The following explanatory comments and analyses are derived from the audited MTU consolidated financial statements for the financial years ending December 31, 2008, 2007 and 2006, which are included in this document. The financial statements are drawn up in accordance with International Financial Reporting Standards (IFRSs) issued by the International Accounting Standards Board, to the extent that these have been adopted by the European Union.

In accordance with IFRS requirements, certain new or revised standards and interpretations were applied for the first time in the financial statements for 2008. This did not give rise to any changes in the company’s consolidation or financial reporting principles. Consequently, no changes in the financial reporting principles or in management judgements with respect to the application of the accounting standards had any effect on the group’s business activities during the period under review.

MTU Aero Engines Holding AG was created in 2004, as a result of MTU Aero Engines Erste Holding GmbH’s transformation into a joint stock company, shortly before the IPO. Prior to the IPO, the company was owned by funds managed by one of the world’s leading private equity firms, Kohlberg Kravis Roberts & Co. (KKR). The funds had acquired the company at the end of 2003. Until that time, it had been a wholly owned subsidiary of the then DaimlerChrysler AG. Additional amortization expenses on intangible assets and depreciation expenses on property, plant and equipment arose as a result of the acquisition with effect of January 1, 2004 and through the subsequent purchase price allocation. These expenses are recognized in the income statement. To facilitate comparison, adjustments for these depreciation and amortization items are applied when determining earnings before interest, tax, depreciation and amortization (EBITDA) and when determining earnings before interest and tax (EBIT adjusted). Because the long-established MTU only became an independently controlled company again as from the 2004 financial year, the comparative presentations in this Annual Report are limited to the years 2004 to 2008.

The financial data presented in this document are stated in euros, United States dollars, Canadian dollars, Chinese yuan renminbi, Malaysian ringgit, Polish zloty or British pounds sterling. The table below provides information on the exchange rate parity between the euro and the above-mentioned currencies for the years as listed. This information was compiled on the basis of the official exchange rates published by the European Central Bank:

MTU’s credit rating is continuously monitored by the leading rating agencies Standard & Poor’s (S&P) and Moody’s.

S&P continues to affirm a corporate credit rating of BB+ for MTU, with a stable outlook, while Moody’s rates the company at an unchanged Ba1, also with a stable outlook.

S&P has been evaluating MTU’s convertible bond since June 2007. Its rating has improved from BB- in the financial year 2007 to BB+ in the financial year 2008.

The table below shows a year-by-year comparison of the respective credit ratings for the group (corporate) and for the convertible bond:

MTU Aero Engines Holding AG in its present form was created with effect of January 1, 2004 through the purchase by Kohlberg, Kravis, Roberts & Co. Ltd. (KKR) of the 100 % shareholding from what is now Daimler AG. In the context of the acquisition, assets, liabilities and contingent liabilities were identified according to IFRS 3 and measured at fair value. Since then, the identified intangible assets, in particular, have led to considerable scheduled amortization expenses each year. In the following text, they are referred to collectively as “effects of purchase price allocation” and corresponding adjustments have been applied to the indicators presented below for the purposes of comparison.

A presentation of the nonrecurring items contained in the consolidated income statement and of the reconciliation of EBIT to EBITDA adjusted can be found on page 72.

Group revenues increased by a further € 148.4 million to € 2,724.3 million, despite the MTU increased its revenues to a unfavorable exchange rate parity with the U.S. dollar that existed up until September 2008. total of just over € 2.7 billion in MTU’s operating results progressed in a similarly positive way, improving by comparison the financial year 2008. with 2007 as planned. EBITDA adjusted rose to € 405.7 million (2007: € 392.9 million) while EBIT increased by 2.1 % to € 248.3 million (2007: € 243.3 million). EBT increased by 10.3 % to € 197.8 million (2007: € 179.4 million). Net profit went up by 16.6 % to € 179.7 million (2007: € 154.1 million). Expectations for the financial year 2008 were met both in terms of revenues and in terms of operating profit (EBITDA adjusted) and net profit.

For explanatory comments on depreciation/amortization and nonrecurring items, please see the table showing the reconciliation of the consolidated income statement later in this section.

The gross profit margin increased to 17.7 % in the financial year 2008 (2007: 17.3 %). The adjusted EBITDA margin amounted to 14.9 % (2007: 15.3 %) while the EBIT margin fell slightly by 0.3 percentage points to 9.1 % (2007: 9.4 %). The ratio of net profit to revenues (return on sales) improved by 0.6 percentage points to 6.6 % (2007: 6.0 %).

MTU’s order backlog consists of firm orders placed directly by customers which commit the group to delivering products or providing services. Orders for maintenance work to be performed under the contractual terms of long-term service agreements are not included in the order backlog for the commercial MRO business. In order to obtain a picture of the economic value of the total contracted order volume and the corresponding degree of capacity utilization, the figures for the contractual value of service agreements in the commercial MRO business are stated in a separate line of the financial statements, in addition to the conventionally defined order backlog for the commercial and military engine business (OEM) and the commercial maintenance business (MRO). Further information on the value of orders in the commercial MRO business is provided in Section “MRO business”.

At December 31, 2008, the group’s total order backlog including the value of commercial MRO contracts (group order volume) amounted to € 9,245.7 million, or € 889.3 million (10.6%) above the previous year’s figure of € 8,356.4 million. The majority of orders in the commercial engine business and in commercial MRO are priced in U.S. dollars. If translated at the exchange rate in effect on December 31, 2007, the group order volume would have been € 424.8 million lower (down 5.0 %), bringing the total amount to € 8,820.9 million. Adjusted to eliminate the effect of the U.S. dollar exchange rate, this nevertheless represents an increase of 5.6 %.

Excluding the value of contracts in the commercial MRO business, the group order backlog amounted to € 4,015.7 million, or € 704.6 million (21.3 %) higher than the previous year’s level, following consolidation effects amounting to € 0.2 million (2007: € 0.4 million). Applying the exchange rate parity prevailing at December 31, 2007, the group order backlog would have been € 139.2 million lower, at a total of € 3,876.5 million, which would nevertheless represent an increase of 17.1 % compared with 2007.

