Mahle GmbH Business Report FY2006

Business Highlights

Financial overview

in million euros
(Consolidated)
FY2006 FY2005

Rate of
change (%)

Factors
Sales 4,314.0 4,121.8 4.7 See note 1) below
Net Income 191.8 159.0 20.6 See note 2) below
Sales by segments
Piston Systems Product Line 1,279 1,262 1.3 See note 3) below
Cylinder Components Product Line 483 460 5.0 See note 4) below
Valve Train Systems Product Line 527 512 2.9 See note 5) below
Air Management Systems Product Line 690 645 7.0 See note 6) below
Liquid Management Systems Product Line 510 521 (2.1) See note 7) below

-The Company has 17 German and 65 foreign subsidiaries (consolidated).
Factors
1)
- The sales of the Group developed in line with the growth level of the global automotive industry, with growth of approximately EUR 200 million (4.7%) in comparison with the previous year.
- Changes in the international currency exchange rate structures led to an increase of EUR 25.7 million (0.6%) in reported sales. Positive effects from the Polish zloty, the Korean won, and, in particular, the Brazilian real were largely eroded by a devaluation of the Japanese yen and the US dollar.
- On the other hand, additions of companies in 2006 resulting from acquisitions brought
sales amounting to EUR 28.5 million (0.7%) into the consolidation group. The major
company acquisitions were made in the industrial filtration business segment.
- Allowing for currency and consolidation effects, the sales increase amounted to 3.5%
and was thus on a similar scale to the quantity increases recorded by the market as a whole. This shows that the considerable price reductions on our products could be compensated for by gains of market share and increasing systems supplies.

2)
- The operating profit of the Group also increased in line with the rise in sales. Considerable improvements in profit generated by increased sales volumes, the shutdown of unprofitable business divisions, and improvements in productivity were offset by the strain on profit resulting from reductions in sales prices, significant increases in material prices, pay scale increases, and foreign currency changes. The unexpectedly heavy strain prevented a more significant improvement in profit in comparison with the previous year.

3)
Supported by the satisfactory economic situation in the worldwide automotive industry, the product line recorded sustained high demand for piston/connecting rod assemblies in the passenger car segment, thus becoming more firmly established in its strategic positioning as a systems supplier. The sales increase in the commercial vehicle sector in comparison
with the previous year was primarily due to the rising demand for single-piece forged MONOTHERM steel pistons, which replaced articulated and aluminum pistons on the market to some extent.
- In Europe, invoiced sales slightly exceeded the previous year窶冱 level, although a shift in sales occurred as a result of the discontinuation and new startup of piston types, as well as changes in technology. In terms of products, significant market success was recorded in the commercial vehicle sector by MONTHERM pistons. Sales of pistons for passenger cars fell slightly below the previous year's level, as passenger car gasoline piston activities remained stable and slight declines were recorded in passenger car diesel pistons.
- Sales in North America experienced slightly positive development in comparison with the previous year. In its commercial vehicle piston activities, the sales increase of 13.1% in comparison with the previous year was positively affected by the tightening of emission regulations from 2007 and the fact that purchases were brought forward accordingly. In the passenger car sector, sales continued to shift from pure passenger car pistons to passenger car piston/connecting rod assemblies. In the 2006 business year, sales of piston/connecting rod assemblies to North American customers rose by approximately 46% in comparison with the previous year.
- In South America, the Company's plants recorded a significant recovery in unit sales in comparison with the previous year as a consequence of the favorable economic conditions and the rise in local automobile production (2.6 million units, an increase of 3% compared with the previous year). Customer demand for pistons for both passenger cars and commercial vehicle engines intensified. In the past business year, the region also benefited from the resumption of direct supply to its North American customers as part of the optimization of logistical processes.
- The sales achieved by the Asia/Pacific region in the 2006 business year approximately equaled those of the previous year. Volume impetus resulting from good overall economic development in Thailand and new startups in its Chinese companies in Nanjing and Yingkou compensated for declines in sales in Australia. Mahle's Japanese company achieved sales around the previous year's level.

