Dear Stockholders,
The ability to respond quickly and effectively to a business cycle downturn while continuing to invest in the future has always set Emerson apart, and this year was no exception. In 2002 we took steps that strengthened the global leadership of our businesses, positioned the company for strong growth, and enhanced our solid financial position.
 
This year's economy was characterized by reductions in capital expenditures and business investment around the world, leading to reduced demand and overcapacity in many of the industries Emerson serves. We responded aggressively by restructuring, closing and consolidating facilities and exiting some product lines as we improved productivity and our underlying cost position. Through this restructuring process, we positioned the company for profitable growth when the economy rebounds.
 
Despite the economic challenges, we also invested in our leadership positions in major market segments as well as in key regions of the world. We maintained our commitment to new technologies and new product development. We enhanced the companys engineering capabilities, particularly in Asia-Pacific and Eastern Europe. And we continued to strengthen our financial position and further improve cash flow. These actions have resulted in Emersons outdistancing the competition.
 
Financial and Operational Highlights
 
Sales in 2002 were $13.8 billion, down from $15.5 billion the prior year. Earnings, excluding the non-cash accounting change related to the adoption of FAS 142 for goodwill, were $1.1 billion, or $2.52 per share for the year. This compares to operating earnings of $1.3 billion, or $3.01 per share, the year before, excluding the pretax $377 million year-end incremental rationalization charge. Reported earnings for 2002 were $122 million, or $0.29 per share, while reported net earnings for 2001 were $1.0 billion, or $2.40 per share.
 
A highlight for the year was cash flow performance and a strong focus on improving operating capital efficiency. Operating cash flow for the year increased 6 percent to $1.8 billion despite lower sales volume, and free cash flow increased 24 percent to a record $1.4 billion, representing over 135 percent of earnings. This is the second consecutive year that free cash flow has exceeded earnings, demonstrating the companys focus on improving working capital performance and conservative capital spending.
 
Average trade working capital as a percent of sales decreased from 23.5 percent in 2001 to 22.8 percent in 2002, an improvement of $450 million. Our goal is to drive this below 20 percent to further enhance cash flow and return on capital.
 
Throughout 2002, we continued to reposition Emerson into the mix of businesses that will provide maximum, long-term shareholder value. This process includes divesting companies that are no longer core or strategic as well as acquiring companies with good growth potential. Over the past three years, we have sold companies with about $1.2 billion in revenues, including divestitures of approximately $300 million in 2002.
 
Returns well exceed the cost of capital today, and while that is good performance in the current environment, we intend to drive return on total capital back to historic levels. We plan to improve margins, cash flow, and capital utilization in part by strengthening core manufacturing and technology competencies and moving less strategic activities to outside sources. This approach, in conjunction with expanding lean manufacturing initiatives, allows us to significantly reduce capital spending while maintaining strategic investments.
 
Office of the Chief Executive: Edward L. Monser, Chief Operating Officer; Walter J. Galvin, Executive Vice President and Chief Financial Officer; David N. Farr, Chief Executive Officer; James G. Berges, President; Charles A. Peters, Senior Executive Vice President
 
Investing in Leading Business and Technology Platforms
 
Emersons long-time focus on technology leadership continues to be a key differentiator across our businesses. We lead the industries we serve with breakthrough innovation and technology such as PlantWeb digital architecture for the process industries; Copeland Scroll compressors for air-conditioning and refrigeration markets; reliable power systems for computing and communications; and variable-speed motors used in applications ranging from home appliances to industrial manufacturing equipment.
 
In 2002, Emerson again strengthened its technology, global reach, and solutions and service capabilities. Nowhere is this more apparent than in our Climate Technology business, where Scroll compressor sales reached nearly $900 million. With the introduction of high-volume Scroll technology in the early 1990s, Emerson perfected a better way to compress gas and changed the game in the air-conditioning and refrigeration industries through increased energy efficiency and reliability, and quieter, more environmentally friendly operation. We are the leader in this business, and in 2002 we again led the market by introducing digital Scroll technology in Asian residential and U.S. commercial air-conditioning and refrigeration markets. This new technology offers infinite capacity modulation and increased efficiency and comfort, from high-rise apartments to computer rooms and telecommunication facilities.
 
Emerson Climate Technology is also at the forefront in developing remote refrigeration and air-conditioning monitoring systems, which are improving energy efficiency and reducing costs for the worlds top supermarket, convenience, and drugstore chains. Capabilities like this enabled us to sign major contracts with domestic and international supermarket chains in 2002 and helped extend our position in services and solutions in the commercial refrigeration market.
 