Orders in the military engine business are priced in euros. The order backlog at year-end 2008 had fallen by € 126.7 million (7.9 %) to € 1,467.6 million (2007: € 1,594.3 million).

Altogether, the total volume of book orders (order value plus value of contracts) corresponds to a workload of approximately three years.

Group revenues increased in the financial year 2008 by € 148.4 million (up 5.8 %) to € 2,724.3 million. Revenues in the OEM business (commercial and military engines) increased by € 43.4 million (up 2.7 % on the previous year) to € 1,642.9 million, while revenues in the commercial MRO business increased by € 108.3 million (up 10.8 %) to € 1,113.0 million. MTU is thus continuing along the same positive trend that has marked previous years.

Cost of sales increased by € 111.3 million (5.2 %) to € 2,240.8 million. Due to the fact that cost of sales increased at a lower rate than sales revenue, gross profit rose to € 483.5 million (2007: € 446.4 million), a year-on-year increase of € 37.1 million (8.3 %). The gross margin improved to 17.7% (2007: 17.3 %).

Research and development costs recognized in the income statement amounted to € 94.9 million, or € 10.4 million higher than the equivalent figure in 2007. For a more detailed description of the composition of these expenses and their allocation to the different business segments, please refer to the section entitled “Research and development”.

Selling expenses increased by € 25.2 million, principally due to the inclusion of selling expenses relating to the GE38 engine program for the Sikorsky CH-53K heavy-lift helicopter. General administrative expenses, by contrast, were reduced by € 1.6 million.

In 2008, total depreciation and amortization expenses included in the costs by function amounted to € 125.0 million (2007: € 134.9 million). This includes € 47.5 million resulting from the purchase price allocation (2007: € 54.6 million). In 2007, an impairment loss on intangible assets of € 14.7 million was charged as an additional amortization expense under ‘cost of sales’ after comparing the carrying amount of a license for CF34 repair techniques employed in commercial engine maintenance with its recoverable amount (present value of all future cash flows) and establishing that the recoverable amount was lower than the carrying amount.

The costs by function for the financial year 2008 include impairment losses totaling € 35.2 million (2007: € 14.7 million). Explanatory comments and a more detailed breakdown of the total amount can be found under the heading “Impairment losses (IAS 36)” later in this section of the group management report.

Earnings before interest, tax, depreciation and amortization (EBITDA adjusted) are determined by adding scheduled depreciation/amortization and the effects of purchase price allocation arising from the company’s acquisition to earnings before interest and tax (EBIT). In the year under review, an adjustment was also applied for capitalized development costs relating to the GE38 engine program, which amounted to € 2.8 million (2007: € 0.0 million). Operating profit (EBITDA adjusted) improved by 3.3 % to € 405.7 million (2007: € 392.9 million). The EBITDA margin narrowed by 0.4 percentage points to 14.9 % (2007: 15.3 %), thus deviating only slightly from the previous year’s level.

Adjusted performance indicators include EBITDA and EBITDA excluding the effect of nonrecurring items as indicators of operating profit, EBITDA margin, and EBITDA margin excluding the effect of nonrecurring items, and free cash flow, gross financial liabilities and net financial liabilities as financial indicators.

The International Financial Reporting Standards (IFRSs) do not stipulate any requirements concerning adjusted performance indicators. Since other companies do not necessarily employ the same calculation methods as MTU Aero Engines Holding AG to obtain the adjusted performance indicators presented in their financial statements, the adjusted figures presented by MTU Aero Engines Holding AG can only be compared with similarly named items in the statements of other companies to a limited extent.

Consequently, the adjusted performance indicators should not be viewed in isolation as an alternative to the presented figures for EBIT, net profit, cash flow from operating and investing activities, nor to the liabilities and other indicators presented in the consolidated balance sheet for MTU Aero Engines Holding AG in accordance with IFRSs.

EBITDA for the business segments and the group as a whole is derived from earnings before interest and tax (EBIT). EBITDA is calculated on the basis of earnings before interest and tax, and includes corrections for depreciation and amortization, including the effects of purchase price allocation on intangible assets and property, plant and equipment.

MTU Aero Engines Holding AG employs EBITDA adjusted for nonrecurring items as an internal performance indicator.

A variety of nonrecurring factors have an impact on the net profit of MTU Aero Engines Holding AG and on the EBITDA of the group and its individual business segments, both in the year under review and in previous annual periods.

The main reason why adjustments are applied is to eliminate the effect of nonrecurring items which are superimposed on the results of operating activities and thus obscure the true comparability of EBITDA and other performance indicators for the group and the individual business sectors with the figures for previous years. Moreover, the inclusion of nonrecurring items imposes limits on the reliability of statements concerning future changes in EBITDA and net profit. Starting out from the unadjusted earnings figures, the respective adjusted values are obtained by adding (expenses) or subtracting (income) the nonrecurring items.

The adjustments are applied regardless of whether the income and expense items are presented as part of EBIT, the financial result, or tax expenses. The income and expense items to which the adjustments are applied are those immediately affected by the circumstances under which the nonrecurring items arose. The table shows the reconciliation between individual lines in the consolidated income statement and the equivalent items adjusted for nonrecurring effects. It also shows how MTU Aero Engines Holding AG derives the performance indicators EBITDA and EBITDA adjusted (excluding the effect of nonrecurring items) presented in the consolidated financial statements from earnings before interest and tax (EBIT) as defined in the IFRSs. The reconciliation table presents comparative data for previous annual periods in addition to the data for the year under review.

 

The impairment losses recognized in the 2008 consolidated financial statements, totaling € 35.2 million, comprise impairment losses on the fair value of old GE engine programs amounting to € 34.3 million and of old military engine programs amounting to € 0.9 million. In each case, the fair value was compared with the recoverable amount. The recoverable amount was found to be below the carrying amount of the program, necessitating an impairment charge on the recoverable amount.

The impairment loss on intangible assets in the financial year 2007, amounting to € 14.7 million, related to the carrying amount of a license for CF34 repair techniques employed in commercial engine maintenance. Comparison of the license’s carrying amount with its recoverable amount revealed that the latter was below the carrying amount, and hence an impairment loss was recognized to reduce the carrying amount to the level of the recoverable amount.

