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## Restatement of Historical Financial Statements We restated our previously issued financial statements for the fis- cal years ended October 31, 1999, 2000, 2001 and 2002, the interim quarters of 2002 and the first three quarters of 2003 to reflect our revised revenue recognition policy. Under this policy, we recognize as a reduction of net sales a reserve for estimated future price conces- sions in the period in which the sale is recorded. Measurement of the reserve is based on, among other factors, an historical analysis of price concessions, an assessment of field inventory levels and sell- through for each product, current industry conditions and other factors affecting the estimated timing and amount of concessions manage- ment believes will be granted. We previously recognized price con- cession reserves in the period in which we communicated the price concessions to our customers. We also restated our financial state- ments for the fiscal years ended October 31, 2000 and 2001 to increase our provision for returns at October 31, 2000 by approxi- mately $4.9 million for certain sales transactions primarily to retail cus- tomers in fiscal 2000, and to reflect the fiscal 2001 returns as a reduc- tion of the revised October 31, 2000 reserve for returns rather than the previously reported reduction of sales in fiscal 2001. Additionally, fiscal 2000 and 2001 revenues were restated for approximately $0.2 million to adjust for sales cut-off transactions at the end of fiscal 2000. See Notes 2 and 19 to Consolidated Financial Statements for details relating to the restatement. Our 2002 financial statements have been restated as follows: <img src='content_image/64231.jpg'> <img src='content_image/64229.jpg'> All applicable amounts relating to the aforementioned restatements have been reflected in these consolidated financial statements and notes thereto. Our Consolidated Statement of Operations for the year ended October 31, 2001 has been restated as follows: <img src='content_image/64230.jpg'> * As required by Statement of Financial Accounting Standards No. 145, “Rescis- sion of FASB Statements No. 4, 44 and 64, Amendment to FASB Statement No. 13, and Technical Corrections”, the $1,948 net loss on extinguishment of debt for the year ended October 31, 2001, previously classified as an extraor- dinary item, has been reclassified in the As Reported column as follows: $3,165 of loss on extinguishment to non-operating expenses and $1,217 of tax benefit to benefit for income taxes in the above table. ## Overview We are a leading global publisher of interactive software games designed for personal computers, video game consoles and handheld platforms manufactured by Sony, Microsoft and Nintendo. We also distribute our products as well as third-party products, hardware and accessories to retail outlets in North America through our Jack of All Games subsidiary, and we have sales, marketing and publishing oper- ations in the United Kingdom, France, Germany, Holland, Austria, Italy, Australia, New Zealand and Canada.

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Our principal sources of revenue are derived from publishing and distribution operations. Publishing revenues are derived from the sale of internally developed software titles or software titles licensed from third parties. Operating margins in our publishing business are dependent upon our ability to continually release new, commercially successful products. We develop most of our front-line products inter- nally, and we own all of our major intellectual properties, which we believe permits us to maximize profitability. Our distribution revenues are derived from the sale of third-party software titles, accessories and hardware. Operating margins in our distribution business are dependent on the mix of software and hard- ware sales, with software generating higher margins than hardware. Publishing activities generate significantly higher margins than distribu- tion activities, with sales of PC software titles resulting in higher margins than sales of products designed for video game consoles. We have pursued a growth strategy by capitalizing on the wide- spread market acceptance of video game consoles and the growing popularity of innovative gaming experiences that appeal to more mature audiences. We have established a portfolio of successful pro- prietary software content, including our premier brands: Grand Theft Auto, Max Payne and Midnight Club , for the major hardware plat- forms. We expect to continue to be the leader in the mature, action product category by leveraging our existing franchises and develop- ing new brands, such as Manhunt . We currently anticipate that the release of new brands in fiscal 2004, including The Warriors and Red Dead Revolver , along with the launch of the next installment of Grand Theft Auto , will generate sig- nificant cash flow from our publishing business. We also believe that we will be able to continue to grow our distribution business through a combination of our retail relationships and our value product offer- ings. Historically, each generation of video game consoles and hand- held platforms experiences a gradual decrease in retail pricing over the life of the system, with retail pricing for software titles following a similar trend. The PlayStation 2 and Xbox were introduced several years ago, and have been reduced in price since their launch, with additional price reductions anticipated to occur in 2004. Reduced pricing for our titles could result in lower margins for our published products and reduced growth rates in our publishing business. However, as retail prices for interactive entertainment hardware and software decline, our distribution business benefits from the wider availability of higher margin, value priced software titles. ## Estimates The preparation of financial statements in conformity with general- ly accepted accounting principles requires management to make esti- mates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net sales and expenses during the reporting periods. The most significant estimates and assumptions relate to the recoverability of prepaid roy- alties, capitalized software development costs and other intangibles, ## Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) ## TAKE-TWO INTERACTIVE SOFTWARE, INC. AND SUBSIDIARIES (Dollars in thousands, except per share amounts) inventories, realization of deferred income taxes and the adequacy of allowances for returns, price concessions and doubtful accounts. Actual amounts could differ significantly from these estimates. ## Revenue Recognition We recognize revenue upon the transfer of title and risk of loss to our customers. We apply the provisions of Statement of Position 97-2, “Software Revenue Recognition” in conjunction with the applicable provisions of Staff Accounting Bulletin No. 101, “Revenue Recogni- tion.” Accordingly, we recognize revenue for software when (1) there is persuasive evidence that an arrangement with our customer exists, which is generally a customer purchase order, (2) the software is deliv- ered, (3) the selling price is fixed or determinable and (4) collection of the customer receivable is deemed probable. Our payment arrange- ments with customers typically provide net 30- and 60-day terms. Revenue is recognized after deducting estimated reserves for returns and price concessions. In specific circumstances when we do not have a reliable basis to estimate returns and price concessions or are unable to determine that collection of receivables is probable, we defer the sale until such time as we can reliably estimate any related returns and allowances and determine that collection of the receiv- ables is probable. ## Allowances for Returns and Price Concessions We accept returns and grant price concessions in connection with our publishing arrangements. Following reductions in the price of our products, we grant price concessions to permit customers to take credits against amounts they owe us with respect to merchandise unsold by them. Our customers must satisfy certain conditions to entitle them to return products or receive price concessions, including compliance with applicable payment terms and confirmation of field inventory levels. Our distribution arrangements with customers do not give them the right to return titles or to cancel firm orders. However, we some- times accept returns from our distribution customers for stock balanc- ing and make accommodations to customers, which include credits and returns, when demand for specific titles falls below expectations. We make estimates of future product returns and price conces- sions related to current period product revenue. We estimate the amount of future returns and price concessions for published titles based upon, among other factors, historical experience, customer inventory levels, analysis of sell-through rates and changes in demand and acceptance of our products by consumers. Significant management judgments and estimates must be made and used in connection with establishing the allowance for returns and price concessions in any accounting period. We believe we can make reliable estimates of returns and price concessions. However, actual results may differ from initial estimates as a result of changes in circumstances, market conditions and assumptions. Adjustments to estimates are recorded in the period in which they become known.

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## Prepaid Royalties Our agreements with licensors and developers generally provide us with exclusive publishing rights and require us to make advance royalty payments that are recouped against royalties due to the licensor or developer based on product sales. Prepaid royalties are amortized as cost of sales on a title-by-title basis, based on the greater of the proportion of current year sales to total of current and estimated future sales for that title or the contractual royalty rate based on actual net product sales. We continually evaluate the recov- erability of prepaid royalties and charge to cost of sales the amount that management determines is probable that will not be recouped at the contractual royalty rate in the period in which such determination is made or if we determine that we will cancel a development project. Prepaid royalties are classified as current and non-current assets based upon estimated net product sales within the next year. See Note 3 to Consolidated Financial Statements. ## Capitalized Software Development Costs We capitalize internal software development costs subsequent to establishing technological feasibility of a title. Capitalized software development costs represent the costs associated with the internal development of our publishing products. Amortization of such costs as a component of cost of sales is recorded on a title-by-title basis, based on the greater of the proportion of current year sales to total of current and estimated future sales for the title or the straight-line method over the remaining estimated useful life of the title. We con- tinually evaluate the recoverability of capitalized software costs and will charge to cost of sales any amounts that are deemed unrecover- able or for projects that we will abandon. See Note 3 to Consolidated Financial Statements. ## Income Taxes Income tax assets and liabilities are determined by taxable jurisdic- tion. We do not provide taxes on undistributed earnings of our interna- tional subsidiaries. The total amount of undistributed earnings of foreign subsidiaries was approximately $60,700 and $41,900 for the years ended October 31, 2003 and 2002, respectively. It is our intention to reinvest undistributed earnings of our foreign subsidiaries and thereby indefinitely postpone their remittance. Accordingly, no provision has been made for foreign withholding taxes or United States income taxes which may become payable if undistributed earnings of foreign sub- sidiaries are paid as dividends to us. The realization of deferred tax assets depends on whether the Company generates future taxable income of the appropriate type. In addition, we may adopt tax planning strategies to realize these assets. If future taxable income does not materialize or tax planning strategies are not effective, we may be required to record a valuation allowance. ## Recently Adopted Accounting Pronouncements In August 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 143, “Accounting for Obligations Associated with the Retirement of Long- Lived Assets” (“SFAS 143”). The objective of SFAS 143 is to provide accounting guidance for legal obligations associated with the retire- ment of long-lived assets. The provisions of SFAS 143 are effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of SFAS 143 in fiscal 2003 did not have an impact on our financial condition, cash flows and results of operations. In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment to FASB Statement No. 13, and Technical Corrections” (“SFAS 145”). SFAS 145 eliminates the requirement (in SFAS No. 4) that gains and losses from the extinguishments of debt be aggregated and classified as extraordinary items, net of the related income tax. As a result of the adoption of this pronouncement, the $1,948 net loss on extinguishment of debt for the year ended October 31, 2001 clas- sified as an extraordinary item was reclassified as follows: $3,165 of loss on extinguishment to non-operating expenses and $1,217 of tax benefit to provision for income taxes. The adoption of SFAS 145 in fiscal 2003 did not have any impact on our financial condition, cash flows and results of operations, other than the reclassification referred to above. In January 2002, the FASB issued Statement of Financial Account- ing Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 requires the recognition of such costs when they are incurred rather than at the date of a commitment to an exit or disposal plan. The provisions of SFAS 146 are to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The adoption of SFAS 146 in the first quarter of fiscal 2003 did not have a material impact on our financial condition and results of operations. In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS 148”). SFAS 148 amends the transition provisions of FASB No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), for entities that voluntarily change to the fair value method of accounting for stock-based employee compensation. We do not currently intend to change our accounting to the fair value method. SFAS 148 also amends the disclosure provisions of SFAS 123 to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation and amends APB Opinion No. 28, “Interim Financial Reporting” to require disclosures about such effects in interim financial information. The disclosure provisions of the amendments to FASB 123 were adopted by us in the second quarter of fiscal 2003.

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In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 expands previously issued accounting guidance and disclosure requirements for certain guarantees and requires recognition of an initial liability for the fair value of an obligation assumed by issuing a guarantee. The provision for initial recognition and measurement of liability will be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 in the first quarter of fiscal 2003 did not have any impact on our financial condition or results of operations. In January 2003, the FASB issued Interpretation No. 46, “Consoli- dation of Variable Interest Entities” (“FIN 46”). FIN 46 requires a vari- able interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest enti- ty’s activities or is entitled to receive a majority of the entity’s residual return or both. FIN 46 also provides criteria for determining whether an entity is a variable interest entity subject to consolidation. FIN 46 requires immediate consolidation of variable interest entities created after January 31, 2003. For variable interest entities created prior to February 1, 2003, consolidation is required on July 1, 2003. The adop- tion of FIN 46 in the third quarter of fiscal 2003 did not have a materi- al impact on our financial condition or results of operations (see Note 4 to Consolidated Financial Statements). In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 149”). SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instru- ments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” In general, SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designat- ed after June 30, 2003. The adoption of SFAS 149 did not have any impact on our financial condition or results of operations. In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with SFAS 150, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003, except for the provisions relating to mandatorily redeemable financial instruments which have been deferred indefinitely. The adop- tion of SFAS 150 did not have any impact on our financial condition. ## Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollars in thousands, except per share amounts) ## Results of Operations The following table sets forth for the periods indicated the per- centage of net sales represented by certain items reflected in our statement of operations, and sets forth net sales by territory, sales mix, platform and principal products: <img src='content_image/85726.jpg'>

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## Business Acquisitions During fiscal 2003, we acquired the assets of Frog City, Inc. (“Frog City”), the developer of Tropico 2 : Pirate Cove , and all of the outstanding membership interests of Cat Daddy Games LLC (“Cat Daddy”), another development studio. The total purchase price for both studios consisted of $757 in cash and $319 of prepaid royalties previously advanced to Frog City. We also agreed to make additional payments of up to $2,500 to the former owners of Cat Daddy, based on a percentage of Cat Daddy’s profits for the first three years after acquisition, which will be recorded as compensation expense if the targets are met. In connection with the acquisitions, we recorded goodwill of $1,267 and net liabilities of $191. In November 2002, we acquired all of the outstanding capital stock of Angel Studios, Inc. (“Angel”), the developer of the Midnight Club and Smuggler’s Run franchises. The purchase price consisted of 235,679 shares of restricted common stock (valued at $6,557), $28,512 in cash and $5,931 (net of $801 of royalties payable to Angel) of prepaid royalties previously advanced to Angel. In connec- tion with the acquisition, we recorded identifiable intangibles of $4,720 (comprised of intellectual property of $2,810, technology of $1,600 and non-competition agreements of $310), goodwill of $37,425 and net liabilities of $1,145. In August 2002, we acquired all of the outstanding capital stock of Barking Dog Studios Ltd. (“Barking Dog”), a Canadian-based ## Fiscal Years Ended October 31, 2003 and 2002 ## Net Sales development studio. The purchase price consisted of 242,450 shares of restricted common stock (valued at $3,801), $3,000 in cash, $825 of prepaid royalties previously advanced to Barking Dog and assumed net liabilities of $70. In connection with the acquisition, we recorded identifiable intangibles of $2,200, comprised of non- competition agreements of $2,000 and intellectual property of $200, and goodwill of $6,372. In November 2000, we acquired all of the capital stock of VLM Entertainment Group Inc. (“VLM”), a third-party video game distribu- tor, for $2,000 in cash and 875,000 shares of common stock (valued at $8,039). VLM accounted for 14.5% of our distribution net sales in fiscal 2001. The acquisitions have been accounted for as purchase transactions and, accordingly, the results of operations and financial position of the acquired businesses are included in our consolidated financial statements from the respective dates of acquisition. In December 2003, we acquired all of the outstanding capital stock and paid certain liabilities of TDK Mediactive, Inc. (“TDK”). The pur- chase price of approximately $14,276 consisted of $17,116 in cash and issuance of 163,641 restricted shares of our common stock (valued at $5,160), reduced by approximately $8,000 due to TDK under a distri- bution agreement. We are in the process of completing the purchase price allocation. TDK’s results will be included in our operating results beginning in the first quarter of fiscal 2004. <img src='content_image/77023.jpg'> Net Sales. The increase in net sales was attributable to growth in our publishing and distribution operations. The increase in publishing revenues was primarily attributable to sales of Grand Theft Auto: Vice City for PlayStation 2, which was released in October 2002 in North America and in November 2002 internationally and reflected the growth of our publishing operations in Europe. We expect continued growth in our publishing business in fiscal 2004. Publishing revenues in fiscal 2003 and 2002 include licensing revenues of $25,002 and $13,873, respectively. Products designed for video game console platforms accounted for 81.2% of fiscal 2003 publishing revenues as compared to 83.9% for fiscal 2002. Products designed for PC platforms accounted for 17.2% of fiscal 2003 publishing revenues as compared to 14.3% for fiscal 2002. We anticipate our product mix will remain relatively constant for the foreseeable future but may fluctuate from period to period. Distribution revenues are derived from the sale of third-party soft- ware titles, accessories and hardware. The increase in distribution revenues was primarily attributable to our increasing market share for budget titles in North American retail channels. We expect continued growth in our distribution business in fiscal 2004, and that distribution revenues may increase as a percentage of net sales during this period. International operations accounted for approximately $288,753, or 27.9% of net sales for fiscal 2003 compared to $159,245, or 20.0% of net sales for fiscal 2002. The increases were primarily attributable to expanded publishing operations in Europe, which benefited from the November 2002 release of Grand Theft Auto: Vice City for PlayStation 2, and significantly higher average foreign exchange rates. We expect international sales to continue to account for a significant portion of our revenues.

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## Cost of Sales ## TAKE-TWO INTERACTIVE SOFTWARE, INC. AND SUBSIDIARIES Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollars in thousands, except per share amounts) <img src='content_image/87656.jpg'> Cost of Sales. The increase in product costs is primarily attributa- ble to higher costs associated with our expanded distribution opera- tions. These costs were partly offset by lower product pricing from suppliers and lower manufacturing costs (principally attributable to volume purchase discounts and rebates) and lower cost PC titles. Product costs for fiscal 2003 included a charge of $7,892 relating to the impairment of intangibles related to certain products in develop- ment, including Duke Nukem Forever and its sequel. The impairment was based on continued product development delays and our assessment of current market acceptance and projected cash flows for these products. Product costs for fiscal 2002 included $3,064 of litigation settlement costs relating to a distribution agreement. ## Operating Expenses Royalties. The increase in royalties was primarily due to expense under a royalty program based on product sales for certain of our internal development personnel, partly offset by lower royalties payable to third parties and lower write-downs and amortization of prepaid royalties. Our internal royalty program may continue to be a significant expense in future periods. Software Development Costs. Software development costs increased due to the release of a greater number of internally devel- oped titles during this period resulting in higher amortization in the current period. These software development costs relate to our internally developed titles. In future periods, cost of sales may be adversely affected by man- ufacturing and other costs, price competition and by changes in prod- uct and sales mix and distribution channels. <img src='content_image/87667.jpg'> Selling and marketing. The increase in selling and marketing expense was attributable to increased levels of advertising and pro- motional support for existing and new titles as well as higher person- nel expenses and is consistent with the growth of our business. General and administrative. The general and administrative expense increase in absolute dollars was principally attributable to costs associated with the consolidation of our distribution operations, as well as increased personnel expenses (including bonuses, severance pay- ments and the issuance of restricted stock), higher rent and bad debt expenses. Higher costs were partly offset by lower professional fees, including the reimbursement of $1,100 of legal fees from insurance proceeds in fiscal 2003 relating to costs recorded in the prior year. Fiscal 2002 costs reflected litigation settlement costs of $1,190 relating to a distribution arrangement. The fiscal 2003 net consolidation charge of $2,621 consisted of: lease termination costs, representing the fair value of remaining lease payments, net of estimated sublease rent; dis- position of fixed assets, representing the net book value of fixed assets and leasehold improvements; and other exit costs. Bad debt expense increased as a result of customer bankruptcies not covered by insur- ance during the current year. Research and development. Research and development costs increased primarily due to the acquisitions of development studios, as well as increased personnel costs. Once software development projects reach technological feasibility, which is relatively early in the development process, a substantial portion of our research and development costs are capitalized and subsequently amortized as cost of goods sold. Depreciation and amortization. Depreciation and amortization expense increase includes $4,407 related to the impairment of a cus- tomer list from a previous acquisition as a result of the consolidation of our distribution operations, higher amortization of intangible assets as a result of acquisitions and higher depreciation related to the implementation of accounting software systems. Income from Operations. Income from operations increased by $40,306, or 32.8%, to $163,011 for fiscal 2003 from $122,705 for fiscal 2002, due to the changes referred to above.

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Interest (Income) Expense, net. Interest income of $2,265 for fiscal 2003 was attributable to interest earned on the invested cash. Interest expense of $480 for fiscal 2002 reflected borrowings from our credit facilities, which were repaid in early fiscal 2002. Class Action Settlement Costs. During fiscal 2002, we recorded $1,468 of class action settlement costs, which represents a settlement of $7,500 and related legal fees, net of $6,145 of insurance proceeds. Provision for Income Taxes. Income tax expense was $67,197 for fiscal 2003 as compared to $49,375 for fiscal 2002. The increase was primarily attributable to increased taxable income. The effective tax rate was 40.6% for fiscal 2003, as compared to an effective tax rate of 40.8% for fiscal 2002. The effective income tax rate differs from the statutory rate primarily as a result of non-taxable foreign income, non- deductible expenses, valuation allowances for deferred tax assets and the mix of foreign and domestic taxes as applied to the income. The valuation allowances relate to capital loss and state net operating loss carryforwards. At October 31, 2003 and October 31, 2002, we had capital loss carryforwards totaling approximately $21,000. The capital loss carry- forwards will expire in the periods fiscal 2006 through fiscal 2008. Failure to achieve sufficient levels of taxable income from capital transactions might affect the ultimate realization of the capital loss ## Fiscal Years Ended October 31, 2002 and 2001 ## Net Sales carryforwards. At October 31, 2002, management had a strategy of selling net appreciated assets of the company, to the extent required to generate sufficient taxable income prior to the expiration of these benefits. At October 31, 2003, based on management’s future plans, this strategy was no longer viable, and accordingly a valuation allowance has been recorded for this asset. At October 31, 2003, we had foreign net operating losses of $9,800 expiring between 2005 and 2010, and state net operating losses of $41,700 expiring between 2021 and 2023. Limitations on the utilization of these losses may apply, and accordingly valuation allowances have been recorded for these assets. Net Income. Net income increased $26,555, or 37.1%, to $98,118 for fiscal 2003 from $71,563 for fiscal 2002, due to the changes referred to above. Diluted Net Income per Share. Diluted net income per share increased $0.46, or 25.4%, to $2.27 for fiscal 2003 from $1.81 for fiscal 2002. The increase in net income was partly offset by the higher weighted average shares outstanding. The increase in weighted shares outstanding resulted from the issuance of shares underlying stock options and to the acquisitions of the Max Payne intellectual property and the development studios. <img src='content_image/14042.jpg'> Net Sales. The increase in revenues was primarily attributable to growth in publishing operations. Included in net sales for fiscal 2001 was $23,846 attributable to the adoption of SAB 101. See Note 3 to Consolidated Financial Statements. The increase in publishing revenues was primarily attributable to the continued strong sales of Grand Theft Auto 3 for PlayStation 2 and the release of Grand Theft Auto: Vice City for the PlayStation 2, Max Payne for the PlayStation 2 and Xbox, State of Emergency for the PlayStation 2 and Grand Theft Auto 3 for the PC. Fiscal 2001 included $17,248 of net sales attributable to the adoption of SAB 101. Products designed for video game console platforms accounted for 83.9% of fiscal 2002 publishing revenues as compared to 57.6% for fiscal 2001. The increase was primarily attributable to continued sales of Grand Theft Auto 3 for PlayStation 2 and the release of Grand Theft Auto: Vice City for the PlayStation 2, Max Payne for PlayStation 2 and Xbox and State of Emergency for PlayStation 2. Products designed for the PC accounted for approximately 14.3% of fiscal 2002 publishing net sales as compared to 35.6% for fiscal 2001. The decrease is a result of fewer PC titles released during fiscal 2002. The increase in distribution revenues was primarily attributable to the commercial introduction of Xbox and GameCube and the contin- ued rollout of PlayStation 2 and the sale of software for these console platforms. Distribution revenue represented 28.5% and 45.9% of net sales for fiscal 2002 and 2001, respectively. Fiscal 2001 included $6,598 attributable to the adoption of SAB 101. International operations accounted for approximately $159,245, or 20.0% of net sales for fiscal 2002 compared to $106,565, or 23.6% for fiscal 2001. The increase in absolute dollars was primarily attributable to expanded publishing operations in Europe, including the release of Max Payne and State of Emergency for PlayStation 2, Grand Theft Auto 3 for the PC and continued sales of Grand Theft Auto 3 for PlayStation 2.

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## Cost of Sales ## Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) ## TAKE-TWO INTERACTIVE SOFTWARE, INC. AND SUBSIDIARIES (Dollars in thousands, except per share amounts) <img src='content_image/68467.jpg'> Cost of Sales. The decrease in product costs as a percentage of net sales was due to the higher proportion of publishing net sales which have lower product costs than distribution net sales, partly offset by the shift in publishing product mix to higher cost console titles from lower- cost PC titles. Fiscal 2002 includes $3,064 of litiga- tion settlement costs relating to a distribution agreement, while fiscal 2001 includes an impairment charge of $3,397 relating to a reduction in the value of certain acquired Internet assets. Product costs in fiscal 2001 included $15,106 related to the adoption of SAB 101. ## Operating Expenses Royalties. The increase in royalties were due to higher royalty payments and increased amortization of prepaid royalties as a result of increased product sales, principally for State of Emergency , Max Payne , Midnight Club and Smuggler’s Run . In addition, we wrote off $14,122 of prepaid royalties, principally due to the termination of several projects in 2002. We also implemented a royalty program for certain of our development personnel based on product sales. Software Development Costs. The increase in software develop- ment costs in absolute dollars reflects higher amortization principally related to the Grand Theft Auto titles. These software development costs relate to our internally developed titles. <img src='content_image/68466.jpg'> Selling and marketing. The increase in selling and marketing expense was attributable to television and other advertising expenses relating to Grand Theft Auto 3, Max Payne, Grand Theft Auto: Vice City and Conflict Desert Storm during fiscal 2002. General and administrative. The increase in general and adminis- trative expense was attributable to increased personnel expenses primarily relating to salaries of additional executive, financial, account- ing and information technology personnel and legal and professional fees incurred in connection with legal proceedings and regulatory matters as well as litigation settlement costs relating to a distribution arrangement. Research and development . The increase in research and devel- opment costs was attributable to bonus compensation, increased staffing levels and the acquisition of Barking Dog Studios. Once soft- ware development projects reach technological feasibility, which is relatively early in the development process, a substantial portion of our research and development costs are capitalized and subsequently amortized as cost of goods sold. Depreciation and amortization. The depreciation and amortiza- tion expense decrease was due to our adoption of SFAS 142, and was partly offset by increased depreciation related to the implementation of a new accounting software system and amortization related to the Max Payne acquisition. Income from Operations. Income from operations increased by $94,328, or 332.4%, to $122,705 for fiscal 2002 from $28,377 for fiscal 2001, due to the changes referred to above. Interest (Income) Expense, net. Interest expense decreased by $8,030, or 94.4%, to $480 for fiscal 2002 from $8,510 for fiscal 2001. The decrease was attributable to substantially lower levels of borrowing from our credit facilities and interest income earned on invested cash. Gain on Sale of Subsidiary. We recorded a non-operating gain of $651 on the sale of our Jack of All Games UK subsidiary during fiscal 2001. (Gain) Loss on Internet Investments. For fiscal 2002, we recog- nized a gain of $181 from the sale of marketable securities. During fiscal 2001, we incurred an impairment charge of $21,477 relating primarily to our investments in Gameplay and eUniverse to reflect other- than-temporary declines in the value of these investments.

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## Financial Highlights <img src='content_image/3262.jpg'> <img src='content_image/3256.jpg'> <img src='content_image/3255.jpg'> <img src='content_image/3254.jpg'>

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Class Action Settlement Costs. During fiscal 2002, we recorded $1,468 of class action settlement costs, which represents a settlement of $7,500 and related legal fees, net of $6,145 of insurance proceeds. Loss on Early Extinguishment of Debt. During fiscal 2001, we incurred a charge of $3,165 upon the early repayment of $15,000 of subordinated indebtedness. Provision for Income Taxes. We incurred income tax expense of $49,375 for fiscal 2002 as compared to a benefit of $2,450 for fiscal 2001. The increase was primarily attributable to increased taxable income. The difference between the statutory rate and the effective rates of 40.8% and (59.4%) for fiscal 2002 and 2001, respectively, primarily is the result of state and foreign tax rate differentials and non-deductible items, such as amortization of intangibles. Cumulative Effect of Change in Accounting Principle. In connec- tion with the adoption of SAB 101, we recognized a cumulative effect of $5,244, net of taxes of $3,496, in fiscal 2001. Net Income. For fiscal 2002, we achieved net income of $71,563, as compared to net loss of $6,918 for fiscal 2001. ## Liquidity and Capital Resources Our primary cash requirements are to fund the development and marketing of our products. We satisfy our working capital require- ments primarily through cash flow from operations. At October 31, 2003, we had working capital of $348,155 as compared to working capital of $196,555 at October 31, 2002. Our cash and cash equivalents increased $75,108 to $183,477 at October 31, 2003, from $108,369 at October 31, 2002. The increase is primarily attributable to $80,628 of cash provided by operating activities and by $44,562 provided by financing activities, partly offset by $45,881 used in investing activities. Net cash provided by operating activities for fiscal 2003 was $80,628 compared to $144,998 for fiscal 2002 and $27,319 for fiscal 2001. The decrease in fiscal 2003 was primarily attributable to cash used to finance significantly increased levels of accounts receivables and inventories, increases in prepaid expenses and software develop- ment costs, partly offset by an increase in net income, higher non-cash adjustments principally relating to the consolidation of our distribution facilities and increased tax benefit from stock options. The increase in cash provided by operating activities in fiscal 2002 was primarily attrib- utable to increased net income and our focus on working capital man- agement in both fiscal 2002 and 2001. The increase in cash provided from operations for fiscal 2002 was also attributable to increases in accounts payable and accrued expenses, partly offset by increased levels of inventories, prepaid expenses and accounts receivable. Net cash used in investing activities for fiscal 2003 was $45,881 as compared to $18,084 for fiscal 2002 and $13,479 for fiscal 2001. The increase in fiscal 2003 is primarily attributable to higher expen- ditures for the acquisition of development studios and lower pro- ceeds from sale of investments, partly offset by fewer intangible assets acquisitions. The increase in fiscal 2002 is primarily attributa- ble to the acquisition of the Max Payne intangible assets and the Barking Dog development studio and increased expenditures for fixed assets. Net cash used in investing activities for fiscal 2001 related primarily to the purchase of fixed assets and, to a lesser extent, acquisitions. Net cash provided by financing activities for fiscal 2003 was $44,562 as compared to net cash used in financing activities for fiscal 2002 of $31,988 and $11,790 for fiscal 2001. The increase in fiscal 2003 was primarily attributable to the absence of repayment of indebtedness and higher proceeds from the exercise of stock options. The increase in net cash used in financing activities for fiscal 2002 was primarily attributable to the absence of private placement proceeds in fiscal 2002 and the repayment of indebtedness. Net cash used in fis- cal 2001 related primarily to the repayment of indebtedness offset by proceeds from equity offerings and the exercise of stock options and warrants. In December 1999, we entered into a credit agreement, as amended and restated in August 2002, with a group of lenders led by Bank of America, N.A., as agent. The agreement provides for borrow- ings of up to $40,000 through the expiration of the line of credit on August 28, 2005. Generally, advances under the line of credit are based on a borrowing formula equal to 75% of eligible accounts receivable plus 35% of eligible inventory. Interest accrues on such advances at the bank’s prime rate plus 0.25% to 1.25%, or at LIBOR plus 2.25% to 2.75% depending on our consolidated leverage ratio (as defined). We are required to pay a commitment fee to the bank equal to 0.5% of the unused loan balance. Borrowings under the line of credit are collateralized by our accounts receivable, inventory, equipment, general intangibles, securities and other personal proper- ty, including the capital stock of our domestic subsidiaries. Available borrowings under the agreement are reduced by the amount of out- standing letters of credit, which were $9,290 at October 31, 2003. The loan agreement contains certain financial and other covenants, including the maintenance of consolidated net worth, consolidated leverage ratio and consolidated fixed charge coverage ratio. As of October 31, 2003, we were in compliance with such covenants. The loan agreement limits or prohibits us from declaring or paying cash dividends, merging or consolidating with another corporation, selling assets (other than in the ordinary course of business), creating liens and incurring additional indebtedness. We had no outstanding bor- rowings under the revolving line of credit as of October 31, 2003. In February 2001, our United Kingdom subsidiary entered into a credit facility agreement, as amended in March 2002, with Lloyds TSB Bank plc (“Lloyds”) under which Lloyds agreed to make available bor- rowings of up to approximately $22,200. Advances under the credit facility bear interest at the rate of 1.25% per annum over the bank’s base rate, and are guaranteed by us. Available borrowings under the agreement are reduced by the amount of outstanding guarantees. The facility expires on March 31, 2004. We had no outstanding guarantees or borrowings under this facility as of October 31, 2003. For fiscal 2003, 2002 and 2001, we received proceeds of $44,865, $23,308 and $22,931, respectively, relating to the exercise of stock options and warrants.

