Group Management Report of MTU Aero Engines Holding AG

Substantial growth in revenues and earnings – an overview of financial year 2005

MTU Aero Engines Holding AG and its affiliates (hereinafter referred to as “MTU” or“Company”) have substantially increased their revenues and earnings in financial year 2005. Revenues increased by 12.0 %, from €1,918.0 million in 2004 to €2,148.6 million in 2005. Commercial engine maintenance saw a particularly dynamic growth; revenues in this business unit increased by 27.1 %, from €575.9 million to €732.1 million. Contributing to this strong increase were numerous new customers, such as China’s Shanghai Airlines, or the US’ JetBlue and America West. JetBlue, for instance, has signed an exclusive 10-year contract for the maintenance of the V2500 engines that power its fleet of Airbus A320-family aircraft.

In the commercial engine business, too, MTU benefited from its well-balanced product portfolio in the year under review. The number of orders received increased in both existing programs, such as the V2500 (Airbus A320 family) and the PW2000 (Boeing 757 and C-17), and in new programs ramping up for production, such as the PW6000 for the Airbus A318 and the GP7000. The GP7000 for the Airbus A380 already boasts a market share of more than 50% even before production is launched.

The military engine business was marked by three key events in 2005: First, MTU strengthened this business unit over the long term with the expansion of the Cooperative Model of joint industry-military engine maintenance with the German Air Force. Second, the EJ200 order from Austria demonstrates the Eurofighter’s export prospects. And third, an order for an upgrade of the T64 helicopter engines improves capacity utilization in this business segment.

The positive business development in all business segments led to significant improvements in the earnings and cashflow situation for the financial year. MTU in 2005 increased adjusted EBITDA by 35.3% to €233.0 million, from €172.2 million in the previous year. EBIT grew by 60.3 % to €130.0 million in 2005, from €81.1 million the previous year. During the same period, cashflow from operational activities quadrupled from €72.9 million to €290.1 million. The positive business development also allows the company to pay a dividend.

The Board of Management and the Supervisory Board will propose to the General Shareholders’ Meeting, held on May 12, 2006, a dividend payment of €0.73 per share, which is equivalent to a distribution volume of €40.15 million. The dividend rights cover the full financial year 2005.

The MTU share was admitted to trading for the first time on June 6, 2005. The successful 35,650,000 share issue was a key event for the financial year. 20,650,000 of these shares were originally owned by the existing majority shareholder, and 15,000,000 shares resulted from the increase in equity. The
net proceeds of the emission amounted to €294.7 million.

In 2005, MTU essentially utilized these assets and additional inflows of liquidity from its operational activities for the repayment of existing liabilities. The net financial liabilities of the company decreased from €838.0 million to €237.2 million within one year. The equity ratio of 20.7% underscores MTU’s solid post-IPO financial position.

The Airline Industry on a Steep Upturn Trend

During financial year 2005, MTU benefited from accelerated growth in worldwide air traffic, which recovered from the fallout of the events of September 11, 2001, the war in Iraq, and the SARS outbreak. According to IATA (International Air Transport Association), global passenger traffic (measured in passenger kilometers) in 2005 increased 7.6% over the the previous year, and cargo traffic measured in freight ton kilometers) by 3.2%. This growth was particularly strong in Asia and North America.

On the US market, the insolvency of major airlines such as Delta Airlines and Northwest Airlines was cause for concern. It is apparent, however, that major parts of the fleets continue operating even under Chapter 11 bankruptcy protection, and keep the US market growing despite such proceedings. Even the sharply rising fuel prices, with the price for kerosene soaring 42% in 2005, has not weakened the upturn in the airline industry in the long run. The airlines managed to recoup some of these additional costs from their passengers by imposing fuel surcharges on ticket sales.

The growth in commercial air traffic necessitates an expansion of global flight capacities. During the financial year, the number of Airbus and Boeing new deliveries increased by 10.4 %, from 605 to 668 aircraft. During that same period, the number of engine deliveries (not including spare engines) to airlines increased by 8.8%.