The calculated impairment loss on intangible assets totaling € 2.5 million accounted for in the 2006 income statement was largely attributable to the investment in the TP400-D6 engine program for the A400M military transporter. The impairment loss on property, plant and equipment in the financial year 2006, amounting to € 3.8 million, was necessitated by the fact that the carrying amounts of MTU Maintenance Canada Ltd., Canada, and MTU Aero Engines North America Inc., USA, no longer adequately reflected their respective recoverable amounts.

The amount of € 2.8 million (2007: € 0.0 million) for capitalized development costs (OEM) relates to the GE38 engine program for the Sikorsky CH-53K heavy-lift helicopter and has been adjusted to permit comparison with the previous years’ data. The company-funded development costs for special repair techniques were not adjusted when they were recognized and capitalized for the first time in 2007. Consequently, the amount of € 3.4 million (2007: € 4.3 million) presented in Note 8. to the 2008 consolidated financial statements under capitalized development costs (MRO), relating to further development costs for special repair techniques, has not been adjusted either.

The subject of depreciation/amortization resulting from purchase price allocation is dealt with in the introductory paragraphs of Section 3. of this group management report.

MTU’s financial result improved in the year under review, decreasing by € 13.4 million to a net expense of € 50.5 million (2007: a net expense of € 63.9 million). This was mainly attributable to an improved interest result. The improvement in the interest result for 2008 compared with that for 2007 is attributable to the expense resulting from early repayment of the high yield bond amounting to € 19.1 million recognized in 2007. The financial result on other items deteriorated in the financial year 2008, increasing by € 8.5 million to a net expense of € 38.7 million (2007: a net expense of € 30.2 million). This was attributable to losses on forward commodity sales contracts for nickel amounting to € 11.7 million (2007: € 9.7 million) and fair value losses on currency derivatives and interest rate derivatives amounting to € 1.3 million (2007: fair value gains of € 8.2 million).

In addition to the good operating business performance, the improved financial result also had a positive effect on earnings before tax (EBT), which increased by € 18.4 million to € 197.8 million (2007: € 179.4 million).

Income taxes in the financial year 2008 amounted to a total of € 18.1 million (2007: € 25.3 million). The effective group tax rate, relative to earnings before tax, thus came to 9.2 % (2007: 14.1%). A table showing the reconciliation of the expected tax expense to the actual tax expense can be found in Note 15. to the consolidated financial statements.

The tax field audit covering the period 2000 to 2003 was completed during the financial year 2008. Since tax pooling arrangements had been in place during that period with the company that is now Daimler AG, the tax audit findings were taken into account in tax assessments at the level of Daimler AG. Due to the contractual terms and conditions agreed by MTU and Daimler AG, the additional tax expense resulting from the tax field audit triggered a retrospective adjustment to the purchase price (originally agreed in 2003) for the MTU Group. The corresponding reductions in tax expense for the financial years 2004 to 2008 were recognized in 2008 with a positive tax effect of € 33.0 million (2007: € 0.0 million).

Unlike for IFRS accounting purposes, treasury shares acquired by MTU Aero Engines Holding AG are required to be presented for German accounting (HGB) and tax purposes within current assets measured at their average acquisition cost. Such assets are required to be written down to their “fair value” (for HGB purposes) or their “Teilwert” (for tax purposes) if lower at the end of the reporting period. Since MTU Aero Engines Holding AG is classified for tax purposes as a finance company, the write-down on treasury shares reduced taxable profit by € 36.9 million (2007: € 0.0 million).

 

As a result of the good business performance in the financial year 2008, net profit increased by € 25.6 million (16.6 %) to € 179.7 million (2007: € 154.1 million).

The net profit available for distribution to the shareholders of MTU Aero Engines Holding AG in accordance with the German Commercial Code amounted to € 45.4 million (2007: € 47.2 million). At December 31, 2008 at total of 48,770,945 shares (2007: 50,729,590 shares) were entitled to receive a dividend.

Undiluted earnings per share amounted to € 3.64 (2007: € 2.95). Potential common shares from the convertible bond diluted these earnings per share. Inclusive of this effect, diluted earnings per share amounted to € 3.54 (2007: € 2.83).

In view of the group’s good performance, the Board of Management and Supervisory Board of MTU Aero Engines Holding AG will propose to the Annual General Meeting on May 26, 2009, that a dividend of € 0.93 per share should be paid, as in the previous year. The total dividend will amount to € 45.4 million (2007 at the time of the Annual General Meeting’s resolution: € 47.2 million), which corresponds to 65.8 % (2007: 72.2 %) of the unappropriated profit of MTU Aero Engines Holding AG available for distribution measured in accordance with the German Commercial Code, amounting to € 69.0 million. The net dividend yield for 2008, based on the share price at December 31, 2008, of € 19.58, is therefore 4.7 %. The dividend is expected to be paid on May 27, 2009. A table showing the reconciliation of group net profit (IFRS) with the unappropriated profit of MTU Aero Engines Holding AG, Munich, available for distribution can be found in Section VII. of the notes to the consolidated financial statements.

The order backlog for commercial and military engines (OEM business) is reported on the basis of list prices. Given that orders for spare parts for commercial engines are generally fulfilled within a short time of their receipt, the order backlog does not usually contain a substantial volume of such orders.

The invoiced value of MTU’s order book for commercial engines, expressed in U.S. dollars, stood at U.S. $ 3,363.6 million at December 31, 2008, and therefore U.S. $ 975.1 million or 40.8 % higher than in 2007, when it stood at U.S. $ 2,388.5 million. This increase is largely attributable to the order volume for the GEnx (General Electric next Generation) engine.

The order backlog for commercial translated into euros at the year-end closing rate increased by 49.0 % or € 794.4 million to € 2,416.9 million (2007: € 1,622.5 million) at the end of 2008.

In purely arithmetical terms, the order backlog in the commercial engine business corresponds to approximately two years’ production capacity.

In the case of military programs, the customer typically places an order for a fixed number of engines at the time the production agreement is concluded. The full value of the contract flows into the order backlog when the contract is signed. This order backlog reduces over a prolonged period of time, in line with deliveries.