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In December 2003, we acquired all of the outstanding capital stock and paid certain liabilities of TDK. The purchase price of approximately $14,276 consisted of $17,116 in cash and issuance of 163,641 restricted shares of our common stock (valued at $5,160), reduced by approximately $8,000 due to TDK under a distribution agreement. Our accounts receivable, less allowances, which includes doubtful accounts, returns, price concessions, rebates and other sales allowances at October 31, 2003 was $166,536 as compared to $105,576 at October 31, 2002. The increase of $92,971 in gross accounts receivable at October 31, 2003 principally reflects increased product releases at year end as well as cash received in advance of products shipped at the end of fiscal 2002. Two retail customers each accounted for more than 10% of the domestic receivable balance (28.3% in aggregate) at October 31, 2003. As of October 31, 2003, most of our receivables had been covered by insurance, with certain limits and deductibles, in the event of a customer’s bankruptcy or insolvency. In November 2003, we ter- minated our domestic receivables insurance. Generally, we have been able to collect our receivables in the ordinary course of business. We do not hold any collateral to secure payment from customers. As a result, we are subject to credit risks, particularly in the event that any of the receivables represent a limited number of retailers or are con- centrated in foreign markets. If we are unable to collect our accounts receivable as they become due, we could be required to increase our allowance for doubtful accounts, which could adversely affect our liquidity and working capital position. Our allowances increased from $30,806 at October 31, 2002 to $62,817 at October 31, 2003 and increased as a percentage of gross receivables from 22.6% at October 31, 2002 to 27.4% at October 31, 2003. The increase was due to additional price concessions and returns for our published products and additional bad debts, net of deductibles and insurance proceeds, related to the bankruptcy of two customers, the losses from which were not entirely covered by insur- ance. We had accounts receivable days outstanding of 54 days for the three months ended October 31, 2003, as compared to 45 days for the three months ended October 31, 2002. Receivable days outstanding increased primarily as a result of increased product releases at year end. Our receivable days outstanding fluctuate from period to period depending on the timing of product releases. Inventories of $101,748 at October 31, 2003 increased $27,357 from October 31, 2002, reflecting higher levels of distribution products to support the growth of this business. Accounts payable of $106,172 at October 31, 2003 increased $26,512 primarily due to the increase in inventory levels. In September 2002, we relocated our principal executive offices to 622 Broadway, New York, New York. We have recently leased additional space at 622 Broadway to accommodate our expanded operations. We estimate that as of October 31, 2003 we will incur an additional $1,200 in capital expenditures for continuing renova- tions and leasehold improvements for this space. In connection with signing a ten year lease, we provided a standby letter of credit of ## Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollars in thousands, except per share amounts) $1,560, expiring December 31, 2003. As a result of the relocation, we recorded expenses of $363 and $514 in fiscal 2003 and 2002, respectively, related to lease costs with regard to our former execu- tive offices. In addition, we expect to spend an additional $4,000 in connection with the implementation of accounting software systems for our international operations and the upgrade for our domestic operations. We are considering expanding our distribution facilities in Cincinnati, Ohio, which would require additional capital expendi- tures for leasehold improvements and equipment. As of the date of this report, we have no other material commitments for capital expenditures. Our Board of Directors authorized a stock repurchase program under which we may repurchase up to $25,000 of our common stock from time to time in the open market or in privately negotiated transac- tions. We have not repurchased any shares under this program. We have incurred and may continue to incur significant legal, accounting and other professional fees and expenses in connection with pending regulatory matters. Based on our currently proposed operating plans and assump- tions, we believe that projected cash flow from operations and avail- able cash resources will be sufficient to satisfy our cash requirements for the reasonably foreseeable future. ## Contractual Obligations and Contingent Liabilities and Commitments Our offices and warehouse facilities are occupied under non- cancelable operating leases expiring at various times from December 2003 to October 2013. We also lease certain furniture, equipment and automobiles under non-cancelable leases expiring through October 2007. Our future minimum rental payments for the year ending October 31, 2004 are $7,268 and aggregate minimum rental payments through applicable lease expirations are $37,865. We have entered into distribution agreements under which we purchase various software games. These agreements, which expire between June 2004 and March 2005, require remaining aggregate minimum guaranteed payments of $14,330 at October 31, 2003, including $3,491 of payments due pursuant to an agreement with TDK. These agreements are collateralized by a standby letter of credit of $3,600 at October 31, 2003. Additionally, assuming performance by third-party developers, we have outstanding commitments under various software development agreements to pay developers an aggregate of $27,224 over the fiscal year ending October 31, 2004. In connection with our acquisition of the publishing rights to the Duke Nukem franchise for PC and video games in December 2000, we are obligated to pay $6,000 contingent upon delivery of the final version of Duke Nukem Forever for the PC. In May 2003, we agreed to pay up to $6,000 upon the achievement of certain sales targets for Max Payne 2 . We also agreed to make additional payments of up to $2,500 to the former owners of Cat Daddy based on a percentage Cat Daddy’s profits for the first three years after acquisition. The payables will be recorded when the conditions requiring their payment are met.

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The following table summarizes our minimum contractual obligations and commercial commitments as of October 31, 2003: <img src='content_image/100292.jpg'> ## Fluctuations in Operating Results and Seasonality We have experienced fluctuations in quarterly operating results as a result of the timing of the introduction of new titles; variations in sales of titles developed for particular platforms; market acceptance of our titles; development and promotional expenses relating to the introduction of new titles, sequels or enhancements of existing titles; projected and actual changes in platforms; the timing and success of title introductions by our competitors; product returns; changes in pricing policies by us and our competitors; the size and timing of acquisitions; the timing of orders from major customers; and order cancellations and delays in product shipment. Sales of our titles are also seasonal, with peak shipments typically occurring in the fourth calendar quarter (our fourth and first fiscal quarters) as a result of increased demand for titles during the holiday season. Quarterly comparisons of operating results are not necessarily indicative of future operating results. ## International Operations Sales in international markets, principally in the United Kingdom and other countries in Europe, have accounted for a significant por- tion of our net sales. For fiscal 2003 and 2002, sales in international markets accounted for approximately 27.9% and 20.0%, respectively, of our net sales. We are subject to risks inherent in foreign trade, including increased credit risks, tariffs and duties, fluctuations in for- eign currency exchange rates, shipping delays and international politi- cal, regulatory and economic developments, all of which can have a significant impact on our operating results. ## Cautionary Statement and Risk Factors Safe Harbor Statement under the Securities Litigation Reform Act of 1995: We make statements in this report that are considered forward-looking statements under federal securities laws. Such forward-looking statements are based on the beliefs of management as well as assumptions made by and information currently available to them. The words “expect,” “anticipate,” “believe,” “may,” “estimate,” “intend” and similar expressions are intended to identi- fy such forward-looking statements. Forward-looking statements involve risks, uncertainties and assumptions including, but not limited to, the following which could cause our actual results, performance or achievements to be materially different from results, performance or achievements, expressed or implied by such forward-looking statements: The market for interactive entertainment software titles is characterized by short product life cycles. The interactive entertain- ment software market is characterized by short product life cycles and frequent introductions of new products. New products introduced by us may not achieve significant market acceptance or achieve suffi- cient sales to permit us to recover development, manufacturing and marketing costs. Historically, few interactive entertainment software products have achieved sustained market acceptance. Even the most successful titles remain popular for only limited periods of time, often less than nine months, although sales of certain products may extend for significant periods of time, including through our election to participate in Sony’s Greatest Hits and Microsoft’s Platinum Hits programs. The life cycle of a game generally involves a relatively high level of sales during the first few months after introduction followed by a decline in sales. Because net sales associated with the initial ship- ments of a new product generally constitute a high percentage of the total net sales associated with the life of a product, any delay in the introduction of one or more new products could adversely affect our operating results. Additionally, because we introduce a relatively limit- ed number of new products in any period, the failure of one or more of our products to achieve market acceptance could adversely affect our operating results. A significant portion of our net sales is derived from a limited number of titles. For the year ended October 31, 2003, our ten best- selling titles accounted for approximately 50.5% of our net sales, with Grand Theft Auto: Vice City for PlayStation 2 accounting for 33.6% of our net sales, Midnight Club 2 for PlayStation 2 accounting for 4.1% of our net sales and Grand Theft Auto: Vice City for PC accounting for 2.6% of our net sales. Our ten best-selling titles accounted for approxi- mately 59.5% of our net sales for the year ended October 31, 2002. For this period, Grand Theft Auto 3 for PlayStation 2 accounted for 29.8% of our net sales, Grand Theft Auto: Vice City for the PlayStation 2 accounted for 7.5% of our net sales and Max Payne for PlayStation 2 accounted for 6.6% of our net sales. Our ten best-selling titles accounted for approximately 30.8% of our net sales for the fiscal year ended October 31, 2001. Our future titles may not be commercially viable. If we fail to continue to develop and sell new, commercially successful titles, our net sales and profits may decrease substantially and we may incur losses.

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Our quarterly operating results may vary significantly, which could cause our stock price to decline. We have experienced, and may continue to experience, wide fluctuations in quarterly operating results. The interactive entertainment industry is highly seasonal, with sales typically higher during the fourth calendar quarter (our fourth and first fiscal quarters), due primarily to the increased demand for games during the holiday buying season. Our failure or inability to introduce products on a timely basis to meet seasonal fluctuations in demand will harm our business and operating results. These fluctua- tions could also cause our stock price to decline. Other factors that cause fluctuations include: • delays in the introduction of new titles; • the size and timing of product and business acquisitions; • variations in sales of titles designed to operate on particular platforms; • development and promotional expenses relating to the introduc- tion of new titles; • availability of hardware platforms; • the timing and success of title introductions by our competitors; • product returns and price concessions; and • the timing of orders from major customers. Our expense levels are based, in part, on our expectations regard- ing future sales and therefore our operating results would be harmed by a decrease in sales or a failure to meet our sales expectations. The uncertainties associated with interactive entertainment software development, manufacturing lead times, production delays and the approval process for products by hardware manufacturers and other licensors make it difficult to predict the quarter in which our products will ship and therefore may cause us to fail to meet financial expecta- tions. In future quarters, our operating results may fall below the expectations of securities analysts and investors. In this event, the market price of our common stock could significantly decline. The interactive entertainment software industry is cyclical, and we may fail to anticipate changing consumer preferences. Our business is subject to all of the risks generally associated with the interactive entertainment software industry, which has been cyclical in nature and has been characterized by periods of significant growth followed by rapid declines. Our future operating results will depend on numerous factors beyond our control, including: • the popularity, price and timing of new software and hardware platforms being released and distributed by us and our competitors; • international, national and regional economic conditions, particular- ly economic conditions adversely affecting discretionary consumer spending; • war, acts of terrorism and military action, which could adversely affect consumer preferences in entertainment; • changes in consumer demographics; • the availability and popularity of other forms of entertainment; and • critical reviews and public tastes and preferences, all of which change rapidly and cannot be predicted. ## Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) ## TAKE-TWO INTERACTIVE SOFTWARE, INC. AND SUBSIDIARIES (Dollars in thousands, except per share amounts) In order to plan for acquisition and promotional activities, we must anticipate and respond to rapid changes in consumer tastes and preferences. A decline in the popularity of interactive entertainment software or particular platforms could cause sales of our titles to decline dramatically. The period of time necessary to develop new game titles, obtain approvals of manufacturers and produce finished products is unpredictable. During this period, consumer appeal of a particular title may decrease, causing product sales to fall short of expectations. Rapidly changing technology and platform shifts could hurt our operating results. The interactive entertainment industry in general is associated with rapidly changing technology. As more advanced platforms achieve market acceptance, consumer demand for software for older platforms declines. We are devoting significant development resources primarily on products designed for Sony’s PlayStation 2 and Microsoft’s Xbox. If consumer demand for these platforms declines generally or as a result of the next hardware transition cycle, we may experience lower than expected sales or losses from products designed for these platforms. A number of software publishers who compete with us have devel- oped or are currently developing software for use by consumers over the Internet. Future increases in the availability of such software or technological advances in such software or the Internet could result in a decline in platform-based software and impact our sales. Direct sales of software by major publishers over the Internet would materi- ally adversely affect our distribution business. It is difficult to anticipate hardware development cycles and we must make substantial development and investment decisions well in advance of the introduction of new hardware products. If new hard- ware products are delayed or do not meet our expectations for con- sumer acceptance, we may not be able to recover our investment and our business and financial results could be adversely affected. Our business is dependent on publishing arrangements with third parties. Our success depends on our ability to identify and develop new titles on a timely basis. We have entered into agree- ments with third parties to acquire the rights to publish and distribute interactive entertainment software. These agreements typically require us to make advance payments, pay royalties and satisfy other condi- tions. Our advance payments may not be sufficient to permit devel- opers to develop new software successfully. In addition, software development costs, promotion and marketing expenses and royalties payable to software developers have increased significantly in recent years and reduce the potential profits derived from sales of our soft- ware. Future sales of our titles may not be sufficient to recover advances to software developers, and we may not have adequate financial and other resources to satisfy our contractual commitments. If we fail to satisfy our obligations under these license agreements, the agreements may be terminated or modified in ways that may be burdensome to us.

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Returns of our published titles and price concessions may adversely affect our operating results. We are exposed to the risk of product returns and price concessions with respect to our cus- tomers. Our distribution arrangements with customers do not give them the right to return titles to us or to cancel firm orders. However, we sometimes accept product returns from our distribution customers for stock balancing and negotiate accommodations to customers which include credits and returns, when demand for specific products falls below expectations. We accept returns and grant price conces- sions in connection with our publishing arrangements. Revenue is rec- ognized after deducting estimated reserves for returns and price con- cessions. We believe that we can reliably estimate future returns and price concessions. However, if return rates and price concessions for our published titles exceed our reserves, our net sales will decline. The interactive entertainment software industry is highly com- petitive. We compete for both licenses to properties and the sale of interactive entertainment software with Sony, Microsoft and Nintendo, each of which is a large developer and marketer of software for its own platforms. Each of these competitors has the financial resources to withstand significant price competition and to implement extensive advertising campaigns, particularly for prime-time television spots. These companies may also increase their own software development efforts or focus on developing software products for third-party plat- forms. We also compete with domestic companies such as Electronic Arts, Activision, THQ, Midway Games, Acclaim Entertainment and Atari and international companies such as Sega, Vivendi, Ubi Soft, Eidos, Capcom, Konami and Namco. Some of our competitors have greater financial, technical, personnel and other resources than we do, and are able to carry larger inventories and make higher offers to licensors and developers for commercially desirable properties than we can. Our titles also compete with other forms of entertainment such as motion pictures, television and audio and video products featuring similar themes, online computer programs and forms of entertainment which may be less expensive or provide other advantages to consumers. Our distribution business also operates in a highly competitive environment. The intense competition that characterizes our industry is based primarily on breadth, availability and quality of product lines; price; terms and conditions of sale; credit terms and availability; speed and accuracy of delivery; and effectiveness of sales and marketing pro- grams. Our competitors include regional, national and international distributors, as well as hardware manufacturers and software publish- ers. We may lose market share or be forced in the future to reduce our prices in response to the actions of our competitors, and thereby experience a reduction in our gross margins. Increased competition for limited shelf space and promotional support from retailers could affect the success of our business and require us to incur greater expenses to market our titles. Retailers have limited shelf space and promotional resources, and competition is intense among an increasing number of newly introduced interac- tive entertainment software titles for adequate levels of shelf space and promotional support. Competition for retail shelf space is expect- ed to increase, which may require us to increase our marketing expenditures just to maintain current levels of sales of our titles. Competitors with more extensive lines and popular titles frequently have greater bargaining power with retailers. Accordingly, we may not be able to achieve the levels of promotional support and shelf space that such competitors receive. A limited number of customers may account for a significant portion of our sales. Sales to our five largest customers accounted for approximately 38.6%, 31.4% and 20.8%, respectively, of our net sales for the years ended October 31, 2003, 2002 and 2001. For the year ended October 31, 2003, sales of our products to Wal-Mart accounted for 11.4% of our net sales. Our sales are made primarily pursuant to purchase orders without long-term agreements or other commitments. Our customers may terminate their relationship with us at any time. The loss of our relationships with principal customers or a decline in sales to principal customers could harm our operating results. Bankruptcies or consolidations of certain large retail cus- tomers could also seriously hurt our business. We are subject to credit and collection risks. Our sales are typically made on credit. We do not hold any collateral to secure payment by our customers. As a result, we are subject to credit risks, particularly in the event that any of our receivables represent sales to a limited number of retailers or are concentrated in foreign markets. We recently terminated our domestic receivables insurance. Although we continually assess the creditworthiness of our customers, which are principally large, national retailers, if we are unable to collect our accounts receivable as they become due, it could adversely affect our financial condition. Rating systems for interactive entertainment software, potential legislation and consumer opposition could inhibit sales of our prod- ucts. Trade organizations within the video game industry require inter- active entertainment software publishers to provide consumers with information relating to graphic violence, profanity or sexually explicit material contained in software titles, and impose penalties for non- compliance. Certain countries have also established similar rating systems as prerequisites for sales of interactive entertainment software in such countries. In some instances, we may be required to modify our products to comply with the requirements of such rating systems, which could delay the release of those products in such countries. Our software titles receive a rating of “E” (age 6 and older), “T” (age 13 and over) or “M” (age 17 and over). Most of our new titles (including Grand Theft Auto 3 , Grand Theft Auto: Vice City , Max Payne 2 : The Fall of Max Payne , Manhunt and Mafia ) have received an “M” rating. We believe that we comply with such rating systems and properly display the ratings and content descriptions received for our titles. Several proposals have been made for federal legislation to regu- late the interactive entertainment software, motion picture and recording industries, including a proposal to adopt a common rating system for interactive entertainment software, television and music containing violence or sexually explicit material, and the Federal Trade Commission has issued reports with respect to the marketing of such material to minors. Consumer advocacy groups have also opposed sales of interactive entertainment software containing graphic violence or sexually explicit material by pressing for

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legislation in these areas (including legislation prohibiting the sale of certain “M” rated video games to minors) and by engaging in public demonstrations and media campaigns. Retailers may decline to sell interactive entertainment software containing graphic violence or sex- ually explicit material, which may limit the potential market for our “M” rated products and adversely affect our operating results. If any groups (including international, national and local political and regula- tory bodies) were to target our “M” rated titles, we might be required to significantly change or discontinue a particular title, which in the case of our best-selling titles could seriously hurt our business. Although lawsuits seeking damages for injuries allegedly suffered by third parties as a result of video games have been unsuccessful, a claim of this kind has been asserted against us. We cannot publish our console titles without the approval of hardware manufacturers. We are required to obtain a license from Sony, Microsoft and Nintendo, our principal competitors, to develop and publish titles for their respective hardware platforms. Our existing hardware console platform licenses require that we obtain approval for the publication of new titles on a title-by-title basis. As a result, the number of titles we are able to publish for these hardware plat- forms, along with our ability to time the release of these titles and, accordingly, our net sales from titles for these hardware platforms, may be limited. If any manufacturer chooses not to renew or extend our license agreement at the end of its current term, or if the manu- facturer were to terminate our license for any reason, we would be unable to publish additional titles for that manufacturer’s hardware platform. Termination of any such agreements would seriously hurt our business. License agreements relating to these rights generally extend for a term of three or four years. The agreements are terminable upon the occurrence of a number of factors, including: (1) breach of the agree- ment by us; (2) our bankruptcy or insolvency; or (3) our entry into a relationship with, or acquisition by, a competitor of the manufacturer. We cannot assure you that we will be able to obtain new or maintain existing licenses on acceptable terms, or at all. Sony and Nintendo are the sole manufacturers of the titles we publish under license from them. Games for the Xbox must be man- ufactured by pre-approved manufacturers. Each platform license provides that the manufacturer may raise prices for the titles at any time and grants the manufacturer substantial control over the release of new titles. Each of these manufacturers also publishes software for its own platforms and manufactures titles for all of its other licensees and may choose to give priority to its own titles or those of other publishers if it has insufficient manufacturing capacity or if there is increased demand for its or other publishers’ products. In addition, these manufacturers may not have sufficient produc- tion capacity to satisfy our scheduling requirements during any period of sustained demand. If manufacturers do not supply us with finished titles on favorable terms without delays, our operations would be materially interrupted and we would be unable to obtain sufficient amounts of our product to sell to our customers. If we cannot obtain sufficient product supplies, our net sales will decline and we could incur losses. ## Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollars in thousands, except per share amounts) We may not be able to protect our proprietary rights or avoid claims that we infringe on the proprietary rights of others. We develop proprietary software and have obtained the rights to publish and distribute software developed by third parties. We attempt to protect our software and production techniques under copyright, trademark and trade secret laws as well as through contractual restric- tions on disclosure, copying and distribution. Interactive entertain- ment software is susceptible to unauthorized copying. Unauthorized third parties may be able to copy or to reverse engineer our software to obtain and use programming or production techniques that we regard as proprietary. As the amount of interactive entertainment software titles in the market increases and the functionality of this software further overlaps, we believe that interactive entertainment software will increasingly become the subject of claims that such software infringes the copyrights or patents of others. From time to time, we receive notices from third parties or are named in lawsuits by third parties alleging infringement of their proprietary rights. Although we believe that our software and technologies and the software and technologies of third-party developers and publishers with whom we have contrac- tual relations do not and will not infringe or violate proprietary rights of others, it is possible that infringement of proprietary rights of others has or may occur. Any claims of infringement, with or without merit, could be time consuming, costly and difficult to defend. More- over, intellectual property litigation or claims could require us to discontinue the distribution of products, obtain a license or redesign our products, which could result in additional substantial costs and material delays. We are dependent on third-party software developers to complete certain of our titles. We rely on third-party software devel- opers for the development of certain of our titles. Quality third-party developers are continually in high demand. Software developers who have developed titles for us in the past may not be available to devel- op software for us in the future. Due to the limited number of third- party software developers and the limited control that we exercise over them, these developers may not be able to complete titles for us on a timely basis or within acceptable quality standards, if at all. We depend on third-party software developers and our internal development studios to develop new interactive entertainment soft- ware within anticipated release schedules and cost projections. The development cycle for new titles ranges from twelve to twenty-four months. After development of a product, it may take between nine to twelve additional months to develop the product for other hardware platforms. If developers experience financial difficulties, additional costs or unanticipated development delays, we will not be able to release titles according to our schedule. Our software is susceptible to errors, which can harm our finan- cial results and reputation. The technological advancements of new hardware platforms allow more complex software products. As software products become more complex, the risk of undetected errors in prod- ucts when first introduced increases. If, despite testing, errors are found in new products or releases after shipments have been made, we could experience a loss of or delay in timely market acceptance, product returns, loss of net sales and damage to our reputation.

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Gross margins relating to our distribution business have been historically narrow which increases the impact of variations in costs on our operating results. As a result of intense price competi- tion, our gross margins in our distribution business have historically been narrow and we expect them to continue to be narrow in the future. We receive purchase discounts from suppliers based on vari- ous factors, including volume purchases. These purchase discounts directly affect our gross margins. It may become more difficult for us to achieve the percentage growth in sales required to continue to receive volume purchase discounts. ## We may not be able to adequately adjust our cost structure in a timely fashion in response to a sudden decrease in demand. A significant portion of our selling and general and administrative expense is comprised of personnel and facilities. In the event of a significant decline in net sales, we may not be able to exit facilities, reduce personnel, or make other significant changes to our cost structure without significant disruption to our operations or without significant termination and exit costs. Management may not be able to implement such actions in a timely manner, if at all, to offset an immediate shortfall in net sales and gross profit. Our distribution business is dependent on suppliers to maintain an adequate supply of products to fulfill customer orders on a timely basis. Our ability to obtain particular products in required quantities and to fulfill customer orders on a timely basis is critical to our success. In most cases, we have no guaranteed price or delivery agreements with suppliers. In certain product categories, limited price concessions or return rights offered by publishers may have a bearing on the amount of product we may be willing to purchase. Our indus- try may experience significant hardware supply shortages from time to time due to the inability of certain manufacturers to supply certain products on a timely basis. As a result, we have experienced, and may in the future continue to experience, short-term hardware inven- tory shortages. In addition, manufacturers or publishers who currently distribute their products through us may decide to distribute, or to substantially increase their existing distribution, through other distributors, or directly to retailers. We are subject to the risk that our inventory values may decline and protective terms under supplier arrangements may not adequately cover the decline in values. The interactive enter- tainment software and hardware industry is characterized by the intro- duction of new and enhanced generations of products and evolving industry standards. These changes may cause inventory to decline substantially in value or to become obsolete. We are also exposed to inventory risk in our distribution business to the extent that supplier price concessions are not available on all products or quantities and are subject to time restrictions. In addition, suppliers may become insolvent and unable to fulfill price concession obligations. ## We are subject to risks and uncertainties of international trade. Sales in international markets, primarily in the United Kingdom and other countries in Europe, have accounted for a significant portion of our net sales. Sales in international markets accounted for approxi- mately 27.9%, 20.0% and 23.6%, respectively, of our net sales for the years ended October 31, 2003, 2002 and 2001. We are subject to risks inherent in foreign trade, including increased credit risks; tariffs and duties; fluctuations in foreign currency exchange rates; shipping delays; and international political, regulatory and economic develop- ments, all of which can have a significant impact on our operating results. All of our international sales are made in local currencies. ## The market price for our common stock may be highly volatile. The market price of our common stock has been and may continue to be highly volatile. Factors such as our operating results, announce- ments by us or our competitors and various factors affecting the inter- active entertainment software industry may have a significant impact on the market price of our common stock. We are subject to rapidly evolving regulation affecting financial reporting, accounting and corporate governance matters. In response to recent corporate events, legislators and government agencies have focused on the integrity of financial reporting, and regulatory accounting bodies have recently announced their intention to issue several new accounting standards, including accounting for stock options as compensation expense, certain of which are signifi- cantly different from current accounting standards. We cannot predict the impact of the adoption of any such proposals on our future financial results. Additionally, recently enacted legislation focused on corporate governance, auditing and internal accounting controls imposes compliance burdens on us, and will require us to devote significant financial, technical and personnel resources to address compliance issues. We are subject to SEC proceedings that may result in sanctions and monetary penalties. We received a Wells Notice from the Staff of the SEC stating the Staff’s intention to recommend that the SEC bring an enforcement action seeking an injunction and monetary damages against us alleging that we violated certain provisions of the federal securities laws. The proposed allegations stem from the previously disclosed SEC investigation into certain accounting matters related to our financial statements, periodic reporting and internal accounting controls. The investigation is continuing and we expect to receive additional requests for information. Restatements of our financial statements could result in lawsuits. The Staff of the SEC has raised issues with respect to our revenue recognition policies and certain sales transactions and their impact on our current and historical financial statements. After a detailed review, we restated our previously issued financial state- ments to reflect our revised revenue recognition policy with respect to establishing reserves for price concessions for our published products, as well as to increase our provision for returns at October 31, 2000 with respect to certain sales transactions, primarily to retail customers with a corresponding reduction in the returns provision in 2001. Although we have entered into discussions with the Staff to address the issues raised in the Wells Notice, we are unable to predict the outcome of these discussions. We may be subject to class action lawsuits seeking damages as a result of the restatements. See Note 2 to Consolidated Financial Statements. We are uncertain about the future of our management and key personnel. Our Chairman has received a Wells Notice from the Staff of the SEC. Our Chairman founded the company and we depend on

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this individual for our strategic and operating decisions. The loss of the services of this individual could have a material adverse effect on our business and prospects. Additionally, pursuant to the terms of his amended employment contract, our Chief Executive Officer has the right to elect to voluntarily terminate his agreement and resign at any time after March 30, 2004 and receive his full salary and bonus during the eighteen-month period following such resignation. Furthermore, we are dependent upon the expertise and skills of certain of our Rockstar employees responsible for content creation and product development and marketing. Although we have employment agree- ments with each of these creative, development and marketing per- sonnel, and we have granted them incentives in the form of an inter- nal royalty program based on sales of Rockstar published products, there can be no assurance that we will be able to continue to retain these personnel at current compensation levels, or at all. Failure to continue to attract and retain qualified management, creative, devel- opment, financial, marketing, sales and technical personnel could materially adversely affect our business and prospects. ## Management’s Discussion and Analysis of Financial Condition and Results of Operations (concluded) (Dollars in thousands, except per share amounts) ## Quantitative and Qualitative Disclosures About Market Risk We are subject to market risks in the ordinary course of our busi- ness, primarily risks associated with interest rate and foreign currency fluctuations. Historically, fluctuations in interest rates have not had a significant impact on our operating results. At October 31, 2003, we had no outstanding variable rate indebtedness. We transact business in foreign currencies and are exposed to risks resulting from fluctuations in foreign currency exchange rates. Accounts relating to foreign operations are translated into United States dollars using prevailing exchange rates at the relevant fiscal quarter or year-end. Translation adjustments are included as a sepa- rate component of stockholders’ equity. For the year ended October 31, 2003, our foreign currency translation adjustment gain was $4,119. Foreign exchange transaction gain for the year ended Octo- ber 31, 2003 was $2,015. A hypothetical 10% change in applicable currency exchange rates at October 31, 2003 would result in a materi- al translation adjustment.

