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with terms of one or more years, and are stated at cost, less cost of timber harvested (COTH). Costs attributable to timber are charged against income as trees are cut. The rate charged is determined annually based on the relationship of incurred costs to estimated current merchantable volume. Effective January 1, 2002, International Paper prospectively changed its method of accounting for mid-rotation fertilization expenditures to include such expenditures in the capitalized cost of forestlands. Accordingly, these costs are included as part of the COTH as trees are sold. ## Goodwill Effective January 1, 2002, International Paper adopted Statement of Financial Accounting Standards (SFAS) No. 142. As required by SFAS No. 142, an initial assessment of recorded goodwill for possible impairment was conducted as of January 1, 2002. Annual testing for possible goodwill impairment is performed as of the end of the third quarter of each year. A transitional impairment charge of $1.2 billion, including all of the goodwill associated with CHH, was recorded upon the initial adoption of this standard in 2002. In addition, CHH recorded $35 million of goodwill upon its acquisition of Plantation Timber Products which was written off by International Paper following an impairment evaluation in 2004 (see Note 5). No impairment charges were recorded in 2003. Goodwill relating to a single business reporting unit is included as an asset of the applicable segment while goodwill arising from major acquisitions that involve multiple business segments is classified as a corporate asset for segment reporting purposes. For goodwill impairment testing, this goodwill is allocated to business segments. ## Impairment of Long-Lived Assets Long-lived assets are reviewed for impairment upon the occurrence of events or changes in circumstances that indicate that the carrying value of the assets may not be recoverable, as measured by comparing their net book value to their projected undiscounted future cash flows generated by their use. Impaired assets are recorded at their estimated fair value. ## Income Taxes International Paper uses the asset and liability method of accounting for income taxes whereby deferred income taxes are recorded for the future tax consequences attributable to differences between the financial statement and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets and liabilities are revalued to reflect new tax rates in the periods rate changes are enacted. International Paper records its worldwide tax provision based on the respective tax rules and regulations for the jurisdictions in which it operates. Where the Company believes that the deduction of an item is supportable for income tax purposes, the item is deducted in its income tax returns. However, where treatment of an item is uncertain, tax accruals are recorded based upon the expected most probable outcome taking into consideration the specific tax regulations and facts of each matter, the results of historical negotiated settlements, and the results of consultations with outside tax advisors. These accruals for tax contingencies are recorded in the accompanying consolidated balance sheet in Other liabilities. Changes to the reserves are only made when an identifiable event occurs that changes the probable outcome, such as a settlement with relevant tax authority, the expiration of statutes of limitation for the subject tax year, change in tax laws, or a relevant court decision that addresses the matter. While the Company believes that these judgments and estimates are appropriate and reasonable under current circumstances, actual resolution of these matters may differ from recorded estimated amounts. ## Stock-Based Compensation Stock options and other stock-based compensation awards are accounted for using the intrinsic value method prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Had compensation cost for International Paper’s stock-based compensation programs been determined consistent with the provisions of SFAS No. 123, its net earnings, earnings per common share and earnings per common share - assuming dilution would have been reduced to the pro forma amounts indicated in the following table: <img src='content_image/24136.jpg'> The effect on 2004, 2003 and 2002 pro forma net earnings, earnings per common share and earnings per common share

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- assuming dilution of expensing the estimated fair market value of stock options is not necessarily representative of the effect on reported earnings for future years due to the vesting period of stock options and the potential for issuance of additional stock-based compensation. ## Environmental Remediation Costs Costs associated with environmental remediation obligations are accrued when such costs are probable and reasonably estimable. Such accruals are adjusted as further information develops or circumstances change. Costs of future expenditures for environmental remediation obligations are discounted to their present value when the amount and timing of expected cash payments are reliably determinable. ## Asset Retirement Obligations In accordance with the provisions of SFAS No. 143, “Accounting for Asset Retirement Obligations,” adopted effective January 1, 2003 (see Note 4), a liability and an asset are recorded equal to the present value of the estimated costs associated with the retirement of long-lived assets where a legal or contractual obligation exists. The liability is accreted over time and the asset is depreciated over the life of the related equipment or facility. International Paper’s asset retirement obligations under this standard relate to closure costs for landfills. Revisions to the liability could occur due to changes in the estimated costs or timing of closures, or possible new federal or state regulations affecting these closures. ## Translation of Financial Statements Balance sheets of international operations are translated into U.S. dollars at year-end exchange rates, while statements of operations are translated at average rates. Adjustments resulting from financial statement translations are included as cumulative translation adjustments in Accumulated other comprehensive income (loss) (OCI). See Note 13 related to derivatives and hedging activities. ## Reclassifications Certain reclassifications have been made to prior-year amounts to conform to the current year presentation. ## NOTE 2 EARNINGS PER COMMON SHARE Earnings per common share from continuing operations before the cumulative effect of accounting changes are computed by dividing earnings from continuing operations before the cumulative effect of accounting changes by the weighted average number of common shares outstanding. Earnings per common share from continuing operations before the cumulative effect of accounting changes, assuming dilution, are computed assuming that all potentially dilutive securities, including “in-the-money” stock options, are converted into common shares at the beginning of each year. In addition, beginning in the fourth quarter of 2004, the computation of diluted earnings per share reflects the inclusion of contingently convertible securities in periods when dilutive (see “Information About Capital Structure – Contingently Convertible Securities” in Note 4). Furthermore, as required by the recent consensus of the Emerging Issues Task Force of the Financial Accounting Standards Board (FASB), the computations of diluted earnings per share for all prior periods have been restated on this basis. A reconciliation of the amounts included in the computation of earnings per common share from continuing operations before the cumulative effect of accounting changes, and earnings per common share from continuing operations before the cumulative effect of accounting changes, assuming dilution, is as follows: <img src='content_image/69112.jpg'> Note: If an amount does not appear in the above table, the security was antidilutive for the period presented. Antidilutive securities included preferred securities of a subsidiary trust for 2002.

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## NOTE 3 INDUSTRY SEGMENT INFORMATION Financial information by industry segment and geographic area for 2004, 2003 and 2002 is presented on pages 33 and 34. ## NOTE 4 RECENT ACCOUNTING DEVELOPMENTS ## Share-Based Payment Transactions: In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which will require compensation costs related to share-based payment transactions to be recognized in the financial statements. The amount of the compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards will be remeasured each reporting period. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. This statement will apply to all awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. FASB Statement No. 123(R) replaces FASB Statement No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and will be effective for International Paper in the third quarter of 2005. Since, beginning in 2005, stock option grants will be limited only to certain non-U.S. employees, the provisions of this statement will mainly affect only previously issued options that are still outstanding and unvested on the effective date, as well as reload grants. While the exact impact on expense will depend upon the number of remaining unvested options at that time, the adoption of this standard could increase pre-tax compensation expense by approximately $20 million in both 2005 and 2006, with no significant impact on the Company’s financial statements in subsequent years. ## Exchanges of Nonmonetary Assets: In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29,” which replaces the exception from fair value measurement in APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” for nonmonetary exchanges of similar productive assets with a general exception from fair value measurement for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. This statement is to be applied prospectively and will be effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. International Paper believes that the adoption of SFAS No. 153 will not have a material impact on its consolidated financial statements. ## Accounting for Income Taxes: In December 2004, the FASB issued FASB Staff Position (FSP) Financial Accounting Standard (FAS) 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004 (the Act)” that provides tax relief to U.S. domestic manufacturers. The FSP states that the manufacturers’ deduction provided for under the Act should be accounted for as a special deduction in accordance with Statement 109 rather than as a tax rate reduction. Also in December 2004, the FASB issued FSP FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004,” addressing accounting and disclosure guidance relating to a company’s repatriation program. The additional disclosures required under this staff position are included in Note 9, Income Taxes. Both FSP’s were effective upon issuance. ## Inventory Costs: In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” which requires that abnormal amounts of idle facility expense, freight, handling costs and wasted material be recognized as current-period charges. This statement also introduces the concept of “normal capacity” and requires the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. Unallocated overheads must be recognized as an expense in the period in which they are incurred. This statement will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. International Paper believes that the adoption of SFAS No. 151 will not have a material impact on its consolidated financial statements. ## Accounting for Medicare Benefits: In May 2004, the FASB issued FSP FAS 106-2 that provides guidance on the accounting and required disclosures for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003. International Paper adopted FSP FAS 106-2 prospectively in the third quarter of 2004. The impact was a reduction of net postretirement benefit cost of approximately $8 million for the last half of 2004 and a reduction of the accumulated postretirement benefit obligation of approximately $110 million. See Note 16 for further discussion.

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## Information about Capital Structure – Contingently Convertible Securities: In April 2004, the FASB issued FSP FAS 129-1, Disclosure Requirements under FASB Statement No. 129, “Disclosure of Information about Capital Structure,” relating to contingently convertible securities and to their potentially dilutive effects on earnings per share. The FSP required expanded disclosures of the significant terms of the conversion features of these securities to enable users of the financial statements to understand the circumstances of the contingencies and the potential impact of conversion. These additional disclosures are presented for International Paper’s contingently convertible securities in Note 12. In October 2004, the FASB ratified a consensus reached by the Emerging Issues Task Force of the FASB that, effective for periods ending after December 15, 2004, contingently convertible securities should be included in the computation of diluted earnings per share regardless of whether or not the market price trigger for issuance of the securities has been met. Furthermore, the calculation of diluted earnings per share for all prior periods presented should be restated to reflect this consensus. At December 31, 2004, International Paper had outstanding $2.1 billion principal amount at maturity of zero-coupon convertible senior debentures. The debentures are contingently convertible into shares of the Company’s common stock at a conversion ratio of 9.5111 shares per $1,000 principal amount at maturity of debentures totaling approximately 20 million shares. See Note 12 for additional information. Accordingly, the calculation of diluted earnings per common share shown in Note 2 considers, when dilutive, the assumed conversion of these debentures for all periods presented. ## Consolidation of Variable Interest Entities: In January 2003, the FASB issued Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” This interpretation changed existing consolidation rules for certain entities, those in which equity investors do not have the characteristics of a controlling financial interest, or do not have sufficient equity at risk for the entity to finance the entity’s activities without additional subordinated financial support. The interpretation applied immediately to variable interest entities (VIE’s) created after January 31, 2003, and to VIE’s in which an enterprise obtains an interest after that date. International Paper has neither entered into nor obtained an interest in any VIE’s after January 31, 2003. For VIE’s created before February 1, 2003, this interpretation was effective for the first reporting period ending after December 15, 2003. During December 2003, the FASB issued a revision to FIN 46, FIN 46(R), with varying effective dates. International Paper applied FIN 46(R) to its variable interest entities as of December 31, 2003. As a result of the application of the provisions of FIN 46(R) during 2003, four entities that were required to be consolidated under prior accounting rules were deconsolidated, and one previously unconsolidated entity was consolidated, at December 31, 2003. The following paragraphs describe the entities affected by the new FIN 46(R) consolidation rules and the effects on International Paper’s December 31, 2003 financial statements: (a) A special purpose leasing entity that was formerly part of an operating lease arrangement between International Paper and a third party was determined to be a VIE and required to be consolidated by the Company. Plants, properties and equipment and Long-term debt of approximately $50 million that were formerly part of this operating lease arrangement were consolidated and a non-cash, after-tax charge of $3 million was recorded as the cumulative effect of an accounting change. (b) In connection with a forestlands sale in 2001, International Paper received notes having a value of approximately $480 million on the date of sale. During 2001, International Paper contributed the notes to an unconsolidated entity in exchange for a preferred interest in that entity valued at approximately $480 million, and accounted for this transfer as a sale of the notes for financial reporting purposes with no associated gain or loss. Also during 2001, the entity acquired approximately $561 million of other International Paper debt obligations for cash. In December 2002, International Paper acquired an option to purchase the third party’s interest in the unconsolidated entity and modified the terms of the entity’s special loss allocation between the third party and International Paper. These actions required the entity to be consolidated by International Paper at December 31, 2002, resulting in increases in installment notes receivable (included in Deferred charges and other assets) of $480 million, Long-term debt of $460 million and Minority interest of $20 million. In the fourth quarter of 2003, International Paper determined that it is not the primary beneficiary of the entity under the provisions of FIN 46(R) and, accordingly, deconsolidated the entity effective December 31, 2003. At December 31, 2003, International Paper’s $530 million preferred interest in the entity has been offset against $530 million of International Paper debt obligations since International Paper has, and intends to effect, a legal right to net settle these two amounts.

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(c) In a similar transaction completed in June 2002, approximately $400 million of installment notes received in connection with the sale of forestlands in various states were transferred to a consolidated entity in exchange for a preferred interest in the entity. In the same period, the entity acquired International Paper debt obligations of $450 million for cash. Under the provisions of FIN 46(R), International Paper is not the primary beneficiary of this entity, resulting in its deconsolidation as of December 31, 2003. The deconsolidation increased Investments by $465 million, Long-term debt by $100 million, and decreased notes receivable (included in Deferred charges and other assets) by $415 million and Minority interest by $50 million. (d) In the third quarter of 2003, International Paper Capital Trust and International Paper Capital Trust III (the Trusts), were determined to be VIE’s for which International Paper is not the primary beneficiary. Prior to July 1, 2003, the Trusts had been consolidated in the Company’s financial statements, and the preferred securities of the Trusts of approximately $1.3 billion were presented in the consolidated balance sheet as International Paper – Obligated Mandatorily Redeemable Preferred Securities of Subsidiaries Holding International Paper Debentures. Effective July 1, 2003, the Trusts were deconsolidated and the previously consolidated Mandatorily Redeemable Securities were replaced with International Paper’s obligations to the Trusts of approximately $1.3 billion that were classified as Long- term debt. In addition, interest on the International Paper debt obligations totaling approximately $44 million was recorded as Interest expense in the last half of 2003, replacing preferred dividends on the Mandatorily Redeemable Securities of the Trusts that, prior to the deconsolidation, would have been recorded as Minority interest expense. Preferred dividends for periods prior to the July 1, 2003 deconsolidation continue to be reported as Minority interest expense. A further discussion of the Company’s obligations to the Trusts is presented in Note 8. In December 2003, International Paper exercised its option to redeem the securities of one of the Trusts effective January 14, 2004, and, consequently, reclassified $830 million to Current maturities of long-term debt. In February 2005, International Paper redeemed the preferred securities of the remaining Trust which were classified in Long-term debt at December 31, 2004. ## See Notes 8 and 12 for additional information. The following table summarizes increases (decreases) in 2003 Consolidated Balance Sheet captions resulting from the application of FIN 46(R) to the entities described above. <img src='content_image/58619.jpg'> The pro forma effects on earnings (loss) before extraordinary items and cumulative effect of accounting changes, and net earnings, for the year ended December 31, 2002, assuming the adoption of FIN 46(R) as of January 1, 2002, were not material to net earnings or earnings per share. ## Financial Instruments with Characteristics of Both Liabilities and Equity: In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” It established standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This standard was effective for financial instruments entered into or modified after May 31, 2003, and otherwise was effective at the beginning of the first interim period beginning after June 15, 2003. International Paper adopted this standard during the third quarter ended September 30, 2003, with no material effect on the Company’s consolidated financial statements. ## Costs Associated with Exit or Disposal Activities: In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The statement changed the measurement and timing of recognition for exit costs, including restructuring charges, and was effective for activities initiated after December 31, 2002. It requires that a liability for costs associated with an exit or disposal activity, such as one-time termination

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benefits, be recognized when the liability is incurred, rather than at the date of a company’s commitment to an exit plan. It had no effect on charges recorded for exit activities begun prior to December 31, 2002. International Paper adopted this standard effective January 1, 2003, with no material effect on the Company’s consolidated financial statements. ## Impairment and Disposal of Long-Lived Assets: In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” It established a single accounting model for the impairment of long-lived assets to be held and used or to be disposed of by sale or abandonment, and broadened the definition of discontinued operations. International Paper adopted SFAS No. 144 in 2002, with no significant change in the accounting for the impairment and disposal of long-lived assets. ## Asset Retirement Obligations: In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” It requires the recording of an asset and a liability equal to the present value of the estimated costs associated with the retirement of long-lived assets where a legal or contractual obligation exists. The asset is required to be depreciated over the life of the related equipment or facility, and the liability accreted each year using a credit- adjusted risk-free rate. International Paper adopted SFAS No. 143 effective January 1, 2003, recording a discounted liability of $22 million, an increase in Property, plant and equipment, net, of $7 million, and a one-time cumulative effect of accounting change charge of $10 million (net of a deferred tax benefit of $5 million). The pro forma effects on earnings (loss) before extraordinary items and cumulative effect of accounting changes, and net earnings, for the year ended December 31, 2002, assuming the adoption of SFAS No. 143 as of January 1, 2002, were not material to net earnings or earnings per share. ## NOTE 5 ACQUISITIONS On July 2, 2004, Carter Holt Harvey (CHH) completed the purchase of an 85% interest in Plantation Timber Products (PTP), a Chinese premium panels manufacturer, for $134 million. PTP is a manufacturer of special medium density fiberboard and flooring products. In connection with this acquisition, CHH recorded $35 million of goodwill. However, in 2002, International Paper wrote off all CHH goodwill under newly adopted U.S. accounting standards. The goodwill arising in subsequent CHH acquisitions must be evaluated for impairment in International Paper’s consolidated financial statements and, in this case, was written off. This acquisition was accounted for using the purchase method with operating results included in the consolidated statement of operations from the date of acquisition. On July 1, 2004, International Paper completed the previously announced acquisition of Box USA Holdings, Inc. (Box USA). Prior to its acquisition by International Paper, Box USA was America’s largest independent packaging producer with 23 industrial packaging converting facilities across the country. The acquisition of Box USA, which is now included in the Industrial and Consumer Packaging segment, provides improved access to markets, better integration between International Paper mills and converting plants and other operating synergies. International Paper acquired all of the outstanding common and preferred stock of Box USA for approximately $189 million in cash and a $15 million 6% note payable issued to Box USA’s controlling shareholders. In addition, International Paper assumed approximately $197 million of debt, of which approximately $193 million was repaid by July 31, 2004. The note payable represents contingent consideration to be paid within two years from the July 1, 2004 acquisition date provided that no claims for indemnification are offset against the note. This acquisition was accounted for using the purchase method with the operating results of Box USA included in the accompanying consolidated statement of operations from the acquisition date. The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the date of the Box USA acquisition, subject to adjustment upon completion of purchase accounting activities in 2005: <img src='content_image/105582.jpg'> The following unaudited pro forma information for the years ended December 31, 2004, 2003 and 2002, presents the combined results of the continuing operations of International Paper and Box USA as if the acquisition had occurred as of January 1, 2002. This pro forma information does not purport to represent International Paper’s actual results of operations if the transaction described above would have occurred on January 1, 2002, nor is it necessarily indicative of future results.

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<img src='content_image/41474.jpg'> In December 2002, CHH acquired Starwood Australia’s Bell Bay medium density fiberboard plant in Tasmania for $28 million in cash. This acquisition was accounted for using the purchase method with operating results included in the consolidated statement of operations from the date of acquisition. ## NOTE 6 RESTRUCTURING, BUSINESS IMPROVEMENT AND OTHER CHARGES This footnote discusses restructuring, business improvement and other charges recorded for each of the three years included in the period ended December 31, 2004. It includes a summary of activity for each year, a roll forward associated with severance and other cash costs arising in each year, a table presenting details of the 2004 organizational restructuring program, and tables showing quarterly charges by business along with explanations for 2003 and 2002. 2004: During 2004, restructuring and other charges before taxes and minority interest of $211 million ($124 million after taxes and minority interest) were recorded. These charges included a $74 million charge before taxes and minority interest ($43 million after taxes and minority interest) for a corporate-wide organizational restructuring program, a $92 million charge before taxes ($57 million after taxes) for losses on early extinguishment of debt, a $35 million charge before minority interest ($18 million after minority interest) for the impairment of goodwill arising in connection with CHH’s purchase of Plantation Timber Products (PTP) and a $10 million charge before taxes ($6 million after taxes) for legal settlements. In addition, credits of $123 million before taxes ($76 million after taxes) for net insurance recoveries related to the hardboard siding and roofing litigation (see Note 10) and $35 million before taxes and minority interest ($22 million after taxes and minority interest) for the net reversal of restructuring reserves no longer needed were recorded. Also, a $5 million net increase in the tax provision, after minority interest, was recorded reflecting a $32 million charge for an adjustment of deferred tax balances and a $27 million credit from the reduction of valuation reserves for capital loss carryovers. The following table presents a detail of the $74 million corporate-wide organizational restructuring program charge in 2004, by business: <img src='content_image/41473.jpg'> The following table presents a roll forward of the severance and other costs included in the 2004 restructuring plans: <img src='content_image/41475.jpg'> The severance charges recorded in 2004 related to 984 employees. As of December 31, 2004, 833 employees had been terminated and 151 employees retained. Actual pension and postretirement costs exceeded estimates despite the lower number of employees terminated. 2003: During 2003, restructuring and other charges before taxes and minority interest of $298 million ($184 million after taxes and minority interest) were recorded. These charges included a $236 million charge before taxes and minority interest ($144 million after taxes and minority interest) for asset shutdowns of excess internal capacity and cost reduction actions, a $63 million charge before taxes ($39 million after taxes) for legal reserves, and a $1 million credit before taxes ($1 million charge after taxes) for early debt retirement costs. In addition, a $40 million credit before taxes and minority interest ($25 million after taxes and minority interest) was recorded for the net reversal of restructuring reserves no longer required.

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The $236 million charge in 2003 for the asset shutdowns of excess internal capacity and cost reduction actions consisted of a $91 million charge in the fourth quarter, a $71 million charge in the third quarter, a $51 million charge in the second quarter, and a $23 million charge in the first quarter. The fourth-quarter charge included $49 million of asset write-downs and $42 million of severance and other charges. The third-quarter charge included $9 million of asset write- downs and $62 million of severance and other charges. The second-quarter charge consisted of $16 million of asset write-downs and $35 million of severance and other charges. The first-quarter charge included $2 million of asset write- downs and $21 million of severance and other charges. The following table and discussion present details related to the 2003 fourth-quarter charge: <img src='content_image/70026.jpg'> (a) The Printing Papers business recorded a charge of $5 million to write off certain assets at the Courtland, Alabama and Franklin, Virginia mills. Management also approved a $14 million charge to write down the assets of the Maresquel, France mill to its net realizable value of approximately $5 million. The Printing Papers business also recorded a charge of $2 million for severance costs relating to 42 employees associated with a manufacturing excellence program. (b) The Consumer Packaging business recorded an additional charge of $22 million in conjunction with the closure of the Rolark manufacturing facility in Toronto, Canada, and a rationalization plan implemented in the second quarter of 2003. Closure costs for Rolark consisted of an $8 million charge to write down assets to their salvage value, $3 million of severance costs covering the termination of 178 employees and other exit costs of $1 million. The charge also included an additional provision for the previously implemented commercial business rationalization initiative. These charges included $8 million to write down assets to their salvage value and $2 million of severance costs covering the termination of 153 employees. (c) The Forest Products business approved plans in the fourth quarter of 2003 to shut down the Tuskalusa lumber mill in Moundville, Alabama. Operations at this mill had been temporarily ceased in the second quarter of 2003. Charges associated with this shutdown included $10 million of asset write-downs to salvage value and $1 million of other exit costs. (d) The Distribution business (xpedx) recorded a charge of $3 million to cover lease termination costs related to the Nationwide San Francisco, California facility that was vacated in the fourth quarter of 2003. (e) CHH recorded a charge of $7 million to shut down the Tokoroa, New Zealand sawmill. Charges associated with this shutdown included $4 million to write down assets to salvage value, $2 million for severance costs covering the termination of 115 employees and other exit costs of $1 million. CHH also implemented a cost reduction initiative recording a charge of $4 million for severance covering the termination of 229 employees. (f) During the fourth quarter of 2003, International Paper implemented the second phase of the previously announced Overhead Reduction Program to improve competitive performance. Charges associated with this initiative included $23 million of severance costs covering the termination of 557 employees. The $23 million charge included: Printing Papers - $6 million; Industrial and Consumer Packaging - $7 million; Forest Products - $5 million; Specialty Businesses and Other - $1 million; and Corporate - $4 million. The following table and discussion present details related to the 2003 third-quarter charge: <img src='content_image/70027.jpg'> (a) During the third quarter of 2003, International Paper implemented the initial phase of an Overhead Reduction Program to improve competitive performance. Charges associated with this initiative included $37 million of severance costs covering the termination of 744 employees and other cash costs of $1 million. The $38 million charge included: Printing Papers - $12 million; Industrial and Consumer Packaging - $11 million; Distribution - $2 million; Forest Products - $6 million; Specialty Businesses - $2 million; and Corporate - $5 million. (b) Specialty Businesses recorded an additional charge of $33 million in connection with the July 15, 2003 shutdown of the Natchez, Mississippi mill. The charge included $9 million of asset write-downs to salvage value, $1 million of severance costs covering the termination of 20 employees, $20 million of environmental closure costs and other cash costs of $3 million.

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The following table and discussion present details related to the 2003 second-quarter charge: <img src='content_image/43062.jpg'> (a) The Printing Papers business recorded a charge of $2 million for severance costs relating to 19 employees associated with an organizational restructuring initiative. The business also recorded an additional charge of $3 million to write off obsolete equipment. (b) The Consumer Packaging business implemented a rationalization plan at the Clifton and Englewood, New Jersey plants as a result of increased competition and slowing growth rates in key market segments. Management also approved a plan to exit leased space at the Montvale, New Jersey office in connection with the realignment of the Beverage Packaging and Foodservice businesses. Additionally, the Consumer Packaging business initiated an organizational restructuring program at several of its Bleached Board facilities. Charges associated with the programs included $2 million to cover the termination of 79 employees, lease termination costs of $3 million, and other cash costs of $1 million. (c) The Forest Products business approved plans to shut down the Springhill, Louisiana lumber facility and the Slaughter Industries Distribution Center in Portland, Oregon, and to temporarily cease operations at the Tuskalusa lumber mill in Moundville, Alabama. Charges associated with the shutdowns included $12 million of asset write-downs to salvage value at Springhill and Slaughter, $5 million of severance costs covering the termination of 198 employees at all three facilities, and $1 million of other exit costs. Management also approved the closure of the Madison, New Hampshire lumber mill. Charges associated with this plan included $1 million to write down assets to their net realizable value and other cash costs of $1 million. (d) The Distribution business (xpedx) recorded a severance charge of $4 million covering the termination of 176 employees in a continuing effort to consolidate duplicative facilities and reduce ongoing operational expenses. (e) Specialty Businesses recorded a severance charge of $16 million associated with the termination of 447 employees in connection with the July 15th shutdown of the Natchez, Mississippi mill. The following table and discussion present details related to the 2003 first-quarter charge: <img src='content_image/43063.jpg'> (a) The Industrial Packaging business implemented a plan to reorganize the Creil and Mortagne locations in France into a single complex. Charges associated with the reorganization included $1 million for severance costs covering the termination of 31 employees and other cash costs of $1 million. (b) Arizona Chemical recorded a charge of $1 million for severance costs of 51 employees associated with the Valkeakoski, Finland plant closure. Chemical Cellulose implemented a plan to shut down the Natchez, Mississippi dissolving pulp mill by mid-2003. Charges associated with this shutdown included a $1 million charge to write down assets to their salvage value and $12 million of severance costs covering the termination of 141 employees in April and other employees to be terminated upon closure. Additional shutdown charges for severance and closure costs were recorded in the second and third quarters of 2003. Additionally, Industrial Papers approved a plan to restructure converting operations at the Kaukauna, Wisconsin facility, modify its release products organization and implement division-wide productivity improvement actions. Charges associated with these plans included $1 million to write down assets to their salvage value and $5 million of severance costs covering the termination of 130 employees. (c) CHH recorded a charge of $1 million for severance costs for 33 employees associated with a headcount reduction initiative.