The backlog of orders for military engines accounted for in euros totaled € 1,467.6 million at the end of 2008, which is € 126.7 million (7.9 %) below the previous year’s amount of € 1,594.3 million. In purely arithmetical terms, the order backlog in the military engine business corresponds to just under three years’ production capacity.

 

The company generated revenues of € 1,642.9 million in its OEM business; this represents growth of € 43.4 million or 2.7 % compared with 2007.

During the year under review, MTU improved its revenues in the commercial engine business by € 44.3 million to € 1,146.3 million. This increase is largely attributable to sales of the V2500 (A320) engine, which has been in production for many years, together with an improved level of business with Pratt & Whitney Canada engines and the first production phase of the GP7000. Revenues from sales of modules and components for new engines also increased. Adjusted for the effect of the U.S. dollar exchange rate, the increase amounted to approximately 12 %.

Revenues in the military engine business, at € 496.6 million, were virtually unchanged in comparison with the previous year’s amount of € 497.5 million. The ongoing entry into service of the Eurofighter Typhoon assures a steady flow of revenue from the EJ200 engine, and revenues generated by the majority of other military programs have remained stable.

Earnings before interest, tax, depreciation and amortization (EBITDA adjusted) in the OEM business increased from € 305.7 million to € 330.3 million as a result of the good business performance, and the adjusted EBITDA margin improved from 19.1% to 20.1 %.

The order backlog for commercial MRO consists of orders for work on engines that have been delivered to the maintenance shop and where failure analysis has been completed. When revenues are recognized from the orders, the order backlog is reduced accordingly.

Future orders under long-term service agreements, even though they form part of the contract volume, are not included in the order backlog. Consequently, the order backlog in the commercial MRO business is relatively low. For this reason, in addition to the narrowly defined order backlog, MTU also discloses in its statements the expected value of contracts for work on engines for which maintenance agreements are in place.

The short- to medium-term workload can be estimated by adding together the order backlog and the value of contracts. On a purely arithmetical basis, the sum total of order backlog and value of contracts represents a workload of just under five years. The majority of contracts in the commercial MRO business are priced in U.S. dollars. The order backlog for commercial MRO in 2008 amounted to U.S. $ 182.9 million, which is U.S. $ 43.5 million or 31.2 % higher than the equivalent figure for 2007 of U.S. $ 139.4 million. The value of contracts for engines for which maintenance agreements are in place decreased by 2.0 % to U.S. $ 7,278.3 million in the year under review.

Translated into euros, the order backlog and value of contracts in the commercial MRO business increased by € 221.6 million (4.3 %) to € 5,361.2 million (2007: € 5,139.6 million) at the end of 2008.

MTU’s revenues in the commercial MRO business increased in 2008 to € 1,113.0 million (2007: € 1,004.7 million). This 10.8 % increase was achieved in spite of the additional burden incurred in connection with the introduction of new software and logistics systems at MTU Maintenance Hannover and the unfavorable changes in the U.S. dollar exchange rate parity during part of the year. MTU Maintenance Zhuhai Co. Ltd., Zuhai, China, also reported an increase in revenues of € 39.2 million to € 125.9 million (2007: € 86.7 million). Adjusted to eliminate the effect of the U.S. dollar exchange rate, the increase in revenues in this specific case would have been in the order of 19 %.

Earnings before interest, tax, depreciation and amortization (EBITDA adjusted) in the commercial MRO business was reduced by € 9.0 million (10.2 %) to € 78.9 million. The EBITDA margin fell accordingly to 7.1 % (2007: 8.7 %). This reduction of the EBITDA margin by 1.6 percentage points is largely due to the unfavorable U.S. dollar exchange rate.

The main objective of financial management is to avoid financial risks and to secure financial flexibility. The group employs a number of different financial instruments to attain these objectives. In the financial year 2007, these included the issue of a convertible bond with a term to maturity of five years and the establishment of lines of credit giving MTU adequate headroom to meet its short-term and medium-term borrowing requirements. The revolving credit facilities (RCFs), which are utilized only to a limited extent, give MTU the necessary scope to manage its funding needs. The decisive parameters applied when choosing a financial instrument are flexibility, the nature of credit terms, the existing debt repayment schedule, and borrowing costs. The group’s corporate departments manage financing arrangements on the basis of the group structure.

The group’s main source of liquidity is the cash flow resulting from the operating activities of the business segments. Longer-term liquidity forecasts are based on operative planning. Short-to-medium-term forecasts are updated once a month. All group companies are included in the process. MTU utilizes cash flow surpluses generated by individual group companies to cover the funding requirements of other companies in the group. This reduces the need for external financing and optimizes net interest expenses.

The prescribed procedures for dealing with banking policy, the approval of banking relationships, loan agreements, worldwide liquidity and asset management, the management of currency and interest risks and the management of the group’s internal cash flow are laid down in the treasury principles.

It is a basic principle of the group that 100 % of its lines of credit are administered at corporate level. Certain of these lines of credit are passed on to affiliated companies and, if necessary in individual cases, guaranteed by the parent company. By centralizing the liquidity management function, the group is in a position to allocate resources efficiently within the organization. As a rule, the group’s financial liabilities are not secured by collateral.

The group maintains good business relationships with a number of different partner lending banks, and in this way avoids being too strongly dependent on a single institution. The banking partners with whom the group and its affiliates conduct business are required to have a long-term credit rating of at least “investment grade”.

Net financial liabilities is used as a performance indicator by leading capital market analysts, and is a common reference in MTU’s sector. MTU defines net financial liabilities as the difference between gross financial liabilities and current financial assets. It serves as an indicator of the MTU group’s overall liquidity. Total net financial liabilities increased by € 31.3 million (14.0 %) to € 254.7 million compared with the amount of € 223.4 million reported at December 31, 2007, owing to the fact that derivative financial liabilities and derivative financial receivables had deteriorated by a combined total of € 63.5 million (2007: improved by € 0.5 million) as a result of market fluctuations. The components of net financial liabilities changed as follows in the financial year 2008:

In the period from September 17 to October 31, 2008, MTU repurchased units of its own convertible bond from the market with a total nominal volume of € 27.2 million (approximately 15.1% of the original nominal volume of € 180.0 million) prior to their final maturity. The expense of this repurchase exercise was split into equity and liability components. The remaining outstanding units of the convertible bond with a total par value of € 152.8 million (2007: € 180.0 million) were measured at amortized cost. More detailed comments, including the calculation of the equity and liability components of the repurchased units of the bond, are provided in Note 34. to the consolidated financial statements.

