2 Annual Report005cdn2.ms-motorservice.com/fileadmin/media/kspg/Broschueren/Gesc… · The KS...

Annual Report

22000055

Kolbenschmidt Pierburg in figures

Net sales

EBITDA

EBIT

EBT

Net income

Gross cash flow

Capital expenditures 2)/3)

Amortization/depreciation 4)

R+D expenditures

Accounting equity

Total assets

EBIT margin

ROCE

Earnings per share

Total dividend

Dividend per share

Headcount (Dec. 31)

2004

1,941

261

139

111

79

188

133

122

97

428

1,225

7.2

20.0

2.79

20

0.70

11,364

Kolbenschmidt Pierburg in figures 1)

€ million

€ million

€ million

€ million

€ million

€ million

€ million

€ million

€ million

€ million

€ million

in %

in %

€

€ million

€

2005

2,050

263

146

127

86

206

162

117

104

516

1,353

7.1

20.2

3.01

36

1.30

11,699

2001 after adjustment under IAS8; the adjustments are insignificant, both individually and in the aggregateExcluding financial investments and additions to goodwill Beginning in 2002, tooling grants/allowances have been directly offset against capital expendituresExcluding goodwill amortization

1)

2)

3)

4)

2001

1,826

238

91

50

32

174

175

146

80

341

1,338

5.0

10.1

1.18

14

0.50

11,662

2002

1,883

235

97

60

37

170

144

134

86

333

1,252

5.2

11.8

1.32

14

0.50

11,535

2003

1,884

239

103

73

43

170

127

132

81

363

1,214

5.5

13.8

1.51

14

0.50

11,316

Kolbenschmidt Pierburg Group at a glance

Locations

MexicoCelaya

BrazilNova Odessa

Czech RepublicÚstí nad Labem

TurkeyIstanbul

GermanyNeckarsulm

Berlin

Dormagen

Düsseldorf

Hamburg

Hartha

Nettetal

Neuss

Neuenstadt

Papenburg

St. Leon-Rot

Stuttgart

Walldürn

JapanHiroshima

OdawaraChinaShanghai

FranceThionville

Paris

Lyon

SpainAbadiano

ItalyLanciano

Livorno

USAMarinette, WI

Fort Wayne, IN

Greensburg, IN

Greenville, SC

Detroit, MI

CanadaLeamington

Pierburg

Systems and componentsfor air supplyand emission control

Oil and water pumps, vacuum pumps

Sales€900 million

EBIT €68 million

Headcount3,480

LocationGermanyFranceItalySpainCzech RepublicUSABrazilChina (Joint Venture)

KS Pistons

Passenger car pistonsPiston modules

Commercial-vehicle pistons

Large-bore pistons

Sales€640 million

EBIT €39 million

Headcount5,780

LocationGermanyFranceCzech RepublicUSACanadaBrazilMexicoJapanChina (Joint Venture)

KS Plain Bearings

Plain bearings, BushingsThrust washers

Dry bearings (Permaglide)

Continuous NF castings

Sales€170 million

EBIT €18 million

Headcount1,020

LocationGermanyUSABrazil

KS Aluminum-Technology

Aluminum Engine blocks

Sales€210 million

EBIT €9 million

Headcount1,010

LocationGermany

Motor Service

Automotive partsfor engine repair and workshops

Sales€160 million

EBIT €10 million

Headcount370

LocationGermanyFranceTurkeyBrazil

Divisions

Contents

Report of the Supervisory Board

Report of the Executive Board

Letter from the Executive Board

Corporate Governance

Management Report on the Kolbenschmidt Pierburg Group

Underlying economic conditions

The situation of the group

Future prospects

Kolbenschmidt Pierburg AG

Consolidated financial statements 2005

Consolidated balance sheet

Consolidated income statement

Consolidated statement of cash flows

Statement of changes in equity

Notes

Auditor’s opinion

Group of consolidated companies

Additional information

Kolbenschmidt Pierburg AG: Balance sheet and income statement

Supervisory Board and Executive Board

List of addresses

04

06

06

08

11

11

13

29

31

33

34

35

36

37

38

65

66

67

67

68

72

4 Report of the Supervisory Board

Report of the Supervisory Board

During fiscal 2005, the Supervisory Board of Kolbenschmidt Pierburg AG performed the functions andduties incumbent on it under law and the bylaws. It regularly advised the Executive Board, monitoring itsmanagement of the company. The Supervisory Board was included in decisions of fundamental importanceto the company.

The Executive Board reported regularly, timely and comprehensively to the Supervisory Board on the Com-pany’s and the Group’s situation and development, as well as on fundamental issues of business policy,management and corporate planning, including finance, capital expenditure and human resources planning,the risk position and risk management matters. In addition, the Supervisory Board was regularly briefed inwriting on the Kolbenschmidt Pierburg Group’s business situation and trends.

The Supervisory Board met twice in the first and twice in the second half-year periods of 2005. The Super-visory Board’s Personnel Committee members convened twice in fiscal 2005 (March 8 and November 24,2005) and took the actions considered necessary.

When the Auditing Committee (previously known as the Finance Committee) met on March 16, 2005, it dealtwith the preparatory deliberations concerning the 2005 annual accounts. At its meeting of November 14, 2005,the Auditing Committee decided on the main points of the 2005 annual accounts audit, after which theChairman of the Supervisory Board awarded contracts to the statutory auditors. There was no reason forthe Slate Submittal Committee to convene.

The full Supervisory Board was duly informed about its committees’ activities. At the full Supervisory Boardmeetings, the members discussed in detail the situation and development of the Group, the various divisionsand all major subsidiaries in Germany and abroad, as well as all significant transactions. At its meetingheld on November 21, 2005, the Supervisory Board passed the Declaration on the German Code of CorporateGovernance published on November 24, 2005. In addition, a review of the Supervisory Board’s efficiencywas also carried out in 2005.

Furthermore, the Supervisory Board dealt with issues of strategic and organizational orientation and, at itsmeeting of November 21, 2005, deliberated on the Group’s medium-term plans. All Executive Board actionsrequiring Supervisory Board approval were submitted in full on a timely basis to the Supervisory Board.After careful scrutiny and detailed discussion, all items were approved.

The Chairman of the Supervisory Board was briefed continuously and promptly on all major transactionsinvolving the company and the Group. He had major matters and issues referred to the Supervisory Boardfor discussion and met regularly with the Chairman of the Executive Board to review strategy, current business,and risk management issues. The separate and consolidated financial statements and the managementreports of Kolbenschmidt Pierburg AG and the Group for the fiscal year ended December 31, 2005, includingthe accounting system, were all audited by PricewaterhouseCoopers Aktiengesellschaft, Wirtschaftsprüfungs-gesellschaft of Stuttgart, which had been appointed as statutory auditors by the annual stockholders’meeting on May 4, 2005.

On February 28, 2006, the statutory auditors issued their unqualified opinion on both sets of financial state-ments. Within the scope of the audit, the statutory auditors also had to examine whether the ExecutiveBoard had duly implemented the legally required procedures, and especially if it had set up a monitoringsystem that would identify at an early stage any risks likely to jeopardize the company’s continued existenceas a going concern. The auditors declared that the Executive Board had met the requirements of Art. 91(2)German Stock Corporation Act (“AktG”). At its meeting on March 10, 2006, the financial committee of theSupervisory Board reviewed and approved the separate and consolidated financial statements for fiscal

2005 on the basis of the reports and findings of the statutory auditor. The statutory auditors participatedin this meeting, reporting on the essential results of the audit and answering questions. No objectionswere raised. Well before the balance sheet meeting of the Supervisory Board on March 10, 2006, all themembers of the Supervisory Board were provided with the annual accounts, the separate and consolidatedfinancial statements, the management reports on the company and the Group, and the report of the statutoryauditor. At the balance sheet meeting, the Supervisory Board reviewed these documents in great detail.

