Annual report 2008

Revenues have developed as follows

A more detailed presentation showing external revenues and inter-segment revenues is provided in the section headed “Segment reporting by business segment”.

Cost of sales includes a reduction of € 1.3 million (2007: an increase of € 7.1 million) in write-downs on inventories, in order to account for them at their net realizable value. Further explanatory comments on write-downs on inventories are provided in Note 22. Cost of sales also includes impairment losses on intangible assets amounting to € 35.2 million (2007: € 14.7 million). The table below classifies the impairment losses by business segment and asset category:

The impairment losses recognized in the 2008 income statement, totaling € 35.2 million, comprise impairment losses on the fair value of old GE engine programs amounting to € 34.3 million and on 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 fair value, and hence an impairment loss was recognized to match the carrying amount to 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. Hence an impairment loss of € 14.7 million, representing the full carrying amount of the CF34 license, was recognized in costs of sales and thus reduced the net profit of the commercial maintenance business.

Total impairment losses in the financial year 2006 amounted to € 6.3 million. 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 impairment loss on intangible assets totaling € 2.5 million accounted for in the same year comprised € 0.1 million attributable to MTU Maintenance Canada Ltd., Canada, and € 2.4 million attributable to the investment in the TP400-D6 engine program for the A400M military transporter. In each case the carrying amount no longer adequately reflected the respective recoverable amount. An allocation was also made to provisions.

Internally generated, company-funded research and development expenditure was expensed or capitalized as follows:

Development costs for the GE38 engine program amounting to € 2.8 million, incurred in connection with the risk- and revenue-sharing agreement with the General Electric Company (GE), were capitalized. In addition to these self-created development costs, the cost of development services purchased from GE amounting to € 45.2 million was also capitalized. In total, therefore, capitalized development costs for the GE38 engine program amounted to € 48.0 million. The expenditure on the purchased development services was recognized directly as an intangible asset, and is included in the analysis of changes in intangible assets, property, plant and equipment and financial assets presented in Note 18.

Development costs for special repair techniques for use in engine maintenance, amounting to € 3.4 million, were also capitalized (2007: € 4.3 million), given that they met the recognition criteria for intangible assets according to IAS 38. The research costs were not capitalized.

Consequently, out of the total € 101.1 million (2007: € 88.8 million) company-funded research and development expenditure generated internally, a total of € 6.2 million (2007: € 4.3 million) was recognized as self-created intangible assets. These assets will be amortized over the useful economic life of the corresponding engine program or technology from the time at which it becomes ready for sale or use.

Externally funded development expenditure relates to the military engine business and is accounted for as construction contracts. This expenditure is disclosed under “Contract production receivables” and “Contract production payables” due to the fact that the work is conducted under contract to national and international consortia on a customer-specific basis.

Under the terms of the risk- and revenue-sharing agreement with the General Electric Company (GE), MTU acquired sales and supply rights amounting to € 27.6 million in respect of the GE38 engine program. However, this expenditure does not yet meet the recognition criteria for intangible assets. For this reason, “Other selling expenses” increased from € 14.7 million in 2007 to € 42.0 million in 2008.

Apart from this, selling expenses are mainly comprised of expenses for marketing, advertising and sales personnel, valuation allowances and write-downs on trade accounts receivable.

General administrative expenses are expenses incurred in connection with administrative activities unrelated to development, production or sales activities.

In 2008, other operating income did not include any government grants (2007: € 0.3 million).

The improved interest result in 2008 compared with the financial year 2007 is attributable to the previous year’s expense resulting from early repayment of the high yield bond amounting to € 19.1 million.

The interest income on financial instruments not within the scope of IFRS 7 or IAS 39, amounting to € 0.9 million (2007: € 4.4 million), is attributable to cash and cash equivalents.

Profit/loss of companies accounted for using the equity method comprises the operating loss of the joint venture Pratt & Whitney Canada Customer Service Centre Europe GmbH, Ludwigsfelde. The operating loss of €1.0 million (2007: €2.3 million) was a result of the continuing difficult market conditions which were negatively affected by the exchange rate parity between the U.S. dollar and the euro.