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## Consolidated Balance Sheets (In thousands, except share data) <img src='content_image/36413.jpg'> The accompanying notes are an integral part of these consolidated financial statements.

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## TAKE-TWO INTERACTIVE SOFTWARE, INC. AND SUBSIDIARIES ## Consolidated Statements of Operations (In thousands, except per share data) <img src='content_image/111918.jpg'> The accompanying notes are an integral part of these consolidated financial statements.

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<img src='content_image/45236.jpg'> ## Rockstar Games Rockstar Games, Take-Two’s world-renowned publishing label, developed the blockbuster Grand Theft Auto , Midnight Club and Max Payne franchises. Recognized for outstanding game play, unique game style and witty humor, Rockstar titles are among the most anticipated in the interactive entertainment industry. Rockstar operates from New York City with a family of development studios in North America and Europe. ## Letter to Shareholders: Take-Two Interactive Software marked its tenth year of operations in 2003. In this relatively short period of time, Take-Two has become one of the top publishers and distributors of interactive entertain- ment products. Concurrently, the industry has grown significantly as video games have become a top form of entertainment and a lifestyle choice for millions of peo- ple around the globe. <img src='content_image/45244.jpg'> In our publishing business, we’ve achieved success by developing games based primarily on our proprietary brand franchises, as well as selective licensed properties. Take-Two’s premier publishing label, Rockstar Games, has forged a unique niche with its titles, which utilize sophisticated game play, humor, and immersion into environments that are unmatched in any other entertainment medium. The world-renowned reputation of Rockstar Games and the success of their blockbuster Grand Theft Auto fran- chise is the hallmark for Take-Two. Our Jack of All Games distribution divi- sion has built a business that directly ben- efits from the expansion of the video game industry and the need for other publishers to effectively distribute their products. When Jack was founded, sell- ing video games was considered a spe- cialty business, but today retailers of near- ly every size want to participate in this expanding industry. Jack is the most comprehensive, one-stop source for North American retailers who want to be in the interactive entertainment business.

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TAKE-TWO INTERACTIVE SOFTWARE, INC. AND SUBSIDIARIES ## Consolidated Statements of Cash Flows (In thousands) <img src='content_image/127799.jpg'> The accompanying notes are an integral part of these consolidated financial statements.

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## Consolidated Statements of Cash Flows (continued) (In thousands) <img src='content_image/101077.jpg'> The accompanying notes are an integral part of these consolidated financial statements.

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## Consolidated Statements of Stockholders’ Equity For the Years Ended October 31, 2001 (Restated), 2002 (Restated) and 2003 (In thousands) <img src='content_image/44241.jpg'> The accompanying notes are an integral part of these consolidated financial statements.

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## 1. DESCRIPTION OF THE BUSINESS Take-Two Interactive Software, Inc. (the “Company”) was incorpo- rated in the State of Delaware in September 1993. The Company develops interactive software games designed for PCs, video game consoles and handheld platforms and publishes games developed internally and by third parties. The Company also distributes games for video game consoles and handheld platforms published internally and by third parties, as well as hardware and accessories manufac- tured by third parties. ## 2. RESTATEMENT OF FINANCIAL STATEMENTS The Company restated its previously issued financial statements for the fiscal years ended October 31, 2000 (not presented herein), 2001 and 2002 to reflect its revised revenue recognition policy. Under this policy, the Company recognizes as a reduction of net sales a reserve for estimated future price concessions in the period in which the sale is recorded. Measurement of the reserve is based on, among other factors, an historical analysis of price concessions, an assess- ment of field inventory levels and sell-through for each product, current industry conditions and other factors affecting the estimated timing and amount of concessions management believes will be granted. The Company previously recognized price concession reserves in the period in which it communicated the price concessions to its customers. The Company also restated its financial statements for the years ended October 31, 2000 and 2001 to increase its provi- sion for returns at October 31, 2000 by approximately $4.9 million for certain sales transactions primarily to retail customers in fiscal 2000, and to reflect the fiscal 2001 returns as a reduction of the revised October 31, 2000 reserve for returns rather than the previously reported reduction of sales in fiscal 2001. Additionally, fiscal 2000 and 2001 revenues were restated for approximately $0.2 million to adjust for sales cut-off transactions at the end of fiscal 2000. The impact of these changes on opening retained earnings as of November 1, 2000 was $2.6 million. See Note 19. The Company’s 2002 financial statements have been restated as follows: <img src='content_image/59605.jpg'> ## Notes to Consolidated Financial Statements (Dollars in thousands, except per share amounts) <img src='content_image/59603.jpg'> * Restated amounts reflect a reclassification relating to the presentation of allowances. The Company’s Consolidated Statement of Operations for the year ended October 31, 2001 has been restated as follows: <img src='content_image/59604.jpg'> * As required by Statement of Financial Accounting Standards No. 145, “Rescis- sion of FASB Statements No. 4, 44 and 64, Amendment to FASB Statement No. 13, and Technical Corrections”, the $1,948 net loss on extinguishment of debt for the year ended October 31, 2001, previously classified as an extraordinary item, has been reclassified in the As Reported column in the above table as follows: $3,165 of loss on extinguishment to non-operating expenses and $1,217 of tax benefit to benefit for income taxes. All applicable amounts relating to the aforementioned restate- ments have been reflected in these consolidated financial statements and notes thereto. ## 3. SIGNIFICANT ACCOUNTING POLICIES ## Basis of Presentation The consolidated financial statements include the financial state- ments of the Company and its wholly owned subsidiaries and for enti- ties for which the Company is deemed to be the primary beneficiary as defined in FASB Interpretation No. 46, “Consolidation of Variable Interest Entities.” All material intercompany balances and transactions have been eliminated in consolidation.

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Certain amounts in the financial statements of the prior years have been reclassified to conform to the current year presentation for comparative purposes. ## Estimates The preparation of financial statements in conformity with general- ly accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net sales and expenses during the reporting periods. The most significant estimates and assumptions relate to the recoverability of prepaid royalties, capitalized software development costs and other intangibles, valuation of inventories, realization of deferred income taxes and the adequacy of allowances for returns, price concessions and doubtful accounts. Actual amounts could differ significantly from these estimates. ## Concentration of Credit Risk A significant portion of the Company’s cash balance is maintained with several major financial institutions. While the Company attempts to limit credit exposure with any single institution, there are times that balances will exceed insurable amounts. If the financial condition and operations of the Company’s customers deteriorate, the risk of collection could increase substantially. As of October 31, 2003 and 2002, the receivable balances from the Compa- ny’s five largest customers amounted to approximately 54.6% and 43.6% of the Company’s net receivable balance, respectively, with two cus- tomers accounting for 16.6% and 11.7% at October 31, 2003 and with two customers representing 14.1% and 10.3% at October 31, 2002. For each of the three years in the period ended October 31, 2003, the Company’s five largest customers accounted for 38.6%, 31.4%, and 20.8% of net sales, respectively. For the year ended October 31, 2003, one customer accounted for $117,636, or 11.4%, of net sales. Except for the largest customers noted above, all receivable balances from the remaining individual customers were less than 10% of the Company’s net receivable balance. The Company maintained insurance, to the extent available, on the receivable balances, with certain limits, in the event of a customer’s bankruptcy or insolvency. In November 2003, the Company terminated this insurance on domestic receivables. ## Revenue Recognition Publishing revenue is derived from the sale of internally developed interactive software titles or from the sale of titles licensed from third- party developers. Publishing revenue amounted to $671,892, $568,492, and $244,071 in 2003, 2002 and 2001, respectively. Distribution revenue is derived from the sale of third-party interac- tive software titles, hardware and accessories. Distribution revenue amounted to $361,801, $226,184 and $207,325 in 2003, 2002 and 2001, respectively. The Company recognizes revenue upon the transfer of title and risk of loss to its customers. The Company applies the provisions of Statement of Position 97-2, “Software Revenue Recognition” in con- junction with the applicable provisions of Staff Accounting Bulletin No. 101, “Revenue Recognition.” Accordingly, the Company recog- nizes revenue for software when (1) there is persuasive evidence that an arrangement with our customer exists, which is generally a cus- tomer purchase order, (2) the software is delivered, (3) the selling price is fixed or determinable and (4) collection of the customer receivable is deemed probable. The Company’s payment arrange- ments with customers typically provide net 30 and 60-day terms. Revenue is recognized after deducting estimated reserves for returns and price concessions. In specific circumstances when the Company does not have a reliable basis to estimate returns and price concessions or is unable to determine that collection of receivables is probable, it defers the sale until such time as it can reliably estimate any related returns and allowances and determine that collection of the receivables is probable. The Company accepts returns and grants price concessions in con- nection with its publishing arrangements. Following reductions in the price of the Company’s products, it grants price concessions to permit customers to take credits against amounts they owe the Company with respect to merchandise unsold by them. The Company’s customers must satisfy certain conditions to entitle them to return products or receive price concessions, including compliance with applicable payment terms and confirmation of field inventory levels. The Company’s distribution arrangements with customers do not give them the right to return titles or to cancel firm orders. However, the Company sometimes accepts returns from its distribution cus- tomers for stock balancing and makes accommodations to customers, which includes credit and returns, when demand for specific titles falls below expectations. The Company makes estimates of future product returns and price concessions related to current period product revenue. The Company estimates the amount of future returns and price concessions for pub- lished titles based upon, among other factors, historical experience, customer inventory levels, analysis of sell-through rates and changes in demand and acceptance of its products by consumers. Significant management judgments and estimates must be made and used in connection with establishing the allowance for returns and price concessions in any accounting period. The Company believes it can make reliable estimates of returns and price conces- sions. However, actual results may differ from initial estimates as a result of changes in circumstances, market conditions and assump- tions. Adjustments to estimates are recorded in the period in which they become known. Effective November 1, 2000, the Company adopted Staff Account- ing Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial State- ments.” Consistent with the guidelines provided in SAB No. 101, the Company changed its revenue recognition policy to recognize revenue as noted above. Prior to the adoption of SAB 101, the Company recog- nized revenue upon shipment. As a result of adopting SAB 101, net sales and cost of sales of approximately $23.8 million and $15.1 million, respectively, which were originally recognized in the year ended October 31, 2000 were also recognized in the year ended October 31, 2001. The cumulative effect of the application of the revenue recogni- tion policies set forth in SAB 101 for the year ended October 31, 2001, as restated, was approximately $5.2 million, net of tax benefit of approximately $3.5 million, or $0.15 per share.

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## Advertising The Company expenses advertising costs as incurred. Advertising expense for the years ended October 31, 2003, 2002 and 2001 amounted to $55,795, $39,909 and $22,983, respectively. ## Cash and Cash Equivalents The Company considers all highly liquid instruments purchased with original maturities of three months or less to be cash equivalents. ## Inventory Inventories are stated at the lower of average cost or market. The Company periodically evaluates the carrying value of its inventories and makes adjustments as necessary. Estimated product returns are included in the inventory balance at their cost. Estimated product returns at October 31, 2003 and 2002 were $8,706 and $5,015, respectively. ## Prepaid Royalties The Company’s agreements with licensors and developers gener- ally provide it with exclusive publishing rights and require it to make advance royalty payments that are recouped against royalties due to the developer based on product sales. Prepaid royalties are amor- tized as cost of sales on a title-by-title basis, based on the greater of the proportion of current year sales to total of current and estimated future sales for that title or the contractual royalty rate based on actual net product sales. The Company continually evaluates the recoverability of prepaid royalties and charges to cost of sales the amount that management determines is probable that will not be recouped at the contractual royalty rate in the period in which such determination is made or if the Company determines that it will can- cel a development project. Included in prepaid royalties at October 31, 2003 and 2002, respectively, are $14,241 and $22,561 related to titles that have not been released yet. Prepaid royalties are classified as current and non-current assets based upon estimated net product sales within the next year. The following table provides the details of total prepaid royalties: <img src='content_image/88304.jpg'> ## Notes to Consolidated Financial Statements (continued) ## TAKE-TWO INTERACTIVE SOFTWARE, INC. AND SUBSIDIARIES (Dollars in thousands, except per share amounts) The reclassification for the year ended October 31, 2003 principal- ly reflects the transfer of prepaid royalties paid to Angel Studios, Inc. and Frog City, Inc. prior to their acquisition by the Company as a component of the purchase price of the acquisitions. ## Capitalized Software Development Costs The Company capitalizes internal software development costs, as well as film production and other content costs, subsequent to estab- lishing technological feasibility of a title. Capitalized software develop- ment costs represent the costs associated with the internal develop- ment of the Company’s publishing products. Amortization of such costs as a component of cost of sales is recorded on a title-by-title basis, based on the greater of the proportion of current year sales to total of current and estimated future sales for the title or the straight-line method over the remaining estimated useful life of the title. The Com- pany continually evaluates the recoverability of capitalized software costs and will charge to cost of sales any amounts that are deemed unrecoverable or for projects that it will abandon. The following table provides the details of capitalized software development costs: <img src='content_image/88306.jpg'> For the year ended October 31, 2001, capitalized software development costs of $389 were written off as cost of sales—software development costs, as part of the impairment charge as described in Note 4. ## Property and Equipment Office equipment, furniture and fixtures and automobiles are depreciated using the straight-line method over their estimated lives ranging from five to seven years. Computer equipment and software are depreciated using the straight-line method over three years. Lease- hold improvements are amortized over the lesser of the term of the related lease or estimated useful lives. Accumulated amortization includes the amortization of assets recorded under capital leases, which amounted to approximately $88 and $92 at October 31, 2003 and 2002, respectively. The cost of additions and betterments is capi- talized, and repairs and maintenance costs are charged to operations in the periods incurred. When depreciable assets are retired or sold, the cost and related allowances for depreciation are removed from the accounts and the gain or loss is recognized. The carrying amounts of these assets are recorded at historical cost.

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## Intangible Assets Intangible assets consist of identifiable intangibles and the remain- ing excess purchase price paid over identified intangible and tangible net assets of acquired companies (goodwill). Effective November 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS 141”) in its entirety and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 141 requires all business combinations be accounted for using the purchase method of accounting and that certain intangible assets acquired in a business combination shall be recognized as assets apart from goodwill. SFAS 142 addresses the recognition and meas- urement of goodwill and other intangible assets subsequent to their acquisition. SFAS 142 provides that intangible assets with finite useful lives be amortized and that intangible assets with indefinite lives and goodwill not be amortized. The Company discontinued the amortiza- tion of goodwill as of November 1, 2001. Identifiable intangibles are amortized under the straight-line method over the period of expected benefit ranging from three to ten years, except for intellectual proper- ty, which is amortized based on the shorter of the useful life or expected revenue stream. Prior to November 1, 2001, intangible assets were amortized under the straight-line method over the period of expected benefit of seven years for the acquisition of development studios and ten years for the acquisition of distribution operations. Upon completion of the transitional impairment test, the fair value for each of our reporting units exceeded the reporting unit’s carrying amount and no impairment was indicated. SFAS 142 requires an annual test for impairment of goodwill, and between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. In assessing potential impairment of good- will, the Company determines the implied fair value of each reporting unit using discounted cash flow analysis and compares such values to the respective reporting unit’s carrying amount. The Company per- forms its annual test for indication of goodwill impairment in the fourth quarter of each fiscal year. At October 31, 2003 and 2002, the fair value of the Company’s reporting units exceeded the carrying amounts and no impairment was indicated. ## Impairment of Long-Lived Assets The Company accounts for long-lived assets in accordance with the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), which was adopted in the first quarter of fiscal 2003 with no material effect on the Company’s financial condition and results of operations. SFAS 144 requires that long-lived assets be reviewed for impairment whenever events or changes in circum- stances indicate that the carrying amount of an asset may not be recoverable, including assets to be disposed of by sale, whether pre- viously held and used or newly acquired. The Company compares the carrying amount of the asset to the estimated undiscounted future cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds estimated expected undiscounted future cash flows, the Company records an impairment charge for the differ- ence between the carrying amount of the asset and its fair value. The estimation of fair value is generally measured by discounting expect- ed future cash flows at the Company’s incremental borrowing rate or fair value if available. ## Stock-Based Compensation The Company accounts for its employee stock option plans in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Under APB 25, generally no compensation expense is recorded when the terms of the award are fixed and the exercise price of the employee stock option equals or exceeds the fair value of the underlying stock on the date of grant. The Company adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Had compensation cost for the Company’s stock option plans been determined based on the fair value at the grant date for awards consistent with the provisions of SFAS 123, the Company’s net income and the net income per share would have been reduced to the pro forma amounts indicated below. <img src='content_image/109667.jpg'> The pro forma disclosures shown are not representative of the effects on net income and the net income per share in future periods. Pro forma net income (loss) and net income (loss) per share for the years ended October 31, 2002 and 2001 also differ from amounts previously reported as a result of adjustments made to correct com- putational errors. The fair value of the Company’s stock options used to compute pro forma net income and the net income per share disclosures is the estimated present value at the grant date using the Black-Scholes option-pricing model. The weighted average fair values of options granted were $15.05, $9.13 and $5.76 for the years ended October 31, 2003, 2002 and 2001, respectively. The following weighted aver- age assumptions for 2003 were used to value grants: expected volatility of 78%; a risk-free interest rate of 2.60%; and an expected

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holding period of 4.2 years. The following weighted average assump- tions for 2002 were used to value grants: expected volatility of 74%; a risk-free interest rate of 1.77%; and an expected holding period of 4.1 years. The following weighted average assumptions for 2001 were used to value grants: expected volatility of 85% for grants with a holding period of 2 years, 79% for a holding period of 3 years and 75% for holding periods of 4 to 5 years; a risk-free interest rate of generally 4.85% to 5.0%; and an expected holding period of two to five years. Dividends were assumed to be zero for the years ended October 31, 2003, 2002 and 2001. ## Net Income (Loss) per Share Basic earnings per share (“EPS”) is computed by dividing the net income (loss) applicable to common stockholders for the year by the weighted-average number of common shares outstanding during the year. Diluted EPS is computed by dividing the net income (loss) appli- cable to common stockholders for the year by the weighted-average number of common and common stock equivalents, which include common shares issuable upon the exercise of stock options, restricted stock (for fiscal 2003) and warrants outstanding during the year. Common stock equivalents are excluded from the computation if ## Comprehensive Income (Loss) Comprehensive income (loss) includes net income adjusted for the change in foreign currency translation adjustments and the change in net unrealized gain (loss) from investments. ## Income Taxes The Company recognizes deferred taxes under the asset and lia- bility method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for differences between the financial statement and tax bases of assets and liabilities at currently enacted statutory tax rates for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expect- ed to be realized after considering tax planning strategies, if applica- ble. No income taxes have been provided on the undistributed earnings of foreign subsidiaries, as such earnings are expected to be permanently reinvested in those companies. ## Foreign Currency Translation The functional currency for the Company’s foreign operations is the applicable local currency. Accounts of foreign operations are translated into U.S. dollars using quarter or year-end exchange rates for assets and liabilities at the balance sheet date and average pre- vailing exchange rates for the period for revenue and expense accounts. Adjustments resulting from translation are included in other comprehensive income (loss). Realized and unrealized transaction gains and losses are included in income in the period in which they occur. Foreign exchange transaction gains (loss) included in net income for fiscal years ended October 31, 2003, 2002 and 2001 amounted to $2,015, $840 and $(108), respectively. ## Fair Value of Financial Instruments The carrying amounts of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximates fair value because of their short maturities. Investments are reported at fair value. The carrying amount of prepaid royalties approximates fair value based upon the recoverability of these assets. The carrying amount of the Company’s lines of credit approximates fair value because the interest rates of the lines of credit are based on floating rates identified by reference to market rates. The carrying amounts of the Company’s loan payable and capital lease obligations approximate the fair value of such instruments based upon management’s best estimate of inter- est rates that would be available to the Company for similar debt obligations. ## Consideration Given to Customers or Resellers In November 2001, the Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force (EITF) reached a consensus on EITF Issue 01-09, “Accounting for Consideration Given by a Vendor to a Customer or Reseller of the Vendor’s Products,” which is a codifi- cation of EITF 00-14, 00-22 and 00-25. This EITF presumes considera- tion from a vendor to a customer or reseller of the vendor’s products to be a reduction of the selling prices of the vendor’s products and, therefore, should be characterized as a reduction of revenue when recognized in the vendor’s income statement and could lead to nega- tive revenue under certain circumstances. Revenue reduction is required unless consideration relates to a separate identifiable benefit and the benefit’s fair value can be established. The Company has early adopted EITF 01-09 effective November 1, 2001. The adoption of the new standard did not have a material impact on the consolidat- ed financial statements. The prior period financial statements have been reclassified in accordance with this statement and as a result, net sales and selling and marketing expenses have been reduced by $2,255 for the year ended October 31, 2001, with no impact on reported net loss. ## Recently Adopted Accounting Pronouncements In August 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 143, “Accounting for Obligations Associated with the Retirement of Long-Lived Assets” (“SFAS 143”). The objective of SFAS 143 is to provide accounting guidance for legal obligations associated with the retirement of long-lived assets. The provisions of SFAS 143 are effec- tive for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of SFAS 143 in the first quarter of fiscal 2003 did not have an impact on the Company’s financial condition, cash flows and results of operations. In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment to FASB Statement No. 13, and Technical Corrections” (“SFAS 145”). SFAS 145 eliminates the requirement (in SFAS 4) that gains and losses from the extinguishments of debt be aggregated and classified as extraordinary items, net of the related income tax.

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Under this pronouncement, the $1,948 net loss on extinguishment of debt for the year ended October 31, 2001, previously classified as an extraordinary item, has been reclassified as follows: $3,165 of loss on extinguishment to non-operating expenses and $1,217 of tax ben- efit to provision for income taxes. The adoption of SFAS 145 in fiscal 2003 did not have any impact on the Company’s financial condition, cash flows and results of operations, other than the reclassification referred to above. In January 2002, the FASB issued Statement of Financial Account- ing Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 requires the recognition of such costs when they are incurred rather than at the date of a com- mitment to an exit or disposal plan. The provisions of SFAS 146 are to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The adoption of SFAS 146 in the first quarter of fiscal 2003 did not have a material impact on the Company’s financial condition and results of operations. In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Com- pensation—Transition and Disclosure” (“SFAS 148”). SFAS 148 amends the transition provisions of FASB No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), for entities that voluntarily change to the fair value method of accounting for stock-based employee compensation. The Company does not currently intend to change its accounting to the fair value method. SFAS 148 also amends the disclosure provisions of SFAS 123 to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation, and amends APB Opinion No. 28, “Interim Financial Reporting” to require disclosures about such effects in interim financial information. The disclosure provisions of the amendments to FASB 123 were adopted by the Company in the second quarter of fiscal 2003. In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guaran- tees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 expands previously issued accounting guidance and dis- closure requirements for certain guarantees and requires recognition of an initial liability for the fair value of an obligation assumed by issu- ing a guarantee. The provision for initial recognition and measure- ment of liability will be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 in the first quarter of fiscal 2003 did not have any impact on the Com- pany’s financial condition or results of operations. In January 2003, the FASB issued Interpretation No. 46, “Consoli- dation of Variable Interest Entities” (“FIN 46”). FIN 46 requires a vari- able interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual return or both. FIN 46 also provides criteria for determining whether an entity is a variable interest entity subject to consolidation. FIN 46 requires immediate consolidation of variable interest entities created after January 31, 2003. For variable interest entities created prior to February 1, 2003, consolidation is required on July 1, 2003. The adoption of FIN 46 in the third quarter of fiscal 2003 did not have a material impact on the Company’s financial condition or results of operations (see Note 4). In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 149”). SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” In general, SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging rela- tionships designated after June 30, 2003. The adoption of SFAS 149 did not have any impact on the Company’s financial condition or results of operations. In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with SFAS 150, financial instruments that embody obligations for the issuer are required to be classified as lia- bilities. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003, except for the provisions relating to mandatorily redeemable financial instruments which have been deferred indefinitely. The adoption of SFAS 150 in the fourth quarter of fiscal 2003 did not have any impact on the Company’s financial condition. ## 4. BUSINESS ACQUISITIONS AND CONSOLIDATION The Company acquired seven companies that develop, publish or distribute interactive software games during the three-year period ended October 31, 2003. The aggregate purchase price, including cash payments and issuance of its common stock, was $42,075, $7,626 and $28,143 in 2003, 2002 and 2001, respectively. The value of the Company’s common stock issued in connection with these acquisitions has been based on the market price of the Company’s common stock at the time such proposed transactions were agreed and announced. The acquisitions described below have been accounted for as purchase transactions in accordance with APB No. 16 and SFAS 141 (for transactions after July 1, 2001) and, accordingly, the results of operations and financial position of the acquired businesses are included in the Company’s consolidated financial statements from the respective dates of acquisition. ## 2003 Transactions During the quarter ended July 31, 2003, the Company acquired the assets of Frog City, Inc. (“Frog City”), the developer of Tropico 2: Pirate Cove , and the outstanding membership interests of Cat Daddy Games LLC (“Cat Daddy”), another development studio. The total purchase price for both studios consisted of $757 in cash and $319 of prepaid royalties previously advanced to Frog City. The Company also

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agreed to make additional payments of up to $2,500 to the former owners of Cat Daddy, based on a percentage of Cat Daddy’s profits for the first three years after acquisition, which will be recorded as compensation expense if the targets are met. In connection with the acquisitions, the Company recorded goodwill of $1,267 and net liabilities of $191. In November 2002, the Company acquired all of the outstanding capital stock of Angel Studios, Inc. (“Angel”), the developer of the Midnight Club and Smuggler’s Run franchises. The purchase price consisted of 235,679 shares of restricted common stock (valued at $6,557), $28,512 in cash and $5,931 (net of $801 of royalties payable to Angel) of prepaid royalties previously advanced to Angel. In con- nection with the acquisition, the Company recorded identifiable intan- gibles of $4,720 (comprised of intellectual property of $2,810, tech- nology of $1,600 and non-competition agreements of $310), goodwill of $37,425 and net liabilities of $1,145. In April 2003, the Company entered into an agreement with Desti- neer Publishing Corp. (“Destineer”), a publisher of PC games, under which Destineer granted the Company exclusive distribution rights to eight PC games and two console ports to be published by Destineer. The Company agreed to make recoupable advances to Destineer of approximately $6,700 and to pay Destineer with respect to product sales under the distribution agreement. In addition, the Company agreed to make a loan to Destineer of $1,000. Destineer granted the Company an immediately exercisable option to purchase a 19.9% interest in Destineer and a second option to purchase the remaining interest for a price equal to a multiple of Destineer’s EBIT, exercisable during a period following April 2005. The fair value of these options was not significant. Pursuant to the requirements of FIN 46, since Destineer is a variable interest entity and the Company is considered to be the primary beneficiary (as defined in FIN 46), the results of Destineer’s operations have been consolidated in the accompanying financial statements. The 2003 acquisitions did not have a material effect on the Company’s fiscal 2003 results of operations. ## Notes to Consolidated Financial Statements (continued) ## TAKE-TWO INTERACTIVE SOFTWARE, INC. AND SUBSIDIARIES (Dollars in thousands, except per share amounts) ## 2002 Transaction In August 2002, the Company acquired all of the outstanding capital stock of Barking Dog Studios Ltd. (“Barking Dog”), a Canadian-based development studio. The purchase price consisted of 242,450 shares of restricted common stock (valued at $3,801), $3,000 in cash, $825 of prepaid royalties previously advanced to Barking Dog and assumed net liabilities of $70. In connection with the acquisition, the Company recorded identifiable intangibles of $1,800, comprised of non-competi- tion agreements of $1,600 and intellectual property of $200, and good- will of $6,772. The acquisition of Barking Dog did not have a significant effect on the Company’s fiscal 2002 results of operations. ## 2001 Transactions In July 2001, the Company acquired all of the outstanding capital stock of Techcorp Limited (“Techcorp”), a Hong Kong-based design and engineering firm specializing in video game accessories. In con- sideration, the Company issued 30,000 shares of the Company’s restricted common stock (valued at $572), paid $100 in cash and assumed net liabilities of approximately $2,856. In connection with the acquisition, the Company recorded goodwill of $3,558. In November 2000, the Company acquired all of the outstanding capital stock of VLM Entertainment Group, Inc. (“VLM”), a company engaged in the distribution of third-party software products. In connection with this transaction, the Company paid the former stock- holders of VLM $2,000 in cash and issued 875,000 shares of the Company’s common stock (valued at $8,039) and assumed net liabili- ties of approximately $10,627. In connection with this transaction, the Company recorded intangible assets of approximately $20,693. In connection with the sale of a subsidiary to Gameplay.com plc (“Gameplay”) in October 2000, the Company agreed to acquire Gameplay’s game software development and publishing business, Neo Software Produktions GMBH (“Neo”). Such acquisition was completed in January of 2001 and the Company assumed net liabili- ties of $808, in addition to the prepaid purchase price of $17,266. In connection with the acquisition, the Company recorded goodwill and intangibles of $18,183. <img src='content_image/6863.jpg'>