The statutory auditor took part in the Supervisory Board’s discussion of the separate and consolidatedfinancial statements. The Supervisory Board concurs with the results of the audit, and has reviewed theseparate and consolidated financial statements, the management reports on the Company and the Group,and the profit appropriation as proposed by the Executive Board, having raised no objections. At its meetingon March 10, 2006, the Supervisory Board approved the separate and consolidated financial statementsfor fiscal 2005 as submitted by the Executive Board, which are thus adopted. The Supervisory Board endorsesthe Executive Board’s proposal to the General Meeting for the appropriation of the net earnings for fiscal 2005that a cash dividend of €1.30 per no-par share will be distributed.

The Executive Board’s report on affiliations in fiscal 2005 as defined by Art. 312 AktG, and the pertinentreport of the statutory auditors, were submitted to the Supervisory Board, which examined the report ofthe Executive Board and concurs with it, as with the results of the examination by the statutory auditors.The auditors issued the following opinion on the dependency report of the Executive Board concerningaffiliations:

“Based on our examination, which we performed with due professional care, and on our evaluation wecertify that

(1) the facts stated in the report are valid;(2) the Company’s consideration for the legal transactions

referred to in the report was not unreasonably high.”

After reviewing the final results of its own examination, the Supervisory Board has found no reasons forobjections to the Executive Board’s concluding representation in the report on affiliations for fiscal 2005.

The Supervisory Board thanks the men and women of the Kolbenschmidt Pierburg Group for their dedicationand commitment in 2005.

Düsseldorf, March 10, 2006

The Supervisory Board

Klaus EberhardtChairman

5

6 Letter from the Executive Board

Letter from the Executive Board

Ladies and gentlemen,

With a wide range of innovative products, in 2005 the Kolbenschmidt Pierburg Group once again achieveda rate of growth well above that of the world market. Moreover, we were able to improve on last year’s alreadyrobust earnings performance.

Sales exceeded the 2 billion mark for the first time, increasing to 2,050 million. Net income for the year alsoimproved, rising to 86 million, up from 79 million in 2004.

Success in the operational sphere was accompanied by a strong focus on strategic expansion. By promotinginnovation, a further increase in research and development spending accelerated the process of organicgrowth.

Furthermore, we systematically pursued our strategic goal of greater internationalization, focusing primarilyon Asia. The KS Pistons division invested in the Indian company Shriram Pistons & Rings, as well as buyingPistones Moresa, a Mexican pistons manufacturer (finalized in February 2006). In Japan, work began onsetting up a customer service center near Tokyo. This paves the way for a further expansion of Group salesin the Japanese market, especially by KS Pistons, KS Plain Bearings and Pierburg.

Confirming the overall positive trend, Moody’s upgraded the Group’s rating to Baa2 (outlook: positive). More-over, the increase in value achieved by Kolbenschmidt Pierburg AG during the past three years receivedspecial recognition in the form of a PricewaterhouseCoopers Shareholder Value Award: We took secondplace in the Automotive Parts sector.

As for the future, we will continue to pursue our present policy, which is geared to systematically improvingour products, cost structures and standing in the market, thus assuring long-term profitable growth.

We would like to take this opportunity to thank you very much for your continuing confidence in Kolben-schmidt Pierburg.

Sincerely

Dr. Kleinert Dr. Merten Dr. Friedrich

7

Dr. Gerd Kleinert Dr. Peter P. Merten Dr. Jörg-Martin Friedrich

Corporate Governance

Kolbenschmidt Pierburg AG adheres to a policy of responsible and transparent corporate management andcontrol, oriented to securing a sustained increase in corporate value. Even in the past, the company’s practiceslargely corresponded to the recommendations and suggestions of the German Corporate GovernanceCode. The intention is to reinforce further the confidence of German and international investors, our businesspartners, our employees and the public at large in the management and monitoring of the KolbenschmidtPierburg Group. Kolbenschmidt Pierburg AG sees Corporate Governance as a continuous process for improvingthe management and control of the company in response to ongoing experience and regulations as wellas steadily evolving national and international standards.

The Executive Board. The Executive Board has overall responsibility for managing the company’s operationsin accordance with uniform objectives, plans and guidelines. The responsibilities and prerogatives of theExecutive Board derive from statutory regulations, the bylaws of Kolbenschmidt Pierburg AG and the internaloperating procedures of the Executive Board. The Executive Board of Kolbenschmidt Pierburg AG consistsof three members, with each member assigned special responsibility for a particular sphere; however,they are enjoined to place the overall wellbeing of the company above the interests of their own particularsphere. The Chairman of the Executive Board coordinates the work of the Executive Board.

In the notes to the consolidated financial statements, the compensation of the entire Executive Board ofKolbenschmidt Pierburg AG is stated in summarised, informative fashion, broken down into fixed, perform-ance-related and long-term incentive portions. For the shareholder, it is crucial to have an impression ofthe entire Executive Board, which, as a collegiate body, is charged with joint responsibility for managingthe company. The summarized presentation contains all the information necessary for making a rationalassessment of the performance of the Executive Board, as well as enabling an assessment of whether theratio of fixed and performance-related compensation components is appropriate, and whether the necessaryperformance incentives for the members of the Executive Board have been established. A statement ofindividual compensation would not contain information relevant to the capital market, nor would it improvethe overall quality of the information provided. Moreover, it should be noted that disclosing the compensationpaid to individual members of the Executive Board can lead to an undesirable leveling of task- and perform-ance-related remuneration, while the disclosure of salaries could result in a ranking in the importance ofindividual members of the Executive Board.

Compensation is set by the Supervisory Board at an appropriate level and on the basis of a personal perform-ance assessment, with due regard to any other compensation paid by the Group. Assessment criteria fordefining an appropriate remuneration of Executive Board members include each member’s responsibilitiesand personal performance, as well as the financial strength, success and future prospects of the company,taking into account comparable companies in the industry. Compensation is set at an internationally compet-itive level capable of attracting highly qualified executives; the amount and structure of Executive Boardcompensation is oriented to that of comparable German and foreign firms.

Normally, remuneration consists of a 60 percent fixed-income component and a 40 percent variable compo-nent, with 70 per cent of the variable component in turn consisting of so-called Result Contribution 1 (a com-parison of projected and actual figures viz. the plan of one’s own unit), and 30 percent relating to Result Con-tribution 2 (a comparison of projected and actual figures viz. the plan of the next higher own unit), based onthe performance indicators EBIT and ROCE.

A further program has been established to serve as an additional incentive model. It is not linked to thecompany’s share performance, but instead depends exclusively on the absolute increase in “fundamentalequity value” based on defined corporate performance ratios.

Introduced in 2004, the program applies to all members of the Executive Board as well as to the top twolayers of management beneath the Executive Board.


9

At the General Meeting on May 4, 2005, the Chairman of the Supervisory Board informed the ExecutiveBoard concerning the essential features of the compensation system. The basic features of the compensationsystem also appear on the company’s website.

During the year under review, no loans or advances were extended to members of the Executive Board.

The corporation has taken out a Directors’ and Officer’s Liability Insurance policy for the Executive Board;an appropriate deductible was agreed.

Supervisory Board. The Supervisory Board consists of 12 members. In accordance with the German Codeter-mination Act of 1976, six members represent the shareholders, while six represent the company’s employees.The Supervisory Board’s composition corresponds to the recommendations contained in Clause 5.4.2 of theJune 2, 2005 edition of the Code. Its current term expires at the end of the General Meeting in 2008. It conductsits activities on the basis of the laws and bylaws, as well as the rules of procedure in force since 2003.

Its committees, composed of an equal number of members, deal with complex issues which fall under thepurview of the full Supervisory Board, as well as preparing resolutions of the Supervisory Board. Specifically,the tasks of the committees are as follows:

Personnel Committee. The Personnel Committee is responsible for all personnel matters pertaining to mem-bers of the Executive Board, and represents the company in its dealing with members of the Executive Board.Furthermore, it makes preparations for the appointment and reappointment of Executive Board members,submits recommendations to the full Supervisory Board, and, in cooperation with the Executive Board,engages in long-term planning for an orderly succession.