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The following table presents a roll forward of the severance and other costs included in the 2003 restructuring plans: <img src='content_image/13686.jpg'> The severance charges recorded in the first, second, third and fourth quarters of 2003 related to 3,343 employees. As of December 31, 2004, 3,305 employees had been terminated and 38 employees retained. 2002: During 2002, restructuring and other charges before taxes and minority interest of $695 million ($435 million after taxes and minority interest) were recorded. These charges included a $199 million charge before taxes and minority interest ($130 million after taxes and minority interest) for asset shutdowns of excess internal capacity and cost reduction actions, a $450 million pre-tax charge ($278 million after taxes) for additional exterior siding legal reserves discussed in Note 10, and a charge of $46 million before taxes and minority interest ($27 million after taxes and minority interest) for early debt retirement costs discussed in Note 12. In addition, a $68 million pre-tax credit ($43 million after taxes) was recorded in 2002, including $45 million for the reversal of 2001 and 2000 reserves no longer required and $23 million for the reversal of excess Champion purchase accounting reserves. The $199 million charge in 2002 for the asset shutdowns of excess internal capacity and cost reduction actions consisted of a $101 million charge in the fourth quarter, a $19 million charge in the third quarter and a $79 million charge in the second quarter. The fourth-quarter charge included $29 million of asset write-downs and $72 million of severance and other charges. The third-quarter charge included $9 million of asset write-downs and $10 million of severance and other charges. The second-quarter charge consisted of $42 million of asset write-downs and $37 million of severance and other charges. The following table and discussion present details related to the 2002 fourth-quarter charge: <img src='content_image/13687.jpg'> (a) The Printing Papers business approved a restructuring plan at the Maresquel, France plant in an effort to improve efficiencies. Charges associated with the plan included $1 million of asset write-downs to salvage value, $7 million of severance costs covering the termination of 80 employees and other cash costs of $1 million. Management also implemented a reduction in force initiative at several of its Coated and SC mills resulting in severance charges of $18 million covering the termination of 245 employees. Also, an additional charge of $1 million was recorded to write down the remaining assets at the Erie, Pennsylvania mill to salvage value. (b) The Industrial Packaging business recorded a charge of $3 million for severance costs relating to the Las Palmas, Canary Islands facility in the second phase of an effort to consolidate duplicative facilities and eliminate excess internal capacity. Redundancies associated with this charge included 56 employees. The Consumer Packaging business approved a plan to shut down the Hopkinsville, Kentucky Foodservice plant due to the facility’s financial shortfalls, a continuing weak economy, reduced demand from its Quick Service Restaurant (QSR) customers and increased competition for remaining QSR volumes. Charges associated with this shutdown included $10 million to write down assets to their estimated realizable value of $4 million, $3 million of severance costs covering the termination of 327 employees, and other exit costs of $1 million. The Hopkinsville plant had revenues of $47 million, $31 million and $24 million in 2002, 2001 and 2000, respectively. This plant had operating losses of $8 million in 2002, $1 million in 2001 and zero in 2000. Management also implemented a business-reorganization plan for the Foodservice group that included $2 million to write down assets to salvage value, $3 million of severance costs covering the termination of 113 employees and other cash costs of $1 million. The Consumer Packaging charge also included $4 million of asset

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write-offs and $1 million of other cash charges associated with its international joint ventures. (c) The Forest Products business charge of $12 million resulted from management’s decision to exit the development of the wood plastic composite business and shut down the Whelen Springs, Arkansas lumber mill. Charges associated with the wood plastic composite business consisted of $10 million of asset write-downs to salvage value and $1 million of other exit costs. The Whelen Springs lumber mill was closed due to the impact of the strong dollar on export sales. The Whelen Springs shut-down charge consisted of $1 million of exit costs. (d) The Distribution business (xpedx) implemented a plan to consolidate duplicative facilities and reduce ongoing operating logistics and selling and administrative expenses. Charges associated with this plan included $1 million of asset write-downs to salvage value, $2 million of severance costs covering the termination of 68 employees, and other cash costs of $3 million. (e) The Specialty Businesses approved a plan to shut down the Valkeakoski, Finland chemicals plant, as well as a management plan to implement headcount reduction programs within the Chemicals group. Charges associated with the Valkeakoski shutdown included $8 million of other cash costs not including severance. The Valkeakoski plant had revenues of $20 million, $19 million and $19 million in 2002, 2001 and 2000, respectively. This plant had operating earnings of $1 million in both 2002 and 2001, and $2 million in 2000. Charges associated with the headcount reduction programs consisted of $3 million of severance covering 11 employees to be terminated and $1 million of other related costs. The Specialty Businesses also implemented a plan to restructure manufacturing operations at the Polyrey facility in France. The plan includes consolidation of decorative high-pressure laminate production in order to optimize efficiencies and provide higher levels of quality and service. Charges associated with the restructuring included $2 million of severance costs covering the termination of 46 employees and $1 million of other exit costs. Other charges included a $1 million reserve for facility environmental costs at the Natchez, Mississippi facility. (f) CHH recorded a charge of $11 million for severance costs associated with a reduction-in-force at its Kinleith, New Zealand facility as part of a continuing program to improve the cost structure at the mill. Redundancies associated with the charge included 260 employees. The following table and discussion present details related to the 2002 third-quarter charge: <img src='content_image/788.jpg'> (a) The Specialty Businesses charge of $3 million relates to the severance costs for 43 employees in Arizona Chemical’s U.S. operations to reduce costs. (b) The CHH severance and other charge of $7 million relates primarily to severance for job reductions at the Kinleith, New Zealand mill (102 employees) and at packaging operations in Australia (45 employees). The Kinleith reductions are part of a continuing program to improve the cost structure at the mill. In addition, CHH recorded a $5 million loss related to a write- down of non-refundable tax credits to their estimated realizable value. (c) This $4 million charge relates to the write-down to zero of International Paper’s investment in Forest Express, a joint venture engaged in electronic commerce transaction processing for the Forest Products Industry. The following table and discussion present details related to the 2002 second-quarter charge: <img src='content_image/793.jpg'> (a) The Printing Papers business approved a plan to permanently shut down the Hudson River, New York mill by December 31, 2002, as many of the specialty products produced at the mill were not competitive in current markets. The assets of the mill are currently being marketed for sale. Impairment charges associated with the shutdown included $39 million to write the assets down to their estimated realizable value of approximately $5 million, $9 million of severance costs covering the termination of 294 employees, and other cash costs of $7 million. The Hudson River mill had revenues of $61 million, $80 million and $139 million in 2002, 2001 and 2000, respectively, and operating losses of $15 million in 2002 and $22 million in 2001, and operating earnings of $9 million in 2000. The Printing Papers business also recorded an additional

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charge of $2 million related to the termination of 52 employees in conjunction with the business’s plan to streamline and realign administrative functions at several of its locations. (b) The Consumer Packaging business approved the first phase of a plan to consolidate duplicative facilities and eliminate excess internal capacity. The $3 million charge recorded relates to the write-down of assets to their estimated salvage value. (c) The Distribution business (xpedx) severance charge of $7 million reflects the termination of 145 employees in conjunction with the business’s plan to consolidate duplicative facilities and eliminate excess internal capacity. (d) During the second quarter of 2002, International Paper implemented the second phase of its cost reduction program to realign its administrative functions across all business and staff support groups. As a result, a $12 million severance charge was recorded covering the termination of 102 employees. The following table presents a roll forward of the severance and other costs included in the 2002 restructuring plans: <img src='content_image/24521.jpg'> The severance charges recorded in the second, third and fourth quarters of 2002 related to 1,989 employees. As of December 31, 2003, 1,849 employees had been terminated and 140 employees retained. ## NOTE 7 BUSINESSES HELD FOR SALE AND DIVESTITURES ## Discontinued Operations: In the third quarter of 2004, International Paper entered into an agreement to sell its Weldwood of Canada Limited (Weldwood) business to West Fraser Timber Co., Ltd. of Vancouver, Canada (West Fraser), for approximately C$1.26 billion in cash, subject to certain adjustments at closing. Accordingly, a $323 million pre-tax loss on impairment ($711 million after taxes), including a $101 million pre-tax credit from cumulative translation adjustments, was recorded in Discontinued operations to write down the assets of Weldwood to their estimated net realizable value upon sale. The Company completed the sale of Weldwood in the fourth quarter for C$1.23 billion. International Paper’s net cash proceeds received from the sale were approximately U.S. $1.1 billion. All periods presented have been restated to present the operating results of Weldwood as a discontinued operation. Revenues associated with this discontinued operation were $1,021 million, $791 million and $708 million for 2004, 2003 and 2002, respectively. Earnings and earnings per share related to Weldwood were as follows: <img src='content_image/24522.jpg'>

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(a) Reflects the low historic tax basis in Weldwood that was carried over in connection with the acquisition of Champion in June 2000. Assets and liabilities of Weldwood, included in International Paper’s consolidated balance sheet at December 31, 2003 as Assets and Liabilities of businesses held for sale, were as follows: <img src='content_image/98806.jpg'> In the second quarter of 2004, CHH completed the sale of its Tissue business to Svenska Cellulosa Aktiebolaget (SCA). As a result of this sale, International Paper recognized a gain of $268 million before taxes and minority interest ($90 million after taxes and minority interest). This gain on sale is included along with the net income of the Carter Holt Harvey Tissue business prior to the sale in Discontinued operations in the accompanying consolidated statement of operations. Additionally, all periods presented have also been restated to present the operating results of the Tissue business as a discontinued operation. Revenues associated with this discontinued operation were $153 million in 2004, $433 million in 2003 and $369 million in 2002, respectively. Earnings and earnings per share related to the Tissue business were as follows: <img src='content_image/98807.jpg'> The assets and liabilities of the Tissue business, included in International Paper’s consolidated balance sheet at December 31, 2003 as a component of Assets and Liabilities of businesses held for sale, were as follows: <img src='content_image/98808.jpg'>

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## Other Divestitures: In December 2004, International Paper committed to plans for the sale in 2005 of its Fine Papers business and its Maresquel mill and Papeteries de France distribution business in France. As a result, charges of $11 million before taxes ($8 million after taxes), $34 million before and after taxes, and $11 million before taxes ($12 million after taxes), respectively, were recorded to write down the assets of these entities to their estimated fair values less costs to sell. In October 2004, International Paper sold two box plants located in China to International Paper Pacific Millennium, resulting in a pre-tax loss of $14 million ($4 million after taxes). Finally, also in the fourth quarter, a $9 million loss before taxes ($6 million after taxes) was recorded to adjust estimated gains/losses of businesses previously sold. In July 2004, International Paper signed an agreement to sell Scaldia Papier B.V., and its subsidiary, Recom B.V. in the Netherlands, to Stora Enso for approximately $36 million in cash. This sale was completed in the third quarter and resulted in a loss of $34 million (no impact from taxes or minority interest). In addition, a $4 million loss (no impact from taxes or minority interest) was recorded to adjust the estimated loss on sale of Papeteries de Souche L.C. in France. In the second quarter of 2004, a $27 million loss before and after taxes was recorded to write down the assets of Papeteries de Souche L.C. in France to their estimated realizable value. In addition, a $9 million loss before taxes and minority interest ($5 million after taxes and minority interest) was recorded to write down the assets of Food Pack S.A. in Chile to their estimated realizable value. In the first quarter of 2004, a $9 million gain before taxes ($6 million after taxes) was recorded to adjust estimated gains/losses of businesses previously sold. The net 2004 pre-tax losses totaling $144 million discussed above are included in Net losses (gains) on sales and impairments of businesses held for sale in the accompanying consolidated statement of operations. In the fourth quarter of 2003, International Paper recorded a $34 million charge to write down the assets of its Polyrey business in France to their estimated fair value. In addition, a $13 million pre-tax gain ($8 million after taxes) was recorded to adjust estimated gains/losses of businesses previously sold. In the third quarter of 2003, a $1 million charge before and after taxes was recorded to adjust estimated gains/losses of businesses previously sold. In the second quarter of 2003, a $10 million pre-tax charge ($6 million after taxes) was recorded to adjust estimated gains/losses of businesses previously sold. The net 2003 pre-tax losses, totaling $32 million, discussed above are included in Net losses (gains) on sales and impairments of businesses held for sale in the accompanying consolidated statement of operations. In the fourth quarter of 2002, International Paper recorded a $10 million pre-tax credit ($4 million after taxes) to adjust estimated accrued costs of businesses previously sold. In the third quarter of 2002, International Paper completed the sale of its Decorative Products operations to an affiliate of Kohlberg & Co. for approximately $100 million in cash and a note receivable with a fair market value of $13 million. This transaction resulted in no gain or loss as these assets had previously been written down to fair market value. Also during the third quarter of 2002, a net gain of $3 million before taxes ($1 million after taxes) was recorded related to adjustments of previously estimated accrued costs of businesses held for sale. During the second quarter of 2002, a net gain on sales of businesses held for sale of $28 million before taxes and minority interest ($96 million after taxes and minority interest) was recorded, including a pre-tax gain of $63 million ($40 million after taxes) from the sale in April 2002 of International Paper’s oriented strand board facilities to Nexfor Inc. for $250 million, and a net charge of $35 million before taxes and minority interest (a gain of $56 million after taxes and minority interest) relating to other sales and adjustments of previously recorded estimated costs of businesses held for sale. This net pre-tax charge included: (1) a $2 million net loss associated with the sales of the Wilmington, North Carolina carton plant and CHH’s distribution business; (2) an additional loss of $12 million to write down the net assets of Decorative Products to fair market value; (3) $11 million of additional expenses relating to the decision to continue to operate Arizona Chemical, including a $3 million adjustment of estimated accrued costs incurred in connection with the prior sale effort and an $8 million charge to permanently close a production facility; and (4) a $10 million charge for additional expenses relating to prior divestitures. The net tax credit associated with these charges reflects the reversal of an Arizona Chemical impairment tax charge in a prior period. The net 2002 pre-tax gains, totaling $41 million, discussed above are included in Net losses (gains) on sales and impairments of businesses held for sale in the accompanying consolidated statement of operations.

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## NOTE 8 PREFERRED SECURITIES OF SUBSIDIARIES In March 2003, Southeast Timber, Inc. (Southeast Timber), a consolidated subsidiary of International Paper, issued $150 million of preferred securities to a private investor with future dividend payments based on LIBOR. Southeast Timber, which through a subsidiary initially held approximately 1.5 million acres of forestlands in the southern United States, is International Paper’s primary vehicle for future sales of Southern forestlands. The preferred securities may be put back to International Paper by the private investor upon the occurrence of certain events, and have a liquidation preference that approximates their face amount. The $150 million preferred third-party interest is included in Minority interest in the accompanying consolidated balance sheet. The agreement with the private investor also places certain limitations on International Paper’s ability to sell forestlands in the Southern United States outside of Southeast Timber. In addition, because Southeast Timber is a separate legal entity, the assets of Southeast Timber and its subsidiaries, consisting principally of forestlands having a book value of approximately $280 million at December 31, 2004, will not be available to satisfy future liabilities and obligations of International Paper, although the value of International Paper’s interests in Southeast Timber and its subsidiaries will be available for these purposes. In September 1998, International Paper Capital Trust III issued $805 million of International Paper-obligated mandatorily redeemable preferred securities. Prior to July 1, 2003, International Paper Capital Trust III was a wholly- owned consolidated subsidiary of International Paper (see Note 4). Its sole assets were International Paper 7.875% debentures. The obligations of International Paper Capital Trust III related to its preferred securities were unconditionally guaranteed by International Paper. In January 2004, International Paper redeemed these securities at par plus accrued interest. In the third quarter of 1995, International Paper Capital Trust (the Trust) issued $450 million of International Paper- obligated mandatorily redeemable preferred securities. Prior to July 1, 2003, the Trust was a wholly-owned consolidated subsidiary of International Paper (see Note 4) and its sole assets were International Paper 5.25% convertible subordinated debentures. In February 2005, International Paper redeemed these securities at 100.5% of par plus accrued interest. Effective July 1, 2003, as required by FIN 46, International Paper deconsolidated International Paper Capital Trust III and International Paper Capital Trust, holding approximately $1.3 billion of mandatorily redeemable preferred securities, previously classified as a separate line item on the Company’s consolidated balance sheet, and recorded approximately $1.3 billion of borrowings from these trusts as Long-term debt. In June 1998, IP Finance (Barbados) Limited, a non-U.S. wholly-owned consolidated subsidiary of International Paper, issued $550 million of preferred securities with a dividend payment based on LIBOR. These preferred securities were redeemed in June 2003 with the proceeds of debt issuances (see Note 12). Timberlands Capital Corp. II, Inc., a wholly-owned consolidated subsidiary of International Paper, issued $170 million of 4.5% preferred securities in March 2003. These securities were not mandatorily redeemable and were classified in the consolidated balance sheet as a Minority interest. In November 2004, these securities became mandatorily redeemable and were reclassified from Minority interest to Current maturities of long-term debt pursuant to SFAS No. 150 and redeemed in December 2004 (see Note 12). Distributions paid under all of the preferred securities noted above were $52 million, $111 million and $115 million in 2004, 2003 and 2002, respectively. The expense related to these preferred securities is shown in Minority interest expense in the consolidated statement of operations, except for $32 million in 2004 and $44 million in 2003 included in Interest expense subsequent to the adoption of FIN 46 and reclassifications mandated under SFAS No. 150. ## NOTE 9 INCOME TAXES The components of International Paper’s earnings (loss) from continuing operations before income taxes and minority interest by taxing jurisdiction were: <img src='content_image/35965.jpg'>

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The provision (benefit) for income taxes by taxing jurisdiction was: <img src='content_image/112444.jpg'> International Paper made income tax payments, net of refunds, of $254 million, $253 million and $270 million in 2004, 2003 and 2002, respectively. A reconciliation of income tax expense (benefit) using the statutory U.S. income tax rate compared with actual income tax expense (benefit) follows: <img src='content_image/112443.jpg'> The tax effects of significant temporary differences representing deferred tax assets and liabilities at December 31, 2004 and 2003 were as follows: <img src='content_image/112445.jpg'> ## Deferred tax liabilities: <img src='content_image/112447.jpg'> Deferred tax assets and liabilities are recorded in the accompanying consolidated balance sheet under the captions Deferred income tax assets, Deferred charges and other assets, Other accrued liabilities and Deferred income taxes. The increase in 2004 in Deferred income taxes principally reflects the use of U.S. net operating loss carryforwards. The valuation allowance for deferred tax assets as of January 1, 2004 was $179 million. The net change in the total valuation allowance for the year ended December 31, 2004 was a decrease of $42 million. The 2004 second-quarter provision for income taxes included a $54 million credit before minority interest ($27 million after minority interest) from the reduction of valuation reserves for capital loss carryovers and a $32 million charge for the adjustment of deferred tax balances. The reduction of valuation reserves reflected capital gains generated by the sale of the CHH Tissue business. During 2003, International Paper recorded decreases totaling $123 million in the provision for income taxes for significant items occurring in 2003, including a $13 million reduction in the fourth quarter ($26 million before minority interest) for a favorable settlement with Australian tax authorities of net operating loss carryforwards, a $60 million reduction in the third quarter reflecting a favorable revision of estimated tax accruals upon filing the 2002 federal income tax return and increased research and development credits, and a $50 million

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reduction in the second quarter reflecting a favorable tax audit settlement and benefits from an overseas tax program. During the fourth quarter of 2002, International Paper completed a review of its deferred income tax accounts, including the effects of state tax credits and the taxability of the Company’s operations in various state taxing jurisdictions. As a result of this review, the Company recorded a decrease of approximately $46 million in the income tax provision in the 2002 fourth quarter, reflecting the effect of the estimated state income tax effective rate applied to these deferred tax items. International Paper has federal and non-U.S. net operating loss carryforwards that expire as follows: years 2005 through 2014 - $169 million, years 2015 through 2024 - $2.7 billion, and indefinite carryforwards - $829 million. International Paper has tax benefits from net operating loss carryforwards for state taxing jurisdictions of approximately $326 million that expire as follows: years 2005 through 2014 - $84 million, and years 2015 through 2024 - $242 million. International Paper also has federal, non-U.S. and state tax credit carryforwards that expire as follows: years 2005 through 2014 - $52 million, years 2015 through 2024 - $119 million, and indefinite carryforwards - $405 million. Deferred taxes are not provided for temporary differences of approximately $2.7 billion, $2.5 billion and $1.8 billion as of December 31, 2004, 2003 and 2002, respectively, representing earnings of non-U.S. subsidiaries that are intended to be permanently reinvested. Computation of the potential deferred tax liability associated with these undistributed earnings and other basis differences are not practicable. International Paper is currently being audited by various federal, state and non-U.S. taxing authorities for the tax periods 1995 through 2003. Some of these audits are expected to conclude in 2005. The Company believes that it is adequately accrued for any possible audit adjustments. While the overall resolution of these examinations cannot be determined at this time, the Company may realize a tax benefit, the effects of which could be material to the reported operating results for any given period, if such positions are ultimately sustained. In October 2004, the American Jobs Creation Act of 2004 (the Act) was signed into law. The Act provides for a special one-time deduction of 85% of certain foreign earnings that are repatriated. International Paper may elect to apply this provision to qualifying earnings repatriations in 2005. As of December 31, 2004, International Paper has started an evaluation of the effects of the repatriation provision, but does not expect to be able to complete this evaluation until the second quarter of 2005. While no repatriation decisions have been made as of December 31, 2004, the range of possible amounts that the Company is considering for repatriation is between zero and $1.8 billion. The related potential range of deferred taxes that would have to be provided should a repatriation decision be made is between zero and $300 million. ## NOTE 10 COMMITMENTS AND CONTINGENT LIABILITIES Certain property, machinery and equipment are leased under cancelable and non-cancelable agreements. At December 31, 2004, total future minimum rental commitments under non- cancelable leases were $918 million, due as follows: 2005 - $211 million; 2006 - $170 million; 2007 - $141 million; 2008 - $115 million; 2009 - $67 million; and thereafter - $214 million. Rent expense was $259 million, $262 million and $267 million for 2004, 2003 and 2002, respectively. Unconditional purchase obligations have been entered into during the ordinary course of business for the purchase of certain pulpwood, logs, wood chips, raw materials, energy and services. At December 31, 2004, total unconditional purchase obligations were $6,853 million, due as follows: 2005 - $2,723 million; 2006 - $447 million; 2007 - $354 million; 2008 - $337 million; 2009 - $292 million; and thereafter - $2,700 million. International Paper entered into an agreement in 2000 to guarantee, for a fee, an unsecured contractual credit agreement of an unrelated third party customer. The guarantee, which expires in 2008, was made in exchange for a ten-year contract as the exclusive paper supplier to the customer. Both the loan to the customer and the guarantee are unsecured. Under the terms of the guarantee, International Paper could be required to make future payments up to a maximum of $110 million if the third party were to default under the credit agreement. There is no liability recorded on International Paper’s books for the guarantee. It is possible that payments may be required under this guarantee arrangement in the future, although it is uncertain how much or when such payments, if any, might be required. In connection with sales of businesses, property, equipment, forestlands, and other assets, International Paper commonly makes representations and warranties relating to such businesses or assets, and may enter into indemnification arrangements with respect to tax and environmental liabilities, breaches of representations and warranties, and other matters. Where any liabilities for such matters are probable and subject to reasonable estimation, accrued liabilities are recorded at the time of sale as a cost of the transaction. International Paper believes that possible future unrecorded liabilities for these matters, if any, would not have a material adverse effect on its consolidated financial statements.

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## Exterior Siding and Roofing Litigation Three nationwide class action lawsuits relating to exterior siding and roofing products manufactured by Masonite that were filed against International Paper have been settled in recent years. The first suit, entitled Judy Naef v. Masonite and International Paper, was filed in December 1994 (Hardboard Lawsuit). The plaintiffs alleged that hardboard siding manufactured by Masonite fails prematurely, allowing moisture intrusion that in turn causes damage to the structure underneath the siding. The class consisted of all U.S. property owners having Masonite hardboard siding installed on and incorporated into buildings between January 1, 1980 and January 15, 1998. The Court granted final approval of the settlement on January 15, 1998. The settlement provides for monetary compensation to class members meeting the settlement requirements on a claims-made basis, which requires a class member to individually submit proof of damage to, or caused by, Masonite product, proof of square footage involved, and proofs of various other matters in order to qualify for payment with respect to a claim. It also provides for the payment of attorneys’ fees equaling 15% of the settlement amounts paid to class members, with a non-refundable advance of $47.5 million plus $2.5 million in costs. Those amounts were paid to class counsel in 1998. For siding that was installed between January 1, 1980 and December 31, 1989, the deadline for filing claims expired January 18, 2005, and for siding installed between January 1, 1990 through January 15, 1998, claims must be made by January 15, 2008. The second suit, entitled Cosby, et. al. v. Masonite Corporation, et. al., was filed in 1997 (Omniwood Lawsuit). The plaintiffs made allegations with regard to Omniwood siding manufactured by Masonite which were similar to those alleged in the Hardboard Lawsuit. The class consisted of all U.S. property owners having Omniwood siding installed on and incorporated into buildings from January 1, 1992 to January 6, 1999. The settlement relating to the Omniwood Lawsuit provides that qualified claims must be made by January 6, 2009 for Omniwood siding that was installed between January 1, 1992 and January 6, 1999. The third suit, entitled Smith, et. al. v. Masonite Corporation, et. al., was filed in 1995 (Woodruf Lawsuit). The plaintiffs alleged that Woodruf roofing manufactured by Masonite is defective and causes damage to the structure underneath the roofing. The class consisted of all U.S. property owners who had incorporated and installed Masonite Woodruf roofing from January 1, 1980 to January 6, 1999. The settlement relating to the Woodruf Lawsuit provides that for product installed between January 1, 1980 and December 31, 1989, claims must be made by January 6, 2006, and for product installed between January 1, 1990 and January 6, 1999, claims must be made by January 6, 2009. The Court granted final approval of the settlements of the Omniwood and Woodruf Lawsuits on January 6, 1999. The settlements provide for monetary compensation to class members meeting the settlement requirements on a claims- made basis, which requires a class member to individually submit proof of damage to, or caused by, Masonite product, proof of square footage involved, and proofs of various other matters. The settlements also provide for payment of attorneys’ fees equaling 13% of the settlement amounts paid to class members with a non-refundable advance of $1.7 million plus $75,000 in costs for each of the two cases. Those amounts were paid in 1999. The liability for these matters was retained after the sale of Masonite to Premdor Inc. in 2001. ## Claim Filing and Determination Once a claim is determined to be valid under the respective settlement agreement covering the claim, the amount of the claim is determined by reference to a negotiated compensation formula established under the settlement agreements designed to compensate the homeowner for all damage to the structure. The compensation formula is based on (1) the average cost per square foot for product replacement, including material and labor as calculated by industry standards, in the area in which the structure is located, adjusted for inflation, or (2) the cost of appropriate refinishing as determined by industry standards in such area, adjusted for inflation. Persons receiving compensation pursuant to this formula also agree to release International Paper and Masonite from all other property damage claims relating to the product in question. In connection with the products involved in the lawsuits described above, where there is damage, the process of degradation, once begun, continues until repairs are made. International Paper estimates that approximately 4 million structures have installed products that are the subject of the Hardboard Lawsuit, 300,000 structures have installed products that are subject to the Omniwood Lawsuit and 86,000 structures have installed products that are the subject of the Woodruf Lawsuit. Masonite stopped selling the products involved in the Hardboard Lawsuit in May 2001, the products involved in the Woodruf Lawsuit in May 1996, and the products involved in the Omniwood Lawsuit in September 1996. Persons who are class members under the Hardboard, Omniwood and Woodruf Lawsuits who do not pursue remedies under the respective settlement agreement pertaining to such suits may have recourse to warranties, if any, in existence at the expiration of the respective terms established under the settlement agreements for making claims. The warranty period generally extends for 25 years following the installation of the product in question and,

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although the warranties vary from product to product, they generally provide for a payment of up to two times the purchase price. ## Reserve Analysis The following table presents an analysis of the net reserve activity related to the Hardboard, Omniwood and Woodruf Lawsuits for the years ended December 31, 2004, 2003 and 2002. <img src='content_image/118415.jpg'> ## Additional Provisions In the third quarter of 2001, a determination was made that an additional provision would be required to cover an expected shortfall in the reserves that had arisen since the third quarter of 2000 due to actual claims experience exceeding projections. An additional $225 million was added to the existing reserve balance at that time. This increase was based on third party consultants’ statistical studies of future costs, which analyzed trends in the claims experience through August 31, 2001. The amount was based on a statistical outcome that assumed that Hardboard claims growth continued through mid-2002, then declined by 50% per year. Omniwood claims growth was assumed to continue through mid-2002, decline by 50% in 2003 and thereafter increase at the rate of 10% per year. Woodruf claims were assumed to decline at a rate of 50% per year. Unit costs per claim were assumed to hold at the 2001 level. The statistical model used to develop this outcome also included assumptions on the geographic patterns of claims rates and assumptions related to the cost of claims, including forecasts relating to the rate of inflation. Average claim costs were calculated from historical claims records, taking into consideration structure type, location and source of the claim. During 2002, tracking of the actual versus projected number of claims filed and average cost per claim indicated that although total claims costs were approximately equal to projected amounts, the number of claims filed was higher than projected, offsetting the effect of lower average claims payment amounts. Accordingly, updated projections were developed by two third-party consultants utilizing the most current claims experience data. Principal assumptions used in the development of these projections were that the number of Hardboard claims filed, which account for approximately 85% of all claims costs, would average slightly above current levels until January 2005, then would decline by about 70% in 2005 and remain flat to the end of the claims period. Average claims costs were assumed to continue to decline at the rate experienced during the last twelve months. While management believes that the assumptions used in developing these outcomes represent the most probable scenario, factors which could cause actual results to vary from these assumptions include: (1) area specific assumptions as to growth in claims rates could be incorrect, (2) locations where previously there had been little or no claims could emerge as significant geographic locations, and (3) the cost per claim could vary materially from that projected. The first consultant provided two statistical outcomes, with the higher outcome indicating a required provision of approximately $430 million. The second consultant provided a range of possible outcomes, with the most probable outcome indicating a required provision of approximately $475 million. The estimate ranged from a low (a 95% probability that future charges would exceed this amount) of $338 million to a high (5% probability that future charges would exceed this amount) of $635 million. Using these projections, management determined that a provision of $450 million should be recorded in the fourth quarter of 2002 as an estimate of the most probable outcome based on the consultants’ projections. During 2004 and 2003, claims filed and average costs per claim were in line with 2002 projections and no adjustments of reserve balances were required. ## Reserve Balances At December 31, 2004, net reserves for these matters totaled $259 million, including $158 million for the Hardboard Lawsuit, $97 million for the Omniwood Lawsuit and $4 million for the Woodruf Lawsuit. At December 31, 2004, there were $33 million of costs associated with claims inspected and not paid ($27 million for Hardboard, $5 million for Omniwood and $1 million for Woodruf) and $29 million of costs associated with claims in process and not yet inspected ($24 million for claims related

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to the Hardboard Lawsuit, $4 million for claims related to the Omniwood Lawsuit and $1 million for claims related to the Woodruf Lawsuit). In addition, there were approximately $11 million of costs associated with administrative and legal fees incurred but not paid prior to year-end. The estimated claims reserve includes $187 million for unasserted claims that are probable of assertion. While additional reserve balances may be required for future payments under the Woodruf Lawsuit, International Paper believes that the aggregate reserve balance for claims arising in connection with exterior siding and roofing products, described above, are adequate, and that additional amounts will be recovered from its insurance carriers in the future relating to these claims (described below). International Paper is unable to estimate at this time the amount of additional charges, if any, which may be required for these matters in the future. ## Claims Statistics The average settlement cost per claim for the years ended December 31, 2004, 2003, and 2002 for the Hardboard, Omniwood and Woodruf Lawsuits is set forth in the table below: ## Average Settlement Cost Per Claim <img src='content_image/64366.jpg'> ## Claims Activity The above information is calculated by dividing the amount of claims paid by the number of claims paid. Through December 31, 2004, net settlement payments totaled $866 million ($713 million for claims relating to the Hardboard Lawsuit, $105 million for claims relating to the Omniwood Lawsuit and $48 million for claims relating to the Woodruf Lawsuit), including $51 million of non-refundable attorneys’ advances discussed above ($47.5 million for the Hardboard Lawsuit and $1.7 million for each of the Omniwood Lawsuit and Woodruf Lawsuit). Also, payments of $50 million have been made to the attorneys for the plaintiffs in the Hardboard, Omniwood and Woodruf Lawsuits. In addition, through December 31, 2004, International Paper had received $223 million related to the Hardboard Lawsuit from our insurance carriers. The following table shows an analysis of claims statistics related to the Hardboard, Omniwood and Woodruf Lawsuits for the years ended December 31, 2004, 2003 and 2002. The table reflects an increase in the number of claims filed in December 2004 on the eve of the January 2005 deadline for filing certain claims under the Hardboard Lawsuit settlement agreement. These increases were anticipated in prior claim projections and did not adversely affect the evaluation of the adequacy of reserve balances at December 31, 2004. <img src='content_image/64367.jpg'>

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## PART I <img src='content_image/3429.jpg'> ## PART II. <img src='content_image/3428.jpg'> ## INTERNATIONAL PAPER COMPANY ## Index to Annual Report on Form 10-K For the Year Ended December 31, 2004 <img src='content_image/3427.jpg'> ## PART III. <img src='content_image/3425.jpg'> ## PART IV. <img src='content_image/3432.jpg'> <img src='content_image/3433.jpg'>

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## Insurance Matters In November 1995, International Paper and Masonite commenced a lawsuit in the Superior Court of the State of California against certain of their insurance carriers (the Indemnification Lawsuit) because of their refusal to indemnify International Paper and Masonite for, among other things, the settlement relating to the Hardboard Lawsuit and the refusal of one insurer, Employer’s Insurance of Wausau (Wausau), to provide a defense of that lawsuit. During the fall of 2001, a trial of Masonite’s claim that Wausau breached its duty to defend (the Breach of Duty Lawsuit) was conducted in a state court in California. The jury found that Wausau had breached its duty to defend Masonite and awarded Masonite $13 million for its expense to defend the Hardboard Lawsuit; an additional $12 million in attorneys’ fees and interest for Masonite’s expense to prosecute the Breach of Duty Lawsuit based on a finding that Wausau had acted in bad faith in refusing to defend the Hardboard Lawsuit and an additional $68 million in punitive damages. In a post-trial proceeding, the court awarded an additional $2 million in attorneys’ fees which Masonite had incurred in the trial of the Breach of Duty Lawsuit. The trial of the Indemnification Lawsuit against 22 insurers (the Defendants) began in April 2003 to recover $470 million paid to claimants pursuant to the settlement of the Hardboard Lawsuit through May 2003. In July 2003, the jury determined that $383 million of International Paper’s payments to settle these claims are covered by its insurance policies (the Phase I Verdict). In the current phase of the case the court will determine how much of the $383 million can be allocated to the policies of the Defendants. The Company anticipates that, before a judgment is entered, the California court will also make a determination about indemnification for future claims based on the Phase I Verdict. The court will also determine whether amounts paid and to be paid to the plaintiff class counsel pursuant to the settlement of the Hardboard Lawsuit, and administrative expenses that have been and will be incurred in connection with that settlement, are covered by insurance. A judgment has not yet been entered on the verdict in the Indemnification Lawsuit. It is difficult to predict when the judgment will be entered. This judgment will be subject to appeal when entered. Because of the uncertainties inherent in the litigation, including the outcome of any appeal, International Paper is unable to estimate the amount that it ultimately may recover against its insurance carriers. The Company is presently engaged in court-ordered mediation with several of the Defendants. During 2004, International Paper reached settlements with Wausau, with respect to both the Indemnification and the Breach of Duty Lawsuits, and with four other insurance companies under which International Paper received $164 million, including approximately $118 million received in 2004, and an additional payment of $46 million in January 2005. In addition, the Company has begun arbitration proceedings against American Excess Insurance Association and ACE Insurance Company, Ltd., to recover additional insurance proceeds. As of December 31, 2004, International Paper had received an aggregate of $223 million in settlement payments from certain of its insurance carriers which had been named as defendants in the Indemnification Lawsuit or which otherwise provided International Paper with insurance coverage for hardboard siding. Under an alternative risk-transfer agreement, International Paper contracted with a third party for payment in an amount up to $100 million for certain costs relating to the Indemnification Lawsuit if payments by International Paper with respect thereto exceeded a specified retention that was indexed to account for inflation over a several year period. The agreement with the third party was in excess of liability insurance recoveries obtained by International Paper, which are the subject of the separate litigation described above. Accordingly, International Paper believes that the obligation of the third party with respect to this agreement did not constitute “other valid and collectible insurance” that would either limit or otherwise affect the Company’s right to collect insurance available to it and Masonite under the insurance policies, which are the subject of the Indemnification Lawsuit. At December 31, 2001, International Paper had received the $100 million from the third party. A dispute between International Paper and the third party, concerning a number of issues, including the relationship of the contract funding obligation to insurance proceeds recovered in the Indemnification Lawsuit, was the subject of an arbitration commenced in 2002 by the third party in London, England and scheduled to begin in February 2004. Before the hearing started, the parties settled the dispute. Under the settlement, International Paper agreed to pay the third party a portion of insurance proceeds recovered by International Paper under its insurance policies, beginning on January 1, 2004 and thereafter, up to a maximum of $95 million. The precise amount that International Paper will pay to the third party under the settlement will depend upon, and will be a specified portion of insurance recoveries received by International Paper after January 1, 2004. As of December 31, 2004, approximately $32 million had been paid to the third party under this settlement.