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<img src='content_image/8537.jpg'> As a result of these factors, Take-Two is in the strongest financial and operational position in its history. For fiscal 2003, Take-Two’s revenues exceeded $1 billion, with net income of $98 million – a nearly 40 percent increase over fiscal 2002. The Company ended the fiscal year with $183 million in cash, a compelling achieve- ment, resulting from the tireless efforts of Take-Two’s global workforce. From our 500-plus development team to our employees working to fulfill customer orders at our distribution facilities, Take- Two generated revenues of about $900,000 per employee in 2003. Take-Two’s distinctive strength lies in our ability to create outstanding products that set – and then exceed – industry stan- dards. Rockstar’s 2002 holiday release of Grand Theft Auto: Vice City is still the measure by which all other games are judged. Based on a comparison of avail- able industry estimates – March 2004 NPD Funworld data for domestic video games sales estimates and March 2004 Variety estimates for gross domestic box office pro- ceeds – Grand Theft Auto: Vice City would rank as the 22nd top grossing movie of all time, with Grand Theft Auto III ranking 27th on this list. Grand Theft Auto: Vice City and Grand Theft Auto III have sold more than 22 million copies globally, with sales of over 30 million units for the entire Grand Theft Auto franchise. Rockstar recently announced the next addition to the Grand Theft Auto dynasty, Grand Theft Auto: San Andreas , scheduled for an October 2004 launch. ## Gathering Gathering publishes premium and mid-priced products on PC, console and handheld plat- forms. Gathering’s critically acclaimed franchis- es include Mafia , Railroad Tycoon , Hidden & Dangerous , Tropico and Stronghold . Based in New York City, Gathering works with internally owned development studios as well as top independent development studios worldwide. <img src='content_image/8544.jpg'>

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Certain of Neo’s Internet-related technology assets were deter- mined to be impaired in April 2001. Accordingly, the Company recorded as cost of sales an impairment charge of $3,786, consisting of $2,350 relating to server maintenance technologies and $1,047 relating to multiplayer technologies developed by Neo’s development studio in connection with Online Pirates and $389 of capitalized soft- ware relating to other products to be developed by Neo. In addition, the Company recorded as selling and marketing expenses an impair- ment charge of $401 related to online sales promotions. Pro forma financial information for fiscal 2003 and 2002 acquisi- tions is not presented since the impact is not material. The unaudited pro forma data below for the year ended October 31, 2001 is pre- sented as if purchase acquisitions for fiscal 2001 had been made as of November 1, 2000. The unaudited pro forma financial information is based on management’s estimates and assumptions and does not purport to represent the results that actually would have occurred if the acquisitions had, in fact, been completed on the date assumed, or which may result in the future. <img src='content_image/38937.jpg'> Included in the unaudited pro forma information is amortization of goodwill of approximately $7,320, net of taxes of $2,799, for the year ended October 31, 2001. ## 5. DISPOSITION OF ASSETS In July 2001, the Company sold all of the outstanding capital stock of Jack of All Games UK, a video game distributor, to Jay Two Limited, an unaffiliated third party controlled by Freightmasters Ltd., for approximately $215. In connection with the sale, the purchaser assumed net liabilities of $436. The Company recorded a non-operat- ing gain of $651. There were no income taxes payable on this gain. ## 6. INTANGIBLE ASSETS AND GOODWILL As a result of the adoption of SFAS 142, the Company discontin- ued the amortization of goodwill effective November 1, 2001. Identifi- able intangible assets are amortized under the straight-line method over the period of expected benefit ranging from three to ten years, except for intellectual property, which is amortized based on the shorter of the useful life or expected revenue stream. The Company re-characterized acquired workforce of $925, which is not defined as an acquired intangible asset under SFAS 141, as goodwill. Additional- ly, the estimated useful lives of certain identifiable intangible assets were adjusted in conjunction with the adoption of SFAS 142. The adjustment to the useful lives did not have a material effect on the results of operations. Intangible assets consist of trademarks, intellectual property, cus- tomer lists and acquired technology. The excess purchase price paid over identified intangible and tangible net assets of acquired compa- nies is reported separately as goodwill. During the year ended October 31, 2003, the Company acquired all the intellectual property rights associated with Army Men and School Tycoon for an aggregate cost of $1,075. In May 2002, the Company acquired all rights, title and interest to the Max Payne product franchise, including all of the intellectual property rights associated with the brand, and a perpetual, royalty- free license to use the Max Payne game engine and related technolo- gy. The purchase price consisted of $10,000 in cash and 969,932 shares of restricted common stock (valued at $18,543). In October 2003, the Company recorded an additional intangible of $8,000, of which $1,000 related to the delivery of the final version of Max Payne 2 for the PC and $7,000 based on the determination that the sales targets for the PC and console versions of Max Payne would be achieved. The Max Payne assets acquired have been recorded as intellectual property and included in intangible assets. In December 2000, the Company acquired the exclusive world- wide publishing rights to the franchise of Duke Nukem PC and video games. In connection with the transaction, the Company paid $2,300 in cash and issued 557,103 shares of its common stock (valued at approximately $5,400). In addition, the Company is required to make a further payment of $6,000 contingent upon delivery of the final ver- sion of Duke Nukem Forever for the PC. The Company recorded an intangible asset of $7,700 related to the intellectual property pur- chased in this transaction. The additional $6,000 will be recorded as an additional intangible asset upon resolution of the contingency. In 2003, the Company recorded a charge of $4,407 related to the impairment of a customer list, which was included in depreciation and amortization (see Note 20). In addition, cost of sales—product costs include $7,892 of intellectual property and technology written off in 2003, of which $5,499 related to Duke Nukem Forever and its sequel, reflecting the continued development delays for these products.

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## Notes to Consolidated Financial Statements (continued) (Dollars in thousands, except per share amounts) The following table sets forth the components of the intangible assets subject to amortization as of October 31, 2003 and 2002: <img src='content_image/21620.jpg'> Amortization expense (including goodwill for 2001) for the years ended October 31, 2003, 2002 and 2001 amounted to $11,600, $9,893 and $9,309, respectively. Estimated amortization expense for the fiscal years ending October 31 is as follows: <img src='content_image/21626.jpg'> The following table provides a reconciliation of net income for exclusion of goodwill amortization: The change in goodwill for the fiscal year ended October 31, 2003 is as follows: <img src='content_image/21627.jpg'> The addition to goodwill in 2002 was the $5,496 related to the Barking Dog acquisition. <img src='content_image/21628.jpg'>

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## 7. INVESTMENTS Investments are comprised of marketable equity securities and are classified as current and non-current assets. The investments are accounted for under the cost method as “available-for-sale” in accor- dance with Statement of Financial Standards No. 115 “Accounting for Certain Investments in Debt and Equity Securities.” The investments are stated at fair value, with unrealized appreciation (loss) reported as a separate component of accumulated other comprehensive income (loss) in stockholders’ equity. For the fiscal years ended October 31, 2003 and 2002, the gross proceeds from the sale of investments were $114 and $6,170, respec- tively. The gross realized gain from these sales totaled $39 and $181, respectively. The gain/loss on sale of securities is based on the aver- age cost of the individual securities sold. During 2001, the Company recorded an impairment charge of $21,477, consisting of approximately $19,171 relating to its invest- ment in Gameplay, $2,000 relating to its investment in eUniverse, Inc. based on the quoted market prices and $306 relating to its invest- ment in a privately held company, which is included in other non- current assets. All of these investments were deemed to be other than temporarily impaired. ## 8. INVENTORIES As of October 31, 2003 and 2002, inventories consist of: <img src='content_image/8749.jpg'> ## 9. FIXED ASSETS As of October 31, 2003 and 2002, fixed assets consist of: <img src='content_image/8746.jpg'> In 2003 and 2002, the Company capitalized costs of approximately $2,923 and $4,113, respectively, associated with software and hard- ware upgrades to its accounting systems. Depreciation expense for the years ended October 31, 2003, 2002, and 2001 amounted to $9,510, $6,457 and $3,731, respectively. ## 10. LINES OF CREDIT In December 1999, the Company entered into a credit agreement, as amended and restated in August 2002, with a group of lenders led by Bank of America, N.A., as agent. The agreement provides for bor- rowings of up to $40,000 through the expiration of the line of credit on August 28, 2005. Generally, advances under the line of credit are based on a borrowing formula equal to 75% of eligible accounts receivable plus 35% of eligible inventory. Interest accrues on such advances at the bank’s prime rate plus 0.25% to 1.25%, or at LIBOR plus 2.25% to 2.75% depending on the Company’s consolidated leverage ratio (as defined). The Company is required to pay a com- mitment fee to the bank equal to 0.5% of the unused loan balance. Borrowings under the line of credit are collateralized by the Compa- ny’s accounts receivable, inventory, equipment, general intangibles, securities and other personal property, including the capital stock of the Company’s domestic subsidiaries. Available borrowings under the agreement are reduced by the amount of outstanding letters of cred- it, which was $9,290 at October 31, 2003. The loan agreement con- tains certain financial and other covenants, including the maintenance of consolidated net worth, consolidated leverage ratio and consoli- dated fixed charge coverage ratio. As of October 31, 2003, the Com- pany was in compliance with such covenants. The loan agreement limits or prohibits the Company from declaring or paying cash divi- dends, merging or consolidating with another corporation, selling assets (other than in the ordinary course of business), creating liens and incurring additional indebtedness. The Company had no out- standing borrowings under the revolving line of credit as of October 31, 2003 and 2002. In February 2001, the Company’s United Kingdom subsidiary entered into a credit facility agreement, as amended in March 2002, with Lloyds TSB Bank plc (“Lloyds”) under which Lloyds agreed to make available borrowings of up to approximately $22,200. Advances under the credit facility bear interest at the rate of 1.25% per annum over the bank’s base rate, and are guaranteed by the Company. Avail- able borrowings under the agreement are reduced by the amount of outstanding guarantees. The facility expires on March 31, 2004. The Company had no outstanding guarantees or borrowings under this facility as of October 31, 2003 and 2002. ## 11. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities as of October 31, 2003 and 2002 consist of: <img src='content_image/8745.jpg'>

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## 12. LOSS ON EARLY EXTINGUISHMENT OF DEBT In July 2000, the Company entered into a subordinated loan agreement with Finova Mezzanine Capital Inc. in the principal amount of $15 million. The loan was payable in full in July 2005, and bore interest at the rate of 12.5% per annum. In July 2001, the Company prepaid the outstanding subordinated loan and recorded a loss of $3,165 related to the deferred financing costs and the unamortized discount associated with the loan. ## 13. COMMITMENTS AND CONTINGENCIES ## Capital Leases The Company leases equipment under capital lease agreements, which extend through fiscal year 2006. Future minimum lease pay- ments under these capital leases, and the present value of such payments as of October 31, 2003 are as follows: <img src='content_image/45436.jpg'> ## Lease Commitments The Company leases 33 office and warehouse facilities. The former corporate headquarters are leased under a non-cancelable operating lease with a company controlled by the father of the chairman of the board and expires in March 2004. Rent expense and certain utility expenses under this lease amounted to $444, $403 and $474, for the years ended October 31, 2003, 2002, and 2001, respec- tively. The other offices are under non-cancelable operating leases expiring at various times from December 2003 to October 2013. In addition, the Company has leased certain equipment, furniture and auto lease under non-cancelable operating leases which expire through October 2007. In September 2002, the Company relocated its principal executive offices to 622 Broadway, New York, New York. The Company has recently leased additional space at 622 Broadway to accommodate its expanded operations. The Company estimates that as of October 31, 2003 it will incur an additional $1,200 in capital expenditures for con- tinuing renovations and leasehold improvements for this space. In connection with signing a ten year lease, the Company provided a standby letter of credit of $1,560, expiring December 31, 2003. As a result of the relocation, the Company recorded expenses of $363 and $514 in fiscal 2003 and 2002, respectively, related to lease costs with regard to the Company’s former executive offices. ## Notes to Consolidated Financial Statements (continued) (Dollars in thousands, except per share amounts) Year ending October 31: Future minimum rentals required as of October 31, 2003 are as follows: <img src='content_image/45439.jpg'> Rent expense amounted to $7,445, $5,090 and $3,353, for the years ended October 31, 2003, 2002, and 2001, respectively. The Company received a Wells Notice from the Staff of the Securities and Exchange Commission stating the Staff’s intention to recommend that the SEC bring a civil action seeking an injunction and monetary damages against the Company alleging that it violated certain provisions of the federal securities laws. The proposed allegations stem from the previously disclosed SEC investigation into certain accounting matters related to the Company’s financial state- ments, periodic reporting and internal accounting controls. The Company’s Chairman, an employee and two former officers also received Wells Notices. The Company has entered into discussions with the Staff to address the issues raised in the Wells Notice. The SEC’s Staff also raised issues with respect to the Company’s revenue recognition policies and its impact on its current and historical finan- cial statements. The Company is unable to predict the outcome of these matters. The Company is involved in routine litigation in the ordinary course of its business, which in management’s opinion will not have a material adverse effect on the Company’s financial condition, cash flows or results of operations. ## Other The Company periodically enters into distribution agreements to purchase various software games that require the Company to make minimum guaranteed payments. These agreements, which expire between June 2, 2004 and March 22, 2005, require remaining aggre- gate minimum guaranteed payments of $14,330 at October 31, 2003, including $3,491 of payments due pursuant to an agreement with TDK Mediactive, Inc. (“TDK”). These agreements are collateralized by a standby letter of credit of $3,600 at October 31, 2003. Additionally, assuming performance by third-party developers, the Company has outstanding commitments under various software development agreements to pay developers an aggregate of $27,224 during fiscal 2004. The Company also expects to spend an additional $4,000 in connection with the implementation of accounting software systems for its international operations and the upgrade for its domestic operations. Year ending October 31:

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Additionally, in connection with the Company’s acquisition of the publishing rights to the franchise of Duke Nukem PC and video games in December 2000, the Company is contingently obligated to pay $6,000 in cash upon delivery of the final version of Duke Nukem Forever for the PC. In May 2003, the Company agreed to make pay- ments of up to $6,000 in cash upon the achievement of certain sales targets for Max Payne 2 . The Company also agreed to make addition- al payments of up to $2,500 to the former owners of Cat Daddy based on a percentage of Cat Daddy’s future profits for the first three years after acquisition. See Note 4. The payables will be recorded when the conditions requiring their payment are met. ## 14. EMPLOYEE SAVINGS PLAN The Company maintains a 401(k) retirement savings plan and trust (the “401(k) Plan”). The 401(k) Plan is offered to all eligible employees and participants may make voluntary contributions. The Company did not match employee contributions during the year ended October 31, 2001. The Company began matching contributions in July 2002. The matching contribution expense incurred by the Company during the years ended October 31, 2003 and 2002 was $384 and $95, respectively. ## 15. INCOME TAXES The Company is subject to foreign income taxes in certain coun- tries where it does business. Domestic and foreign income (loss) before income taxes and cumulative effect of change in accounting principle is as follows: <img src='content_image/63565.jpg'> Income tax expense (benefit) is as follows: <img src='content_image/63566.jpg'> The differences between the provision for income taxes and the income tax computed using the U.S. statutory federal income tax rate to pretax income are as follows: <img src='content_image/63570.jpg'> The components of the net deferred tax asset as of October 31, 2003 and 2002 consist of the following: <img src='content_image/63571.jpg'> At October 31, 2003 and October 31, 2002, the Company had capital loss carryforwards totaling approximately $21,000. The capital loss carryforwards will expire in the periods fiscal 2006 through fiscal 2008. Failure to achieve sufficient levels of taxable income from capi- tal transactions will affect the ultimate realization of the capital loss carryforwards. At October 31, 2002 management had a strategy of

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selling net appreciated assets of the Company to the extent required to generate sufficient taxable income prior to the expiration of these benefits. At October 31, 2003, based on management’s future plans, this strategy was no longer viable, and accordingly a valuation allowance has been recorded for this asset as it is more likely than not that the deferred tax asset related to these carryforwards will not be realized. At October 31, 2003, the Company had foreign net operat- ing losses of $9,800 expiring between 2005 and 2010 and state net operating losses of $41,700 expiring between 2021 and 2023. Limita- tions on the utilization of these losses may apply, and accordingly val- uation allowances have been recorded for these assets. The total amount of undistributed earnings of foreign subsidiaries was approximately $60,700 and $41,900 for the years ended October 31, 2003 and 2002, respectively. It is the Company’s intention to rein- vest undistributed earnings of its foreign subsidiaries and thereby indefinitely postpone their remittance. Accordingly, no provision has been made for foreign withholding taxes or United States income tax- es which may become payable if undistributed earnings of foreign subsidiaries were paid as dividends to the Company. ## 17. COMPREHENSIVE INCOME The components of and changes in accumulated other comprehensive income (loss) are: ## Notes to Consolidated Financial Statements (continued) (Dollars in thousands, except per share amounts) ## 16. STOCKHOLDERS’ EQUITY In July 2001, the Company issued 1,300,000 shares of common stock in a private placement to institutional investors and received proceeds of $20,892, net of $1,400 of selling commissions and offer- ing expenses. In February 2001, certain stockholders of the Company exchanged and surrendered for cancellation 564,212 shares of the Company’s common stock (valued at $7,310) for shares of Gameplay having an equal value. In February 2002, the Company issued 20,000 shares of restricted common stock to a former employee in connection with a separation agreement. In January 2003, the Board of Directors authorized a stock repur- chase program under which the Company may repurchase up to $25,000 of its common stock from time to time in the open market or in privately negotiated transactions. The Company has not repur- chased any shares under this program. In November 2003, at a special meeting, the Company’s stock- holders voted to amend the certificate of incorporation to increase the Company’s authorized shares of common stock from 50,000,000 to 100,000,000. <img src='content_image/128943.jpg'> The taxes in the above table relate to the changes in the net unrealized gain (loss) on investments. The foreign currency adjustments are not adjusted for income taxes as they relate to indefinite investments in non-U.S. subsidiaries. ## 18. INCENTIVE PLANS ## Incentive Stock Plan The Incentive Stock Plan (“Incentive Plan”), adopted by the Board of Directors on June 12, 2003, allows the granting of restricted stock, deferred stock and other stock-based awards of the Company’s com- mon stock to directors, officers and other employees of the Company. A maximum of 500,000 shares are available for distribution under the Incentive Plan. As of October 31, 2003, 285,000 shares of restricted common stock have been granted under the Incentive Plan. The cost of the restricted shares granted is expensed over the vesting period. The Incentive Plan is administered by the Compensation Committee of the Board of Directors. ## Stock Option Plans In June 2002, the stockholders of the Company approved the Company’s 2002 Stock Option Plan, as previously adopted by the Company’s Board of Directors (the “2002 Plan”), pursuant to which officers, directors, employees and consultants of the Company may receive stock options to purchase up to an aggregate of 3,000,000 shares of common stock. In April 2003, the stockholders approved an increase in the aggregate amount of shares to 4,000,000 shares. In January 1997, the stockholders of the Company approved the Company’s 1997 Stock Option Plan, as amended, as previously adopted by the Company’s Board of Directors (the “1997 Plan”), pur- suant to which officers, directors, employees and consultants of the Company may receive options to purchase up to an aggregate of 6,500,000 shares of the Company’s common stock.

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Subject to the provisions of the plans, the Board of Directors or any Committee appointed by the Board of Directors has the authority to determine the individuals to whom the stock options are to be granted, the number of shares to be covered by each option, the option price, the type of option, the option period, restrictions, if any, on the exercise of the option, the terms for the payment of the option price and other terms and conditions. As of April 30, 2002, there were no options available for grant under the 1997 Plan. As of October 31, 2003 and 2002, the plans had outstanding stock options for an aggregate of 3,066,000 and 2,764,000 shares of the Company’s common stock, respectively, vesting at various times from 1998 to 2006 and expiring at various times from 2002 to 2007. Options granted generally vest over a period of three to five years. ## Non-Plan Stock Options As of October 31, 2003 and 2002, there are non-plan stock options outstanding for an aggregate of 1,503,000 and 2,931,000 shares of the Company’s common stock, respectively, vesting from 1999 to 2006 and expiring at various times from 2003 to 2007. For those options with exercise prices less than fair value of the underlying shares at the measurement date, the difference is recorded as deferred compensation and is amortized over the vesting period. Compensation expense for the years ended October 31, 2003, 2002, and 2001 was approximately $26, $1,976 and $5, respectively. The following table summarizes the activity in options under the plans, inclusive of non-plan options: <img src='content_image/62106.jpg'> At October 31, 2003 and 2002, the number of options exercisable are 1,389,000 and 3,014,000, respectively, and their related weighted average exercise prices are $15.09 and $12.56, respectively. The following summarizes information about stock options outstanding and exercisable at October 31, 2003: <img src='content_image/62107.jpg'>

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## 19. RESULTS BY QUARTER (UNAUDITED) ## Notes to Consolidated Financial Statements (continued) (Dollars in thousands, except per share amounts) The following tables set forth restated quarterly supplementary data for each of the years in the two-year period ended October 31, 2003. The unaudited quarterly results of operations for each of the quarters in the fiscal year ended October 31, 2002 and for each of the three quarters in the period ended July 31, 2003 have been restated for the revised revenue recognition policy related to the change in the method of accounting for price concessions identified in Note 2. <img src='content_image/61419.jpg'> <img src='content_image/61418.jpg'> The following table summarizes the increase (decrease) in the results of operations for the reported 2003 and 2002 fiscal quarters as a result of the restatement discussed above: <img src='content_image/61417.jpg'>

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<img src='content_image/86297.jpg'> (1) The net sales reclassification represents freight income previously recorded as a reduction to product costs. The quarter ended October 31, 2002 also reflects a reclassification of $358 from depreciation and amortization to product costs. ## 20. CONSOLIDATION OF DISTRIBUTION FACILITIES In January 2003, based on management’s strategy to consolidate the Company’s distribution business, and after taking into account the relative cost savings involved, the Company closed its warehouse operations in Ottawa, Illinois and College Point, New York. Operations at these warehouses ceased by January 31 and the business conducted there was consolidated with the operations of the Company’s Jack of All Games distribution facility in Ohio. As a result of the closures, the Company recorded a charge of $7,028. The charge consisted of: (1) lease termination costs, representing the fair value of remaining lease payments, net of estimated sublease rent; (2) disposition of fixed assets, representing the net book value of fixed assets and leasehold improvements; (3) other exit costs; and (4) an impairment charge with respect to an intangible asset, representing a customer list relating to the business conducted at the Illinois facility. These costs are included in general and administrative expense for the year ended October 31, 2003, except for the intangibles impairment which is included in depreciation and amortization expense, and are summarized in the table below: <img src='content_image/86298.jpg'>

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## 21. SEGMENT INFORMATION The Company has adopted Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”), which established standards for reporting by public business enterprises of information about product lines, geographical areas and major customers. The method for determining what information to report is based on the way man- agement organizes the Company for making operational decisions and assessment of financial performance. The Company’s chief oper- ating decision maker is considered to be the Company’s Chief Execu- tive Officer (“CEO”). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about sales by geographic region and by product platforms. The Company’s Board of Directors reviews consolidated financial informa- tion. The Company’s operations employ the same products and types of customers worldwide. The Company’s product development, pub- lishing and marketing activities are centralized in the United States under one management team, with distribution activities managed geographically. Accordingly, the Company’s operations fall within one reportable segment as defined in SFAS 131. For the years ended October 31, 2003, 2002, and 2001, the Com- pany’s net sales in domestic markets accounted for approximately 72.1%, 80.0% and 76.4%, respectively, and net sales in international markets accounted for 27.9%, 20.0% and 23.6%, respectively. As of October 31, 2003 and 2002, the Company’s net property, plant and equipment in domestic markets accounted for approxi- mately $13,789 and $11,222, respectively, and net property, plant and equipment in international markets accounted for $8,471 and $4,097, respectively. Information about the Company’s total non-current assets in the United States and international areas as of October 31, 2003 and 2002 is presented below: <img src='content_image/40542.jpg'> ## Notes to Consolidated Financial Statements (continued) (Dollars in thousands, except per share amounts) Information about the Company’s net sales in the United States and international areas for the years ended October 31, 2003, 2002 and 2001 is presented below (net sales are attributed to geographic areas based on product destination): <img src='content_image/40544.jpg'> Information about the Company’s net sales by product platforms for the years ended October 31, 2003, 2002 and 2001 is presented below: <img src='content_image/40543.jpg'>

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<img src='content_image/23.jpg'> ## Global Star Global Star Software publishes value-priced entertainment software across all platforms. Cor Global Star franchises include the hit Outlaw sports series (under license from MTV);the Tycoon franchise, including School Tycoon , Airport Tycoon 3 and Mall Tycoon 2 ; Motocr oss Mania ; and Army Men . In addition to original content, Global Star manages the jewel case and value compilation business for all Take-T wo PC products. While the success of the Grand Theft Auto franchise is extremely rewarding, creating a blockbuster of this magnitude also affords Take-Two an invaluable base of knowledge and expertise. During fiscal 2003, Take-Two took significant steps to share and leverage internal resources and experiences to create a more integrated and seamless publishing operation. Our Rockstar Games, Gathering and Global Star Software publishing labels have been streamlined to tap Rockstar’s knowledge, <img src='content_image/18.jpg'> attention to detail and ability to recognize what makes games compelling. Rockstar’s unique market position is com- plemented by Gathering’s focus on pub- lishing premium and mid-priced products on PC, console and handheld platforms. We firmly believe demand for our premi- um priced games such as Grand Theft Auto, Max Payne, Midnight Club, Manhunt, and Mafia will continue to grow as the installed base of video game plat- forms increases – creating more con- sumers for our products. Additionally, with gradual reductions in hardware pricing and the resulting increased penetration of video game plat- forms, there is a much greater opportuni- ty to attract a more diverse and, at times, price conscious gamer. Jack of All Games’ success in distributing budget- priced titles has proven that the value segment of the software market is a desir- able long-term business. Accordingly, our Global Star label is publishing games that combine value pricing with compelling game play and is distributing these titles exclusively through Jack of All Games,

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## Notes to Consolidated Financial Statements (concluded) (Dollars in thousands, except per share amounts) ## 22. NET INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE PER SHARE The following table provides a reconciliation of basic earnings (loss) per share to diluted earnings per share for the years ended October 31, 2003, 2002, and 2001. <img src='content_image/43019.jpg'> The computation for the diluted number of shares excludes those unexercised stock options and warrants which are antidilutive. The number of such shares was 1,000,000, 143,000 and 222,000 for the years ended October 31, 2003, 2002 and 2001, respectively. ## 23. SUBSEQUENT EVENT In December 2003, the Company acquired all of the outstanding capital stock and paid certain liabilities of TDK Mediactive (TDK). The pur- chase price of approximately $14,276 consisted of $17,116 in cash and issuance of 163,641 restricted shares of the Company’s common stock (valued at $5,160), reduced by approximately $8,000 due to TDK under a distribution agreement. The Company is in the process of completing the purchase price allocation. TDK’s results will be included in the Company’s operating results beginning in the first quarter of fiscal 2004. In September 2003, the Company and TDK entered into an agreement providing the Company with the exclusive North American distribu- tion rights for certain TDK titles, including The Haunted Mansion, Star Trek: Shattered Universe and Corvette . During the three months ended October 31, 2003, the Company recorded $9,225 of net sales related to this agreement. At October 31, 2003, the Company owed $5,945 to TDK for purchases made under the agreement, which was included in accounts payable, and remaining guarantee payments of $3,491 under the contract.