Audit Committee. The Supervisory Board has established an Audit Committee which is responsible for thetasks specified in Clause 5.3.2 of the Code. Moreover, it prepares resolutions of the Supervisory Boardrelating to capital measures and approval of the annual accounts. It is also charged with monitoring thefinancial structures of the Kolbenschmidt Pierburg Group.

Arbitration Committee. Mandated by the German Codetermination Act, the Arbitration Committee submitspersonnel proposals to the Supervisory Board when the majority necessary for the appointment of membersof the Executive Board has not been attained.

Compensation paid to the Supervisory Board consists of a fixed and a variable component, the latterdepending on the amount of the dividend paid out by the company. The existing system of SupervisoryBoard compensation is set forth in detail in Art. 13 of the company’s Articles of Association. Pursuant toClause 5.4.7, Sub-clause 3 of the Code, the chairmanship and membership of committees should be takeninto account when determining Supervisory Board compensation.

A survey of members of the Supervisory Board revealed no conflicts of interest as defined in Clauses 5.5.2and 5.5.3 of the Code.

During the year under review, no loans or advances were extended to members of the Supervisory Board.

The corporation has taken out a Directors’ and Officer’s Liability Insurance policy for the Supervisory Board;an appropriate deductible was agreed.

At the meeting on November 21, 2005, the Supervisory Board reviewed its activities during fiscal 2005, aswell as conducting an efficiency audit.


Transparency. Pursuant to Art. 15 of the German Securities Trading Act (“WpHG”), members of the ExecutiveBoard and Supervisory Board of Kolbenschmidt Pierburg AG are required to disclose the purchase or saleof Kolbenschmidt Pierburg AG stock. Kolbenschmidt Pierburg AG received no reports of purchase or saleduring the period under review; nor did any shareholdings exist which were reportable under the terms ofClause 6.6 of the German Corporate Governance Code.

Originally published on the company’s website in November 2005 as a declaration of conformity by theExecutive Board and Supervisory Board of Kolbenschmidt Pierburg AG, a statement of the recommenda-tions of the June 2, 2005 version of the Code not adopted by the company appears below:

Declaration of Conformity pursuant to Art. 161 AktG

Kolbenschmidt Pierburg AG’s Executive and Supervisory Boards declare that Kolbenschmidt Pierburg AGhas, since the issuance of the preceding declaration of conformity in November 2004, fully carried out orwill act on, the recommendations of the German Corporate Governance Code Government Commission asamended up to June 2, 2005 and published in the digital Federal Gazette on July 20, 2005, except for thefollowing recommendation that neither has been nor will be implemented:

– The remuneration paid to each individual Executive and Supervisory Board member (Clause 4.2.4 andClause 5.4.5 of the Code, respectively) will not be disclosed in the notes to the consolidated financialstatements.

Neckarsulm, November 2005

The Executive Board The Supervisory Board

11

Underlying economic conditions

Performance of the world economy. During fiscal 2005, despite higher energy and raw materials prices,the global economy was characterized by solid growth. According to estimates of the International MonetaryFund (IMF) and the Organization for Economic Development and Cooperation (OECD), international economicoutput–that is to say, the total of every country’s gross domestic product (GDP) worldwide–rose by around4.3 percent. Particularly important for the state of the world economy was the sharp increase in the cost ofraw materials. Within the space of a year, the price of oil surged from just under US$40 to nearly US$60 abarrel at the end of 2005. This had an adverse impact on inflation rates worldwide. Whereas inflationarypressure in Europe remained relatively mild at just below 2.4 percent (according to Eurostat), in the UnitedStates the National Association for Business Economics estimated that the rate of inflation was close tofour percent. Accordingly, the US Federal Reserve and the European Central Bank responded with a restrictivemonetary policy, raising key interest rates.

The fact that the world economy still performed positively in 2005 was due among other things to rapid growthin China, which continued unchecked. Positive impulses came from India and Russia as well, both of whichattained rates of growth exceeding five percent. According to OECD estimates, the United States had thestrongest domestic economy of the Western industrialized nations last year, with GDP increasing betweenthree and four percent. For its part, Japanese GDP in 2005 grew by roughly two percent, a respectable figure.Buoyed by a weaker euro and strong exports, European growth remained robust, sluggish domestic demandnotwithstanding. According to IMF forecasts, GDP in the European Union (EU) grew last year by roughly1.5 percent. But not everywhere: in December 2005, the IFO Institute’s estimate put German GDP growthat just under one percent, down from 1.6 percent in 2004. It was only in the last quarter of 2005 that the KielInstitute for World Economics (IfW) detected a significant improvement in the German economy. The relevanteconomic data showed increasingly positive signals, resulting first and foremost from strong incoming ordersin the manufacturing sector.

Global automobile sales rise despite higher fuel prices. The increase in fuel prices failed to have a negativeimpact on world automobile production. Strong global growth and pent-up demand in the expandingeconomies of Asia resulted in a respectable 2005 for the automobile industry. Compared to 2004, globalproduction of passenger cars and light commercial vehicles grew by over four percent, rising to 62.3 millionunits.

It was once again the Asia-Pacific region which reported the strongest rates of growth in 2005. Availableestimates place total production in the region at just under 12.9 million units, a good 15 percent higherthan the previous year’s figure. Growth was especially impressive in China and India. With a productionvolume of 4.3 million units–equating to an increase of 19 percent–China emerged as the world’s fourth-largest producer nation. In Japan, output edged up from 9.6 million units to 9.9 million.

At approximately 20 million units, European automobile production in 2005 slightly exceeded the previousyear’s figure. Growth was disproportionately strong in Eastern Europe, where, favored by a generally positiveeconomic climate and pent-up consumer demand, production increased by 8 percent. By contrast, outputin Western Europe declined by roughly one percent to 16.7 million units. Germany, however, did better thanexpected: in 2005, Europe’s largest auto producing nation turned out a total of 5.3 million passenger carsand light commercial vehicles, an increase of well over five percent. Steady domestic demand and risingexport sales contributed to this positive trend. Conversely, the automotive industry in other traditionalEuropean car making nations suffered a downturn in production. This is particularly true of Italian automakers,which had to contend with a roughly ten percent drop in volume. The UK and France likewise reporteddeclining production figures.

In the NAFTA nations–the United States, Canada and Mexico–automobile production remained unchangedfrom the previous year’s figure of 15.8 million units, despite good economic growth and massive salesinducements on the part of automakers. Conversely, production volume in South America rose by 14 percentto 2.8 million units.

Sharply increased fuel prices in 2005 boosted the popularity of vehicles offering greater fuel efficiency andreduced emissions. As a result, lightweight materials like aluminum and magnesium are found in more andmore automobiles, as are products containing advanced mechanical and electronic technologies. Theboom in diesel vehicles remains unabated, which, thanks to their low fuel consumption and the compar-atively low price of diesel, continued to be particularly popular in 2005 with European motorists. Thus,in the period under review, more than 50 percent of all newly registered passenger cars in Western Europehad diesel engines. Owing to its technological lead, competitive edge, and a product range geared to mainmarket trends, Kolbenschmidt Pierburg definitely benefited from these developments.

12 Management report

13

The situation of the Group

Significant events. At the end of fiscal 2005, the Pierburg division sold its Air-Mass Sensor product unitto Texas Instruments Holland BV of Amelo, the Netherlands, further streamlining the division’s productportfolio. Apart from the manufacturing rights, production lines and inventory, Texas Instruments Hollandhas also acquired the customer and supplier contracts in two phases, assuring a seamless transition forcustomers in the automobile industry. Employees assigned to this product unit at Pierburg’s plants in Neussand Nettetal will remain with Pierburg GmbH.

In order to expand its presence in the Indian market, the KS Pistons division has gradually increased itsstake in Shriram Pistons & Rings Ltd. of New Delhi to 20 percent. In these annual accounts, this investmentis consolidated at equity for the first time. With a view to obtaining 100 percent control of the companyMetal a.s. in the Czech Republic, a squeeze-out procedure was conducted to compensate minority share-holders.

