DURING 2002 SMITHS MADE SOLID PROGRESS IN SPITE OF EXCEPTIONALLY DIFFICULT ECONOMIC CONDITIONS. MANY OF OUR BUSINESSES CONTINUED TO EXPAND, WHILE OTHERS WERE RESILIENT IN THE FACE OF LOWER DEMAND. THROUGHOUT THE GROUP, WE TOOK ACTION TO INCREASE EFFICIENCY AND TO IMPROVE OUR FOCUS ON THE AREAS WITH GREATEST OPPORTUNITY FOR LONG-TERM GROWTH.

Big increases in the US defence budget led to higher sales of military equipment in Aerospace, our largest division. However, the beneficial effects of this were offset by the serious downturn in civil aerospace. Notably, the Medical division's sales continued to increase, benefiting from strong competitive positions in a number of high-growth markets.

The year called more than ever for our active style of management. We took decisive action to cut capacity in those areas affected by the poor business environment, at the same time establishing new manufacturing jobs in low-cost economies in Eastern Europe and Mexico. We increased efficiency in many of our activities through the introduction of lean initiatives.

The benefits of this will be in addition to the synergy gains already being achieved from the TI merger restructuring. As you will read later, the latter had a particularly positive impact on the profits of our Sealing Solutions division.

On a like-for-like basis Smiths' headcount fell by 7%.

Smiths generated £3,070m of sales from continuing activities in the year to 31 July 2002, a decline of just 2% from 2001's result. Operating profits fell by 9% to £452m and pre-tax profits by 8% to £406m, as the decline in sales was concentrated in higher-margin activities. Earnings per share reduced by 7% to 52.3p. Even in these challenging times, our margins remain first-class at 15%, broadly in line with Smiths' historically high profitability.

From a sales perspective we started to see the anticipated rewards from our merger with TI. Within Aerospace, we are now winning major contracts as a direct result of broadening the division's activities.

Exceptional items of £68m reflect the cost of the restructuring programme and a loss on the book value of discontinued businesses.

Our cash performance illustrated the group's underlying financial strength. While Smiths always generates a high level of cash, we significantly exceeded our target of 80% profit-to-cash conversion, with operating cash-flow (after capital expenditure) of £473m for the continuing activities. This robust cash-flow allows us to pay down debt and gives us the flexibility to make acquisitions.

As a matter of course, we continued to improve our strategic position through disposing of non-core businesses and making bolt-on acquisitions in growth areas. We sold the John Crane-Lips marine seals business and most of the former EIS engineering businesses. In total, we raised £247m from disposals. We spent £66m on small but strategic acquisitions and remain keen to buy businesses that fulfil our acquisition criteria.

Debt was reduced substantially. Disposal proceeds were responsible for some of the reduction, but operating cash-flow played the greatest part. Net debt stood at £725m at the year-end, 35% less than the debt of £1,120m at the end of 2001. All borrowings are recorded on our balance sheet. Interest costs for the year amounted to £46m.

We also increased our spending on research and development (R&D), as new technology is a driver of our growth. The year's £212m R&D spend compares with £188m in 2001. From an accounting perspective, £116m of this was treated as an expense during the year, while our customers paid for the remainder.

In summary, while we have not been able to avoid the world's economic difficulties, we have found protection in the strength and diversity of our businesses. After a careful review, we have concluded that our greatest opportunities lie in the Aerospace and Medical divisions – which are both in sectors with attractive long-term growth prospects. As a result, we are concentrating on building these divisions both by product development and acquisition. We are also continuing to improve our Sealing Solutions and Industrial divisions.