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## Antitrust Matters On May 14, 1999 and May 18, 1999, two lawsuits were filed in federal court in the Eastern District of Pennsylvania against International Paper, the former Union Camp Corporation (acquired by International Paper in 1999), and other manufacturers of linerboard (the Defendants). These suits allege that the Defendants conspired to fix prices for corrugated sheets and containers during the period from October 1, 1993 through November 30, 1995. These lawsuits, which seek injunctive relief as well as treble damages and other costs associated with the litigation, were consolidated and, on September 4, 2001, certified as a class action. On September 22, 2003, International Paper, along with Weyerhaeuser Co. and Georgia-Pacific Corp., agreed with the class plaintiffs to settle the litigation for an aggregate amount of $68 million. The settlement, of which International Paper’s and Union Camp’s share totaled $24.4 million, was approved by the court in an order entered on December 10, 2003. Twelve complaints with multiple plaintiffs who opted out of the class action described above, have been filed in various federal district courts around the country. These suits allege that the defendants conspired to fix prices for corrugated sheets and containers during the period from October 1, 1993 through February 28, 1997. One opt-out plaintiff voluntarily dismissed its complaint on October 10, 2003. Another opt-out plaintiff settled its case. All of the remaining federal opt-out cases have been consolidated for pre-trial purposes in the federal court for the Eastern District of Pennsylvania. Discovery in the federal opt-out cases is currently scheduled to conclude in June 2005. Additionally, one opt-out case was originally filed in Kansas state court, but has been removed to federal court and transferred to the Eastern District of Pennsylvania. The plaintiff in that case has filed a motion to remand the case to Kansas state court. The Company is vigorously defending these cases and believes it has valid defenses. However, due to the complexity of evaluating the factors upon which damages might be based (including, but not limited to, the uncertainties of the class period, defendants’ sales to various opt-out plaintiffs, and other defendants’ potential settlements), the Company cannot assess its potential exposure at this time. In 2000, purchasers of high-pressure laminates filed a number of purported class actions under the federal antitrust laws alleging that International Paper’s Nevamar division (which was part of the Decorative Products division) participated in a price-fixing conspiracy with competitors between January 1, 1994 and June 30, 2000. In 2000 and 2001, indirect purchasers of high-pressure laminates also filed similar purported class action cases under various state antitrust and consumer protection statutes in Arizona, California, Florida, Maine, Michigan, Minnesota, New Mexico, New York, North Carolina, North Dakota, South Dakota, Tennessee, West Virginia, Wisconsin and the District of Columbia. In the third quarter of 2002, International Paper completed the sale of the Decorative Products operations, but retained any liability for these cases. In June 2003, the federal district court certified the consolidated federal cases as a class action. In 2004, the federal and all of the state cases were settled for a total of $38.5 million. The federal settlement has been approved by the court, and the state cases have all received preliminary approval and are proceeding toward final approval. On September 16, 2002, International Paper was served in Federal District Court in Columbia, South Carolina with a class action lawsuit by a group of private landowners alleging that International Paper and certain of its fiber suppliers, known as Quality Suppliers, engaged in an unlawful conspiracy to artificially depress the prices at which International Paper procures fibers for its mills. The suit seeks injunctive relief as well as treble damages and other costs associated with the litigation. On March 31, 2004, the case was certified as a class action. International Paper then asked the U.S. Court of Appeals for the Fourth Circuit for permission to appeal the District Court’s order granting class certification, but that request was denied. Discovery and issues concerning class notice are ongoing. On January 10, 2005, with the District Court’s approval, International Paper filed motions requesting dismissal of the plaintiffs’ claim based on plaintiffs’ lack of standing to sue and decertification of the class. The motions are scheduled for hearing on April 7, 2005. In May 2004, the press reported that European, U.S. and Canadian antitrust authorities were investigating possible cartel activity relating to publication papers. Following these press reports, a number of private plaintiffs filed purported class actions on behalf of purchasers of publication papers in various U.S. federal and state courts. These class actions allege that manufacturers of publication papers, including International Paper, participated in a price fixing consipiracy from 1993 to the present. The cases filed in federal court assert a violation of the federal antitrust laws, while the cases filed in the state court allege violations of state antitrust and consumer protection statutes. These lawsuits seek injunctive relief, as well as treble damages and other costs associated with the litigation. The federal cases were consolidated for pre-trial purposes in December 2004 in the federal court for the District of Connecticut. Discovery and related pretrial proceedings have not yet begun. Discovery in the state cases is expected to be coordinated with the consolidated federal cases. The Company believes it has valid defenses and intends to vigorously defend these cases. However, at this early stage the Company cannot assess its potential exposure.

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## Summary International Paper is also involved in various other inquiries, administrative proceedings and litigation relating to contracts, sales of property, environmental protection, tax, antitrust, personal injury and other matters, some of which allege substantial monetary damages. While any proceeding or litigation has the element of uncertainty, International Paper believes that the outcome of any of the lawsuits or claims that are pending or threatened, or all of them combined, including the preceding antitrust matters, will not have a material adverse effect on its consolidated financial statements. ## NOTE 11 SUPPLEMENTARY FINANCIAL STATEMENT INFORMATION Inventories by major category were: <img src='content_image/11759.jpg'> The last-in, first-out inventory method is used to value most of International Paper’s U.S. inventories. Approximately 70% of total raw materials and finished products inventories were valued using this method. If the first-in, first-out method had been used, it would have increased total inventory balances by approximately $170 million and $133 million at December 31, 2004 and 2003, respectively. Plants, properties and equipment by major classification were: <img src='content_image/11760.jpg'> Interest costs related to the development of certain long-term assets are capitalized and amortized over the related assets’ estimated useful lives. Capitalized net interest costs were $11 million in 2004, $9 million in 2003 and $12 million in 2002. Interest payments made during 2004, 2003 and 2002 were $807 million, $855 million and $904 million, respectively. Total interest expense was $840 million in 2004, $875 million in 2003 and $891 million in 2002. Interest income was $97 million, $103 million and $106 million in 2004, 2003, and 2002, respectively. The following tables present changes in the goodwill balances as allocated to each business segment for the years ended December 31, 2004 and 2003. <img src='content_image/11770.jpg'> (a) Restated for the reclassification of Weldwood to Discontinued operations (b) Represents the effects of foreign currency translations and reclassifications from other long-term assets (c) Represents the reclassification of the goodwill of Fine Papers to Assets of businesses held for sale (d) Includes the effects of the acquisition of Box USA ($238 million) offset by the sale of Food Pack S.A. ($3 million) (e) Represents the effects of the sale of Scaldia Papier B.V. ($23 million) and the reclassification of the goodwill of Papeteries de France to Assets of businesses held for sale ($12 million) (f) Represents goodwill recorded by International Paper upon the acquisition of Plantation Timber Products and the subsequent write-off following an impairment evaluation <img src='content_image/11761.jpg'> (a) Restated for the reclassification of Weldwood to Discontinued operations (b) Represents the effects of foreign currency translations and reclassifications from other long-term assets

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The following table presents an analysis of activity related to asset retirement obligations since January 1, 2003: <img src='content_image/21816.jpg'> This liability is included in Other liabilities in the accompanying consolidated balance sheet together with tax contingency reserves and pension and postretirement liabilities. The following table presents changes in minority interest balances for the years ended December 31, 2004 and 2003: <img src='content_image/21815.jpg'> (a) In August 2004, Carter Holt Harvey used a portion of the funds generated in connection with the second quarter sale of its Tissue business to repurchase shares from its shareholders, including approximately $158 million that was paid to minority shareholders. In December 2004, International Paper completed the sale of 1.1 million acres of forestlands in Maine and New Hampshire to a private forest investment company for $244 million. Since International Paper has some continuing interest in these forestlands through a long-term fiber supply agreement, no gain was recognized in 2004 on this transaction. However, the net cash proceeds from the transaction of approximately $242 million are included as a source of cash in the accompanying consolidated statement of cash flows. The deferred gain on the transaction totaling $114 million at December 31, 2004, included in Other liabilities in the accompanying consolidated balance sheet, will be amortized to earnings in future periods over the term of the fiber supply agreement. ## NOTE 12 DEBT AND LINES OF CREDIT In December 2004, Timberlands Capital Corp. II, Inc., a wholly-owned consolidated subsidiary of International Paper, redeemed $170 million of 4.5% preferred securities. In November 2004, these preferred securities were reclassified from Minority interest to Current maturities of long-term debt pursuant to SFAS No. 150. Additionally during the fourth quarter of 2004, International Paper redeemed approximately $295 million of mostly domestic debt, including $108 million of 9.77% notes with a maturity date in December 2009 and $88 million of 6.9% industrial development bonds with a maturity date in August 2022. In November 2004, CHH borrowed $425 million under their multi-currency and commercial paper credit facilities at interest rates ranging from 5.5% to 6.8% to be repaid during 2005. The proceeds from the borrowings were used to repay approximately $305 million of 8.875% notes with a maturity date in December 2004 and to settle maturing cross-currency and interest rate swaps. In August 2004, an International Paper wholly-owned subsidiary issued 500 million of Euro-denominated long-term debt (equivalent to approximately $619 million at issuance) with an initial interest rate of EURIBOR plus 55 basis points that can vary depending upon the credit rating of the Company and a maturity date in August 2009. Also in August 2004, International Paper repurchased $168 million of limited partnership interests in Georgetown Equipment Leasing Associates, L.P. and Trout Creek Equipment Leasing, L.P. In June 2004, these partnership interests had been reclassified from Minority interest to Current maturities of long-term debt pursuant to SFAS No. 150. Additionally, during the third quarter of 2004, approximately $500 million of debt was redeemed, including $150 million of 8.125% notes with a maturity date in June 2024 and $193 million of debt assumed in connection with the Box USA acquisition. In June 2004, an International Paper wholly-owned subsidiary issued $650 million of long-term debt with an interest rate of LIBOR plus 62.5 basis points that can vary depending upon the credit rating of the Company and a maturity date in June 2007, which refinanced $650 million of long-term debt with an interest rate of LIBOR plus 100 basis points and a maturity date in August 2004. In March 2004, International Paper issued $600 million of 4.00% notes due April 2010 and $400 million of 5.25% notes due April 2016. The proceeds from these issuances were used in April 2004 to retire approximately $1.0 billion of 8.125% coupon rate debt with an original maturity date in July 2005.

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A pre-tax early debt retirement expense of $92 million related to the above 2004 redemptions is included in Restructuring and other charges in the accompanying consolidated statement of operations. In December 2003, International Paper completed a private placement with registration rights of $500 million of 4.25% notes due in January 2009 and $500 million of 5.50% notes due in January 2014. The net proceeds from the notes were used in January 2004 for the redemption of all of the outstanding $805 million aggregate principal amount of International Paper Capital Trust III 7.875% preferred securities originally due in December 2038 and for the repayment or early retirement of other debt. In conjunction with the Company’s adoption of FIN 46 and FIN 46(R) (see Note 4), Long-term debt at December 31, 2003 (1) increased by $50 million due to the consolidation of an entity that was formerly treated as an operating lease arrangement; (2) decreased by $460 million due to the deconsolidation of an entity that had previously been consolidated; and (3) increased by a net $100 million upon the deconsolidation of an entity created in June 2002. The net $100 million increase included an addition to debt of $450 million representing International Paper’s obligations to the deconsolidated entity and a reduction of $350 million due to the deconsolidation of third-party debt owed by the entity. Also, related to the application of FIN 46 to certain entities, effective July 1, 2003, International Paper deconsolidated two trusts with holdings of approximately $1.3 billion of mandatorily redeemable preferred securities, previously classified as a separate line item on the Company’s balance sheet, and recorded approximately $1.3 billion of borrowings from the trusts as Long-term debt. In December 2003, International Paper exercised its option to redeem the securities of one of the trusts effective in January 2004, and consequently, reclassified $830 million to Current maturities of long-term debt. In February 2005, International Paper redeemed the preferred securities of the remaining trust, which were classified in Long-term debt at December 31, 2004. The implementation of FIN 46 and FIN 46(R) had no adverse affect on existing debt covenants. In March 2003, International Paper completed a private placement with registration rights of $300 million of 3.80% notes due in April 2008 and $700 million of 5.30% notes due in April 2015. Proceeds from the notes were used to repay approximately $450 million of commercial paper and long- term debt and to redeem $550 million of preferred securities of IP Finance (Barbados) Limited, a non-U.S. consolidated subsidiary of International Paper. A pre-tax early debt retirement expense of $1 million related to the 2003 redemptions discussed above is included in Restructuring and other charges in the accompanying consolidated statement of operations. In October 2002, International Paper completed a private placement with registration rights of $1.0 billion aggregate principal amount of 5.85% notes due in October 2012. In November 2002, the sale of an additional $200 million principal amount of 5.85% notes due in October 2012 was completed. The net proceeds of these sales were used to refinance most of International Paper’s $1.2 billion aggregate principal amount of 8% notes due in July 2003, that were issued in connection with the Champion acquisition. The pre- tax early debt retirement cost of $41 million is included in Restructuring and other charges in the accompanying consolidated statement of operations. Also during 2002, approximately $1.8 billion of long-term debt was repaid, including about $800 million of Champion acquisition debt. Increases in 2002 included approximately $800 million from new borrowings, and non-cash increases of approximately $620 million, including $460 million relating to the consolidation of a debt obligation of a special purpose entity following the modification of the terms of the related agreement.

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A summary of long-term debt follows: <img src='content_image/67579.jpg'> (a) The weighted average interest rate on these notes was 8.1% in 2004 and 2003. (b) The weighted average interest rate on these notes was 2.9% in 2004 and 2.4% in 2003. Includes $670 million of Euro borrowings with a weighted average interest rate of 2.7% in 2004. (c) The weighted average interest rate on these bonds was 5.6% in 2004 and 5.8% in 2003. (d) Includes $22 million of bonds at December 31, 2004 and $23 million of bonds at December 31, 2003, which may be tendered at various dates and/or under certain circumstances. (e) The weighted average interest rate was 6.1% in 2004 and 4.2% in 2003. Includes $162 million of New Zealand dollar commercial paper borrowings with an interest rate of 6.8% in 2004. (f) Includes $245 million of Australian dollar borrowings with a fixed interest rate of 5.5% and $29 million of New Zealand dollar borrowings with a fixed interest rate of 6.8% in 2004. Also includes $54 million at December 31, 2004 and $86 million at December 31, 2003 related to interest rate swaps treated as fair value hedges. (g) The fair market value was approximately $15.3 billion at December 31, 2004 and $16.4 billion at December 31, 2003. Total maturities of long-term debt over the next five years are 2005 - $506 million; 2006 - $882 million; 2007 - $1.2 billion; 2008 - $326 million; and 2009 - $1.3 billion. At December 31, 2004 and 2003, International Paper classified $87 million and $1.5 billion, respectively, of tenderable bonds, commercial paper and bank notes and Current maturities of long-term debt as Long-term debt. International Paper has the intent and ability to renew or convert these obligations, as evidenced by the available bank credit agreements described below. At December 31, 2004, International Paper’s unused contractually committed bank credit agreements amounted to $3.2 billion. The agreements generally provide for interest rates at a floating rate index plus a pre-determined margin dependent upon International Paper’s credit rating. In March 2004, International Paper replaced its maturing $750 million bank credit agreement with a five-year, $1.25 billion bank credit facility maturing in March 2009. Concurrently, an existing three- year bank credit agreement maturing in March 2006 was reduced from $1.5 billion to $750 million. These agreements have a facility fee of 0.15% that is payable quarterly. In addition, in November 2004, International Paper amended its receivables securitization program established in December 2001 to increase the line of credit from $650 million to $1.2 billion of commercial paper-based financings, based on the amount of qualifying receivables. The program extends through November 2007 with a facility fee of 0.20%. There were no borrowings under either the bank credit agreements or receivables securitization program at December 31, 2004. In November 2004, CHH entered into a short-term multi- currency credit facility with a NZ$400 million line of credit that extends through August 2005 with a facility fee of 0.05%. Also, CHH has an existing NZ$ 325 million multi-currency credit facility that supports its commercial paper program. This facility matures in two tranches from 2006 to 2008. The facility fee ranges from 0.27% to 0.32% at current credit ratings and is payable quarterly. The unused portion of these facilities at December 31, 2004 amounted to approximately NZ$344 million. At December 31, 2004, outstanding debt included approximately $227 million of commercial paper and bank notes with interest rates that fluctuate based on market conditions and the Company’s credit rating. Maintaining a strong investment-grade rating is an important element of International Paper’s corporate finance strategy. At December 31, 2004, the Company held long-term credit ratings of BBB (negative outlook) and Baa2 (negative outlook) by Standard & Poor’s (S&P) and Moody’s Investor Services (Moody’s), respectively. The Company currently has short-term credit ratings by S&P and Moody’s of A-3 and P-2, respectively.

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## Contingently Convertible Securities Included in debt at December 31, 2004 and 2003 were $2.1 billion principal amount at maturity of zero-coupon convertible senior debentures with a 20-year term. This debt accretes to face value at maturity at a rate of 3.75% per annum. Beginning on June 20, 2004, and every June 20th and December 20th until maturity, the debentures are subject to an increased accretion rate if the closing sales price of the Company’s common stock is equal to or less than 60% of the then current conversion price of the notes for any 20 trading days out of the last 30 consecutive trading days ending three business days prior to June 20, 2004, or later semiannual date. The conversion price of the notes as of December 31, 2004 was $56.96, and the bonds were not subject to an increased accretion rate for the semiannual period beginning December 20, 2004. These debentures may be converted into shares of the Company’s common stock at a conversion ratio of 9.5111 shares per $1,000 principal amount at maturity of debentures, which was equal to an initial conversion price of $50.01 per share of the Company’s common stock. The debenture holders may convert their debentures into the Company’s common stock prior to maturity under any of the following circumstances: (1) the closing sales price of the Company’s common stock for at least 20 trading days in the 30 consecutive trading days ending on the day prior to the surrender date is more than 120% (declining by .256% at the end of each semi-annual period over the life of the debentures to 110%) of the then-current conversion price; (2) International Paper’s credit rating is downgraded by each of Moody’s and S&P to below Baa3 and BBB-, respectively; (3) the Company has called the notes for redemption; (4) the Company distributes to all holders of the Company’s common stock certain rights entitling them to purchase, for a period expiring within 60 days, common stock at less than the closing sales price of the Company’s common stock at the time; or (5) the Company distributes to all holders of our common stock, the assets, debt securities or certain rights to purchase the Company’s debt securities, which distribution has a per share value exceeding 12.5% of the closing sales price of the Company’s common stock on the day preceding the declaration for such distribution. Beginning in the fourth quarter of 2004, as required by a recent FASB consensus, the dilutive effect of the convertible notes has been reflected in diluted earnings per share in periods when dilutive (see the caption “Information About Capital Structure – Contingently Convertible Securities” in Note 4), with prior periods restated. Security holders have the right to require repurchase of these securities on June 20th in each of the years 2006, 2011 and 2016, at a repurchase price equal to the accreted principal amount to the repurchase date. The repurchase may be for International Paper common stock or cash, or a combination of both, at the Company’s option. International Paper also has the option to redeem the securities for cash after June 19, 2006. On or after June 20, 2006 and prior to June 20, 2008, the redemption may only occur if the closing sales price of the Company’s common stock exceeds 120% of the then-current conversion price for at least 20 trading days in the 30 consecutive trading days ending on the date redemption notice is given. On or after June 20, 2008, the redemption price will be equal to the then-accreted principal amount plus any accrued and unpaid cash interest to the redemption date. ## NOTE 13 DERIVATIVES AND HEDGING ACTIVITIES International Paper periodically uses derivatives and other financial instruments to hedge exposures to interest rate, commodity and currency risks. For hedges that meet the criteria under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” International Paper, at inception, formally designates and documents the instrument as a hedge of a specific underlying exposure, as well as the risk management objective and strategy for undertaking each hedge transaction. Because of the high degree of effectiveness between the hedging instrument and the underlying exposure being hedged, fluctuations in the value of the derivative instruments are generally offset by changes in the value or cash flows of the underlying exposures being hedged. Derivatives are recorded in the consolidated balance sheet at fair value, determined using available market information or other appropriate valuation methodologies, in other current or noncurrent assets or liabilities. The earnings impact resulting from the change in fair value of the derivative instruments is recorded in the same line item in the consolidated statement of operations as the underlying exposure being hedged. The financial instruments that are used in hedging transactions are assessed both at inception and quarterly thereafter to ensure they are effective in offsetting changes in either the fair value or cash flows of the related underlying exposures. The ineffective portion of a financial instrument’s change in fair value, if any, would be recognized currently in earnings together with the changes in fair value of any derivatives not designated as hedges. ## Interest Rate Risk Interest rate swaps may be used to manage interest rate risks associated with International Paper’s debt. Some of these instruments qualify for hedge accounting in accordance with SFAS No. 133 and others do not. Interest rate swap agreements with a total notional amount at December 31,

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2004 of approximately $500 million and maturities ranging from two to 19 years do not qualify as hedges under SFAS No. 133 and, consequently, were recorded at fair value on the transition date by a pre-tax charge of approximately $20 million to earnings in 2001 upon adoption of SFAS No. 133. For the years ended December 31, 2004, 2003 and 2002, the change in fair value of these swaps was immaterial. The remainder of International Paper’s interest rate swap agreements qualify as fully effective fair value hedges under SFAS No. 133. At December 31, 2004 and 2003, outstanding notional amounts for its interest rate swap fair value hedges amounted to approximately $2.2 billion and $2.1 billion, respectively. The fair values of these swaps were net assets of approximately $70 million and $113 million at December 31, 2004 and 2003, respectively. In 2004, International Paper cash settled interest rate swaption contracts for a loss of $10 million, which was recorded in earnings. In April 2004, interest rate swaps with a notional value of $500 million were terminated in connection with the early retirement of International Paper’s $1.0 billion notes due in July 2005. The resulting gain of approximately $14 million is included in Restructuring and other charges in the accompanying consolidated statement of operations (see Note 6). In November 2002, interest rate swaps with a notional value of $550 million were terminated in connection with the early retirement of International Paper’s $1.2 billion notes due in July 2003. The resulting gain of approximately $6 million is included in Restructuring and other charges in the accompanying consolidated statement of operations (see Note 6). During 2002, International Paper entered into agreements to fix interest rates on an anticipated $1.15 billion issuance of debt. Upon issuance of the debt in the fourth quarter of 2002, these agreements generated a pre-tax loss of $2.8 million that was recorded in Accumulated other comprehensive income (OCI). This amount is being amortized to interest expense over the term of the bonds through October 30, 2012, yielding an effective interest rate of 5.94%. ## Commodity Risk To minimize volatility in earnings due to large fluctuations in the price of commodities, International Paper has used swap and option contracts to manage risks associated with market fluctuations in energy prices. Such cash flow hedges are accounted for by deferring the after-tax quarterly change in fair value of the outstanding contracts in OCI. On the date a contract matures, the gain or loss is reclassified into cost of products sold concurrently with the recognition of the commodity purchased. For the year ended December 31, 2004, the reclassification from OCI to earnings was immaterial. For the years ended 2003 and 2002, the reclassifications to earnings were after-tax gains of $24 million and after-tax losses of $10 million, respectively. These amounts represent the after-tax cash settlements on the maturing energy hedge contracts. Unrealized after-tax losses of $2 million and after-tax gains of $12 million and $24 million were recorded to OCI during the years ended December 31, 2004, 2003 and 2002, respectively. There were no outstanding energy hedge contracts as of December 31, 2004. ## Foreign Currency Risk International Paper’s policy has been to hedge certain investments in non-U.S. operations with borrowings denominated in the same currency as the operation’s functional currency, or by entering into long-term cross- currency and interest rate swaps or short-term foreign exchange contracts. These financial instruments are effective as a hedge against fluctuations in currency exchange rates. Gains or losses from changes in the fair value of these instruments, which are offset in whole or in part by translation gains and losses on the non-U.S. operation’s net assets hedged, are recorded as translation adjustments in OCI. Upon liquidation or sale of the foreign investments, the accumulated gains or losses from the revaluation of the hedging instruments, together with the translation gains and losses on the net assets, are included in earnings. For the years ended December 31, 2004, 2003 and 2002, net losses included in the cumulative translation adjustment on derivative and debt instruments hedging foreign net investments amounted to $74 million, $89 million and $46 million after taxes and minority interest, respectively. Cumulative after-tax losses of $50 million on net investment hedges were included in the loss on sale of Weldwood in Discontinued operations in 2004. Long-term cross-currency and interest rate swaps and short- term currency swaps have been used to mitigate the risk associated with changes in foreign exchange rates, affecting the fair value of debt denominated in a foreign currency. In 2004, CHH paid $180 million to settle these hedges concurrent with the repayment of the related debt. Prior to the settlement, the impact on earnings from the derivative revaluations were substantially offset by the earnings impact from remeasuring the foreign currency debt each period. Foreign exchange contracts (including forward, swap and purchase option contracts) are also used to hedge certain transactions, primarily trade receipts and payments denominated in foreign currencies, to manage volatility associated with these transactions and to protect International Paper from currency fluctuations between the contract date and ultimate settlement. These contracts, most of which have

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been designated as cash flow hedges, had maturities of five years or less as of December 31, 2004. For the years ended December 31, 2004, 2003 and 2002, net unrealized gains totaling $72 million, $53 million and $49 million after taxes and minority interest, respectively, were recorded to OCI. Net gains after taxes and minority interest of $26 million, $41 million and $14 million were reclassified to earnings for the years ended December 31, 2004, 2003 and 2002, respectively. Of the net gains reclassified to earnings in 2004, $6 million related to hedges that are no longer probable. As of December 31, 2004, gains of $40 million after taxes and minority interest are expected to be reclassified to earnings in 2005. Other contracts are used to offset the earnings impact relating to the variability in exchange rates on certain short- term monetary assets and liabilities denominated in non- functional currencies and are not designated as hedges. Changes in the fair value of these instruments, recognized currently in earnings to offset the remeasurement of the related assets and liabilities, were not significant. International Paper does not hold or issue financial instruments for trading purposes. The counterparties to swap agreements and foreign exchange contracts consist of a number of major international financial institutions. International Paper continually monitors its positions with and the credit quality of these financial institutions and does not expect nonperformance by the counterparties. ## NOTE 14 CAPITAL STOCK The authorized capital stock at both December 31, 2004 and 2003 consisted of 990,850,000 shares of common stock, $1 par value; 400,000 shares of cumulative $4 preferred stock, without par value (stated value $100 per share); and 8,750,000 shares of serial preferred stock, $1 par value. The serial preferred stock is issuable in one or more series by the Board of Directors without further shareholder action. ## NOTE 15 RETIREMENT PLANS ## U.S. Defined Benefit Plans International Paper maintains pension plans that provide retirement benefits to substantially all domestic employees hired prior to July 1, 2004. These employees generally are eligible to participate in the plans upon completion of one year of service and attainment of age 21. Employees hired after June 30, 2004, who are not eligible for this pension plan will receive an additional company contribution to their savings plan (see “Other Plans” on page 74). The plans provide defined benefits based on years of credited service and either final average earnings (salaried employees), hourly job rates or specified benefit rates (hourly and union employees). International Paper makes contributions that are sufficient to fully fund its actuarially determined costs, generally equal to the minimum amounts required by the Employee Retirement Income Security Act (ERISA). International Paper made no contribution in 2003 or 2004, and does not expect to make any contributions in 2005 or 2006, to the qualified defined benefit plan. The nonqualified plan is only funded to the extent of benefits paid which are expected to be $21 million in 2005. ## Net Periodic Pension Expense (Income) Service cost is the actuarial present value of benefits attributed by the plans’ benefit formula to services rendered by employees during the year. Interest cost represents the increase in the projected benefit obligation, which is a discounted amount, due to the passage of time. The expected return on plan assets reflects the computed amount of current year earnings from the investment of plan assets using an estimated long-term rate of return. Net periodic pension expense (income) for qualified and nonqualified U.S. defined benefit plans comprised the following: <img src='content_image/35.jpg'> (a) Excludes $3.4 million, $8.3 million and $2.6 million in 2004, 2003 and 2002, respectively, in curtailment losses, and $1.4 million, $6.3 million and $2.4 million in 2004, 2003 and 2002, respectively, of special termination benefits, in connection with a cost reduction program and facility rationalizations that were recorded in Restructuring and other charges in the consolidated statement of operations. Also excludes $0.3 million and $8.8 million of curtailment losses in 2003 and 2002, respectively, and $10.6 million of settlement gains in 2002, related to the divestitures of Masonite, Flexible Packaging, Decorative Products and other smaller businesses that were recorded in Net losses (gains) on sales and impairments of businesses held for sale in the consolidated statement of operations. The increase in 2004 U.S. pension expense, and the change in 2003 to net pension expense from income in 2002, were principally due to a reduction in 2003 in the expected long-