The financial result on other items deteriorated in the financial year 2008. The net expense increased by € 8.5 million to € 38.7 million (2007: € 30.2 million). This was attributable to expenses in connection with forward commodity sales contracts for nickel amounting to € 11.7 million (2007: € 9.7 million) and to fair value losses on derivative financial instruments totaling € 1.3 million (2007: fair value gains of € 8.2 million). Further explanatory comments on derivative financial instruments are provided in Note 42. (Risk management and financial derivatives).

Financial result on other items groups together the profit/loss of related companies accounted for at cost, totaling € 1.5 million (2007: € 1.3 million) with all other income and expense items, including interest income and expenses on financial instruments classified as “held for trading” in accordance with IAS 39. Interest rate gains or losses from derivative financial instruments (interest rate swaps) accrued with respect to subsequent accounting years are balanced against the corresponding expenses per contract and the net amount is recognized as income or expense. The net interest expense is classified on the basis of the type of underlying transaction.

Exchange rate losses on currency holdings in 2008 amounted to € 4.8 million (2007: € 14.8 million) and are attributable to the unfavorable exchange rate parity between the U.S. dollar and the euro that existed for part of the year. Exchange rate gains/losses on finance leases relate to engines carried as capitalized assets in the MRO segment, which are leased to airlines for the duration of maintenance work on their own engines, permitting the aircraft to continue flight operations. Finance lease liabilities derive from contracts priced in U.S. dollars, which are translated into euros at the exchange rate prevailing on the balance sheet date.

Fair value losses on derivative financial instruments amounting to € 1.3 million (2007: € 8.2 million) and losses on forward commodity sales contracts for nickel amounting to € 11.7 million (2007: € 9.7 million) resulted in a total year-on-year increase in the fair value loss on derivatives of € 11.5 million (2007: € 8.6 million).

The group holds a structured product as a currency hedge that allows a defined quantity of U.S. dollars to be sold at a fixed exchange rate or, if the exchange rate parity between the U.S. dollar and the euro falls below a defined limit, obliges the group to sell. This transaction covers a total future currency swap volume of up to U.S. $ 240.0 million. Because this product does not form part of a direct hedging relationship, the negative change in its fair value of € 7.5 million (2007: € 1.4 million) was recognized directly in the income statement under “Financial result on other items”.

At December 31, 2008, MTU held contractual obligations arising from three interest-rate swaps. One of the interest-rate swaps with a nominal value of € 10.0 million reaches maturity in 2013. Both of the two other interest rate swaps are cross-currency swaps with a total nominal value of U.S. $ 73.0 million that reach maturity before the end of 2009. The fair value loss on these swap transactions, amounting to € 0.3 million (2007: € 0.0 million), is included in the financial result on other items.

To minimize exposure to rising commodity prices for nickel, at December 31, 2008 MTU had taken out forward commodity sales contracts for nickel with banks for a total of 1,210 metric tons of this essential raw material, covering the period from 2009 to May 2011. These transactions have no designated hedging relationship for accounting purposes. The financial result on other items includes an amount of € 11.7 million (2007: € 9.7 million) for the fair value losses on these forward commodity sales contracts.

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 at the issue date) prior to their final maturity. Out of the effective amount of the repurchase exercise in September and October 2008, amounting to € 21.9 million, € 20.0 million was allocated to the liabilities component and € 1.9 million to the equity component, net of taxes. The difference between the fair value of the liability component and its value measured at amortized cost, amounting to € 5.0 million (2007: € 0.0 million), was recognized in the income statement under ‘Results from other financial instruments’ in accordance with IAS 32.AG34. More information on the repurchase transactions for the convertible bond is provided in Note 34. (Financial liabilities).

This line of the financial result on other items mainly comprises the reversal of the discount on pension obligations amounting to € -21.7 million (2007: € -19.8 million), expected income from fund-financed and loan-financed plan assets amounting to € 1.8 million (2007: € 1.6 million), and the amortized cost of other provisions and prepayments representing a total expense of € 9.4 million (2007: a total income of € 0.5 million).