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To the Board of Directors and Shareholders of Take-Two Interactive Software, Inc. ## Report of Independent Auditors In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Take-Two Interactive Software, Inc. and its subsidiaries (“the Company”) at October 31, 2003 and October 31, 2002, and the results of their operations and their cash flows for each of the three years in the period ended October 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 misstate- ment. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the account- ing principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 2 to Consolidated Financial Statements, the Company has restated its financial statements for the years ended October 31, 2002 and 2001. As discussed in Note 3, effective November 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards No. 141, “Business Combinations” and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” Accordingly, the Company discontinued the amortization of goodwill as of that date. Also, as discussed in Note 3, effective November 1, 2000, the Company changed its method of accounting for revenue recognition to conform to the requirements of SEC Staff Bulletin No. 101, “Revenue Recognition.” <img src='content_image/25025.jpg'> New York, New York February 12, 2004

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## CORPORATE OFFICES ## Corporate Headquarters ## Take-Two Interactive Software, Inc. 622 Broadway New York, NY 10012 (646) 536-2842 ## Principal Operating Offices ## Rockstar Games, Inc. 622 Broadway New York, NY 10012 ## Jack of All Games, Inc. 8800 Global Way West Chester, OH 45069 ## OFFICERS AND DIRECTORS ## Officers ## Richard W. Roedel Chairman of the Board, Director and Interim Chief Executive Officer ## Paul Eibeler President and Director ## Directors ## Todd Emmel Director, Structured Products John Hancock Financial Services ## Robert Flug President S.L. Danielle ## Oliver R. Grace, Jr. General Partner Anglo American Security Fund, L.P. ## TAKE-TWO INTERACTIVE SOFTWARE, INC. AND SUBSIDIARIES ## Corporate Information ## Take-Two Interactive Software Europe, Ltd. Saxon House 2-4 Victoria Street Windsor, Berkshire SL4 1EN England ## Gathering, Inc. 622 Broadway New York, NY 10012 ## Global Star Software, Inc. 622 Broadway New York, NY 10012 ## Gary Lewis Global Chief Operating Officer ## Karl H. Winters Chief Financial Officer ## Mark Lewis Director Muse Communications Corp. ## Steven Tisch Partner Escape Artists ## CORPORATE INFORMATION ## Stockholder Information A copy of the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission, will be furnished without charge upon written request to Investor Relations at the Corporate Headquarters. ## Legal Counsel Blank Rome LLP 405 Lexington Avenue New York, NY 10174 ## Independent Auditors PricewaterhouseCoopers LLP 1301 Avenue of the Americas New York, NY 10019 ## Transfer Agent American Stock Transfer & Trust Company 59 Maiden Lane New York, NY 10038 ## Common Stock Information The Company’s common stock is listed on the Nasdaq National Market® under the symbol TTWO. ## Common Stock Price Range <img src='content_image/33312.jpg'> <img src='content_image/33313.jpg'> <img src='content_image/33314.jpg'>

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Take-Two Interactive Software, Inc. www.take2games.com

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<img src='content_image/74602.jpg'> further reinforcing Jack’s leadership posi- tion in the value segment of the business. On a personal note, I am extremely hon- ored that the Board of Directors has asked me to serve as Chairman and Interim Chief Executive Officer. There have been a number of other executive changes this year, notably the decision by our founder, Ryan Brant, to relinquish his role as Chairman in order to concentrate on our publishing business, the return of Paul Eibeler as President, and the appointment of company veteran Gary Lewis as Global Chief Operating Officer. These changes demonstrate the pool of management talent we have to draw upon. Fiscal 2003 was an exceptional year for Take-Two. Our success has afforded Take- Two the opportunity to attract and retain some of the best creative talent in the industry and to be opportunistic, responding to market trends and refining our operations to maximize profitability. We believe there is tremendous opportu- nity for Take-Two in 2004 and beyond. Thank you for your interest in our company and your continued support. <img src='content_image/74608.jpg'> ## Jack of All Games Jack of All Games is the largest distributor of video game software, hardwar and acces- sories in North America. Jack distributes all Take-Two published products, as well as fr ont line products from all major publishers. They have capitalized on the growing installed base of hardware and proliferationof softwar e titles and outlets to purchase softwar e, by emphasizing sales of both exclusive and non- exclusive mid and budget-priced software to their expanding customer base. <img src='content_image/74609.jpg'>

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<img src='content_image/78937.jpg'> Take-Two is headquartered in New York City, with its international headquarters based in Windsor (England). The Company has development studios in Edinburgh, San Diego, V ancouver, Toronto, Vienna, Leeds (England), Fenton (Missouri), Bellevue (Washington) and San Francisco; product development and testing in Lincoln (England), San Francisco, <img src='content_image/78938.jpg'>

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Westlake Village (California), New York City and Austin; electronic peripheral and acces- sory manufacturing in Hong Kong; and sales and marketing offices in Cincinnati, New York City, Toronto, London, Windsor (England), Paris, Munich, Madrid, Milan, Sydney, Breda (Netherlands) and Auckland. <img src='content_image/63418.jpg'>

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## TAKE-TWO INTERACTIVE SOFTWARE, INC. “For fiscal 2003, Take-Two’s revenues exceeded $1 billion, with net income of $98 million”

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<img src='content_image/67942.jpg'> # Form 10-K Annual Report # 2004

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W e are shaping International Paper to win in a global market. The end game is being a more successful company so that we can provide expanded opportunities for employees, meet the increasing needs of our customers and satisfy the expectations of our shareowners. <img src='content_image/46718.jpg'> <img src='content_image/46716.jpg'> North America As we build a more global company, we are continuing to capitalize on our strong position in North America by investing in our best performing businesses and divesting non-strategic operations. In 2004, there were good examples of this across our three core businesses. In our paper business, we began modernizations at our Eastover, S.C., Androscoggin, Maine, and Quinnesec, Mich., paper mills, and we invested in the continued growth of our packaging business by acquiring Box USA. We also strengthened the focus of our forest products business by divesting our Canadian pulp and wood operations as well as non-strategic forestlands. All of these moves will help us succeed in this key market. <img src='content_image/46717.jpg'> Latin America Looking at Latin America, we have strong mill and forestry operations across the region. Given that about 1.2 million acres of the forestlands we sustainably own or manage worldwide are located in the region, we have a strong source of fiber for our operations. With our mills, infrastructure and fiber base in Brazil, we have multiple options to build on our success there and better serve fast-growing local demand as well as key markets in the United States, Asia and Western Europe. <img src='content_image/46715.jpg'> Asia We have a small but strong base in Asia today, which includes operations through Carter Holt Harvey, our majority-owned subsidiary headquartered in New Zealand. Going forward, our growth strategy is to focus on China by investing in our packaging operations. We will also continue to evaluate our options in the areas of pulp, paper and board, and explore opportunities to ship to China from low-cost producing areas. Our focus will be to strengthen our ability to serve both the fast-growing local markets and grow with our global customers. Europe and Russia In Europe and Russia, we have large-scale pulp and paper mills as well as packaging operations in a joint venture in Turkey. In these areas, we are building on the success of our mills in Kwidzyn, Poland, and Svetogorsk, Russia – both of which have been very successful at meeting the needs of their growing markets. Our goal is to grow as the leading supplier of uncoated freesheet and coated board earning a cost of capital return. To date, these businesses have delivered on this and that’s why we have invested to improve and expand these mills even more.

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## Research and Development The Company operates research and development centers at Loveland, Ohio; Sterling Forest, New York; Kaukauna, Wisconsin; Savannah, Georgia; Almere, the Netherlands; a regional center for applied forest research in Bainbridge, Georgia; a forest biotechnology center in Rotorua, New Zealand; and several product laboratories. Additionally, the Company has approximately a 1/3 interest in ArborGen, LLC, a joint venture with certain other forest products and biotechnology companies formed for the purpose of developing and commercializing improvements to increase growth rates and improve wood and pulp quality. We direct research and development activities to short-term, long-term and technical assistance needs of customers and operating divisions; to process, equipment and product innovations; and to improve profits through tree generation and propagation research. Activities include studies on improved forest species and management; innovation and improvement of pulping, bleaching, chemical recovery, papermaking and coating processes; packaging design and materials development; reduction of environmental discharges; re-use of raw materials in manufacturing processes; recycling of consumer and packaging paper products; energy conservation; applications of computer controls to manufacturing operations; innovations and improvement of products; and development of various new products. Our development efforts specifically address product safety as well as the minimization of solid waste. The cost to the Company of its research and development operations in 2004 was $68 million; $73 million in 2003; and $77 million in 2002. We own numerous patents, copyrights, trademarks, and trade secrets relating to our products and to the processes for their production. We also license intellectual property rights to and from others where necessary. Many of the manufacturing processes are among our trade secrets. Some of our products are covered by U.S. and non-U.S. patents and are sold under well known trademarks. We derive competitive advantage by protecting our trade secrets, patents, trademarks and other intellectual property rights, and by using them as required to support our businesses. ## Environmental Protection Information concerning the effects of the Company’s compliance with federal, state and local provisions enacted or adopted relating to environmental protection matters is set forth on page 30 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. ## Employees As of December 31, 2004, we had approximately 80,000 employees, 52,000 of whom were located in the United States. Of the domestic employees, approximately 34,000 are hourly, with unions representing approximately 20,000. Approximately 16,000 of the union employees are represented by the Paper, Allied-Industrial, Chemical and Energy International Union (PACE) under individual location contracts. During 2004, new labor agreements were ratified at four paper mills with one paper mill contract carrying over to early 2005. During 2005, labor agreements are scheduled to be negotiated at four paper mill operations including Kaukauna, Wisconsin; Ticonderoga, New York; Savannah, Georgia and Roanoke Rapids, North Carolina. During 2004, 13 labor agreements were settled in non-paper mill operations. Settlements included paper converting, wood products, chemical, distribution and woodlands operations. During 2005, new labor agreements are scheduled to be negotiated in 21 non-paper mill operations. In January 2005, the Company’s principal union, PACE, announced that it was merging with the United Steelworkers Union. The merger is subject to a vote of the memberships of both unions in April 2005. The name of the resulting union will be United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial and Service Workers International Union. ## Executive Officers of the Registrant John V. Faraci, 55, chairman and chief executive officer since November 2003. Prior to this, he was president since February 2003, and executive vice president and chief financial officer from 2000 to 2003. From 1999 to 2000, he was senior vice president-finance and chief financial officer. From 1995 until 1999, he was chief executive officer and managing director of Carter Holt Harvey Limited of New Zealand. Robert M. Amen, 55, president since November 2003. Previously, he served as executive vice president responsible for the Company’s paper business, technology and corporate marketing from 2000 through 2003. He also served as senior vice president-president of International Paper-Europe from 1996 to 2000. Newland A. Lesko, 59, executive vice president-manufacturing and technology since June 2003. He previously served as senior vice president-industrial packaging group from 1998 to 2003. Marianne M. Parrs, 60, executive vice president- administration since 1999 responsible for information technology, investor relations, and global sourcing. H. Wayne Brafford, 53, senior vice president-industrial packaging group since June 2003. He previously served as vice president and general manager-converting, specialty and pulp from 1999 to 2003.

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## IP Mineral Resources Houston, Texas leased ## Chocolate Bayou Water Company Alvin, Texas ## Industrial Papers ## U.S.: Lancaster, Ohio De Pere, Wisconsin Kaukauna, Wisconsin Menasha, Wisconsin ## International: Heerlen, Netherlands ## Polyrey Couze, France Ussel, France

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## 2004 CAPACITY INFORMATION <img src='content_image/35679.jpg'> <img src='content_image/35680.jpg'> * International Paper has a net surplus pulp position of 0.6 million tons. This is the difference between the 1.6 million tons of dried pulp capacity and 1.0 million tons of dried pulp purchased and consumed. <img src='content_image/35681.jpg'>

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## SENIOR LEADERSHIP John V. Faraci Chairman and Chief Executive Officer Robert M. Amen President Marianne M. Parrs Executive Vice President Newland A. Lesko Executive Vice President Michael J. Balduino Senior Vice President and President, Shorewood Packaging H. Wayne Brafford Senior Vice President Industrial Packaging Jerome N. Carter Senior Vice President Human Resources C. Cato Ealy Senior Vice President Corporate Development Thomas E. Gestrich Senior Vice President Consumer Packaging Paul Herbert Senior Vice President Printing & Communications Papers William Hoel Senior Vice President Sales and Marketing Thomas G. Kadien Senior Vice President and President, International Paper Europe Andrew R. Lessin Senior Vice President Internal Audit Christopher P. Liddell Senior Vice President and Chief Financial Officer Richard B. Lowe Senior Vice President and President, xpedx Richard B. Phillips Senior Vice President Technology LH Puckett Senior Vice President Coated and SC Papers Maura Abeln Smith Senior Vice President, General Counsel and Corporate Secretary W. Dennis Thomas Senior Vice President Public Affairs and Communications W. Michael Amick Jr. Vice President Supply Chain – North America David A. Bailey Vice President, Business Development International Paper Europe John N. Balboni Vice President and Chief Information Officer Information Technology Aleesa L. Blum Vice President Communications Dennis J. Colley Vice President Containerboard William P. Crawford Vice President Global Sourcing Arthur J. Douville Vice President xpedx Michael P. Exner Vice President, Manufacturing Containerboard and Specialty Papers Lyle J. Fellows Vice President, Manufacturing Coated and SC Papers Greg Gibson Vice President Commercial Printing & Imaging Papers Robert Grillet Vice President and Controller Finance Jeffrey A. Hearn Vice President Bleached Board Robert M. Hunkeler Vice President Investments Tommy S. Joseph Vice President Specialty Papers Paul J. Karre Vice President Human Resources Tim Kelly Vice President, Manufacturing and Technology International Paper Europe Timothy P. Keneally Vice President Specialty Packaging Austin E. Lance Vice President Converting Papers Mary Laschinger Vice President Wood Products David A. Liebetreu Vice President Forest Resources Gerald C. Marterer Vice President Arizona Chemical Jonathan Mason Vice President Treasury Brian McDonald Vice President and President International Paper Asia Mark McGuire Vice President and Deputy General Counsel Legal William A. Merrigan Vice President Global Supply Chain, Deliver John L. Moorhead Vice President Imaging Papers J. Scott Murchison Vice President Beverage Packaging and Foodservice Ted R. Niederriter Vice President and Deputy General Counsel Legal Timothy S. Nicholls Vice President and Chief Financial Officer International Paper Europe Larry Norton Vice President, Manufacturing Printing & Communications Papers Maximo Pacheco Vice President and President and Managing Director International Paper Brazil Jean-Michel Ribieras Vice President Pulp Carol L. Roberts Vice President Container, Americas Ethel A. Scully Vice President Corporate Marketing Barbara L. Smithers Vice President Legal Darial R. Sneed Vice President Investor Relations Peter Springford Chief Executive Officer and Managing Director Carter Holt Harvey Larry J. Stowell Vice President David B. Struhs Vice President Environmental Affairs Mark S. Sutton Vice President European Container Greg Wanta Vice President, Manufacturing Bleached Board Robert W. Wenker Vice President and Chief Technology Officer Information Technology Lyn M. Withey Vice President Public Affairs

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## DIRECTORS John V. Faraci Chairman and Chief Executive Officer International Paper Robert M. Amen President International Paper Martha Finn Brooks Chief Operating Officer Novelis, Inc. Samir G. Gibara Retired Chairman The Goodyear Tire & Rubber Company James A. Henderson Retired Chairman and Chief Executive Officer Cummins Inc. W. Craig McClelland Retired Chairman and Chief Executive Officer Union Camp Corporation Donald F. McHenry Distinguished Professor of Diplomacy Georgetown University Charles R. Shoemate Retired Chairman, President and Chief Executive Officer Bestfoods William G. Walter Chairman, President and Chief Executive Officer FMC Corp. Papers used in this annual report: Coated cover: Carolina ® C2S Cover, 8 pt., made by our employees at the Riegelwood, N.C., Mill. Coated paper: Savvy TM Gloss, 80 lb. text made by our employees at the Quinnesec, Mich., Mill. Uncoated paper: Accent ® Opaque, Smooth, 50 lb. text made by our employees at the Ticonderoga, N.Y., Mill. Printed in the United States by Sandy Alexander, Clifton, N.J. Design: Joseph Rattan Design, Dallas, Texas Photography: Rusty Hill, Dallas, Texas; Tracey Kroll, Stamford, Conn.; and Ron Mueller, Stevensville, Mont. ©2005 International Paper. All rights reserved. ## SHAREHOLDER INFORMA TION Corporate Headquarters International Paper Company 400 Atlantic Street Stamford, Connecticut 06921 1-203-541-8000 ## Annual Meeting The next annual meeting of shareholders will be held at 10:30 a.m., Tuesday, May 10, 2005 at the Marriott Columbia City Center, Columbia, South Carolina. ## Transfer Agent and Registrar Mellon Investor Services, our transfer agent, maintains the records of our registered shareholders and can help you with a variety of shareholder related services at no charge including: Change of name or address Consolidation of accounts Duplicate mailings Dividend reinvestment enrollment Lost stock certificates Transfer of stock to another person Additional administrative services Please write or call: Mellon Investor Services LLC Overpeck Center 85 Challenger Road Ridgefield Park, New Jersey 07660-2108 Telephone Number: 1-800-678-8715 ## Stock Exchange Listings Common shares (symbol: IP) are traded on the following exchanges: New York, Swiss and Amsterdam. International Paper options are traded on the Chicago Board of Options Exchange. ## Direct Purchase Plan Under our plan, you may invest all or a portion of your dividends, and you may purchase up to $20,000 of additional shares each year. International Paper pays most of the brokerage commissions and fees. You may also deposit your certificates with the transfer agent for safekeeping. For a copy of the plan prospectus, call or write to the corporate secretary at the corporate headquarters. Independent Public Accountants Deloitte & Touche LLP Two World Financial Center New York, New York 10281 ## Reports and Publications Additional copies of this annual report, SEC filings and other publications are available by calling 1-800-332-8146 or writing to the investor relations department at corporate headquarters. Copies of our most recent environment, health and safety report are available by calling 1-901-419-3945. Additional information is also available on our Web site, http://www .internationalpaper .com. ## Investor Relations Investors desiring further information about International Paper should contact the investor relations department at corporate headquarters, 1-203-541-8625.

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<img src='content_image/18160.jpg'> ## International Paper’s Board of Directors Seated, from left, John V. Faraci , chairman and chief executive officer, International Paper; Samir G. Gibara , retired chairman, The Goodyear Tire & Rubber Company; W. Craig McClelland , retired chairman and chief executive officer, Union Camp Corporation. Standing, from left, Robert J. Eaton , retired chairman of the Board of Management DaimlerChrysler AG*; Charles R. Shoemate , retired chairman, president and chief executive officer, Bestfoods; William G. Walter , chairman, president and chief executive officer, FMC Corporation; Donald F. McHenry , distinguished professor of diplomacy, Georgetown University; Robert M. Amen , president, International Paper; James A. Henderson , retired chairman and chief executive officer, Cummins Inc.; Martha Finn Brooks , chief operating officer, Novelis Inc. * Mr. Eaton retired from the Board of Directors effective Feb. 9, 2005. ## Corporate Headquarters 400 Atlantic Street, Stamford, CT 06921 1-203-541-8000 ## Operations Center 6400 Poplar Avenue, Memphis, TN 38197 1-901-419-9000 ## Global Offices: International Paper Europe Chaussée de la Hulpe, 166, 1170 Brussels, Belgium 32-2-774-1211 International Paper do Brasil Rodovia SP 340 Km 171, 13840-970 Mogi Guaçu SP, Brazil 55-19-3861-8121 International Paper Asia Room 3001, K. Wah Center 1010 Huaihai Zhong Road Shanghai, 200031 P. R. China 8621-6113-3200

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<img src='content_image/79328.jpg'> 400 Atlantic Street Stamford, CT 06921 1-203-541-8000 www.internationalpaper.com Listed on the New York Stock Exchange Equal Opportunity Employer (M/F/D/V)

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Jerome N. Carter, 56, senior vice president-human resources since 1999 when he joined the Company from Union Camp. Thomas E. Gestrich, 58, senior vice president-consumer packaging since 2001. He previously served as vice president and general manager-beverage packaging from 1999 to 2001. Andrew R. Lessin, 62, senior vice president-internal audit since 2002. He previously served as vice president-finance from 2000 to 2002. From 1995 to 2000, he served as vice president-controller. He is also a director of Carter Holt Harvey Limited. Christopher P. Liddell, 46, senior vice president and chief financial officer since March 2003. Prior to this, he served as vice president-finance and controller since February 2003. From 2002 to 2003, he served as vice president-finance. From 1999 to 2002, he served as chief executive officer of Carter Holt Harvey Limited. He is also a director of Carter Holt Harvey Limited. Richard B. Lowe, 50, senior vice president-xpedx since April 2003. He previously served as region president-xpedx from 1995 to 2003. Maura A. Smith, 49, senior vice president, general counsel and corporate secretary since April 2003 when she joined the Company. From 1998 to 2003 she served as senior vice president, general counsel and corporate secretary of Owens Corning and in addition, from 2000 to 2003, as chief restructuring officer. W. Dennis Thomas, 61, senior vice president-public affairs and communications since 1998. Robert J. Grillet, 49, vice president-finance and controller since April 2003. He previously served as region senior vice president-xpedx from 2000 to 2003. He was group vice president-xpedx from 1995 to 2000. ## Raw Materials For information on the sources and availability of raw materials essential to our business, see Item 2. Properties. ## FORWARD-LOOKING STATEMENTS Certain statements in this Annual Report on Form 10-K, and in particular, statements found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, that are not historical in nature may constitute forward-looking statements. These statements are often identified by the words, “will,” “may,” “should,” “continue,” “anticipate,” “believe,” “expect,” “plan,” “appear,” “project,” “estimate,” “intend,” and words of similar import. Such statements reflect the current views of International Paper with respect to future events and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in these statements. Factors which could cause actual results to differ include, among other things, the strength and demand for the Company’s products and changes in overall demand, the effects of competition from foreign and domestic producers, the level of housing starts, changes in the cost or availability of raw materials, unanticipated expenditures relating to the cost of compliance with environmental and other governmental regulations, the ability of the Company to continue to realize anticipated cost savings, performance of the Company’s manufacturing operations, results of legal proceedings, changes related to international economic conditions, specifically in Brazil and Russia, changes in currency exchange rates, particularly the relative value of the U.S. dollar to the Euro, the current military action in Iraq, and the war on terrorism. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. These and other factors that could cause or contribute to actual results differing materially from such forward-looking statements are discussed in greater detail in the Company’s Securities and Exchange Commission filings. ## ITEM 2. PROPERTIES ## Forestlands The principal raw material used by International Paper is wood in various forms. As of December 31, 2004, the Company or its subsidiaries owned or managed approximately 6.8 million acres of forestlands in the United States, 1.2 million acres in Brazil and had, through licenses and forest management agreements, harvesting rights on government-owned forestlands in Russia. An additional 785,000 acres of forestlands in New Zealand were held through Carter Holt Harvey, a consolidated subsidiary of International Paper. During 2004, the Company’s U.S. forestlands supplied 14.7 million tons of roundwood to its U.S. facilities, representing 23% of its wood fiber requirements. The balance was acquired from other private industrial and nonindustrial forestland owners, with only an insignificant amount coming from public lands of the United States government. In addition, in 2004, 3.8 million tons of wood were sold to other users. As one of the largest private landowners in the world, International Paper employs professional foresters and wildlife biologists to manage our forestlands with great care

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in compliance with the rigorous standards of the Sustainable Forestry Initiative program (SFI ® ). SFI ® includes an independent certification system to ensure the sustainable planting, growing and harvesting of trees while protecting wildlife, plants, soil, water and air quality. All of our U.S. forestlands are certified as complying with SFI ® standards by an independent third party, and most of our forestlands outside of the United States comply with similar local or regional sustainable forestry programs as well. ## Mills and Plants A listing of our production facilities, the vast majority of which we own, can be found in Appendix I hereto, which is incorporated herein by reference. The Company’s facilities are in good operating condition and are suited for the purposes for which they are presently being used. We continue to study the economics of modernization or adopting other alternatives for higher cost facilities. ## Capital Investments and Dispositions Given the size, scope and complexity of our business interests, we continuously examine and evaluate a wide variety of business opportunities and planning alternatives, including possible acquisitions and sales or other dispositions of properties. You can find a discussion about the level of planned capital investments for 2005 on page 24, and dispositions and restructuring activities as of December 31, 2004, on pages 12 through 14 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and on pages 49 through 56 of Item 8. Financial Statements and Supplementary Data. ## (c) Purchases of Equity Securities by the Issuer and Affiliated Purchasers. ## ITEM 3. LEGAL PROCEEDINGS Information concerning the Company’s legal proceedings is set forth on pages 30 and 31 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and on pages 59 through 65 of Item 8. Financial Statements and Supplementary Data. ## ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2004. ## PART II ## ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Dividend per share data on the Company’s common stock and the high and low sales prices for the Company’s common stock for each of the four quarters in 2003 and 2004 are set forth on page 79 of Item 8. Financial Statements and Supplementary Data. Information concerning the exchanges on which the Company’s common stock is listed is set forth on the back cover. As of March 4, 2005, there were approximately 29,180 record holders of common stock of the Company. <img src='content_image/89217.jpg'> (a) Represents shares tendered in connection with stock option exercises.

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## ITEM 6. SELECTED FINANCIAL DATA ## Five-Year Financial Summary (a) <img src='content_image/39839.jpg'>

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## FINANCIAL GLOSSARY Current ratio - current assets divided by current liabilities. Total debt to capital ratio - long-term debt plus notes payable and current maturities of long-term debt divided by long-term debt, notes payable and current maturities of long-term debt, minority interest and total common shareholders’ equity. Return on equity - net earnings divided by average common shareholders’ equity (computed monthly). Return on investment - the after-tax amount of earnings from continuing operations before interest and minority interest divided by the average of total assets minus accounts payable and accrued liabilities (computed on a monthly basis). ## FOOTNOTES TO FIVE-YEAR FINANCIAL SUMMARY (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. ## 2004: (b) Includes restructuring and other charges of $211 million before taxes and minority interest ($124 million after taxes and minority interest), including a $74 million charge before taxes and minority interest ($43 million after taxes and minority interest) for organizational restructuring programs, a $92 million charge before taxes ($57 million after taxes) for early debt retirement costs, a $35 million charge before minority interest ($18 million after minority interest) for a goodwill impairment, and a $10 million charge before taxes ($6 million after taxes) for litigation settlements. Also included are a $123 million pre-tax credit ($76 million after taxes) for net insurance recoveries related to the hardboard siding and roofing litigation, a $35 million credit before taxes and minority interest ($22 million after taxes and minority interest) for the net reversal of restructuring reserves no longer required, and a pre-tax charge of $144 million ($128 million after taxes) for net losses on sales and impairments of businesses sold or held for sale. (c) Includes net income of Weldwood of Canada Limited and the Carter Holt Harvey Tissue business prior to their sales. Also included in 2004 is a gain of $268 million before taxes and minority interest ($90 million after taxes and minority interest) for the sale of the Carter Holt Harvey Tissue business, and a pre-tax charge of $323 million ($711 million after taxes) for the sale of Weldwood of Canada Limited. (d) Includes a $5 million net 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. ## 2003: (e) Includes restructuring and other charges of $298 million before taxes and minority interest ($184 million after taxes and minority interest), including 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. Also included are a pre-tax charge of $32 million ($33 million after taxes) for net losses on sales and impairments of businesses held for sale, and a credit of $40 million before taxes and minority interest ($25 million after taxes and minority interest) for the net reversal of restructuring reserves no longer required. (f) Includes a charge of $10 million after taxes for the cumulative effect of an accounting change for the adoption of SFAS No. 143, “Accounting for Asset Retirement Obligations,” and a charge of $3 million after taxes for the cumulative effect of an accounting change related to the adoption of FIN 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” (g) Includes a $123 million reduction after minority interest of the income tax provision recorded for significant tax events occurring in 2003. ## 2002: (h) Includes restructuring and other charges of $695 million before taxes and minority interest ($435 million after taxes and minority interest), including 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, and a charge of $46 million before taxes and minority interest ($27 million after taxes and minority interest) for early debt retirement costs. Also included are a credit of $41 million before taxes and minority interest ($101 million after taxes and minority interest) to adjust accrued costs of businesses sold or held for sale, and a pre-tax credit of

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$68 million ($43 million after taxes) for the reversal of 2001 and 2000 reserves no longer required. (i) Includes a $1.2 billion charge for the cumulative effect of an accounting change for the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets.” (j) Reflects a decrease of $46 million in income tax provision for a reduction of deferred state income tax liabilities. ## 2001: (k) Includes restructuring and other charges of $1.1 billion before taxes and minority interest ($752 million after taxes and minority interest), including an $892 million charge before taxes and minority interest ($606 million after taxes and minority interest) for asset shutdowns of excess internal capacity and cost reduction actions and a $225 million pre-tax charge ($146 million after taxes) for additional exterior siding legal reserves. Also included are a net pre-tax charge of $629 million ($587 million after taxes) related to dispositions and asset impairments of businesses held for sale, a $42 million pre-tax charge ($28 million after taxes) for Champion merger integration costs, and a $17 million pre-tax credit ($11 million after taxes) for the reversal of excess 2000 and 1999 restructuring reserves. (l) Includes an extraordinary pre-tax charge of $73 million ($46 million after taxes) related to the impairment of the Masonite business and the divestiture of the Petroleum and Minerals assets, and a charge of $25 million before taxes and minority interest ($16 million after taxes and minority interest) for the cumulative effect of a change in accounting for derivatives and hedging activities. ## 2000: (m) Includes restructuring and other charges of $949 million before taxes and minority interest ($589 million after taxes and minority interest), including an $824 million charge before taxes and minority interest ($509 million after taxes and minority interest) for asset shutdowns of excess internal capacity and cost reduction actions and a $125 million pre-tax charge ($80 million after taxes) for additional exterior siding legal reserves. Also included are a $54 million pre-tax charge ($33 million after taxes) for merger-related expenses and a $34 million pre-tax credit ($21 million after taxes) for the reversal of reserves no longer required. (n) Includes an extraordinary gain of $385 million before taxes and minority interest ($134 million after taxes and minority interest) on the sale of International Paper’s investment in Scitex and Carter Holt Harvey’s sale of its share of Compania de Petroleos de Chile (COPEC), an extraordinary loss of $460 million before taxes ($310 million after taxes) related to the impairment of the Zanders and Masonite businesses, an extraordinary gain before taxes and minority interest of $368 million ($183 million after taxes and minority interest) related to the sale of Bush Boake Allen, an extraordinary loss of $5 million before taxes and minority interest ($2 million after taxes and minority interest) related to Carter Holt Harvey’s sale of its Plastics division, and an extraordinary pre-tax charge of $373 million ($231 million after taxes) related to impairments of the Argentine investments and the Chemical Cellulose Pulp and the Fine Papers businesses.