 
In Process Management, PlantWeb is driving next-generation technologies across industries that produce such essential items as food, fuel, chemicals and medicine. Emerson has created the most comprehensive portfolio of technologically superior field devices, one-of-a-kind automation system software, and an award-winning field-based architecture. PlantWeb enables our customers to monitor and diagnose their plant operations, contributing to increased uptime, lower maintenance costs, greater throughput and improved quality.
 
We have coupled this advantage with our consulting, engineering, and optimization service expertise. This innovative process technology is delivering solid and measurable business results for our customers, which is why we are winning with nearly 3,000 project wins to date. Our Process Management development engineers continue to focus on new technologies to increase our leadership edge in products, systems, and solutions, as we drive to deliver more value to customers.
 
Despite the industry downturn in 2002, the underlying fundamentals of Emersons electronics and telecommunications segment are solid for long-term growth and profitability. We continue to serve major, global marquee customers with the latest reliable power, climate and connectivity technologies, and customers are rewarding us with an increased portion of their purchases because of our long-term commitment and financial strength. We made a significant investment in this business in October 2001, when we acquired Avansys, the power business of Huawei Technologies in China. This key acquisition not only provides access to the growth of the Chinese market it also helps Emerson reduce total costs and accelerate new product development in this important business.
 
Global Emerson
 
We are a leader among manufacturers in managing information technology, a capability that increases our ability to operate globally at a faster rate with reduced costs and better customer service. Information Week recently recognized this leadership when it ranked Emerson 50th on its Top 500 up from 247th just two years ago. Initiatives in e-Business are expected to provide $400 million in savings over the next five years and lower costs through increased productivity; streamlined logistics; and enhancements in areas such as engineering, information technology, and accounts payable. Information technology enables us to preserve the independence and autonomy of our divisions, yet leverages the global power of Emersons infrastructure.
 
We are further maximizing global customer reach through the Emerson brand. This brand platform enables us to leverage the strength of our products, market and technology positions, global span, and service capabilities. Today, customers find it easier than ever to get complete solutions from one company Emerson.
 
We continue to build our sales and manufacturing presence around the world, with a particular focus on Asia-Pacific, Eastern Europe and India. We have built exceptional capabilities in Asia, a region well suited to Emerson products and pivotal to the growth of many businesses. More than 22,000 of our people are located in Asia, and our sales in the region in 2002 reached $1.6 billion compared with only $400 million in 1990.
 
As a result of these investments, we are well positioned to serve our traditional global customers in process control, network power, climate control, and the appliance and motor businesses from Asia, and we continue to penetrate local Asian markets. Emerson will continue to utilize Asian engineering centers, manufacturing facilities, sales support operations such as customer call centers, and other resources to meet customers' needs. Our global sales, service and manufacturing presence, e-Business strategy, and the strength of our brand are increasingly important in building business in international markets.
 
Organizational Strength
 
We continue to benefit from one of our greatest strengths the integrity of Emersons people. Emersons leadership continuity has been well recognized, and our management team has again done an excellent job in the current environment. We are committed to assuring strong management through our organizational planning process and executive leadership development. An investment in Emerson is an investment in world-class people.
 
Stockholders can be equally assured of the integrity of our financial reporting. Emersons corporate governance program and ethics standards are an integral part of our management process; we will not compromise honesty, trust or integrity.
 
We are also proud of the role Emerson people play in the communities where they live and work. In 2002, Emerson and its Charitable Trust donated nearly $20 million to important initiatives in education, health and human services, arts and culture, civic organizations and youth programs. Our people contributed significantly, too, giving time, energy and personal funds.
 
I would like to thank our management team and our employees, whose contributions continually strengthen Emerson. I also thank Emersons chairman, Chuck Knight, and the board for their guidance and confidence in our team, and their support as we reposition the company for long-term growth and profitability. Larry Browning and Dick Loynd are retiring from the board in February after serving for 34 years and 16 years, respectively. We are grateful for their many contributions on behalf of our stockholders. John Menzer, CEO of Wal-Mart International, joined the board in November and we look forward to his contributions.
 
Worldwide economic uncertainty continues as we enter 2003. In this environment, we expect to generate solid earnings and cash flow. Aggressive restructuring and strategic investments have made us a stronger competitor and prepared us for the future.
 
On behalf of the Office of Chief Executive,
David N. Farr
Chief Executive Officer