4)
- A sales increase of 5% was generated exclusively by organic growth, with all products contributing to this growth. The continuation of the healthy economic situation in the commercial vehicle sector in 2006 had a particularly positive impact.
- Increases in sales of engine bearings were achieved primarily in the commercial vehicle sector in the USA. Growth was achieved in piston ring activities, particularly in Europe, as a result of increased sales of piston rings for passenger car diesel engines and the new startup of a new generation of engines in the commercial vehicle sector. The healthy economic situation in the automotive industry also continued in South America, leading to an increase in sales of piston rings. Piston pin activities were positively affected by the South American automotive industry and the good economic situation in the commercial vehicle sector worldwide.

5)
- In the Valve Train Systems product line, sales were slightly above the previous year's level. As a result of changes in the product mix, shifts occurred within the product groups. For example, in the valve seat inserts and valve seat guides segment, the trend toward increased customer demand for sintered rather than cast products continued. The lower price level of the sintered parts led to a decline in sales, despite a significant rise in unit sales. As in previous years, unit sales of other sintered parts in the European and South American markets increased further. Sales of turbocharger parts were only slightly above the previous year's level, but were characterized by considerable price reductions.
- In the composite camshafts segment, the further ramp-up of existing series led to corresponding growth in sales. The Company's cast camshaft activities generated significantly higher sales, particularly in the North American market. End-of-series products in the valve actuator segment could not be replaced because of price pressure from competitors in countries where labor costs are low. The start of series production of roller tappets for commercial vehicles led to sales increases in the European market.
- MAHLE Powertrain Ltd. in England assembled significantly more complete engines than in the previous year, intended for the Asian market, among others. Unit sales of machined cylinder heads decreased slightly in comparison with the previous year.
Sales growth in the valves segment was achieved as a result of new series production parts in the European market. In particular, the strong market presence with hollow valves was established more firmly in the past business year. A decline was recorded in sales of valve timing parts, which resulted from a change in one customer'fs engine design.

6)
- Overall, business development in the Air Management Systems product line was satisfactory. Sales increased in comparison with the previous year in all regions of the world. Even allowing for changes in exchange rates, the regions exceeded the previous year's sales values. In particular, the positive exchange rate effects for sales in the Korean won almost offset the considerable negative impact of the Japanese yen in Asia.
- In Europe, sales were characterized by the unit sales figures for intake modules and air filter elements produced in Austria. Together with high tool sales, these sales more than offset the
discontinuation of a range of intake modules in Germany. In France, air filter and air filter element activities remained below expectations. However, this was partly compensated for by
higher tool sales. Sales growth was achieved in North America as a result of the further expansion of cylinder head cover activities, particularly for new engine types for Japanese customers. South America was included in the product line's consolidation group for the first time. As a result of the expansion of cylinder head cover activities in particular, the sales increase was higher than expected. In Japan, sales declines in the passenger car sector, allowing for foreign currency exchange rate effects, could not be offset by the higher unit
sales in commercial vehicle activities. In contrast, sales of intake modules and air filters in Korea, allowing for foreign currency exchange rate effects, substantially exceeded the previous year's sales. At the Chinese location in Tianjin, air filter and air filter element activities developed more positively than planned. Production of air intake modules for Chinese customers was also started.
Overall, further increases in unit sales were achieved with all product groups in the product line. Production of air filters commenced at the majority joint venture in Turkey, founded in 2005 to supply the Turkish market. The new location in Guangzhou, China, which was founded to supply mainly Japanese customers, commenced production of air filters in the last quarter of the year. The location in Shanghai, China, was included in the product line's consolidation group for the first time..

