Pirelli S.p.A. Business report FY2007

Business Highlights

Financial overview
(in millions of euro) FY2007 FY2006 Rate of
Net Sales 4,161.7 3,949.5 5.4 (1)
Operating Profit 358.1 342.3 4.6 (2)


-The increase in net sales was driven by higher volume (+1.8%), despite the sluggish performance of the Winter segment in Western Europe in the last quarter, and especially the price/mix trend (+4.7%), due especially the increasing concentration on segments with high added value.

-The foreign exchange component was a negative figure (-1.1%), mainly due to the loss of the U.S.dollar.

-Sales growth continued in markets with a higher growth rate, most in particular as a result of higher production capacity in those areas (particularly China, South America and Romania to support development in Eastern Europe).

-Sales in North America are higher on a comparable exchange basis but remain unchanged in percentage terms due to the cited foreigh exchange effect.

-The percentage of operating profit to net sales was at 8.6%, which is basically in line with the prior year. The growth of volumes and the price/mix trend, combined with actions to raise productivity and reduce costs, more than compensated, in amount, the higher price of production factors and the negative exchange effect. In spite of the actions undertaken, the Company maintained a high level of R&D expenditures.

Business overview by segment
-In the Car/Light Truck segment, the Company's business grew in North America in a context of a substantially steady demand for replacements and a decline in OE. On the other hand, the segment benefited from higher demand in South America which growth was particularly evident in the OE segment.
In Europe, as well, volumes increased in OE and in the premium segments of the replacements channel. The only exception was the winter tyres segment which was affected by the contraction in the demand, especially in the last quarter. Sales in the Asia/Africa/Pacific area increased significantly, reflecting investments in the area.

Industrial Market
-In the Industrial business area, net sales amount to Euros 1,300 million, with an increase of 7.1 percent compared to the prior year. The operating profit from ordinary operations is Euros 105.6 million, an increase compared to 2006 (+3.8 percent). As a percentage of sales, this represents 8.1 percent, slightly less (-0.3 percent) than in 2006, mainly due to the cost of natural rubber and steel, which was not totally compensated by the price/mix trend.
In the segment of tyres for Trucks, in Europe, the replacements channel reported strong growth during the first half and fairly steady growth during the second, whereas original equipment reported constantly high growth throughout the year. In both channels, the increase was mainly driven by the growth of the Eastern European markets. In South America, the market reported significant growth rates, both in the replacements channel, driven by the strong demand from the agricultural sector, and especially in the original equipment channel, with a high demand for new vehicles, especially in Brazil, thanks to the agricultural sector and the overall positive economic situation.
In Africa and the Middle East, the trend of replacing conventional tyres with radial tyres continues, while, in China, the market continues to report growth of more than 10 percent. In this context of global demand, the Company increased its volumes in the South American and Asia/Pacific markets, and undertook a further selection of the mix/focus on the premium lines in Europe, Africa and the Middle East.

-Sales volumes and production of the steelcord line increased by 4 percent in 2007 compared to the prior year. Demand worldwide increased by about 6 percent, driven principally by the Chinese market, where consumption increased by almost 25 percent. Strong growth rates were also reported in South America and Eastern Europe, supported by the continuous process of relocation and expansion of production facilities to those areas. The absorption of mature markets such as North America and Western Europe was again down, whereas consumption was constant in Japan and South Korea.


R&D expenditure

(in millions of euro) FY2007 FY2006 FY2005
R&D 148 147 146
% of Sales 3.6% 3.7% 4.0%

-Traditionally this activity has focused on the development of new high-performance products (e.g. UHP, Winter, Runflat, SUV and motorcycle
tires) by exploiting technological components and very advanced know-how which are the result of intensive research in the areas of materials, design, profiles, tread patterns and processes.

R&D Structure

-In July 2007, a framework agreement to create a state-of-the-art technological and industrial centre for producing car and truck tyres at Settimo Torinese was signed between the Company and Piedmont Regional Authority, Turin Provincial Authority, Settimo Torinese Municipal Authority. The Company already has two production facilities in that area. The industrial regeneration plan will entail transferring the production operations currently carried out in the car-tyre plant to the truck-tyre plant.

-In July 2007, the Company announced that it is building in two different areas of Romania an integrated industrial and technology pole, with the dual objective of conquering Central and Eastern European tyre markets while increasing high-end manufacturing capacity, and developing the new business of particulate filters. The new Pirelli pole in Romania calls for a total investment of approximately 235 million euros. A central element is the factory in Slatina for production of high-performance tyres for cars and SUVs. The factory, inaugurated at the end of 2006, will close its first year in line with expectations for production of more than 2 million pieces, to become approximately 4 million in 2008. Construction work has just begun on a new factory, destined mainly to mass production of particulate filters. The plant, located in the county of Gorj, will be operational starting from the second half of 2008.

Technological partnership
-During the year, new research agreements were signed with some of the most prestigious universities worldwide. A far-reaching collaboration agreement was reached with the Faculty of Industrial Automation at the University of Craiova (Romania) which, among other things, includes the development of RFID, a system for monitoring tyre production phases (remotely by radio waves from a chip).

-A five-year agreement was signed with the Politecnico University di Torino with the aim of further developing hi-tech production processes and products based on the Company's technology. With regard to processes, they will be working on the next generation of MIRS邃「 (Modular Integrated Robotized System), and the CCM邃「 (Continuous Compound Mixing system). With regard to products, they will be concentrating on developing the Cyber Tyre, the intelligent tyre capable of 窶歪ommunicating窶 with the vehicle and created to augment safety on the road.

Product Development
-In 2007, the Company launched the P Zero the Hero on the racetrack in Dubai. This new ultra high-performance type was developed for supercars and derives directly from the Company's experience on the racetrack.

Investment Activities

Capital Expenditure
(in millions of euro) FY2007 FY2006 FY2005
Tire Sector 262 224 208

-Installation began of the new Next MIRS production plant. MIRS stands for Modular Integrated Robotized System. With regard to traditional processes, in European factories, concentration of the production capacity on the 窶鷲igh-performance窶 product range and the upgrading of installed machinery continued. With the aim of meeting increased market demand while at the same time reducing production costs, a greater boost was given to increasing production in geographical areas with low costs. In particular, a new factory was opened at Yanzhou in China and expansion continues in order to augment the capacity of the factory at Slatina in Romania. In Turkey, a new production unit for Motorsport tyres was opened at the factory in Izmit.

Truck - all steel
-The increase of production capacity was concentrated in the low-cost areas of Brazil, Egypt and China. In the sphere of innovative processes, at Settimo Torinese, the installation of machinery for producing products with the SATT (Spiral Advanced Technology for Trucks) derived from MIRS technology continued. Installation of this production process has begun at the factory in Izmit.

-The expansion plan continued to move forward, especially in the new factories in Romania and in Brazil, whereas the activities to develop prototypes for new products and materials are concentrated in Italy.