Income tax expense comprises the following:

At December 31, 2008 all deferred tax assets and liabilities of German entities relating to temporary differences were measured on the basis of the expected tax rate of 32.6 %. Deferred taxes arise on temporary differences between the tax bases of assets and liabilities of the individual group companies and their carrying amounts in the consolidated balance sheet in accordance with the liability method. Based on MTU Aero Engines Holding AG’s good earnings in the past and positive earnings forecasts for the future, it is probable that the taxable profit of MTU Aero Engines Holding AG and other group companies will be sufficient to recover recognized deferred tax assets.

The corporation tax rate in Germany for the financial year 2008 was 15 % plus a solidarity surcharge of 5.5 % on the calculated corporation tax expense, giving an applicable corporation tax rate of 15.8 %. Municipal trade tax was levied at 16.8 %, resulting in an applicable group tax rate of 32.6 %.

The actual tax expense for the year amounted to € 18.1 million (2007: € 25.3 million). This was € 46.4 million (2007: € 47.2 million) lower than the expected group tax expense of € 64.5 million (2007: € 72.5 million) which would have arisen if the applicable group tax rate had been applied. Overall, the effective group tax rate for the financial year 2008 was 9.2 % (2007: 14.1 %). Excluding the impact of a tax field audit and before tax reimbursement claims relating to the write-down of treasury shares, the effective group tax rate for 2008 would have been 32.5 % or 0.1 percentage point lower than the applicable group tax rate of 32.6 %.

Further information relating to the impact of the tax field audit and the deductibility of write-downs on treasury shares is provided below.

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 purchase price adjustment was recognized as additional goodwill without impact on profit or loss. Further information is provided in Note 19. Most of the tax audit findings relate to items that will result in lower taxable profits in subsequent years. The corresponding reductions in tax expense for the financial years 2004 to 2007 were recognized in 2008 with a positive tax effect of € 33.0 million (2007: € 0.0 million). The tax-relevant result for financial year 2008 is included in income tax expense for that year.

Unlike for IFRS accounting purposes, treasury shares acquired by MTU Aero Engines Holding AG up to December 31, 2008 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). Reference is made to Note 30.6. for further information on the average acquisition cost of treasury shares.

The average acquisition cost of shares sold to group employees in conjunction with the Employee Stock Program (MAP) originally totaled € 8.2 million. The loss of € 3.3 million resulting from the difference between sale proceeds and the original average cost was set off against taxable profit as a tax deductible expense.

The total benefit of the deductibility of write-downs on treasury shares in the financial year 2008 was € 13.1 million (2007: € 0.0 million).

The actual tax expense for the financial year 2007 was reduced by €46.8 million as a result of revaluing cumulative deferred tax and liabilities using the reduced tax rate applicable after enactment of the German Business Tax Reform 2008. After taking account of this impact, the effective group tax rate in 2007 was 14.1 %.

The Business Tax Reform 2008 legislation came into force on January 1, 2008. The previous corporation tax rate of 25 % was reduced to a uniform rate of 15% for all corporations, irrespective of whether profits are retained or distributed. The basic tax rate for municipal trade tax was reduced from 5.0 % to 3.5 %, whereby municipal trade tax at that stage ceased to be deductible for corporation tax purposes.

As a result, the combined tax rate for corporation tax and municipal trade tax relevant for the group parent company, MTU Aero Engines Holding AG, Munich, applied up to December 31, 2007, was reduced with effect from January 1, 2008 from 40.4 % to 32.6 %. Deferred tax liabilities – most of which relate to the acquisition of the business by Kohlberg Kravis Roberts & Co. (KKR), London, from DaimlerChrysler AG on January 1, 2004 – were measured during the financial year 2007 using the expected future uniform group tax rate of 32.6 % (applicable rate up to December, 31 2007: 40.4 %) based on the reduced tax rate valid from January 1, 2008. The overall tax benefit of €46.8 million relating to future reductions in tax expense was recognized in profit in the financial year 2007.