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term rate of return on plan assets and an increase in the amortization of unrecognized actuarial losses, with smaller impacts from reductions in the discount rate and the assumed rate of future compensation increase. International Paper evaluates its actuarial assumptions annually as of December 31 (the measurement date) and considers changes in these long-term factors based upon market conditions and the requirements of SFAS No. 87, “Employers’ Accounting for Pensions.” These assumptions are used to calculate benefit obligations as of December 31 of the current year and pension expense to be recorded in the following year. Weighted average assumptions used to determine net pension expense (income) for 2004, 2003 and 2002 were as follows: <img src='content_image/73110.jpg'> Weighted average assumptions used to determine benefit obligations as of December 31, 2004 and 2003 were as follows: <img src='content_image/73109.jpg'> The expected long-term rate of return on plan assets is based on projected rates of return for current and planned asset classes in the plan’s investment portfolio. Projected rates of return are developed through an asset/liability study, in which projected returns for each of the plan’s asset classes are determined after analyzing historical experience and future expectations of returns and volatility of the various asset classes. Based on the target asset allocation for each asset class, the overall expected rate of return for the portfolio is developed considering the effects of active portfolio management and expenses paid from plan assets. The discount rate assumption is determined based on a yield curve that incorporates approximately 570 Aa-graded bonds. The plan’s projected cash flows are then matched to the yield curve to develop the discount rate. To calculate pension expense for 2005, the Company will use an expected long- term rate of return on plan assets of 8.50%, a discount rate of 5.75% and an assumed rate of compensation increase of 3.25%. The Company estimates that it will record net pension expense of approximately $210 million for its U.S. defined benefit plans in 2005, principally reflecting an increase in the amortization of unrecognized actuarial losses over a shorter average remaining service period, a decrease in the assumed discount rate to 5.75% in 2005 from 6.00% in 2004, and a decrease in the expected return on assets to 8.50% in 2005 from 8.75% in 2004. The following illustrates the effect on pension expense for 2005 of a 25 basis point decrease in these assumptions: <img src='content_image/73111.jpg'> ## Investment Policy / Strategy Plan assets are invested to maximize returns within prudent levels of risk and to maintain full funding of the benefit obligations. The target allocations by asset class are summarized in the following table. Investments are diversified across classes and within each class to minimize risk. The investment policy permits the use of swaps, options, forwards and futures contracts. Periodic reviews are made of investment policy objectives and investment managers. International Paper’s pension plan asset allocation by type of fund at December 31, 2004 and 2003, and target allocations by asset category are as follows: <img src='content_image/73108.jpg'> No plan assets were invested in International Paper common stock at December 31, 2004 or 2003. At December 31, 2004, total future pension benefit payments are estimated as follows: <img src='content_image/73107.jpg'>

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## ITEM 1. BUSINESS ## General International Paper Company (the “Company” or “International Paper,” which may be referred to as “we” or “us”), is a global forest products, paper and packaging company that is complemented by an extensive North American merchant distribution system, with primary markets and manufacturing operations in the United States, Europe, the Pacific Rim and South America. We are a New York corporation and were incorporated in 1941 as the successor to the New York corporation of the same name organized in 1898. Our home page on the Internet is www.internationalpaper.com. You can learn more about us by visiting that site. In the United States at December 31, 2004, the Company operated 27 pulp, paper and packaging mills, 103 converting and packaging plants, 25 wood products facilities, and seven specialty chemicals plants. Production facilities at December 31, 2004 in Europe, Asia, Latin America and South America included seven pulp, paper and packaging mills, 42 converting and packaging plants, one wood products facility, two specialty panels and laminated products plants and six specialty chemicals plants. We distribute printing, packaging, graphic arts, maintenance and industrial products principally through over 286 distribution branches located primarily in the United States. At December 31, 2004, we owned or managed approximately 6.8 million acres of forestlands in the United States, mostly in the South, approximately 1.2 million acres in Brazil and had, through licenses and forest management agreements, harvesting rights on government- owned forestlands in Russia. Substantially all of our businesses have experienced, and are likely to continue to experience, cycles relating to available industry capacity and general economic conditions. Carter Holt Harvey Limited, a New Zealand company that is listed on the New Zealand and Australian stock exchanges and is approximately 50.5% owned by International Paper, operates four mills producing pulp, paper and packaging products, 17 converting and packaging plants and 82 wood products manufacturing and distribution facilities, primarily in New Zealand, Australia and, through the 2004 acquisition of Plantation Timber Products, in China. In New Zealand, Carter Holt Harvey owns approximately 785,000 acres of forestlands. For management and financial reporting purposes, our businesses are separated into six segments: Printing Papers; Industrial and Consumer Packaging; Distribution; Forest Products; Carter Holt Harvey; and Specialty Businesses and Other. A description of these business segments can be found on pages 15 through 17 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. From 2000 through 2004, International Paper’s capital expenditures approximated $5.9 billion, excluding mergers and acquisitions. These expenditures reflect our continuing efforts to improve product quality and environmental performance, lower costs, and improve forestlands. Capital spending for continuing operations in 2004 was $1.3 billion and is expected to be approximately $1.4 billion in 2005. This amount is below our expected annual depreciation and amortization expense of $1.7 billion. You can find more information about capital expenditures on page 22 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Discussions of mergers and acquisitions can be found on page 22 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You can find discussions of restructuring charges and other special items on pages 13 and 14 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Throughout this Annual Report on Form 10-K, we “incorporate by reference” certain information in parts of other documents filed with the Securities and Exchange Commission (SEC). The SEC permits us to disclose important information by referring to it in that manner. Please refer to such information. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, along with all other reports and any amendments thereto filed with or furnished to the SEC, are publicly available free of charge on the Investor Relations section of our Internet Web site at www.internationalpaper.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on or connected to our Web site is not incorporated by reference into this Form 10-K and should not be considered part of this or any other report that we filed with or furnished to the SEC. ## Financial Information Concerning Industry Segments The financial information concerning segments is set forth on pages 33 and 34 of Item 8. Financial Statements and Supplementary Data. ## Financial Information About International and Domestic Operations The financial information concerning international and domestic operations and export sales is set forth on page 34 of Item 8. Financial Statements and Supplementary Data.

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## Minimum Pension Liability Adjustment At December 31, 2002, International Paper’s qualified defined benefit pension plan had a prepaid benefit cost of approximately $1.7 billion. At the same date, the market value of the plan assets was less than the accumulated benefit obligation (ABO) for this plan. In accordance with the requirements of SFAS No. 87, the prepaid asset was reversed and an additional minimum liability of $2.7 billion was established equal to the shortfall of the market value of plan assets below the ABO plus the prepaid benefit cost. This resulted in an after-tax direct charge to Accumulated other comprehensive income (OCI) of $1.5 billion, with no impact on earnings, earnings per share or cash. This reduction to Shareholders’ equity had no adverse affect on International Paper’s debt covenants. Strong actual returns on plan assets in the fourth quarters of 2004 and 2003 increased the market value of plan assets by more than the increase in the ABO, resulting in a reduction in the required additional minimum pension liability. As a result, credits to after-tax OCI were recognized in the amount of $41 million and $163 million at December 31, 2004 and 2003, respectively. International Paper also incurred adjustments to the nonqualified plan additional minimum liabilities and recorded charges to OCI of $8 million and $13 million, at December 31, 2004 and 2003, respectively. The following table summarizes the projected and accumulated benefit obligations and fair values of plan assets for the qualified and nonqualified defined benefit plans at December 31, 2004 and 2003: <img src='content_image/6185.jpg'> ## Unrecognized Actuarial Losses SFAS No. 87 provides for delayed recognition of actuarial gains and losses, including amounts arising from changes in the estimated projected plan benefit obligation due to changes in the assumed discount rate, differences between the actual and expected return on plan assets, and other assumption changes. These net gains and losses are recognized prospectively over a period that approximates the average remaining service period of active employees expected to receive benefits under the plans (approximately 13 years) to the extent that they are not offset by gains and losses in subsequent years. Unrecognized actuarial losses shown in the following table were $2.6 billion in 2004 and 2003. While actual future amortization charges will be affected by future gains/losses, amortization of cumulative unrecognized losses as of December 31, 2004 is expected to increase pension expense by approximately $53 million in 2005 and $41 million in 2006, while decreasing expense by $14 million in 2007. The following table shows the changes in the benefit obligation and plan assets for 2004 and 2003, and the plans’ funded status and amounts recognized in the consolidated balance sheet as of December 31, 2004 and 2003. The benefit obligation as of December 31, 2004 increased by $395 million, principally as a result of a decrease in the discount rate used in computing the estimated benefit obligation. Plan assets increased by $309 million, principally reflecting higher actual market returns. <img src='content_image/6184.jpg'> ## Non-U.S. Defined Benefit Plans Generally, International Paper’s non-U.S. pension plans are funded using the projected benefit as a target, except in certain countries where funding of benefit plans is not required. Net periodic pension expense for non-U.S. plans was as follows:

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<img src='content_image/117785.jpg'> (a) Excludes $19.4 million of net settlement gains and $1.2 million of curtailment gains in 2004 related to the divestitures of Weldwood, Papeteries de Souche and the CHH Tissue business that were recorded in Net losses (gains) on sales and impairments of businesses held for sale in the consolidated statement of operations. The following table shows the changes in the benefit obligation for 2004 and 2003. <img src='content_image/117784.jpg'> The fair value of plan assets for non-U.S. plans amounted to $255 million and $423 million at December 31, 2004 and 2003, respectively. The reduction in plan assets is mainly due to the sale of Weldwood. For non-U.S. plans with accumulated benefit obligations in excess of plan assets, the projected benefit obligations, accumulated benefit obligations, and fair values of plan assets totaled $272 million, $240 million, and $164 million, respectively. Plan assets consist principally of common stock and fixed income securities. Adjustments to the non-U.S. plans’ additional minimum liabilities resulted in a credit to OCI of $1 million and a charge of $4 million after taxes and minority interest at December 31, 2004 and 2003, respectively. ## Other Plans International Paper sponsors defined contribution plans (primarily 401(k)) to provide substantially all U.S. salaried and certain hourly employees of International Paper an opportunity to accumulate personal funds, and to provide additional benefits to employees hired after June 30, 2004 for their retirement. Contributions may be made on a before-tax basis to substantially all of these plans. As determined by the provisions of each plan, International Paper matches the employees’ basic voluntary contributions and, for employees hired after June 30, 2004, contributes an additional percentage of pay. Such contributions to the plans totaled approximately $87 million, $95 million and $66 million for the plan years ending in 2004, 2003 and 2002, respectively. The net assets of these plans were approximately $4.3 billion as of the 2004 plan year-end including approximately $789 million (18.5%) in International Paper common stock. ## NOTE 16 POSTRETIREMENT BENEFITS ## U.S. Postretirement Benefits International Paper provides certain retiree health care and life insurance benefits covering a majority of U.S. salaried and certain hourly employees. These employees are generally eligible for benefits upon retirement and completion of a specified number of years of creditable service. Excluded from company-provided medical benefits are salaried employees whose age plus years of employment with the Company total less than 60 as of January 1, 2004. International Paper does not fund these benefits prior to payment and has the right to modify or terminate certain of these plans in the future. On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) was signed into law. This Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In accordance with FSP FAS 106-2, the effects of the Act on International Paper’s plans have been recorded prospectively beginning July 1, 2004. This resulted in a reduction in 2004 of net postretirement benefit cost of approximately $8 million and a reduction of the accumulated postretirement benefit obligation of approximately $110 million, which is treated as a reduction of unrecognized actuarial losses that are amortized to expense over the average remaining service period of employees eligible for postretirement benefits. In addition, net postretirement benefit cost in 2004 was reduced by $5 million, and the accumulated postretirement benefit obligation by $56 million, reflecting assumptions about plan participation.

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The components of postretirement benefit expense in 2004, 2003 and 2002 were as follows: <img src='content_image/74772.jpg'> (a) Excludes $1.0 million, $5.3 million and $1.2 million of curtailment gains in 2004, 2003 and 2002, respectively, and $1.0 million and $1.3 million of special termination benefits in 2004 and 2003, respectively, related to cost reduction programs and facility rationalizations that were recorded in Restructuring and other charges in the consolidated statement of operations. Also excludes $1 million of curtailment gains in 2002 related to the divestitures of Masonite, Flexible Packaging, Decorative Products and other smaller businesses that were recorded in Net losses (gains) on sales and impairments of businesses held for sale in the consolidated statement of operations. International Paper evaluates its actuarial assumptions annually as of December 31 (the measurement date) and considers changes in these long-term factors based upon market conditions and the requirements of SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” The discount rate assumptions used to determine net cost for the years ended December 31, 2004, 2003 and 2002 were as follows: <img src='content_image/74778.jpg'> The weighted average assumptions used to determine the benefit obligation at December 31, 2004 and 2003 were as follows: <img src='content_image/74779.jpg'> A 1% increase in the assumed annual health care cost trend rate would have increased the accumulated postretirement benefit obligation at December 31, 2004 by approximately $54 million. A 1% decrease in the annual trend rate would have decreased the accumulated postretirement benefit obligation at December 31, 2004 by approximately $50 million. The effect on net postretirement benefit cost from a 1% increase or decrease would be approximately $4 million. The plan is only funded in an amount equal to benefits paid. The following table presents the changes in benefit obligation and plan assets for 2004 and 2003: <img src='content_image/74773.jpg'> Change in plan assets: <img src='content_image/74782.jpg'> At December 31, 2004, estimated total future postretirement benefit payments, net of participant contributions, and estimated future Medicare Part D subsidy receipts are as follows: <img src='content_image/74780.jpg'>

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## Non-U.S. Postretirement Benefits In addition to the U.S. plan, certain Canadian and Brazilian employees are eligible for retiree health care and life insurance. Net postretirement benefit costs for our non-U.S. plans were $5 million for 2004, which excludes $22.1 million of income for settlements related to the divestiture of Weldwood that were recorded in net losses on sales in Discontinued operations in the consolidated statement of operations, and $5 million for 2003. The benefit obligation for these plans was $20 million in 2004 and $43 million in 2003. The reduction in benefit obligation reflects the sale of Weldwood. ## NOTE 17 INCENTIVE PLANS International Paper currently has a Long-Term Incentive Compensation Plan (LTICP) that includes a Stock Option Program, a Restricted Performance Share Program and a Continuity Award Program, administered by a committee of nonemployee members of the Board of Directors (Committee) who are not eligible for awards. Also, stock appreciation rights (SAR’s) have been awarded to employees of a non-U.S. subsidiary, with 5,435 and 9,710 issued and outstanding at December 31, 2004 and 2003, respectively. We also have other performance-based restricted share/unit programs available to senior executives and directors. International Paper applies the provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations and the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” in accounting for our plans. ## Stock Option Program International Paper accounts for stock options using the intrinsic value method under APB Opinion No. 25. Under this method, compensation expense is recorded over the related service period when the market price exceeds the option price at the measurement date, which is the grant date for International Paper’s options. No compensation expense is recorded as options are issued with an exercise price equal to the market price of International Paper stock on the grant date. During each reporting period, fully diluted earnings per share is calculated by assuming that “in-the-money” options are exercised and the exercise proceeds are used to repurchase shares in the marketplace. When options are actually exercised, option proceeds are credited to equity and issued shares are included in the computation of earnings per common share, with no effect on reported earnings. Equity is also increased by the tax benefit that International Paper will receive in its tax return for income reported by the optionees in their individual tax returns. Under the program, officers and certain other employees may be granted options to purchase International Paper common stock. The option price is the market price of the stock on the close of business on the day prior to the date of grant. Options must be vested before they can be exercised. Upon exercise of an option, a replacement option may be granted under certain circumstances with an exercise price equal to the market price at the time of exercise and with a term extending to the expiration date of the original option. Beginning in 2005, U.S. employees will no longer receive stock option awards. These benefits will be replaced with performance share awards or enhanced management incentive plan awards. For pro forma disclosure purposes, the fair market value of each option grant has been estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 2004, 2003 and 2002, respectively: <img src='content_image/60763.jpg'> (a) The average fair market values of initial option grants during 2004, 2003 and 2002 were $6.90, $5.86 and $8.77, respectively. (b) The average fair market values of replacement option grants during 2004, 2003 and 2002 were $4.76, $4.39 and $8.59, respectively.

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The following summarizes the status of the Stock Option Program and the changes during the three years ending December 31, 2004: <img src='content_image/21652.jpg'> (a) The table does not include Continuity Award tandem stock options described below. No fair market value is assigned to these options under SFAS No. 123. The tandem restricted shares accompanying these options are expensed over their vesting period. (b) The table includes options outstanding under an acquired company plan under which options may no longer be granted. The following table summarizes information about stock options outstanding at December 31, 2004: <img src='content_image/21654.jpg'> ## Performance - Based Restricted Shares Under the Restricted Performance Share Program, contingent awards of International Paper common stock are granted by the Committee. Shares are earned on the basis of International Paper’s financial performance over a period of consecutive calendar years as determined by the Committee. Under a Restricted Performance Share Program approved during 2001 and amended in 2004, awards vesting over a three-year period were granted in 2002, 2003 and 2004. Compensation expense for this variable plan is recorded over the applicable vesting period. The following summarizes the activity of all performance-based programs for the three years ending December 31, 2004: <img src='content_image/21653.jpg'> (a) The weighted average fair value of performance shares granted was $42.95, $35.34 and $40.09 in 2004, 2003 and 2002, respectively. ## Continuity Award Program The Continuity Award Program provides for the granting of tandem awards of restricted stock and/or nonqualified stock options to key executives. Grants are restricted and awards conditioned on attainment of specified age and years of service requirements. Awarding of a tandem stock option results in the cancellation of the related restricted shares. The Continuity Award Program also provides for awards of restricted stock to key employees.

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The following summarizes the activity of the Continuity Award Program for the three years ending December 31, 2004: <img src='content_image/40868.jpg'> (a) The weighted average fair value of restricted shares granted was $43.20, $37.20 and $43.88 in 2004, 2003 and 2002, respectively. (b) Also includes restricted shares canceled when tandem stock options were awarded. No tandem options were awarded in 2004, 2003 or 2002. At December 31, 2004 and 2003, a total of 20.3 million and 14.9 million shares, respectively, were available for grant under the LTICP. In 2004, shareholders approved an additional 14 million shares to be used for restricted stock, including grants of performance-based restricted stock, as well as stock options, SARs and performance-based restricted stock units. In 2003, shareholders had approved an additional 10 million shares to be made available for grant, with 100 thousand of these shares reserved specifically for the granting of restricted stock. No additional shares were made available during 2002. A total of 14.9 million shares and 2.3 million shares were available for the granting of restricted stock as of December 31, 2004 and 2003, respectively. The compensation cost charged to earnings for all the incentive plans under the LTICP was $29 million for both 2004 and 2003, and $28 million for 2002.

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## Interim Financial Results (Unaudited) (a) <img src='content_image/31600.jpg'> Note: Since basic and diluted earnings per share are computed independently for each period and category, full year per share amount may not equal to the sum of the four quarters.

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## Footnotes to Interim Financial Results (a) All periods presented have been restated to reflect the Carter Holt Harvey Tissue business and the Weldwood of Canada Limited business as Discontinued operations. (b) Gross margin represents net sales less cost of products sold. (c) Includes a $14 million charge before taxes ($9 million after taxes) for organizational restructuring programs, a $16 million charge before taxes ($10 million after taxes) for losses on early debt extinguishment, a credit of $9 million before taxes ($6 million after taxes) to adjust estimated gains/losses of businesses previously sold, and a credit of $7 million before taxes ($4 million after taxes) for the net reversal of restructuring and realignment reserves no longer required. (d) Includes net income of Weldwood and Carter Holt Harvey’s Tissue business prior to their sales in the fourth and second quarters of 2004, respectively. Also included in the 2004 second quarter is a gain of $268 million before taxes and minority interest ($90 million after taxes and minority interest) for sale of the Carter Holt Tissue business; in the 2004 third quarter is a charge of $306 million before taxes ($716 million after taxes) to write down the assets of Weldwood to their estimated net realizable value; and in the 2004 fourth quarter is a charge of $17 million before taxes ($5 million credit after taxes) to adjust the loss on the sale of Weldwood. (e) Includes a $42 million charge before taxes and minority interest ($23 million after taxes and minority interest) for organizational restructuring programs, a $65 million charge before taxes ($40 million after taxes) for losses on early debt extinguishment, a charge of $36 million before taxes and minority interest ($32 million after taxes and minority interest) for estimated losses of businesses held for sale, and a credit of $5 million before taxes and minority interest ($3 million after taxes and minority interest) for the net reversal of restructuring and realignment reserves no longer required. (f) Includes a $5 million increase, net of minority interest, in the income tax provision reflecting an adjustment of deferred tax balances and a reduction of valuation reserves for capital loss carryovers. (g) Includes an $18 million charge before taxes and minority interest ($11 million after taxes and minority interest) for organizational restructuring programs, a charge of $29 million before minority interest ($15 million after minority interest) for the impairment of goodwill, a charge of $8 million before taxes ($5 million after taxes) for losses on early debt extinguishment, a credit of $103 million before taxes ($64 million after taxes) for insurance recoveries, a net charge of $38 million before and after taxes for estimated losses of businesses sold or held for sale, and a credit of $6 million before taxes ($4 million after taxes) for the net reversal of restructuring and realignment reserves no longer required. (h) Includes a $10 million charge before taxes ($6 million after taxes) for litigation settlements, a $6 million charge before minority interest ($3 million after minority interest) for the impairment of goodwill, a $3 million charge before taxes ($2 million after taxes) for losses on early debt extinguishment, a credit of $20 million before taxes ($12 million after taxes) for insurance recoveries related to the hardboard siding and roofing litigation, a charge of $79 million before taxes ($64 million after taxes) for estimated losses of businesses sold or held for sale, and a credit of $17 million before taxes ($11 million after taxes) for the net reversal of restructuring and realignment reserves no longer required. (i) Includes a $23 million charge before taxes and minority interest ($14 million after taxes and minority interest) for asset shutdowns of excess internal capacity and cost reduction actions. (j) Includes a charge of $10 million after taxes for the cumulative effect of an accounting change to record the charge for the adoption of SFAS No. 143, “Accounting for Asset Retirement Obligations.” (k) Includes a pre-tax charge of $51 million ($32 million after taxes) for facility shutdown costs and severance costs associated with organizational restructuring programs, a $20 million pre-tax charge ($12 million after taxes) for legal reserves, a $10 million charge before taxes ($6 million after taxes) for early debt retirement costs, a $10 million pre-tax charge ($6 million after taxes) to adjust previous estimated gains/losses of businesses previously sold, and a $9 million credit before taxes and minority interest ($5 million after taxes and minority interest) for the reversal of restructuring reserves no longer required. (l) Includes a $50 million reduction of the income tax provision resulting from settlements of prior period tax issues and benefits from an overseas tax program. (m)Includes a pre-tax charge of $71 million ($43 million after taxes) for facility closure costs and severance costs associated with organizational restructuring programs, a $14 million charge before taxes ($9 million after taxes) for legal reserves, an $8 million charge before taxes ($7 million after taxes) for early debt retirement costs, a

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$1 million pre-tax charge ($1 million after taxes) to adjust estimated gains/losses of businesses previously sold, and an $8 million pre-tax credit ($5 million after taxes) for the net reversal of restructuring and realignment reserves no longer required. (n) Includes a decrease in the income tax provision of $60 million reflecting a favorable revision of estimated tax accruals upon filing the 2002 federal income tax return and increased research and development credits. (o) Includes a $91 million charge before taxes and minority interest ($55 million after taxes and minority interest) for asset shutdowns of excess internal capacity and cost reduction actions, a $29 million pre-tax charge ($18 million after taxes) for legal reserves, a credit of $19 million before taxes ($12 million after taxes) for gains on early extinguishment of debt, a $21 million charge before taxes ($26 million after taxes) for net losses on sales and impairments of businesses held for sale, and a $23 million credit before taxes ($15 million after taxes) for the reversal of restructuring reserves no longer required. (p) Includes a $13 million credit after minority interest related to a favorable settlement with Australian tax authorities of net operating loss carryforward credits. (q) Includes a charge of $3 million after taxes for the cumulative effect of an accounting change to record the transitional charge for the adoption of FIN 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.”

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## ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None ## ITEM 9A. CONTROLS AND PROCEDURES ## Disclosure Controls and Procedures As of December 31, 2004, an evaluation was carried out under the supervision and with the participation of the Company’s management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures, as defined in Rule 13a- 15 under the Securities Exchange Act (the Act). Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports we file under the Act is recorded, processed, summarized, and reported by management of the Company on a timely basis in order to comply with the Company’s disclosure obligations under the Act and the SEC rules thereunder. ## Management’s Report on Internal Control Over Financial Reporting As of December 31, 2004, management has assessed the effectiveness of the Company’s internal control over financial reporting. In a report included on page 35, management concluded that, based on its assessment, the Company’s internal control over financial reporting is effective as of December 31, 2004. ## Changes in Internal Control over Financial Reporting During the fourth quarter of 2004, there were no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. ## ITEM 9B. OTHER INFORMATION The following information is being provided in lieu of filing a Form 8-K to report our entry into a material definitive agreement under Item 1.01: Consistent with the Company’s compensation philosophy and its objective to attract and retain top talent, the Management Development and Compensation Committee of the Board, composed entirely of independent non-employee directors, reviews the base salaries of senior management on an annual basis and makes adjustments, as necessary, to recognize individual performance against objectives, promotions and competitive compensation levels. In connection with this annual review, on March 7, 2005, the Management Development and Compensation Committee and the Board of Directors made changes to the salaries of the Company’s named executive officers, effective as of April 1, 2005. The adjustment to Mr. Faraci’s base salary was made in recognition of both his performance against objectives as Chairman and CEO, as well as competitive market salary levels. The salary adjustments for each of the named executive officers are set forth in Exhibit 10.17. ## PART III ## ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information concerning our directors is hereby incorporated by reference to our definitive proxy statement which will be filed with the Securities and Exchange Commission (SEC) within 120 days of the close of our fiscal year. The Audit and Finance Committee of the Board of Directors has at least one member who is a financial expert. Further information concerning the composition of the Audit and Finance Committee and our audit committee financial experts is hereby incorporated by reference to our definitive proxy statement that will be filed with the SEC within 120 days of the close of our fiscal year. Information with respect to our executive officers is set forth on pages 4 and 5 in Part I of this Form 10-K under the caption, “Executive Officers of the Registrant.” Executive officers of International Paper are elected to hold office until the next annual meeting of the Board of Directors following the annual meeting of shareholders and until election of successors, subject to removal by the Board. The Company’s Code of Business Ethics is applicable to all employees of the Company, including the chief executive officer and senior financial officers, as well as the Board of Directors. No amendments or waivers of the Code have occurred. We intend to disclose any amendments to our Code of Business Ethics and any waivers from a provision of our Code of Business Ethics granted to our directors, chief executive officer and senior financial officers on our Internet Web site within five business days following such amendment or waiver. We make available free of charge on our Internet Web site at www.internationalpaper.com, and in print to any shareholder who requests, our Corporate Governance Principles, our Code of Business Ethics and the charters of our Audit and Finance Committee, Management Development and Compensation Committee, Governance Committee and Public Policy and Environment Committee. Requests for copies may be directed to the corporate

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## Competition and Costs Despite the size of the Company’s manufacturing capacity for paper, paperboard, packaging and pulp products, the markets in all of the cited product lines are large and highly fragmented. The markets for wood and specialty products are similarly large and fragmented. There are numerous competitors, and the major markets, both domestic and international, in which the Company sells its principal products are very competitive. These products are in competition with similar products produced by others, and in some instances, with products produced by other industries from other materials. Many factors influence the Company’s competitive position, including prices, costs, product quality and services. You can find more information about the impact of prices and costs on operating profits on pages 9 through 21 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You can find information about the Company’s manufacturing capacities on page A-5 of Appendix II. ## Marketing and Distribution The Company sells paper, packaging products, building materials and other products directly to end users and converters, as well as through resellers. We own a large merchant distribution business that sells products made both by International Paper and by other companies making paper, packaging and supplies. Sales offices are located throughout the United States as well as internationally. We also sell significant volumes of products through paper distributors, including our own merchant distribution network, and agents. We market our U.S. production of lumber and plywood through independent distribution centers. ## Description of Principal Products The Company’s principal products are described on pages 15 through 17 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. ## Sales Volumes by Product Sales volumes of major products for 2004, 2003, and 2002 were as follows: ## International Paper Consolidated (excluding Carter Holt Harvey) <img src='content_image/70339.jpg'> ## Carter Holt Harvey (4) <img src='content_image/70338.jpg'> (1) Includes third party and inter-segment sales. (2) Sales volumes for divested businesses are included through the date of sale, except for discontinued operations. (3) Includes internal sales to mills. (4) Includes 100% of volumes sold. ## Sales Volumes by Product (1) (2) (Unaudited)

