SALES AND PRE-TAX PROFITS FROM CONTINUING BUSINESSES WERE SIMILAR TO THOSE OF LAST YEAR DESPITE CONTINUED SLUGGISH GROWTH IN SOME MARKETS AND A SUBSTANTIAL WEAKENING OF THE US DOLLAR. STRONG OPERATING CASH-FLOW AND THE DISPOSAL OF THE POLYMER BUSINESS AND OTHER NON-CORE OPERATIONS HELPED REDUCE NET DEBT TO £273M AT THE YEAR END.

ACCOUNTING POLICIES
The accounting policies used in these accounts are consistent with those used in the 2003 accounts in all respects apart from a change required to comply with Abstract 38 of the Urgent Issues Task Force (UITF 38). This Abstract requires shares held in Employee Share Ownership Plans to be treated as a reduction in shareholders' funds, rather than as a fixed asset. The balance sheet for 2003 has been restated to reflect this change, by reducing Investments and advances-other and shareholders' equity by £5.4m.

PROFIT AND LOSS ACCOUNT FORMAT
The Profit and Loss Account of the Company as a whole shows total sales of £2.7bn (2003 £3.1bn), pre-tax profit of £300m (2003 £217m), and earnings per share of 38.0p (2003 20.0p). These results, however, do not present an accurate picture of the performance of the continuing businesses. For this reason, 'Discontinued businesses', comprising the Polymer business for the two months prior to disposal, are shown in a separate column in the Profit and Loss Account in order to show the results of ongoing activities more clearly. Interest is allocated to discontinued businesses on the basis of net proceeds received. As a result, the profit before tax in the 'Ordinary Activities' column is stated on a comparable basis between 2004 and 2003.

'Goodwill amortisation' and 'exceptional items' are also shown in separate columns in the Profit and Loss Account and are discussed below.

PROFIT AND LOSS
Continuing activities (before goodwill amortisation and exceptional items).

	2004 £m	2003 £m	Change
Sales	2,678	2,629	+2%
Operating profit	360	372	–3%
Pre-tax profit	350	349	–
EPS	45.9p	45.6p	+1%

Sales of £2.7bn were slightly ahead of the prior year, with growth being derived from a combination of acquisitions and underlying business, offset by adverse currency translation (see below).

Operating profit before goodwill amortisation and exceptional items of £360m was 3% down on the prior year. This was a result of higher research and development costs and an adverse sales mix in Detection, as lower margin military sales replaced higher margin civil sales (including the substantial one-off order last year). The operating margin was therefore 0.7% lower at 13.4%.

Total interest on net debt reduced to £15m. Despite a background of rising borrowing rates in both the UK and USA, Smiths has benefited from the substantial reduction in net debt resulting from the sale of the Polymer business. The total interest charge was covered 24 times by operating profit before goodwill amortisation and exceptional items.

Other finance income/costs – retirement benefits, representing the financing cost of pensions and post retirement healthcare benefits, were a net credit of £3m (2003 net charge £2m). This improvement reflected the changed asset mix of the principal schemes at the beginning of the year.

The pre-tax profit before exceptional charges and goodwill amortisation was slightly above the prior year. This was a creditable achievement against a background of adverse exchange translation and, overall, underlying growth was positive. Underlying growth is a combination of operational improvements and contributions from acquisitions and lower interest costs, partially reduced by higher research and development costs.

Earnings per share ('eps') from continuing activities before goodwill amortisation and exceptional items were 1% ahead of prior year – benefiting from a 0.5% point reduction in the tax rate to 26.5%.

The dividend for the year is 27p which is a 4% rise on 2003. With eps from continuing activities at 45.9p, the dividend is 1.7 times covered by earnings. The Board normally considers a dividend cover of twice earnings to be the appropriate level, but in the light of a positive trading outlook, and in a year in which free cash-flow per share is almost equal to earnings, a reduced cover is considered acceptable.

RESTRUCTURING AND OTHER EXCEPTIONAL ITEMS
As part of the strategic initiatives arising from the reorganisation of the business announced at the beginning of the year, restructuring charges of £31m have been incurred. These costs, disclosed as exceptional charges to operating profit, cover the significant changes being made in Aerospace, Detection and Medical. The costs relate to systems integration, severance and site closures.

In June, a substantial property asset was sold to an institutional purchaser at a profit of £12m and is disclosed as an exceptional item.

TAXATION
The tax charge for the year represented an effective rate of 26.5% on profit of ongoing businesses before taxation, goodwill amortisation and exceptional items (2003 27%).

CASH-FLOW
We believe that profit performance should be underpinned by strong and reliable cash generation. We monitor cash performance by the conversion rate of operating profit into cash from our operations (after taking account of net capital expenditure) and by the generation of free cash-flow at group level. This year we achieved a conversion rate of 91% and free cash-flow of £255m, compared to 90% and £270m last year.

DISCONTINUED BUSINESSES
We continued to focus on core activities and dispose of non-core businesses during the year. The net proceeds of these disposals amounted to £507m.

The principal disposal took place in September 2003 when the Polymer business was sold to Trelleborg AB for £483m net of costs. This gave rise to an exceptional profit on disposal of £12m, although £137m had been written off in respect of associated goodwill in the prior year. The results of the Polymer business for the period of ownership are disclosed in the 'discontinued businesses' column in the Profit and Loss Account.

Other, smaller, disposals were completed during the year which raised £24m in net proceeds and gave rise to an exceptional loss of £4m. The results of these businesses are not of sufficient size to qualify for separate disclosure as part of 'discontinued businesses' and, accordingly, they have been included as part of continuing operations.

GOODWILL
Goodwill on all acquisitions since 1998 is capitalised and amortised over a maximum 20-year period. The carrying value of acquisitions is formally reviewed at the first full year-end following acquisition and is also reviewed when circumstances require it. The annual goodwill amortisation for 2004 was £39m (2003 £44m). No impairment charges have been made in 2004 (2003 £137m).

ACQUISITIONS
£219m was spent on acquisitions during the year, the largest being the business of DGT (£56m) and TRAK Communications (£61m). Acquisitions were completed in each division and their details have been dealt with in the Chief Executive's Review. The phasing of the acquisitions was weighted towards the end of the year and, combined, they contributed £29m to sales and £3m to operating profit, well in excess of the associated financing cost.