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## ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ## Executive Summary International Paper benefited from a strong economy in 2004 as demand for paper and packaging products was improved from 2003. Overall average price realizations were up year over year across all our major product lines except for European paper products where a strong Euro attracted imports. Our total industry segment operating profits were up from 2003 reflecting the higher average prices and improved shipments combined with benefits from cost reduction initiatives and a more favorable product mix. These positive effects were partially offset by higher input costs, including wood, energy and chemical costs. Looking forward to 2005, we expect demand in the first quarter to be somewhat positive, although this is a seasonally slow period for many of our businesses. Overall, demand remains solid in the United States and Europe, with strong order backlogs in our coated papers and bleached board businesses. Containerboard and box orders are also good. Uncoated papers’ backlogs were below prior year levels, but are improving as the first quarter progresses. Our average price realizations for most paper and packaging products began the year well above 2004 levels reflecting the realization of previously announced price increases. Raw material costs, especially wood, polyethylene and chemical costs, are expected to increase in early 2005, although energy costs should be flat compared with the fourth quarter of 2004. In addition, pension and other benefit related costs, plus supply chain expenses are expected to be higher in 2005. However, interest costs will decline due to debt repayments in 2004 and the 2005 first quarter. ## Results of Operations Industry segment operating profits are used by International Paper’s management to measure the earnings performance of its businesses. Management believes that this measure allows a better understanding of trends in costs, operating efficiencies, prices and volumes. Industry segment operating profits are defined as earnings before taxes and minority interest, interest expense, corporate items and corporate special items. Industry segment operating profits are defined by the Securities and Exchange Commission as a non-GAAP financial measure, and are not GAAP alternatives to net income or any other operating measure prescribed by accounting principles generally accepted in the United States. International Paper operates in six segments: Printing Papers, Industrial and Consumer Packaging, Distribution, Forest Products, Carter Holt Harvey, and Specialty Businesses and Other. The following table shows the components of net earnings (loss) for each of the last three years: <img src='content_image/57637.jpg'> *Special items include restructuring and other charges, net losses (gains) on sales and impairments of businesses held for sale, insurance recoveries and reversals of reserves no longer required. Industry segment operating profits were $315 million higher in 2004 due principally to improved sales volume ($263 million), higher average prices ($201 million), and the effect of cost reduction initiatives, improved operating performance and a more favorable product mix ($186 million), all partially offset by the impact of higher energy and raw material costs ($192 million), lower earnings from land sales ($95 million), the impact of hurricanes in the South ($18 million), and foreign currency translation rates and other items ($30 million). <img src='content_image/57645.jpg'> The principal changes by segment were as follows: Printing Papers’ profits were $119 million higher as increased sales volume, improved sales mix and lower operating and overhead costs more than offset higher energy and raw material costs. Industrial and Consumer Packaging’s profits were up $92 million. Higher average sales prices and volumes, improved product mix, and reduced overhead costs and improved operations more than offset the effect of higher energy and raw material costs. Forest Products’ profit was $73 million higher. Higher average prices for wood products more than offset the effect of lower harvest volumes and lower earnings from land sales.

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Corporate items of $469 million net expense in 2004 was slightly higher than the $466 million net expense in 2003, due to higher pension and supply chain initiative costs, increased inventory-related costs and lower gains on energy hedging transactions, offset in part by lower administrative overhead and benefit-related costs. Corporate special items, including restructuring and other charges, gains/losses on sales and impairments of businesses held for sale, insurance recoveries and reversals of reserves no longer required, declined to $188 million from $290 million in 2003 and from $586 million in 2002. The decline in 2004 reflects lower restructuring charges that relate to excess capacity shutdowns and organizational restructuring programs, and insurance recoveries relating to hardboard siding and roofing matters. Interest expense, net, decreased to $743 million from $772 million in 2003 and $785 million in 2002. The decline in 2004 compared with both 2003 and 2002 reflects the lower average interest rates from the refinancing of high coupon rate debt, and higher interest income at Carter Holt Harvey. The income tax provision of $206 million includes a $41 million tax benefit related to 2004 special items. The $113 million income tax benefit in 2003 included $231 million of benefits for special items occurring in 2003. The $72 million benefit in 2002 also reflected adjustments for special tax items. During 2004, International Paper completed the sale of its Weldwood of Canada Limited business in the fourth quarter and Carter Holt Harvey completed the sale of its Tissue business in the second quarter. As a result of these transactions, the operating results of these businesses and the gain or loss on the sales are reported in discontinued operations for all periods presented. Accounting changes included a charge of $13 million in 2003 for the adoption of new accounting pronouncements, and a $1.2 billion charge in 2002 for the adoption of the new goodwill accounting standard. ## Liquidity and Capital Resources For the year ended December 31, 2004, International Paper generated $2.4 billion of operating cash flow, up from $1.8 billion in 2003. Capital spending from continuing operations for the year totaled $1.3 billion, or 81% of depreciation and amortization expense. We repaid approximately $900 million of debt during the year, including various higher coupon rate debt, that will result in lower interest charges in future years. Our liquidity position remains strong, supported by approximately $3.2 billion of unused, committed credit facilities that we believe are adequate to meet future short- term liquidity requirements. Maintaining an investment grade credit rating for our long-term debt continues to be an important element in our overall financial strategy. Our focus in 2005 will be to continue to maximize our financial flexibility and preserve liquidity while further reducing future interest expense through the repayment or refinancing of high coupon rate debt, with a target of reducing consolidated debt to approximately $12 billion by the end of 2006. ## Critical Accounting Policies and Significant Accounting Estimates Accounting policies that may have a significant effect on our reported results of operations and financial position, and that can require judgments by management in their application, include accounting for contingent liabilities, impairments of long-lived assets and goodwill, pensions and postretirement benefit obligations and income taxes. Pension expenses for our U.S. plans increased to $111 million in 2004 from $60 million in 2003 due principally to increased amortization of unrecognized actuarial losses and a reduction in the assumed discount rate. A further increase of approximately $100 million is expected in 2005, also due to an increase in the amortization of unrecognized actuarial losses, a further reduction in the assumed discount rate, and a decrease in the expected return on plan assets to 8.50% from 8.75% in 2004. Our pension funding policy continues to be to fully fund actuarially determined costs, generally equal to the minimum amounts required by the Employee Retirement Income Security Act (ERISA). Unless investment performance is negative or changes are made to our funding policy, it is unlikely that any contributions to our U.S. qualified plan will be required before 2007. ## Recent Accounting Developments Several new accounting standards and interpretations were released that are effective in either 2004 or 2005. The revised standard on share-based payment that will be effective in the third quarter of 2005 will require recognition of compensation cost for any outstanding option grants that are unvested at June 30, 2005, as well as reload grants. While the exact impact will depend upon the number of unvested options at that time, this standard could increase compensation expense by approximately $20 million in both 2005 and 2006, with no significant impact in subsequent years. Accounting guidance was also issued addressing accounting and disclosure for the foreign earnings repatriation provision within the American Jobs Creation Act of 2004. We have started an evaluation of the effects of this provision, but do not expect to complete this evaluation until the second quarter of 2005.

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## Legal Payments relating to exterior siding and roofing class action settlements continue to be in line with projections made in 2002. Federal and state court antitrust cases relating to alleged price fixing in the sale of high-pressure laminates were settled in 2004 for a total of $38.5 million. The Company is defending opt-out cases related to a settled class action brought by purchasers of corrugated sheets and containers. Additional information on these matters is included in Note 10 of the Notes to Consolidated Financial Statements in Item 8. ## Corporate Overview While the operating results for International Paper’s various business segments are driven by a number of business- specific factors, changes in International Paper’s operating results are closely tied to changes in general economic conditions in the United States, Europe and Asia. Factors that impact the demand for our products include industrial non- durable goods production, consumer spending, commercial printing and advertising activity, white-collar employment levels, new home construction and repair and remodeling activity, and movements in currency exchange rates. Product prices also tend to follow general economic trends, and are also affected by inventory levels, currency movements and changes in worldwide operating rates. In addition to these revenue-related factors, net earnings are impacted by various cost drivers, the more significant of which include changes in raw material costs, principally wood fiber and chemical costs, energy costs, salary and benefits costs, including pensions, and manufacturing conversion costs. The following is a discussion of International Paper’s results of operations for the year ended December 31, 2004, and the major factors affecting these results compared to 2003 and 2002. ## Results of Operations For the year ended December 31, 2004, International Paper reported net sales of $25.5 billion, compared with $24.0 billion in 2003 and $23.9 billion in 2002. International net sales (including U.S. exports) totaled $7.9 billion, or 31% of total sales in 2004. This compares to international net sales of $7.2 billion in 2003 and $6.4 billion in 2002. Full year 2004 results totaled a net loss of $35 million ($0.07 per share basic and diluted), compared with net income of $302 million ($0.63 per share basic and diluted) in 2003 and a net loss of $880 million ($1.83 per share basic, $1.82 per share diluted) in 2002 and amounts include results of discontinued operations and the cumulative effect of accounting changes. Earnings from continuing operations in 2004 were $478 million compared with $294 million in 2003 and $260 million in 2002. Earnings in 2004 benefited from higher sales volumes, higher average sales prices, cost reduction initiatives, improved mill operations and lower interest expense. These factors more than offset the negative impacts of increased energy and wood fiber costs, lower earnings from land sales, a higher effective tax rate, increased special charges and the impact of the hurricanes in the South. See Industry Segment Results on pages 17 through 21 for a discussion of the impact of these factors by segment. <img src='content_image/52265.jpg'> ## Earnings From Continuing Operations (after taxes, in millions)

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The following table presents a reconciliation of International Paper’s net earnings (loss) to its operating profit: <img src='content_image/77952.jpg'> ## Discontinued Operations and Cumulative Effect of Accounting Changes In the third quarter of 2004, International Paper entered into an agreement to sell its Weldwood of Canada Limited (Weldwood) business. The Company completed the sale in the fourth quarter for approximately $1.1 billion. As a result of the sale, a $323 million pre-tax loss on the sale was recorded ($711 million after taxes) as a discontinued operations charge. In the 2004 second quarter, a $90 million after-tax and minority interest discontinued operations gain was recorded from the sale of the Carter Holt Harvey Tissue business. As a result, prior periods operating results have been restated to present the operating results of these businesses as earnings from discontinued operations, including earnings of $108 million in 2004, $21 million in 2003, and $35 million in 2002. Net earnings for 2003 included after-tax charges of $3 million and $10 million for the cumulative effect of accounting changes for the adoption of the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities,” and Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations, respectively.” Results for 2002 included a charge of $1.2 billion after minority interest for the cumulative effect of an accounting change to record the transitional impairment charge for the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets.” ## Income Taxes The income tax provision for 2004 was $206 million, or 28% of pretax earnings from continuing operations before minority interest. This included a $41 million tax benefit related to special items. Excluding the impact of special items, the tax provision was $247 million, or 26% of pre-tax earnings before minority interest. While the Company reported pre-tax income in 2003, a net income tax benefit was recorded reflecting decreases totaling $231 million in the provision for income taxes for special items. These included 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 reduction in the second quarter reflecting a favorable tax audit settlement and benefits from a government sponsored overseas tax program in Italy. Excluding the year-to-date tax effects of special items, the effective tax rate for 2003 was 20%. The net tax benefit in 2002 reflects the reversal of the assumed stock-sale tax treatment of the 2001 fourth-quarter write-down to net realizable value of the assets of Arizona Chemical upon the decision to discontinue sale efforts and to hold and operate this business in the future, and a $46 million fourth-quarter adjustment of deferred income tax liabilities for the effects of state tax credits and the taxability of the Company’s operations in various state tax jurisdictions.

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## Corporate Items and Interest Expense Minority interest expense, net of taxes, decreased to $62 million in 2004 compared with $111 million in 2003 and $118 million in 2002. The decreases in 2004 and 2003 reflect a reduction in minority interest related to preferred securities that were replaced by debt obligations in the second half of 2003. This decrease was partially offset in 2004 by higher earnings at Carter Holt Harvey. Interest expense, net, decreased to $743 million compared with $772 million in 2003 and $785 million in 2002. The decline reflects lower interest rates from the refinancing of high coupon debt, the impact of interest rate swaps, and, in 2004, higher interest income from Carter Holt Harvey, net of the additional expense of $36 million for the preferred debt securities discussed above. For the twelve months ended December 31, 2004, corporate items totaled $469 million compared with $466 million of expense in 2003 and $253 million in 2002. The increased expense in 2004 compared with 2003 is due to higher pension, inventory-related and supply chain initiative costs, and lower gains on energy hedging transactions, offset in part by reduced administrative overhead costs. Higher pension, inventory-related and supply chain costs were also factors in 2003 as compared with 2002, which also included income from an insurance company demutualization and foreign exchange gains. Our supply chain project, begun in late 2002, is a corporate- wide initiative to improve customer service capabilities and implement “best practice” supply chain business processes for order management, supply and demand planning, product scheduling and tracking, transportation and warehousing, and procurement. Expenses related to this program in 2005, should be approximately $100 million above the 2004 level of $84 million. The associated benefits are reflected in business earnings as the programs are implemented. ## Special Items ## Restructuring and Other Charges International Paper continually evaluates its operations for opportunities for improvement. These evaluations are targeted to (a) focus our portfolio on our core businesses of paper, packaging and forest products, (b) rationalize and realign capacity to operate fewer facilities with the same revenue capability and close high cost facilities, and (c) reduce costs. Annually, strategic operating plans are developed by each of our businesses to demonstrate that they will achieve a return at least equal to their cost of capital over an economic cycle. If it subsequently becomes apparent that a facility’s plan will not be achieved, a decision is then made to (a) invest additional capital to upgrade the facility, (b) shut down the facility and record the corresponding charge, or (c) evaluate the expected recovery of the carrying value of the facility to determine if an impairment of the asset value of the facility has occurred under SFAS No. 144. In recent years, this policy has led to the shutdown of a number of facilities and the recording of significant asset impairment charges and severance costs. As this profit improvement initiative is ongoing, it is possible that additional charges and costs will be incurred in future periods should such triggering events occur. 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 organizational restructuring programs, a $92 million charge before taxes ($57 million after taxes) for early debt retirement costs, a $35 million charge before minority interest ($18 million after minority interest) for a goodwill impairment charge, and a $10 million charge before taxes ($6 million after taxes) for a litigation settlement. Also in 2004, a $123 million credit before taxes ($76 million after taxes) was recorded for insurance recoveries related to the hardboard siding and roofing litigation, and a $35 million credit before taxes and minority interest ($22 million after taxes and minority interest) was recorded for the net reversal of restructuring reserves no longer required. 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. 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, and a charge of $46 million before taxes and minority interest ($27 million after taxes and minority interest) for early debt

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retirement costs. In addition, a $68 million pre-tax credit ($43 million after taxes) was recorded in 2002 for the reversal of 2001 and 2000 reserves no longer required. A further discussion of restructuring, business improvement and other charges can be found in Note 6 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. ## Net Losses (Gains) on Sales and Impairments of Businesses Held for Sale Net losses (gains) on sales and impairments of businesses held for sale totaled $135 million in 2004, $32 million in 2003 and ($41) million in 2002 before taxes and minority interest. The principal components of these gains/losses were: 2004: 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 Europe, resulting in charges of $56 million before taxes ($54 million after taxes) 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, resulting in a pre-tax loss of $14 million ($4 million after taxes). Also in the fourth quarter, a $9 million loss before taxes ($6 million after taxes) was recorded to adjust gains/losses of businesses previously sold. In the 2004 third quarter, a charge of $38 million before and after taxes was recorded for losses associated with the sale of Scaldia Papier B.V. and its subsidiary Recom B.V. ($34 million) and to adjust the estimated loss on sale of Papeteries de Souche L.C. ($4 million). In the 2004 second quarter, a charge of $27 million before and after taxes was recorded to write down the assets of Papeteries de Souche L.C. to their estimated realizable value. In the 2004 first quarter, a pre-tax gain of $9 million ($6 million after taxes) was recorded to adjust previously estimated gains/losses of businesses previously sold. In addition, the 2004 second quarter included a loss of $9 million before taxes and minority interest ($5 million after taxes and minority interest) to write down the assets of Food Pack S.A. to their estimated realizable value, of which $4 million was included in the Packaging segment, $3 million was included in the Carter Holt Harvey segment and $2 million was included in Minority interest. 2003: In the fourth quarter of 2003, International Paper recorded a $34 million pre-tax charge ($34 million after taxes) to write down the assets of its Polyrey business to 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. A pre-tax charge of $1 million ($1 million after taxes) was recorded in the 2003 third quarter to adjust previously 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. 2002: In the fourth and third quarters of 2002, International Paper recorded $10 million and $3 million of pre-tax credits ($4 million and $1 million after taxes, respectively), to adjust estimated accrued costs of businesses previously sold. 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. The impairment charge recorded for Arizona Chemical in the fourth quarter of 2001 included a tax expense based on the form of sale being negotiated at that time. As a result of the decision in the second quarter of 2002 to discontinue sale efforts and to hold and operate Arizona Chemical in the future, this provision was no longer required. Consequently, special items for the second quarter of 2002 include a gain of $28 million before taxes and minority interest, with an associated $96 million benefit after taxes and minority interest. ## Industry Segment Operating Profit Industry segment operating profits of $2.1 billion were higher than the $1.8 billion in 2003 and the $1.9 billion in 2002. The higher profit in 2004 was principally due to improved sales volumes ($263 million), higher average sales prices ($201 million), and cost reduction initiatives and a more favorable product mix ($186 million), all partially offset by higher energy and raw material costs ($192 million), lower earnings from land sales ($95 million), the impact of hurricanes in the South ($18 million) and unfavorable foreign currency exchange rates ($30 million). In 2003, industry segment operating profits declined slightly as compared with 2002 principally due to higher energy and raw material costs ($275 million) and lower average prices ($85 million), partially offset by the effect of cost reduction initiatives, improved operating performance and a more favorable product mix ($245 million).

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The rationalization and realignment program announced in 2003 was completed during 2004. The program announced in July 2003 targeted significant additional reductions in overhead costs and included the elimination of approximately 3,000 salaried positions in the United States. We are currently engaged in a customer-driven, company-wide supply chain initiative that will enhance International Paper’s customer relationships and standardize processes while improving overall company profitability. Ultimately, the initiative will provide the foundation upon which to build improved customer value propositions while enabling International Paper to become increasingly competitive. International Paper experienced an improving business environment during 2004 as higher sales volume and average prices reflected a steadily improving economy. Demand for our paper and packaging products was stronger resulting in only about 70,000 tons of market related downtime in our mill system compared with 590,000 tons in 2003. Our focus on operational performance and improvements to our internal cost structure and product mix helped mitigate the impact of increased raw material and energy costs. Looking forward to 2005, we anticipate a seasonally slow start in the first quarter as wood and chemical costs continue to be high with further increases expected early in the year. Earnings in 2005 should benefit from increased price realizations and improved demand for our products. We believe that the actions taken over the last few years to restructure our operations and eliminate excess manufacturing capacity, to reduce overhead costs, and to focus on our customer relationships will favorably position International Paper as market conditions continue to improve. ## Description of Industry Segments International Paper’s industry segments discussed below are consistent with the internal structure used to manage these businesses. All segments, except for Carter Holt Harvey, are differentiated on a common product, common customer basis consistent with the business segmentation generally used in the Forest Products industry. The Carter Holt Harvey business includes the results of multiple Forest Products businesses. ## Printing Papers International Paper is one of the world’s leading producers of printing and writing papers. Products in this segment include uncoated and coated papers, market pulp and bristols. Uncoated Papers: This business produces papers for use in desktop and laser copiers and digital imaging printing as well as in advertising and promotional materials such as brochures, pamphlets, greeting cards, books, annual reports and direct mail publications. Uncoated Papers also produces a variety of grades that are converted by our customers into envelopes, tablets, business forms and file folders. Fine papers are used in high-quality text, cover, business correspondence and artist papers. Uncoated papers are sold under private label and International Paper brand names that include Hammermill, Springhill, Great White, Strathmore, Ballet, Beckett and Rey. The mills producing uncoated papers are located in the United States, Scotland, France, Poland and Russia. These mills have uncoated paper production capacity of approximately 5.3 million tons annually. Coated Papers: This business produces coated papers used in a variety of printing and publication end uses such as catalogs, direct mailings, magazines, inserts and commercial printing. Products include coated free sheet, coated groundwood and supercalendered groundwood papers. Production capacity in the United States amounts to approximately 2.0 million tons annually. Market Pulp: Market pulp is used in the manufacture of printing, writing and specialty papers, towel and tissue products and filtration products. Pulp is also converted into products such as diapers and sanitary napkins. Pulp products include fluff, southern softwood pulp, as well as northern, southern, and birch hardwood pulps. These products are produced in the United States, France, Poland and Russia, and are sold around the world. International Paper facilities have annual dried pulp capacity of about 1.6 million tons. Brazilian Paper: Brazilian operations function through International Paper do Brasil, Ltda and subsidiaries, that own or manage 1.2 million acres of forestlands in Brazil. Our annual production capacity in Brazil is approximately 685,000 tons of coated and uncoated papers. Our uncoated papers are primarily sold under the brand name Chamex . The Company also operates a wood chip business that sells eucalyptus and pine chips on a global basis. ## Industrial and Consumer Packaging Industrial Packaging: With production capacity of about 4.7 million tons annually, International Paper is the third largest manufacturer of containerboard in the United States. Over one-third of our production consists of specialty grades, such as BriteTop . About 70% of our production is converted domestically into corrugated boxes and other packaging by our 70 U.S. container plants. In Europe, our operations include one recycled containerboard mill in France and 23 container plants in France, Ireland, Italy, Spain and the United Kingdom. Global operations also include facilities in Chile, Turkey and China. Our container plants are supported by regional design centers, which offer total packaging solutions and supply chain initiatives. We have the capacity to produce approximately 600,000 tons of kraft paper each year for use in multi-wall, retail bags and saturated kraft. We manufacture lightweight and pressure sensitive papers and converted

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products in four domestic facilities and one in the Netherlands with an annual capacity of 375,000 tons. These products are used in applications such as pressure sensitive labels, food and industrial packaging, industrial sealants and tapes, and consumer hygiene products. Consumer Packaging: International Paper is the world’s largest producer of solid bleached sulfate packaging board with annual U.S. production capacity of about 1.8 million tons. On a global basis, our businesses work closely with our customers to understand their needs and create profitable business opportunities sourced from our broad base of packaging solutions: substrates and barrier board technologies combined with our printing expertise, graphics and structural design, filling equipment and service, Smart Packaging and marketing services. All are tailored to create packaging that appeals to consumers while building customer brand equity. Our Everest, Fortress and Starcote brands are used in packaging applications for everyday products such as juice, milk, food, cosmetics, pharmaceuticals, computer software and tobacco products. Approximately 33% of our bleached board production is converted into packaging products in our own plants. Our Beverage Packaging business, made up of 17 facilities worldwide, offers complete packaging systems. From paper to filling machines, using proprietary technologies including Tru-Taste brand barrier board technology for premium long-life juices, our expertise is utilized to produce creative customer solutions and value. Shorewood Packaging Corporation utilizes emerging technologies in its 17 facilities worldwide to produce world- class packaging with high-impact graphics for a variety of markets, including home entertainment, tobacco, cosmetics, general consumer and pharmaceuticals. The Foodservice business offers cups, lids, bags, food containers and plates through four domestic plants and four international facilities. ## Distribution Through xpedx , our North American merchant distribution business, we service the commercial printing market with printing papers and graphic art supplies, high traffic/away- from-home markets with facility supplies, and various manufacturers and processors with packaging supplies and equipment. xpedx is the leading wholesale distribution marketer in these customer and product segments in North America, operating 136 warehouse locations and 148 retail stores in the United States and Mexico. ## Forest Products Forest Resources: International Paper owns or manages approximately 6.8 million acres of forestlands in the United States, mostly in the South. All lands are independently third- party certified under the operating standards of the Sustainable Forestry Initiative (SFI ® ). In 2004, these forestlands supplied about 23% of the wood fiber requirements of our other businesses. Our forestlands are managed as a portfolio to optimize the economic value to our shareholders. Principal revenue-generating activities include the sale of trees for harvest, the sale of forestlands to investment funds and other buyers for various uses, real estate development, and the leasing of our properties for third-party recreational and commercial uses. The mix of these activities varies based on the fiber requirements of our mills and wood products plants, prevailing stumpage prices, supply and demand for forestlands, and market preferences for timber and forestlands. When stumpage prices are depressed relative to land values, forestland sales tend to comprise a larger part of our portfolio mix. Conversely, when stumpage prices are high, stumpage sales may be the best alternative to maximize the value of our forestland holdings. Wood Products: International Paper owns and operates 25 plants producing lumber, plywood, engineered wood products and utility poles in the southern United States. Through these, we produce approximately 2.5 billion board feet of lumber and 1.6 billion square feet of plywood annually. On December 31, 2004, International Paper sold its wholly-owned subsidiary Weldwood of Canada Limited (Weldwood) to West Fraser Timber Company Limited. During our ownership, Weldwood operated 10 plants in the Canadian provinces of British Columbia and Alberta, which produced about 1.3 billion board feet of lumber and 495 million square feet of plywood annually. Prior to the sale, we had harvesting rights on 10.2 million acres of government-owned forestlands in Canada through licenses and forest management agreements. ## Carter Holt Harvey Carter Holt Harvey is approximately 50.5% owned by International Paper. It is one of the largest forest products companies in the Southern Hemisphere, with operations in New Zealand, Australia and Asia. Sales consist of approximately 46% in New Zealand, 36% in Australia and 18% in Asia and elsewhere. Carter Holt Harvey’s major businesses include: Forests , including ownership of 785,000 acres of predominantly radiata pine plantations that currently yield 5.5 million tons of logs annually. Long term sustainable yield of the estate is about 8.5 million tons of logs annually. Wood Products , including about 467 million board feet of lumber capacity, 90 million square feet of laminated veneer lumber production and about 1,072 million square feet of plywood and panel production, including approximately 205 million square feet from Plantation Timber Products in China acquired in 2004. Carter Holt Harvey is the largest Australasian producer of lumber, plywood, panels and laminated veneer lumber.

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Pulp, Paper and Packaging , with overall capacity of more than 1.1 million tons of annual linerboard and pulp capacity at four mills, Carter Holt Harvey is New Zealand’s largest manufacturer and marketer of pulp and paper products. These supply 65% of the needs of their packaging plants which produce corrugated boxes, cartons and paper bags, with a focus on horticulture and primary produce. ## Specialty Businesses and Other Chemicals: Arizona Chemical is a leading producer of oleo chemicals and specialty resins based on crude tall oil, byproducts of the wood pulping process. These products, used in adhesives and inks, are made at 13 plants in the United States and Europe. European Distribution: International Paper sold Scaldia on August 31, 2004. Prior to the sale, European Distribution consisted of Papeteries de France and Scaldia and served markets in France, Belgium and the Netherlands. Products and brand designations appearing in italics are trademarks of International Paper or a related company. ## Industry Segment Results ## Printing Papers Demand for Printing Papers products is closely correlated with changes in commercial printing and advertising activity, direct mail volumes and, for uncoated free sheet products, with changes in white-collar employment levels that affect the usage of copy and laser printer paper. These products are further affected by changes in currency rates that can enhance or disadvantage producers in different geographic regions. Principal cost drivers include manufacturing efficiency and raw material, transportation and energy costs. Printing Papers net sales for 2004 increased 5% from 2003 and 2002. Operating profits in 2004 were 26% higher than in 2003 and 6% higher than in 2002. Earnings in 2004 compared with 2003 improved across all Printing Papers businesses. Higher sales volumes ($130 million), improved mill operations and lower overhead costs ($90 million) and a more profitable product mix ($20 million) contributed to the earnings increase, although these effects were partially offset by higher raw material and energy costs ($90 million) and lower average prices in Europe which more than offset higher average prices in the United States ($30 million). Compared with 2002, higher 2004 earnings in the Brazilian Papers and Market Pulp businesses were partially offset by lower earnings in both the Uncoated and Coated Papers businesses. The Printing Papers segment took 525,000 tons of downtime in 2004, including 65,000 tons of lack-of-order downtime to align production with customer demand. This compared with 750,000 tons of downtime in 2003, of which 335,000 tons related to lack of orders. <img src='content_image/8818.jpg'> Uncoated Papers sales were $4.9 billion in 2004, up 4% from 2003 and 2% from 2002. Operating profits rose 11% compared with 2003, but were 18% lower than 2002. In the United States, our average price realizations improved steadily during 2004 compared with 2003 and ended the year higher than in either 2003 or 2002. On average, prices were up 1% in 2004 compared with 2003 and 2002. The improving economic environment in 2004 resulted in stronger demand, particularly in the commercial printing and converting markets, as sales volumes rose 4% and 2% compared with 2003 and 2002, respectively. In addition to higher average sales prices and improved shipments, improved mill operations also had a positive impact on 2004 earnings. These positive factors were partially offset by higher input costs, particularly for wood and energy costs. The business was also adversely impacted by higher transportation costs in 2004 compared with 2003 and the impact of hurricanes in the South. The earnings decline in 2004 compared with 2002 was due principally to higher wood and energy costs offset somewhat by an increase in shipments and lower overhead costs as a result of our cost reduction initiatives. Average prices in our European operations declined throughout most of 2004 as a strong Euro made Western Europe a more attractive market for imports, putting pressure on prices. Average prices were down 8% and 17% as compared with 2003 and 2002, respectively. European sales volumes rose 5% in 2004 compared with 2003 and 6% versus 2002. Earnings in Eastern Europe in 2004 were higher than in 2003, but were more than offset by the earnings decline in the West. Overall, lower average prices and higher wood and energy costs offset the favorable effects of higher sales volumes, a better mix of products sold and improved mill operations. Coated Papers sales were $1.5 billion in 2004, compared with $1.4 billion in 2003 and $1.5 billion in 2002. Although the business reported an operating loss for the year, a profit was recorded for the second half of 2004. The improvement in earnings in 2004 compared with 2003 was driven by lower overhead costs, improved mill operations and higher sales prices for our products. These positive factors, combined with improved product sales mix, more than offset the impact

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of higher energy and wood costs. Average prices in 2004 were up versus 2003 and 2002 due to price increases effective in the second half of 2004. Sales volume was up about 4% in 2004 versus 2003 but down about 2% from 2002. Market Pulp sales from our U.S. and European facilities totaled $661 million in 2004 compared with $571 million and $520 million in 2003 and 2002, respectively. In 2004, the business reported an operating profit, after incurring losses in 2003 and 2002, as higher average price realizations and sales volumes, lower overhead costs, and improved mill operations more than offset increases in raw material costs. Our U.S. pulp prices improved steadily through the 2004 third quarter, then declined slightly during the fourth quarter, but ended the year about 6% higher than 2003 and 21% higher than 2002. U.S. pulp volumes were strong in the fourth quarter and ended the year 5% higher than in 2003 and 4% higher than in 2002 reflecting increased global demand, primarily in Asia. European pulp volumes decreased 12% and 3% compared with 2003 and 2002, respectively. The negative effects of these lower volumes and higher wood costs were partially offset by the benefits from average price realizations, which were 3% and 18% higher than in 2003 and 2002, respectively. Brazilian Paper sales were $592 million in 2004 compared with $540 million in 2003 and $440 million in 2002. The increase compared with 2003 reflects increased sales volume for uncoated papers and a doubling of wood chip operations in the North. The effect of currency translation, as the Real appreciated 8% versus the U.S. dollar, was another factor in the increased reported U.S. dollar sales. Uncoated paper pricing in Reals in 2004 declined 9% versus 2003, while coated paper prices were down 3%. Operating profits in 2004 were up 13% and 28% from 2003 and 2002, respectively. The earnings improvement in 2004 reflected the increased shipments and operational improvements, partially offset by higher transportation, energy and chemical costs and lower average prices. As 2005 begins, the outlook for Printing Papers is positive as our previously announced price increases have been fully implemented. Demand for both coated papers and pulp is strong. Uncoated papers’ backlogs were below prior year levels, but are improving as the first quarter progresses. Further strengthening is expected in customer demand as improving economic conditions lead to increased employment and higher demand. We expect continued high costs for wood fiber and raw materials such as caustic soda, although energy prices should stabilize. We will continue our focus on further improvements in manufacturing efficiency and overall cost structure. ## Industrial and Consumer Packaging Demand for Industrial Packaging products is closely correlated with non-durable industrial goods production in the United States, as well as with demand for processed foods, poultry, meat and agricultural products. Demand and pricing for Consumer Packaging products correlate closely with consumer spending and general economic activity. In addition to prices and volumes, major factors affecting the profitability of both Industrial and Consumer Packaging are raw material and energy costs, manufacturing efficiency and product mix. Industrial and Consumer Packaging net sales for 2004 were 12% and 14% higher than 2003 and 2002, respectively. Operating profits in 2004 were 20% higher than 2003 but were down 1% from 2002. Increased volume ($95 million), higher price realizations ($40 million), improved mill operations and reduced overhead costs ($35 million), and a more favorable mix of products sold ($20 million) contributed to the improved earnings in 2004 compared with 2003. These benefits were partially offset by increased raw material and transportation costs ($100 million). The segment took 210,000 tons of downtime in 2004, including only 5,000 tons of lack-of-order downtime to balance internal supply with customer demand, compared to a total of 400,000 tons in 2003, of which 255,000 tons were market related. ## Industrial and Consumer Packaging <img src='content_image/52925.jpg'> Industrial Packaging net sales for 2004 totaled $4.9 billion, compared with $4.2 billion in 2003 and $4.1 billion in 2002. Our average containerboard prices were up about 9%, specialty papers prices were up about 5% and U.S. box prices were up about 2% compared to 2003; however, container prices in Europe were down about 3% on a constant dollar basis. Operating profits increased 43% from 2003 and 25% from 2002. Increased prices, higher containerboard and U.S. converting shipments, a more favorable mix, mill operating improvements, and lower overhead costs were partially offset by raw material and transportation cost increases. U.S. converting shipments were up about 7% from 2003 for the Company’s ongoing operations, and were up about 19% including the additional contributions from the acquisition of Box USA in July 2004. A slight increase in demand for International Container coupled with operational cost reduction efforts more than offset the decrease in price so that operating results improved 4%. In 2004, the Industrial Packaging business took 5,000 tons of market related downtime compared to 245,000 tons in 2003, reflecting the improved market conditions.