In the KS Plain Bearings division, the KS Bearings Inc. of Fountain Inn, South Carolina, and Miba Bearings USLLC of McConnelsville, Ohio, set up a joint venture for manufacturing pre-materials for plain bearings. Thenew joint venture, ABM Advanced Bearing Materials LLC of Greensburg, South Carolina, in which both com-panies own an equal share, will primarily produce cast bronze and brass composite materials, both lead-containing and non-lead-containing. These will then be shipped for further processing at Miba and KS loca-tions in the United States, Germany and Austria. The new company’s management team is made up in equalmeasure of representatives from KS Plain Bearings and Miba Gleitlager.

GVN Grundstücksverwaltung Neckarsulm GmbH & Co. KG, directly owned by Kolbenschmidt Pierburg AG,began a major program of capital expenditure on buildings for expanding final processing capacity in theKS Aluminum Division; for organizational purposes, the company has therefore now been placed withinthe KS Aluminum Technology division.

Effective November 29, 2005, the Group sold its interest in the Motor Service division’s unit KS MotorServis CZ s.r.o. to the company Vanep s.r.o. To safeguard the distribution channel, a licensing agreement,a sales contract, and a time-limited loan contract were signed with the purchaser after the sale of the division’sstake. The liquidated company KS Winston Ltd. was deconsolidated at the end of the year.

In the third quarter of 2005, the property company KS Grundstücksverwaltung GmbH & Co. KG was statis-tically divided between the KS Pistons and KS Plain Bearings division and other units of the Group in order toachieve a rational allocation of its tangible assets.

To facilitate the planned growth of the Group, capital increases were undertaken at the following units:Pierburg s.r.o., KS ATAG Bearbeitungs-GmbH, MSD Motor Service Deutschland GmbH, Pierburg do BrasilInd. e Comercio Ltda. and KS Bearings Inc.

The trend in sales and earnings. Following a stagnant first quarter, sales throughout the rest of the periodgrew continuously. Thus, during fiscal 2005, Group sales reached approximately €2,050 million, a rise of5.6 percent from the previous year. Strong growth in sales was favored by positive exchange rate trends,particularly with regard to the Brazilian real. Corrected to reflect these currency translation effects, salesgrew by 5.2 percent, exceeding growth in the global automobile industry, which came to 4.2 percent.Indeed, in terms of Kolbenschmidt Pierburg’s current core markets (Western Europe and NAFTA), which grewweakly or even contracted, Group sales grew significantly faster than the market.



During the period under review, sales shifted away from Germany to the production units of its Germancustomers in other European countries, especially Austria, Hungary and Poland. Sales growth in North andCentral America was generated largely in the United States, while in South America Brazil proved to be thegrowth market. Our efforts in Asia resulted in a dynamic increase in sales, manifested in a tripling of exportsto China. Customers in Japan and India likewise increased their orders, with rates of growth well into thedouble-digits. Not included in the sales figures for the Asia/Pacific region is our share in the sales of theGroup’s two Chinese joint ventures, which are consolidated at equity.

Breakdown of sales by region in %

Sales by region € million

Germany

Europe (without Germany)

North and Central America

South America

Asia 1)

Other regions

Group

(25)

75

21

21

18

(1)

109

2004

667

843

272

62

71

26

1,941

2005

642

918

293

83

89

25

2,050

change

1)

in %

(3.7)

8.9

7.7

33.9

25.4

3.8

5.6

With the exception of the Motor Service division, all of Kolbenschmidt Pierburg’s divisions participated in theGroup’s sales growth. Meriting special mention are the KS Aluminum Technology division, whose salesgrew by 14.8 percent, and KS Pistons, with sales growth of 9.6 percent.

Sales by division € million

Pierburg

KS Pistons

KS Plain Bearings

KS Aluminum Technology

Motor Service

Other/consolidation

Group

2004

889

582

160

183

161

(34)

1,941

2005

903

638

171

210

160

(32)

2,050

change

14

56

11

27

(1)

2

109

in %

1.6

9.6

6.9

14.8

(0.6)

5.9

5.6

34 Germany

44 Europe(without Germany)

14 North/Central America

03 South America

04 Asia

01 Other regions

€ million

€ million

2004

32 Germany

45 Europe(without Germany)

14 North/Central America

04 South America

04 Asia

01 Other regions

2005

Without the Chinese joint ventures (the Group’s share of sales in 2004: €47 million; in 2005: €38 million)

15

The Pierburg division’s sales grew by 1.6 percent to €903 million. Positive sales trends in the division’stwo product units Air Supply and Pumps more than compensated weaker growth in its Emission Reductionproduct unit, which was hit by declining demand for secondary air systems. In the Air Supply domain, salesof the two principle product groups, electric throttle bodies and intake manifolds, both rose, while in thePumps unit, it was above all stronger sales of water and vacuum pumps that led to an increase on theprevious year’s figures.

The Piston’s division ended fiscal 2005 with sales of €638 million, exceeding the figure for 2004 by 9.6 per-cent. Corrected for the effects of currency translation, this corresponds to a real rate of growth of 9.3 percent.Above all, KS Pistons’ plant for large-bore pistons in the United States and its Czech and Japanese subsidiariesachieved double-digit rates of growth, as did its German unit. However, all of the division’s units contributedto its increase in sales.

Building on a successful 2004, the KS Plain Bearings division succeeded in increasing sales during the periodunder review by 6.9 percent to €171 million. Sales were higher in all of the division’s product groups. Theprime driver of growth was the Continuous Casting product unit, which saw an increase in volume and wasalso able to pass on higher material prices to customers. Increased volume also explains the stronger salesin the division’s Permaglide and Metallic Bearings product units.

The KS Aluminum Technology division remained successfully on course, increasing its sales by an impressive14.8 percent to €210 million. The division’s Low Pressure Casting segment was the chief contributor here,benefiting from new products coming on stream. The Pressure Casting segment also experienced a slightimprovement on the previous year’s sales figure.

At €160 million, despite difficult markets in Western Europe as well as in the Middle East and East Asia,the Motor Service division’s sales revenues remained close to their 2004 level. In Germany in particular,strong price competition led to declining sales. In Brazil as well, the division had to contend with decliningsales in the local currency caused by sharp price competition; owing to the effect of currency translation,however, sales actually increased in euro terms.

The distribution of Group sales by division changed only marginally from 2004.

The breakdown of sales by division in %

45 Pierburg

30 KS Pistons

08 KS Plain Bearings

09 KS AluminumTechnology

08 Motor Service

2004

43 Pierburg

31 KS Pistons

08 KS Plain Bearings

10 KS AluminumTechnology

08 Motor Service

2005



The sharp rise in sales, coupled with slightly lower changes in inventory, led to an increase in total operatingearnings in the Group, which grew by €107 million to €2,074 million. Other operating earnings increasedby €9 million to €61 million. Material expenses came to €1,081 million in 2005, €71 million more thanthe year before. As a result, the material expenses ratio went up by 0.8 percentage points to 52.1 percent.Personnel expenses rose by €23 million to €544 million. Compared to a year earlier, the sum of materialand personnel costs increased slightly to 78.4 percent, a rise of 0.6 percentage points.

Owing to the planned reduction of capital expenditure in previous years, depreciation and amortizationdeclined by €5 million to €117 million. Other operating expenses increased by €9 million to €252 million,largely due to higher repair and maintenance expenses as well as the formation of accruals. Savings wereachieved first of all in spending on social compensation plans and severance packages as well as generaladministrative costs.

The financial result deteriorated from €2 million to (€14 million). The net interest component contained inthis item developed along distinctly positive lines, with a slight increase in net interest income and a €7 mil-lion decline in net interest expense. Income from trade investments declined by €12 million, the result ofbook earnings from the sale of an investment the previous year, as well as lower contributions to earningsfrom the Group’s joint ventures in China. The item “other financial expenses and income” improved slightly.

