shares each. They have otherwise the same rights as the ordinary shares, except that Reed Elsevier NV may pay a lower dividend on the R-shares.

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## Shareholders' funds 18 <img src='content_image/76081.jpg'> Other than in respect of the representation of shares held in treasury (see note 20), the adoption of UK GAAP by Reed Elsevier NV had no impact on group shareholders’ funds as at 1 January 2003 or on the group earnings for the year ended 31 December 2003. The adoption of UK GAAP had the effect of reducing parent company shareholders’ funds as at 1 January 2003 by € 34m and parent company attributable profit for the year ended 31 December 2003 by € 39m compared to the amounts that would have been reported under Dutch GAAP. Within paid-in surplus, an amount of € 1,286m (2002: € 1,283m) is free of tax. Details of shares held in treasury are provided in note 26 to the combined financial statements. A reconciliation between the parent company profit attributable to ordinary shareholders and the group profit attributable to ordinary shareholders presented under the gross equity method is provided below: 2003 <img src='content_image/76083.jpg'> A reconciliation between the parent company shareholders’ funds and group shareholders’ funds presented under the gross equity method is provided below: <img src='content_image/76085.jpg'>

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## Contingent liabilities 19 There are contingent liabilities in respect of borrowings of Reed Elsevier Group plc group and Elsevier Reed Finance BV group guaranteed by Reed Elsevier NV as follows: <img src='content_image/48884.jpg'> Financial instruments disclosures in respect of the borrowings covered by the above guarantees are given in note 22 to the Reed Elsevier combined financial statements. ## Prior year adjustment 20 In accordance with UITF38: Accounting for ESOP Trusts issued in December 2003 by the Urgent Issues Task Force of the UK Accounting Standards Board, the Reed Elsevier combined businesses now present the shares in Reed Elsevier PLC and Reed Elsevier NV held by the Reed Elsevier Group plc Employee Benefit Trust as shares held within treasury, which are deducted within combined shareholders' funds. Previously, such shares were included within the other fixed asset investments of the combined businesses. The group balance sheet as at 31 December 2002 has been restated to reflect Reed Elsevier NV's share of the restatement made in the combined financial statements in relation to the presentation of shares held in treasury. ## Principal joint ventures 21 The principal joint ventures are: <img src='content_image/48883.jpg'> The "R" shares in Reed Elsevier Group plc and Elsevier Reed Finance BV are owned by Reed Elsevier PLC. In addition, Reed Elsevier NV holds € 0.14m par value in shares with special dividend rights in Reed Elsevier Overseas BV and Reed Elsevier Nederland BV, both with registered offices in Amsterdam. These shares are included in the amount shown under investments in joint ventures. They enable Reed Elsevier NV to receive dividends from companies within the same tax jurisdiction. A list of companies within the Reed Elsevier combined businesses is filed with the Amsterdam Chamber of Commerce in the Netherlands. M Tabaksblat Chairman M H Armour Chief Financial Officer

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## Independent auditors’ report to the shareholders of Reed Elsevier NV We have audited the 2003 financial statements of Reed Elsevier NV, Amsterdam, which comprise the accounting policies, the profit and loss account, cash flow statement, reconciliation of shareholders’ funds, balance sheet, the statement of total recognised gains and losses and the related notes 1 to 21. These financial statements have been prepared under the accounting policies set out therein and include the Reed Elsevier combined financial statements for the year ended 31 December 2003 which comprise the accounting policies, the profit and loss account, the balance sheet, the cash flow statement, the statement of total recognised gains and losses, the shareholders’ funds reconciliation and the related notes 1 to 28, having been prepared under the accounting policies set out therein, dated 18 February 2004. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. ## Basis of audit opinion We conducted our audit in accordance with auditing standards generally accepted in the Netherlands. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. ## Opinion In our opinion, the financial statements of Reed Elsevier NV, which include the Reed Elsevier combined financial statements, give a true and fair view of the financial position of Reed Elsevier NV at 31 December 2003 and the result and the cash flows for the year then ended in accordance with accounting principles generally accepted in the United Kingdom and comply with the legal requirements for financial statements as included in Book 2 Title 9 of the Netherlands Civil Code. ## Deloitte Accountants Amsterdam 18 February 2004 <img src='content_image/83847.jpg'> The combined Supervisory and Executive Board determines the part of the profit to be retained. The profit to be distributed is paid on the ordinary shares and the R-shares in proportion to their nominal value. The combined board may resolve to pay less per R-share, but not less than 1% of the nominal value. The company is bound by the Governing Agreement with Reed Elsevier PLC, which provides that Reed Elsevier NV shall declare dividends such that the dividend on one Reed Elsevier NV ordinary share, which shall be payable in euros, will equal 1.538 times the dividend, including the related UK tax credit, paid on one Reed Elsevier PLC ordinary share.

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## Additional information for US investors ADDITIONAL INFORMATION FOR US INVESTORS 106 Reed Elsevier combined businesses 111 Reed Elsevier PLC 113 Reed Elsevier NV

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## ADDITIONAL INFORMATION FOR US INVESTORS > REED ELSEVIER COMBINED BUSINESSES ## Summary financial information in US dollars ## Basis of preparation The summary financial information is a simple translation of the Reed Elsevier combined financial statements into US dollars at the stated rates of exchange. The financial information provided below is prepared under UK GAAP as used in the preparation of the Reed Elsevier combined financial statements. It does not represent a restatement under US GAAP which would be different in some significant respects. <img src='content_image/29685.jpg'> ## Profit and loss account <img src='content_image/29684.jpg'> Adjusted figures are used by Reed Elsevier as additional performance measures and are stated before the amortisation of goodwill and intangible assets and exceptional items. ## Cash flow statement <img src='content_image/29683.jpg'> Reed Elsevier businesses focus on adjusted operating cash flow as a key cash flow measure. Adjusted operating cash flow is measured after dividends from joint ventures, tangible fixed asset spend and proceeds from the sale of tangible fixed assets but before exceptional payments and proceeds. Adjusted operating cash flow conversion expresses adjusted operating cash flow as a percentage of adjusted operating profit.

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## Summary financial information in US dollars (continued) ## Balance sheet As at 31 December 2003 <img src='content_image/91745.jpg'>

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## Summary of the principal differences to US GAAP The combined financial statements are prepared in accordance with UK GAAP, which differ in certain significant respects to US GAAP. The principal differences that affect net income and combined shareholders’ funds are explained below and their approximate effect is shown on page 110. The Reed Elsevier Annual Report 2003 on Form 20-F provides further information for US investors. ## Goodwill and intangible assets Under UK GAAP, acquired goodwill and intangible assets are capitalised and amortised systematically over their estimated useful lives up to a maximum of 40 years, subject to impairment review. Under US GAAP, acquired goodwill and intangible assets are accounted for in accordance with SFAS141: Business Combinations and SFAS142: Goodwill and Other Intangible Assets. In accordance with these SFAS, goodwill and intangible assets with indefinite lives are not amortised and are subject to at least annual impairment review. Other intangible assets with definite lives are amortised over periods up to 40 years, also subject to annual impairment review under SFAS144. Under US GAAP, as at 31 December 2003, the carrying value of goodwill is £3,045m (2002: £3,225m), the gross cost of intangible assets is £5,000m (2002: £5,264m) and accumulated amortisation of intangible assets is £1,522m (2002: £1,352m). ## Deferred taxation Under UK GAAP, the combined businesses provide in full for timing differences using the liability method. Under US GAAP, deferred taxation is provided on all temporary differences under the liability method subject to a valuation allowance on deferred tax assets where applicable, in accordance with SFAS109: Accounting for Income Taxes. The most significant adjustment to apply SFAS109 arises on the recognition of a deferred tax liability in respect of acquired intangible assets for which amortisation is not tax deductible. Under the timing difference approach applied under UK GAAP, no such liability would be recognised. ## Pensions Under UK GAAP, the combined businesses account for pension costs under the rules set out in SSAP24: Accounting for Pension Costs. Its objectives and principles are broadly in line with SFAS87: Employers’ Accounting for Pensions. However, SSAP24 is less prescriptive in the application of the actuarial methods and assumptions to be applied in the calculation of pension assets, liabilities and costs. Under UK GAAP, pension plan assets and liabilities are based on the results of the latest actuarial valuation. Pension assets are valued at the discounted present value determined by expected future income. Liabilities are assessed using the expected rate of return on plan assets. Under US GAAP, plan assets are valued by reference to market-related values at the date of the financial statements. Liabilities are assessed using the rate of return obtainable on fixed or inflation-linked bonds. ## Stock based compensation Under US GAAP, the combined businesses apply the accounting requirements of APB25: Accounting for Stock Issued to Employees and related interpretations in accounting for stock based compensation. Under APB25 compensatory plans with performance criteria qualify as variable plans, for which total compensation cost must be recalculated each period based on the current share price. The total compensation cost is amortised over the vesting period. Under UK GAAP, compensation cost is determined based on a comparison of the exercise price with the share price on the date of grant. Also under US GAAP, SFAS123: Accounting for Stock Based Compensation establishes a fair value based method of computing compensation cost. It encourages the application of this method in the profit and loss account but, where APB25 is applied, the proforma effect on net income must be disclosed. The disclosure only provisions of SFAS123, as amended by SFAS148: Accounting for Stock Based Compensation – Transition and Disclosure, have been adopted. If compensation costs based on fair value at the grant date had been recognised in the profit and loss account, net income under US GAAP would have been reduced by £43m in 2003 (2002: £36m). ## Derivative instruments Under US GAAP, SFAS133: Accounting for Derivative Instruments and Hedging Activities requires all derivative instruments to be carried at fair value on the balance sheet. Changes in fair value are accounted for through the profit and loss account or comprehensive income statement, depending on the derivative’s designation and effectiveness as a hedging instrument. Certain derivative instruments used by Reed Elsevier have not been designated as qualifying hedge instruments under SFAS133 and, accordingly, a charge or credit as appropriate to net income is recorded under US GAAP for the changes in the fair value of those derivative instruments. Under UK GAAP, derivative instruments intended as hedges are recorded at appropriate historical cost amounts, with fair values shown as a disclosure item. The adoption of SFAS133, which was effective from

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## LEGAL <img src='content_image/79949.jpg'> The LexisNexis business has continued to perform well in markets seeing slower growth. The US legal business is performing ahead of the market, whilst the continued slow down within US corporate and federal markets for corporate business information has been offset by the stronger growth in the risk solutions business. Continued investment is being made in new content and online services whilst further cost actions have improved operational efficiency and margins. Revenues and adjusted operating profits increased by 3% and 10% respectively at constant exchange rates, or 3% and 8% excluding acquisitions and disposals. LexisNexis North America saw underlying revenue growth at 2% held back by the late cycle impact of the economic slowdown, particularly in corporate markets. Outside the US, revenue growth before acquisitions was 4% which, while seeing similar weakness in UK corporate information markets, saw strong growth in Asia-Pacific. Adjusted operating margins improved by 1.5 percentage points to 22.8% as a result of the continued action to improve efficiency and release funds for investment. In US legal markets, revenues grew by 3%. Online revenue growth was 7% with good growth in national law firms and, in particular, in the small law firm market. Print and CD sales were marginally lower as the market continues to move online. The legal directories business again performed well with strong renewals and expanded web services. In US corporate and federal markets, underlying revenues were flat. Strong growth in the risk solutions business was offset by declines in corporate and academic information markets reflecting the difficult budgetary environment. Continued action on the cost base funded further increases in investment and delivered underlying operating profit growth in LexisNexis North America of 10%.

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1 January 2001, resulted in a cumulative transition adjustment in other comprehensive income, of which £7m was charged to US GAAP net income in 2003 (2002: £7m). ## Equity dividends Under UK GAAP, dividends are provided for in the year in respect of which they are proposed by the directors. Under US GAAP, such dividends would not be provided for until they are formally declared by the directors. ## Available for sale investments Under UK GAAP, fixed asset investments (excluding investments in joint ventures) are recorded at historical cost less provision for any impairment in value. Under US GAAP, investments in equity securities with readily determinable fair values are classified as available for sale and are reported at fair value, with unrealised gains or losses reported as a separate component of shareholders’ funds. ## Acquisition accounting Under UK GAAP, severance and integration costs in relation to acquisitions are expensed as incurred and, depending on their size and incidence, these costs may be disclosed as exceptional items charged to operating profit. Under US GAAP, certain integration costs may be provided for as part of purchase accounting adjustments on acquisition. ## Exceptional items Exceptional items are material items within the combined businesses’ ordinary activities which, under UK GAAP, are required to be disclosed separately due to their size or incidence. These items do not qualify as extraordinary under US GAAP. ## Adjusted earnings In the combined financial statements adjusted profit and cash flow measures are presented as permitted by UK GAAP as additional performance measures. US GAAP does not permit the presentation of alternative earnings measures. ## Short term obligations expected to be refinanced Under US GAAP, where it is expected to refinance short term obligations on a long term basis and this is supported by an ability to consummate the refinancing, such short term obligations should be excluded from current liabilities and shown as long term obligations. Under UK GAAP, such obligations can only be excluded from current liabilities where, additionally, the debt and facility are under a single agreement or course of dealing with the same lender or group of lenders. Short term obligations at 31 December 2003 of £1,182m (2002: £1,359m) would be excluded from current liabilities under US GAAP and shown as long term obligations.

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## Effects on net income of material differences to US GAAP <img src='content_image/33169.jpg'> ## Effects on combined shareholders’ funds of material differences to US GAAP <img src='content_image/33168.jpg'>

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## Summary financial information in US dollars ## Basis of preparation The summary financial information is a simple translation of Reed Elsevier PLC’s consolidated financial statements into US dollars at the stated rates of exchange. The financial information provided below is prepared under UK GAAP as used in the preparation of the Reed Elsevier PLC consolidated financial statements. It does not represent a restatement under US GAAP which would be different in some significant respects. ## Exchange rates for translation of sterling ($:£1) <img src='content_image/109257.jpg'> ## Consolidated profit and loss account <img src='content_image/109256.jpg'> ## Data per American Depositary Share <img src='content_image/109255.jpg'> ## Consolidated balance sheet <img src='content_image/109254.jpg'> Adjusted earnings per American Depositary Share is based on Reed Elsevier PLC shareholders’ 52.9% share of the adjusted profit attributable of the Reed Elsevier combined businesses, which excludes amortisation of goodwill and intangible assets and exceptional items. Adjusted figures are described in note 9 to the Reed Elsevier PLC consolidated financial statements. Reed Elsevier PLC shares are quoted on the New York Stock Exchange and trading is in the form of American Depositary Shares (“ADSs”), evidenced by American Depositary Receipts (“ADRs”), representing four Reed Elsevier PLC ordinary shares of 12.5p each. (CUSIP No. 758205108; trading symbol, RUK; Bank of New York is the ADS Depositary.)