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secretary at our corporate headquarters. Information with respect to compliance with Section 16(a) of the Securities and Exchange Act is hereby incorporated by reference to our definitive proxy statement that will be filed with the SEC within 120 days of the close of our fiscal year. ## ITEM 11. EXECUTIVE COMPENSATION Information with respect to the compensation of executives and directors of the Company is hereby incorporated by reference to our definitive proxy statement that will be filed with the SEC within 120 days of the close of our fiscal year. ## ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT A description of the security ownership of certain beneficial owners and management and equity compensation plan information is hereby incorporated by reference to our definitive proxy statement which will be filed with the SEC within 120 days of the close of our fiscal year. ## ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS A description of certain relationships and related transactions is hereby incorporated by reference to our definitive proxy statement that will be filed with the SEC within 120 days of the close of our fiscal year. ## ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information with respect to fees paid to, and services rendered by, our principal accountant and our policies and procedures for pre-approving those services is hereby incorporated by reference to our definitive proxy statement which will be filed with the SEC within 120 days of the close of our fiscal year. ## PART IV ## ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (a) (1) Financial Statements – See Item 8. Financial Statements and Supplementary Data. (2) Financial Statement Schedules – The following additional financial data should be read in conjunction with the financial statements in Item 8. Schedules not included with this additional financial data have been omitted because they are not applicable, or the required information is shown in the financial statements or the notes thereto. Report of Independent Registered Public Accounting Firm on Financial Statement Schedule for 2004 and 2003........86 Consolidated Schedule: II-Valuation and Qualifying Accounts...........................................................................87 (3) Exhibits: (3.1) Form of Restated Certificate of Incorporation of International Paper Company (incorporated by reference to the Company’s Report on Form 8-K dated November 20, 1990, File No. 1-3157). (3.2) Certificate of Amendment to the Certificate of Incorporation of International Paper Company (incorporated herein by reference to Exhibit (3) (i) to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1999, File No. 1-3157). (3.3) Certificate of Amendment of the Certificate of Incorporation of International Paper Company (incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, File No. 1-3157). (3.4) By-laws of the Company, as amended (incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001, File No. 1-3157). (4.1) Specimen Common Stock Certificate (incorporated by reference to Exhibit 2-A to the Company’s registration statement on Form S-7, No. 2-56588, dated June 10, 1976). (4.2) Indenture, dated as of April 12, 1999, between International Paper and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.1 to International Paper’s Report on Form 8-K filed on June 29, 2000, File No. 1-3157). (4.3) Floating Rate Notes Supplemental Indenture, dated as of June 14, 2000, between International Paper and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.2 to International Paper’s Report on Form 8-K filed on June 29, 2000, File No. 1-3157). (4.4) 8% Notes Due July 8, 2003 Supplemental Indenture, dated as of June 14, 2000, between International Paper and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.3 to ## Additional Financial Data 2004, 2003 and 2002

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(4.5) 8 1/8% Notes Due July 8, 2005 Supplemental Indenture dated as of June 14, 2000, between International Paper and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.4 to International Paper’s Report on Form 8-K filed on June 29, 2000, File No. 1-3157). (4.6) Form of new 8 1/8% Notes due July 8, 2005 (incorporated by reference to Exhibit 4.1 to International Paper Company’s Registration Statement on Form S-4 dated October 23, 2000, as amended November 15, 2000, File No. 333-48434). (4.7) Zero Coupon Convertible Senior Debentures due June 20, 2021 (incorporated by reference to Exhibit 4.2 to International Paper Company’s Registration Statement on Form S-3 dated June 20, 2001, as amended September 7, 2001, October 31, 2001 and January 16, 2002, File No. 333-69082). (4.8) 6.75% Notes due 2011 Supplemental Indenture between International Paper Company and The Bank of New York (incorporated by reference to Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, File No. 1-3157). (4.9) 4.25% Notes due 2009 and 5.50% Notes due 2014 Supplemental Indenture dates as of December 15, 2003, between International Paper Company and The Bank of New York (incorporated by reference to Exhibit 4.9 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-3157). (4.10) 4.00% Notes due 2010 and 5.25% Notes due 2016 Supplemental Indenture, dated as of March 18, 2004, between International Paper Company and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.1 to the Company’s Report on Form 8-K dated March 19, 2004, File No. 1-3157). (4.11) In accordance with Item 601 (b) (4) (iii) (A) of Regulation S-K, certain instruments respecting long- term debt of the Company have been omitted but will be furnished to the Commission upon request. (10.1) Amended and Restated Long-Term Incentive Compensation Plan, as of February 2, 2005 (incorporated by reference to Exhibit 99.1 of the Company’s Report on Form 8-K dated February 11, 2005, File No. 1-3157). (10.2) Form of Confidentiality and Non-Competition International Paper’s Report on Form 8-K filed on June 29, 2000, File No. 1-3157). (10.3) Management Incentive Plan, amended and restated as of January 1, 2003 (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003, File No. 1-3157). (10.4) Form of individual non-qualified stock option agreement under the Company’s Long-Term Incentive Compensation Plan (incorporated by reference to Exhibit 10.6 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001, File No. 1-3157). (10.5) Form of individual executive continuity award under the Company Long-Term Incentive Compensation Plan (incorporated by reference to Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1999, File No. 1-3157). (10.6a) Form of Change of Control Agreement for Chief Executive Officer (incorporated by reference to Exhibit 10.8a to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001, File No. 1-3157). (10.6b) Form of Change of Control Agreement--Tier I (incorporated by reference to Exhibit 10.8b to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001, File No. 1-3157). (10.6c) Form of Change of Control Agreement--Tier II (incorporated by reference to Exhibit 10.8c to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001, File No. 1-3157). (10.7) Unfunded Supplemental Retirement Plan for Senior Managers, as amended (incorporated by reference to Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001, File No. 1-3157). (10.8) International Paper Company Unfunded Savings Plan (incorporated by reference to Exhibit 10.11 to the Company’s Form 10K/A for the year 2000 dated January 16, 2002, File No. 1-3157). (10.9) International Paper Company Pension Restoration Plan for Salaried Employees (incorporated by reference to Exhibit 10.12 to the Company’s Form 10K/A for the year 2000 dated January 16, 2002, Agreement entered into by Company employees who may receive restricted stock awards pursuant to the Long-Term Incentive Compensation Plan of the Company (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, File No. 1-3157).

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(10.10) $650 million credit agreement dated as of June 28, 2004, among the Company, Ngahere Aotearoa, the Lenders Party thereto, Bank of Tokyo - Mitsubishi Trust Company. As Syndication Agent, Mizoho Corporate Bank, USA, as Documentation Agent, and Deutsche Bank AG New York Branch, as Administrative Agent (incorporated by reference to Exhibit 10.1 and the Company’s Report on Form 8-K dated July 1, 2004, File No. 1-3157). (10.11) $1.5 Billion 3-Year Credit Agreement dated as of March 6, 2003 between International Paper Company, the Lenders Party thereto, Citibank, N.A., as Syndication Agent, Bank of America, N.A., BNP Paribas and Deutsche Bank Securities Inc., as Documentation Agents and J.P. Morgan Securities Inc. and Salomon Smith Barney Inc., as Joint Lead Arrangers and Joint Bookrunners (incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003, File No. 1-3157). (10.12) 5-Year Credit Agreement, dated as of March 30, 2004, between International Paper Company, the lenders party thereto, Bank of America, N.A., as syndication agent, BNP Paribas, Citibank, N.A. and Deutsche Bank Securities inc., as Co- Documentation Agents, J.P. Morgan Securities Inc. and Banc of America Securities LLC, as Lead Arrangers and Joint Bookrunners, and JPMorgan Chase Bank, as Administrative Agent (incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 8-K dated April 2, 2004, File No. 1-3157). (10.13) Amended and Restated Credit and Security Agreement dated as of November 17, 2004 among Red Bird Receivables, Inc., as Borrower, International Paper Financial Services, Inc., as Servicer, International Paper Company, as Performance Guarantor, The Conduits from Time to Time Party thereto, The Bank of Tokyo-Mitsubishi, Ltd., New York Branch, as Gotham Agent, JPMorgan Chase Bank, N.A., as Prefco Agent, BNP Paribas, Acting through its New York Branch, as StarBird Agent, Citicorp North America, Inc., as CAFCO Agent and Wachovia Bank, National Association as Blue Ridge Agent and as Administrative Agent (incorporated by reference to Exhibit 10.01 to the Company’s Report on Form 8-K/A dated December 9, 2004, File No. 1-3157). (10.14) EUR500 million 5-year credit facility, dated as of August 26, 2004, among the Company, as File No. 1-3157). (10.15) Form of Indemnification Agreement for Directors (incorporated by reference to Exhibit 10.13 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1- 3157). (10.16) Supplemental Pension Benefit Agreement between International Paper Company and Christopher P. Liddell dated December 14, 2004 (incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 8-K dated December 20, 2004, File No. 1-3157). (10.17) Amendments to Compensation for Named Executive Officers. (11) Statement of Computation of Per Share Earnings. (12) Computation of Ratio of Earnings to Fixed Charges and Preferred Stock Dividends. (21) List of Subsidiaries of Registrant. (23) Consent of Independent Auditors. (24) Power of Attorney. (31.1) Certification by John V. Faraci, Chairman and Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (31.2) Certification by Christopher P. Liddell, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (32) Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002. (99.1) Board Policy on Severance Agreements with Senior Executives (incorporated by reference to Exhibit 99.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, File No. 1-3157). (99.2) Board Policy on Change of Control Agreements (Incorporated by reference to Exhibit 99.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, File No. 1-3157). Guarantor, International Paper Investments (France) S.A.S., a French wholly-owned subsidiary of the Company, as Borrower, BNP Paribas, Barclays Capital and ABN AMRO N.V., as mandated lead arrangers, certain financial institutions named therein and BNP Paribas, as facility agent.

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## REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of International Paper Company Stamford, Connecticut We have audited the consolidated financial statements of International Paper Company and subsidiaries (the “Company”) as of December 31, 2004 and 2003, and for each of the three years in the period ended December 31, 2004, management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, and the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, and have issued our reports thereon dated March 7, 2005; such consolidated financial statements and reports are included in your 2004 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedule of the Company listed in Item 15. This consolidated financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. NEW YORK, N.Y. MARCH 7, 2005

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## INTERNATIONAL PAPER COMPANY AND CONSOLIDATED SUBSIDIARIES SCHEDULE II – VALUATION AND QUALIFYING ACCOUNTS <img src='content_image/8302.jpg'> <img src='content_image/8303.jpg'> <img src='content_image/8304.jpg'> (a) Includes write-off, less recoveries, of accounts determined to be uncollectible and other adjustments. (b) Includes payments and deductions for reversals of previously established reserves that were no longer required.

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## SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ## INTERNATIONAL PAPER COMPANY <img src='content_image/52216.jpg'> ## POWER OF ATTORNEY March 10, 2005 KNOW ALL MEN BY THESE PRESENTS, that each person whose signatur e appears below constitutes and appoints Maura A. Smith and Andrea L. Dulberg, jointly and severally, as his or her true and lawful attorney-in-fact and agent, acting alone, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities, to sign any or all amendments to this annual report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said atto rney-in-fact full power and authority to do and reform each and every act and thing requisite or necessary to be done, hereby ratifying and confirming all that said attorney-in-fact and agent, or his or her substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: <img src='content_image/52212.jpg'>

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## 2004 Listing of Facilities (all facilities are owned except as noted otherwise) ## PRINTING PAPERS ## Business Papers, Coated Papers, Fine Papers and Pulp ## U.S.: Courtland, Alabama Selma, Alabama (Riverdale Mill) Pine Bluff, Arkansas Ontario, California leased (C & D Center) Cantonment, Florida (Pensacola Mill) Augusta, Georgia Bastrop, Louisiana (Louisiana Mill) Springhill, Louisiana (C & D Center) Bucksport, Maine Jay, Maine (Androscoggin Mill) Westfield, Massachusetts (C & D Center) Quinnesec, Michigan Sturgis, Michigan (C & D Center) Sartell, Minnesota Ticonderoga, New York Riegelwood, North Carolina Hamilton, Ohio Saybrook, Ohio leased (C & D Center) Hazleton, Pennsylvania (C & D Center) Eastover, South Carolina Georgetown, South Carolina Sumter, South Carolina (C & D Center) Franklin, Virginia (2 locations) ## International: Arapoti, Parana, Brazil Mogi Guacu, São Paulo, Brazil Maresquel, France Saillat, France Kwidzyn, Poland Svetogorsk, Russia Inverurie, Scotland ## INDUSTRIAL AND CONSUMER P ACKAGING ## INDUSTRIAL P ACKAGING ## Containerboard ## U.S.: Prattville, Alabama Savannah, Georgia Terre Haute, Indiana Ft. Madison, Iowa Mansfield, Louisiana Pineville, Louisiana Vicksburg, Mississippi ## International: Arles, France ## Corrugated Container ## U.S.: Bay Minette, Alabama Decatur, Alabama Dothan, Alabama leased Conway, Arkansas Fordyce, Arkansas leased Jonesboro, Arkansas Russellville, Arkansas Carson, California Hanford, California Modesto, California San Leandro, California leased Stockton, California Vernon, California Putnam, Connecticut Auburndale, Florida Jacksonville, Florida leased Lake Wales, Florida Forest Park, Georgia Savannah, Georgia Stockbridge, Georgia leased Bedford Park, Illinois leased Chicago, Illinois Des Plaines, Illinois Litchfield, Illinois leased Northlake, Illinois Fort Wayne, Indiana Hartford City, Indiana Portland, Indiana leased Lexington, Kentucky Louisville, Kentucky Lafayette, Louisiana Shreveport, Louisiana Springhill, Louisiana Auburn, Maine Brownstown, Michigan Howell, Michigan Kalamazoo, Michigan Minneapolis, Minnesota (2 locations) 1 leased Houston, Mississippi Kansas City, Missouri North Kansas City, Missouri leased Geneva, New York King’s Mountain, North Carolina leased Statesville, North Carolina Bethesda, Ohio leased Cincinnati, Ohio Newark, Ohio Solon, Ohio Wooster, Ohio Eighty-four, Pennsylvania Lancaster, Pennsylvania Mount Carmel, Pennsylvania Sharpsburg, Pennsylvania Washington, Pennsylvania Georgetown, South Carolina Laurens, South Carolina Spartanburg, South Carolina Morristown, Tennessee Murfreesboro, Tennessee Dallas, Texas Edinburg, Texas (2 locations) El Paso, Texas Ft. Worth, Texas San Antonio, Texas Chesapeake, Virginia Richmond, Virginia Cedarburg, Wisconsin Fond du Lac, Wisconsin ## International: Las Palmas, Canary Islands Tenerife, Canary Islands Rancagua, Chile Arles, France Chalon-sur-Saone, France Chantilly, France Creil, France

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LePuy, France Mortagne, France Guadeloupe, French West Indies Asbourne, Ireland Bellusco, Italy Catania, Italy Pomezia, Italy San Felice, Italy Alcala, Spain leased Almeria, Spain leased Barcelona, Spain Bilbao, Spain Gandia, Spain Valladolid, Spain Thrapston, United Kingdom Winsford, United Kingdom ## Kraft Paper Courtland, Alabama Bastrop, Louisiana Roanoke Rapids, North Carolina Franklin, Virginia ## CONSUMER PACKAGING ## Bleached Board Pine Bluff, Arkansas Augusta, Georgia Riegelwood, North Carolina Prosperity, South Carolina Texarkana, Texas ## Beverage Packaging ## U.S.: Turlock, California Plant City, Florida Cedar Rapids, Iowa Framingham, Massachusetts Kalamazoo, Michigan Raleigh, North Carolina ## International: London, Ontario, Canada Longueuil, Quebec, Canada leased Shanghai, China Santiago, Dominican Republic San Salvador, El Salvador leased Ashrat, Israel Fukusaki, Japan Seoul, Korea Jeddah, Saudi Arabia Taipei, Taiwan Guacara,V enezuela ## Foodservice ## U.S.: Visalia, California Shelbyville, Illinois Kenton, Ohio Jackson, T ennessee ## International: Brisbane, Australia Shanghai, China Bogota, Columbia leased ## Shorewood Packaging ## U.S.: Waterbury, Connecticut Indianapolis, Indiana Louisville, Kentucky Edison, New Jersey Harrison, New Jersey leased West Deptford, New Jersey Hendersonville, North Carolina Weaverville, North Carolina Springfield, Oregon Danville, V irginia Newport News, Virginia Roanoke, V irginia ## International: Brockville, Ontario, Canada Smith Falls, Ontario, Canada Toronto, Ontario, Canada Guangzhou, China Ebbw Vale, W ales, United Kingdom ## DISTRIBUTION ## xpedx ## U.S.: Stores Group Chicago, Illinois 148 locations nationwide 138 leased South Central Region Greensboro, North Carolina 35 branches in the Southeast States and Ohio 21 leased Midwest Region Denver, Colorado 37 branches in the Great Lakes, Mid-America, Rocky Mountain and South Plain States 22 leased West Region Downey, California 27 branches in the Northwest and Pacific States 21 leased Northeast Region Hartford, Connecticut 22 branches in New England and Middle Atlantic States 17 leased ## International: Mexico (15 locations) all leased Papeteries de France Pantin, France (2 locations) 1 leased ## FOREST PRODUCTS ## Forest Resources ## U.S.: Approximately 6.8 million acres in the South and North ## International: Approximately 1.2 million acres in Brazil ## Realty Projects Daufuskie Island, South Carolina (Haig Point Incorporated) ## Wood Products ## U.S.: Chapman, Alabama Citronelle, Alabama Maplesville, Alabama Opelika, Alabama Thorsby, Alabama

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Gurdon, Arkansas Leola, Arkansas McDavid, Florida Whitehouse, Florida Augusta, Georgia Folkston, Georgia Meldrim, Georgia Springhill, Louisiana Wiggins, Mississippi Joplin, Missouri Armour, North Carolina Seaboard, North Carolina Johnston, South Carolina Newberry, South Carolina Sampit, South Carolina Camden, Texas Corrigan, Texas Henderson, Texas New Boston, Texas Franklin, Virginia ## International: Santana, Amapa, Brazil Arapoti, Parana, Brazil ## CARTER HOLT HARVEY ## Forestlands Approximately 785,000 acres in New Zealand owned & leased ## Wood Products Sawmills and Processing Plants Morwell, Victoria, Australia Oberon, New South Wales, Australia Mt. Gambier, South Australia, Australia (2 plants) Myrtleford, Victoria, Australia Kopu, New Zealand Nelson, New Zealand Putaruru, New Zealand Rotorua, New Zealand Taupo, New Zealand Tokoroa, New Zealand Timber Merchants Warehousing - Australia Sydney, New South Wales leased Brisbane, Queensland leased Perth, Western Australia leased Melbourne, Victoria leased Plywood Mills Myrtleford, V ictoria, Australia Tokoroa, New Zealand Laminated Veneer Lumber Auckland, New Zealand leased Nangwarry, South Australia, Australia Marsden Point, New Zealand Decorative Products Processing Plant Auckland, New Zealand Decorative Products Distribution Center Christchurch, New Zealand leased Panel Production Plants - New Zealand Auckland Kopu Rangiora Panel Production Plants - Australia Oberon, New South Wales (2 plants) Tumut, New South Wales Gympie, Queensland leased Mt. Gambier, South Australia (2 plants) Bell Bay, T asmania Medium Density Fiberboard Plants Leshan City, Sichuan Province, China Shishou City, Hubei Province, China Flooring Overlay Panel Plant Leshan City, Sichuan Province, China Building Supplies Retail Outlets Retail Outlets, 43 branches in New Zealand ( 26 leased ) Frame and Truss Auckland, New Zealand (2 locations) 2 leased Christchurch, New Zealand leased Rotorua, New Zealand leased Upper Hutt, New Zealand leased ## Pulp and Paper Kraft Paper, Pulp, Coated and Uncoated Papers and Bristols Kinleith, New Zealand Pulp Mill Kawerau, New Zealand Cartonboard Whakatane, New Zealand Containerboard Kinleith, New Zealand Auckland, New Zealand Fiber Recycling Operations Auckland, New Zealand leased ## Packaging Case Manufacturing Suva, Fiji Auckland, New Zealand Christchurch, New Zealand Hamilton, New Zealand Levin, New Zealand Carton Manufacturing Sydney, New South Wales, Australia Brisbane, Queensland, Australia leased Adelaide, South Australia, Australia Melbourne, Victoria, Australia (2 locations) leased Auckland, New Zealand Corrugated Manufacturing Melbourne, Australia leased Sydney, Australia leased Paper Bag Manufacturing Auckland, New Zealand Paper Cups Brisbane, Queensland, Australia Graphics (Pre-Press) Melbourne, Victoria, Australia leased ## SPECIALTY BUSINESSES AND OTHER ## Chemicals ## U.S.: Panama City, Florida Pensacola, Florida Port St. Joe, Florida Savannah, Georgia Valdosta, Georgia Picayune, Mississippi Dover, Ohio ## International: Oulu, Finland Niort, France Greaker, Norway Sandarne, Sweden Bedlington, United Kingdom Chester-le-Street, United Kingdom

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<img src='content_image/79058.jpg'> # Con Edison 2003 Annual Report <img src='content_image/79059.jpg'> <img src='content_image/79057.jpg'> <img src='content_image/79060.jpg'>

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<img src='content_image/71131.jpg'> <img src='content_image/71126.jpg'> ## Con Edison Company of New York 90,218 miles of underground distribution cables 32,840 miles of overhead distribution lines 4,261 miles of gas mains 87 miles of steam pipes 3.1 million electric customers 1.1 million gas customers 1,825 steam customers ## Orange and Rockland Utilities 2,688 miles of underground distribution lines 5,120 miles of overhead distribution lines 1,805 miles of gas mains 285,000 electric customers 120,000 gas customers

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2003 on a weather-normalized basis. The steam system is a vital part of New York City’s energy infrastructure and critical to its economic well-being. Many major commercial buildings use steam for space heating and to produce hot water and cool air. The steam system also creates significant environmental benefits since it displaces hundreds of individ- ual boiler plants that would generate higher emissions and cause increased oil-delivery truck traffic. In the summer, the system supplies the equivalent of 400 megawatts of air conditioning load, an amount equal to that produced by a large power plant. Our steam customers include several large facilities, including Rockefeller Center, the Waldorf-Astoria Hotel, Pace University, the New York University Medical Center, Lincoln Center, and the United Nations headquarters. More important, the majority of all new commercial buildings in midtown and downtown Manhattan choose to use steam for heating and hot water. Con Edison’ steam unit in 2003 was awarded the Intern ational District Energy Association’ (IDEA) District Energy Space GOLD A ward for expanding our system. We also celebrated the conversion of the Seward Park Housing project from a local oil burning system to a central steam system. The conversion will result in improved air quality through the annual re duction of approximately 60 tons of air pollutants and 13,500 tons of carbon dioxide. Work also continues on our East River power plant in Manhattan, which will enhance the reliability of Con Edison’s steam supply by pr oviding three million pounds of steam per hour and additional electric capacity . ## Orange and Rockland Utilities Orange and Rockland Utilities (O&R) provides electric and gas service to a growing region. Orange County boasts the lowest unemployment rate of any major metropolitan ar ea in the state, and over the past year , median house values increased 21.3 percent. Rockland County has also seen rising home sales and values, and its strong economic growth is based in a diverse mix of private businesses and public companies. Inc. magazine recently ranked Rockland County as the fourth- best “small metro area” for doing business in the country. On a weather- normalized basis, O&R’s electric delivery volumes rose 2.5 percent in 2003, and total firm gas delivery volumes grew 3.0 percent. During the 2003-2004 heating season, O&R hit all-time winter peak distribution loads for both electricity and gas, and the electric system recorded an all- time peak in June 2003. The growth in the company’s service territory did not diminish O&R’s outstanding record of reliability; in the summer of 2003, the company set a new record for the fewest customer interruptions on its system. Last year, O&R invested more than $46 million in its electric transmission and distribution systems. These invest- ments will help ensure system reliability and security. Major system upgrades in Rockland County included the comple- tion of a critical distribution substation <img src='content_image/110686.jpg'>

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Rockland Electric has always been a reliable partner in promoting the economic growth and vitality of Bergen County and its communities. They’re a valued ally in retaining businesses and ensuring the county’s economic health. Beth R. Gorin, President, Bergen County Economic Development Corp. in Stony Point, New York, and a transmission substation upgrade in Haverstraw, New York. O&R also completed upgrades that doubled the capacity of both the Oakland and Upper Saddle River distribution substations in Bergen County, New Jersey. In preparation for summer 2004, the company is nearing completion on a new, large distribution substation in Chester, New York. In 2003, O&R also re placed more than 100,000 feet of gas mains and more than 1,300 service connections to customers’ homes. To accommodate growth, the company upgraded 15,000 feet of existing gas supply mains and extended the system to serve new subdivisions. O&R has initiated a number of signifi- cant technological enhancements that are driving impr ovements in both electric and gas operations. For example, 2003 saw expanded use of digital equipment and automation technologies that pr ovided more and improved data on every aspect of the system to operators, resulting in increased reliability and safety. Our focus on maintaining reliability and safety also brings benefits to the environment. For the third consecutive year, O&R won the Tree Line USA Award from the National Arbor Day Foundation, in r ecognition of an active and sensitive right-of-way vegetation management program. ## Con Edison’s Competitive Businesses Through measured investments in its unregulated businesses, Con Edison participates in new markets and offers new services to governmental, indus- trial, commercial, and residential cus- tomers. The unregulated businesses often work in concert to provide com- prehensive solutions to customers’ evolving needs. Con Edison Solutions provides a wide range of energy procurement and management services that help cus- tomers take advantage of opportunities created by the new competitive energy landscape. In 2003, the company continued to expand its retail energy business. The Durst Organization, a large New York City commercial real estate owner, selected Con Edison Solutions, in partnership with Community Energy, Inc., to provide 10.5 million kilowatt-hours of “green power” for seven high-rise office buildings in Manhattan, making it the largest commercial wind power customer in the state. Con Edison Solutions also began offering electric power in 2003 to government and commercial customers in upstate New York and New Jersey. As an example, the company was recently awarded a contract by Monmouth County, <img src='content_image/82517.jpg'>

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<img src='content_image/49727.jpg'> service area. We also understand that the quality of life in our region is closely linked to the health of the environment. For this reason, Con Edison is committed to policies that respect and protect the environment. ## Communication With Customers Con Edison has dedicated significant resources to develop technologies that make doing business with us easier. Both Con Edison of New York and O&R have successfully invested in initiatives that provide our customers with more options and choices, rang- ing from our Direct Payment Plan to online payment options. In 2003, as the result of a major effort to increase the number of customers using such paperless programs, we processed more than five million payments electronically. Together, our companies’ retail access programs are the largest in New York State. More than 28 percent of Con Edison of New York’s electric peak load is served by alternate energy sup- pliers. At O&R, more than 29 percent of electric customers and more than 33 percent of gas customers have elected to purchase their electricity and gas from alternate energy suppliers. <img src='content_image/49728.jpg'> As the Kids Island Club’s natur partner, Con Edison demonstrates its active engagement with the envir onment. The par tnership enables us to develop science and environ- mental pr ograms with schools and to offer students the opportu- nity to explor e the natural world. Aimee Boden, Executive Director, Randall’ Island Sports Foundation Con Edison designed and launched www.conEd.com/kids, a Web site that helps children explore the world of energy. Working with the New York City Department of Education, we are using this We site to help educate a new generation of energy consumers about the importance of conservation and other energy-r elated issues. ## Commitment to Communities Con Edison’s commitment to the neighborhoods, boroughs, towns, and cities we serve includes a long-stand- ing tradition of supporting educational, cultural, and civic organizations that make our communities stronger and more vibrant. This year, as in past years, the company’s strategic partner- ships were furthered by the energy and enthusiasm of the many employees who served as volunteers. Our strategic partnerships in 2003 included the Neighborhood Housing Services (NHS), a not-for-profit organi- zation that helps people achieve first- time homeownership and then improve their homes and neighborhoods. With a grant from Con Edison, NHS spon- sored a home maintenance training program, which provided new home- owners with basic home repair and safety skills. Another key partnership, this one with the Asian American Business Development Corporation, promoted tourism in New York City’s Chinatown. Con Edison supported the creation of The New York City Chinatown Travel Guide and assisted in promoting it throughout the metropolitan New York City area. <img src='content_image/49729.jpg'>

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In recognition of our commitment to civic involvement, the League of Women Voters of the City of New York awarded Con Edison the 2003 Voting Rights Award. The award cited Con Edison for holding voter registration drives for employees and the public, and for encouraging people to vote through customer outreach information. ## Advancing Environmental Initiatives Recognizing that few issues are as important as the environment, Con Edison actively supports a number of organizations that seek to improve existing environmental conditions and educate students on the need to protect our air, water, and land. Our sponsorship of the Randall's Island Sports Foundation’s Kids Island Club Nature Program enables fourth and fifth graders from East Harlem to study water and land preservation in the natural setting of the island’s freshwater wetlands. Through the Trout in the Classroom program, which Con Edison also supports, students at Brooklyn’s Ditmas Intermediate School 62 and Manhattan’s P.S. 116 raise hatchlings in their classrooms and learn how to pr otect watershed areas. Each spring, students release their fish into streams upstate. In 2003, Con Edison also sponsored the Daffodil Project, a citywide living memorial of the 9/11 attacks. Since 2001, 15,000 New Yo rk volunteers have planted over two million daffodils in parks and gardens across the city to commemorate the attacks and celebrate the importance of parks in our community. Our pursuit of envir onmental excel- lence in operations continued in 2003, with several initiatives producing measurable and substantial benefits to the area’s air, land, and water. For example, in April Con Edison was awarded a Certificate of Achievement “for aggressively re ducing methane emissions and helping lead the way to reducing climate change impacts” by the U.S. Envir onmental Protection Agency. ## Helping Employees Gr ow In 2003, as in past years, our employees were both a major focus and a major force for Con Edison. Our commitment to train the best workers in the industry continued at The Learning Center. Whether it is training new customer service representatives or upgrading the skills of field workers, The Learning Center staff works closely with operating departments to develop training programs that enable us to maintain our system, run more effective opera- tions, improve customer service, and nurture employee leadership skills. Our instructors teach more than 750 active courses on electric, gas, and steam systems; customer operations; environment, health, and safety information technology; and leadership skills. Strategic Issues Seminars are designed to help employees gain the leadership skills necessary to run the Con Edison of tomorrow. In 2003, more than 11,000 employees attended on-site training programs and approximately 3,200 employees participated in interactive, long- distance learning and Web-based, self-study programs. <img src='content_image/28721.jpg'>

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Con Edison is especially proud of The Learning Center’s Nontraditional Employment for Women (NEW) program, which this year trained 115 women in basic electricity and plumbing skills, preparing them to work in jobs few women have ever held. In all our programs, we attempt to instill in employees a sense of the larger context in which Con Edison operates. Being aware of how our operations interact with and affect the world around us is a significant component of this larger context. As a company, Con Edison is committed to continuous improvement in environment, health, and safety performance that goes beyond complying with all laws and regulations. We strive to instill in every employee, at every level of the com- pany, a sense of concern for the welfare of each other, and of our customers. Through The Learning Center, we are also sharing our knowledge and experience with other organizations. Under a contract with the New York City Department of Environmental Protection, for example, we are providing environment, health, and ## Con Edison’ Learning Center and its team of instructors have become invaluable educational colleagues for DEP. The training courses The Learning Center cr eated, in partnership with DEP, ar helping to make our workforc e more safety-awar and better able to make critical safety judg- ments in the field. Christopher O. Ward Commissioner, New York City Department of Environmental Pr otection safety training to appr oximately 2,100 New York City employees. In 2003, Con Edison earned, for the second year a place on LATINA Style magazine’s “Top 50” list, recognizing our efforts to build a positive work environment for Hispanic women employees. Each year , the magazine evaluates American companies on their sensitivity to Latina workplace issues. Con Edison was recognized for the number of Hispanic women holding top corporate positions and for employee benefits, such as scholarship opportunities, mentoring, generous childbirth leave, and emergency childcare plans. This past year Con Edison was also named by FORTUNE magazine as one of “America’s 50 Best Companies for Minorities,” in recognition for programs that actively promote diversity among our workers. Currently, minorities make up more than 36.8 percent of Con Edison’s workforce and 49.7 percent of new employees. Every year, our employees make outstanding contributions to the energy industry, and 2003 was no exception. The Institute of Electrical and Electronics Engineers (IEEE) awarded Dr. Mayer Sasson, one of our senior engineers, the status of Life Fellow. The prestigious honor is given to those who have demonstrated significant lifetime accomplishments in engineer- ing. Dr. Sasson was recognized in part for his contributions to the analy- sis and real-time monitoring of power systems. In addition, Paul V. Stergiou, <img src='content_image/81989.jpg'>