Earnings before interest and tax (EBIT) of the Kolbenschmidt Pierburg Group grew by 5.0 percent to€146 million. Just as in 2004, all of the divisions contributed to the Group’s successful performancewith positive results. The Kolbenschmidt Pierburg Group’s return on sales in fiscal 2005 came to 7.1 per-cent (2004: 7.2 percent).

EBIT by divisions € million

Pierburg

KS Pistons

KS Plain Bearings


Motor Service

Other/consolidation

Group

2004

67

37

17

5

13

0

139

2005

68

39

18

9

10

2

146

change

1

2

1

4

(3)

2

7

in %

1.5

5.4

5.9

80.0

(23.1)

--

5.0

In absolute terms, the Pierburg division was once again the largest single contributor to Group earnings,with all of the Pierburg units making a positive contribution. Compared to 2004, the division’s performanceimproved by 1.5 percent, due first and foremost to improved earnings at its Italian and French units. Burdenedby start-up costs the previous year, Pierburg’s newly established Czech subsidiary experienced a significantimprovement in earnings in fiscal 2005. As expected, the division’s Spanish unit made a smaller contributionto earnings due to declining sales; this is also true of the division’s German lead company, which had tocontend with smaller earnings contributions (especially from its Chinese joint venture) as well as lowersales. The result for the year contains the profit from the sale of its Air-Mass Sensor product unit; the previousyear’s result contained a similar amount, i.e. the book profit from the sale of the division’s stake in PierburgInstruments GmbH. The Pierburg division’s return on sales came to 7.5 percent, unchanged from 2004.

€ million

17

Asset and capital structure. At December 31, 2005, total assets increased compared to a year earlier by10.4 percent to €1,353 million. Despite this rise, 2005 witnessed a further improvement in key balancesheet ratios.

At the end of fiscal 2005, fixed assets amounted to €802 million. This represents an increase comparedto the previous year of 10.9 percent. This rise was largely due to the increase in tangible assets–additionssignificantly outpaced depreciation/amortization for the year–and to the exchange rate-related effects ofcurrency translation. The increase in financial assets, arising from the acquisition of a stake in ShriramPistons & Rings Ltd. of New Delhi and the setting up of a new plain bearings joint venture in the UnitedStates, likewise contributed to the increase in fixed assets. Long-term deferred taxes rose by €11 million.The share of fixed assets in the balance sheet total amounted to 59.3 percent (2004: 59.0 percent).

EBIT reported by the KS Pistons division for fiscal 2005 was 5.4 percent higher than the previous year’s figure.This was due in particular to improved earnings–driven by improved sales–at the division’s German,Czech and Japanese units, as well as its North American operations (the only exception here being itsCanadian subsidiary, which is due to close). Owing to unfavorable exchange rate trends, added sales bythe division’s Brazilian subsidiary, whose export customers are primarily in the US dollar zone, did notresult in added earnings. In fiscal 2005, the KS Pistons division’s return on sales was 6.1 percent (2004:6.4 percent).

The KS Plain Bearings division increased its EBIT to €18 million. Here, a slight dip in earnings by the division’sGerman and Brazilian units was more than offset by the strong performance of its North American sub-sidiary, which profited from increased sales and additional improvements in its operations. This confirmsthe turnaround begun the previous year. Return on sales in the KS Plain Bearings division in fiscal 2005came to 10.5 percent (2004: 10.6 percent).

In the KS Aluminum Technology division, additional profit contributions from increased sales and an improvedproduction costs structure pushed earnings up to €9 million. This resulted in a return on sales for the KSAluminum Technology division in 2005 of 4.3 percent (2004: 2.7 percent).

At €10 million, the Motor Service division’s EBIT was €3 million lower than in fiscal 2004. Apart from the costsof integrating new engine parts units, sharper price competition meant that higher materials costs couldnot be passed on to customers. In Brazil, the impact of negative exchange rate trends on its US dollar-based export business also hit earnings. As a result, the Motor Service division’s return on sales in 2005fell to 6.3 percent, down from 8.1 percent in 2004.

The EBIT of the other companies, including Group consolidation, is determined by the result of KolbenschmidtPierburg AG, which, adjusted for income from trade investments with a neutral effect on Group earnings,rose compared to the previous year by €5 million. Essentially, this was due to lower operating costs andhigher other operating earnings. Group-wide consolidation effects had a countervailing influence.

Taken as a whole, our share in the Group’s two Chinese joint venture companies (both of which are consoli-dated at equity) remained positive, though €5 million below the figure for fiscal 2004.

For fiscal 2005, Kolbenschmidt Pierburg reported earnings before tax (EBT) of €127 million, an increase of14.4 percent from the previous year’s figure. Income tax expense rose by €9 million to €41 million; thiscorresponds to an income tax ratio of 32.3 percent as opposed to 28.8 percent a year earlier. The low taxratio in 2004 was essentially due to the higher share of tax-free profits in that year. Thus, profits after taxation(i.e. Group net income) rose by €7 million to €86 million. Taking into account the share in Group netincome owed to minority shareholders, earnings per share came to €3.01, up from €2.79 in 2004, with thenumber of shares remaining constant.



Current assets–including cash and cash equivalents of €49 million–amounted to €551 million at Decem-ber 31, 2005, a rise of 9.8 percent from the previous year. Apart from the exchange-related effects of currencytranslation, the €19 million-increase in inventory assets to €245 million related to the growing number ofproduction facilities currently under construction, built by the Group within the framework of customerprojects and sold to customers after completion. Compared to a year earlier, the volume of trade receivableslikewise increased sharply, growing by €51 million to €231 million. Apart from higher sales, this resultedfrom the exchange rate-related effects of currency translation and lower sales of trade receivables. Neverthe-less, the share of capital in the balance sheet total tied up in current assets edged down from 41.0 percentin 2004 to 40.7 percent.

At December 31, 2005, equity had risen by 20.6 percent to €516 million compared to a year earlier. Thiswas essentially due to Group net income of €86 million. The equity ratio rose by 3.2 percentage points to38.1 percent.

At the end of 2005 long-term liabilities came to €350 million, an increase of €8 million compared to theprevious year’s figure. Long-term accruals grew by a total of €9 million, €6 million of which were accrualsfor pensions. Long-term financial liabilities to banks fell once again by €3 million to €7 million. Other long-term liabilities, including deferred taxes, remained virtually constant. The share of long-term debt in thebalance sheet total declined to 25.9 percent (2004: 27.9 percent).

Short-term liabilities increased by €32 million to €487 million, essentially relating to trade payables andincome tax obligations. The €14 million increase in trade payables was due primarily to increased factory out-put. Income tax obligations rose because of higher income tax expenses. Other short-term liabilitiesremained roughly at the previous year’s level. The share of short-term liabilities in the balance sheet totalfell to 36.0 percent, down from 37.1 percent in 2004.

Compared to the previous year, free cash flow contracted sharply, dropping by €117 million to €3 million. Cashinflow from ongoing business activities fell by €72 million to €150 million, while cash outflow relating to cap-ital expenditure rose by €45 million. The decline in cash inflow from current business activities largelyresulted from the €61 million-increase in working capital (reduction in 2004: €19 million). In particular, theincrease in cash outflow relating to capital expenditure was due to the €28 million-rise in spending on tan-gible and intangible assets, as well as to a €22 million-reduction in cash inflow from disinvestments infinancial assets.

Together with the €21 million in dividends disbursed in 2005, the free cash flow of €3 million led to a drop innet liquidity (as a balance of cash and cash equivalents and short- and long-term financial liabilities) from€4 million in 2004 to (€16 million) in the year under review.

At December 31, 2005, coverage of fixed assets by equity rose to 64.3 percent; a year earlier this ratio was59.2 percent. Together, equity and long-term debt completely covered fixed assets at the end of 2005.