The commercial MRO business, too, saw a marked increase in 2005. The management consulting firm AeroStrategy is forecasting sustained growth at an average annual rate of about 7% from 2004 to 2014.

The military business, characterized by longterm, multinational alliances, saw stable development in 2005. Despite tight budgets, the new Eurofighter with its EJ200 engines has entered service with European air forces almost on schedule. Many national armed forces, including Germany’s, are replacing their Panavia Tornados powered by RB199 engines with Eurofighters, which will result in a decline in the military spare parts and maintenance business. However, business is expected to pick up again over the next several years with the procurement of the Airbus A400M military transport powered by TP400-D6 engines.

MTU’s strategic orientation
MTU and its affiliates are among the world’s largest manufacturers of engine modules and components. In the commercial arena, the company is the world’s largest independent provider of maintenance services for aircraft engines. Its activities span the entire life cycle of an engine program – from the development, design, testing and production of new commercial and military engines and spare parts to maintenance services for commercial and military engines.

MTU’s activities break down into two businesses: the commercial and military engine business, and the commercial maintenance, repair and overhaul (MRO) business. In its commercial engine business, the company designs, develops and manufactures modules and components as well as spare parts for non-defense engine programs, and performs final assembly. In the military business, MTU focuses on the development and manufacture of engine modules and components, the production of spare parts, final assembly and repair and overhaul services. The commercial MRO business covers all of the company’s activities in the field of maintenance, repair and overhaul and logistic support services for commercial engines.

Through technological leadership and product quality, MTU has established a strong market position. Its primary customers are leading engine manufacturers such as Pratt & Whitney and General Electric with whom the company is working closely together, the programs involving a variety of engine families. MTU also is a shareholder in IAE, the consortium for the manufacture of the V2500 engine family. In addition, the company also collaborates on a number of projects with other manufacturers of engine modules and components, such as Volvo Aero, ITP, and Avio. MTU has major roles in key European military engine programs and, through its alliances, is the German industrial lead partner for the engines flown by the German Armed Forces. It is by far the largest external service provider to the German Armed Forces in the field of repair and overhaul of military engines.

MTU’s organization and accounting standards
When preparing for the IPO, MTU in 2005 put a simple and transparent corporate structure in place by merging the two general partner and limited liability companies from the previous structure into their respective parent companies. At the same time, MTU Aero Engines Zweite Holding GmbH and MTU Aero Engines Dritte Holding GmbH were merged into MTU Aero Engines Erste Holding GmbH, since both companies had been relieved of their original financing function. MTU Aero Engines Erste Holding GmbH was then transformed into a stock corporation under the name of MTU Aero Engines Holding AG. This company now manages the operational activities of MTU Aero Engines GmbH and its subsidiaries via MTU Aero Engines Investment GmbH. MTU Aero Engines Investment GmbH is also the issuer of the high yield bond. The consolidated financial statements of MTU Aero Engines Holding AG are prepared according to the International Financial Reporting Standards (IFRS), account being taken of the interpretations of the International Financial Reporting Interpretations Committee (IFRIC). The companies reported in the consolidated financial statements are listed in the Notes to the Consolidated Financial Statements under
Item 1.2.

In compiling the annual accounts and consolidated financial statements it was necessary to make certain assumptions and estimates that affect the reported amount of assets and liabilities. These forecasts are made to the best of our knowledge and in good faith to ensure that the consolidated financial statements provide a realistic and accurate picture of the company’s assets, finances, and earnings. The following aspects in particular are affected by these estimates and assumptions:

• Value of goodwill and other intangible assets
• Valuation of accounts receivable
• Analytical parameters for provisions for pensions
• Risk assessment for the remainingprovisions
• Revenues from long-term contracts and the commercial MRO business

The Notes to the Consolidated Financial Statements contain additional information.