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Entering 2005, additional favorable price effects are expected to continue. Synergies associated with the Box USA acquisition will benefit 2005 through both volume improvements and cost reductions. The implementation of a new operating model at our mills, representing the first phase of our supply chain project, will result in some efficiency improvements and cost savings in 2005. The European operating results are expected to improve as a result of targeted market growth and cost reduction initiatives. Consumer Packaging 2004 net sales of $2.6 billion were up compared to the 2003 and 2002 sales of $2.5 billion each. Our average prices in 2004 increased about 1% for bleached board over 2003, and were up about 4% for the beverage and foodservice converting businesses. The higher prices reflect the pass-through of higher raw material costs, although this continues to be tempered by competitive pressures. Our bleached board mills operated with no market-related downtime in 2004, with shipments up 10% over the prior year. Operating profits in 2004 declined 12% from 2003 and 34% from 2002 as improved pricing and favorable operations in the mills did not overcome the impact of cost increases in raw materials, especially wood, energy and resin. During 2004, manufacturing improvement, rationalization and organizational restructuring plans were implemented throughout this business to reduce costs and improve market alignment. Improved price realizations are expected to continue into 2005 as the market remains strong; however, raw material costs for wood and resin are expected to be negative factors. Capital improvements and cost reduction efforts made in 2004 will benefit operating results in 2005. ## Distribution Our Distribution business, including xpedx , markets a diverse array of products and services to customers in many business segments, including commercial printing, manufacturing and building services. Distribution’s customer demand is sensitive to changes in general economic conditions. Sales to commercial printers are heavily dependent on the levels of corporate advertising and promotional spending. In addition, efficient customer service, cost-effective logistics, and controlled working capital management are key factors in this segment’s profitability. <img src='content_image/70665.jpg'> Distribution’s 2004 net sales increased 3% from 2003 and 1% from 2002. Operating profits in 2004 were 9% higher than 2003, but were 4% lower than 2002. Sales revenue increases and cost containment initiatives drove the 2004 earnings improvement. The sales growth reflects rising prices for paper and tissue products and for packaging products. Also contributing to the sales growth were the addition of new national retail accounts to Distribution’s customer portfolio and brisk demand from commercial printers. Reduction in operating costs continued in 2004 as the business consolidated facilities and rationalized its information systems. Since 2002, Distribution has reduced its work force 38% through actions related to consolidations and system efficiencies. The outlook for 2005 is favorable. Our average prices are expected to remain at or above 2004 levels, and additional market penetration is planned through new initiatives in the printing and manufacturing segments. Additional improvement is expected from programs to further reduce operating costs. ## Forest Products Forest Products manages approximately 6.8 million acres of forestlands in the United States, and operates wood products plants in the United States that produce lumber, plywood, engineered wood products and utility poles. Forest Resources’ operating results are largely driven by demand and pricing for softwood sawtimber, and to a lesser extent for softwood pulpwood, by the volume of merchantable timber on Company forestlands, and by demand and pricing for specific forestland tracts offered for sale. Wood Products operating results are driven by new housing starts and repair and remodeling activity. Fiber costs are a major factor in Wood Products’ profitability. Forest Products net sales for 2004 were about even with 2003, but were 5% lower than in 2002. Operating profits in 2004 were 10% and 24% higher than in 2003 and 2002, respectively. Earnings in 2004 reflected continued strong contributions from the U.S. Wood Products business, primarily as a result of higher average plywood and lumber prices ($180 million) and improved mix of products sold ($20 million). Lower earnings from forestland and real estate sales ($95 million) and from reduced Forest Resources’ harvest volumes ($15 million), combined with higher raw material costs ($15 million) to partially offset the impact of these higher prices. <img src='content_image/70666.jpg'> Forest Resources sales in 2004 were $900 million compared with $1.1 billion in 2003 and $1.2 billion in 2002. Operating profits in 2004 were 16% lower than in 2003 and

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19% lower than in 2002 principally due to lower stumpage and forestland sales. Gross margins from stumpage sales and recreational income were $281 million in 2004 compared with $268 million in 2003 and $324 million in 2002. Harvest volumes declined 8% in 2004, compared with 2003, and 14% from 2002, reflecting a lower inventory of mature sawtimber in 2004. Sawtimber prices were flat compared to 2003 and down 11% compared to 2002. Gross margins from forestland sales were $315 million in 2004 as compared with $462 million in 2003 and $461 million in 2002, reflecting a lower number of acres sold, partially offset by higher average per-acre sales realizations. Operating expenses increased to $178 million in 2004 from $157 million in 2003 due primarily to higher information systems costs. Operating expenses for 2004 decreased from $190 million in 2002 reflecting the impact of restructuring and cost reduction actions. Operating profits for the Real Estate division, which sells higher-use properties, were $124 million, $71 million and $75 million in 2004, 2003 and 2002, respectively. International Paper monetizes its forest assets in various ways, including sales of short- and long-term harvest rights, on a pay-as-cut or lump-sum bulk- sale basis, as well as sales of timberlands. For 2005, our harvest is projected to decline due to a lower inventory of mature timber. In future years, harvests are expected to increase as timber tracts mature and the benefits of higher yield-per-acre initiatives are realized. Average first quarter 2005 southern pine pulpwood, pine sawtimber, and hardwood pulpwood prices are expected to remain close to fourth quarter 2004 levels. Forestland sales will continue to be dependent upon various factors including tract location and the level of investor interest. Wood Products sales in the United States in 2004 of $1.5 billion were up about 15% from both 2003 and 2002. Operating profits in 2004 were about three times higher than in 2003. The business had recorded a net operating loss in 2002. Substantially higher average prices more than offset the effects of increased raw material costs. Average plywood prices rose 22% above 2003 levels and were 43% higher than 2002. Plywood sales volumes in 2004 were slightly higher than 2003 and 2002. Average prices for lumber were up 11% and 13% in 2004 compared with 2003 and 2002, respectively. Lumber sales volumes were up 5% in 2004 versus 2003 and about even with 2002. In 2004, log costs were up 2.5% versus 2003, negatively impacting both plywood and lumber profits. Lumber and plywood operating costs were also negatively impacted by substantially higher raw material and natural gas costs versus both 2003 and 2002. Looking ahead to 2005, robust housing starts in the fourth quarter of 2004, combined with low inventory in the distribution chain, should translate into continued strong lumber and plywood demand in the first half of 2005. However, an expected slowing in housing starts and higher interest rates in the second half of 2005 could put downward pressure on pricing in the second half of 2005. The lower tariff rate on Canadian lumber imports announced in December may result in higher lumber imports and increased pressure on pricing. However, a weaker U.S. dollar could partially offset this impact. ## Carter Holt Harvey Carter Holt Harvey, International Paper’s approximately 50.5% owned subsidiary operating principally in New Zealand and Australia, is in many of the same businesses as International Paper, and is thus affected by many of the same economic factors as our other segments. Additionally, Carter Holt Harvey’s reported operating results are sensitive to changes in currency exchange rates, especially changes in the New Zealand dollar versus the U.S. dollar since most operating costs are New Zealand dollar denominated while a large portion of its export sales are denominated in U.S. dollars. Demand for its wood products is largely driven by housing and remodeling activity in Australia and New Zealand. ## Carter Holt Harvey <img src='content_image/114619.jpg'> Carter Holt Harvey’s 2004 U.S. dollar net sales and operating profits were about 20% higher than 2003, due mainly to favorable U.S. dollar translation rates. Net sales for 2004 in New Zealand dollars were up 3% compared with 2003. Operating profit for 2004 in New Zealand dollars was down 5% versus 2003, principally due to higher pension and benefit-related costs. Earnings for Forests in 2004 were down compared with 2003 as the strong New Zealand dollar and increased freight costs negatively impacted price realizations. As a result of the lower realizations, harvest volumes were reduced by 13%. Wood Products earnings were down in 2004 versus 2003, largely due to an unfavorable mix of products sold and higher input costs, somewhat mitigated by improved sales volumes in New Zealand building distribution and the laminated veneer lumber businesses. Pulp and Papers’ 2004 earnings were ahead of 2003, which was impacted by a three-month labor strike at the Kinleith mill, reflecting record production by two key mills in 2004. Packaging’s 2004 earnings were up versus 2003. Lower production costs and benefits from productivity and business restructuring programs contributed to the improved results. During 2004, Carter Holt Harvey sold its Tissue business. Accordingly, all periods presented have been restated to

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separately present the operating results of the Tissue business as a discontinued operation excluded from segment operating results. Market conditions are expected to be challenging in 2005. The New Zealand dollar closed 2004 at its highest ever month- end rate, and should continue to adversely impact New Zealand dollar realizations and shipments into export markets. The log export market is expected to remain difficult, while the housing markets in Australia and New Zealand are expected to remain robust, although down somewhat from 2004 levels. The Company’s total productivity program will continue to contribute to earnings, as will contributions from recently acquired Plantation Timber Products. The planned 2005 acquisitions of the Australian carton business of Wadepack Limited and the structural lumber business of New Zealand based Tenon Limited should also benefit future operating results. ## Specialty Businesses and Other The Specialty Businesses and Other segment includes the operating results of Arizona Chemical, European Distribution and, prior to its closure in 2003, our Natchez, Mississippi Chemical Cellulose Pulp mill. Also included are certain divested businesses whose results are included in this segment for periods prior to their sale (excluding Weldwood and the Carter Holt Harvey Tissue business that are included in discontinued operations). This segment’s 2004 net sales declined 9% and 23% from 2003 and 2002, respectively. Operating profits in 2004 improved substantially from 2003 and 2002. Both the decline in sales and improved earnings are principally due to lost contributions from businesses previously sold. ## Specialty Businesses and Other <img src='content_image/44109.jpg'> Chemicals sales were $670 million in 2004, compared with $625 million in 2003 and $595 million in 2002. Operating profits in 2004 were flat with 2003 and 27% higher than in 2002 as the impact of increased volumes and manufacturing and overhead cost reduction efforts more than offset increased raw material costs and lower average prices compared with 2003. Other businesses in the above totals include operations that have been sold, closed, or are held for sale, principally the European Distribution business, the oil and gas and mineral royalty business, Decorative Products, Retail Packaging, and the Natchez Chemical Cellulose Pulp mill. Sales for these businesses were approximately $450 million in 2004 (mainly European Distribution and Decorative Products) compared with $610 million in 2003 (mainly European Distribution, Decorative Products and the Chemical Cellulose Pulp mill), and $860 million in 2002. ## Liquidity and Capital Resources ## Overview A major factor in International Paper’s liquidity and capital resource planning is its generation of operating cash flow, which is highly sensitive to changes in the pricing and demand for our major products. While changes in key cash operating costs, such as energy and raw material costs, do have an effect on operating cash generation, we believe that our strong focus on cost controls has improved our cash flow generation over an operating cycle. As a result, we believe that we are well positioned for continued strong operating cash flow generation as prices and worldwide economic conditions improve. As part of our continuing focus on improving our return on investment, we have focused our capital spending on those businesses with the best returns and in geographic areas with strong growth opportunities. Spending levels have been kept well below the level of depreciation and amortization charges for each of the last three years, and we anticipate continuing this approach in 2005. With the low interest rate environment in 2004, financing activities have focused largely on the repayment or refinancing of higher coupon debt, resulting in a net reduction in debt of approximately $900 million in 2004. An additional $750 million was subsequently repaid as of February 2005. We plan to continue this program, with a target of reducing consolidated debt balances to approximately $12 billion by the end of 2006. Our liquidity position continues to be strong, with approximately $3.2 billion of committed liquidity to cover future cash flow requirements not met by operating cash flows. Management believes it is important for International Paper to maintain an investment-grade credit rating to facilitate access to capital markets on favorable terms. ## Cash Provided by Operations Cash provided by operations totaled $2.4 billion for 2004, compared with $1.8 billion in 2003 and $2.1 billion in 2002. The major components of cash provided by operations are net income adjusted for primarily non-cash income and expense items and changes in working capital. Also included in 2004 was $242 million representing cash proceeds from the Maine and New Hampshire forestlands transaction (see

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Note 11 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data). Net income adjusted for non-cash items increased $817 million in 2004 compared with 2003. The increase for 2003 over 2002 was $126 million. Working capital, representing International Paper’s investments in accounts receivable and inventory less accounts payable and accrued liabilities, was $4.4 billion at December 31, 2004. Cash used for working capital components totaled $305 million in 2004, compared with $54 million in 2003 and a $344 million decrease in 2002. The increase in 2004 was principally due to an increase in accounts receivable reflecting higher fourth-quarter sales. ## Investment Activities Capital spending from continuing operations was $1.3 billion in 2004, or 81% of depreciation and amortization as compared to $1.1 billion, or 71% of depreciation and amortization in 2003, and $0.9 billion, or 63% of depreciation and amortization in 2002. The following table presents capital spending from continuing operations by each of our business segments for the years ended December 31, 2004, 2003 and 2002. <img src='content_image/123452.jpg'> In addition, capital spending related to businesses sold and held for sale was $66 million, $72 million and $73 million in 2004, 2003 and 2002, respectively. We expect capital expenditures in 2005 to be about $1.4 billion, or about 83% of depreciation and amortization. Capital allocations will focus on businesses with the best returns, including an upgrade to our Eastover, South Carolina mill, and growth opportunities in Eastern Europe and Brazil where we are conducting a study to evaluate the potential construction of a new mill in Tres Lagoas in the 2007 to 2008 time frame. ## Mergers and Acquisitions On July 2, 2004, Carter Holt Harvey completed the purchase of an 85% interest in a Chinese premium panels manufacturer, Plantation Timber Products (PTP), for $134 million. PTP is a manufacturer of special medium density fiberboard and flooring products. On July 1, 2004, International Paper acquired Box USA, one of America’s leading corrugated packaging companies, for approximately $400 million, including the assumption of approximately $197 million of debt. In December 2002, Carter Holt Harvey acquired Starwood Australia’s Bell Bay medium density fiberboard plant in Tasmania, for $28 million in cash. Each of the above acquisitions was accounted for using the purchase method. The operating results of these mergers and acquisitions have been included in the consolidated statement of operations from the dates of acquisition. ## Financing Activities 2004: Financing activities during 2004 included debt issuances of $3 billion and retirements of $4.5 billion, including repayments of $193 million of debt assumed in the Box USA acquisition in July and $340 million of debt that was reclassified from Minority interest in 2004 prior to repayment. Excluding these repayments, and currency translation effects, the net reduction in debt during 2004 was approximately $900 million. In December 2004, Timberlands Capital Corp. II, a wholly- owned consolidated subsidiary of International Paper, redeemed $170 million of 4.5% preferred securities. 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. Both of these securities had been reclassified from Minority interest to Current maturities of long-term debt prior to their repayment. Also 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 and a maturity in August 2009. 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 and a maturity date of June 2007, which refinanced $650 million of long- term debt having an interest rate of LIBOR plus 100 basis points and a maturity date in August 2004. In April 2004, $1.0 billion of 8.125% coupon rate debt was retired using the proceeds from the March 2004 issuance of $400 million of 5.25% notes due in April 2016 and $600 million of 4.00% notes due in April 2010.

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In January 2004, approximately $1.0 billion of debt with an 8.05% blended coupon rate was retired, including all of the outstanding $805 million principal amount of International Paper Capital Trust III 7.875% preferred securities, using the proceeds from the two December 2003 issuances of $500 million each of notes discussed below. During 2004, Carter Holt Harvey borrowed $425 million under its multi-currency and commercial paper credit facilities at interest rates ranging from 5.5% to 6.8% to be repaid during 2005. Proceeds from the borrowing were used to repay approximately $305 million of 8.875% notes and cross-currency and interest rate swap settlements with a maturity date of December 2004. In addition to the preceding repayments, various other International Paper borrowings totaling approximately $1.0 billion were repaid in 2004. Other financing activity in 2004 included the issuance of approximately 3,652,000 treasury shares and 2,333,000 common shares under various incentive plans, including stock option exercises that generated $164 million of cash. 2003: Financing activities during 2003 included debt and preferred security issuances of $2.4 billion and retirements totaling $1.4 billion for a net increase of $1.0 billion, before non-cash adjustments under FIN 46 (see Recent Accounting Developments). The increase reflects the timing of $1 billion of borrowings in December 2003 used to retire approximately $1 billion of debt in early 2004 as discussed above. Other 2003 financing activity included the redemption of $550 million and the issuance of $150 million of preferred securities of International Paper subsidiaries. In December 2003, $500 million of 4.25% Senior Unsecured Notes due January 15, 2009, and $500 million of 5.50% Senior Unsecured Notes due January 15, 2014, were issued. In January 2004, the proceeds from these issuances were used to redeem $805 million of 7.875% preferred securities of International Paper Capital Trust III that, prior to July 1, 2003, was a subsidiary of International Paper (see Notes 4 and 8 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data). The remaining proceeds were used for the repayment or early retirement of other debt. In March 2003, $300 million of 3.80% notes due in April 2008, and $700 million of 5.30% notes due in April 2015, were issued. The proceeds from these 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. In the same period, International Paper sold a minority interest in Southeast Timber, Inc., a consolidated subsidiary of International Paper, to a private investor for $150 million with future dividend payments based on LIBOR. Other financing activity included $26 million for the repurchase of approximately 713,000 shares of International Paper common stock, and the issuance of 2,725,000 treasury shares under various incentive plans, including stock option exercises that generated $80 million of cash. 2002: Financing activities during 2002 included debt issuances of $2.0 billion and retirements of $3.0 billion, for a net debt reduction of $1.0 billion. Debt issuances in 2002 included $1.2 billion of 5.85% Senior Unsecured Notes due in October 2012, the proceeds of which were used to retire most of International Paper’s $1.2 billion of 8.0% notes due July 2003 that were issued in connection with the Champion acquisition. Other financing activity included $169 million for the repurchase of approximately 4,390,000 shares of International Paper common stock, and the issuance of 1,403,000 shares for various incentive plans, including stock option exercises that generated $53 million of cash. Refinancing of high coupon rate debt in the last three years is one means the Company uses to manage interest expense. Another method is the use of interest rate swaps to change the mix between fixed and variable rate debt. At December 31, 2004, International Paper had entered into interest rate swaps with a total notional amount of $2.2 billion. These swaps reduced 2004 interest expense by $52 million before taxes and minority interest, or 236 basis points, on $2.2 billion of related debt. At December 31, 2004, the swaps reduced the weighted average fixed rate on the debt of 5% to an effective rate of 2.6% with maturities ranging from one to 11 years. Dividend payments totaled $485 million in 2004, $480 million in 2003 and $482 million in 2002. The International Paper common stock dividend remained at $1.00 per share during the three-year period. In August 2004, CHH 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. At December 31, 2004 and 2003, cash and temporary investments totaled $2.6 billion and $2.4 billion, respectively. Both balances were higher than normal as they included cash proceeds from the sales of Weldwood of Canada Limited and the Maine and New Hampshire forestlands (2004) and $1 billion of borrowings (2003) that were used in part for the retirement of debt in January of the following year.

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## Capital Resources Outlook for 2005 International Paper can meet projected capital expenditures, service existing debt and meet working capital and dividend requirements during 2005 through cash from operations, supplemented as required by its various existing credit facilities. International Paper has approximately $3.2 billion of committed liquidity, which we believe is adequate to cover expected operating cash flow variability during our industry’s economic cycles. This includes $2 billion available under contractually committed bank credit agreements and up to $1.2 billion of available commercial paper-based financings under a receivables securitization program. At December 31, 2004, there were no outstanding borrowings under these agreements. Additionally, multi-currency credit facilities equivalent to NZ$725 million are available for liquidity requirements of our Carter Holt Harvey subsidiary in New Zealand. At December 31, 2004, CHH had approximately NZ$381 million of borrowings under these facilities. Liquidity could also be enhanced by possible future earnings repatriation decisions associated with the American Jobs Creation Act of 2004. See Note 9 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data, for additional information. The Company will continue to rely upon debt capital markets for the majority of any necessary funding not provided by operating cash flow or repatriated cash. Funding decisions will be guided by our capital structure planning and liability management practices. The primary goals of the Company’s capital structure planning are to maximize financial flexibility and preserve liquidity while reducing interest expense. In 2005, the Company will continue to access the capital markets where there are opportunities to replace high coupon debt with new financing instruments at lower interest rates, with a target of reducing consolidated debt to approximately $12 billion by the end of 2006. Accordingly, an additional $750 million of debt was subsequently repaid as of February 2005. The majority of International Paper’s debt is accessed through global public capital markets where we have a wide base of investors. The Company was well within the requirements for compliance with all its debt covenants at December 31, 2004. Principal financial covenants include maintenance of a minimum net worth of $9 billion, defined as the sum of common stock, paid-in capital and retained earnings, less treasury stock, plus any goodwill impairment charges, and a maximum total debt to capital ratio, defined as total debt divided by total debt plus net worth plus the minority interest in CHH, of 60%. Maintaining an investment grade credit rating is an important element of International Paper’s financing strategy. At December 31, 2004, the Company held long-term credit ratings of BBB (negative outlook) and Baa2 (negative outlook) by Standard & Poor’s and Moody’s Investor Services, respectively. The Company currently has short-term credit ratings by Standard & Poor’s and Moody’s Investor Services of A-3 and P-2, respectively. Contractual obligations for future payments under existing debt and lease commitments and purchase obligations at December 31, 2004 were as follows: <img src='content_image/26897.jpg'> (a) The 2005 amount includes $2.1 billion for contracts made in the ordinary course of business to purchase pulpwood, logs and wood chips by Forest Resources and Carter Holt Harvey. The majority of our other purchase obligations are take-or-pay or purchase commitments made in the ordinary course of business related to raw material purchases and energy contracts. Other significant items include purchase obligations related to contracted services. ## Critical Accounting Policies The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires International Paper to establish accounting policies and to make estimates that affect both the amounts and timing of the recording of assets, liabilities, revenues and expenses. Some of these estimates require judgments about matters that are inherently uncertain. Accounting policies whose application may have a significant effect on the reported results of operations and financial position of International Paper, and that can require judgments by management that affect their application, include SFAS No. 5, “Accounting for Contingencies,” SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” SFAS No. 142, “Goodwill and Other Intangible Assets,” SFAS No. 87, “Employers’ Accounting for Pensions,” SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” as amended by SFAS No. 132 and 132R, “Employers’ Disclosures About Pension and Other Postretirement Benefits,” and SFAS No. 109, “Accounting for Income Taxes.” The following is a discussion of the impact of these accounting policies on International Paper:

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Contingent Liabilities. Accruals for contingent liabilities, including legal and environmental matters, are recorded when it is probable that a liability has been incurred or an asset impaired and the amount of the loss can be reasonably estimated. Liabilities accrued for legal matters require judgments regarding projected outcomes and range of loss based on historical experience and recommendations of legal counsel. Additionally, as discussed in Note 10 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data, reserves for projected future claims settlements relating to exterior siding products previously manufactured by Masonite require judgments regarding projections of future claims rates and amounts. International Paper utilizes independent third parties to assist in developing these estimates. Liabilities for environmental matters require evaluations of relevant environmental regulations and estimates of future remediation alternatives and costs. International Paper determines these estimates after a detailed evaluation of each site. Impairment of Long-Lived Assets and Goodwill. An impairment of a long-lived asset exists when the asset’s carrying amount exceeds its fair value, and is recorded when the carrying amount is not recoverable through future operations. A goodwill impairment exists when the carrying amount of goodwill exceeds its fair value. Assessments of possible impairments of long-lived assets and goodwill are made when events or changes in circumstances indicate that the carrying value of the asset may not be recoverable through future operations. Additionally, testing for possible impairment of recorded goodwill and intangible asset balances is required annually. The amount and timing of impairment charges for these assets require the estimation of future cash flows and the fair market value of the related assets. ## Pension and Postretirement Benefit Obligations. The charges recorded for pension and other postretirement benefit obligations are determined annually in conjunction with International Paper’s consulting actuary, and are dependent upon various assumptions including the expected long-term rate of return on plan assets, discount rates, projected future compensation increases, health care cost trend rates and mortality rates. Income Taxes. International Paper records its world-wide 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 specialists. These accruals 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 settlement with relevant tax authority, the expiration of statutes of limitation for the subject tax year, change in tax laws, or a recent court case that addresses the matter. While International Paper believes that these judgments and estimates are appropriate and reasonable under the circumstances, actual resolution of these matters may differ from recorded estimated amounts. ## Significant Accounting Estimates Pension and Postretirement Benefit Accounting. The calculations of pension and postretirement benefit obligations and expenses require decisions about a number of key assumptions that can significantly affect liability and expense amounts, including the expected long-term rate of return on plan assets, the discount rate used to calculate plan liabilities, the projected rate of future compensation increases and health care cost trend rates. Benefit obligations and fair values of plan assets as of December 31, 2004, for International Paper’s pension and postretirement plans are as follows: <img src='content_image/82684.jpg'> The table below shows the assumptions used by International Paper to calculate U.S. pension expenses for the years shown: <img src='content_image/82685.jpg'>

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Additionally, the health care cost trend rates used in the calculation of U.S. postretirement obligations for the years shown were: <img src='content_image/94448.jpg'> International Paper determines these actuarial assumptions, after consultation with our actuaries, on December 31 of each year to calculate liability information as of that date and pension and postretirement expense for the following year. 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 this yield curve to develop the discount rate. The expected long-term rate of return on plan assets reflects projected returns for an investment mix, determined upon completion of a detailed asset/liability study that meets the plans’ investment objectives. Increasing (decreasing) the expected long-term rate of return on U.S. plan assets by an additional 0.25% would decrease (increase) 2005 pension expense by approximately $16 million, while a (decrease) increase of .25% in the discount rate would (increase) decrease pension expense by approximately $22 million. The effect on net postretirement benefit cost from a 1% increase or decrease in the annual trend rate would be approximately $4 million. Actual rates of return earned on U.S. pension plan assets for each of the last 10 years were: <img src='content_image/94446.jpg'> The following chart, prepared by International Paper, illustrates the quarterly performance ranking of our pension fund investments compared with approximately 100 other corporate and public pension funds. The peer group, of which International Paper is one, is the “State Street Corporate and Public Master Trusts Universe.” <img src='content_image/94445.jpg'> SFAS No. 87, “Employers’ Accounting for Pensions,” 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 in pension expense 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. At December 31, 2004, unrecognized net actuarial losses for International Paper’s U.S. pension plans totaled approximately $2.6 billion. 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 U.S. pension expense by approximately $53 million in 2005, an additional $41 million in 2006, then decreasing expense by $14 million in 2007. Net periodic pension and postretirement plan expense (income), calculated for all of International Paper’s plans were as follows: <img src='content_image/94447.jpg'> (a) Excludes $4.8 million, $10.9 million and $1.0 million of expense in 2004, 2003 and 2002, respectively, for curtailments, settlements and special termination benefits related to divestitures and restructurings that were recorded in Restructuring and other charges and Net losses (gains) on sales and impairments of businesses held for sale in the consolidated statement of operations. (b) Excludes $42.7 million of income in 2004 for curtailments and settlements related to divestitures that were recorded in Net losses (gains) on sales and impairments of businesses held for sale in the consolidated statement of operations.

