OPERATING AND FINANCIAL REVIEW Cash flows and debt  ACCOUNTING POLICIES Introduction Adjusted operating cash flow , before exceptional items, was £1,028m/ € 1,491m representing an 87% conversion rate of adjusted operating profits into cash. This compares with a conversion rate in 2002 of 89%. Capital expenditure in the year amounted to £168m/ € 244m and depreciation was £134m/ € 194m, both similar to the prior year. Free cash flow  – after interest and taxation but before acquisition spend, exceptional receipts and payments and dividends – was £669m/ € 970m, compared to £651m/ € 1,035m in 2002. After dividends, free cash flow was £377m/ € 547m compared to £378m/ € 601m in 2002. Net exceptional cash inflows of £34m/ € 50m included £96m/ € 140m proceeds from disposals of businesses and fixed asset investments and £36m/ € 52m of reduced tax payments, less exceptional acquisition related and restructuring payments of £98m/ € 142m. In 2003,  acquisitions were made for a total consideration of £226m/ € 328m, including £3m/ € 5m deferred to future years, and after taking account of £9m/ € 13m of net cash acquired. An amount of £229m/ € 332m was capitalised as goodwill and intangible assets. Deferred consideration paid in respect of prior year acquisitions and payment of change of control and other non-operating liabilities assumed on the acquisition of Harcourt totalled £35m/ € 50m. The 2003 acquisitions contributed £16m/ € 25m to adjusted operating profit in the year and added £15m/ € 22m to adjusted operating cash flow. Net borrowings at 31 December 2003 were £2,372m/ € 3,368m, a decrease of £360m in sterling and € 812m in euros since 31 December 2002, reflecting the free cash flow less acquisition spend, and favourable exchange translation effects from the weaker US dollar. Gross borrowings at 31 December 2003 amounted to £3,010m/ € 4,274m, denominated mostly in US dollars, and were partly offset by cash balances totalling £638m/ € 906m invested in short term deposits and marketable securities. After taking account of interest rate derivatives, a total of 65% of Reed Elsevier’s gross borrowings were at fixed rates, including £1,270m/ € 1,797m of floating rate debt fixed through the use of interest rate derivatives, and had a weighted average interest coupon of 6.3% and an average remaining life of 5.8 years. The accounting policies of the Reed Elsevier combined businesses are described in the combined financial statements. Prior to 2003, the Reed Elsevier combined financial statements were presented in accordance with both UK and Dutch Generally Accepted Accounting Principles (“GAAP”). Following changes to Dutch GAAP effective for the 2003 financial year in respect of the presentation of dividends and pension accounting, UK and Dutch GAAP have diverged such that the Reed Elsevier accounting policies no longer accord with Dutch GAAP. Under Article 362.1 of Book 2 Title 9 of the Netherlands Civil Code, UK GAAP may be adopted by Dutch companies with international operations for the preparation of financial statements and, accordingly, UK GAAP has been so adopted, ensuring consistency with the prior year of the accounting policies applied in the combined financial statements. Reed Elsevier NV has adopted UK GAAP in its statutory financial statements and has therefore presented both group financial statements, in which its investments in Reed Elsevier Group plc and Elsevier Reed Finance BV are presented using the gross equity method, and parent company financial statements, in which its investments are presented using the historical cost method. The adoption of UK GAAP by Reed Elsevier NV had no impact on group shareholders’ funds as at 1 January 2003 or on the group earnings for the year ended 31 December 2003. The adoption of UK GAAP had the effect of reducing parent company shareholders’ funds as at 1 January 2003 by  € 34m and parent company attributable profit for the year ended Turnover by business segment  Business 27% Science & Medical 28% Legal 27% Education 18% North America 59% United Kingdom 11% The Netherlands 4% Rest of Europe 14% Rest of world 12% Turnover by geographical market Subscriptions 39% Circulation 31% Exhibitions 9% Advertising 13% Other 8% Turnover by source REED ELSEVIER ANNUAL REPORTS & FINANCIAL STATEMENTS 2003 17