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## Summary of the principal differences between UK and US GAAP Reed Elsevier PLC accounts for its 52.9% economic interest in the Reed Elsevier combined businesses, before the effect of tax credit equalisation, using the gross equity method in conformity with UK GAAP which is similar to the equity method in US GAAP. Using the equity method to present its net income and shareholders’ funds under US GAAP, Reed Elsevier PLC reflects its 52.9% share of the effects of differences between UK and US GAAP relating to the combined businesses as a single reconciling item. The most significant differences relate to the capitalisation and amortisation of goodwill and intangibles, pensions, deferred taxes and derivative financial instruments. A more complete explanation of the accounting policies used by the Reed Elsevier combined businesses and the differences between UK and US GAAP is given on pages 108 and 109. The Reed Elsevier Annual Report 2003 on Form 20-F provides further information for US investors. ## Effects on net income of material differences between UK and US GAAP <img src='content_image/100565.jpg'> ## Effects on shareholders’ funds of material differences between UK and US GAAP <img src='content_image/100566.jpg'>

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## Summary financial information in US dollars ## Basis of preparation The summary financial information is a simple translation of the Reed Elsevier NV group financial statements into US dollars at the stated rates of exchange. The financial information provided below is prepared under UK GAAP as used in the preparation of the Reed Elsevier NV statutory financial statements. It does not represent a restatement under US GAAP which would be different in some significant respects. ## Exchange rates for translation of euros ( € :$1) <img src='content_image/6191.jpg'> ## Group profit and loss account For the year ended 31 December 2003 <img src='content_image/6195.jpg'> ## Data per American Depositary Share <img src='content_image/6196.jpg'> ## Group balance sheet As at 31 December 2003 <img src='content_image/6200.jpg'> Adjusted earnings per American Depositary Share is based on Reed Elsevier NV’s 50% share of the adjusted profit attributable of the Reed Elsevier combined businesses, which excludes amortisation of goodwill and intangible assets and exceptional items. Adjusted figures are described in note 8 to the Reed Elsevier NV statutory financial statements. Reed Elsevier NV shares are quoted on the New York Stock Exchange and trading is in the form of American Depositary Shares (“ADSs”), evidenced by American Depositary Receipts (“ADRs”), representing two Reed Elsevier NV ordinary shares of € 0.06 each. (CUSIP No. 758204101; trading symbol, ENL; Bank of New York is the ADS Depositary.)

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## Summary of the principal differences between UK and US GAAP Reed Elsevier NV accounts for its 50% economic interest in the Reed Elsevier combined businesses, before the effect of tax credit equalisation, using the gross equity method in its group financial statements. Using the equity method to present its net income and shareholders’ funds under US GAAP, Reed Elsevier NV reflects its 50% share of the effects of differences between UK and US GAAP relating to the combined businesses as a single reconciling item. The most significant differences relate to the capitalisation and amortisation of goodwill and intangibles, pensions, deferred taxes and derivative financial instruments. A more complete explanation of the accounting policies used by the Reed Elsevier combined businesses and the differences between UK and US GAAP is given on pages 108 and 109. The Reed Elsevier Annual Report 2003 on Form 20-F provides further information for US investors. ## Effects on group net income of material differences between UK and US GAAP <img src='content_image/16603.jpg'> ## Effects on group shareholders’ funds of material differences between UK and US GAAP <img src='content_image/16604.jpg'>

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## Reed Elsevier 1-3 Strand, London, WC2N 5JR, UK Tel: +44 (0)20 7930 7077 Fax: +44 (0)20 7166 5799 Sara Burgerhartstraat 25 1055 KV Amsterdam, The Netherlands Tel: +31 (0)20 485 2434 Fax: +31 (0)20 618 0325 125 Park Avenue, 23rd Floor New York, NY 10017, USA Tel: +1 212 309 5498 Fax: +1 212 309 5480 ## Elsevier Reed Finance BV Sara Burgerhartstraat 25 1055 KV Amsterdam, The Netherlands Tel: +31 (0)20 485 2434 Fax: +31 (0)20 618 0325 ## Elsevier Elsevier Sara Burgerhartstraat 25 1055 KV Amsterdam, The Netherlands www.elsevier.com Elsevier The Boulevard, Langford Lane Kidlington, Oxford OX5 1GB, UK www.elsevier.com Elsevier 360 Park Avenue South New York NY 10010-1710, USA www.elsevier.com Elsevier Independence Square West Suite 300, The Curtis Centre Philadelphia, PA 19106-3399, USA www.us.elsevierhealth.com Elsevier 11830 Westline Industrial Drive St. Louis, M063146, USA www.us.elsevierhealth.com ## LexisNexis LexisNexis US 9393 Springboro Pike Miamisburg, Ohio 45342, USA www.lexisnexis.com LexisNexis US 121 Chanlon Road New Providence, N107974, USA www.martindale.com For further information or contact details, please consult our website: www.reedelsevier.com LexisNexis UK Halsbury House, 35 Chancery Lane London WC2A 1EL, UK www.lexisnexis.co.uk LexisNexis Juris Classeur 141 rue de Javel, 75747 Paris Cedex 15 France www.lexisnexis.fr ## Harcourt Education Harcourt School Publishers 6277 Sea Harbor Drive Orlando FL 32819, USA www.harcourtschool.com Holt Rinehart and Winston 10801 N. MoPac Expressway Building 3, Austin, TX 78759-5415, USA www.hrw.com Harcourt Assessment 19500 Bulverde Road San Antonio TX 78259, USA www.harcourtassessment.com Harcourt Achieve 10801 N. MoPac Expressway Building 3, Austin, TX 78759-5415, USA www.harcourtachieve.com Harcourt Education International Halley Court, Jordan Hill Oxford OX2 8EJ, UK www.harcourteducation.co.uk ## Reed Business Reed Business Information US 360 Park Avenue South New York NY 10010-1710, USA www.reedbusiness.com Reed Business Information UK Quadrant House, The Quadrant Sutton, Surrey SM2 5AS, UK www.reedbusiness.co.uk Reed Business Information Netherlands Hanzestraat 1 7006 RH Doetinchem The Netherlands www.reedbusiness.nl Reed Exhibitions Oriel House, 26 The Quadrant Richmond, Surrey TW9 1DL, UK www.reedexpo.com Design: Corporate Edge www.corporateedge.com Print: Pillans & Waddies. ISO 14001 accredited

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<img src='content_image/114420.jpg'> www.reedelsevier.com

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## OPERATING AND FINANCIAL REVIEW <img src='content_image/129321.jpg'> The LexisNexis International businesses outside North America saw revenues and adjusted operating profits up 4% and 2% respectively at constant exchange rates before acquisitions. Strong growth in online sales of legal, tax and regulatory product across all major markets was in part offset by print migration and by weakness in demand in the UK for corporate news and business information. Underlying operating margins were broadly maintained, despite increased investment in new online services and expansion of the business in Germany, as a result of continued cost actions, most particularly in rationalisation of editorial and production processes within Europe. LexisNexis is continuing to invest in new content and improved online functionalities for its core products as well as expanding into contiguous markets through investment in new development and acquisitions. Good further progress has been made in expanding coverage of annotated codes for individual states and in case law summaries. The first development phase of the global online delivery platform has been completed, with the launch of services on the new platform in France, with the UK and Australia to follow later in the year, significantly enhancing product functionality and, after the initial launch phases, delivering greater operational efficiency. Two acquisitions made in the second half of the year in the US have expanded LexisNexis’ position in fast growing contiguous markets. Applied Discovery Inc is the leading provider in the US of electronic discovery services, which is a rapidly growing market. The public records business of Dolan Media, including important electronic information on court judgements and liens, has further expanded LexisNexis’ position in the strongly growing risk management market. Courtlink, the leading provider of electronic court document filing and court access services acquired just over two years ago, is continuing to grow strongly as these markets expand. LexisNexis is increasing investment behind faster growth opportunities, to continue to drive above market revenue growth and which positions the business well for the future. The outlook for the LexisNexis business is good. Revenue growth is being stimulated by new publishing and product initiatives and the declines seen in corporate and business information markets appear to be abating. Increases in investment are expected to be funded by the actions taken to further improve operational efficiency.

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## EDUCATION <img src='content_image/54058.jpg'> The Harcourt Education business performed well given the difficult schools markets, with education budgets under pressure and a trough in the US state textbook adoption cycle, and the effect on revenues of past contract losses. Harcourt performed well in new US state textbook adoptions and saw good growth in backlist sales and non-adoption states. Revenues, before acquisitions and disposals, were 2% lower than in the prior year whilst adjusted operating profits were 3% ahead at constant exchange rates. Excluding the impact of the loss of the California state testing contract announced in 2002, underlying revenue growth would have been 1-2%, broadly in line with the market. Despite lower revenues, adjusted operating margins improved by 1.0 percentage points to 19.4% as substantial cost savings were realised from rationalisation of editorial and production processes and further integration. The Harcourt US K-12 schools business performed well in 2003 state adoptions, gaining the joint overall market share leadership in new state adoption opportunities. Taking into account that Harcourt did not participate in the second year implementation of the 2002 California elementary reading adoption, this is an impressive performance. Particular successes in the Elementary market were achieved in Georgia reading and in social studies in North Carolina and Texas. In the secondary market, whilst performance in social studies was below expectation, the literature and language arts programmes have maintained their leading positions with successes in California and Florida and the science programme also led with a major win in Tennessee. The market for state adoptions was however weak due to the

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<img src='content_image/130625.jpg'> trough in the US state textbook adoption cycle and some adoption deferrals due to the pressures on state budgets. This was compensated by good growth in backlist sales and sales to open territories in both elementary and secondary schools markets. Overall revenues were however held back by weakness in the supplemental business ahead of new publishing that addresses federally funded programmes. Underlying operating profits were up 2%, reflecting the significant cost savings achieved through supply chain rationalisation and further integration of the supplemental businesses. The Harcourt Assessment businesses saw underlying revenues down 5%, reflecting the loss of the California state testing contract which was announced in 2002. Without this, underlying revenue growth would have been over 15%. This has been primarily driven by strong new publishing in the clinical testing market. The new edition of the Stanford Achievement Test, which combines the power of the well established norm-reference test with the flexibility to test state-specific criteria, has been well received in the market and has been instrumental in winning a number of new state contracts, including Nevada, New Mexico and Minnesota, which will impact in 2004. Underlying operating profits were up 10% due to the strong growth in higher margin product and the actions taken to improve operational efficiency. Increased investment is being put into classroom-based assessment to improve individual educational outcomes, linking assessment to reinforcement of learning through linked curriculum and remediation products. The Harcourt Education International businesses saw revenues 5% ahead and adjusted operating profits 1% ahead, with strong growth in academic publishing and the global library business offset by a marked reduction in the UK schools market due to shortfalls in governmental funding. In 2004, the US schools market is expected to decline further as the low point is reached in the three year trough in the adoptions cycle combined with continuing state budget pressures. Harcourt expects to perform well in the new 2004 adoptions and the early market reaction to new publishing programmes has been encouraging. The assessment business will benefit from the recent state contract wins and the International business is expected to recover from the UK funding constraints seen last year. 2005 and the following years are expected to see a significant recovery in US market growth given the much stronger adoption calendar and Harcourt should be well placed to perform strongly.

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## BUSINESS <img src='content_image/76179.jpg'> The Reed Business division has again performed well in yet another difficult year. The continued decline of advertising volumes was in part compensated by continued market share gains, yield improvement and significant growth in online sales. The exhibitions business has been tightly managed through weak economic conditions but has been adversely affected by the net cycling out of non-annual shows as well as the impact of the war in Iraq and the SARS outbreak. Underlying margins improved through firm cost management. Revenues and adjusted operating profits were respectively 4% lower and flat at constant exchange rates, or 5% and 2% lower excluding acquisitions and disposals. The underlying magazine and information publishing businesses saw a revenue decline of 5% due to the advertising market weakness, and the exhibitions business revenues were 6% lower, or 3% before taking account of the net cycling out of non-annual shows. Adjusted operating margin was 0.9 percentage points ahead at 17.8% reflecting the actions taken on costs to mitigate the impact of lower revenues and to fund investment. In the US, Reed Business Information saw revenues 6% lower than in the prior year. Growth in the entertainment sector was more than offset by declines in the manufacturing, electronics and construction sectors. Significant focus on improving yields and building share could not compensate for the volume decline. Despite the revenue decline, underlying operating profits have risen by 23% reflecting the significant actions taken to reduce costs. In the UK, Reed Business Information revenues were down 3%. Whilst display and recruitment advertising markets saw lower revenues, good growth was achieved in online sales. Adjusted operating profits

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## OPERATING AND FINANCIAL REVIEW <img src='content_image/51819.jpg'> were similar to the prior year, with operating margins improved through firm cost management. In Continental Europe, Reed Business Information saw underlying revenues down 5%. Continued focus on market share gains and improving yields mitigated to an extent the significant decline in advertising markets. Economic conditions in the Netherlands remain very weak, with only the healthcare and regulatory titles showing growth. Significant cost actions taken throughout the year resulted in adjusted operating profits 5% higher despite the revenue decline. At Reed Exhibitions, revenues and adjusted operating profits were lower by 3% and 9% respectively at constant exchange rates. Underlying revenues, excluding acquisitions and disposals, were 6% lower, or 3% lower before the effect of the net cycling out of non-annual shows. Growth in Asia-Pacific and the majority of North American shows was offset by weakness in the US manufacturing sector and in Europe, particularly in the international shows. Underlying operating profits were 14% lower, or 3% lower before the cycling out of non-annual shows. Given the weak economic conditions in most markets and the impact on business travel of the Iraq war and the SARS outbreak, this is a very resilient performance and reflects the quality of the exhibitions business and very focused management. Reed Business is not yet budgeting for any real upturn in its markets and, taken with increased investment in online services, is not anticipating growth this year. If, however, an economic recovery really does take hold and becomes more broadly based, then Reed Business should recover quickly, most immediately in its advertising revenues. Given the dramatic improvements made in operational efficiency over the last three years, the flow through to increased profitability will be strong.