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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 the expected long-term rate of return on plan assets in 2003, and increases in the amortization of unrecognized actuarial losses, with smaller impacts from reductions in the assumed discount rate and the assumed rate of future compensation increases. For 2005, the Company estimates that it will record net pension expense of approximately $210 million for its U.S. defined benefit plans, with the increase versus 2004 principally reflecting increased 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 plan assets to 8.50% in 2005 from 8.75% in 2004. The estimated 2005 pension expense for our non-U.S. plans is $32 million, with the decrease from 2004 reflecting the sale of Weldwood. Net postretirement benefit costs in 2005 will decrease by approximately $13 million reflecting the impact of the Medicare Prescription Drug, Improvement and Modernization Act of 2003, partially offset by a decline in the discount rate assumption from 6.00% in 2004 to 5.75% in 2005. The market value of plan assets for International Paper’s U.S. pension plan at December 31, 2004, totaled approximately $6.7 billion, consisting of approximately 62% equity securities, 27% fixed income securities, and 11% real estate and other assets. Plan assets did not include International Paper common stock. 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). While International Paper may elect to make voluntary contributions to its U.S. qualified plan up to the maximum deductible amount per IRS tax regulations in the coming years, it is unlikely that any contributions to the plan will be required before 2007 unless investment performance is negative or International Paper changes its funding policy to make contributions above the minimum requirements. The U.S. nonqualified plans are only funded to the extent of benefits paid which are expected to be $21 million in 2005. Accounting for Stock Options. International Paper accounts for stock options using the intrinsic value method under Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” 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 provisions of SFAS No. 123, “Accounting for Stock- Based Compensation,” expense for stock options is measured at the grant date based on a computed fair value of options granted, and then charged to expense over the related service period. Had this method of accounting been applied, additional expense of $38 million in 2004, $44 million in 2003, and $41 million in 2002 would have been recorded, decreasing reported earnings (loss) per share by 114% to ($.15) in 2004, 14% to $.54 in 2003, and 5% to ($1.92) in 2002. Beginning in 2005, U.S. employees will no longer receive stock option awards. Accordingly, the provisions of recently issued SFAS No. 123 (revised 2004), that require compensation costs related to share-based payment transactions to be recognized in the financial statements, 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 in subsequent years. At December 31, 2004, 45.4 million options were outstanding with exercise prices ranging from $29.31 to $66.81 per share. At December 31, 2003, 42.8 million options were outstanding with exercise prices ranging from $29.31 to $69.63 per share. ## Income Taxes Before minority interest, discontinued operations, extraordinary items and the cumulative effect of accounting changes, the effective income tax rates were 28%, (39%) and (24%) for 2004, 2003 and 2002, respectively. These effective tax rates include the tax effects of certain special and unusual items that can affect the effective income tax rate in a given year, but may not recur in subsequent years. Management believes that the effective tax rate computed after excluding these special or unusual items may provide a better estimate of the rate that might be expected in future years if no additional special or unusual items were to occur in those years. Excluding these special and unusual items, the effective income tax rate for 2004 was 26% of pre-tax earnings

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compared with 20% in 2003 and 29% in 2002. The increase in the rate in 2004 reflects a higher proportion of earnings in higher tax rate jurisdictions. We estimate that the 2005 effective income tax rate will be approximately 33% based on expected earnings and business conditions, which are subject to change. ## Recent Accounting Developments The following represent recently issued accounting pronouncements that will affect reporting and disclosures in future periods. See Note 4 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data for a further discussion of each item. ## 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 applies to all awards granted after the required effective date and to awards modified, repurchased or cancelled after that date. This Statement will be effective for International Paper in the third quarter of 2005. ## 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 is 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 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 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. These 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 regardless of whether they meet the “so abnormal” criterion outlined in ARB No. 43. 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 is 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. ## 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

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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 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. 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 of zero- coupon convertible senior debentures that are convertible into approximately 20 million shares of common stock subject to certain conditions. Accordingly, the calculation of diluted earnings per common share shown in Note 2 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data, reflects 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 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. The cumulative effect of adoption of FIN 46(R) amounted to a $3 million charge after taxes. ## 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 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 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 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

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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). ## Legal Proceedings ## Environmental Matters International Paper is subject to extensive federal and state environmental regulation as well as similar regulations in all other jurisdictions in which we operate. Our continuing objectives are to: (1) control emissions and discharges from our facilities into the air, water and groundwater to avoid adverse impacts on the environment, (2) make continual improvements in environmental performance, and (3) maintain 100% compliance with applicable laws and regulations. A total of $99 million was spent in 2004 for capital projects to control environmental releases into the air and water, and to assure environmentally sound management and disposal of waste. We expect to spend approximately $140 million in 2005 for similar capital projects, including the costs to comply with the Environmental Protection Agency’s (EPA) Cluster Rule regulations. Amounts to be spent for environmental control projects in future years will depend on new laws and regulations and changes in legal requirements and environmental concerns. Taking these uncertainties into account, our preliminary estimate for additional environmental appropriations during the year 2006 is approximately $121 million, and during the year 2007 is approximately $42 million. The reduced capital forecast for 2007 reflects the reduction in Cluster Rule spending and completion of significant environmental improvement projects in Brazil. On April 15, 1998, the EPA issued final Cluster Rule regulations that established new requirements regarding air emissions and wastewater discharges from pulp and paper mills to be met by 2006. The projected costs included in our spending estimate related to the Cluster Rule regulations for the year 2005 are $61 million. Included in this estimate are costs associated with pulp and paper industry combustion source standards that were issued by the EPA on January 12, 2001. Total projected Cluster Rule costs for 2006 through 2007 are $58 million. The EPA is continuing the development of new programs and standards such as additional wastewater discharge allocations, water intake structure requirements and national ambient air quality standards. When regulatory requirements for new and changing standards are finalized, we will add any resulting future cost requirements to our expenditure forecast. International Paper has been named as a potentially responsible party in a total of 88 environmental remediation actions under various federal and state laws, including the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). Most of these proceedings involve the cleanup of hazardous substances at large commercial landfills that received waste from many different sources. While joint and several liability is authorized under CERCLA and equivalent state laws, as a practical matter, liability for CERCLA cleanups is allocated among the many potential responsible parties. Based upon previous experience with respect to the cleanup of hazardous substances and upon presently available information, International Paper believes that it has de minimis or no liability with respect to 20 of these sites; that liability is not likely to be significant at 29 sites; and estimates that liability at the remaining 39 sites is likely to be significant, but not material to International Paper’s consolidated financial statements. Related costs are recorded in the financial statements when they are probable and reasonably estimable. International Paper believes that the probable liability associated with these 88 proceedings is approximately $48 million. In addition to the above 88 proceedings, other remediation costs recorded as liabilities in the balance sheet totaled approximately $37 million. Completion of these actions is not expected to have a material adverse effect on our consolidated financial statements. As of February 2005, there were no other pending judicial proceedings, brought by government authorities against International Paper, for alleged violations of applicable environmental laws or regulations. Finally, on October 10, 2003, the Company was served with a civil administrative complaint by the EPA seeking a civil penalty of $673,969 based on alleged hazardous waste deficiencies at the Company’s treated pole facility in Joplin, Missouri. In August 2004, the Company and the EPA settled the matter and the Company agreed to pay a penalty in the amount of $86,649 and to perform additional environmental assessments of the facility. International Paper is involved in other contractual disputes, administrative and legal proceedings and investigations of various types. While any litigation, proceeding or investigation has an element of uncertainty, we believe that the outcome of any proceeding, lawsuit or claim that is pending or threatened, or all of them combined, will not have a material adverse effect on our consolidated financial statements. ## Litigation See Note 10 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data, for a detailed discussion of each of the following litigation matters. Exterior Siding and Roofing Litigation: Three nationwide class action lawsuits filed against International Paper have been settled in recent years. A provision of $450

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million was recorded in 2002 to increase existing reserve balances to projected settlement amounts. At December 31, 2004, reserves for these actions totaled $259 million. Insurance Matters: In connection with one of the exterior siding and roofing actions above, International Paper commenced a lawsuit against certain insurance carriers relating to their refusal to indemnify International Paper and, in the case of one insurance carrier, also for its refusal to provide a defense. In July 2003, a jury determined that $383 million of International Paper’s payments to settle these claims are covered by its insurance policies. International Paper is engaged in further court proceedings to determine each carrier’s allocable share. International Paper is also participating in court-ordered mediation with some of those insurance carriers and has settled its claims with certain other insurance carriers. In addition, International Paper was involved in a dispute with a third party regarding $100 million paid to International Paper under an alternative risk-transfer agreement. In February 2004, an agreement was reached whereby International Paper agreed to pay the third party a portion of future insurance proceeds as they are recovered by International Paper beginning in 2004, up to a maximum of $95 million. Antitrust Matters: In 2003, International Paper, along with two other defendants, settled a class action lawsuit alleging that it and other manufacturers of linerboard conspired to fix prices for corrugated sheets and containers during the period October 1, 1993, through November 30, 1995. International Paper’s share of this settlement, with a substantial proportion of the class (which included claims brought against Union Camp acquired by the Company in 1999), was $24.4 million. In connection with this class action lawsuit, a number of plaintiffs opted out of the class action and filed lawsuits in various federal district courts. These lawsuits, which have been consolidated for pretrial purposes in federal court in Pennsylvania, allege a class period of October 1, 1993 through February 28, 1997. In addition to the foregoing the Company is a defendant in several other antitrust class actions. One of the matters, relating to the Company’s fiber procurement, has been certified as a class action in the federal court in the District of South Carolina. Another purported class action involves publication papers, and has been recently consolidated for pre-trial purposes in the federal court for the District of Connecticut. Discovery in that case has not yet begun. The Company is vigorously defending these cases and believes it has valid defenses. ## Effect of Inflation While inflationary increases in certain input costs, such as energy, wood fiber and chemical costs, have an impact on the Company’s operating results, changes in general inflation have had minimal impact on our operating results in the last three years. Sales prices and volumes are more strongly influenced by supply and demand factors in specific markets and by exchange rate fluctuations than by inflationary factors. ## Foreign Currency Effects International Paper has operations in a number of countries. Its operations in those countries also export to, and compete with imports from, other regions. As such, currency movements can have a number of direct and indirect impacts on the Company’s financial statements. Direct impacts include the translation of international operations’ local currency financial statements into U.S. dollars. Indirect impacts include the change in competitiveness of imports into, and exports out of, the United States (and the impact on local currency pricing of products that are traded internationally). In general, a lower U.S. dollar and stronger local currency is beneficial to International Paper. The currencies that have the most impact are the Euro, the Canadian dollar, the New Zealand dollar, the Brazilian real, the Polish zloty and the Russian ruble. ## Market Risk We use financial instruments, including fixed and variable rate debt, to finance operations, for capital spending programs and for general corporate purposes. Additionally, financial instruments, including various derivative contracts, are used to hedge exposures to interest rate, commodity and foreign currency risks. We do not use financial instruments for trading purposes. Information related to International Paper’s debt obligations is included in Note 12 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. A discussion of derivatives and hedging activities is included in Note 13 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. The fair value of our debt and financial instruments varies due to changes in market interest and foreign currency rates and commodity prices since the inception of the related instruments. We assess this market risk utilizing a sensitivity analysis. The sensitivity analysis measures the potential loss in earnings, fair values and cash flows based on a hypothetical 10% change (increase and decrease) in interest and currency rates and commodity prices.

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## Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to short- and long-term debt obligations and investments in marketable securities. We invest in investment grade securities of financial institutions and industrial companies and limit exposure to any one issuer. Our investments in marketable securities at December 31, 2004 are stated at cost, which approximates market due to their short-term nature. Our interest rate risk exposure related to these investments was immaterial. We issue fixed and floating rate debt in a proportion consistent with International Paper’s optimal capital structure, while at the same time taking advantage of market opportunities to reduce interest expense as appropriate. Derivative instruments, such as interest rate swaps, may be used to implement the optimal capital structure. At December 31, 2004 and 2003, the net fair value liability of financial instruments with exposure to interest rate risk was approximately $11.3 billion and $11.8 billion, respectively. The potential loss in fair value resulting from a 10% adverse shift in quoted interest rates would be approximately $419 million and $430 million for 2004 and 2003, respectively. ## Commodity Price Risk The objective of our commodity exposure management is to minimize volatility in earnings due to large fluctuations in the price of commodities. Commodity swap and option contracts have been used to manage risks associated with market fluctuations in energy prices. There are no outstanding energy hedge contracts as of December 31, 2004. As of December 31, 2003, the net fair value of such contracts was a $5 million asset. The potential loss in fair value resulting from a 10% adverse change in the underlying commodity prices would have been immaterial for 2003. ## Foreign Currency Risk International Paper transacts business in many currencies and is also subject to currency exchange rate risk through investments and businesses owned and operated in foreign countries. Our objective in managing the associated foreign currency risks is to minimize the effect of adverse exchange rate fluctuations on our after-tax cash flows. We address these risks on a limited basis through financing a portion of our investments in overseas 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. At December 31, 2004 and 2003, the net fair value liability of financial instruments with exposure to foreign currency risk was approximately $510 million and $540 million, respectively. The potential loss in fair value for such financial instruments from a 10% adverse change in quoted foreign currency exchange rates would be immaterial for both 2004 and 2003. ## ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See the discussion under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations on pages 31 and 32, and under Item 8. Financial Statements and Supplementary Data in Note 13 of the Notes to Consolidated Financial Statements on pages 69 through 71.

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2003 net sales of $24 billion. We saw our top line improve throughout 2004, and the fourth quarter was our best sales revenue quarter since the first quarter of 2001. In terms of International Paper’s core businesses – paper packaging and forest products – we had solid year-over-year earnings gains based on our cost-reduction efforts, operating performance, pricing and volume. However, these gains were offset by significant pressure from raw material costs. It wasn’ until the fourth quarter that our prices in our U.S.-based paper and packaging businesses went up more than our major input costs of wood, energy and chemicals. ## Continuing our Commitment Looking forward, we remain committed to our goal of a 9 percent return on investment over the cycle and moving ahead of our competitors. And, while we have made progress, particularly against our industry competitors, we are far from satisfied with our absolute levels of earnings and returns. In today’ environment, with high raw material costs, we know that achieving the 9 percent ROI goal may be harder may take longer and require further adjustment to our strategies and plans. Nonetheless, we are prepared to meet those challenges and are absolutely dedicated to achieving this level of return. As a company and as individuals, we will continue to set tough but doable stretch goals. Achieving this goal will reflect not only our success in achieving our ROI goal – it will mean we are doing the best job possible at providing greater opportunities for our employees, better meeting the needs of our customers and communities, and satisfying the expectations of our shareowners. And in all of these things, our efforts begin and end with ethics and integrity. In last year’s shareowners letter I stated that we will become a more global company. As we define what that means, we know we can only become more successful by building stronger businesses in North America – we call it earning the right to grow. This is not a bigger is better strategy Our goal is to not only be the best performing company in our industry but also one of the best industrial companies in the world. All of our initiatives are designed to provide a greater return to those who have chosen to invest in our company. also said that we would be changing the way we as leaders of International Paper are compensated. A year later, we have significantly adjusted our incentive compensation plans so they are far more directly tied to external performance measures. Our senior executives now have a majority of their total compensation tied to external measures of performance – return on investment and total shareowner return. Our compensation is based on rewarding, motivating, aligning and enhancing accountability. ## Looking Ahead We know our shareowners want to see better earnings performance from International Paper and going forward, we are prepared to take the steps necessary to build on what we accomplished in 2004. Our strategy is to focus on a few key paper packaging and forest products businesses in North America. We will drive both our manufacturing and supply chain cost to best-in-class levels while we are investing in new capabilities so that we can have the most effective supply chain cost to serve our customers. We remain committed to the financial discipline of keeping overall capital expenditures to less than depreciation over the cycle. We are focused on reducing debt and have paid down $1.3 billion in the last three months. We have targeted an additional reduction of $1.7 billion by the end of 2006, which will reduce our debt to levels we had in 2000 prior to the Champion merger. We will continue to make strategic choices going forward to ensure we have our resources focused on the areas where we can succeed and grow profitability. We’ll have to make some tough choices just as we did in 2004 with the decision to sell our Canadian wood and pulp business – we see that as part of our strategy. We want to grow International Paper but only grow profitably Much of our growth will be outside North America. But we will selectively invest in our core businesses to make them better and more competitive. Our customers are increasingly becoming more global in their own businesses and in turn, we need to become more global with them. We have small but strong platforms in Brazil, Eastern Europe and Russia that we will look to grow over time.

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## ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ## Financial Information by Industry Segment and Geographic Area For information about our industry segments, see the “Description of Industry Segments” included on pages 15 through 17 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. For management purposes, we report the operating performance of each business based on earnings before interest and income taxes (“EBIT”) excluding special and extraordinary items, gains or losses on sales of businesses and cumulative effects of accounting changes. Our Carter Holt Harvey segment includes our share, about half, of their operating earnings adjusted for accounting principles generally accepted in the United States of America. The remaining half is included in minority interest. Intersegment sales and transfers are recorded at current market prices. External Sales by Major Product is determined by aggregating sales from each segment based on similar products or services. External sales are defined as those that are made to parties outside International Paper’s consolidated group, whereas sales by segment in the Net Sales table are determined by the management approach and include intersegment sales. Capital Spending by Industry Segment is reported on page 22 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Prior-year industry segment information has been restated to conform to the 2004 management structure and to reflect the Weldwood of Canada Limited business and Carter Holt Harvey Tissue business sold in 2004 as discontinued operations. ## INFORMATION BY INDUSTRY SEGMENT ## Net Sales <img src='content_image/19532.jpg'> ## Assets <img src='content_image/19531.jpg'> ## Operating Profit <img src='content_image/19530.jpg'>

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## Restructuring and Other Charges <img src='content_image/101988.jpg'> ## Depreciation and Amortization (d) <img src='content_image/101999.jpg'> ## External Sales by Major Product <img src='content_image/102002.jpg'> ## INFORMATION BY GEOGRAPHIC AREA <img src='content_image/101989.jpg'> ## European Sales by Industry Segment <img src='content_image/102000.jpg'> ## Long-Lived Assets (i) <img src='content_image/102004.jpg'> (a) Includes Arizona Chemical and Chemical Cellulose Pulp. Also included are certain other smaller businesses identified in the Company’s divestiture program. (b) Includes corporate assets and assets of discontinued operations in 2003 and 2002. (c) Operating profits for industry segments include each segment’s percentage share of the profits of subsidiaries included in that segment that are less than wholly-owned. The pre-tax minority interest for these subsidiaries is added here to present consolidated earnings before income taxes, minority interest, extraordinary items, and cumulative effect of accounting changes. (d) Includes cost of timber harvested. (e) Includes sales of products not included in our major product lines. (f) Net sales are attributed to countries based on location of seller. (g) Export sales to unaffiliated customers (in billions) were $1.5 in 2004, $1.4 in 2003 and $1.3 in 2002. (h) Operations in New Zealand and Australia account for most of the Pacific Rim amounts. (i) Long-Lived Assets includes Forestlands and Plants, Properties and Equipment, net.

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Report of Management on: Financial Statements - The management of International Paper Company is responsible for the preparation of the consolidated financial statements in this annual report. The consolidated financial statements have been prepared using accounting principles generally accepted in the United States of America considered appropriate in the circumstances to present fairly the Company’s consolidated financial position, results of operations and cash flows on a consistent basis. Management has also prepared the other information in this annual report and is responsible for its accuracy and consistency with the consolidated financial statements. As can be expected in a complex and dynamic business environment, some financial statement amounts are based on estimates and judgments. However, measures have been taken to provide reasonable assurance of the integrity and reliability of the financial information contained in this annual report. We have formed a Disclosure Committee to oversee this process. The accompanying consolidated financial statements have been audited by the independent registered public accounting firm, Deloitte & Touche LLP. During their audits, they were given unrestricted access to all financial records and related data, including minutes of all meetings of stockholders and the board of directors and all committees of the board. Management believes that all representations made to the independent auditors during their audits were valid and appropriate. Internal Controls over Financial Reporting - The management of International Paper Company is also responsible for establishing and maintaining adequate internal controls over financial reporting including the safeguarding of assets against unauthorized acquisition, use or disposition. These controls are designed to provide reasonable assurance to management and the board of directors regarding preparation of reliable published financial statements and such asset safeguarding. The system is supported by written policies and procedures, contains self-monitoring mechanisms, and is audited by internal audit. Appropriate actions are taken by management to correct deficiencies as they are identified. The Company has assessed the effectiveness of its internal control over financial reporting as of December 31, 2004. In making this assessment, it used the criteria described in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management believes that, as of December 31, 2004, the Company’s internal control over financial reporting is effective. Deloitte & Touche LLP, have issued their report on management’s assessment of the effectiveness of the Company’s internal control over financial reporting. The report appears on page 37. Internal Control Environment and Board of Directors Oversight - Our internal control environment includes an enterprise-wide attitude of integrity and control consciousness that establishes a positive “tone at the top.” This is exemplified by our ethics program that includes long- standing principles and policies on ethical business conduct that require employees to maintain the highest ethical and legal standards in the conduct of International Paper business, that have been distributed to all employees, a toll-free telephone helpline whereby any employee may report suspected violations of law or International Paper’s policy, and an office of ethics and business practice. The internal controls system further includes careful selection and training of supervisory and management personnel, appropriate delegation of authority and division of responsibility, dissemination of accounting and business policies throughout International Paper, and an extensive program of internal audits with management follow-up. The Board of Directors, assisted by the Audit and Finance Committee (Committee), monitors the integrity of the Company’s financial statements and financial reporting procedures, the performance of the Company’s internal audit function and independent auditors, and other matters set forth in its charter. The Committee, which currently consists of four independent directors, meets regularly with representatives of management, and with the independent auditors and the Internal Auditor, with and without management representatives in attendance, to review their activities. The Committee’s Charter takes into account the New York Stock Exchange rules relating to Audit Committees and the SEC rules and regulations promulgated as a result of the Sarbanes-Oxley Act of 2002. A copy of the charter will be included in the Company’s definitive proxy statement relating to the annual meeting of shareholders in 2005. The Committee has reviewed and discussed the consolidated financial statements for the year ended December 31, 2004, including critical accounting policies and significant management judgments, with management and the independent auditors. The Committee’s report recommending the inclusion of such financial statements in this Annual Report on Form 10-K will be set forth in our proxy statement. <img src='content_image/24945.jpg'> <img src='content_image/24946.jpg'>

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## Report of Deloitte & Touche LLP, Independent Registered Public Accounting Firm, on Consolidated Financial Statements To the Shareholders of International Paper Company: We have audited the accompanying consolidated balance sheets of International Paper Company and subsidiaries (the “Company”) as of December 31, 2004 and 2003, and the related statements of operations, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of International Paper Company and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 7, 2005 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. <img src='content_image/31195.jpg'> NEW YORK, N.Y. MARCH 7, 2005

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## Report of Deloitte & Touche LLP, Independent Registered Public Accounting Firm, on Internal Controls Over Financial Reporting To the Shareholders of International Paper Company: We have audited management’s assessment, included in the accompanying Report of Management on Internal Controls over Financial Reporting, that International Paper Company and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the consolidated financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the criteria established in Internal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2004 of the Company and our report dated March 7, 2005 expressed an unqualified opinion on those financial statements and financial statement schedule. <img src='content_image/89157.jpg'>

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## CONSOLIDATED STATEMENT OF OPERATIONS <img src='content_image/36233.jpg'> The accompanying notes are an integral part of these financial statements.

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## CONSOLIDATED BALANCE SHEET <img src='content_image/42562.jpg'> The accompanying notes are an integral part of these financial statements.

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## CONSOLIDATED STATEMENT OF CASH FLOWS <img src='content_image/49524.jpg'> The accompanying notes are an integral part of these financial statements.

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## CONSOLIDATED STATEMENT OF CHANGES IN COMMON SHAREHOLDERS’ EQUITY In millions, except share amounts in thousands <img src='content_image/102880.jpg'> (1) The cumulative foreign currency translation adjustment (in millions) was $(29), $(284) and $(1,092) at December 31, 2004, 2003 and 2002, respectively, and is included as a component of accumulated other comprehensive income (loss). The accompanying notes are an integral part of these financial statements.

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## NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ## Nature of Our Business International Paper 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. Substantially all of our businesses have experienced, and are likely to continue to experience, cycles relating to available industry capacity and general economic conditions. ## Financial Statements These financial statements have been prepared in conformity with accounting principles generally accepted in the United States that require the use of management’s estimates. Actual future results could differ from management’s estimates. ## Consolidation The consolidated financial statements include the accounts of International Paper and its wholly-owned, controlled majority- owned and financially controlled subsidiaries. Minority interest principally represents minority shareholders’ proportionate share of the equity in our consolidated subsidiary, Carter Holt Harvey Limited (CHH). All significant intercompany balances and transactions are eliminated. Investments in affiliated companies are accounted for by the equity method, including companies owned 20% to 50%. International Paper’s share of affiliates’ earnings totalled $18 million, $10 million and ($10) million in 2004, 2003 and 2002, respectively. ## Revenue Recognition Revenue is recognized when the customer takes title and assumes the risks and rewards of ownership. Revenue is recorded at the time of shipment for terms designated f.o.b. (free on board) shipping point. For sales transactions designated f.o.b. destination, revenue is recorded when the product is delivered to the customer’s delivery site, when title and risk of loss are transferred. Timber and timberland sales revenue is generally recognized when title and risk of loss pass to the buyer. ## Shipping and Handling Costs Shipping and handling costs, such as freight to our customers’ destinations, are included in distribution expenses in the consolidated statement of operations. These costs, when included in the sales price charged for our products, are recognized in net sales. ## Annual Maintenance Costs Annual maintenance costs for major planned maintenance shutdowns (in excess of $1 million) are expensed ratably over the year in which the maintenance shutdowns occur since the Company believes that operations benefit throughout the year from the maintenance work performed. These costs, including manufacturing variances and out-of- pocket costs that are directly related to the shutdown, are fully expensed in the year of the shutdown with no amounts remaining accrued at year-end. Other maintenance costs are expensed as incurred. ## Temporary Investments Temporary investments with an original maturity of three months or less are treated as cash equivalents and are stated at cost, which approximates market. ## Inventories Inventory is valued at the lower of cost or market and includes all costs directly associated with manufacturing products: materials, labor and manufacturing overhead. In the United States, costs of raw materials, finished lumber and panels and finished pulp and paper products are generally determined using the last-in, first-out method. Other inventories are valued using the first-in, first-out or average cost methods. ## Plants, Properties and Equipment Plants, properties and equipment are stated at cost, less accumulated depreciation. Expenditures for betterments are capitalized whereas normal repairs and maintenance are expensed as incurred. The units-of-production method of depreciation is used for major pulp and paper mills and certain wood products facilities and the straight-line method for other plants and equipment. Annual straight-line depreciation rates are, for buildings, 2 1/2% to 8 1/2%, and, for machinery and equipment, 5% to 33%. ## Forestlands At December 31, 2004, International Paper and its subsidiaries owned or controlled about 6.8 million acres of forestlands in the United States, 1.2 million acres in Brazil, 785,000 acres in New Zealand, and had, through licenses and forest management agreements, harvesting rights on government-owned forestlands in Russia. Forestlands include owned property as well as certain timber harvesting rights

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Although we will continue to face challenges, we have opportunities and I am excited about the direction of our company. The economy in the United States has picked up and demand for our products is better now than it was at this time last year. genuinely believe our best days are ahead of us and I want to thank our employees for their hard work and contributions that have enabled International Paper to make the progress we did in 2004. I also want to thank our customers for the business they placed with International Paper and I want to thank our shareowners for their confidence and the investments they have made in our company. We are dedicated to earning your continued support. <img src='content_image/47221.jpg'> <img src='content_image/47223.jpg'> ## International Paper’s Senior Leadership Seated, from left, Marianne Parrs , executive vice president; Tom Gestrich , senior vice president, Consumer Packaging; Rob Amen , president; Dennis Thomas , senior vice president, Public Affairs and Communications; John Faraci , chairman and chief executive officer; Rich Lowe , senior vice president and president, xpedx; Maura Smith , senior vice president, general counsel and corporate secretary; Newland Lesko , executive vice president; and Andy Lessin senior vice president, Internal Audit. Standing, from left, Bill Hoel , senior vice president, Sales and Marketing; George O’Brien , senior vice president, Forest Resources and Wood Products*; Wayne Brafford , senior vice president, Industrial Packaging; LH Puckett , senior vice president, Coated and SC Papers; Chris Liddell , senior vice president and chief financial officer; Cato Ealy , senior vice president, Corporate Development; Mike Balduino , senior vice president and president, Shorewood Packaging; Richar Phillips , senior vice president, Technology; Paul Herbert , senior vice president, Printing & Communications Papers; Tom Kadien senior vice president and president, International Paper Europe; and Jerry Carter , senior vice president, Human Resources. *Mr. O’Brien recently retired.