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a senior engineer at Con Edison of New York, and David Kalokitis of Sarnoff Corporation, were named to the list of “50 Key Information Technology Players in Energy” by RaderEnergy, a Houston-based consultancy. Stergiou and Kalokitis were honored for leading the development of a system that used Global Positioning Satellite (GPS) technology to bring a new power substation on line in just four hours instead of the normal 72 hours. The breakthrough will allow power systems to recover more quickly after unforeseen events. ## On It for the Future Over the next 10 years, residential and business customers within Con Edison’s service area will require the delivery of significantly more energy than they do today. We are meeting this challenge through increased investment in our transmission and distribution networks and development of new technologies and processes that increase efficiency and product- ivity in every area of the company. The industries that will drive the growth of our area — financial services, business services, communications, health care, and technology — are all consuming more energy. And the telecommunications infrastructure that supports the growing technological sophistication of other industries is itself evolving into a highly energy- intensive one. As new supplies of electricity become available, and as the demand for energy in our region continues to rise, Con Edison will continue to reinforc its transmission and delivery infrastructure so that it can accommodate the addition of new power sources and new power users — all while maintaining our industry- leading reliability. Doing so will require the steady commitment of resources, time, and attention. But these efforts will be necessary to continue our tradition of excellent service. Page 14, Left: Katherine Boden, chief engineer, reviewing electric operations. Center: The company’ s commitment to the community is furthered by the energy and enthusiasm of the many Con Edison employees who serve as volunteers. Right: Each year we invest significant resources to maintain our electric system, including upgrading equipment at substations. Page 15, Left: Norman Clarke, mechanic A. To improve the gas system, more than 150,000 feet of gas mains are being replaced. Center: New businesses are putting down roots in our area and Con Edison is preparing to meet their needs. Right: The needs of future energy users will be met through the investments being made today in our transmission and distribution systems. Back Cover, Left: James Wong, customer field representative, checking meters. Center Left: Our commitment is to continue to successfully deliver power to the world‘s most dynamic marketplace. Center Right: Con Edison proudly serves an area that includes the world’s greatest city. Right: Kevin McGuire, senior specialist, Central Field Services, helping to install a new transformer at the World Trade Center substation. <img src='content_image/49.jpg'>

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## Financial Highlights The following table is a reconciliation of Con Edison’s earnings and ear nings per share from ongoing operations to reported net income for common stock and earnings per share. <img src='content_image/43057.jpg'> ## Selected Financial Data <img src='content_image/43058.jpg'>

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## To Our Shareholders ## Investing for Growth, Focusing on Core Business 2003 was a year of both challenge and accomplishment. We are proud of our achievements in continuing to provide service to customers at the highest levels of reliability. Although earnings declined somewhat, we maintained our strong balance sheet and solid credit ratings. While many indicators point to an improving economy in 2004, it will be some time before New York recovers fully from the recent slowdown. Nevertheless, we must put in place the infrastructure necessary to support tomorrow’s economic growth and to enhance our customers’ quality of life. As we do so, we will maintain our focus on operating excellence and long-range strategy. W e will sustain the strong financial position that will enable us to make new capital investments. Preparing for the region’s future energy needs will increase our costs. But our program of capital investment in the energy infrastructure will serve to maintain service reliability, build our equity base, and provide a source of future ear nings growth. ## Reliability Is Our Focus We’re proud to serve an area that includes the world’s gr eatest city, where a reliable supply of energy is especially important. Like New York’s bridges, tunnels, subways, express- ways, telecommunications systems, and airports, Con Edison’s facilities are a key component of the region’s overall economic infrastructure. There is a deep and enduring link <img src='content_image/69132.jpg'> between the strength of our infrastruc- ture and the prospects of our service area — between our own financial and operational health and that of the communities we serve. A robust economy generates greater demand for electricity and power, which boosts our business. But a healthy economy can’t function and thrive without reliable and safe electric service — day in and day out. Today, everyone uses increasing amounts of energy to operate our businesses, power our computers, run our appliances, and heat and cool our homes. In New York, people also depend on electricity, every day, to move — vertically, in high-rise office and apartment towers, and horizontally, on the subway. And thanks to the energy and skills of our 14,000 Front Cover, Left: The computers and other devices so integral to today’s quality of life require a re liable supply of energy. Center Top: Con Edison serves 3.1 million electric customers, 1.1 million gas customers, and 1,825 steam customers. Center Bottom: Anthony J. Rendino, mechanic B. Right: In 2003, with the help of its employees, Con Edison was again recognized as the most reliable utility in North America. Solano Santiago, mechanic B, assists with trenching for new ductwork. Page 1, Left: Every hour of every day, the metropolitan New York City area relies on the power Con Edison provides. Right: Eugene R. McGrath, Chairman, President, and Chief Executive Officer. <img src='content_image/69130.jpg'> <img src='content_image/69129.jpg'>

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## Selected Quarterly Information <img src='content_image/8562.jpg'> In the opinion of Con Edison, these quarterly amounts include all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation. ## Market Price Range in Consolidated Reporting System and Dividends Paid on Common Stock <img src='content_image/8565.jpg'> As of January 31, 2004, there were 93,760 holders of recor of Con Edison’s Common Shares.

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## Glossary of Terms The following is a glossary of frequently used abbreviations or acronyms that are found throughout this report: ## Con Edison Companies <img src='content_image/88947.jpg'>

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## Management’s Discussion and Analysis of Financial Condition and Results of Operations This discussion and analysis relates to the consolidated finan- cial statements of Consolidated Edison, Inc. (Con Edison) and should be read in conjunction with the financial statements and the notes thereto. Consolidated Edison Company of New York, Inc. (Con Edison of New York) and Orange and Rockland Utilities, Inc. (O&R), which are regulated utilities, are sub- sidiaries of Con Edison and are referred to in this manage- ment’s discussion and analysis of financial condition and results of operations (MD&A) as the “Utilities.” The Utilities, together with Con Edison, are referred to in this MD&A as the “Companies.” Neither Con Edison of New York nor O&R makes any representation as to information in this report relating to Con Edison or the subsidiaries of Con Edison other than itself. Information in the notes to the consolidated financial state- ments referred to in this discussion and analysis is hereby incorporated by reference herein. The use of terms such as “see” or “refer to” shall be deemed to incorporate by reference into this discussion and analysis the information to which reference is made. ## Corporate Overview Con Edison’s principal business operations are those of the Utilities. Con Edison also has unregulated subsidiaries that compete in energy-related and telecommunications industries. Certain financial data of Con Edison’s subsidiaries is presented below: <img src='content_image/123287.jpg'> Con Edison’s net income for common stock in 2003 was $528 million or $2.39 a share. Net income for common stock in 2002 and 2001 was $646 million or $3.03 a share and $682 million or $3.22 a share, respectively. Included in 2003 net income for common stock were impairment charges for certain unregulated telecommunications and generating assets ($94 million after-tax or $0.43 per share) and the impact of a regula- tory settlement ($5 million after-tax charge or $0.03 per share), partially offset by the cumulative effect of changes in account- ing principles ($3 million after-tax gain or $0.02 per share). Included in the 2002 results was the cumulative effect of changes in accounting principles ($22 million after-tax charges or $0.11 per share). For additional segment financial information, see Note O to the financial statements and “Results of Operations,” below. The Companies are each subject to certain material contingen- cies, including certain Utility environmental matters and Con Edison’s legal proceedings relating to its October 1999 agree- ment to acquire Northeast Utilities. See “Application of Critical Accounting Policies - Accounting for Contingencies,” below. ## Regulated Utility Subsidiaries Con Edison of New York provides electric service to over 3.1 million customers and gas service to 1.1 million customers in New York City and Westchester County. The company also provides steam service in parts of Manhattan. O&R, along with its regulated utility subsidiaries, provides electric service to over 285,000 customers in southeastern New York and adjacent sections of New Jersey and northeastern Pennsylvania and gas service to over 120,000 customers in southeastern New York and northeastern Pennsylvania. The Utilities are primarily “wires and pipes” energy delivery companies that are subject to extensive federal and state regu- lation. Pursuant to restructuring agreements, the Utilities have sold most of their electric generating capacity and provide their customers the opportunity to buy electricity and gas directly from other suppliers through the Utilities’ retail access pro- grams. The Utilities supply more than half of the energy deliv- ered by them in their service areas and provide delivery service to their customers that buy energy from other suppliers. The Utilities purchase substantially all of the energy they supply to customers pursuant to firm contracts or through wholesale energy markets. In general, the Utilities recover on a current basis the fuel and purchased power costs they incur in supply- ing energy to their full-service customers, pursuant to appr oved rate plans. Con Edison anticipates that the Utilities will provide substantial- ly all of its earnings over the next few years. The Utilities’ earn-

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ings will depend on various factors including demand for utility service and the Utilities’ ability to charge rates for their services that reflect the costs of service, including a return on invested equity capital. Demand for utility service is affected by weather, economic conditions and other factors. The Utilities have experienced increased customer demand in recent years. In June, July and August of 2002, both Con Edison of New York and O&R set new three-month electric delivery records of more than 17 mil- lion and 1.7 million megawatt hours, respectively. In June 2003, Con Edison of New York and O&R each experienced a new record electric peak load for that month. The June peak was an all-time peak electric load for O&R. In January 2004, Con Edison of New York and O&R each experienced a new winter electricity peak load. Because the energy delivery infrastructure must be adequate to meet demand in peak periods with a high level of reliability, the Utilities’ capital investment plans reflect in great part actual growth in electric peak load adjusted to summer design weath- er conditions, as well as forecast growth in peak loads. On this basis, Con Edison of New York’s weather-adjusted peak load in the summer of 2003 was 12,600 MW, 1.6 percent higher than the adjusted peak load in 2002. The forecast annu- al growth in the electric peak load over the next five years is 1.6 percent. The company anticipates an ongoing need for substantial capital investment in order to meet this load growth with the exceptionally high level of reliability that it currently provides (see “Capital Requirements,” below). The Utilities have rate plans approved by state utility regulators that cover the rates they can charge their customers. Con Edison of New York has an electric rate agreement (approved in November 2000) that ends March 2005 and gas and steam rate agreements (approved in April 2002 and November 2000, respectively) that end in September 2004. These agreements do not reflect all of the increased construction expenditures and related costs incurred and expected to be incurred to meet increasing customer demand and reliability needs (see “Capital Requirements,” below). The company filed petitions in November 2003 to increase rates for gas and steam service effective October 2004 and expects to file a petition in April 2004 to increase rates for electric service effective April 2005. O&R has rate agreements for its electric and gas services in New York that extend through October 2006. The rate plans generally require the Utilities to share with customers earnings in excess of specified rates of return on equity. Changes in energy sales and delivery volumes are reflected in operating income (except to the extent that weather-normalization provi- sions apply to the gas businesses). Rates charged to cus- tomers, pursuant to these agreements, may not be changed during the respective terms of these agreements other than for recovery of energy costs and limited other exceptions. See “Regulatory Matters” below and “Recoverable Energy Costs” and “Rate and Restructuring Agreements” in Notes A and B, respectively, to the financial statements. Accounting rules and regulations for public utilities include Statement of Financial Accounting Standards (SFAS) No. 71, “Accounting for the Effects of Certain Types of Regulation,” pursuant to which the economic effects of rate regulation are reflected in financial statements. See “Application of Critical Accounting Policies,” below. The respective collective bargaining agreements covering about two-thirds of each of the Utilities’ employees expire in June 2004. ## Unregulated Businesses Con Edison’s unregulated subsidiaries participate in competi- tive businesses and are subject to different risks than the Utilities. In view of conditions affecting certain of its competitive activities, the company recognized impairment charges of $159 million ($94 million after-tax) for its unregulated telecom- munications and generation businesses in the fourth quarter of 2003. See “Application of Critical Accounting Policies,” below and Note H to the financial statements. At December 31, 2003, Con Edison’s investment in its unregulated subsidiaries was $703 million and the unregulated subsidiaries’ assets amount- ed to $1.6 billion, including $339 million related to Con Edison Development’s Newington project. See Note T to the financial statements. Consolidated Edison Solutions, Inc. (Con Edison Solutions) sells electricity and gas to delivery customers of Con Edison of New York, O&R and other utilities and also offers energy relat- ed services. As of December 31, 2003, the company served approximately 30,000 electric customers with an estimated aggregate peak load of 1,400 MW. Consolidated Edison Development, Inc. (Con Edison Development) owns and operates generating plants and energy and other infrastructure projects. At December 31, 2003, the company owned interests of 1,668 MW of capacity in electric generating facilities of which 244 MW are sold under long-term purchase power agreements and the balance is sold on the wholesale electricity markets. Consolidated Edison Energy, Inc. (Con Edison Energy) provides energy and capacity to Con Edison Solutions and others and markets the output of plants owned or operated by Con Edison Development. The company also provides risk management services to Con Edison Solutions and Con Edison Development and offers these services to others.

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## Con Edison Communications, LLC (Con Edison Communications) builds and operates fiber optic networks to provide telecommunications services. The company’s proper- ties (the capitalized cost of which at December 31, 2003 amounted to $30 million, net of the impairment charge discussed above and in Note H to the financial statements) include network facilities and nearly 400 miles of fiber optic cable that has been installed in the New York City metropolitan area primarily through Con Edison of New York’s underground conduits and other rights of way. Con Edison is evaluating strategic alternatives for its telecommunications business. Con Edison anticipates investing $59 million in its unregulated businesses over the next two years and will focus on maximizing the value of their existing assets. See “Capital Requirements” and “Capital Resources,” below. ## Results of Operations - Summary Con Edison’s earnings per share in 2003 were $2.39 ($2.38 on a diluted basis). Earnings per share in 2002 and 2001 were $3.03 ($3.02 on a diluted basis) and $3.22 ($3.21 on a diluted basis). Earnings per share for 2003 and 2002, before the cumulative effect of changes in accounting principles of $3 million and $(22) million after tax, respectively, were $2.37 ($2.36 on a diluted basis) and $3.14 ($3.13 on a diluted basis), respectively. Earnings for the years ended December 31, 2003, 2002 and 2001 were as follows: <img src='content_image/1810.jpg'> (a) Represents inter-company and parent company accounting including interest expense on debt, non-operating income tax expense and goodwill amortization in 2001. See Note L to the financial statements. (b) Includes a charge for the impairment of unregulated telecommunications assets in accordance with SFAS No. 144 totaling $84 million after tax. See Note H to the financial statements. (c) Includes a charge for the impairment of two unregulated generating assets totaling $10 million after tax. In addition, a benefit for the cumulative effect of changes in accounting principles for mark-to-market gains related to power sales contracts at certain generating plants, partially offset by the impact of the financial statement consolidation of the Newington plant totaling $3 million after tax. See Note H to the financial statements. (d) Includes a charge for the cumulative effect of a change in accounting principle for goodwill impairment of certain unregulated generating assets totaling $20 million after tax. See Note L to the financial statements. (e) Includes a charge for the cumulative effect of a change in accounting principle for the rescission of Emerging Issues Task Force (EITF) Issue No. 98-10 totaling $2 million after-tax. See Note P to the financial statements. Con Edison’s earnings in 2003 were $118 million lower than in 2002, reflecting the following factors (after tax, in millions): ## Con Edison of New York: <img src='content_image/1824.jpg'> Con Edison’s earnings in 2002 were $36 million lower than in 2001, reflecting the following factors (after tax, in millions): ## Con Edison of New York: <img src='content_image/1825.jpg'> See “Results of Operations” below for further discussion and analysis of results of operations.

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## Application of Critical Accounting Policies The Companies’ financial statements reflect the application of their accounting policies, which conform to accounting principles generally accepted in the United States of America. The Companies’ critical accounting policies include industry- specific accounting applicable to regulated public utilities and accounting for pensions and other postretirement benefits, contingencies, long-lived assets, derivative instruments, goodwill and leases. The critical accounting policies are as follows: ## Accounting for Regulated Public Utilities - SFAS No. 71 The Utilities are subject to SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation,” and, in accordance with SFAS No. 71, are subject to the accounting requirements of the Federal Energy Regulatory Commission (FERC) and state public utility regulatory authorities having jurisdiction. SFAS No. 71 specifies the economic effects that result from the cause and effect relationship of costs and revenues in the rate-regulated environment and how these effects are to be accounted for by a regulated enterprise. Revenues intended to cover some costs may be recorded either before or after the costs are incurred. If regulation provides assurance that incurred costs will be recovered in the future, these costs would be recorded as deferred charges or “regulatory assets” under SFAS No. 71. If revenues are recorded for costs that are expected to be incurred in the future, these revenues would be recorded as deferred credits or “regulatory liabilities” under SFAS No. 71. The Utilities’ principal regulatory assets and liabilities are detailed in Note B to the financial statements. The Utilities are each receiving or being credited with a return on all regulatory assets for which a cash outflow has been made. The Utilities are each paying or being charged with a return on all regulatory liabilities for which a cash inflow has been received. The regula- tory assets and liabilities will be recovered from customers, or applied for customer benefit, in accordance with rate provisions approved by the applicable public utility regulatory commission. ## Accounting for Pensions and Other Postretirement Benefits The Utilities provide pensions and other postretirement benefits to substantially all of their employees and retirees. Con Edison’s unregulated subsidiaries also provide such benefits to certain of their employees. The Companies account for these benefits in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” and SFAS No. 106, “Employers’ Accounting for Postretirement Benefits other than Pensions.” In applying these accounting policies, the Companies have made critical estimates related to actuarial assumptions, including assump- tions of expected returns on plan assets, future compensation, health care cost trends and appropriate discount rates. See Notes E and F to the financial statements for information about these assumptions, actual performance, amortization of invest- ment and other actuarial gains and losses and calculated plan costs for 2003, 2002 and 2001. Primarily because of the amortization of previous years’ net investment gains, Con Edison of New York’s pension expense for 2003, 2002 and 2001 was negative, resulting in a credit to and increase in net income in each year. Investment gains and losses on plan assets are fully recognized in expense over a 15-year period (20 percent of the gains and losses for each year begin to amortize in each of the following five years and the amortization period for each 20 percent portion of the gains and losses is ten years). This amortization is in accordance with the Statement of Policy issued by the New York Public Service Commission (PSC) and is permitted under SFAS No. 87. The cost of pension and other postretirement benefits in future periods will depend on actual returns on plan assets and assumptions for future periods. Con Edison’s current estimate for 2004 is a reduction, compared with 2003, in the pension and other postretirement benefits net credit of $19 million after tax for Con Edison of New York and an increase, compared to 2003, in pension and other postretirement benefits expense of $1 million for O&R. This reduction reflects, among other fac- tors, the amortization of prior period actuarial losses associated with declines in the market value of assets in recent years, par- tially offset by the amortization of a gain on plan assets in 2003 and by the estimated impact in 2004 of recently enacted Medicare legislation (reduction in other postretirement benefit costs of $10 million after tax, including $9 million for Con Edison of New York and $1 million for O&R). Amortization of market gains and losses experienced in previ- ous years is expected to reduce Con Edison of New York’s pension and other postretirement benefit net credit by an addi- tional $25 million, after tax, in 2005. A 5.0 percentage point variation in the actual annual return in 2004 as compared with the expected annual asset return of 8.8 percent would change net income for Con Edison and Con Edison of New York by approximately $5 million in 2005, assuming no change in regu- latory treatment. In accordance with SFAS No. 71 and consistent with rate provisions approved by the PSC, O&R defers as a regulatory asset any difference between expenses recognized under SFAS No. 87 and the amounts reflected in rates for such

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expenses. Con Edison of New York’s pending petitions for gas and steam rate increases include, and the company anticipates that its petition for an electric rate increase will include, a pro- posal for deferred accounting treatment of such expenses. See “Regulatory Matters”, below. Pension benefits are provided through a pension plan main- tained by Con Edison to which Con Edison of New York, O&R and the unregulated subsidiaries make contributions for their participating employees. Pension accounting by the Utilities includes an allocation of plan assets. An actuarial valuation of the plan’s funded status as of December 31, 2003, showed that the fair value of the plan’s assets exceeded, by $712 mil- lion, the plan’s accumulated benefit obligation (ABO) at that date. However, the fair market value of the plan assets could fall below the plan’s ABO in future years. In that event, each of the Utilities would be required, under SFAS No. 87, to accrue a liability equal in amount to the difference between its share of the fair value of the plan assets and its portion of the ABO, plus, in the case of Con Edison of New York, its total prepaid pension costs, through a non-cash charge to other compre- hensive income (OCI). The charge to OCI, which would be net of taxes, would not affect net income for common stock. The Companies were not required to make cash contributions to their pension plans in 2003 under funding regulations and tax laws. O&R made a discretionary contribution of $18 million to the plan in 2003. In 2004, O&R and Con Edison’s unregulat- ed subsidiaries expect to make discretionary contributions of $22 million and $2 million, respectively. The Companies’ policy is to fund its accounting cost to the extent it is tax deductible. ## Accounting for Contingencies SFAS No. 5, “Accounting for Contingencies,” applies to an existing condition, situation or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur. Known material contingencies include the Utilities’ responsibility for hazardous substances, such as asbestos, polychlorinated biphenyls (PCBs) and coal tar that have been used or generat- ed in the course of operations, workers’ compensation claims and Con Edison’s legal proceedings relating to its October 1999 merger agreement with Northeast Utilities. See Notes G, K, Q, R, S, T and W to the financial statements. In accordance with SFAS No. 5, the Companies have accrued estimates of losses relating to the contingencies as to which loss is proba- ble and can be reasonably estimated and no liability has been accrued for contingencies as to which loss is not probable or cannot be reasonably estimated. ## Accounting for Long-Lived Assets SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” requires that certain long-lived assets must be tested for recoverability whenever events or changes in cir- cumstances indicate their carrying amounts may not be recov- erable. The carrying amount of a long-lived asset is deemed not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Under SFAS No. 144 an impairment loss is recog- nized if the carrying amount is not recoverable from such cash flows, and exceeds its fair value, which approximates market value. The adverse market conditions affecting Con Edison’s unregu- lated telecommunications and generation businesses led to the testing of their assets for impairment in 2003. A critical ele- ment of this test is the forecast of future undiscounted cash flows to be generated from the long-lived assets. Forecast of these cash flows requires complex judgments about future operations, which are particularly difficult to make with respect to evolving industries such as the energy-related and telecom- munications businesses. Under SFAS No. 144, if alternative courses of action are under consideration or if a range is esti- mated for the amount of possible future cash flows, the proba- bility of those possible outcomes must be weighted. As a result of the tests performed in 2003, Con Edison recognized impair- ment charges of $159 million ($94 million after-tax) for the assets of its unregulated telecommunications and generation businesses. See Note H to the financial statements. ## Accounting for Derivative Instruments The Companies apply SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, and other related accounting pronouncements to their deriva- tive financial instruments. The Companies use derivative finan- cial instruments to hedge market price fluctuations in related underlying transactions for the physical purchase and sale of electricity and gas and interest rate risk on certain debt securi- ties. See “Financial and Commodity Market Risks” below and Note P to the financial statements. ## Accounting for Goodwill Con Edison adopted SFAS No. 142, “Goodwill and Other Intangible Assets” on January 1, 2002. In accordance with this standard, Con Edison ceased amortizing goodwill and began testing remaining goodwill balances for impairment on an annual basis. Con Edison completed initial goodwill impairment tests and recorded a loss of $34.1 million ($20.2 million after tax) as of January 1, 2002, relating to certain generation assets owned by an unregulated subsidiary. The unamortized goodwill of $405.8 million, relating to the acquisition of O&R, was tested for impairment and determined not to be impaired. See Note L to the financial statements.

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In determining whether or not its goodwill is impaired, Con Edison is required to make certain estimates and assump- tions that could affect the results of the goodwill impairment test. Actual results could differ from the estimates used. ## Accounting for Leases The Companies apply SFAS No. 13, “Accounting for Leases” and other related accounting pronouncements to their leasing transactions. See Notes K and T to the financial statements. ## Liquidity and Capital Resources The Companies’ liquidity reflects cash flows from operating, investing and financing activities, as shown on their respective consolidated statement of cash flows and as discussed below. The principal factors affecting Con Edison’s liquidity at the hold- ing company level are its investments in the Utilities, the divi- dends it pays to its shareholders and the dividends it receives from the Utilities. In addition, in 2003 Con Edison issued 11.9 million shares of common stock for $431 million ($381 million of which it invested in Con Edison of New York) and $200 mil- lion of five-year debt. In 2002, the company issued $325 million of 40-year debt (most of which it invested in its unregulated subsidiaries). The principal factors affecting the Utilities’ liquidity are the cash flow generated from operations, construction expenditures and maturities of their debt securities. In addition, Con Edison of New York in 2003 received a $381 million capital contribution from Con Edison; in 2002 and 2001 issued $225 million and $95 million, respectively, of additional debt net of redemptions; and in 2001 received net proceeds of $597 million from the sale of generating assets, net of a contribution to its nuclear decommissioning trust (see Note J to the financial statements). Also, since 2001, Con Edison of New York has incurred sub- stantial, primarily capital, costs in connection with the attack on the World Trade Center and the subsequent restoration of lower Manhattan and to date has received reimbursement of such costs of $29 million from the federal government (see Note R to the financial statements). In 2003, O&R redeemed $35 million of debt at maturity with commercial paper. The Companies each believes that it will be able to meet its reasonably likely short-term and long-term cash requirements, assuming that the Utilities’ rate plans reflect their costs of serv- ice, including a return on invested capital. See “Regulatory Matters,” below and “Application of Critical Accounting Policies - Accounting for Contingencies,” above. Changes in the Companies’ cash and temporary cash invest- ments resulting from operating, investing and financing activi- ties for the years ended December 31, 2003, 2002 and 2001 are summarized as follows: ## Con Edison <img src='content_image/62029.jpg'> ## Con Edison of New York <img src='content_image/62028.jpg'> ## O&R <img src='content_image/62027.jpg'> ## Cash Flows from Operating Activities The Utilities’ cash flows from operating activities reflect princi- pally their energy sales and deliveries and cost of operations. The volume of energy sales and deliveries is dependent prima- rily on factors external to the Utilities, such as weather and economic conditions. The prices at which the Utilities provide

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energy to their customers are determined in accordance with rate plans approved by the state public utility regulatory author- ity having jurisdiction – the PSC, the New Jersey Board of Public Utilities (NJBPU) and the Pennsylvania Public Utility Commission (PPUC). See “Regulatory Matters” below. In gen- eral, changes in the Utilities’ cost of purchased power, fuel and gas may affect the timing of cash flows but not net income because the costs are recovered in accordance with rate plans. See “Recoverable Energy Costs” in Note A to the finan- cial statements. Net income for common stock is the result of cash and non- cash (or accrual) transactions. Only cash transactions affect the Companies’ cash flows from operating activities. Principal non-cash charges include depreciation and deferred taxes, and for Con Edison in 2003, impairment charges. For Con Edison of New York, principal non-cash credits include prepaid pen- sion costs. Pension credits result from past favorable perform- ance in Con Edison of New York’s pension fund and assump- tions about future performance. See “Application of Critical Accounting Policies – Accounting for Pensions and Other Postretirement Benefits” and Notes E and F to the financial statements. Net cash flows from operating activities in 2003 for Con Edison and Con Edison of New York were $203 million and $141 mil- lion lower than 2002, respectively. This decrease reflects lower net income at Con Edison of New York (due to a certain extent to costs not reflected in current rates) and for Con Edison (due to greater losses at the unregulated subsidiaries). This decrease also reflects Con Edison of New York’s increase in the value of gas in storage (reflecting both higher unit costs and higher volumes) and a higher level of accrued construction commitments at year-end 2002 that were paid for in 2003. This decrease was partially offset by an increase in deferred income tax expense. Net cash flows from operating activities in 2003 for O&R were $24 million higher than in 2002 due primarily to increased deferred income tax expense, partially offset by the increased value of gas in storage (resulting from higher unit costs and volumes). Net cash flows from operating activities in 2002 for Con Edison were $65 million lower than in 2001. This decrease was due principally to higher energy costs and sales at the Utilities in December 2002 as compared with December 2001, resulting in increased customer accounts receivable and recoverable energy costs, offset in part by increased accounts payable bal- ances. The net benefit to cash flows from these activities in 2001 was greater than the benefit in 2002 because high ener- gy costs at year-end 2000 were collected in 2001 and energy purchases at year-end 2001 were lower than the prior year. The change in cash flows also reflects the timing of federal income tax payments and refunds for the Utilities and net cash r eceived related to regulatory liabilities, such as transmission congestion contracts, offset by increased cash expended relat- ed to regulatory assets. Net cash flows from operating activities in 2002 for Con Edison of New York were $4 million higher than in 2001. The change in cash flows reflects the aforementioned impact of the timing of energy sales and cost recovery, the timing of federal income tax payments and refunds, and cash received or expended related to regulatory liabilities and regulatory assets, r espectively. ## Cash Flows Used in Investing Activities Net cash flows used in investing activities for Con Edison were $107 million lower in 2003 than in 2002, due primarily to lower construction expenditures by its unregulated subsidiaries, partially offset by increased construction expenditures by the Utilities. Cash flows used in investing activities were $64 million and $11 million higher in 2003 than in 2002 for Con Edison of New York and O&R, respectively, due primarily to increased construction expenditures. Net cash flows used in investing activities for Con Edison and Con Edison of New York were $693 million and $704 million higher in 2002 compared with 2001, respectively, due primarily to the receipt in 2001 of net proceeds from generation divesti- ture. See Note J to the financial statements. In addition, Con Edison of New York construction expenditures increased in 2002 compared with 2001, principally to meet load growth on the company’s electric distribution system, to effect permanent restoration of portions of the electric, gas and steam systems in lower Manhattan following the World Trade Center attack and for the ongoing project to add incremental generating capacity at Con Edison of New York’s East River steam-electric generating plant (the East River Repowering Project). Deferred real estate sale costs related to the demolition and remediation of a nine-acre development site in midtown Manhattan along the East River were $134 million at December 31, 2002, compared with $105 million at December 31, 2001. In 2000, Con Edison of New York agreed to sell this site for an expected price of $576 million to $680 million, depending on zoning and other adjustments. The sale is subject to PSC approval and other conditions. The buyer paid Con Edison of New York $50 million in 2000 as a down payment, which Con Edison used to fund a portion of the demolition and remedia- tion expenses. The down payment has been recorded as a re gulatory liability.

