MANAGING DIRECTOR JOHN FERRIE

AS A FIRST-TIER SUPPLIER OF INTEGRATED SYSTEMS TO THE PRIME AIRCRAFT MANUFACTURERS AND ENGINE BUILDERS, SMITHS AEROSPACE SPECIALISES IN DESIGNING AND MANUFACTURING HIGH-VALUE, AFFORDABLE SOLUTIONS FOR MILITARY AND CIVIL APPLICATIONS. WE FOCUS ON APPLYING TECHNOLOGIES TO ENHANCE THE CAPABILITIES OF AIRCRAFT, WHILE REDUCING THE COST OF CONSTRUCTION, MAINTENANCE AND OPERATION.

For the aerospace industry, the last 12 months were among the most difficult ever. Airlines delayed orders of new aircraft, and their appetite for spares and retrofits diminished, reflecting their weak financial state. To an extent, this commercial recession was offset by the US-led continuing expansion in military expenditure.

Increased sales to military aircraft programmes limited the decline in Smiths Aerospace sales, which fell by 7% to £998m. However, margins on military sales are lower than those on civil. Additionally, the weaker US dollar exchange rate resulted in a £10m adverse currency translation and we spent £8m more on research and development. As a result, operating profit fell by 24% to £105m.

Defence equipment now represents more than half of the division's sales and we are chosen suppliers to most of the high-value programmes of the next decade, including the Joint Strike Fighter, which will be the highest volume fighter jet in production. Spending on military aircraft is projected to continue to rise for the rest of the decade.

In civil aerospace, the number of new passenger jets with more than 100 seats built annually will have declined from a peak of over 900 four years ago to fewer than 600 this year and there is no sign of an upturn before 2006. We are well positioned on aircraft which are likely to benefit when the cycle turns, such as the Boeing 737.

The division continues to develop its technology and to adapt its products to the needs of today's military and civil customers. The increase in company funded research and development spending reflects success in winning opportunities on programmes such as the Airbus A380, Boeing 767 Tanker, and the Lockheed Martin Joint Strike Fighter. Also, Smiths is one of a team of companies developing technologies and design concepts for Boeing's new 7E7 airplane programme, including the Core Common Computing and Power Management systems.

STRATEGIC INITIATIVES
We have improved our organisational structure to provide greater focus on core activities and key customers. The division is now split into its two core activities of systems (actuation and avionics) and engine components. Within the systems business, key customers now have a single point of contact.

In recognition of engine manufacturers' moves to outsource the machining of engine components to high-quality, low-cost manufacturers, we are building a new facility in Suzhou, Jiang Su province, China. The facility will start operation in early 2004 and has sufficient capacity to meet demand when the civil aerospace cycle recovers.

We have continued to sharpen our strategic focus and to consolidate production facilities. In November 2002 we sold the Lodge business for £33m. Additionally, a number of manufacturing facilities have been consolidated in the United Kingdom. Our actions have reduced cost, while preserving the flexibility to grow.

OUTLOOK
Smiths Aerospace is well-positioned for long-term growth. In the meantime, we have a strong position on most of the high-value military programmes of the next decade. Even so, we are continuing to take action to reduce cost and restructure our activities.