Return on capital employed (ROCE) grew by 0.2 percentage points to 20.2 percent. In this context, the improve-ment in EBIT was partially neutralized by the simultaneous increase in the average amount of capitalemployed.

19

Value added. In fiscal 2005 Kolbenschmidt Pierburg generated a value added of €715 million, up from€690 million in 2004, representing an increase of 3.6 percent. Underlying this, Group operating performancegrew by €111 million to €2,179 million, the result of increased sales revenue, higher other operating earningsand other financial earnings. The necessary advances grew by €91 million, reaching a volume of €1,347 mil-lion. This increase was essentially brought about by stronger sales, changes in the product mix and higherraw materials prices. Depreciation of intangible and tangible assets continued to decline thanks to a focusedpolicy of capital expenditure in previous years.

Value added per employee rose by approximately €2,000 to €62,000. The increase in absolute value addedwas more than enough to offset the higher average number of employees.

Source and use of value added € million

Source

Group’s total operating performance

Input

Amortization/depreciation

Value added

Use

Employees

Treasury

Lenders (banks)

Stockholders

Kolbenschmidt Pierburg Group

Value added

2005

2,179

1,347

117

715

553

48

28

36

50

715

in%

77

7

4

5

7

100

2004

2,068

1,256

122

690

536

39

35

20

60

690

in%

78

6

5

3

8

100

Of the total amount of valued added, €553 million went to the employees, who accounted for a 77 percentshare, with the State receiving €48.0 million (or 7 percent), and lenders, €28 million (or four percent). Atthe General Meeting on May 4, 2006, a dividend of €36 million (or 5 percent) will be proposed. Thus, €50million (or 7 percent) of value added remain with the company.

Capital expenditure and depreciation. In fiscal 2005, Kolbenschmidt Pierburg invested around €162 millionin intangible assets (excluding goodwill) and tangible assets, up from €133 million the year before. Containedhere our capital outlays for Pierburg’s now completed customer center in Neuss as well as for a customercenter in Neckersulm, currently under construction. The cash flow-neutral addition in the KS Plain Bearingsdivision derived from a piece of property worth approximately €7 million from a financing lease. With aneye to the future, the KS Aluminum division invested in a production building for finishing engine blocksin Neckersulm. Also included in the 2005 capital expenditure volume were investments aimed at expandingthe Group’s activities in the German aftermarket. Adjusted for these special factors, the volume of capitalexpenditure for 2005 comes to €143 million (and for 2004, to €127 million). The adjusted ratio of capitalexpenditure to sales rose from 6.5 percent in 2004 to 7.0 percent in the year under review.

With the aim of further improving the productivity of capital, we continued in 2005 to adhere to our estab-lished policy of highly selective capital expenditure. Just as last year, capital expenditure was nearly evenlydistributed between the Group’s domestic and foreign units, with Germany accounting for around 56 percentof spending and the rest of the world for roughly 44 percent.



As was already the case the year before, the Pierburg and KS Pistons divisions accounted for the bulk of capitalexpenditure in 2005. Apart from replacement and rationalization measures, the creation and expansion ofcapacity for new customer projects was the prime focus of investment.

In Germany, the Pierburg division primarily invested in preparations for new full-scale production runs andin creating capacity for meeting new customer requirements. Capital expenditure focused on the run-up toserial production of intake manifold projects for the 6-, 8- and 10-cylinder engines of premium German car-makers, as well as on increasing capacity for the manufacture of electrical throttle bodies and the constructionof a new customer center in Neuss.

At Pierburg’s foreign subsidiaries, capital expenditure in Spain and the United States chiefly went on addi-tional capacity for assembling exhaust gas re-circulating valves. Its Italian and French units concentrated onboosting manufacturing capacity for oil, water and vacuum pumps. In France, furthermore, resources wereallocated to implementing the mini factory concept. At the division’s new Czech plant, capital expenditurewas directed at creating production capacity for exhaust gas recirculation valves and secondary air pumps,as well as the construction of an administration building and a first production hall.

At the KS Pistons division’s German plants, resources were directed at replacing existing equipment, as wellas at expanding capacity for new piston projects in the gasoline and diesel engine segments as well assteel pistons. Furthermore, new plant and equipment was acquired for its foundry and processing units. Out-side of Germany, capital expenditure was used to create capacity for new projects as well as to expandexisting capacity. Furthermore, conditions were created for enabling new features to be produced underexisting programs.

In Germany, the main focus of capital expenditure by the KS Plain Bearings division in Germany was onexpanding capacity for the production of primary products at its plant in St. Leon-Rot, as well as on boostingproduction capacity at its parts plant in Papenburg. Furthermore, a new research and development centerwas constructed.

Capital expenditure in the United States was geared to further improving productivity of its casting line forbronze materials. In addition, the division continued to invest in equipment for improving worker safety.

In 2005, the Aluminum Technology division once again concentrated capital expenditure on its fast-growingLow Pressure Casting operations. Plant and equipment was acquired in order to permit production run-upsof new products as well as a shift to full-scale production. Moreover, initial capital expenditure on constructiontook place, paving the way for an expansion of the division’s finishing operations.

Capital expenditures by division € million

Pierburg

KS Pistons

KS Plain Bearings


Motor Service

Other/consolidation

Group

2004

54

47

12

13

7

0

133

2005

68

58

17

16

1

2

162

change

14

11

5

3

(6)

2

29

in %

25.9

23.4

41.7

23.1

(85.7)

--

21.8

€ million

21

In Neckarsulm, preliminary work on constructing a new customer center began. Because the entire Groupwill use it, the center is being built under the auspices of a property company that does form part of anyoperational division.

Additions to financial assets in fiscal 2005 amounted to €11 million. The increase related principally to ourincreased stake in Shriram Pistons & Rings Ltd. and to the establishment of a joint venture between KSBearings Inc. and Miba Bearings US LLC.

For the period January 1 to December 31, 2005, Kolbenschmidt Pierburg achieved a gross cash flow of€206 million (2004: €188 million). This meant that all capital expenditure could again be financed internally.

Depreciation of tangibles and amortization of intangibles (excluding goodwill) of the Kolbenschmidt PierburgGroup came to €117 million at December 31, 2005, down from the previous year’s figure of €122 million.Owing to the application of IFRS3 and IAS36 and 38 since 2004, the planned amortization of goodwill nolonger features. The impairment tests conducted did not result in unscheduled amortization or depreciation.

Capital expenditure in fiscal 2005 amounted to €162 million, exceeding (by approximately 38.5 percent)depreciation and amortization of €117 million. The year before, capital expenditure exceeded depreciation andamortization by some 9.0 percent.

Research and development expenditures by division € million

Pierburg

KS Pistons

KS Plain Bearings


Group

2004

55

32

4

6

97

2005

54

37

7

6

104

change

(1)

5

3

0

7

in %

(1.8)

15.6

75.0

0.0

7.2

Research and Development. In fiscal 2005, the Group spent €104 million on research and development,7.2 percent more than the previous year’s already high level. In addition to this comes €7 million in R&Dservices (2004: €5 million) which meet IFRS criteria for capitalization. The R&D ratio, defined as expenditurein relation to sales, rose to 5.1 percent, up from 5.0 percent the year before. At December 31, 2005, thepercentage of Group employees engaged in research and development activities remained constant at 6.2percent.

Once again, the primary objectives of the Pierburg R&D program in fiscal 2005 were improved engine perform-ance coupled with emission and weight reduction. As in the past, numerous projects involved electricaland electronic products, which, unlike conventional mechanical components, lead to reduced fuel consump-tion and lower emissions thanks to demand-controlled operation.

The Air Supply product unit successfully concluded the development of various applications relating to intakemanifolds–including three magnesium intake manifolds projects for premium engines–as well as innova-tive electrical throttle bodies and drive modules for replacing vacuum-controlled systems. Moreover, workcontinued on perfecting a new intake manifold with an integrated exhaust gas recirculation system, a space-saving design that reduces interface requirements.