7)
- While sales of the Liquid Management Systems product line stagnated in Europe, the activated carbon canister activities in North America expanded considerably, primarily as a result of the acquisition of manufacturing equipment. Declining sales in France and Germany were offset by corresponding increases at the production plant in Austria. While OEM/OES sales rose slightly, intra-Group sales in the aftermarket stagnated as a result of the Group's general measures to reduce inventories. Stagnating sales of fuel filters were offset by increasing sales of oil filter modules and activated carbon canisters.
- In South America, a new distribution of production volumes between the two filtration product lines led to declining sales for Liquid Management Systems. In Japan, sales decreased slightly as a result of currency exchange rate effects and the intensified price competition in certain product segments, while sales increases were achieved in Thailand.
- In China, a new distribution of production between the Air Management Systems and Liquid
Management Systems product lines also generated lower sales in comparison with the previous year. In contrast, sales in India rose considerably.
- The new production plants constructed in the growth regions were successfully integrated into the existing production network. In Timisoara, Romania, the production of activated carbon canisters commenced. In addition, the production of oil filters began in Shanghai, China, in a newly opened production plant. In North America, the newly acquired manufacturing equipment was integrated into the production plant in Murfreesboro, USA, to expand the production of activated carbon canisters.

Strategic Acquisitions & Expansion of Production by J/V
(1) Engine Parts Group of the Dana Corporation
- The Company announced that it has entered into a stock and asset purchase agreement with Dana Corporation for the acquisition of Dana's engine hard parts business. The engine hard parts business of Dana consists of 39 locations in 10 countries with approximately 5,000 employees. The business had sales of approximately $670 million in 2005. The main products of the engine hard parts business are piston rings, engine bearings, cylinder liners and camshafts manufactured and sold under the Perfect Circle, Clevite, and Glacier Vandervell brands. (From a press release by the company on Dec.4, 2006)

(2) Air Intake Modules and Air Filtration Business Division of Siemens VDO Automotive
- The Company announced that the acquisition of the air intake module and air filtration business division from Siemens VDO (SVDO), a division of Siemens AG, was success-fully concluded as of June 1, 2007. The acquisition includes all worldwide units of Siemens VDO's business division "air intake modules and air filtration" with locations in Canada, Mexico, England and China. In 2006, the turnover of the division was approximately EUR 300 million, generated by approximately 1,000 employees. The main products are air intake modules and air filter systems for passenger car gasoline and diesel engines. With this acquisition MAHLE is further expanding its worldwide activities in the business division air intake systems and air filtration. (From a press release on June 5, 2007)

(3) Global Expansion of the Engine Valves Products Group
- On January 16, 2007, the Company celebrated the grand opening ceremony of the new valve company MAHLE Tri-Ring Valve Train (Hubei) Co., Ltd. in Macheng, China. The joint venture negotiations have been finalized in the end of 2006. In doing so, MAHLE has strengthened its position in the currently largest automotive growth market. MAHLE holds 60% of the shares of the joint venture. Hubei Tri-Ring Company Limited holds 40%.(From a press release by the company on Jan. 25, 2007)
-The Company announced that MAHLE Metal Leve S.A., its Brazilian subsidiary, has acquired the Argentinean company Edival, located in Rafaela, province of Santa Fe. The acquisition includes the whole operation of Edival comprising the industrial plant as well as the administrative, sales and engineering offices. Edival, which was established in 1953, produces mainly valves, valve guides and valve seat inserts for internal combustion engines supplying to several different markets including OEM, aftermarket, racing, and aircraft segments. In 2006, Edival is expected to reach annual sales above 40 million USD. Edival has approximately 800 employees. (From a press release on Mar. 21, 2007)

Outlook
- On the basis of the expected developments, the Company anticipates a significant sales increase from 2006 to 2007. The Group's expected profit, however, will be affected by the low operational earning power currently prevailing in some areas, the imminent expenditure for restructuring measures, and integration costs for parts of the acquired business segments, and will not exhibit the expected profit relationships until subsequent years.

R&D

R&D Structure
7 R&D centers are as follows :
-Stuttgart, Germany
-Northampton, UK
-Farmington Hills, near Detroit, USA
-Novi, near Detroit, USA
-Sao Paulo, Brazil
-Tokyo, Japan
-China, Shanghai

R&D Expense

in million Euros FY 2006 FY 2005 FY 2004
R&D Expense 242 219 N.A.