At December 31, 2008 the group had drawn down € 61.2 million (2007: € 69.6 million) out of bilateral banking credit facilities. Other liabilities to banks amounting to € 21.3 million (2007: € 26.5 million) relate to loans agreed by subsidiaries in favor of third parties. In total, financial liabilities to banks decreased by € 13.6 million to € 82.5 million (2007: € 96.1 million).

Finance lease liabilities represent obligations under finance lease arrangements that are capitalized and amortized using the effective interest method. For information on the accounting treatment of lease assets and a summary of capitalized lease assets, please refer to Notes 5.6. and 19. to the consolidated financial statements.

The loan from the province of British Columbia to MTU Maintenance Canada Ltd., Canada, is recognized at amortized cost. The change compared with 2007 is mainly attributable to movements in the exchange rate parity between the euro (€) and the Canadian dollar (CAD).

The tax field audit covering the period 2000 to 2003 was completed during the financial year 2008. Since tax pooling arrangements had been in place during that period with Daimler AG, the tax audit findings were taken into account in tax assessments at the level of Daimler AG. The additional tax expense resulting from the tax field audit triggered a retrospective adjustment to the purchase price (originally agreed in 2003) for the MTU group. Additional explanatory comments are provided in Note 19. to the consolidated financial statements.

The increase in derivative financial liabilities by € 39.5 million to € 48.4 million (2007: € 8.9 million) derives principally from the fair values of forward foreign exchange transactions used to hedge cash flows and forward commodity sales contracts for nickel. For further details on credit and market risks arising from derivative financial liabilities, please refer to Note 42. to the consolidated financial statements (Risk management and financial derivatives).

The currency derivatives item mainly represents the fair values of forward foreign exchange transactions used to hedge cash flows. Derivative financial receivables decreased by € 24.0 million to € 11.8 million (2007: € 35.8 million) as a result of market-related changes in the exchange rate parity between the euro and the U.S. dollar. For further details on credit and market risks arising from derivative financial receivables, please refer to Note 42. to the consolidated financial statements (Risk management and financial derivatives).

The cash and cash equivalents of € 69.9 million (2007: € 67.3 million) comprise checks, cash in hand, bank deposits, and short-term securities with an original maturity of three months or less.

The indicator “relative indebtedness” represents the ratio of net financial liabilities to EBITDA (adjusted to eliminate the effect of nonrecurring items). It deteriorated by 5.9 percentage points to 62.8 % (2007: 56.9 %) compared with 2007, because of the increase in net financial liabilities due to changes in the fair value of derivative financial instruments.

MTU meets its financing requirements through a combination of the free cash flow generated by its operating activities and through the utilization of short- to medium-term financial liabilities.

The € 180.0 million convertible bond issued in the financial year 2007 is an important financing instrument that serves as a supplement to conventional bank loans. The convertible bond has a par value of € 180.0 million (divided into 1,800 units each with a par value of € 100,000) and a term to maturity of five years. The units of the bond are scheduled for repayment on February 1, 2012 (date of final maturity) at par value plus interest accrued up to that date, unless they are repaid, converted, or repurchased and invalidated prior to the date of final maturity. The units of the bond can be converted into registered non-par value common shares of the company corresponding to a proportionate amount (€ 1 per share) of the company’s total share capital.

At a conversion price of € 49.50, the conversion ratio at issue date was 2,020.20 shares. The coupon rate is fixed at 2.75 %, payable yearly on February 1. The issuing company is Amsterdam-based MTU Aero Engines Finance B.V., which is wholly owned by MTU Aero Engines Holding AG, Munich. The funds raised through this bond issue were used by MTU in the financial year 2007 to pay outstanding liabilities in connection with the high yield bond, including penalties for early repayment and accumulated interest.

The convertible bond had a market price of 107.00 when the trading year opened on January 2, 2008, and reached its highest annual price of 108.00 on the same date. It reached its lowest annual price of 75.95 on July 17, 2008. The MTU convertible bond closed the financial year 2008 at a market price of 84.00 (2007: 107.00). The average market price of the convertible bond over the course of the year thus lay below its emission price of 100.00. Its present market price (at February 19, 2009) is 85.85.

In the period from September 17 to October 31, 2008, MTU repurchased units of its own convertible bond on the market with a total nominal volume of € 27.2 million (approximately 15.1 % of the original nominal volume of € 180.0 million) prior to their final maturity. The total price paid for these securities amounted to € 21.9 million (including transaction costs but excluding interest at the coupon rate), which corresponds to an average of 80.7 % of the bond units’ nominal value. More detailed comments, including the calculation of the equity and liability components of the repurchased units of the bond, are provided in Note 34. to the consolidated financial statements.

MTU owes its favorable financing situation to the mix of funding sources that it employs, good earnings from operations, its sustainable free cash flow, and the financial market’s positive response to the group’s business strategy. The group has increased its borrowing capacity to € 250.0 million on the basis of a revolving credit facility made available by a consortium of banks in conjunction with agreements that run to March 24, 2010. Direct credit facility arrangements have been agreed with three banks, each for an amount of € 40.0 million (ancilliary facilities). The funds raised through these lines of credit are intended to finance investment in production facilities and are not covered by collateral. At December 31, 2008 the group had drawn down € 61.2 million (2007: € 69.6 million) under these banking credit facilities. Of the remaining € 188.8 million (2007: € 180.4 million) available at the balance sheet date, € 16.9 million (2007: € 16.5 million) had been drawn down as bank guarantees in favor of third parties. Any credit actually utilized is subject to interest at the Euro Overnight Index Average (EONIA) rate plus an additional margin. As of December 31, 2008, MTU and its affiliates had met all loan repayment and other obligations arising from financing arrangements. The availability of unused lines of credit increases the scope and flexibility of the group’s financing opportunities.