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## FINANCIAL REVIEW <img src='content_image/27977.jpg'> Adjusted figures, which exclude the amortisation of goodwill and intangible assets and exceptional items, are used by Reed Elsevier as additional performance measures. A reconciliation between the reported and adjusted figures is provided in note 10 to the combined financial statements. ## Profit and loss The reported profit before tax for the Reed Elsevier combined businesses, after the amortisation of goodwill and intangible assets and exceptional items, was £519m/ € 752m, which compares with a reported profit of £289m/ € 460m in 2002. The increase principally reflects higher underlying operating profits, lower goodwill and intangible asset amortisation and a £65m/ € 108m reduction in exceptional charges, as well as reduced net interest expense. The reported attributable profit of £334m/ € 484m increased against a reported attributable profit of £181m/ € 288m in 2002, reflecting the improved operating performance and the lower interest costs. The year on year decline of the US dollar since 2002 has had adverse translation effects on the results expressed in sterling and, more particularly, in euros. The strengthening of the euro relative to sterling has compounded this adverse translation effect on the results expressed in euros, whilst mitigating the impact on the results expressed in sterling. This translation effect does not however have any impact on the underlying performance of the businesses. Turnover decreased by 2% expressed in sterling to £4,925m, and by 11% expressed in euros to € 7,141m. At constant exchange rates, turnover was 1% higher, or flat excluding acquisitions and disposals. Adjusted operating profits, excluding the amortisation of goodwill and intangible assets and exceptional items, were up 4% expressed in sterling at £1,178m, whilst down 5% expressed in euros at € 1,708m. At constant exchange rates, adjusted operating profits were up 6%, or 5% excluding acquisitions and disposals. Adjusted operating margins improved by 1.3 percentage points to 23.9% reflecting the continued tight management of costs. The amortisation charge for intangible assets and goodwill, including in joint ventures, amounted to £445m/ € 645m, down £82m/ € 193m on the prior year as a result of translation effects and some past acquisitions becoming fully amortised. Exceptional items showed a pre-tax charge of £46m/ € 68m, comprising, £49m/ € 72m of Harcourt and other acquisition integration and related costs, £23m/ € 33m in respect of restructuring actions taken in response to the effect of the protracted global economic slowdown, less a £26m/ € 37m net gain on disposal of businesses and fixed asset investments. After a tax credit of £84m/ € 122m principally arising on the exceptional costs and in respect of prior year disposals, exceptional items showed a net post-tax gain of £38m/ € 54m. This compares with a net post-tax exceptional gain of £11m/ € 18m in 2002. Net interest expense, at £168m/ € 243m, was £38m/ € 84m lower than in the prior year, reflecting the benefit of the 2002 free cash flow, lower interest rates and currency translation effects. Net interest cover on an adjusted basis was 7.0 times. Adjusted profits before tax , before the amortisation of goodwill and intangible assets and exceptional items, at £1,010m/ € 1,465m, were up 9% expressed in sterling, whilst down 1% expressed in euros. At constant exchange rates, adjusted profits before tax were up 10%. The effective tax rate on adjusted earnings was little changed at 26%. The adjusted profit attributable to shareholders of £744m/ € 1,079m was up 9% expressed in sterling, and down 1% expressed in euros. At constant exchange rates, the adjusted profit attributable to shareholders was up 10%.

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## Cash flows and debt Adjusted operating cash flow , before exceptional items, was £1,028m/ € 1,491m representing an 87% conversion rate of adjusted operating profits into cash. This compares with a conversion rate in 2002 of 89%. Capital expenditure in the year amounted to £168m/ € 244m and depreciation was £134m/ € 194m, both similar to the prior year. Free cash flow – after interest and taxation but before acquisition spend, exceptional receipts and payments and dividends – was £669m/ € 970m, compared to £651m/ € 1,035m in 2002. After dividends, free cash flow was £377m/ € 547m compared to £378m/ € 601m in 2002. Net exceptional cash inflows of £34m/ € 50m included £96m/ € 140m proceeds from disposals of businesses and fixed asset investments and £36m/ € 52m of reduced tax payments, less exceptional acquisition related and restructuring payments of £98m/ € 142m. In 2003, acquisitions were made for a total consideration of £226m/ € 328m, including £3m/ € 5m deferred to future years, and after taking account of £9m/ € 13m of net cash acquired. An amount of £229m/ € 332m was capitalised as goodwill and intangible assets. Deferred consideration paid in respect of prior year acquisitions and payment of change of control and other non-operating liabilities assumed on the acquisition of Harcourt totalled £35m/ € 50m. The 2003 acquisitions contributed £16m/ € 25m to adjusted operating profit in the year and added £15m/ € 22m to adjusted operating cash flow. Net borrowings at 31 December 2003 were £2,372m/ € 3,368m, a decrease of £360m in sterling and € 812m in euros since 31 December 2002, reflecting the free cash flow less acquisition spend, and favourable exchange translation effects from the weaker US dollar. Gross borrowings at 31 December 2003 amounted to £3,010m/ € 4,274m, denominated mostly in US dollars, and were partly offset by cash balances totalling £638m/ € 906m invested in short term deposits and marketable securities. After taking account of interest rate derivatives, a total of 65% of Reed Elsevier’s gross borrowings were at fixed rates, including £1,270m/ € 1,797m of floating rate debt fixed through the use of interest rate derivatives, and had a weighted average interest coupon of 6.3% and an average remaining life of 5.8 years. ## ACCOUNTING POLICIES ## Introduction The accounting policies of the Reed Elsevier combined businesses are described in the combined financial statements. Prior to 2003, the Reed Elsevier combined financial statements were presented in accordance with both UK and Dutch Generally Accepted Accounting Principles (“GAAP”). Following changes to Dutch GAAP effective for the 2003 financial year in respect of the presentation of dividends and pension accounting, UK and Dutch GAAP have diverged such that the Reed Elsevier accounting policies no longer accord with Dutch GAAP. Under Article 362.1 of Book 2 Title 9 of the Netherlands Civil Code, UK GAAP may be adopted by Dutch companies with international operations for the preparation of financial statements and, accordingly, UK GAAP has been so adopted, ensuring consistency with the prior year of the accounting policies applied in the combined financial statements. Reed Elsevier NV has adopted UK GAAP in its statutory financial statements and has therefore presented both group financial statements, in which its investments in Reed Elsevier Group plc and Elsevier Reed Finance BV are presented using the gross equity method, and parent company financial statements, in which its investments are presented using the historical cost method. The adoption of UK GAAP by Reed Elsevier NV had no impact on group shareholders’ funds as at 1 January 2003 or on the group earnings for the year ended 31 December 2003. The adoption of UK GAAP had the effect of reducing parent company shareholders’ funds as at 1 January 2003 by € 34m and parent company attributable profit for the year ended <img src='content_image/132758.jpg'>

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31 December 2003 by € 39m compared to the amounts that would have been reported under Dutch GAAP. The most significant accounting policies in determining the financial condition and results of the combined businesses, and those requiring the most subjective or complex judgement, relate to the valuation and amortisation of goodwill and intangible assets, taxation and pensions. Revenue recognition policies, while an area of management focus, are generally straightforward in application as the timing of product or service delivery and customer acceptance for the various revenue types can be readily determined. Allowances for product returns are deducted from revenues based on historical return rates. Pre-publication costs incurred in the origination of content are capitalised and amortised over their estimated useful lives based on sales profiles. Annual reviews are carried out to assess the recoverability of carrying amounts. ## Goodwill and intangible assets Reed Elsevier’s accounting policy is that, on acquisition of a subsidiary, associate, joint venture or business, the purchase consideration is allocated between the net tangible and intangible assets other than goodwill on a fair value basis, with any excess purchase consideration representing goodwill. The valuation of intangible assets other than goodwill represents the estimated economic value in use, using standard valuation methodologies, including as appropriate, discounted cash flow, relief from royalty and comparable market transactions. Acquired goodwill and intangible assets are capitalised and amortised systematically over their estimated useful lives up to a maximum of 40 years, subject to impairment review. Appropriate amortisation periods are selected based on assessments of the longevity of the brands and imprints, the market positions of the acquired assets and the technological and competitive risks that they face. The carrying amounts of goodwill and intangible assets are regularly reviewed, at least twice a year. The carrying amounts of goodwill and intangible assets arising on all significant acquisitions, on all acquisitions made in the previous financial year, and on any acquisitions for which there are indications of possible impairment are compared with estimated values in use based on latest management cash flow projections. Key areas of judgement in estimating the values in use of businesses are the forecast long term growth rates and the appropriate discount rates to be applied to forecast cash flows. Based on the latest value in use calculations, no goodwill or intangible assets were impaired as at 31 December 2003. ## Taxation The Reed Elsevier combined businesses seek to organise their affairs in a tax efficient manner, taking account of the jurisdictions in which they operate. Reed Elsevier’s policy is to make prudent provision for tax uncertainties. Reed Elsevier’s policy in respect of deferred taxation is to provide in full for timing differences using the liability method. Deferred tax assets are only recognised to the extent that they are considered recoverable in the short term based on an assessment of the forecast level of taxable profits in jurisdictions where such assets have arisen. ## Pensions Pension costs are accounted for in accordance with the UK accounting standard SSAP24: Pension costs. Accounting for pension schemes involves judgement about uncertain events, including the life expectancy of the members, salary and pension increases, inflation, the return on scheme assets and the rate at which the future pension payments are discounted. Estimates for all of these factors are used in determining the pension cost and liabilities reported in the financial statements. These best estimates of future developments are made in conjunction with independent actuaries. Each scheme is subject to a periodic review by the independent actuaries. <img src='content_image/84685.jpg'>

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## Financial highlights For the year ended 31 December 2003 ## Reed Elsevier combined businesses <img src='content_image/108861.jpg'> ## Parent companies <img src='content_image/108862.jpg'> The Reed Elsevier combined businesses encompass the businesses of Reed Elsevier Group plc and Elsevier Reed Finance BV, together with their two parent companies, Reed Elsevier PLC and Reed Elsevier NV (the “Reed Elsevier combined businesses”). The results of Reed Elsevier PLC reflect its shareholders’ 52.9% economic interest in the Reed Elsevier combined businesses. The results of Reed Elsevier NV reflect its shareholders’ 50% economic interest in the Reed Elsevier combined businesses. The respective economic interests of the Reed Elsevier PLC and Reed Elsevier NV shareholders take account of Reed Elsevier PLC’s 5.8% interest in Reed Elsevier NV. The financial highlights presented refer to “adjusted” profit and cash flow figures. These figures are used by the Reed Elsevier businesses as additional performance measures and are stated before the amortisation of goodwill and intangible assets, exceptional items and related tax effects. A reconciliation between the reported and adjusted figures is provided in the notes to the financial statements. The percentage change at constant currencies refers to the movements at constant exchange rates, using 2002 full year average rates.

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For defined contribution schemes, the profit and loss account charge represents contributions payable. ## International Accounting Standards Under a Regulation adopted by the European Parliament in 2002, the Reed Elsevier combined financial statements will be prepared under International Accounting Standards (IAS) with effect from the 2005 financial year. Impact assessments have been carried out during 2003 to identify the changes of accounting policy that will be necessary to comply with IAS and implementation plans have been prepared to modify accounting systems and procedures as necessary. The key changes arising on adoption of IAS are expected to relate to the accounting for goodwill and intangible assets, share based payments, pensions, financial instruments and deferred taxation. Final IAS have yet to be issued and endorsed in respect of most of these and other accounting policy areas, and developments will be monitored closely. ## TREASURY POLICIES The boards of Reed Elsevier PLC and Reed Elsevier NV have requested that Reed Elsevier Group plc and Elsevier Reed Finance BV have due regard to the best interests of Reed Elsevier PLC and Reed Elsevier NV shareholders in the formulation of treasury policies. Financial instruments are used to finance the Reed Elsevier businesses and to hedge transactions. Reed Elsevier’s businesses do not enter into speculative transactions. The main treasury risks faced by Reed Elsevier are liquidity risk, interest rate risk and foreign currency risk. The boards of the parent companies agree overall policy guidelines for managing each of these risks and the boards of Reed Elsevier Group plc and Elsevier Finance SA agree policies (in conformity with parent company guidelines) for their respective business and treasury centres. These policies are summarised below and remained broadly unchanged during 2003. ## Funding Reed Elsevier develops and maintains a range of borrowing facilities and debt programmes to fund its requirements, at short notice and at competitive rates. The significance of Reed Elsevier Group plc’s US operations means that the majority of debt is denominated in US dollars and is raised in the US debt markets. A mixture of short term and long term debt is utilised and Reed Elsevier maintains a maturity profile to facilitate refinancing. Reed Elsevier’s policy is that no more than US$1,000m of long term debt should mature in any 12-month period. In addition, minimum levels of net debt with maturities over three years and five years are specified, depending on the level of the total borrowings. After taking account of the maturity of committed bank facilities that back short term borrowings, at 31 December 2003, nil% of debt after utilising available cash resources matures in the first, second and third years, 72% in the fourth and fifth years, 14% in five to ten years, and 14% beyond ten years. At 31 December 2003, Reed Elsevier had access to US$3,000 million (2002 US$3,500 million) of committed bank facilities, of which US$91 million was drawn. These facilities principally provide back up for short term debt but also security of funding for future acquisition spend in the event that commercial paper markets are not available. Of the total committed facilities, US$750 million (2002:US$2,860 million) matures within one year, US$nil (2002: US$640 million) within two to three years, and US$2,250 million (2002: US$nil) within four to five years. ## Interest rate exposure management Reed Elsevier’s interest rate exposure management policy is aimed at reducing the exposure of the combined businesses to changes in interest rates. The proportion of interest expense that is fixed on net debt is determined by reference to the level of net interest cover. Reed Elsevier uses fixed rate term debt, interest rate swaps, forward rate agreements and a range of interest rate options to manage the exposure. Interest rate derivatives are used only to hedge an underlying risk and no net market positions are held. At 31 December 2003, US$4,126 million of Reed Elsevier’s net debt was denominated in US dollars on which approximately 75% of forecast net interest expense was fixed or capped for the next 12 months. This fixed or capped percentage reduces to approximately 60% by the end of the third year and reduces thereafter with all the interest rate derivatives which fix or cap expense and approximately three quarters of fixed rate term debt having matured by the end of 2009 and 2011 respectively. At 31 December 2003, fixed rate US dollar term debt (not swapped back to floating rate) amounted to US$1.2 billion and had a weighted average life remaining of 13.0 years (2002: 14.3 years) and a weighted average interest coupon of 6.9%. Interest rate derivatives in place at 31 December 2003 which fix or cap the interest cost on an additional US$2.0 billion (2002: US$2.1 billion) of variable rate US dollar debt, have a weighted average maturity of 1.9 years (2002: 2.2 years) and a weighted average interest rate of 6.0%. ## Foreign currency exposure management Translation exposures arise on the earnings and net assets of business operations in countries other than those of each parent company. These exposures are hedged, to a significant extent, by a policy of denominating borrowings in currencies where significant translation exposures exist, most notably US dollars. Currency exposures on transactions denominated in a foreign currency are required to be hedged using forward contracts. In addition, recurring transactions and future