The balance sheet items to which deferred tax assets and liabilities relate are disclosed in Note 39. The carrying amounts of deferred tax assets and liabilities and changes during the period under report are also disclosed in Note 39.

The potential issue of common stock in connection with the convertible bond issue in the financial year 2007 had a dilutive effect on earnings per share in the financial year 2008. There was no similar effect resulting from the potential issue of common shares under the Matching Stock Program (MSP) at the end of the financial year 2008, because the option conditions for the not-yet-exercised tranches had not been met. A description of the exercise conditions for the Matching Stock Program is provided in Note 30.4.

The computation of diluted earnings per share involves adding the maximum number of common shares that could be issued through the exercise of conversion rights to the average weighted number of outstanding shares. At the same time, group earnings are adjusted in respect of the interest expense (net of taxes) on the convertible bond. The table on page 186 shows earnings per share together with the dilutive effect of the potential issue of common stock in connection with the convertible bond.

There was no dilutive effect from the employee Matching Stock Program (MSP) on earnings per share in the financial year 2008, since prerequisites for the exercise of tranches still remaining were not fulfilled.

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 total repurchase price 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. This reduced the number of common shares entering into the calculation of undiluted earnings per share to 3,086,869 (2007: 3,636,364 shares). The interest expense of € 8.6 million (2007: € 7.9 million) has been reduced by the amount of interest that would otherwise have had to be paid on the repurchased units of the convertible bond at the time of acquisition. More information on the repurchase of the convertible bond and its accounting treatment is provided in Note 34.

In the financial year 2007, the potential issue of common shares under the Matching Stock Program (MSP) launched on June 6, 2005 had a further dilutive effect on earnings per share, in addition to that of the potential issue of common stock in connection with the convertible bond issue.

The table below shows earnings per share together with the dilutive effect of the potential issue of common stock in connection with the convertible bond and the Matching Stock Program for 2007, the year in which the convertible bond was issued.

The dilutive effect in the financial year 2006 was due solely to the Matching Stock Program (MSP), given that the convertible bond was not issued until the following year.

After adjustments to eliminate the effect of purchase price allocation in connection with the acquisition of the group companies and non-recurring items, and the addition of scheduled depreciation/amortization and impairment losses, the following intermediate results are obtained:

The impairment losses recognized in 2008, totaling € 35.2 million, relate to the carrying amounts of legacy 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 fair value, and hence an impairment loss was recognized to match the carrying amount to 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. Hence an impairment loss of € 14.7 million, representing the full carrying amount of the CF34 license, was recognized in costs of sales and thus reduced the net profit of the commercial maintenance business.

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 impairment loss on intangible assets totaling € 2.5 million accounted for in the same year was mainly attributable to the investment in the TP400-D6 engine program for the A400M military transporter.

The amount of € 2.8 million (2007: € 0.0 million) for capitalized development costs in the engine business 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 internally generated development costs for special repair techniques, has not been adjusted in the financial year 2008 either.

Costs by function include the following personnel expenses items:

Pension benefits account for € 27.9 million (2007: € 4.7 million) of these expenses. The employer’s share of social security contributions, which is recognized as an expense, amounted to € 66.4 million (2007: € 66.1 million).

The interest portion of the expense attributable to pension expenses and income arising from the plan assets are recognized under “Financial result on other items”.

The average number of persons employed during the financial year 2008, broken down into groups, is as follows:

Costs by function include the following cost of materials items:

The expense attributable to fees paid in the financial year 2008 to the accounting firm Deloitte & Touche GmbH, Wirtschaftsprüfungsgesellschaft for the auditing of the consolidated financial statements pursuant to Section 314 (1) no. 9 of the German Commercial Code (HGB) amounted to € 1.1 million (2007: € 1.0 million).

The expense item “Audit of financial statements” comprises all fees paid to the external group auditor for the auditing of the financial statements of MTU Aero Engines Holding AG, the consolidated financial statements, and the financial statements drawn up by the relevant group subsidiaries.