The group’s medium-term flexibility is assured by unused lines of credit amounting to € 171.9 million at the end of the financial year 2008 (2007: € 163.9 million). MTU continuously monitors the need for available lines of credit on the basis of the volume of financial liabilities at any given time as well as future financing requirements.

MTU is not a party to any off-balance-sheet transactions which might in any material way affect the company’s present or future financial situation, operating results, liquidity, capital expenditure, assets or capital resources.

Total capital expenditure in the financial year 2008 amounted to € 293.7 million (2007: € 106.1 million). Of this total amount, € 263.8 million concerned the OEM business (2007: € 68.7 million) and € 29.9 million concerned the commercial MRO business (2007: € 37.4 million).

Capital expenditure on assets of all categories was divided up as follows: € 193.8 million (2007: € 14.3 million) on intangible assets, € 99.9 million (2007: € 86.5 million) on property, plant and equipment, and € 0.0 million (2007: € 5.3 million) on financial assets.

MTU acquired a 6.65 % stake in the GEnx engine program for the Boeing 787 and 747-8 through a cooperation agreement dated December 19, 2008 between the General Electric Company and MTU Aero Engines GmbH. The investment in this new engine program is included in the capital expenditure of the OEM business as an intangible asset valued at an amount of € 126.1 million (2007: € 0.0 million).

MTU’s participation in General Electric’s GE38 helicopter engine development project has enabled the company to acquire an 18 % stake in the engine program for the Sikorsky CH-53K heavy-lift helicopter. Development costs amounting to € 48.0 million (2007: € 0.0 million) arising from this program share are included in the intangible assets for the OEM business, together with an amount of € 2.8 million (2007: € 0.0 million) representing related company-funded R&D expenditure.

The commercial MRO business has developed special repair techniques to reduce the cost and increase the efficiency of engine maintenance, and thereby further consolidate its technological and competitive lead. The recognition criteria for these technologies were met in the financial year 2008, allowing capitalized development costs amounting to € 3.4 million (2007: € 4.3 million) to be recognized within intangible assets.

The tax field audit covering the period up to the date on which MTU was sold by the then DaimlerChrysler AG was completed during the financial year 2008. The resulting purchase price adjustment increased the amount of goodwill by € 15.0 million, € 11.7 million of which was allocated to the commercial and military engine business (OEM) and € 3.3 million to the commercial maintenance business (MRO). Further information on the retrospective purchase price adjustment is provided in Note 19. to the consolidated financial statements.

A detailed analysis of capital expenditure on intangible assets, which amounted to a total of € 193.8 million (2007: € 14.3 million) is provided in Note 18. to the consolidated financial statements (Changes in intangible assets, property, plant and equipment, and financial assets).

Capital expenditure on technical equipment, plant and machinery amounted to a total of € 14.7 million (2007: € 10.0 million). Newly purchased items include a welding system, a combined laser drilling and ablation system, an ultrasonic shot peening system, a tool-grinding machine, a wet-blasting plant, a wire-erosion machining plant, a vacuum furnace and a number of CNC grinding and milling machines.

Other additions to property, plant and equipment in 2008, totaling € 59.8 million (2007: € 49.6 million) and reported under ‘Advance payments and construction in progress’, comprise € 21.6 million for unfinished construction work on the manufacturing facilities of MTU Aero Engines Polska Sp. z.o.o., Rzeszów, Poland, € 24.7 million relating to unfinished work on technical equipment, plant and machinery for new engine programs at the German sites, and construction costs for the new engine test rig in Hannover, which amounted to € 13.5 million up to the end of the financial year 2008. This test rig will enable the company to test large engines of the type destined to power the Airbus A380 (GP7000). Capital expenditure on property, plant and equipment furthermore includes new software and logistics systems being introduced at the Hannover site with a view to optimizing production processes and reducing manufacturing costs.

A detailed analysis of capital expenditure on property, plant and equipment, which amounted to a total of € 99.9 million (2007: € 86.5 million) is provided in Note 18. to the consolidated financial statements (Changes in intangible assets, property, plant and equipment, and financial assets).

MTU controls its liquidity through free cash flow as a performance indicator. MTU defines free cash flow as cash flow from operating activities less capital expenditure on intangible assets, property, plant and equipment, and financial assets. This cash surplus is principally utilized for the dividend payment, the share buyback program, and the repayment of financial liabilities.

Cash flow from operating activities in 2008 amounted to € 405.8 million, or € 169.6 million (71.8 %) higher than the previous year’s level of € 236.2 million. In the financial year 2008, a particularly high level of advance payments from customers was received for production contracts in the military engine business, and similarly in the commercial engine business. Working capital furthermore improved by € 98.5 million (2007: deteriorated by € 74.6 million) despite a higher workload in the commercial MRO business at the end of 2008, preparations for delivery of GP7000 engines for the Airbus A380, and ongoing development work on the TP400-D6 engine for the A400M military transporter.

Cash flow from investing activities increased by € 177.7 million (170.0 %) to € 282.2 million (2007: € 104.5 million) as a result of the capital expenditure described in the preceding section “Analysis of capital expenditure”. Cash flow from investing activities includes proceeds from the disposal of assets amounting to € 11.5 million (2007: € 1.6 million).

Free cash flow, i.e. cash flow from operating activities less cash flow from investing activities, amounted to € 123.6 million in 2008 (2007: € 131.7 million). In the financial year 2008, the majority of the free cash flow was used to purchase treasury shares under the buyback program for an amount of € 56.4 million (2007: € 113.6 million), to cover the dividend payment of € 46.3 million for the financial year 2007 (€ 43.8 million for the financial year 2006), and to repurchase units of the convertible bond at a cost of € 21.9 million (2007: € 0.0 million). MTU bought back additional treasury shares during the period after the respective balance sheet dates up to the date of the Annual General Meeting. In 2008, this reduced the amount of the dividend payment for the financial year 2007 by € 0.9 million (2007: € 0.2 million) compared with the resolution of the Annual General Meeting.