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investment exposures may be hedged, within defined limits, in advance of becoming contractual. The precise policy differs according to the commercial situation of the individual businesses. Expected future net cash flows may be covered for sales expected for up to the next 12 months (50 months for Elsevier science and medical subscription businesses up to limits staggered by duration). Cover takes the form of foreign exchange forward contracts. At the year-end, the amount of outstanding foreign exchange cover in respect of future transactions was US$1.2 billion. ## ELSEVIER REED FINANCE BV ## Structure Elsevier Reed Finance BV, the Dutch resident parent company of the Elsevier Reed Finance BV group (“ERF”), is directly owned by Reed Elsevier PLC and Reed Elsevier NV. ERF provides treasury, finance and insurance services to the Reed Elsevier Group plc businesses through its subsidiaries in Switzerland: Elsevier Finance SA (“EFSA”), Elsevier Properties SA (“EPSA”) and Elsevier Risks SA (“ERSA”). These three Swiss companies are organised under one Swiss holding company, which is in turn owned by Elsevier Reed Finance BV. ## Activities EFSA, EPSA and ERSA each focus on their own specific area of expertise. EFSA is the principal treasury centre for the combined businesses. It is responsible for all aspects of treasury advice and support for Reed Elsevier Group plc’s businesses operating in Continental Europe, South America, the Pacific Rim and certain other territories, and undertakes foreign exchange and derivatives dealing services for the whole of Reed Elsevier. EFSA also arranges or directly provides Reed Elsevier Group plc businesses with financing for acquisitions and product development and manages cash pools and investments on their behalf. EPSA is responsible for the exploitation of tangible and intangible property rights whilst ERSA is responsible for insurance activities relating to risk retention. ## Major developments EFSA continued to diversify its sources of funding in 2003 with an additional US$149 million of term debt raised through bilateral term loans and private placements. In 2003, EFSA organised bank tenders and implemented cash-pooling arrangements in several European and Asian countries. EFSA also provided specialist advice concerning the management of interest exposures and also advised Reed Elsevier Group plc companies in Europe on the further development of their collection and payment mechanisms. The average balance of cash under management, on behalf of Reed Elsevier Group plc and its parent companies, was approximately US$0.3 billion. ## Liabilities and assets At the end of 2003, 88% (2002: 90%) of ERF’s gross assets were held in US dollars and 12% (2002: 10%) in euros, including US$7.2 billion (2002: US$7.1 billion) and € 0.7 billion (2002: € 0.8 billion) in loans to Reed Elsevier Group plc subsidiaries. Loans made to Reed Elsevier Group plc businesses are funded from equity, long term debt of US$0.8 billion and short term debt of € 1.3 billion backed by committed bank facilities. These committed facilities were renegotiated in 2003. Term debt is derived from a Swiss domestic public bond issue, bilateral term loans and private placements. Short term debt is primarily derived from euro and US commercial paper programmes.

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<img src='content_image/87779.jpg'> The results of Reed Elsevier PLC reflect its shareholders’ 52.9% economic interest in the Reed Elsevier combined businesses. The results of Reed Elsevier NV reflect its shareholders’ 50% economic interest in the Reed Elsevier combined businesses. The respective economic interests of the Reed Elsevier PLC and Reed Elsevier NV shareholders take account of Reed Elsevier PLC’s 5.8% interest in Reed Elsevier NV. Both parent companies gross equity account for their respective interests in the Reed Elsevier combined businesses. Adjusted figures, excluding the amortisation of goodwill and intangible assets, exceptional items and related tax effects, are presented as additional performance measures and are reconciled to the reported figures in the notes to the respective financial statements. ## Profit and loss Adjusted earnings per share, measured before the effect of amortisation of goodwill and intangible assets and exceptional items, for Reed Elsevier PLC were 31.2p, up 9% on the previous year, and for Reed Elsevier NV were € 0.69, unchanged from 2002. The difference in percentage change is entirely attributable to the impact of currency movements on the translation of reported results. At constant rates of exchange, the adjusted earnings per share of both companies would have shown an increase of 10% over the previous year. After their share of the charge in respect of goodwill and intangible asset amortisation and of the exceptional items, the reported earnings per share of Reed Elsevier PLC after tax credit equalisation and Reed Elsevier NV were 13.4p and € 0.31 respectively, compared to 7.0p and € 0.18 in 2002. ## Dividends Dividends to Reed Elsevier PLC and Reed Elsevier NV shareholders are equalised at the gross level, including the benefit of the UK attributable tax credit of 10% received by certain Reed Elsevier PLC shareholders. The exchange rate used for each dividend calculation – as defined in the Reed Elsevier merger agreement – is the spot euro/sterling exchange rate, averaged over a period of five business days commencing with the tenth business day before the announcement of the proposed dividend. The Board of Reed Elsevier PLC has proposed a final dividend of 8.7p, giving a total dividend of 12.0p for the year, up 7% on 2002. The Boards of Reed Elsevier NV, in accordance with the dividend equalisation arrangements, have proposed a final dividend of € 0.22. This results in a total dividend of € 0.30 for the year, the same as in 2002. The difference in dividend growth rates reflects the impact of the significant appreciation of the euro against sterling since the prior year dividend declaration dates. Dividend cover for Reed Elsevier PLC, using adjusted earnings before the amortisation of goodwill and intangible assets and exceptional items and related tax effects, was 2.6 times and for Reed Elsevier NV was 2.3 times. Measured for the combined businesses on a similar basis, dividend cover was 2.4 times, unchanged from 2002.

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## STRUCTURE ## Corporate structure Reed Elsevier came into existence in January 1993, when Reed Elsevier PLC and Reed Elsevier NV contributed their businesses to two jointly owned companies, Reed Elsevier Group plc, a UK registered company which owns the publishing and information businesses, and Elsevier Reed Finance BV, a Dutch registered company which owns the financing activities. Reed Elsevier PLC and Reed Elsevier NV have retained their separate legal and national identities and are publicly held companies. Reed Elsevier PLC’s securities are listed in London and New York, and Reed Elsevier NV’s securities are listed in Amsterdam and New York. ## Equalisation arrangements Reed Elsevier PLC and Reed Elsevier NV each hold a 50% interest in Reed Elsevier Group plc. Reed Elsevier PLC holds a 39% interest in Elsevier Reed Finance BV, with Reed Elsevier NV holding a 61% interest. Reed Elsevier PLC additionally holds an indirect equity interest in Reed Elsevier NV, reflecting the arrangements entered into between the two companies at the time of the merger, which determined the equalisation ratio whereby one Reed Elsevier NV ordinary share is, in broad terms, intended to confer equivalent economic interests to 1.538 Reed Elsevier PLC ordinary shares. The equalisation ratio is subject to change to reflect share splits and similar events that affect the number of outstanding ordinary shares of either Reed Elsevier PLC or Reed Elsevier NV. Under the equalisation arrangements, Reed Elsevier PLC shareholders have a 52.9% economic interest in Reed Elsevier, and Reed Elsevier NV shareholders (other than Reed Elsevier PLC) have a 47.1% economic interest in Reed Elsevier. Holders of ordinary shares in Reed Elsevier PLC and Reed Elsevier NV enjoy substantially equivalent dividend and capital rights with respect to their ordinary shares. The boards of both Reed Elsevier PLC and Reed Elsevier NV have agreed, except in exceptional circumstances, to recommend equivalent gross dividends (including, with respect to the dividend on Reed Elsevier PLC ordinary shares, the associated UK tax credit), based on the equalisation ratio. A Reed Elsevier PLC ordinary share pays dividends in sterling and is subject to UK tax law with respect to dividend and capital rights. A Reed Elsevier NV ordinary share pays dividends in euros and is subject to Dutch tax law with respect to dividend and capital rights. ## CORPORATE GOVERNANCE ## Compliance with codes of best practice The boards of Reed Elsevier PLC and Reed Elsevier NV have implemented standards of corporate governance and disclosure policies applicable to companies listed on the stock exchanges of the United Kingdom, the Netherlands and the United States. The effect of this is that an obligation applying to one will, where practicable and not in conflict, also be observed by the other. Reed Elsevier PLC, which has its primary listing on the London Stock Exchange, has complied throughout the period under review with the provisions and principles of Section 1 of the Principles of Good Governance and Code of Best Practice, issued by the UK Financial Services Authority. The boards of Reed Elsevier PLC and Reed Elsevier NV support the provisions and principles of corporate governance set out in the Combined Code on Corporate Governance issued by the UK Financial Reporting Council in July 2003 (the “UK Combined Code”) and believe that each company complied with the provisions and principles of the UK Combined Code at the close of the period under review. Reed Elsevier NV, which has its primary listing on Euronext in Amsterdam, has complied throughout the period under review with the listing rules of Euronext in Amsterdam and best custom and practice appropriate to internationally focused Dutch companies. The boards of Reed Elsevier NV and Reed Elsevier PLC support the principles of corporate governance set out in the Dutch Corporate Governance Code issued in December 2003 (the “Dutch Code”) and believe that they will have no significant issues regarding compliance with the Dutch Code during 2004, subject to reconciliation with the UK Combined Code. The ways in which the relevant principles of corporate governance are applied and complied with within Reed Elsevier PLC, Reed Elsevier NV, Reed Elsevier Group plc and Elsevier Reed Finance BV are described below. ## THE BOARDS The boards of Reed Elsevier PLC, Reed Elsevier NV, Reed Elsevier Group plc and Elsevier Reed Finance BV each comprise a balance of executive and non-executive directors who bring a wide range of skills and experience to the deliberations of the boards. All non-executive directors are independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgment. All directors have full and timely access to the information required to discharge their responsibilities fully and efficiently. The boards of Reed Elsevier PLC, Reed Elsevier NV and Reed Elsevier Group plc are harmonised. Subject to approval by the respective shareholders, all the directors of Reed Elsevier Group plc are also directors of Reed Elsevier PLC and of Reed Elsevier NV. No individual may be appointed to the boards of Reed Elsevier PLC, Reed Elsevier NV or Reed Elsevier Group plc unless recommended by the joint Nominations Committee, although members of the Committee abstain when their own re-appointment is being considered. The Reed Elsevier PLC and Reed Elsevier NV shareholders maintain their rights to appoint individuals to