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Net cash flows used in investing activities for O&R were $1 million lower in 2002 than in 2001. ## Cash Flows from/(used in) Financing Activities Net cash flows from financing activities in 2003 for Con Edison and Con Edison of New York increased $258 million and $327 million, respectively in 2003 compared with 2002. Con Edison’s cash flows from financing activities for the year ended December 31, 2003, reflect the issuance of 9.6 million Con Edison common shares (resulting in proceeds of $381 mil- lion, which was invested by Con Edison in Con Edison of New York) and $200 million of Con Edison’s 3.625 percent 5-year Series 2003A Debentures (most of which was invested in the unregulated subsidiaries). Cash flows from financing activities in 2002 reflect the issuance of $325 million of Con Edison’s 7.25 percent 40-year Series 2002A Debentures (the proceeds of which were used to repay commercial paper). Cash flows from financing activities in both 2003 and 2002 also reflect the issuance of Con Edison common shares through its dividend reinvestment and employee stock plans (2003: 2.3 million shares for $50 million; 2002: 1.7 million shares for $25 million). In addition, common stock dividends paid in 2003 and 2002 were reduced by $46 million and $44 million, respectively, to reflect the amount of dividends reinvested in Con Edison com- mon shares through the dividend reinvestment and employee stock plans. Net cash flows used in financing activities for Con Edison and Con Edison of New York decreased $267 million and $328 mil- lion in 2002 compared with 2001, respectively. This decrease reflects principally increased debt financing for construction expenditures at Con Edison of New York and a reduction in the dividends paid by Con Edison of New York to Con Edison. In addition, in September 2001, Con Edison of New York used the proceeds from the sale of its nuclear plant to repay out- standing short-term borrowing. Net cash flows used in financing activities for O&R were $8 mil- lion lower in 2002 than 2001, due primarily to the retirement of short-term debt in excess of proceeds from issuances. Net cash flows from financing activities during the years ending December 31, 2003, 2002 and 2001 also reflect Con Edison of New York’s (unless otherwise noted) refunding and issuance of long-term debt and preferred stock as follows: ## 2003 - Redeemed in advance of maturity $275 million 7.75 percent - 35-year Series 1996A, Subordinated Deferrable Interest - Debentures using cash held for that purpose at December - 31, 2002; - Redeemed at maturity $150 million of 6.375 percent 10-year - Series 1993D Debentures and issued $175 million 5.875 - percent 30-year Series 2003A Debentures; - Redeemed $380 million 7.5 percent 30-year Series 1993G - Debentures using the net proceeds from the issuance of - $200 million 3.85 percent 10-year Series 2003B Debentures - and $200 million 5.10 percent 30-year Series 2003C - Debentures; - O&R redeemed at maturity its $35 million 6.56 percent - 10-year Series 1993D Debentures using proceeds from - the issuance of commercial paper. ## 2002 - Redeemed at maturity $150 million 6.625 percent - 9-year Series 1993C; - Redeemed at maturity $150 million variable-rate 5-year Series 1997A and issued $300 million of 5.625 percent - 10-year Series 2002A Debentures; - Redeemed at maturity $37 million of Cumulative - Preferred Stock $100 par value 6.125 percent Series J; - Issued $500 million of 4.875 percent 10-year Series - 2002B Debentures. ## 2001 - Redeemed at maturity $150 million 6.5 percent - 10-year Series 1993B; - Issued $400 million 7.5 percent 40-year Series 2001A; - Issued $225 million variable rate 35-year tax-exempt - debt Series 2001A through the New York State Energy - Research and Development Authority (NYSERDA) and - redeemed in advance of maturity $128 million 7.5 percent - 25-year Series 1991A and $100 million 6.75 percent 25-year - Series 1992A NYSERDA bonds; - Issued $98 million variable rate 35-year tax-exempt debt - through NYSERDA and redeemed in advance of maturity - $100 million 6.375 percent 25-year Series 1992B NYSERDA - bonds; - Redeemed at maturity $150 million variable rate 5-year - Series 1996B. In 2002, Con Edison of New York changed the interest rate method applicable to $224.6 million aggregate principal amount of its tax-exempt Facilities Revenue Bonds, Series 2001A from a variable weekly rate mode to a 10-year term mode, callable at par after three years with a 4.7 percent annual interest rate. In addition, Con Edison of New York entered into a swap agreement in connection with these bonds pursuant to which the company pays interest at a variable rate equal to the three-month LIBOR and is paid interest at a fixed rate of 5.375 percent. See Note P to the financial statements. Cash flows from financing activities of the Companies also reflect commercial paper issuance (included on the consolidat- ed balance sheets as “Notes payable”). The commercial paper

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employees, Con Edison delivered in 2003. For the second straight year, PA Consulting named Con Edison Company of New York, which serves New York City and Westchester County, the most reliable electric utility in North America. Our two regulated businesses, Consolidated Edison of New York and Orange and Rockland Utilities (O&R), deliver energy to approximately 3.4 million electric customers, and serve more than 1.1 million gas customers and 1,800 steam customers. We invested $1.2 billion in our regulated businesses in 2003, of which more than $700 million was aimed at improving electric transmission and delivery networks and maintaining our industry-leading reliability. These investments yielded many tangible results: upgrades to existing substations, the construc- tion of new substations, and the installation of transmission facilities to handle energy from new power sources. In November, we installed three electrical transformers at the new World Trade Center substation, a demonstration of our commitment to rebuild the two substations destroyed there on September 11, 2001. Our regulated capital pr ogram for 2004 includes a number of significant projects. For the first time in more than thre decades, we have three major substations under construction simultaneously, with all three schedul- ed to begin service in the same year. At the same time, we’r e completing the installation of new steam/electric generating units as part of the East River Repowering Project. Our capital needs re flect the vibrancy of our service area and the underlying strength of the local economy. ## Financial Results Net income for common stock in 2003 was $528 million, or $2.39 per share. As shown on the Financial Highlights page of this report, earnings from ongoing operations in 2003 were $624 million, or $2.83 per share — 31 cents per shar lower than in 2002. Reflecting our continued confidence in the company’ long-term financial and operating strength, we increased our dividend in January 2004 for the 30th consecutive year, to an annualized $2.26 per share. A number of factors contributed to the lower earnings in 2003 — lingering softness in the local economy, cool summer weather, rising health insurance and pension costs, and weak energy and telecom markets. We offset some of the higher costs through productivity improvements. But we were not willing to take short- term measures that, while perhaps enhancing our bottom line in 2003, could have had a negative effect on our operating strength and flexibility. In recent years, as our industry restructured, we have made limited investments in several unregulated businesses in areas that are closely related to our core expertise — Con Edison Development, Con Edison Energy, Con Edison Solutions, and Con Edison Communications. As a result of adverse conditions in the telecom and energy markets, we recognized after-tax impairment charges in 2003 of $84 million on our telecom investment and $10 million on certain of our energy investments. We continue to have confidence in the long-term potential of the markets served by our unregulated businesses. <img src='content_image/103978.jpg'>

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amounts outstanding at December 31, 2003, 2002 and 2001 and the average daily balance for 2003, 2002 and 2001 for Con Edison, Con Edison of New York and O&R were as follows: <img src='content_image/47248.jpg'> External borrowings are a source of liquidity that could be affected by changes in credit ratings, financial performance and capital markets. For information about the Companies’ credit rating and certain financial ratios, see “Capital Resources,” below. In January 2004, Con Edison of New York issued $245.3 mil- lion of its variable rate, tax-exempt Facilities Revenue Bonds, Series 2004A and B, the proceeds of which are being used to redeem in advance of maturity its fixed rate, tax-exempt Facilities Revenue Bonds, Series 1993A, B and C. In February 2004, Con Edison of New York issued $200 million of 4.7 percent 10-year Series 2004A Debentures and $200 million of 5.7 percent 30-year Series 2004B Debentures, the proceeds of which were used to redeem in advance of maturity the company's $150 million 7.125 percent Series 1994A Debentures and for general corporate purposes. ## Changes in Assets and Liabilities The following table shows changes in assets and liabilities at December 31, 2003, compared with December 31, 2002, that have impacted the Companies’ consolidated statements of cash flows. The changes in these balances are utilized to rec- oncile income to cash flow from operations. With respect to regulatory liabilities, see Note B to the financial statements. <img src='content_image/47247.jpg'> Accounts receivable – customers, less allowance for uncol- lectible accounts increased due primarily to higher electric and gas sales revenue for the Utilities and higher electric purchased power and gas unit costs (which are recoverable from cus- tomers) for Con Edison of New York during December 2003 compared with December 2002. Energy sales and purchased power costs are discussed below under “Results of Operations.” Gas in storage increased at December 31, 2003 as compared with year-end 2002 due primarily to higher unit costs and vol- umes of gas in storage at December 31, 2003 as compared with year-end 2002. Prepaid pension costs for Con Edison and Con Edison of New York increased at December 31, 2003 as compared with year- end 2002 due to the recognition of the current period’s pen- sion credits. Accounts payable for Con Edison and Con Edison of New York decreased at December 31, 2003 as compared with year-end 2002 due primarily to a higher level of accrued construction commitments at year-end 2002. This decrease was offset in part by increased electric purchased power costs for Con Edison of New York at December 31, 2003 as compared with year-end 2002, reflecting higher unit costs. Superfund and other environmental liabilities for the Companies increased at December 31, 2003 as compared with year-end 2002 reflecting increased estimates for investigation, removal and remediation costs. Deferred income taxes – liability increased at December 31, 2003 as compared with year-end 2002 due primarily to accel- erating tax deductions for capitalized indirect costs. Transmission congestion contracts (See “Regulatory Assets and Liabilities” in Note B to the financial statements) increased at December 31, 2003 compared with year-end 2002 reflecting proceeds from the sale through the New York Independent System Operator (NYISO) of transmission rights on Con Edison of New York’s transmission system. These proceeds are being retained for customer benefit. ## Capital Resources Con Edison is a holding company that operates only through its subsidiaries and has no material assets other than its inter- ests in its subsidiaries. Con Edison expects to finance its capi- tal requirements primarily from dividends it receives from its subsidiaries and through the sale of securities, including com- mercial paper. In addition, Con Edison’s ability to make pay- ments on its external borrowings and dividends on its common shares is dependent on its receipt of dividends from its sub-

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sidiaries or proceeds from the sale of its securities or its inter- ests in its subsidiaries. For information about restrictions on the payment of dividends by the Utilities and significant debt covenants, see Note C to the financial statements. For information on the Companies’ commercial paper program and revolving credit agreements with banks, see Note D to the financial statements. The Utilities expect to finance their operations, capital require- ments and payment of dividends to Con Edison from internally generated funds and external borrowings. In December 2001, the PSC authorized the Utilities to issue up to $1.95 billion of debt securities prior to 2006, of which Con Edison of New York issued $195 million and $525 million of debt securities in 2003 and 2002, respectively. In addition, the PSC authorized the refunding of the Utilities’ outstanding debt securities and preferred stock. Con Edison’s unregulated subsidiaries have financed their operations and capital requirements primarily with capital con- tributions from Con Edison, internally generated funds and external borrowings. See Note T to the financial statements. In August 2002, Congress appropriated funds for which Con Edison of New York is eligible to apply, to recover costs it incurred in connection with the World Trade Center attack. In accordance with procedural guidelines for disbursement of the federal funds, Con Edison of New York submitted its initial application for funds in October 2003 and received the first installment of $29 million on October 31, 2003. The Company will submit additional applications when appropriate. See Note R to the financial statements. For each of the Companies, the ratio of earnings to fixed charges (Securities and Exchange Commission basis) for the years ended December 31, 2003, 2002, 2001, 2000 and 1999 was: <img src='content_image/125238.jpg'> For each of the Companies, the common equity ratio at December 31, 2003, 2002 and 2001 was: <img src='content_image/125237.jpg'> The commercial paper of the Companies is rated P-1, A-1 and F1, respectively, by Moody’s Investor Service, Inc. (Moody’s), Standard & Poor’s Rating Services (S&P) and Fitch Ratings (Fitch). Con Edison’s unsecured debt is rated A2, A- and A-, respectively, by Moody’s, S&P and Fitch. The unsecured debt of the Utilities is rated A1, A and A+, respectively, by Moody’s, S&P and Fitch. A securities rating is subject to revision or with- drawal at any time by the assigning rating organization.

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## Capital Requirements The following table compares the Companies’ capital requirements for the years 2001 through 2003 and estimated amounts for 2004 and 2005. <img src='content_image/38568.jpg'> Con Edison of New York’s utility construction expenditure in 2003 and 2004 reflect programs to meet electric load growth and reliability needs, gas infrastructure expenditures, the East River Repowering Project and expenditures for permanent electric, gas and steam system restoration following the World Trade Center attack (see Note R to the financial statements). The increase for 2005 reflects an anticipated higher level of expenditure for electric substations and ongoing improvements and reinforcements of the electric distribution system. The unregulated subsidiaries’ construction expenditure declined in 2003 and are expected to continue to decline, consistent with ther being no major construction or acquisition expected for those businesses. At December 31, 2003 and 2002, Con Edison’ investment balance in these subsidiaries, on an unconsolidated basis, was $703 million and $790 million, respectively.

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## Contractual Obligations The following tables summarize the Companies’ material obligations at December 31, 2003, to make payments pursuant to contracts. Long-term debt, capital lease obligations and other long-term liabilities are included on their balance sheets. Operating leases and non-utility generator (NUG) contracts (for which undiscounted future annual payments are shown) are disclosed in the notes to the financial statements. <img src='content_image/118343.jpg'> (a) Other purchase obligations for the Utilities exclude amounts included in other contractual obligations shown on the table. Amounts shown for purchase obligations were derived from (a) the Utilities’ purchasing systems as the difference between the amounts authorized and the amounts paid (or vouchered to be paid) for each obligation. For most of its purchase obligations, (a) the Utilities are committed to purchase less than the amount authorized, typically a 10 percent commitment. These other purchase obligations reflect capital and operations and maintenance (a) costs entered into by the Utilities in running their day to day operations. Payments of the other pur chase obligations are assumed to be made ratably over the terms of the obligations. (b) Represents commitments to purchase electric energy and capacity natural gas and natural gas pipeline capacity and operation and maintenance generation service agreements entered into (a) by Con Edison’s unregulated subsidiaries. The Companies’ commitments to make payments in addition to these contractual commitments are their other liabilities reflected in their balance sheets and Con Edison’ guarantees of certain obligations of its subsidiaries. See Notes S and T to the financial statements.

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## Electric Power Requirements In 2003, the Utilities purchased substantially all of the energy they sold to customers pursuant to firm contracts with NUGs and others and through the NYISO’s wholesale electricity mar- ket. Con Edison expects that these resources will again be adequate to meet the requirements of its customers in 2004. In general, the Utilities recover prudently incurred purchase power costs pursuant to rate provisions approved by the state public utility regulatory authority having jurisdiction. See “Financial and Commodity Market Risks – Commodity Price Risk” below and “Recoverable Energy Costs” in Note A to the financial statements. From time to time certain parties have petitioned the PSC to review these provisions, the elimination of which could have a material adverse effect on the Companies’ financial position, results of operations or liquidity. To reduce the volatility of electric energy costs, the Utilities have firm contracts to purchase electric energy (including the output of the nuclear generating unit divested in 2001) and have entered into derivative transactions to hedge the costs of expected purchases, which together cover a substantial por- tion of the electric energy expected to be sold to customers in the summer of 2004. See Notes I and P to the financial state- ments. O&R’s New Jersey subsidiary entered into firm con- tracts to purchase electric energy for a substantial portion of the electric energy expected to be sold to its customers in 2004. Con Edison of New York also owns approximately 630 MW of generating stations associated primarily with its steam system, located in New York City, the electricity output of which it sells through the NYISO’s wholesale electricity market. The East River Repowering Project will add incremental electric capacity of approximately 200 MW based on a winter nominal rating or approximately 125 MW based on a summer nominal rating. In a July 1998 order, the PSC indicated that it “agree(s) generally that Con Edison of New York need not plan on con- structing new generation as the competitive market develops,” but considers “overly broad” and did not adopt Con Edison of New York’s request for a declaration that, solely with respect to providing generating capacity, it will no longer be required to engage in long-range planning to meet potential demand and, in particular, that it will no longer have the obligation to con- struct new generating facilities, regardless of the market price of capacity. Con Edison of New York monitors the adequacy of the electric capacity resources and related developments in its service area, and works with other parties on long-term resource adequacy issues within the framework of the NYISO. Con Edison’s unregulated subsidiaries sell electricity in the wholesale and retail NYISO and other markets. At December 31, 2003, Con Edison Development’s interests in electric gen- erating facilities amounted to 1,668 MW. Con Edison Energy sells the electricity from these generating facilities under con- tract or on the wholesale electricity markets. See “Financial and Commodity Market Risks – Commodity Price Risk,” below. ## Regulator y Matters For additonal information about the electric, gas and steam agreements discussed below, see “Rate and Restructuring Agreements” in Note B to the financial statements. ## Electric In July 2002, FERC issued a Notice of Proposed Rulemaking (NOPR) to establish a Standard Market Design (SMD) for wholesale electricity markets across the country. The proposed SMD has many of the elements of the markets that have been established in the Northeast, and if adopted, could facilitate transactions among energy markets across the country. After receiving over 1,000 comments on the proposals contained in its SMD NOPR, the FERC issued its Wholesale Market Platform “White Paper” on April 28, 2003. The White Paper built on the existing rules contained in Order 2000. Key among the attributes discussed in the White Paper are flexibility on the scope and configuration to allow for both Independent System Operators (ISOs) and Regional Transmission Organizations (RTOs); the need for a regional planning process; the need for rate mechanisms that minimize cost shifts; the need to eliminate “seams” charges between ISOs and RTOs; the use of a real-time market for energy to resolve imbalances; and the need for an approach to manage congestion, which could include locational pricing with firm transmission rights, that protects against manipulation, utilizes the grid effectively and promotes the use of lower cost genera- tion. In addition, each region within an RTO or ISO will deter- mine how it will ensure that its region has sufficient resources to meet customers’ needs. Since releasing its White Paper, the FERC has held technical conferences on various issues. However, it has not issued any specific orders for compliance. The energy bill introduced in Congress in 2003 contained a provision remanding SMD to the FERC and requiring that no new rule could be issued before October 31, 2006 or could become effective before December 31, 2006. The energy bill was not passed in 2003. The Senate leadership has stated its intent to bring the bill up for vote again in 2004. In September 1997, the PSC approved a restructuring agree- ment among Con Edison of New York, the PSC staff and cer- tain other parties (the 1997 Restructuring Agreement). Pursuant to the 1997 Restructuring Agreement, Con Edison of New York reduced electric rates on an annual basis by $129 million in 1998, $80 million in 1999, $103 million in 2000 and $209 million in 2001, divested most of its electric generating capacity, and enabled all of its electric customers to be served

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by competitive energy suppliers. In November 2000, the PSC approved an October 2000 agree- ment (the 2000 Electric Rate Agreement) that, among other things, revised and extended the electric rate plan provisions of the 1997 Restructuring Agreement and addressed certain gen- eration divestiture-related issues. The electric rate plan provisions of the 2000 Electric Rate Agreement cover the five-year period ending March 2005. Pursuant to the 2000 Electric Rate Agreement, Con Edison of New York reduced the distribution component of its electric rates by $170 million on an annual basis, effective October 2000. The 2000 Electric Rate Agreement continues the rate provi- sions pursuant to which Con Edison of New York recovers pru- dently incurred purchased power and fuel costs from cus- tomers. See “Recoverable Energy Costs” in Note A to the financial statements. O&R has entered into settlement agreements or similar arrangements with the PSC, NJBPU and PPUC that provide for a transition to a competitive electric market. In October 2003, the PSC approved agreements among O&R, the staff of the PSC and other parties with respect to the rates O&R can charge to its New York customers for electric service. The electric agreement, which covers the period from July 1, 2003 through October 31, 2006, provides for no changes to electric base rates and contains provisions for the amortization and offset of regulatory assets and liabilities, the net effect of which will reduce electric operating income by a total of $11 million (pre-tax) between July 2003 and June 2006. During the second half of 2003, O&R amortized $3.7 million of the $11 million. The agreement continues to provide for recovery of energy costs from customers on a current basis and for O&R to share equally with customers earnings in excess of a 12.75 percent return on common equity during the three year period from July 2003 through June 2006. The period from July 2006 through October 2006 will not be subject to earnings sharing. In July 2003, the NJBPU ruled on the petitions of Rockland Electric Company (RECO), the New Jersey utility subsidiary of O&R, for an increase in electric rates and recovery of deferred purchased power costs. See “Recoverable Energy Costs” and “Rate and Restructuring Agreements – Electric” in Notes A and B, respectively, to the financial statements. The NJBPU ordered a $7 million decrease in RECO’s electric base rates, effective August 2003, authorized RECO’s recovery of approximately $83 million of previously deferred purchased power costs and associated interest and disallowed recovery of approximately $19 million of such costs and associated interest. At December 31, 2002, the company had accrued a reserve for $13 million of the disallowance, and at June 30, 2003 reserved an addi- tional $6 million for the disallowance. ## Gas In November 2003, Con Edison of New York filed a request with the PSC to increase charges for gas service by $108 mil- lion (9.8 percent), effective October 2004. Con Edison of New York is currently operating under a gas rate agreement approved by the PSC in April 2002. The Agreement covers the three-year period ending September 30, 2004. The rate agreement reduced retail sales and transportation rates by $25 million, on an annual basis. In November 2000, the PSC approved an agreement between Con Edison of New York, the PSC staff and certain other par- ties that revised and extended the 1996 gas rate settlement agreement through September 2001. The 1996 agreement, with limited exceptions, continued base rates at September 1996 levels through September 2000. In October 2003, the PSC approved an agreement among O&R, the staff of the PSC and other parties with respect to the rates O&R can charge to its New York customers for gas serv- ice. The O&R gas agreement, which covers the period from November 1, 2003 through October 31, 2006, provides for annual increases in gas base rates of $9 million (5.8 percent) effective November 2003, $9 million (4.8 percent) effective November 2004 and $5 million (2.5 percent) effective November 2005. The O&R gas agreement also continues a weather normalization clause that moderates, but does not eliminate, the effect of weather-related changes on net income. The agreement continues to provide for recovery of energy costs from customers on a current basis and for O&R to share equally with customers earnings in excess of an 11 percent return on common equity over the term of the agreement. The agreement also contains incentives under which, among other things, the company earns additional amounts based on attaining specified targets for customer migration to its retail access programs and the achievement of certain net revenue targets for interruptible sales and transportation customers. In November 2000, the PSC also approved a gas rate agree- ment between O&R, PSC Staff and certain other parties cover- ing the three-year period November 2000 through October 2003. ## Steam In November 2003, Con Edison of New York filed a request with the PSC to increase annual charges for steam service by

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$129 million (14.6 percent), effective October 2004. Con Edison of New York is currently operating under a steam rate agreement that was approved by the PSC in December 2000. The agreement provided for a $16.6 million steam rate increase, which took effect October 2000 and, with limited exceptions, provided for no further changes in steam rates prior to October 2004. ## Financial and Commodity Market Risks The Companies are subject to various risks and uncertainties associated with financial and commodity markets. The most significant market risks include interest rate risk, commodity price risk, credit risk and investment risk. ## Interest Rate Risk The interest rate risk relates primarily to variable rate debt and to new debt financing needed to fund capital requirements, including the construction expenditures of the Utilities and maturing debt securities. Con Edison and its subsidiaries man- age interest rate risk through the issuance of mostly fixed rate- debt with varying maturities and through opportunistic refinanc- ing of debt. Con Edison estimates that, as of December 31, 2003, each 10 percent variation in interest rates applicable to the Companies’ variable rate debt of $816 million would result in a change in annual interest expense of $1 million. For each 10 percent change in Con Edison of New York’s and O&R’s variable interest rates applicable to their variable rate debt of $714 million and $59 million, respectively, annual interest expense for Con Edison of New York would change by $1 million and there would be no material impact for O&R. In addition, Con Edison and its subsidiaries, from time to time, enter into derivative financial instruments to hedge interest rate risk on certain debt securities. See “Interest Rate Hedging” in Note P to the financial statements. ## Commodity Price Risk Con Edison’s commodity price risk relates primarily to the pur- chase and sale of electricity, gas and related derivative instru- ments. The Utilities and Con Edison’s unregulated subsidiaries have risk management strategies to mitigate their related expo- sures. See Note P to the financial statements. Con Edison estimates that, as of December 31, 2003, each 10 percent change in market prices would result in a change in fair value of $12 million for the derivative instruments used by the Utilities to hedge purchases of electricity and gas, of which $8 million is for Con Edison of New York and $4 million for O&R. Con Edison expects that any such change in fair value would be largely offset by directionally opposite changes in the cost of the electricity and gas purchased. In accordance with provisions approved by state regulators, the Utilities generally recover from customers the costs they incur for energy pur- chased for their customers, including gains and losses on cer- tain derivative instruments used to hedge energy purchased and related costs. See “Recoverable Energy Costs” in Note A to the financial statements. Con Edison’s unregulated subsidiaries use a value-at-risk (VaR) model to assess the market risk of their electricity and gas commodity fixed price purchase and sales commitments, physical forward contracts and commodity derivative instru- ments. VaR represents the potential change in fair value of instruments or the portfolio due to changes in market factors, for a specified time period and confidence level. The unregulat- ed subsidiaries estimate VaR across their electricity and natural gas commodity businesses using a delta-normal variance/covariance model with a 95 percent confidence level. Since the VaR calculation involves complex methodologies and estimates and assumptions that are based on past experience, it is not necessarily indicative of future results. VaR for transac- tions associated with hedges on generating assets and com- modity contracts, assuming a one-day holding period, for the years ended December 31, 2003, and 2002, respectively, was as follows: <img src='content_image/7081.jpg'> ## Cr edit Risk The Companies are exposed to credit risk related to over-the- counter transactions entered into primarily for the various ener- gy supply and hedging activities by the Utilities and the unregu- lated energy subsidiaries. Credit risk relates to the loss that may result from a counterparty’s nonperformance. The Companies use credit policies to manage this risk, including an established credit approval process, monitoring of counterparty limits, master netting agreements and collateral or prepayment arrangements. The Companies measure credit risk exposure as the replacement cost for open energy commodity and deriv- ative positions plus amounts owed from counterparties for set- tled transactions. The replacement cost of open positions rep- resents unrealized gains, net of any unrealized losses where the company has a legally enforceable right of setoff. Con Edison’s unregulated energy subsidiaries had $71 million of credit exposure, net of collateral and reserves, at December 31, 2003, of which $63 million was with investment grade counterparties and $8 million was with the New York Mercantile Exchange or independent system operators.

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## Investment Risk The Companies’ investment risk relates to the investment of the assets of their pension and other post retirement benefit plans. See “Application of Critical Accounting Policies - Accounting for Pensions and Other Post-Retirement Benefits,” above. The Companies’ current investment policy for pension plan assets includes investment targets of 65 percent equities and 35 percent fixed income and other securities. At December 31, 2003, the pension plan investments consisted of 64 per- cent equity and 36 percent fixed income and other securities. See Note E to the financial statements. ## Energy Trading Activities Unregulated subsidiaries of Con Edison engage in energy trad- ing activities that are accounted for in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. See Note P to the financial state- ments. Prior to October 2002, these contracts were accounted for under Emerging Issues Task Force (EITF) Issue No. 98-10, “Accounting for Contracts Involved in Energy Trading and Risk Management Activities.” As of October 2002, energy and energy-related trading contracts that meet the definition of a derivative are accounted for under SFAS No. 133. Such con- tracts are marked to market with gains and losses recognized in earnings. For the years ended December 31, 2003 and 2002, Con Edison recognized in income net unrealized pre-tax losses of $3 million and $1 million, respectively, excluding the effect of a cumulative adjustment due to a change in account- ing principle. Contracts that did not fall within the scope of SFAS No. 133 were included in the cumulative effect of a change in accounting principle recognized in December 2002. See Note P to the financial statements. The changes in fair value of energy trading net assets for the years ended December 31, 2003 and 2002 were as follows: <img src='content_image/85279.jpg'> As of December 31, 2003, the sources of fair value of the energy trading net assets were as follows: <img src='content_image/85278.jpg'> “Prices provided by external sources” represent the fair value of exchange-traded futures and options and the fair value of posi- tions for which price quotations are available through or derived from brokers or other market sources. “Prices based on models and other valuation methods” repre- sent the fair value of positions calculated using internal models when directly and indirectly quoted external prices or prices derived from external sources are not available. Internal models incorporate the use of options pricing and estimates of the present value of cash flows based on underlying contractual terms. The models reflect management’s estimates, taking into account observable market prices, estimated market prices in the absence of quoted market prices, the risk-free market dis- count rate, volatility factors, estimated correlations of energy commodity prices and contractual volumes. Counterparty spe- cific credit quality, market price uncertainty and other risks are also factored into the models. ## Environmental Matters For information concerning potential liabilities arising from laws and regulations protecting the environment and from claims relating to alleged exposure to asbestos, see Note G to the financial statements. ## Impact of Inflation The Companies are affected by the decline in the purchasing power of the dollar caused by inflation. Regulation permits the Utilities to recover through depreciation only the historical cost of their plant assets even though in an inflationary economy the cost to replace the asset upon their retirement will substantially exceed historical costs. The impact is, however, partially offset by the repayment of the Companies’ long-term debt in dollars of lesser value than the dollars originally borrowed. Also, to the extent the Companies’ prices change by more or less than inflation, the real price of the Companies’ services will increase or decline. Over the past 20 years, for example, the real price of electric service has declined substantially. ## Material Contingencies For information concerning potential liabilities arising from the Companies’ material contingencies, see “Application of Critical Accounting Policies - Accounting for Contingencies,” above.

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## Results of Operations Year Ended December 31, 2003 Compared with Year Ended December 31, 2002 The Companies’ results of operations (which wer discussed above under “Results of Operations – Summary”) in 2003 compared with 2002 were: Con Edison <img src='content_image/45965.jpg'> * Represents the consolidated financial results of Con Edison and its subsidiaries. A discussion of the results of operations by principal business segment follows. For additional business segment financial infor- mation, see Note O to the financial statements. The results reflect the application of the Companies’ accounting policies and rate plans that cover the rates the Utilities can charge their customers. In general, the Utilities recover on a curre nt basis the fuel and purchased power costs they incur in sup- plying energy to their full-service customers. See “Recoverable Energy Costs” in Note A and “Regulatory Matters” in Note B to the financial statements.