Further information on the utilization of the free cash flow is provided in the consolidated cash flow statement.

Total assets increased year-on-year by € 110.6 million or 3.6% to € 3,196.1 million (2007: € 3,085.5 million), while the equity ratio increased as a result of the good operating results to 19.3 % (2007 18.2 %).

The table below shows an overview of the changes in assets, equity and liabilities, giving separate figures for current and non-current items:

On the assets side, intangible assets and property, plant and equipment increased by a total of € 125.3 million or 7.5 % to € 1,800.0 million (2007: € 1,674.7 million). Intangible assets increased by € 139.9 million, mainly as a result of the company’s stakes in the GEnx engine program and in the development program for the GE38 engine (see section Financial situation, Analysis of capital expenditure). Property, plant and equipment were reduced by € 14.6 million as a result of scheduled depreciation.

Inventories increased in the year under review by € 73.6 million or 12.5 % to € 661.4 million (2007: € 587.8 million). While inventories of raw materials and supplies rose by € 47.6 million to € 311.5 million (2007: € 263.9 million), work in progress increased by € 7.7 million to € 322.2 (2007: € 314.5 million) and advance payments increased by € 18.3 million to € 27.7 million (2007: € 9.4 million). In total, inventories accounted for 20.7 % of net assets (2007: 19.0 %). Inventory turnover expressed as a percentage of revenues decreased only slightly from 4.6 to 4.4. Trade receivables, contract production receivables (after deducting advance payments) and other assets including advance payments decreased year-on-year by € 90.9 million (12.4 %) to € 643.2 million. Of these, trade receivables fell by € 38.8 million (7.8 %) to € 460.4 million. Contract production receivables, net of the corresponding advance payments, reduced by € 32.2 million (18.8 %) compared with the previous year to € 138.9 million.

Cash and cash equivalents amounted to € 69.9 million (2007: € 67.3 million) at the balance sheet date. Expressed as a percentage of total assets, this item remained at the previous year’s level of 2.2 %.

In terms of the structure of assets, the proportion of non-current assets increased by 2.0 percentage points to 57.0 % (2007: 55.0 %). The chart below shows a comparison of the relative proportions of current and non-current assets at the end of 2008 and the two previous years:

The next table shows details of the changes in group equity:

 

The overall increase in group equity in 2008 of € 55.4 million (2007: reduction of € 0.3 million) is mainly attributable to the net profit generated in the financial year, which amounted to € 179.7 million (2007: € 154.1 million). Individual positive changes in equity include an amount of € 0.5 million relating to the fair value measurement of the Matching Stock Program (MSP) share-based payment scheme and an amount of € 4.9 million relating to shares issued to employees under the MAP stock option program. A more detailed description of the components of the share-based payment arrangements is provided in Note 30.4. to the consolidated financial statements. The positive balance of currency translation differences recognized in equity in 2008, amounting to € 3.4 million (2007: negative balance of € 3.6 million), is mainly attributable to MTU Maintenance Zhuhai Co. Ltd., Zhuhai, China.

Negative changes in group equity include an amount of € 29.1 million relating to the fair value measurement of cash flow hedges (2007: positive change of € 2.1 million), an amount of € 46.3 million for the dividend payment to shareholders of MTU Aero Engines Holding AG for the financial year 2007 (€ 43.6 million for the financial year 2006), and an amount of € 56.4 million for the purchase of treasury shares (2007: € 113.6 million). MTU bought back additional treasury shares during the period after the respective balance sheet dates up to the date of the Annual General Meeting. In 2008, this reduced the amount of the dividend payment for the financial year 2007 by € 0.9 million (2007: € 0.2 million) compared with the resolution of the Annual General Meeting.

The capital reduction due to withdrawal of shares comprises a reduction of € 3.0 million in the share capital and a transfer from capital reserves amounting to € 101.4 million authorized at the time the shares were purchased under the terms of section 272, paragraph 2(4) of the German Commercial Code (HGB) in the interests of safeguarding the company’s market capitalization. The original acquisition cost of the withdrawn shares amounted to € 104.4 million, which was transferred to the capital reserves for the purchase of treasury shares.

The following chart illustrates the changes in group equity in the financial year 2008:

At December 31, 2008, the nominal amount of the outstanding portfolio of hedging instruments classified as cash flow hedges in accordance with IAS 39 amounted to U.S. $ 880 million, serving as a hedge against changes in the exchange rate parity between this currency and the euro. Measurement of the fair value of the MTU cash flow hedge portfolio at the end of 2008, based on the €/USD exchange rate of 1.39 prevailing at the balance sheet date, resulted in a negative change in the fair value recognized under other comprehensive income (OCI) of € 29.1 million compared with December 31, 2007. In the previous year, the measurement based on the €/USD exchange rate of 1.47 prevailing at the balance sheet date had resulted in a positive change in the fair value recognized under OCI of € 2.1 million compared with December 31, 2006. Positive changes in the fair value (net of taxes) of cash flow hedges are recognized under financial assets, whereas negative changes in the fair value (net of taxes) of cash flow hedges are included in financial liabilities. Changes in the fair value of cash flow hedges at the end of the financial year are recognized directly in equity as an adjustment to OCI. These adjustments are applied net of the corresponding changes in deferred tax assets (for cash flow hedges with a negative change in fair value) or in deferred tax liabilities (for cash flow hedges with a positive change in fair value).

The following chart illustrates the changes in the fair value of cash flow hedges recognized under other comprehensive income over the past three years.

The negative change in the fair value of cash flow hedges in 2008 resulted in a reduction of € 29.1 million in the fair value of the net assets (after deduction of taxes) recognized under other comprehensive income, whereas in 2007 the fair value of these net assets had increased by € 2.1 million.

Medium- to long-term loans increased by € 7.6 million (0.6%) to € 1,183.8 million. Their proportion of total equity and liabilities fell by 1.1 percentage points to 37.0 % (2007: 38.1 %). This figure includes pension provisions amounting to € 371.7 million (2007: € 359.5 million). Pension provisions increased as expected by € 12.2 million (3.4 %). Contingent liabilities recognized in the balance sheet for uncompleted engine programs identified in connection with the purchase price allocation have fallen by € 27.5 million to a remainder of € 208.7 million.