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their respective boards, in accordance with the provisions of the Articles of Association of those companies. On appointment, directors receive training appropriate to their level of previous experience. This includes the provision of a tailored induction programme, so as to provide newly appointed directors with information about the Reed Elsevier businesses and other information to assist them in performing their duties. Non-executive directors are encouraged to visit the Reed Elsevier businesses to meet directors and senior executives. All directors have access to the services of the respective company secretaries and may take independent professional advice in the furtherance of their duties, at the relevant company’s expense. All Reed Elsevier PLC and Reed Elsevier NV directors are subject to retirement at least every three years, and are able then to make themselves available for re-election by shareholders at the respective Annual General Meetings. As a general rule, non-executive directors of Reed Elsevier PLC and members of the Reed Elsevier NV supervisory board serve on the respective board for two, three year terms, although the boards may invite individual directors to serve up to one additional three year term. ## Reed Elsevier PLC The Reed Elsevier PLC board consists of five executive directors: Crispin Davis – Chief Executive Officer, Mark Armour – Chief Financial Officer, Gerard van de Aast, Andrew Prozes and Patrick Tierney – appointed April 2003, and seven independent non-executive directors: Morris Tabaksblat – Chairman, John Brock, Mark Elliott – appointed April 2003, Cees van Lede – appointed April 2003, David Reid – appointed April 2003, Lord Sharman and Rolf Stomberg – senior independent non-executive director. Roelof Nelissen and Steven Perrick retired as directors in April 2003 and Derk Haank resigned as a director in June 2003. The board met five times during the year. Due to a prior commitment, Mr van Lede was not able to attend one meeting, otherwise there was full attendance. At the Reed Elsevier PLC Annual General Meeting to be held on 28 April 2004, Messrs Tabaksblat, van de Aast and Stomberg and Lord Sharman will retire by rotation. Being eligible, they offer themselves for re-election. ## Reed Elsevier NV Reed Elsevier NV has a two-tier board structure comprising a supervisory board of eight members, all of whom are independent non-executives, and an executive board of five members. The executive board is responsible for the management of the company and the supervisory board supervises the executive board. The members of the supervisory board are Morris Tabaksblat – Chairman, Dien de Boer-Kruyt, John Brock, Mark Elliott – appointed April 2003, Cees van Lede – appointed April 2003, David Reid – appointed April 2003, Lord Sharman and Rolf Stomberg. The executive board comprises Crispin Davis – Chief Executive Officer, Mark Armour – Chief Financial Officer, Gerard van de Aast, Andrew Prozes and Patrick Tierney – appointed April 2003. Roelof Nelissen and Steven Perrick retired as members of the supervisory board in April 2003 and Derk Haank resigned as a member of the executive board in June 2003. The boards met five times during the year. Due to a prior commitment Mr van Lede was not able to attend one meeting and Mrs de Boer-Kruyt was not able to attend three meetings due to illness, otherwise there was full attendance. At the Reed Elsevier NV Annual General Meeting to be held on 29 April 2004, Messrs Tabaksblat and Stomberg and Lord Sharman will retire by rotation as members of the supervisory board, and Mr van de Aast will retire by rotation as a member of the executive board. Being eligible, they offer themselves for re-election. ## Reed Elsevier Group plc The Reed Elsevier Group plc board consists of five executive directors: Crispin Davis – Chief Executive Officer, Mark Armour – Chief Finance Officer, Gerard van de Aast, Andrew Prozes and Patrick Tierney – appointed April 2003, and seven independent non-executive directors: Morris Tabaksblat – Chairman, John Brock, Mark Elliott – appointed April 2003, Cees van Lede – appointed April 2003, David Reid – appointed April 2003, Lord Sharman and Rolf Stomberg. Roelof Nelissen and Steven Perrick retired as directors in April 2003 and Derk Haank resigned as a director in June 2003. The board met six times during the year. Due to a prior commitment, Messrs Haank, van Lede and Reid were each not able to attend one meeting, otherwise there was full attendance. Biographical information in respect of the current members of the boards appears on pages 10 and 11 of the Annual Review and Summary Financial Statements. ## Elsevier Reed Finance BV The management board and the supervisory board of Elsevier Reed Finance BV met three times during the year. All members of these boards attended all board meetings during the year, with the exception of Mrs de Boer-Kruyt who was not able to attend one meeting. The supervisory board comprises Roelof Nelissen – Chairman, Mark Armour and Dien de Boer-Kruyt, with the management board consisting of Willem Boellaard and Jacques Billy. Appointments to the supervisory and management boards are made by the shareholders, in accordance with the company’s Articles of Association. In April 2003 Steven Perrick retired from the supervisory board.

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## BOARD COMMITTEES In accordance with the principles of good corporate governance, the following committees, all of which have written terms of reference, have been established by the respective boards. The terms of reference of these committees are published on the Reed Elsevier website (www.reedelsevier.com). ## Audit Committees Reed Elsevier PLC, Reed Elsevier NV and Reed Elsevier Group plc have established Audit Committees. The Committees comprise only non-executive directors, all of whom are independent. The Committees are chaired by Lord Sharman, the other members being John Brock and David Reid – appointed in April 2003. A report of the Audit Committees, setting out the role of the Committees and their main activities during the year, appears on pages 27 and 28. The Committees met four times during the year, and there was full attendance. ## Corporate Governance Committee Reed Elsevier PLC and Reed Elsevier NV have established a joint Corporate Governance Committee, which comprises only non-executive directors, all of whom are independent. The Committee is chaired by Morris Tabaksblat, the other members being Dien de Boer-Kruyt, John Brock, Mark Elliott – appointed in April 2003, Cees van Lede – appointed in April 2003, David Reid – appointed in April 2003, Lord Sharman and Rolf Stomberg. The Committee met twice during the year and, with the exception of Mrs de Boer-Kruyt who was absent through illness, there was full attendance. In addition to reviewing ongoing developments and best practice in corporate governance, the Committee is also responsible for recommending the structure and operation of the various committees of the boards and the qualifications and criteria for membership of each committee, including the independence of members of the boards. During the period the Committee reviewed ongoing developments and best practice in corporate governance. The Committee also assessed the performance of individual executive directors and the functioning and constitution of the boards and their Committees and the Chairman assessed the individual performance of the non-executive directors, in consultation with the other directors. The Committee, led by the senior independent non-executive director, also assessed the performance of the Chairman. Based on these assessments, the Committee believes that the performance of each director continues to be effective and that they demonstrate commitment to their respective roles in Reed Elsevier. During the course of 2004 the Committee will keep under review the implications of the UK Combined Code and the Dutch Code on the corporate governance structure and practices of Reed Elsevier PLC and Reed Elsevier NV. ## Nominations Committee Reed Elsevier PLC and Reed Elsevier NV have established a joint Nominations Committee, which provides a formal and transparent procedure for the appointment of new directors to the boards. The Committee comprises a majority of independent non-executive directors. The Committee is chaired by Morris Tabaksblat, the other members being Crispin Davis – Chief Executive Officer, Cees van Lede – appointed in April 2003, Lord Sharman – appointed in August 2003 and Rolf Stomberg. The Committee believes that it is appropriate for the Chief Executive Officer to be a member of the Committee since he provides a perspective which assists the Committee in nominating candidates to the board who will be able to work as a team with both the executive and non-executive directors. The Committee met twice during the year, and there was full attendance. The Committee’s terms of reference include assuring board succession and making recommendations to the boards of Reed Elsevier PLC, Reed Elsevier NV and Reed Elsevier Group plc concerning the appointment or reappointment of directors to, and the retirement of directors from, those boards. In conjunction with the Chairman of the Reed Elsevier Group plc Remuneration Committee and external consultants, the Committee is also responsible for developing proposals for the remuneration and fees for new directors. During the period the Committee recommended to the boards of Reed Elsevier PLC, Reed Elsevier NV and Reed Elsevier Group plc the appointment of an additional executive director and three non-executive directors, as set out on pages 31 and 32. In each case the Committee retained the services of external search consultants to produce short lists of potential candidates. ## Remuneration Committee Reed Elsevier Group plc has established a Remuneration Committee which comprises only independent non- executive directors. The Committee is chaired by Rolf Stomberg, the other members being Mark Elliott – appointed in April 2003 and Cees van Lede – appointed in April 2003. The Committee met three times during the year. Mr van Lede was not able to attend one meeting, otherwise there was full attendance. The Committee is responsible for recommending to the board the remuneration in all its forms of executive directors of Reed Elsevier Group plc, and provides advice to the Chief Executive Officer on the remuneration of executives at a senior level below the board. It also makes recommendations to the board of Reed Elsevier PLC and

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Reed Elsevier NV regarding the remuneration of the executive directors of these companies. The fees of non-executive directors are determined by each of the boards as a whole. A Directors’ Remuneration Report, which has been approved by the boards of Reed Elsevier Group plc, Reed Elsevier PLC and Reed Elsevier NV, appears on pages 29 to 38. This report also serves as disclosure of the directors’ remuneration and interests in shares of the two parent companies, Reed Elsevier PLC and Reed Elsevier NV. ## Strategy Committee Reed Elsevier Group plc has established a Strategy Committee, comprising a majority of independent non- executive directors. The Committee is chaired by Morris Tabaksblat, the other members being Crispin Davis, Mark Elliott – appointed in April 2003 and David Reid – appointed in April 2003. The Committee met once during the year, and there was full attendance. The Committee’s terms of reference include reviewing the major features of the strategy proposed by the Chief Executive Officer, and subsequently recommending the proposed strategy to the board. The Committee is also responsible for reviewing any acquisition or investment, which would have major strategic or structural implications for Reed Elsevier Group plc. ## RELATIONS WITH SHAREHOLDERS Reed Elsevier PLC and Reed Elsevier NV participate in regular dialogue with institutional shareholders, and presentations on the Reed Elsevier combined businesses are made after the announcement of the interim and full year results. The boards of Reed Elsevier PLC and Reed Elsevier NV commission periodic reports on the attitudes and views of the companies’ institutional shareholders and the results are the subject of formal presentations to the respective boards. A trading update is provided at the respective Annual General Meetings of the two companies, and near the end of the financial year. The Annual General Meetings provide an opportunity for the boards to communicate with individual shareholders. The Chairman, the Chief Executive Officer, the Chief Financial Officer, the Chairmen of the board committees, other directors and a representative of the external auditor are available to answer questions from shareholders. The interim and annual results announcements and presentations, together with the trading updates and other important announcements concerning Reed Elsevier, are published on the Reed Elsevier website (www.reedelsevier.com). ## INTERNAL CONTROL ## Parent companies The boards of Reed Elsevier PLC and Reed Elsevier NV exercise independent supervisory roles over the activities and systems of internal control of Reed Elsevier Group plc and Elsevier Reed Finance BV. The boards of Reed Elsevier PLC and Reed Elsevier NV have each adopted a schedule of matters which are required to be brought to them for decision. In relation to Reed Elsevier Group plc and Elsevier Reed Finance BV, the boards of Reed Elsevier PLC and Reed Elsevier NV approve the strategy and the annual budgets, and receive regular reports on the operations, including the treasury and risk management activities, of the two companies. Major transactions proposed by the boards of Reed Elsevier Group plc or Elsevier Reed Finance BV require the approval of the boards of both Reed Elsevier PLC and Reed Elsevier NV. The Reed Elsevier PLC and Reed Elsevier NV Audit Committees meet on a regular basis to review the systems of internal control of Reed Elsevier Group plc and Elsevier Reed Finance BV. ## Operating companies The board of Reed Elsevier Group plc is responsible for the system of internal control of the Reed Elsevier publishing and information businesses, while the boards of Elsevier Reed Finance BV are responsible for the system of internal control in respect of the finance group activities. The boards of Reed Elsevier Group plc and Elsevier Reed Finance BV are also responsible for reviewing the effectiveness of their system of internal control. The objective of these systems is to manage, rather than eliminate, the risk of failure to achieve business objectives. Accordingly, they can only provide reasonable, but not absolute, assurance against material misstatement or loss. The boards of Reed Elsevier Group plc and Elsevier Reed Finance BV have implemented an ongoing process for identifying, evaluating and managing the significant risks faced by their respective businesses. This process has been in place throughout the year ended 31 December 2003 and up to the date of the approvals of the Annual Reports and Financial Statements. ## Reed Elsevier Group plc Reed Elsevier Group plc has an established framework of procedures and internal controls, which is set out in a group Policies and Procedures Manual, and with which the management of each business is required to comply. Group businesses are required to maintain systems of internal control, which are appropriate to the nature and scale of their activities and address all significant operational and financial risks that they face. The board of Reed Elsevier Group plc has adopted a schedule of matters that are required to be brought to it for decision. Each business group has identified and evaluated its major risks, the controls in place to manage those risks and the level of residual risk accepted. Risk management and control procedures are embedded into the operations of the

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## STRUCTURE AND CORPORATE GOVERNANCE business and include the monitoring of progress in areas for improvement that come to management and board attention. The major risks identified include business continuity, protection of IT systems and data, challenges to intellectual property rights, management of strategic and operational change, evaluation and integration of acquisitions, and recruitment and retention of personnel. The major strategic risks facing the Reed Elsevier Group plc businesses are considered by the Strategy Committee. Litigation and other legal and regulatory matters are managed by legal directors in Europe and the United States. The Reed Elsevier Group plc Audit Committee receives regular reports on the management of material risks and reviews these reports. The Audit Committee also receives regular reports from both internal and external auditors on internal control matters. In addition, each Business Group is required, at the end of the financial year, to review the effectiveness of its internal controls and report its findings on a detailed basis to the management of Reed Elsevier Group plc. These reports are summarised and, as part of the annual review of effectiveness, submitted to the Audit Committee of Reed Elsevier Group plc. The Chairman of the Audit Committee reports to the board on any significant internal control matters arising. ## Elsevier Reed Finance BV Elsevier Reed Finance BV has established policy guidelines, which are applied for all Elsevier Reed Finance BV companies. The boards of Elsevier Reed Finance BV have adopted schedules of matters that are required to be brought to them for decision. Procedures are in place for monitoring the activities of the finance group, including a comprehensive treasury reporting system. The major risks affecting the finance group have been identified and evaluated and are subject to regular review. The controls in place to manage these risks and the level of residual risk accepted are monitored by the boards. The internal control system of the Elsevier Reed Finance BV group is reviewed each year by its external auditors. ## Annual review As part of the year end procedures, the boards of Reed Elsevier PLC, Reed Elsevier NV, Reed Elsevier Group plc and Elsevier Reed Finance BV have reviewed the effectiveness of the systems of internal control during the last financial year. ## RESPONSIBILITIES IN RESPECT OF THE FINANCIAL STATEMENTS The directors of Reed Elsevier PLC, Reed Elsevier NV, Reed Elsevier Group plc and Elsevier Reed Finance BV are required to prepare financial statements as at the end of each financial period, which give a true and fair view of the state of affairs, and of the profit or loss, of the respective companies and their subsidiaries, joint ventures and associates. They are responsible for maintaining proper accounting records, for safeguarding assets, and for taking reasonable steps to prevent and detect fraud and other irregularities. The directors are also responsible for selecting suitable accounting policies and applying them on a consistent basis, making judgements and estimates that are prudent and reasonable. Applicable accounting standards have been followed and the Reed Elsevier combined financial statements, which are the responsibility of the directors of Reed Elsevier PLC and Reed Elsevier NV, are prepared using accounting policies which comply with UK Generally Accepted Accounting Principles. ## US CERTIFICATIONS As required by section 302 of the US Sarbanes-Oxley Act 2002 and by related rules issued by the US Securities and Exchange Commission, the Chief Executive Officer and Chief Financial Officer of Reed Elsevier PLC and of Reed Elsevier NV certify in the respective Annual Reports 2003 on Form 20-F filed with the Commission that they are responsible for establishing and maintaining disclosure controls and procedures and that they have: •designed such disclosure controls and procedures to ensure that material information relating to Reed Elsevier is made known to them; •evaluated the effectiveness of Reed Elsevier’s disclosure controls and procedures; •based on their evaluation, disclosed to the Audit Committees and the external auditors all significant deficiencies in the design or operation of disclosure controls and procedures and any frauds, whether or not material, that involve management or other employees who have a significant role in Reed Elsevier internal controls; and •presented in the Annual Reports on Form 20-F their conclusions about the effectiveness of the disclosure controls and procedures. A Disclosure Committee, comprising the company secretaries of Reed Elsevier PLC and Reed Elsevier NV and other senior Reed Elsevier managers, provides assurance to the Chief Executive Officer and Chief Financial Officer regarding their certifications. ## GOING CONCERN The directors of Reed Elsevier PLC and Reed Elsevier NV, having made appropriate enquiries, consider that adequate resources exist for the combined businesses to continue in operational existence for the foreseeable future and that, therefore, it is appropriate to adopt the going concern basis in preparing the financial statements.