€ million



Meriting special mention in the Emission Control segment was progress made in developing new exhaustgas recirculation systems. The new systems are characterized by optimized, heavily de-throttled exhaustgas valves and highly integrated EGR cooler modules. These systems, which are used both in the EGR high-pressure segment and the increasingly important EGR low-pressure segment, feature the added possibilityof very efficient exhaust gas recirculation cooling using low-temperature cooling circulation. These measuresare aimed at minimizing nitrogen oxide emissions, and are thus critical in maintaining emission limits. Inthis important segment the first Euro-5 projects have already been booked in the field of diesel enginetechnology. The division’s widely used electro-motor-driven exhaust gas recirculation technology is nowbeing employed for further Euro-5 applications in cost-optimized fashion. For exhaust flaps, the division’sR&D experts discovered a new application for controlling turbochargers in engines with multiple turbochargers(sequential turbo). A first application of the newly developed compact secondary air pump, which is charac-terized by a smaller space requirement and lower weight, was successfully launched on the market. In thesolenoid valves field, the development of new electrical recirculation air valve applications continued, andnew customers were attracted for existing products such as electro-pneumatic modulators and electricalreversing valves. In addition, preliminary studies in the field of electro-hydraulic valves began.

In the Pumps product unit, R&D activity focused on a demand-controlled electric coolant pump, also in thedomain of intercoolers, variable oil pumps, a mechanical water pump with an external bearing, as well asmodularization, especially of the function of oil and vacuum pumps.

In 2005, the Pierburg division spent €54 million on research and development, 1.8 percent less than in2004. The R&D ratio thus came to 6.0 percent of sales. At December 31, 2005, 391 employees were engagedin research and development activities.

In the KS Pistons division, the quest for increased power density and further reductions in fuel consumptionand emissions have for many years propelled the development of new engine components.

In the case of gasoline engines, this generally entails increasing the power density by means of direct fuelinjection and/or variable valve control. This poses huge demands on the pistons, which must combinedurability with low weight. The technology developed by the KS Pistons division in response to this task,LiteKS, is now found in the majority of products currently in serial development. It has been expanded toinclude groove protection features (ring carrier), now being employed in gasoline-powered engines for thefirst time. In addition, cast Otto pistons with a cooling gallery were developed for high-temperature engineapplications.

Owing to increasing power densities, pistons for new automobile turbo diesel engines can only be achievedby using coolant galleries. Along with cooled ring carriers (GalleriKS) coolant galleries with a variable cross-section (ContureKS) are used for the development of pistons with large recess dimensions. The design andcasting technology necessary for advanced variable geometries (DynamiKS) was developed in 2005. Recessedge and groove temperature reductions of approximately 20°C are possible.

In the heavy duty vehicle segment, all-steel pistons continued to be the prime focus of development. Thesepistons are suitable for cylinder pressures of up to 250 bar, which engines will need in order to meet futureemissions standards.

Last year, improved advanced materials capable of withstanding extreme thermal and mechanical stress inautomobile and heavy duty vehicle engines reached the point where they were ready for production.

23

For use in large engines, multiple- and single-part steel pistons are also being developed; the first prototypeshave already been dispatched to several customers for field testing.

In fiscal 2005, expenditure for research and development activities increased by 15.6 percent to €37 millionin the Pistons division, or 5.8 percent of sales. At December 31, 2005, a total of 230 Pistons employeesworked in R&D worldwide.

In the KS Plain Bearings division’s newly restructured R&D unit, all activities in 2005 were directed at signifi-cantly improving the division’s position as a development partner for OE customers in a sharply alteredcompetitive environment.

Advanced materials and coatings and innovative products and processes together form an importantbasis for future success, as do completely new established competences for calculating and simulating inorder to provide analytical solutions for important tribological tasks of customers.

Used as a connecting rod material, the excellent performance characteristics of a new lead-free steel-brasscomposite material were demonstrated in preliminary tests and engine trials. With their attractive cost/benefit ratio, connecting rods with sputter coatings specially optimized for this material constitute somethinginnovative in the market for sputter components. This new material and coating combination is fully capableof meeting the requirements of new and existing applications alike.

Likewise, a newly developed steel-aluminum composite material displays extremely low wear and tear coupledwith highly dynamic load-bearing capacity. During engine trials, the material proved highly effective bothin connecting rod and crankshaft applications.

Also tested in engine trials was a completely new lacquer-based coating for KS Plain Bearings. The plasticrunning surface supports optimum integration of the metallic secondary coating; it also reduces bearingfriction, particularly during an engine’s cold running phase. Consisting of various combinations of fillingmaterials in the selected plastic matrix, for KS Plain Bearings these new lacquer coatings open a marketthat extends far beyond the forms and dimensions of bearing shells, bushings and thrust bushings.

In 2005, laser-welded flange bushings constituted a completely new product program for the KS Plain Bearingsdivision. Apart from various coating materials, laser welding enables various material thicknesses to bewelded to plain bearings with axial and radial functions.

Because they can be focused so precisely, laser beams can even be used for welding steel-plastic compositematerials without compromising the plastic coating. In a particularly promising development, laser-weldedflange bushings made of a high-performance composite were successfully tested in 2005 in high-pressurediesel injection pumps.

In order to ensure the start of serial production in 2006, the KS Plain Bearings development team is now coop-erating with the production unit to define the necessary pre-materials processes and component manufac-turing processes.

Taking into account the modified cost allocation of its new R&D structure, in 2005 spending on R&D activitiesby the KS Plain Bearing division rose to €7 million, up from €4 million the previous year. This equates toan R&D ratio of 4.1 percent. At December 31, 2005, 58 Plain Bearings employees were active in research anddevelopment work worldwide.



Aside from low-pressure casting processes for the premium engine segment, development work in theKS Aluminum Technology division in fiscal 2005 expanded into pressure casting. Economical in large volumeproduction, this process has system-intrinsic drawbacks in meeting technological challenges such as closeddeck applications and high-rigidity main bearing blocks. These characteristics are especially importantin turbocharged engines.

Based on developments in casting technology and experience gained in Lokasil applications, the KS AluminumTechnology division unveiled a pressure-cast high-tech engine block at the IAA 2005 trade fair that meetspremium specifications. By using metal matrix composite (MMC) materials and cores in a pressure castingprocess, it proved possible to produce a straight-type four-cylinder engine block with high-rigidity bearingblocks and closed deck. This means that technical characteristics once confined to the premium segmentwill now be available in volume engines as well, opening up new market opportunities for the KS AluminumTechnology division.

R&D expenditure by the Aluminum Technology division came to €6 million in fiscal 2005, equivalent to 2.9percent of sales. At year’s end, the division employed 44 people in research and development.

Human resources. At December 31, 2005, the companies of the Kolbenschmidt Pierburg Group employeda global workforce of 11,699 employees, i.e. 335 more than a year earlier, a rise of 2.9 percent. The increasein headcount occurred primarily in the KS Pistons, KS Aluminum Technology and KS Plain Bearings divisions,and was the result of higher sales. In the Pierburg and Motor Service divisions the number of staff remained atthe previous year’s level.

At December 31, 2005, the Kolbenschmidt Pierburg Group had 5,917 employees in Germany, an increase of2.7 percent from a year earlier. Due to additional hiring abroad, the share of Group personnel employed inGermany edged down to 50.6 percent (2004: 50.7 percent).

Headcount

Pierburg

KS Pistons

KS Plain Bearings


Motor Service

Other

Group

of which Germany

of which abroad

12/31/2004

3,471

5,568

982

925

379

39

11,364

5,759

5,605

12/31/2005

3,483

5,779

1,015

1,007

375

40

11,699

5,917

5,782

change

absolute

12

211

33

82

(4)

1

335

158

177

in %

0.3

3.8

3.4

8.9

(1.1)

2.6

2.9

2.7

3.2

Per capita sales in fiscal 2005 came to approximately €178,000, exceeding the previous years figure ofapproximately €170,000, a gain of 4.7 percent.