Non-current liabilities totaling € 588.1 million (2007: € 561.4 million) principally comprise financial liabilities amounting to € 58.9 million (2007: € 66.8 million), contract production liabilities amounting to € 273.0 million (2007: € 200.6 million), and deferred tax liabilities amounting to € 227.6 million (2007: € 269.8 million).

Non-current (i.e. medium- and long-term) financing funds increased in the financial year 2008 by € 63.0 million (3.6 %) to € 1,801.2 million (2007: € 1,738.2 million). This means that 98.9 % (2007: 102.5 %) of the company’s non-current assets are matched by financing funds available on a medium- to long-term basis.

Current (i.e. short-term) financing funds increased by € 47.6 million (3.5 %) to € 1,394.9 million, including a reduction in provisions of € 2.2 million (0.7 %) to € 296.9 million.

These provisions include pension provisions amounting to € 18.5 million (2007: € 17.1 million). Current liabilities increased by € 49.8 million (4.8 %) to € 1,098.0 million. These include obligations towards employees totaling € 40.6 million (2007: € 52.6 million), financial liabilities amounting to € 277.5 million (2007: € 259.7 million), trade payables amounting to € 495.7 million (2007: € 462.9 million), accounts payable for contract production after deduction of the corresponding receivables amounting to € 247.6 million (2007: € 239.1 million), and sundry other identifiable obligations. The chart below shows a comparison of the relative proportions of equity, non-current and current financing funds in 2008 and the two previous years:

Within the structure of equity and financial debt, the equity ratio increased by 1.1 percentage points from 18.2 % to 19.3 % compared with the previous year, while non-current provisions decreased by 1.3 percentage points. Overall, the relative proportions of noncurrent debt capital and current financing funds in 2008 remained unchanged compared with 2007.

The ratio of net financial liabilities to equity (gearing) increased by 1.5 percentage points to 41.3 % (2007: 39.8 %). While net financial liabilities increased by a total of 14.0 % compared with the previous year (€ 31.3 million), principally as a result of the increase in liabilities arising from derivative financial instruments (€ 39.5 million) and the decrease in derivative financial receivables (€ 24.0 million), equity increased by only 9.9 % (€ 55.4 million) relative to the previous year.

The chart below illustrates the changes in the ratio of net financial liabilities to equity (gearing) over the past three years.

The value added statement reflects the wealth created by MTU in the course of the financial year after deduction of purchased materials and services. The net method of calculating value added considers depreciation/amortization, cost of materials and other expenses as purchased materials and services. Under the incomes received method, the part of the value creation process attributable to each party is made visible. The gross value added method regards depreciation/amortization as a component of the value chain, which would otherwise be accounted for as internal financing under the incomes received method.

In 2008, MTU’s gross value added increased by 4.7 % to € 878.4 million (2007: € 838.7 million). This increase compared with 2007 is mainly attributable to the increase in revenues of € 148.4 million, against which it was necessary to offset an increase of € 91.1 million in the cost of purchased materials and services occasioned by the expansion of business operations. On balance, the respective increases in value created by company activities and the cost of purchased materials and services more or less canceled each other out. Depreciation and amortization expenses rose by a relatively high amount, mainly as a result of impairment losses recognized in respect of legacy GE and military engine programs. As a result of these effects, net value added increased by a further 4.2 % to € 718.2 million (2007: € 689.1 million).

The company’s employees were the beneficiaries of the major part of the net value added, namely 70.1 % (2007: 68.3 %). The portion received by lenders fell by 55.7 % to 2.4 % (2007: 5.7 %). The public sector received 2.5 % (2007: 3.7 %), including deferred tax liabilities. The shareholders’ portion of the net value added was slightly lower than the previous year’s level, at 6.3 % (2007: 6.8 %). The remaining 18.7 % of the net value added (2007: 15.5 %) has been retained by the group for the financing of future business activities.

Earnings for the financial year 2008 were not affected by any significant nonrecurring factors. Fluctuations in the U.S. dollar exchange rate, and its more recent recovery, did not have a significant impact due to the fact that MTU had hedged the larger part of its U.S. dollar surplus with the aid of forward currency transactions.

In the outlook for 2008 presented by the Board of Management in the Annual Report 2007, it was anticipated that it would be possible to generate revenues on a slightly higher level than in 2007 (approximately € 2,576 million), based on an expected U.S. dollar exchange rate of 1.50 to the euro.

In its third-quarter interim report issued on October 23, 2008, MTU published a revised fullyear estimate of the revenues it expected to generate in 2008, with a forecast of € 2,650 million. This forecast was mainly based on the improved exchange rate parity between the U.S. dollar and the euro. At year-end, MTU had exceeded this forecast by approximately 3 %, having generated revenues of € 2,724.3 million.

During the presentations on September 30, 2008 in connection with the publication of the third-quarter interim report, MTU forecast that operating profit (EBITDA) would rise 2.6 % higher than the originally planned result to € 400 million, producing an operating margin of 15.1 %. This forecast was moderately exceeded, with a year-end EBITDA adjusted of € 405.7 million.

The forecast presented by the Board of Management in the Annual Report 2007 expected group net profit to increase in 2008 by 20 % to around € 180 million, on condition that it would not be necessary to take further measures involving derivatives to reduce exposure to U.S. dollar exchange rate risk. This forecast was reaffirmed in the third-quarter interim report at September 30, 2008. The actual year-end result precisely matched the expected result.

Free cash flow in 2008 was forecast to lie in the region of € 100 million, both in the group management report in the Annual Report 2007 and again in the third-quarter interim report at September 30, 2008. The actual result of € 123.6 million exceeded the forecast result.

Business performance in the financial year 2008 was once again positive. MTU improved on the already-outstanding results it had achieved in the previous year, generating even higher revenues and a slightly higher operating profit (EBITDA adjusted). The good operating results are attributable to stable earnings in the military market and a strong spare parts business, which outweighed the negative effect of the significantly poorer U.S. dollar exchange rate.