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## Report of the Audit Committees This report has been prepared by the Audit Committees of Reed Elsevier PLC and Reed Elsevier NV, in conjunction with the Audit Committee of Reed Elsevier Group plc, (the “Committees”) and has been approved by the respective boards. The report meets the requirements of The Combined Code of Corporate Governance, issued by the UK Financial Services Authority. ## AUDIT COMMITTEES The main role and responsibilities of the Committees in relation to the respective companies are set out in written terms of reference and include: (i) to monitor the integrity of the financial statements of the company, and any formal announcements relating to the company’s financial performance, reviewing significant financial reporting judgements contained in them; (ii) to review the company’s internal financial controls and the company’s internal control and risk management systems; (iii) to monitor and review the effectiveness of the company’s internal audit function; (iv) to make recommendations to the board, for it to put to the shareholders for their approval in general meetings, in relation to the appointment, re-appointment and removal of the external auditor and to approve the remuneration and terms of engagement of the external auditor; (v) to review and monitor the external auditor’s independence and objectivity and the effectiveness of the audit process, taking into consideration relevant professional and regulatory requirements; and (vi) to develop and recommend policy on the engagement of the external auditor to supply non-audit services, taking into account relevant ethical guidance regarding the provision of non-audit services by the external audit firm, and to monitor compliance. The Committees report to the respective boards on their activities identifying any matters in respect of which they consider that action or improvement is needed and making recommendations as to the steps to be taken. The Reed Elsevier Group plc Audit Committee fulfils this role in respect of the publishing and information operating business. The functions of an audit committee in respect of the financing activities are carried out by the supervisory board of Elsevier Reed Finance BV. The Reed Elsevier PLC and Reed Elsevier NV Audit Committees fulfil their roles from the perspective of the parent companies and both committees have access to the reports to and the work of the Reed Elsevier Group plc Audit Committee and the Elsevier Reed Finance BV supervisory board in this respect. The Committees have explicit authority to investigate any matters within their terms of reference and have access to all resources and information that they may require for this purpose. The Committees are entitled to obtain legal and other independent professional advice and have the authority to approve all fees payable to such advisers. A copy of the terms of reference of each Audit Committee is published on the Reed Elsevier website (www.reedelsevier.com). ## COMMITTEE MEMBERSHIP The Committees each comprise at least three independent non-executive directors, at least one of which has significant, recent and relevant financial experience. The current members of each of the Committees are: Lord Sharman (Chairman of the Committees), John Brock and David Reid (appointed April 2003). Lord Sharman (61), a chartered accountant, spent his professional career at KPMG and now serves as non- executive chairman of Aegis Group plc and Securicor plc and is a member of the supervisory board of ABN-AMRO and a non-executive director of BG Group plc. He was elected UK senior partner of KPMG in 1994 and served as Chairman of KPMG Worldwide between 1997 and 1999. John Brock (55) is chief executive officer of Interbrew SA and formerly chief operating officer of Cadbury Schweppes plc. David Reid (57), a chartered accountant, was until December 2003 executive deputy chairman of Tesco PLC, with responsibility for strategy, business development and international operations; he was previously its finance director and is its non-executive chairman designate. During the 2003 financial year, until April 2003, Rolf Stomberg, Roelof Nelissen and Steven Perrick served on the Committees, all being non executive directors and, other than Mr Perrick, independent. Mr Stomberg is the senior independent non executive director and his biographical details are set out in the Reed Elsevier Annual Review. Mr Nelissen has served on a number of supervisory boards and is a former chairman of the managing board of ABN AMRO. Mr Perrick is a partner in Freshfields Bruckhaus Deringer in the Netherlands, an international firm of advisers which provides legal advice to Reed Elsevier. Appointments to the Committees are made on the recommendation of the Nominations Committee and are for periods of up to three years, extendable by no more than two additional three-year periods, so long as the member continues to be independent. Details of the remuneration policy in respect of members of the Committees and the remuneration paid to members for the year ended 31 December 2003 are set out in the Directors’ Remuneration Report on pages 29 to 38. ## COMMITTEE ACTIVITIES The Committees typically hold meetings five times a year: around January, February, June, August and December, and report on these meetings to the respective boards at the next board meetings. The principal business of these meetings includes: - January: review of critical accounting policies and practices, and significant financial reporting issues and judgements made in connection with the annual financial

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## REPORT OF THE AUDIT COMMITTEES statements; review of internal control effectiveness; reviewing and approving the internal audit plan; review of internal audit findings - February: review and approval of annual financial statements, results announcement and related formal statements; review of external audit findings - June: monitoring and assessing the qualification, performance, expertise, resources, objectivity and independence of the external auditors and the effectiveness of the external and internal audit process; agreeing the external audit plan; reviewing significant financial reporting issues and judgements arising in connection with the interim financial statements; review of risk management activities; review of report from external auditors on control matters; review of internal audit findings - August: review and approval of the interim financial statements, results announcement and related formal statements; review of external audit findings; review of internal audit findings - December: review of year end financial reporting and accounting issues; review of significant external financial reporting and regulatory developments; review of external audit findings to date; review of internal audit findings. The Audit Committee meetings are typically attended by the chief financial officer, group chief accountant, director of internal audit and senior representatives of the external auditors. Additionally, the managing director and senior representatives of the external auditors of Elsevier Reed Finance BV attend the August and February meetings of the parent company Audit Committees. At two or more of the meetings each year, the Committees additionally meet separately with the external auditors without management present, and also with the director of internal audit. In discharging their principal responsibilities in respect of the 2003 financial year, the Committees have: (i) received and discussed reports from the Reed Elsevier Group plc group chief accountant that set out areas of significance in the preparation of the financial statements, including: review of the carrying values of goodwill and intangible assets for possible impairment, review of estimated useful lives of goodwill and intangible assets, pensions accounting and related assumptions, accounting treatment for acquisitions and disposals and exceptional items, application of revenue recognition and cost capitalisation and provisioning policies, review of tax reserves and provisions for lease obligations. Discussion of reporting matters has additionally focused on the adoption of UK GAAP by Reed Elsevier NV, the format and content of the operating and financial review to meet the new UK best practice guidelines, and compliance with the new SEC restrictions on the use of non-GAAP financial measures in the Annual Report on Form 20-F. (ii) reviewed the critical accounting policies and compliance with applicable accounting standards and other disclosure requirements and have received regular update reports on accounting and regulatory developments, including in relation to International Accounting Standards. (iii) received and discussed regular reports on the management of material risks and reviewed the effectiveness of the systems of internal control. As part of this review, detailed internal control evaluation and self-certification is obtained from management across the operating businesses, reviewed by internal audit and discussed with the Committees. (iv) received and discussed regular reports from the director of internal audit summarising the status of the Reed Elsevier risk management activities and the findings from internal audit reviews and the actions agreed with management. An area of focus in 2003 has been the development and agreement of plans to meet the new requirements, effective for the 2005 financial year, of Section 404 of the Sarbanes-Oxley Act relating to the documentation and testing of internal financial controls. (v) reviewed and approved the internal audit plan for 2003 and monitored execution. Reviewed the resources and budget of the internal audit function. The external auditors have attended all meetings of the Committees. They have provided written reports at the August, December and February meetings summarising the most significant findings from their audit work. These reports have been discussed by the Committees and actions agreed where necessary. The external auditors have confirmed their independence from management and compliance with the Reed Elsevier policy on auditor independence. This policy sets out inter aliathe requirements for rotation of the lead, review and other senior partners, as well as guidelines for the provision of permitted non-audit services. The Committees have reviewed and agreed the non-audit services provided by the external auditors, together with the associated fees. The external auditors’ fees for audit services have been reviewed and approved by the Committees. Based on their observations on the planning and execution of the external audits, the Committees have recommended to the respective boards that resolutions for the re-appointment of the external auditors be proposed at the forthcoming Annual General Meetings. At their meeting in June 2004, the Committees will conduct a more formal review of the performance of the auditors and the effectiveness of the audit process for both the external and internal audit activities. ## Lord Sharman of Redlynch Chairman of the Audit Committees 18 February 2004

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## Reed Elsevier combined businesses <img src='content_image/78058.jpg'> ## Reed Elsevier PLC <img src='content_image/78060.jpg'> ## Reed Elsevier NV <img src='content_image/78059.jpg'>

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## DIRECTORS’ REMUNERATION REPORT This report has been prepared by the Remuneration Committee (the “Committee”) of Reed Elsevier Group plc and approved by the boards of Reed Elsevier Group plc, Reed Elsevier PLC and Reed Elsevier NV. The report has been prepared in accordance with the UK Directors' Remuneration Report Regulations 2002 (the "Regulations") and serves the requirements for Reed Elsevier NV under the Netherlands Civil Code. The Report also meets the requirements of Schedule A of the Principles of Good Governance and Code of Best Practice, issued by the UK Financial Services Authority and describes how the Principles of Good Governance relating to directors' remuneration have been applied. Information relating to the emoluments of the directors on pages 32 to 34 and directors’ interests in share options on pages 36 and 37 has been audited. ## REMUNERATION COMMITTEE The Committee is responsible for recommending to the boards the remuneration (in all its forms), and the terms of the service contracts and all other terms and conditions of employment of the executive directors, and for providing advice to the Chief Executive Officer on major policy issues affecting the remuneration of executives at a senior level below the board. A copy of the terms of reference of the Committee is published on the Reed Elsevier website at www.reedelsevier.com. Throughout 2003 the Committee consisted wholly of independent non-executive directors. The current members of the Committee are Rolf Stomberg (Chairman of the Committee), Mark Elliott (appointed in April 2003) and Cees van Lede (appointed in April 2003). John Brock and Roelof Nelissen were members of the Committee until April 2003. At the invitation of the Chairman, the Chief Executive Officer attends meetings of the Committee, except when his own remuneration is under consideration. The Committee has appointed Towers Perrin, an external consultancy which has wide experience of executive remuneration in multinational companies, to advise in developing its performance-related remuneration policy. Towers Perrin also provides actuarial and other Human Resources consultancy services direct to some Reed Elsevier companies. In addition to Towers Perrin, the following provided material advice or services to the Committee during the year: Jean-Luc Augustin, Human Resources Director; Christopher Thomas, Director, Compensation and Benefits; and Crispin Davis, Chief Executive Officer. ## REMUNERATION POLICY The remuneration policy is set out below: The principal objectives of the remuneration policy are to attract, retain and motivate people of the highest calibre and experience needed to shape and execute strategy and deliver shareholder value in the context of an ever more competitive and increasingly global employment market. The Committee also has regard to, and balances as far as is practicable, the following objectives: (i) to link reward to individual directors’ performance and company performance so as to align the interests of the directors with the shareholders of the parent companies; (ii) to ensure that it maintains a competitive package of pay and benefits, commensurate with comparable packages available within other leading multinational companies operating in global markets; (iii) to deliver upper quartile total remuneration for clearly superior levels of performance; (iv) to ensure that it encourages enhanced performance by directors and fairly recognises the contribution of individual directors to the attainment of the results of Reed Elsevier, whilst also encouraging a team approach which will work towards achieving the long term strategic objectives of Reed Elsevier; and (v) to provide a consistent approach towards senior executives, including the directors, irrespective of geographical location. In order to meet the above objectives, the remuneration of executive directors comprises a balance between “fixed” remuneration and “variable performance-related” incentives. The policy is that the predominant proportion of reward potential should be linked to performance, and the package composition for 2004 shows that for superior performance some 70% of the total remuneration would be performance related. Effective from January 2003 the Committee adopted a policy of common levels, irrespective of geographical location, for both annual and longer term incentives for executive directors, reflecting the global nature of the role of each director. ## REMUNERATION ELEMENTS Executive directors remuneration consists of the following elements: •Base salary, which is based on comparable positions in leading multinational businesses of similar size and complexity. Salaries are reviewed annually by the Committee to take into account both market movement and individual performance. •A variable annual cash bonus, based on achievement of three financial performance measures (revenue, profit and cash flow) and individual key performance objectives. Targets are set at the beginning of the year by the Committee and are aligned with the annual budget and strategic business objectives. For 2004, no bonus will become payable in respect of an individual financial performance measure unless 94% of the set target for that measure is achieved. Up to 90% of salary may be earned for the achievement of highly stretching targets