New Product Development
- New material development:
A powder metal material infused with copper for valve seat inserts was prepared for series production in 2006 for CNG-type passenger car engines. With a wear- and heat-resistant matrix and a wear-resistant intermetallic phase, this material offers significant advantages under extreme operating conditions.
- Production and process technology: In 2006, the Company was able to introduce a number of improvements. For example, a roller-burnishing process with improved manufacturing quality was developed for pressure rolling the high-performance fillet radius on the flanges of cylinder liners.
- New telemetry system: The newly introduced system allows component temperatures in the operating engine in the range above 450ツー to be determined reproducibly with great precision. These temperatures occur in the combustion chamber of the MONOTHERM steel pistons, which are subject to high loads. The potential of the MONOTHERM piston, which has been in series production for several years, has by no means been fully exploited. The Company anticipates that the ongoing development of this piston type will offer the Company an excellent opportunity to meet the requirements of new emission regulations, such as EU5 or US10.
In the area of cylinder components, the Company have further expanded its systems approach for the development of assemblies. The Company gained important knowledge about the systems properties of piston rings and cylinder liners for heavy commercial vehicle engines. In order to lower the weight of the power cell components, the Company extended the simulation to all relevant components, including the connecting rod. In the future, the ongoing development of coating systems for a variety of components subject to wear will become increasingly important for its customers.
In connection with fully variable valve train adjustment concepts, the Company are testing switchable rollertype cam followers. The CamInCam camshaft systems have now been put into series production. They enable variable valve timing, even with a single camshaft in the engine. An additional valve lift setting feature will be the next modular step in this direction.
The Company's fast-switching air impulse valve can be used as a system for the dethrottling of gasoline engines. This allows dethrottling without interfering with the valve train. Advantages can also be created in terms of cold start characteristics and internal exhaust gas recirculation, as well as support for supercharging systems. the Company is intensively researching the future low-pressure exhaust gas recirculation design, so that high exhaust gas recirculation rates can be achieved with an innovative product, even under unfavorable pressure conditions.
- Air Management System:
In order to reduce oil consumption and comply with more stringent emissions legislation, the Air Management Systems product line is setting standards with novel oil mist separators integrated into the crankcase ventilation system. Cost-effective passive impactors, which can be integrated into the cylinder head covers, are used in this design. The Company's first active electric disk separator worldwide met with great interest among its customers, particularly in view of the extreme requirements in the commercial vehicle sector. In 2006, the Company successfully started series production of plastic cylinder head covers with integrated oil mist separation and pressure regulation.
Another milestone in the development of intake modules is the commencement of series production of a new three-stage resonance-charged intake module. The two integrated, electrically operated valve actuators using innovative molded-in assembly technology are MAHLE窶冱 first electrical actuators developed and produced in house窶芭aking a crucial contribution to its systems competence and increasing added value. Other new customer projects for MAHLE mechatronics components are already in the series production development phase.
- Liquid Managemant System:
MAHLE has been developing highly integrated modular solutions in the Liquid Management Systems product line for many years. Significant progress in design and construction was made through weight-optimized and cost-effective modules with added functionality. Innovative all-plastic oil filter modules, in which the integration of the oil/water heat exchanger is particularly important for the entire module, already account for a significant market share. The elimination of several machining steps in comparison with aluminum high-pressure die casting housings and increased vertical integration during internal production increase the added value and process reliability of these assemblies. Series startups of all-plastic oil filter modules are planned in various regions in the near future.
Another innovative product brought into series production is the MAHLE oil pan top, which integrates oil filtration and engine oil cooling and is inserted between the crankcase and the oil pan. This opens up new design possibilities for the lubricating oil circuit and the positioning of components affecting the oil circuit, and thus allows flexible solutions that utilize the package constraint even more efficiently.