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## Con Edison of New York ## Electric Con Edison of New York’s electric operating revenues increased $559 million in 2003 compared with 2002, due pri- marily to higher fuel and purchased power costs of $503 million (which are recoverable from customers), and a lower amount reserved for earnings in excess of a specified rate of return to be retained for customer benefit ($31 million). Changes to operating revenues also reflect variations in electric sales. Con Edison of New York’s electric sales and deliveries, exclud- ing off-system sales, in 2003 compared with 2002 were: <img src='content_image/40955.jpg'> Electric delivery volumes in Con Edison of New York’s service area decreased 0.4 percent in 2003 compared with 2002. The decrease in delivery volumes reflects the cool weather in the second quarter of 2003 and the lower than normal number of hot days during the summer of 2003 compared with an excep- tionally warm summer in 2002, partially offset by the cold win- ter weather in 2003 compared with the mild winter in 2002. After adjusting for variations, principally weather and billing days in each period and the August 2003 regional power out- age, electric delivery volumes in Con Edison of New York’s service area increased 0.6 percent in 2003 compared with 2002. Weather-adjusted sales represent an estimate of the sales that would have been made if historical average weather conditions had prevailed. Con Edison of New York’s electric purchased power costs increased $477 million in 2003 as compared with 2002, due to an increase in the average unit price of purchased power. This increase was offset in part by lower usage by the company’s full service customers and higher volumes of electricity pur- chased from other suppliers by participants in the company’s retail access programs. Electric fuel costs increased $26 mil- lion, reflecting an increase in the average unit price of fuel. Con Edison of New York’s electric operating income decreased $1 million in 2003 compared with 2002. The principal compo- nent of the decrease was an increase in other operations and maintenance expense ($41 million – due primarily to a reduced net credit for pensions and other postretirement benefits), prop- erty taxes ($17 million) and depreciation ($16 million). The increase in expenses was offset in part by higher net revenues (operating revenues less purchased power and fuel costs - $56 million), lower state and local revenue taxes ($7 million), sales and use tax ($5 million) and payroll taxes ($3 million). ## Gas Con Edison of New York’s gas operating revenues in 2003 increased $250 million compared with 2002, due primarily to the higher cost of purchased gas of $244 million (which is recoverable from customers), and higher sales volumes. Con Edison of New York’s revenues from gas sales are subject to a weather normalization clause that moderates, but does not eliminate, the effect of weather-related changes on net income. Con Edison of New York’s gas sales and deliveries, excluding off-system sales, in 2003 compared with 2002 were: <img src='content_image/40960.jpg'> Con Edison of New York’s sales and transportation volumes for firm customers increased 13.8 percent in 2003 compared with 2002. The increase reflects the impact of the cold weather in the 2003 winter period compared with the mild weather in the 2002 winter period and increased new business. After adjust- ing for variations, principally weather and billing days in each period and the August 2003 regional power outage, firm gas sales and transportation volumes in the company’s service area increased 3.6 percent in 2003.

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In the fourth quarter of 2003, we filed rate requests for Con Edison of New York’s gas and steam businesses. We expect to submit an electric rate request in the spring of 2004. We are communicating and working with all stakeholders to arrive at positive outcomes to these rate proceedings. New rate plans for gas and steam will likely be implemented in the fourth quarter of 2004, while the electric rate case will not affect earnings until 2005. Our “A” level credit ratings have enabled us to take advantage of the current low interest rate environment while raising the funds necessary for our large capital program. To help maintain our capital structure, we issued a total of $477 million of new common stock in 2003, through a stock issue in the spring and our ongoing dividend reinvestment and employee stock plans. At year-end, Con Edison’s equity ratio was a solid 48 percent, making our balance sheet one of the strongest in the industry. Con Edison common stock price at year-end was $43.01, an increase of 0.4 percent for the year. Total 2003 return for our shar eholders, including reinvestment of dividends, was 6.1 percent. Although the average total return for shareholders of the electric industry and the equity markets in general was higher in 2003, those increases reflectedto a great extent recovery in the stock prices of com- panies that suffered major losses in the previous two years. Over the three-year period 2001 through 2003, Con Edison shar eholders’ total return was 31.7 percent, while the S&P Electric Utilities Index r eturned a neg- ative 12.3 percent and the S&P 500 Index returned a negative 11.7 percent. ## Looking Ahead Our strategy for the future is straight- forward. We continue to focus on the basics of our core business while preparing for the future. In recent years, we’ve experienced events and trends that were beyond our control, ranging fr om terrorist attacks to weather extr emes to unex- pected developments in the economy. We deal with such challenges by focusing on the aspects of the bus- iness we can control while maintaining the resources and capabilities to respond to unforeseen developments. And we work closely with all stake- holders — customers, regulators, community leaders, and elected officials — to encourage the develop- ment of policies and practices that will lead to a stronger energy infra- structure for New York, the region, and the nation. Our strategic concentration on several key areas will enable us to build a brighter future — for Con Edison, and for the region we serve. First, we will continue to invest for growth. Many indicators point to an improving economy in our service area. In 2003, for example, the number of permits for new housing units in the city rose to the highest level in 30 years. New residents are buying more appliances, home entertainment centers, computers, and other devices that run on electricity than ever before. Page 2, Left: In 2003, Orange & Rockland invested more than $46 million in its electric transmission and distribution systems. Center: In the home and workplace, customers are using more and more electronic devices. Right: A number of newly completed, large residential and commercial buildings are increasing the demand for energy. Page 3, Left: Many new commercial building projects are underway in the region Con Edison serves. Center: Today, everyone uses incr easing amounts of energy. Right: Through investments in infrastructure, Con Edison is meeting the increasing demand for energy. <img src='content_image/105032.jpg'> <img src='content_image/105033.jpg'> <img src='content_image/105034.jpg'>

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Non-firm transportation of customer-owned gas to NYPA and electric generating plants decreased 34.8 percent in 2003 as compared with 2002 due to higher gas prices. In 2003, because of the relative prices of gas and fuel oil, electric generating plants in the company’s gas service area utilized oil rather than gas for a significant portion of their generation. The decline in gas usage had minimal impact on earnings due to the application of a fixed demand charge for local transportation. Con Edison of New York’s purchased gas cost increased $244 million in 2003 compared with 2002, due to higher unit costs and increased sales volumes for firm sales customers. Con Edison of New York’s gas operating income decreased $10 million in 2003 compared with 2002, reflecting primarily an increase in other operations and maintenance expense ($4 million – due primarily to a reduced net credit for pensions and other postretirement benefits), depreciation ($4 million), state and local taxes on revenues ($5 million) and income tax ($4 million). The increases in expenses were offset in part by higher net revenues (operating revenues less gas purchased for resale - $7 million). ## Steam Con Edison of New York’s steam operating revenues increased $133 million and steam operating income decreased $1 million in 2003 compared with 2002. The higher revenues reflect high- er sales volumes due to the cold winter weather in 2003 as compared with the mild weather in 2002. The increase also includes higher fuel and purchased power costs ($124 million) in 2003 compared with 2002. The decrease in steam operating income reflects primarily higher income taxes ($10 million – due to higher taxable income and a lower level of removal costs in 2003) and operations and maintenance expense ($3 million – due to a reduced net credit for pensions and other postretire- ment benefits) offset in part by an increase in net revenues (operating revenues less fuel and purchased power costs) of $9 million and lower state and local taxes on steam revenues ($4 million). Con Edison of New York’s steam sales and deliveries in 2003 compared with 2002 were: <img src='content_image/105735.jpg'> ## Millions of Pounds Steam sales volumes increased 7.1 percent in 2003 compared with 2002, reflecting the impact of the cold weather in the 2003 winter period compared with the mild weather in the 2002 winter period. After adjusting for variations, principally weather and billing days in each period and the August 2003 regional power outage, steam sales increased 0.9 percent. ## Taxes Other Than Income Taxes At $1 billion, taxes other than income taxes remain one of Con Edison of New York’s largest operating expenses. The principal components of, and variations in, taxes, other than income taxes were: <img src='content_image/105736.jpg'> (a) Including sales tax on customers’ bills, total taxes other than income taxes billed to (a) customers in 2003 and 2002 were $1,393 and $1,352 million, respectively. Effective January 2003, New York City increased Con Edison of New York’s annual property taxes by $94 million. Under the company’s rate agreements, the company is deferring most of the property tax increase as a regulatory asset to be recovered fr om customers. ## Other Income Other income (deductions) decreased $19 million in 2003 compared with 2002, reflecting $27 million of interest income on a federal income tax refund claim recorded in 2002, partially offset by an increase in income tax expense in 2003 as a result of the recognition in 2002 of income tax benefits relating to the September 2001 sale of the company’s nuclear generating unit. ## Net Interest Charges Net interest charges decreased $16 million in 2003 compared with 2002 due primarily to the interest expense associated with a net federal income tax deficiency related to a prior period audit ($19 million) recorded in 2002.

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## Income Taxes Operating income taxes increased $18 million in 2003 com- pared with 2002, primarily as a result of less flow-through (non- deferred) depreciation for tax purposes. In addition, lower oper- ating income taxes in 2002 reflected a tax benefit from an Internal Revenue Service audit for tax years 1995 through 1997 and a write-off of excess deferred tax reserves. ## O&R ## Electric Electric operating revenues increased $54 million in 2003 compared with 2002. The increase is due primarily to higher purchased power costs in 2003 and accounting for the 2003 O&R electric rate agreement and the NJBPU ruling on the RECO rate petitions. O&R’s electric sales and deliveries, excluding off-system sales, in 2003 compared with 2002 were: <img src='content_image/120996.jpg'> Electric delivery volumes in O&R’s service area increased 1.0 percent in 2003 compared with 2002 due to the growth in the number of customers, higher average customer usage, and the positive effect of the cooler-than-normal weather in the first quarter of 2003, partially offset by negative impact of weather on the last nine months of 2003. After adjusting for weather variations and the August 2003 regional power outage, electric delivery volumes in O&R’s service area increased 2.5 percent in 2003. O&R’s purchased power cost increased $31 million in 2003 as compared with 2002 due to an increase in the average unit cost and the regulatory actions referenced above. This increase was offset by lower energy usage by the company’s full-service customers and higher volumes of electricity purchased from other suppliers by participants in O&R’s retail access program. O&R’s electric operating income decreased $6 million in 2003 as compared with 2002 due primarily to the referenced regula- tory actions. ## Gas O&R’s gas operating revenues increased $38 million in 2003 compared with 2002. The increase is due primarily to higher cost of gas purchased for resale in 2003, higher firm sales and transportation volumes and the impact of the 2003 gas rate agr eement. O&R’s gas sales and deliveries, excluding off-system sales, in 2003 compared with 2002 were: <img src='content_image/121004.jpg'> O&R’s sales and transportation volumes for firm customers increased 13.9 percent in 2003 compared with 2002. The increase reflects the impact of the cold weather in the 2003 winter period compared with the mild weather in the 2002 win- ter period. Revenues from gas sales in New York are subject to a weather normalization clause that moderates, but does not eliminate, the effect of weather-related changes on net income. After adjusting for weather variations in each period and the August 2003 regional power outage, total firm sales and trans- portation volumes were 3.0 percent higher in 2003 compared with 2002. Non-firm transportation of customer-owned gas to electric gen- erating plants decreased 79.7 percent in 2003 as compared with 2002 due to higher gas prices. In 2003, because of the relative prices of gas and fuel oil, power plants in the compa- ny’s gas service area utilized oil rather than gas for a significant portion of their generation. In addition, one area power plant completed a construction project to directly connect to a gas transmission provider. The decline in gas usage had minimal impact on earnings due to the application of a fixed demand charge for local transportation. O&R’s cost of gas purchased for resale increased $31 million in 2003 as compared with 2002 due to increased sales to firm

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customers and increased gas unit costs in 2003. The increase is offset in part by increased volumes of gas purchased from other suppliers by participants in O&R’s retail access program. See “Recoverable Energy Costs” in Note A to the financial statements. Gas operating income increased $2 million in 2003 as com- pared with 2002. The increase reflects an increase in net gas revenues (operating revenues less purchased gas) of $7 million, which is due primarily to increased sales and the referenced regulatory actions. The increase in net revenues was offset in part by increased gas operations and maintenance expenses of $2 million and increased federal and state income tax of $3 million. ## Taxes Other Than Income Taxes Taxes other than income taxes decreased $2 million in 2003 compared with 2002. The principal components of, and variation, in taxes, other than income taxes were: <img src='content_image/57810.jpg'> (a) Including sales tax on customers’ bills, total taxes other than income taxes, (a) billed to customers in 2003 and 2002 were $69 and $71 million, respectively. (b) Includes a sales and use tax refund of approximately $800,000. ## Income Taxes Operating income taxes increased by $9 million in 2003 compared with 2002 due primarily to the result of less flow- through (non-deferred) depreciation for tax purposes. ## Other Income O&R’s other income (deductions) decreased $3 million in 2003 compared with 2002, due primarily to the reclassification to other income (deductions) of losses previously recognized in other comprehensive income related to investments in mar- ketable securities. ## Net Interest Charges O&R’s net interest charges decreased by $7 million in 2003 compared with 2002, due primarily to the company recording interest charges of $5 million in 2002 as a result of a change by the NJBPU in the carrying charges allowed on the compa- ny’s deferred purchased power balance in New Jersey and to lower interest on long-term debt as a result of the redemption of a $35 million, 10-year debenture in March 2003 (see “Liquidity and Capital Resources,” above). ## Unregulated Subsidiaries and Other Unregulated subsidiaries’ operating income for 2003 was $122 million lower than 2002. Operating revenues increased $292 million in 2003 compared with 2002 due primarily to higher sales from Con Edison Development’s increased generating capacity and increased retail electric sales at Con Edison Solutions. Unregulated subsidiaries’ operating expenses, excluding income taxes, increased by $502 million, reflecting principally increased fuel and purchased power costs of $260 million, impairment charges of $159 million and increased operation and maintenance expenses of $83 million. See Note H to the financial statements. The increase in operation and mainte- nance expenses was attributable to increased costs at Con Edison Development ($51 million), primarily to operate the new generation assets, Con Edison Communications’ increased operating costs reflecting expansion of the business ($23 mil- lion), and higher depreciation for additional telecommunications facilities and generating assets placed in service ($13 million), offset in part by lower operation and maintenance costs at Con Edison Solutions ($6 million). Operating income taxes decreased $88 million for 2003 as compared with 2002 reflecting primarily lower taxable income (including the tax-effect of the aforementioned impairment charges). Unregulated subsidiaries’ other income (deductions) increased $1 million and interest charges were lower by $1 million for 2003 as compared with 2002. Unregulated subsidiaries’ earnings reflect an increase of $25 million for 2003 as compared with 2002 resulting from the cumulative effect of changes in accounting principles adopted in each year. For 2003, the positive cumulative effect of changes in accounting principles of $3 million (after tax) at Con Edison Development related to mark-to-market gains applica- ble to power sales contracts at certain generating plants, par- tially offset by the impact of the financial statement consolida- tion of its Newington plant. For 2002, the cumulative effect of changes in accounting principles included charges for goodwill impairment of certain generating assets at Con Edison Development, totaling $20 million (after tax), and a charge of $2 million (after tax) at Con Edison Energy relating to the accounting for certain contracts involved in energy trading and risk management activities. Earnings attributable to Other, representing the parent compa- ny and inter-company transactions, were $9 million lower for 2003 as compared with 2002 primarily reflecting higher interest expenses.

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Year Ended December 31, 2002 Compared with Year Ended December 31, 2001 The Companies’ results of operations (which wer discussed above under “Results of Operations – Summary”) in 2002 com- pared with 2001 were: <img src='content_image/116814.jpg'> * Represents the consolidated financial results of Con Edison and its subsidiaries. A discussion of the results of operations by principal business segment follows. For additional business segment financial information, see Note O to the financial statements. The results reflect the application of the Companies’ accounting policies and rate plans that cover the rates the Utilities can charge their customers. In general, the Utilities recover on a current basis the fuel and purchased power costs they incur in supplying energy to their full-service customers. See “Recoverable Energy Costs” in Note A and “Regulatory Matters” in Note B to the financial statements.

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## Con Edison of New York ## Electric Con Edison of New York’s electric operating revenues in 2002 decreased $575 million compared with 2001, reflecting primari- ly lower fuel and purchased power costs of $227 million (dis- cussed below). The decrease also reflects the completion in March 2002 of amortizations of a previously deferred gain on the sale of divested plants and a previously deferred NYPA rev- enue increase ($43 million), a reserve established in 2002 for earnings in excess of a specified rate of return that are to be retained for customer benefit in accordance with the 2000 Electric Rate Agreement ($40 million), a reserve established in 2002 related to the sale of the company’s nuclear generating unit ($25 million), the amortization of the loss ($30 million) relat- ed to the sale of the company’s nuclear generating unit and rate reductions and other amortizations in accordance with the company’s rate agreements. The decrease in electric operating revenues was offset, in part, by an increase in electric sales revenues ($24 million) reflecting principally the hot summer weather. Con Edison of New York’s electric sales and deliveries, exclud- ing off-system sales, in 2002 compared with 2001 were: <img src='content_image/30445.jpg'> Electricity delivery volumes in Con Edison of New York’s service territory increased 1.7 percent in 2002 compared with 2001. The increase reflects the impact of the hot summer weather, offset in part by the mild winter weather in the first quarter of 2002, and the soft economy. After adjusting for variations, prin- cipally weather and billing days in each period, electricity deliv- ery volumes in the service territory increased 0.5 percent in 2002. The company’s electric purchased power costs decreased $175 million in 2002 compared with 2001, due to a decrease in the price of purchased power and an increase in volumes of electricity purchased from other suppliers by participants in the retail access programs. This decrease was offset in part by the company’s increased purchased volumes resulting from the sale of the company’s nuclear generating unit in September 2001 and the hot summer weather in 2002. Fuel costs decreased $52 million as a result of decreased generation at company-owned power plants. In general, the company recovers prudently incurred fuel and purchased power costs pursuant to rate provisions approved by the PSC. The company’s electric operating income decreased $93 mil- lion in 2002 compared with 2001. The principal component of the decrease was lower net electric revenues (operating rev- enues less fuel and purchased power costs) of $348 million. The decrease in net electric revenues reflects the sale of the nuclear generation unit and the same factors (other than lower fuel and purchased power costs) as discussed above with respect to the decrease in electric operating income. The decrease in net electric revenues was offset in part by reduced other operations and maintenance expenses ($137 million) reflecting nuclear production expenses incurred in 2001 but not in 2002, and productivity improvements, lower depreciation and amortization expense ($32 million) and lower revenue taxes ($26 million). The decrease is also offset by lower operat- ing income tax of $62 million. ## Gas Con Edison of New York’s gas operating revenues decreased $223 million, resulting primarily from the lower cost of pur- chased gas ($194 million) in 2002 compared with 2001. The lower cost of purchased gas reflects primarily lower unit costs. The lower revenues also reflect reduced sales volumes, result- ing primarily from the mild winter weather in the first quarter of 2002, and revenue reductions implemented in accordance with the gas rate agreement approved by the PSC in April 2002. Gas operating income decreased $8 million in 2002, reflecting a $29 million decrease in net revenues (operating revenues less gas purchased for resale), and increased property tax expense ($10 million), offset in part by reduced operations and mainte- nance expenses ($16 million), reduced revenue taxes ($10 mil- lion) and lower income taxes ($9 million).

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Con Edison of New York’s gas sales and deliveries, excluding off-system sales, in 2002 compared with 2001 were: <img src='content_image/55151.jpg'> Con Edison of New York’s sales and transportation volumes for firm customers decreased 3.5 percent in 2002 compared with 2001. Revenues from gas sales in New York are subject to a weather normalization clause that moderates, but does not eliminate, the effect of weather-related changes on net income. After adjusting for variations, principally weather and billing days in each period, firm gas sales and transportation volumes in the company’s service territory decreased 1.5 per- cent in the 2002. The company’s gas sales and transportation volumes vary seasonally in response to weather and peak in the winter. A weather-normalization provision that applies to the compa- ny’s gas business moderates, but does not completely elimi- nate, the effect of weather-related changes on gas operating income. ## Steam Con Edison of New York’s steam operating revenues decreased $100 million. The lower revenues reflect reduced sales volumes and lower fuel and purchased power costs pri- marily as a result of the loss of the World Trade Center as a customer, the mild winter weather in the first quarter of 2002 and the soft economy. The lower fuel and purchased power costs reflect primarily lower unit costs and volumes. Steam operating income increased $8 million for 2002 compared with 2001 due primarily to reduced operations and maintenance expenses of $9 million and lower income taxes of $11 million, offset in part by a decrease in net revenues (operating revenues less fuel and purchased power costs) of $11 million. Con Edison of New York’s steam sales and deliveries in 2002 compared with 2001 were: <img src='content_image/55157.jpg'> Steam sales volume decreased 3.2 percent in 2002 compared with 2001, reflecting primarily the loss of the World Trade Center as a customer, the mild winter weather in the first quarter of 2002 and the soft economy. After adjusting for variations, principally weather and billing days in each period, steam sales volume decreased 1.4 percent. ## Taxes Other Than Income Taxes The principal components of, and variations in, taxes, other than income taxes were: <img src='content_image/55161.jpg'> ## Other Income Investment income decreased $4 million in 2002 compared with 2001, due principally to reduced interest income earned on short-term cash investments in 2002 compared with 2001. For 2001, the company had more cash on hand than in 2002, primarily as a result of the sale of its nuclear generating unit. Allowance for equity funds used during construction increased $9 million in 2002 compared with 2001 primarily reflecting the East River Repowering Project. Other income increased $42 million in 2002 compared with 2001 due primarily to $27 million of interest income on a federal income tax refund claim, a $10 million write-off in 2001 of an investment in the New York Discovery Fund, a $9 million increase in interest earned on reg- ulatory assets (See “Application of Critical Accounting Policies – Accounting for Regulated Public Utilities – SFAS No. 71,” above), offset in part by reduced income of $3 million from non-utility operations. Income tax expense decreased $4 mil-

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lion in 2002 compared with 2001 due primarily to the recogni- tion of tax benefits relating to the September 2001 sale of the company’s nuclear generating unit. ## Net Interest Charges Net interest charges increased $7 million in 2002 compared with 2001. The increase reflects principally the interest expense associated with a net federal income tax deficiency related to a prior period audit ($19 million), partially offset by decreased interest expense on long-term debt of $15 million. ## Income Tax Federal income tax decreased $29 million in 2002 compared with 2001, reflecting lower income before tax and deductions related to removal costs and tax credits. In 2000, New York State implemented a tax law change that reduced or repealed certain revenue-based taxes and replaced them with a net income-based tax. State income taxes decreased $57 million in 2002 compared with 2001, reflecting lower income before tax, lowering of the tax rate and prior period adjustments. The state income tax expense is offset against the savings from the eliminated or reduced revenue taxes. Any over- or under-col- lection of these taxes is deferred for return to, or recovery from, customers. See Notes A and M to the financial statements. ## O&R ## Electric Electric operating revenues decreased $62 million in 2002 compared with 2001. This decrease was primarily the result of lower purchased power costs and tax recoveries in 2002. O&R’s electric sales and deliveries, excluding off-system sales, in 2002 compared with 2001 were: <img src='content_image/74573.jpg'> Electricity delivery volumes in 2002 increased 5.8 percent compared with 2001 due to warmer than normal summer weather, customer growth and higher average usage. After adjusting for weather variations, total electricity delivery volumes were 3.2 percent higher in 2002. Net electric revenues (operating revenues less purchased power) were $8 million higher in 2002 than in 2001. Purchased power costs decreased $70 million in 2002 com- pared with 2001, reflecting decreases in the unit cost of pur- chased power and increased volumes of electricity purchased by customers from other suppliers. Electric operating income increased $8 million in 2002 as com- pared with 2001. This increase reflects the impact of higher net electric revenues along with lower New York state and local income and revenue taxes, offset in part by higher operation and maintenance charges and depreciation costs. ## Gas Gas operating revenues decreased $39 million in 2002 as compared with 2001. This decrease was primarily the result of lower gas costs and sales to firm customers in 2002. O&R’s gas sales and deliveries, excluding off-system sales, in 2002 compared with 2001 were: <img src='content_image/74574.jpg'> O&R’s sales and transportation volumes for firm customers decreased 1.6 percent in 2002 compared with 2001. Revenues from gas sales in New York are subject to a weather normalization clause that moderates, but does not eliminate, the effect of weather-related changes on net income. After adjusting for weather variations in each period, total firm sales and transportation volumes were 0.3 percent lower for 2002 compar ed with 2001. Net gas revenues (operating revenues less purchased gas) were $1 million higher in 2002 due primarily to incentives earned from interruptible and off-system gas sales. The cost of gas purchased for resale was $40 million less in 2002 than in 2001, reflecting lower sales volumes and unit costs.

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Decreased gas revenues also reflect the reduced requirement for the company to buy gas for resale because of an increase in the purchase of gas by customers from other suppliers. Gas operating income increased by $1 million in 2002 com- pared with 2001, due primarily to higher net revenues and lower operations and maintenance expenses, offset in part by lower late payment charge revenues and higher depreciation. ## Other Operations and Maintenance Other operations and maintenance expense increased $2 mil- lion in 2002 compared with 2001. The increase was attributa- ble primarily to higher electric transmission and distribution expenditures, partially offset by lower customer bad debt and collections expense. ## Taxes Other Than Income Taxes Taxes other than income taxes decreased by $2 million in 2002 compared with 2001. The decrease was primarily the result of lower New York State revenue taxes of $3 million, which resulted from reduced tax rates and lower energy costs billed to customers. Partially offsetting this decrease were higher property taxes of $1 million. The principal components of, and variations in, taxes, other than income taxes were: <img src='content_image/85609.jpg'> (a) Including sales tax on customers’ bills, total taxes other than income taxes, billed to (a) customers in 2002 and 2001 were $71 and $66 million, respectively. ## Net Interest Charges Interest charges increased by $4 million in 2002 compared with 2001, primarily as a result of a change by the NJBPU in the carrying charges allowed on O&R’s deferred purchased power balance in New Jersey ($5 million) and lower allowance for borrowed funds used during construction ($1 million). These expenses were offset in part by lower net financing costs of $1 million that resulted from lower average debt balances and interest rates in 2002. ## Income Taxes Income taxes decreased by $1 million in 2002 compared with 2001, reflecting primarily lower state income taxes. State income taxes decreased primarily as a result of a 0.5 percent reduction in the New York State tax rate. Excluding certain taxes in New York that are reconciled to amounts included in rates, income taxes increased by $2 million due primarily to higher operating income in 2002. ## Unregulated Subsidiaries and Other Earnings for the unregulated subsidiaries decreased $14 million in 2002 compared with 2001, reflecting a non-cash, after-tax charge in 2002 of $22 million for changes in accounting princi- ples (see Notes L, P and T to the financial statements) and continued start-up losses in the company’s wholesale telecom- munications business, including a non-cash, after-tax charge in 2002 of $5 million for a write-down of an investment in Neon Communications, Inc. (NEON). The decrease in earnings was offset, in part, by higher electric retail sales volumes and gross margins, the capitalization of previously expensed project development costs on generation assets ($4 million after tax) and unrealized mark-to-market gains on derivative instruments ($7 million after tax).

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## Report of the Company The consolidated financial statements have been prepared by the management of Consolidated Edison, Inc. (Con Edison). In Con Edison’s opinion, such statements are in conformity with accounting principles generally accepted in the United States of America. The statements reflect judgments and estimates made in the application of such principles. Management also prepared the other information in the annual report and is responsible for its accuracy and consistency with the consoli- dated financial statements. In the opinion of management, the consolidated financial statements fairly reflect Con Edison’s financial position, results of operations and cash flows. The integrity of Con Edison’s financial records, from which the consolidated financial statements are prepared, is largely dependent upon Con Edison’s system of internal accounting controls. Based upon continued monitoring of such controls, Con Edison believes it provides reasonable assurance that transactions are executed in accordance with management’s authorization and are properly recorded and that assets are appropriately safeguarded against loss from unauthorized use. Con Edison’s Board of Directors maintains an Audit Committee composed of outside independent Directors. The Audit Committee meets with Con Edison’s management, the internal auditors and the independent accountants several times a year to discuss internal accounting controls, financial reporting mat- ters, Con Edison’s consolidated financial statements and the scope and results of the audit by the independent accountants and of the audit programs of the internal auditors. The inde- pendent accountants and internal auditors have direct access to the Audit Committee and periodically meet with it without management representatives present. The consolidated financial statements have been audited by PricewaterhouseCoopers LLP, Con Edison’s independent accountants, in accordance with auditing standards generally accepted in the United States of America. February 19, 2004 ## Report of Independent Auditors <img src='content_image/50031.jpg'> To the Shareholders and Board of Directors of Consolidated Edison, Inc.: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of compre- hensive income, of common shareholders’ equity, of cash flows and of capitalization present fairly, in all material respects, the financial position of Consolidated Edison, Inc. and its sub- sidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. 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 audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement pr esentation. We believe that our audits provide a reasonable basis for our opinion. <img src='content_image/50030.jpg'> New York, NY February 19, 2004

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## Consolidated Balance Sheet Consolidated Edison, Inc. <img src='content_image/89231.jpg'> The accompanying notes are an integral part of these financial statements.

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The commercial sector has begun to turn around as well. And in the past several months, New York City has seen an upsurge in tourism. In addition to our major capital pro- grams, we will continue our advanced research and development programs. Over the years, we’ve created tools and processes that enable us to work more effectively and efficiently. We have also developed sophisticated analytic techniques that help us manage the system more safely and that permit us to get the most value out of every dollar we invest. Second, we will continue to manage the company’s finances in a disciplined manner, focusing on the long term. Our straightforward financial state- ments and disclosures help us maintain the confidence of investors and the financial markets. Our strong financial track record is critical to our ability to access the capital markets on favorable terms — something that’s particularly important in light of our investment needs. Third, we will continue to invest in our most important resource: our people. Our ability to deliver the energy that makes the region strong depends on the outstanding efforts and dedication of our team. The commitment and pro- fessionalism of Con Edison’s employ- ees was most evident during the regional power outage of August 14. Working in coordination with utility industry counterparts and state and local government agencies, we restored service safely — without injury to the public or to company personnel, and without significant damage to equipment. decade ago we made an important investment in the futur e when we built The Learning Center The innovative and comprehensive pr ograms offered ther enable our men and women to continually upgrade their skills in an era of rapidly changing technology, and to enhance their ability to plan and manage for the future. Fourth, we will communicate the importance of investment in infrastruc- ture to the general public, the media and government of ficials. The August power outage again dr ove home the fact that a strong energy infrastructure is vital to the overall fabric of our lives. We have been working with local, state, and federal government officials to improve the nation’ s energy security. We have shared with industry counter- parts and government officials our insights and experience on crucial issues, including the benefits of industry planning and improved communications across regions, the advantages of siting new generating plants near load centers, and the critical need for mandatory reliability standards. We are actively working with all stakeholders to encourage new power generating facilities in our region, and to make sure that our transmission system can accommodate the power when it becomes available. Finally, we are working with regulators and others to ensure that we will have the financial strength and flexibility necessary to continue our investment program. In October 2003, the New York State Public Service Commission approved new three-year agreements with Orange and Rockland Utilities that provide customers with predictable gas and electric delivery rates, and provide the company with the ability to earn a fair return for shareholders. Con Edison of New York’s 2003 gas and steam rate filings and the anticipated electric rate filing in the spring of 2004 support rate levels that will enable us to continue our <img src='content_image/63293.jpg'>

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## Consolidated Balance Sheet Consolidated Edison, Inc. <img src='content_image/84303.jpg'>

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<img src='content_image/43802.jpg'> The accompanying notes are an integral part of these financial statements.