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set by the Committee. For exceptional performance beyond these stretching targets, the Committee has the discretion to award up to 110% of salary. The Committee has also applied the foregoing criteria in assessing the 2003 bonuses. •A bonus investment plan, under which directors and other senior executives were able to invest up to half of their 2002 annual performance related bonus in Reed Elsevier PLC/Reed Elsevier NV shares. 38 senior executives participated in the bonus investment arrangements in respect of their 2002 bonus. Subject to continuing to hold the shares and remaining in employment, at the end of a three year period, the participants will be awarded an equivalent number of Reed Elsevier PLC/Reed Elsevier NV shares at nil cost. Following approval of the 2003 Reed Elsevier Group plc Bonus Investment Plan (the "2003 Bonus Investment Plan) by shareholders of Reed Elsevier PLC and Reed Elsevier NV in April 2003, the Committee has agreed to award options under the 2003 Bonus Investment Plan to directors and selected key employees in respect of the 2003 bonus. Awards under the 2003 Bonus Investment Plan will be made annually, and will be subject to a performance condition requiring the achievement of compound growth in the average of the Reed Elsevier PLC and Reed Elsevier NV adjusted EPS (i.e. before amortisation of goodwill and intangible assets, exceptional items and UK tax credit equalisation) measured at constant exchange rates (“adjusted EPS”) of 6% per annum compound during the three year vesting period. •Share options, where the directors and other senior executives are granted options annually over shares in Reed Elsevier PLC and Reed Elsevier NV at the market price at the date of grant. The Committee approves the grant of any option and sets performance conditions attaching to options. Following approval of the Reed Elsevier Group plc Share Option Scheme (the "Share Option Scheme") by shareholders of Reed Elsevier PLC and Reed Elsevier NV in April 2003, the Remuneration Committee has agreed to award options under the Share Option Scheme to executive directors and selected employees from 2004. The size of the annual grant pool will be determined by reference to the compound annual growth in adjusted EPS over the three years prior to grant, with individual grant size determined by the Committee based on individual performance. At compound growth of between 8% and 10% per annum, the pool of options available will be broadly comparable to the level of options granted under the previous scheme. At executive director level the grants are expected to be up to 3 times salary. For executive directors, option grants will be subject to a performance condition requiring the achievement of 6% per annum compound growth in adjusted EPS at constant exchange rates during the three years following the grant. There will be no re-testing of the 3 year EPS performance period. •Long term incentive plan. Following approval of the Reed Elsevier Group plc Long Term Incentive Share Option Scheme (the “2003 LTIS”) by shareholders of Reed Elsevier PLC and Reed Elsevier NV in April 2003, the Committee has decided to make the first awards under the 2003 LTIS to directors and a small number of key senior executives (approximately 40) during 2004. This award covers the period 2004 to 2006 during which time no further awards under the 2003 LTIS will be made to participants. The Rules require that approximately 50% of the total implied value of grants under the 2003 LTIS will take the form of nil cost conditional shares and 50% will take the form of conventional market value options. On the basis of the current implied values, this will result in a grant of 2.5 times salary in conditional shares and 5.5 times salary in conventional share options. Grants will vest subject to the achievement of compound annual adjusted EPS growth at constant exchange rates, achieved over a three-year performance period from 2004 to 2006, of between 8% and 12%. At 8% compound annual adjusted growth 25% of the award will vest; at 10% compound annual adjusted growth 100% of the award will vest; and at 12% compound annual adjusted growth 125% of the award would vest. Awards will vest on a straight-line basis between each of these points. There will be no re-testing of the three year performance period. Acceptance of an award under the 2003 LTIS by any individual will automatically terminate any award under the previous Reed Elsevier Group plc Senior Executive Long Term Incentive Plan (the “2000 LTIP”). Participants in the 2003 LTIS are required to build up a significant personal shareholding in Reed Elsevier PLC and/or Reed Elsevier NV. At executive director level, the requirement is that they should own shares equivalent to 1 ⁄2 times salary, to be acquired over a three year period. •Post-retirement pensions, where different retirement schemes apply depending on local competitive market practice, length of service and age of the director. The only element of remuneration that is pensionable is base salary. The Committee considers that a successful remuneration policy needs to be sufficiently flexible to take account of future changes in Reed Elsevier's business environment and in remuneration practice. Consequently, the above policy will apply in 2004 but may require to be amended. Any changes in policy will be described in future Directors' Remuneration Reports. ## TOTAL SHAREHOLDER RETURN The graphs below show the Reed Elsevier PLC and Reed Elsevier NV total shareholder return performance, assuming dividends were reinvested. The top two graphs compare the Reed Elsevier PLC performance with the

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## DIRECTORS’ REMUNERATION REPORT performance achieved by the FTSE 100, of which Reed Elsevier PLC is a member, and the Reed Elsevier NV performance with the performance achieved by the Amsterdam Stock Exchange (“AEX”) Index, of which Reed Elsevier NV is a member, for the four years 2000–2003. This period reflects the implementation of the new strategy, announced in February 2000, by the current management team. The other two graphs, which have been prepared in accordance with the Regulations, show the performance over the five years 1999-2003 compared to the performances of the FTSE 100 and the AEX. As Reed Elsevier PLC and Reed Elsevier NV are members of the FTSE 100 and AEX respectively, the Committee considers these indices to be appropriate for comparison purposes. For the four year period since 1 January 2000, the total shareholder return for Reed Elsevier PLC was 24%, significantly outperforming the FTSE 100 which saw a negative return of 26%. For Reed Elsevier NV, in the same four year period total shareholder return was 2%, also significantly outperforming the AEX Index which had a negative return of 41%. <img src='content_image/47408.jpg'> <img src='content_image/47409.jpg'> ## Source: FTSE International <img src='content_image/47411.jpg'> <img src='content_image/47410.jpg'> Source: Datastream The total shareholder return set out above is calculated on the basis of the average share price in the 30 trading days prior to the respective year ends and on the assumption that dividends were reinvested. ## SERVICE CONTRACTS As a condition of receiving an award under the 2003 LTIS, each executive director will be required to enter into a new service contract. The new contract will have a notice period of 12 months and will contain strengthened covenants that will apply for 12 months after leaving employment, preventing a director from working with specified competitors, recruiting Reed Elsevier employees and soliciting Reed Elsevier clients. Each of the executive directors has a service contract, the notice periods of which are described below: G J A van de Aast was appointed a director in December 2000. His service contract, which is dated 15 November 2000, is subject to English law and provides for a notice period of twelve months. M H Armour was appointed a director in July 1996. His service contract, which is dated 7 October 1996, is subject to English law and since 10 June 2003 his contract has provided for a notice period of twelve months, when Mr Armour agreed to a reduction in his notice period from twenty-four months. Mr Armour did not receive any compensation in return for agreeing to this change in his notice period.

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C H L Davis was appointed a director in September 1999. His service contract, which is dated 19 July 1999, is subject to English law and provides for a notice period of twelve months. A Prozes was appointed a director in August 2000. His service contract, which is dated 5 July 2000, is subject to New York law and provides that, in the event of termination without cause by the company, twelve months’ base salary would be payable. P Tierney was appointed a director on 8 April 2003. His service contract, which is dated 19 November 2002, is subject to New York law and provides that, in the event of termination without cause by the company, twelve months' base salary will be payable. The notice periods in respect of individual directors have been reviewed by the Committee. The Committee believes that as a general rule for future contracts, the notice period should be twelve months, and that the directors should, subject to practice within the country in which the director is based, be required to mitigate their damages in the event of termination. The Committee will, however, have regard to local market conditions so as to ensure that the terms offered are appropriate to recruit and retain key executives operating in a global business. ## EXTERNAL APPOINTMENTS Executive directors may, subject to the approval of the Chairman and the Chief Executive Officer, serve as non-executive directors on the boards of up to two non-associated companies (of which only one may be to the board of a major company). The Committee believes that Reed Elsevier can benefit from the broader experience gained by executive directors in such appointments. Directors may retain remuneration arising from such non-executive directorships. During the year CHL Davis was appointed a non-executive director of GlaxoSmithKline plc and received a fee of £28,848 during the year from that company in such capacity. ## REMUNERATION OF NON-EXECUTIVE DIRECTORS The remuneration of the non-executive directors is determined by the boards of Reed Elsevier Group plc, Reed Elsevier PLC and Reed Elsevier NV, with the aid of external professional advice from Towers Perrin. Non-executive directors receive an annual fee and are reimbursed expenses incurred in attending meetings. They do not receive any performance related bonuses, pension provisions, share options or other forms of benefit. During 2003 the boards initiated a review of the fees paid to the non-executive directors compared against the fees paid to non-executive directors of other leading multinational companies operating in global markets. With effect from 1 May 2003 the fees paid to the non-executive directors (other than the Chairman) who serve on the boards of Reed Elsevier Group plc, Reed Elsevier PLC and Reed Elsevier NV were reviewed for the first time since 1999 and were increased to £45,000/ € 65,000. The respective Chairmen of the Remuneration Committee and Audit Committee also receive an additional fee of £7,000/ € 12,000 in respect of those additional duties. The non-executive directors serve under letters of appointment, and do not have contracts of service. ## EMOLUMENTS OF THE DIRECTORS The emoluments of the directors of Reed Elsevier PLC and Reed Elsevier NV (including any entitlement to fees or emoluments from either Reed Elsevier Group plc or Elsevier Reed Finance BV) were as follows: ## (a) Aggregate emoluments <img src='content_image/649.jpg'> No compensation payments have been made for loss of office or termination in 2002 and 2003. Details of share options exercised by the directors over shares in Reed Elsevier PLC and Reed Elsevier NV during the year are shown on pages 36 and 37. The aggregate notional pre-tax gain made by the directors on the exercise of share options during the year was £5,201,190/ € 7,541,726 (2002: £306,843/ € 487,880).

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## (b) Individual emoluments of executive directors <img src='content_image/60890.jpg'> Benefits include the provision of a company car, medical insurance and life assurance. C H L Davis was the highest paid director in 2003, including gains of £4,960,150/ € 7,192,217 on the exercise of nil cost options awarded on his appointment as Chief Executive Officer in 1999. Mr Davis invested the entire after tax gain arising from the exercise of his options in Reed Elsevier PLC/Reed Elsevier NV shares. D J Haank served as a director until 18 June 2003 and remained an employee until 31 August 2003. During the period 18 June to 31 August 2003 he received emoluments of £87,759/ € 127,251, comprising salary (£84,839/ € 123,017) and other benefits (£2,920/ € 4,234). In accordance with the terms of the share options in force at the time of their grant in 1999, Mr Haank has retained his entitlement to options over 18,497 Reed Elsevier PLC shares and 10,925 Reed Elsevier NV shares, as detailed in the schedules on pages 36 and 37. All other options granted to Mr Haank lapsed on termination of his employment. ## (c) Pensions The Committee reviews the pension arrangements for the executive directors to ensure that the benefits provided are consistent with those provided by other multinational companies in its principal countries of operation. Executive directors based in the United Kingdom are provided with pension benefits at a normal retirement age of 60, equivalent to two thirds of base salary in the 12 months prior to retirement, provided they have completed 20 years’ service with Reed Elsevier or at an accrual rate of 1/30th of pensionable salary per annum if employment is for less than 20 years. The target pension for C H L Davis at normal retirement age of 60 is 45% of base salary in the 12 months prior to retirement. In 1989, the Inland Revenue introduced a cap on the amount of pension that can be provided from an approved pension scheme. M H Armour’s, G J A van de Aast’s and C H L Davis’s pension benefits will be provided from a combination of the Reed Elsevier Pension Scheme and the company’s unapproved, unfunded pension arrangements. The target pension for A Prozes, a US based director, is US$300,000 per annum, which becomes payable on retirement only if he completes a minimum of seven years’ service. This pension has no associated contingent benefits for a spouse or dependants, and will be reduced in amount by the value of any other retirement benefits payable by the company or any former employer, other than those attributable to employee contributions. The target pension for P Tierney, a US based director, after completion of five years pensionable service is US$440,000 per annum, inclusive of any other retirement benefits from any former employer. In the event of termination of employment before completion of five years’ pensionable service, the pension payable will be reduced proportionately, subject to a minimum pension of US$220,000 per annum in the event of termination of employment for reasons other than resignation or dismissal for cause. The pension arrangements for all the directors include life assurance cover whilst in employment, an entitlement to a pension in the event of ill health or disability and, except in the case of A Prozes, a spouse’s and/or dependants’ pension on death.

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The increase in the transfer value of the directors’ pensions, after deduction of contributions, is shown below: <img src='content_image/35615.jpg'> <img src='content_image/35614.jpg'> Transfer values have been calculated in accordance with the guidance note "GN11" published by the UK Institute of Actuaries and Faculty of Actuaries. The transfer value in respect of individual directors represents a liability in respect of directors’ pensions entitlement, and is not an amount paid or payable to the director. ## (d) Individual emoluments of non-executive directors <img src='content_image/35613.jpg'> (i) R J Nelissen has served as chairman of the supervisory board of Elsevier Reed Finance BV throughout the year. During the period 9 April to 31 December 2003 he received fees of £7,758/ € 11,250 in such capacity.

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## SHARE OPTIONS AND INTERESTS IN SHARES Options over shares in Reed Elsevier PLC and Reed Elsevier NV have been granted to executive directors and other senior executives under the Reed Elsevier Group plc 1993 Share Option Scheme (the "1993 Scheme"). Approximately 1,500 executives were granted options under the 1993 Scheme during 2003. The terms of the 1993 Scheme were approved by the shareholders of Reed Elsevier PLC and Reed Elsevier NV at their respective Annual General Meetings in 1993. The 1993 Scheme has granted options at the market price at the date of grant, which are normally exercisable between three and ten years from the date of grant. Since 1999 all options granted under the 1993 Scheme have been subject to the performance condition that the compound growth at constant exchange rates in adjusted EPS in the three years immediately preceding vesting must exceed the compound growth in the average of the UK and Dutch retail price indices by a minimum of 6%. Options over shares in Reed Elsevier PLC and Reed Elsevier NV have been granted, at the market price at the date of grant, under the Reed Elsevier Group plc Senior Executive Long Term Incentive Scheme (the “2000 LTIP”). Implementation of the 2000 LTIP was approved by shareholders of Reed Elsevier PLC and Reed Elsevier NV at their respective Annual General Meetings in April 2000. The terms of the 2000 LTIP permitted a one off grant of options to be made to executive directors and a limited number of key employees responsible for reshaping the business, executing the strategy for growth announced in February 2000 and producing a sustainable improvement in shareholder value. 38 key executives have been granted options under the 2000 LTIP. All grants were approved by the Committee, and may only be exercised during the period 1 January 2005 and 31 December 2005, and then only if 20% per annum compound total shareholder return is achieved, together with individual performance targets. In accordance with the terms of the grants proposed to be made under the 2003 LTIS in 2004, acceptance of an award under the 2003 LTIS by any individual will automatically terminate any award under the 2000 LTIP. The performance conditions applicable to the 1993 Scheme and the LTIP were chosen in order to provide an appropriate balance between operational focus and producing a sustainable improvement in shareholder value over the longer term. Options have also been granted over shares in Reed Elsevier PLC under the Reed Elsevier Group plc UK SAYE Option Scheme, in which all eligible UK employees are invited to participate. The SAYE Scheme grants options at a maximum discount of 20% to the market price at the time of grant, and are normally exercisable after the expiry of three or five years from the date of grant. No performance targets attach to options granted under this scheme as it is an all employee scheme. Approximately 1,600 employees participated in the SAYE Scheme during 2003.