Investment Activities

Capital Expenditure:

EUR in millions FY2006 FY2005 FY2004
Piston Systems Product Line 75 87 87
Cylinder Components Product Line 47 54 35
Valve Train Systems Product Line 27 41 42
Air Management Systems Product Line 35 35 35
Liquid Management Systems Product Line 42 34 27

Investments by Segments
<Piston Systems Product Line>
-With capital expenditure on fixed assets of EUR 75 million, the investments made by the Piston Systems product line amounted to 5.4% of its sales, exceeding depreciation once again. Investments focused on rationalization and additional quality improvement measures, as well as innovations in its process technology, and for special customer projects. In the 2006 business year, investments in the commercial vehicle sector for the recent expansion of capacities for MONTHERM steel pistons and the optimization of its foundries were given priority.
- In Europe, the Company invested in expanding and optimizing its raw production equipment and in building up capacities for MONOTHERM steel pistons. In addition, the machining capacities for pistons for passenger cars were expanded and automated. In North America, the expansion of capacities for the production of MONOTHERM steel pistons was also a focal area of investment. Additionally, the process for putting together piston/connecting rod assemblies was optimized. In South America, the partial renovation of output capacities for piston machining, the implementation of customer projects, and automation measures formed the main areas of investment. The Asia/Pacific region expanded its fleet of machinery for melting and casting processes in Japan and Thailand. In addition, the Nishikawa plant in Japan was closed and production was relocated to Tsuruoka. In China, investments focused on its company in Nanjing, to allow for the scheduled ramp-up of output capacities while maintaining a constant level of quality.

<Cylinder Components Product Line>
- In the past business year, heavy investments were made once again, although they fell below the previous year's value. The main area of focus was expanding capacities for the startup of new products. In the piston rings segment, capacities for commercial vehicle and passenger car diesel applications were expanded. Investments in cylinder liners concerned projects in the commercial vehicle sector as well as preparation for new passenger car projects in Europe. Capacities for finish machining of connecting rods for passenger car engines were expanded at its location in Mexico for new customer projects in the USA. These capacities were reused to a large extent by the Piston Systems product line for the assembling of power cell units.
- In Brazil, additional capacities for manufacturing pre-products in raw part manufacturing were created for the bearings product group. In the piston pins segment, investments focused on rationalization measures connected with the conversion to improved production processes in raw part manufacturing.
In 2006, the Company continued with the construction of production facilities for piston rings in China and expanded capacities for these activities. Since the first half of the year, its Yingkou location in northern China has produced piston rings in addition to bearings.

<Valve Train Systems Product Line>
- Investments in the business year focused primarily on rationalization projects and the expansion of capacities. In Switzerland, a new plant was built in order to concentrate the local sintering activities at one location. An additional line was installed in Leibertingen, Germany, for the production of composite camshafts. In Brazil, the foundry was extended in order to supply the market in accordance with the increased demand for camshafts made from chilled cast iron. At the location in India, additional production capacities were built for the machining of camshafts. In addition, capital expenditure was used to expand sample and prototype construction of camshafts. In the cylinder heads product segment, investments were made in mechanical machining so that unscheduled orders could be accepted at short notice. At its Polish location, the product line invested in the production of valve castings and valve seat guides. Investments were also used to construct valve machining facilities in China in connection with an existing order.

<Air Management Systems Product Line>
- In the year under report, the expansion of activities in Korea and China was one of the main focuses of the product line's capital expenditure on fixed assets. Capital expenditure in Korea was connected with the construction of a new filter plant in Nam-Gu/Ulsan, which offers logistical advantages on account of its proximity to major customers. Investments in China focused primarily on the construction of the new production plant in Guangzhou, along with the necessary production facilities for air filters, intake modules, and cylinder head covers, and the expansion of the plant in Tianjin for the production of intake modules. In addition to these investments, capital expenditure focused, in particular, on expanding capacities at the plants in Austria and Mexico.

<Liquid Management Systems Product Line>
- Investments focused on the acquisition-driven expansion of activated carbon canister production in North America, the expansion of infrastructure for the new location in Romania, and construction, of the new location in Shanghai, China, for the production of screw-on filters, as well as the optimization of production at the locations in Austria, Japan, and Brazil. The majority of the investments, went toward equipment for manufacturing new products in the startup phase.