DURING 2003, MANAGEMENT TOOK SEVERAL STEPS TO INCREASE SMITHS' FOCUS ON THOSE BUSINESSES WITH POTENTIAL FOR HIGHER GROWTH. WE DID SO BY MOVING THE FAST-GROWING SMITHS DETECTION BUSINESS INTO ITS OWN DIVISION, AND SETTING IN MOTION A SERIES OF INITIATIVES TO DRIVE ALL FOUR OF OUR DIVISIONS TOWARDS THEIR FULL POTENTIAL. AT THE SAME TIME, WE MADE FURTHER ACQUISITIONS AND DISPOSALS.

The management of each of our four divisions now has specific growth targets and is in the process of implementing measures designed to achieve these targets.

In Detection, we are taking steps to increase our market share in what is a fast growing market. In Medical, we are introducing innovative new devices and improving our route to market. Aerospace is tackling the cyclical downturn in civil aviation by introducing further efficiencies and cost reductions, while continuing to gain prestigious contracts on new civil and defence programmes. In Specialty Engineering, we are continuously improving product quality, while seeking to grow sales, profits, margins and cash-flow.

Through a combination of acquisitions and disposals, we are focusing the company on the businesses with the greatest growth potential. The acquisition of Heimann Systems GmbH, the world-leader in x-ray inspection of airline baggage and container freight, was highly complementary to our existing detection activities and reinforced our position in this rapidly evolving market. By contrast, we announced the sale of Polymer Sealing Solutions towards the year-end, judging that this business had a greater value to another owner.

As our Chairman has reported, there was robust progress in profits in the face of mixed conditions. For the year ended 31 July 2003, Smiths generated operating profit from continuing activities of £372m, exceeding last year's result by 2%, in spite of the translation effect of an unfavourable US dollar exchange rate. Sales increased by 2% to £2.6bn. Pre-tax profits before exceptional items and amortisation of goodwill declined by 4% to £349m, however, as a result of increased pension cost, which is discussed later in the financial review. Earnings per share of 45.6p were below last year's level of 46.9p. Reflecting the quality of our technology and our tight control over costs, Smiths achieved an unchanged operating profit margin of 14%.

The company maintained its strong record of cash generation, converting 90% of operating profit into operating cash, after capital expenditure. Free cash-flow, after interest, tax and restructuring costs was 48p per share. Net debt was reduced, standing at £715m at the year-end. The total return on shareholder investment, including goodwill previously set off against reserves, was 12% after tax, well above the company's cost of capital.

The year-on-year improvement in underlying operating profit is masked by the decline of the US dollar rate used for currency translation and increased spending on research and development. The negative effect of these factors has been recovered through greater productivity and the benefits of earlier restructuring.

Company funded research and development increased by 11% to £130m, reflecting the cost of developing intelligent technology for new aerospace programmes, detection equipment and medical devices. This should be rewarded by higher growth and reinforced margins in the years ahead. Customer funded research and development also increased, to £121m.

Our investment in acquisitions was immediately beneficial. The purchase of Heimann Systems GmbH for £236m in cash has already significantly enhanced earnings.

Exceptional items of £123m reflect the combined effect of the profit booked on the sale of our Lodge and Air Movement businesses and a write-down of goodwill on the anticipated sale of Polymer. Polymer's full price reflects its increased profitability, but the prices paid for businesses have fallen since the 1990s when it was built by acquisition.

In summary, the balance of our businesses has served us well in another difficult year. Management has identified opportunities to increase profits in each of the four divisions and is taking steps to capture the potential they represent. At the same time, the company is maintaining its financial discipline.