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Details of options held by directors in the ordinary shares of Reed Elsevier PLC and Reed Elsevier NV during the period are shown below. There have been no changes in the options held by directors over Reed Elsevier PLC and Reed Elsevier NV ordinary shares since 31 December 2003. <img src='content_image/65605.jpg'> (i) Retained an interest in 321,200 shares (ii) Options lapsed unexercised during the year (iii) At date of resignation as a director (iv) Retained an interest in all of the shares (v) At date of appointment as a director The middle market price of a Reed Elsevier PLC ordinary share during the year was in the range 392p to 552p and at 31 December 2003 was 467.25p.

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## (b) Options over shares in Reed Elsevier NV <img src='content_image/95373.jpg'> (i) Retained an interest in 191,550 shares (ii) Options lapsed unexercised during the year (iii) At date of resignation as a director (iv) Retained an interest in all of the shares (v) At date of appointment as a director The market price of a Reed Elsevier NV ordinary share during the year was in the range € 8.13 to € 12.03 and at 31 December 2003 was € 9.85.

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## (c) Interests in shares The interests of the directors of Reed Elsevier PLC and Reed Elsevier NV in the issued share capital of the respective companies at the beginning and end of the year are shown below: <img src='content_image/22503.jpg'> (i) At date of appointment as a director, if later (ii) At date of resignation as a director. Any ordinary shares required to fulfil entitlements under nil cost share option grants are provided by the Employee Benefit Trust (“EBT”) from market purchases. As a potential beneficiary under the EBT in the same way as other employees of Reed Elsevier, each executive director is deemed to be interested in all the shares held by the EBT which, at 31 December 2003, amounted to 6,383,333 Reed Elsevier PLC ordinary shares and 1,327,777 Reed Elsevier NV ordinary shares. There have been no changes in the interests of the directors in the share capital of Reed Elsevier PLC or Reed Elsevier NV since 31 December 2003. Approved by the board of Reed Elsevier Group plc on 18 February 2004 ## Rolf Stomberg Chairman of the Remuneration Committee Approved by the board of Reed Elsevier PLC on 18 February 2004 ## Rolf Stomberg Non-executive director Approved by the combined board of Reed Elsevier NV on 18 February 2004 ## Rolf Stomberg Member of the supervisory board

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## Operating and financial review This review provides a commentary on the operating and financial performance of the Reed Elsevier combined businesses for the year ended 31 December 2003. It includes a description of the operating business, a review of performance and a financial review, including consideration of accounting policies, as well as a review of the finance activities and the financial performance and dividends of the parent companies. ## DESCRIPTION OF BUSINESS ## Reed Elsevier Reed Elsevier is one of the world’s leading publishers and information providers. The principal operations are in North America and Europe and include science and medical, legal, education and business publishing. Total revenues for the year ended 31 December 2003 were £4,925 million/ € 7,141 million, principally derived from subscriptions, circulation and copy sales, advertising sales and exhibition fees. Reed Elsevier is well positioned in long term attractive markets and has a clear investment led growth strategy which has delivered significant market outperformance in recent years. Long term growth in our markets is expected to be sustained by the continuing demand for professional information. The increasing levels of scientific, medical, legal and business activity, as well as the commitment to improved educational standards, are generating more demand for high quality, specialist information. In addition, professionals are looking for significant improvements in productivity through access to highly functional online services and associated workflow tools. Our strategy is aimed at delivering good sales growth in these markets through the development of innovative, superior products and strong sales and ## FORWARD LOOKING STATEMENTS marketing capabilities. We expect to see sustainable growth in our core information offerings and to develop these further in new geographical and commercial markets. Additionally we are expanding through investment and acquisition into new and faster growing contiguous markets. Our commitment to our ongoing major investment programmes is aimed at delivering highly functional information based products and services that deliver greater productivity and success for our business and professional customers. Our strategy to deliver good top line growth is accompanied by continued commitment to outstanding execution built on strong management, organisational effectiveness and tight cost control. We have established long term financial targets which are to achieve above market revenue growth and double digit adjusted earnings per share growth at constant currencies. The business is strongly cash generative. ## Science & Medical The science and medical business, Elsevier, comprises worldwide scientific, technical and medical publishing and communications businesses. Total revenues for the year ended 31 December 2003 were £1,381 million/ € 2,002 million. Growth in the scientific information market is driven by ever increasing scientific research and discovery and The Reed Elsevier Annual Reports & Financial Statements 2003 contain forward looking statements within the meaning of Section 27A of the US Securities Act 1933, as amended, and Section 21E of the Securities Exchange Act 1934, as amended. These statements are subject to a number of risks and uncertainties and actual results and events could differ materially from those currently being anticipated as reflected in such forward looking statements. The terms ‘expect’, ‘should be’, ‘will be’, and similar expressions identify forward looking statements. Factors which may cause future outcomes to differ from those foreseen in forward looking statements include, but are not limited to: general economic conditions and business conditions in Reed Elsevier’s markets; exchange rate fluctuations; customers’ acceptance of its products and services; the actions of competitors; legislative, fiscal and regulatory developments; changes in law and legal interpretation affecting Reed Elsevier’s intellectual property rights and internet communications; and the impact of technological change.

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## Combined financial statements ## REED ELSEVIER COMBINED FINANCIAL STATEMENTS 40 Accounting policies 42 Combined profit and loss account 43 Combined cash flow statement 44 Combined balance sheet 45 Combined statement of total recognised gains and losses 45 Combined shareholders’ funds reconciliation 46 Notes to the combined financial statements 70 Independent auditors’ report

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## Accounting policies These financial statements are presented under the historical cost convention and in accordance with applicable UK Generally Accepted Accounting Principles (“GAAP”). Prior to 2003, the financial statements were presented in accordance with both UK and Dutch GAAP. Following changes to Dutch GAAP effective for the 2003 financial year in respect of the presentation of dividends and pension accounting, UK and Dutch GAAP have diverged such that the Reed Elsevier accounting policies no longer accord with Dutch GAAP. Under Article 362.1 of Book 2 Title 9 of the Netherlands Civil Code, UK GAAP may be adopted by Dutch companies with international operations for the preparation of financial statements and, accordingly, UK GAAP has been so adopted ensuring consistency with the prior year of the accounting policies applied in the combined financial statements. ## Basis of preparation The equalisation agreement between Reed Elsevier PLC and Reed Elsevier NV has the effect that their shareholders can be regarded as having the interests of a single economic group. The Reed Elsevier combined financial statements (“the combined financial statements”) represent the combined interests of both sets of shareholders and encompass the businesses of Reed Elsevier Group plc and Elsevier Reed Finance BV and their respective subsidiaries, associates and joint ventures, together with the parent companies, Reed Elsevier PLC and Reed Elsevier NV (“the combined businesses”). These financial statements form part of the statutory information to be provided by Reed Elsevier NV, but are not for a legal entity and do not include all the information required to be disclosed by a company in its financial statements under the UK Companies Act 1985 or Netherlands Civil Code. Additional information is given in the annual reports and financial statements of the parent companies set out on pages 72 to 104. A list of principal businesses is set out on page 115. In addition to the figures required to be reported by applicable accounting standards, adjusted profit and operating cash flow figures have been presented as additional performance measures. Adjusted profit is shown before the amortisation of goodwill and intangible assets and exceptional items. Adjusted operating cash flow is measured after dividends from joint ventures, tangible fixed asset spend and proceeds from the sale of tangible fixed assets, but before exceptional payments and proceeds. ## Foreign exchange translation The combined financial statements are presented in both pounds sterling and euros. Balance sheet items are translated at year end exchange rates and profit and loss account and cash flow items are translated at average exchange rates. Exchange translation differences on foreign equity investments and the related foreign currency net borrowings and on differences between balance sheet and profit and loss account rates are taken to reserves. Transactions entered into in foreign currencies are recorded at the exchange rates applicable at the time of the transaction. The results of hedging transactions for profit and loss amounts in foreign currency are accounted for in the profit and loss account to match the underlying transaction. The principal exchange rates used are set out in note 28. ## Turnover Turnover represents the invoiced value of sales less anticipated returns on transactions completed by performance, excluding customer sales taxes and sales between the combined businesses. Sales are recognised for the various revenue sources as follows: subscriptions – over the period of the subscription; circulation – on despatch; advertising – on publication or period of online display; exhibitions – on exhibition date; educational testing contracts – on performance against delivery milestones. ## Development spend Development spend incurred on the launch of new products or services is expensed to the profit and loss account as incurred. The cost of developing application infrastructure and product delivery platforms is capitalised as a tangible fixed asset and written off over the estimated useful life. ## Pensions The expected costs of pensions in respect of defined benefit pension schemes are charged to the profit and loss account so as to spread the cost over the service lives of employees in the schemes. Actuarial surpluses and deficits are allocated over the average expected remaining service lives of employees. Pension costs are assessed in accordance with the advice of qualified actuaries. For defined contribution schemes, the profit and loss account charge represents contributions payable. ## Taxation Deferred taxation is provided in full for timing differences using the liability method. No provision is made for tax which would become payable on the distribution of retained profits by foreign subsidiaries, associates or joint ventures, unless there is an intention to distribute such retained earnings giving rise to a charge. Deferred tax assets are only recognised to the extent that they are considered recoverable in the short term. Deferred taxation balances are not discounted.

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## Accounting policies (continued) ## Goodwill and intangible assets On the acquisition of a subsidiary, associate, joint venture or business, the purchase consideration is allocated between the underlying net tangible and intangible assets on a fair value basis, with any excess purchase consideration representing goodwill. Acquired goodwill and intangible assets are capitalised and amortised systematically over their estimated useful lives up to a maximum of 40 years, subject to annual impairment review. For the majority of acquired goodwill and intangible assets, the maximum estimated useful life is 20 years, which is the rebuttable presumption under UK GAAP. In view of the longevity of certain of the goodwill and intangible assets relating to acquired science and medical and educational publishing businesses, this presumption has been rebutted in respect of these assets and a maximum estimated useful life of 40 years determined. The longevity of these assets is evidenced by their long established and well regarded brands and imprints, and their characteristically stable market positions. Intangible assets comprise publishing rights and titles, databases, exhibition rights and other intangible assets, which are stated at fair value on acquisition and are not subsequently revalued. ## Tangible fixed assets Tangible fixed assets are stated in the balance sheet at cost less accumulated depreciation. No depreciation is provided on freehold land. Freehold buildings and long leases are depreciated over their estimated useful lives up to a maximum of 50 years. Short leases are written off over the duration of the lease. Plant, equipment and computer systems are depreciated on a straight line basis at rates from 5%–33%. ## Investments Fixed asset investments in joint ventures and associates are accounted for under the gross equity and equity methods respectively. Other fixed asset investments are stated at cost, less provision, if appropriate, for any impairment in value. Short term investments are stated at the lower of cost and net realisable value. ## Inventories and pre-publication costs Inventories and pre-publication costs are stated at the lower of cost, including appropriate attributable overheads, and estimated net realisable value. Pre-publication costs, representing costs incurred in the origination of content prior to publication, are expensed systematically over the economic lives of the related products, generally up to five years. ## Finance leases Assets held under leases which confer rights and obligations similar to those attaching to owned assets are capitalised as tangible fixed assets and the corresponding liability to pay rentals is shown net of interest in the accounts as obligations under finance leases. The capitalised values of the assets are written off on a straight line basis over the shorter of the periods of the leases or the useful lives of the assets concerned. The interest element of the lease payments is allocated so as to produce a constant periodic rate of charge. ## Operating leases Operating lease rentals are charged to the profit and loss account on a straight line basis over the period of the leases. ## Financial instruments Payments and receipts on interest rate hedges are accounted for on an accruals basis over the lives of the hedges and included respectively within interest payable and interest receivable in the profit and loss account. Gains and losses on foreign exchange hedges, other than in relation to net currency borrowings hedging equity investments, are recognised in the profit and loss account on maturity of the underlying transaction. Gains and losses on net currency borrowings hedging equity investments are taken to reserves. Gains and losses arising on hedging instruments that are closed out due to the cessation of the underlying exposure are taken directly to the profit and loss account. Currency swap agreements are valued at exchange rates ruling at the balance sheet date with net gains and losses being included within short term investments or borrowings. Interest payable and receivable arising from the swap is accounted for on an accruals basis over the life of the swap. Finance costs associated with debt issuances are charged to the profit and loss account over the life of the related borrowings. ## Prior year adjustment Following the issuance of UITF38: Accounting for ESOP Trusts in December 2003, shares held in the parent companies by the Reed Elsevier Group plc Employee Benefit Trust, previously included within other fixed asset investments, are now presented as shares held in treasury and deducted within combined shareholders’ funds. Prior year comparatives have been restated accordingly.

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## Combined profit and loss account For the year ended 31 December 2003 <img src='content_image/17753.jpg'> ## Adjusted figures <img src='content_image/17754.jpg'> Adjusted figures, which exclude the amortisation of goodwill and intangible assets, exceptional items and related tax effects, are presented as additional performance measures, and are reconciled to the reported figures in note 10 to the combined financial statements.

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## Combined cash flow statement <img src='content_image/59541.jpg'> Short term investments include deposits of under one year if the maturity or notice period exceeds 24 hours, commercial paper investments and interest bearing securities that can be realised without significant loss at short notice. <img src='content_image/59543.jpg'> Reed Elsevier businesses focus on adjusted operating cash flow as a key cash flow measure. Adjusted operating cash flow is measured after dividends from joint ventures, tangible fixed asset spend and proceeds from the sale of tangible fixed assets but before exceptional payments and proceeds, and is reconciled to the reported figures in note 10 to the combined financial statements. Adjusted operating cash flow conversion expresses adjusted operating cash flow as a percentage of adjusted operating profit.