25

Personnel expenses incurred by the Kolbenschmidt Pierburg Group in 2005 increased by 4.4 percent to€544 million (2004: €521 million). Wages and salaries accounted for €433 million of this amount (2004:€416 million), social security contributions for a further €75 million (2004: €72 million), while pensionexpenses absorbed €36 million (2004: €33 million).

Based on labor agreements concluded in February 2004, which were valid until February 28, 2006, wagesin Germany rose by 2.7 percent, including framework pay agreement (ERA) components. Work continued onstructuring the framework pay agreement parameters, and it will be implemented according to plan startingin 2006, taking into account the individual requirements of the divisions.

Based on the positive results obtained thus far with our profit-sharing models, in 2006 a share in the profitswill again be disbursed to rank-and-file staff of the Group’s management companies in Germany in recognitionof the attainment of earnings targets in 2005.

Necessary restructuring measures continued to be carried out successfully, enabling the Group to adaptflexibly to changing market conditions.

We continued to place even greater emphasis on training. This was by no means limited to improving workingtechniques, but also focused on strengthening communications skills and leadership abilities. The processfor evaluating the existing potential of all executives and junior staff was expanded and improved. Thecompetencies and capabilities of our people form the basis of Kolbenschmidt Pierburg’s success and arethe engine that powers our company. It is only thanks to our employees that we are able to contend success-fully with constant change in the marketplace and the steady march of technical innovation. This requiresconstant improvements in qualification and increased motivation. Our employees have once again livedup to our expectations, leading to further sustained improvements in our organization. Our success inmastering this ongoing process of improvement would have been inconceivable without continuous training,a better system for suggestions from the staff, and the systematic streamlining of technical and operationalprocesses and flows.

Measures for developing leadership potential (including among junior staff) were strengthened when theGroup-wide concept “Leading by Goals” was extended to new layers of management and all the way downto the shop floor. The attainment of goals was made dependent on success-related compensation compo-nents, promoting a stronger sense of personal involvement among executive and rank-and-file employees.

Our employees have demonstrated their active support for the process of change within the company andhave thus become a vehicle for constant improvement.

We continued to attach great importance to apprenticeship training, seeing in it a social duty and a crucialmeans of improving the competitiveness of our company. At December 31, 2005, Kolbenschmidt Pierburgemployed 349 apprentices.

The employee representatives at every one of our companies cooperated actively and constructively in puttingnecessary measures into effect. Invariably based on mutual trust, cooperation with the works councils andstaff representatives on the Supervisory Board has always been a factor of fundamental importance in thesuccess of the entire Group.

Our special thanks go to all of the employees of the Kolbenschmidt Pierburg AG companies for their greatcommitment and exceptional achievements in fiscal 2005–our success would have been impossible withoutthem.



Dependency report. Through the Berlin-based company Rheinmetall Berlin Verwaltungsgesellschaft mbH ofBerlin, Rheinmetall Verwaltungsgesellschaft mbH of Ratingen, and KP Beteiligungs GmbH & Co. KG of Düssel-dorf, Rheinmetall AG of Düsseldorf owns the majority of Kolbenschmidt Pierburg AG’s stock. No intercompanyagreements exist between Kolbenschmidt Pierburg AG and Rheinmetall Berlin Verwaltungsgesellschaft, KPBeteiligungs GmbH & Co. KG, Rheinmetall Verwaltungsgesellschaft mbH or Rheinmetall AG.

Pursuant to Art. 312 AktG, a report concerning affiliations was prepared by the Executive Board and then exam-ined by PricewaterhouseCoopers Aktiengesellschaft, Wirtschaftsprüfungsgesellschaft, the Düsseldorf-based statutory auditors who issued their unqualified opinion thereon. This dependency report of theExecutive Board closes with the following statement:

“Under the circumstances which were known to us at the time legal transactions were entered into andactions taken or omitted, our company has in all cases received an equitable consideration. No disadvantagesfor our company have been involved in connection with such acts or omissions.”

Risk management. The instruments for early recognition, control and monitoring of risks are defined in RiskManagement Regulations applicable throughout the Group. Thanks to clear organizational and managementstructures, unambiguous procedural instructions and guidelines, as well as efficient information and controlsystems, a well-structured system exists enabling the timely recognition of risks and the adoption of appro-priate measures to meet them.

The management of risks is based on an annual update of the existing risk environment, in which potentialrisks are registered and categorized with respect to their likelihood and the potential loss volume. Embeddedin the annual strategic and operative plans and accompanied by monthly controlling reviews, risk reports andmeetings of the Risk Committee, the risk management system ensures that all potential risks are identifiedin good time and their implications assessed. As a result, necessary provisions or remedial action can beinitiated early on at the individual companies, divisions, or at Group level. Moreover, whenever a definedreporting limit is exceeded, the Supervisory Board and the parent company are alerted.

The effectiveness of our risk management system is also subject to regular audits by the Group’s parentcompany, Rheinmetall AG, as well as during the annual audit by the statutory auditors (elected by the GeneralMeeting).

Economic and sector risks. Kolbenschmidt Pierburg AG and its subsidiaries develop and manufacture compo-nents, modules and systems for the international automotive industry. Hence, the future growth of the Groupand its subsidiaries largely depends on global automobile sales.

The impact of individual markets and customers on Kolbenschmidt Pierburg’s business performance is miti-gated by the de facto internationalization of the Group. Furthermore, the Group’s diversified customer basehelps to offset fluctuations in production numbers among individual carmakers.

Pressure from customers for further price reductions remains undiminished. One way of limiting risk is tocreate additional price/cost latitude, achieved through product and process innovations as well as continuousimprovement processes and the enforcement of strict cost management.

27

Operational risks. The organic growth envisaged in the sales plans of Kolbenschmidt Pierburg calls for awhole host of complex, technologically advanced new product start-ups which, because of their number,extent and in some cases the limited availability of skilled labor, inherently involves risks. From the draw-ing board and the invitation to bid through to initial and full-scale production, every phase of a new prod-uct’s emergence is subject to comprehensive project and quality management, ensuring that it translatesinto profitable growth. In the 2005 annual accounts, the accrual for impending losses on individual prod-uct start-ups adequately provides for any losses.

Various Kolbenschmidt Pierburg companies are vulnerable to fluctuating raw materials prices. Thanks tocontractual provisions, increased prices for aluminum–the single most important raw material for theGroup–can generally be passed on to customers. Short- and medium-term changes in the price of otherimportant raw materials, especially steel, copper, nickel, and tin, are covered in purchasing agreementsor, if possible, through forward transactions. On the other hand, longer-term prices increases pose poten-tial risks.

Financing risks. Owing to the international nature of Kolbenschmidt Pierburg’s operations, certain currencyand interest rate risks may arise. These are profiled centrally by the Kolbenschmidt Pierburg AG Treasuryand–whenever feasible and economically warranted–hedged by means of currency futures and interestrate caps in accordance with the guidelines laid down by the Executive Board. For details see Note (37),Hedging Policy and Financial Derivatives.

Carmakers will continue to reduce their vertical integration, shifting more and more value added anddevelopment operations to their parts suppliers. For the latter, this entails new challenges with respect toR&D, production and quality standards; it also means greater pressure on the financial resources neededto fund input and additions to tangible assets. Thus, during the budgeting and approval stages, the allo-cation of investment resources in the Kolbenschmidt Pierburg Group’s divisions is closely scrutinized withregard to economic efficiency in order to relieve cash flows.

Legal risks. Sufficient insurance coverage has been taken out to cover adequately risks from loss or damageby natural forces and the resulting interruption of business, as well as warranty, product liability, and recallrisks. The existing insurance coverage is regularly reviewed for adequacy and, where necessary, modified.At the same time, ongoing projects for process reliability as well as extensive quality assurance programsaim at preventing such risks from occurring. In the 2005 balance sheet, adequate accruals provide for thoserisks, which, despite the aforementioned measures, are covered only partially or not at all (deductible loss).

Since 1998, a court of arbitration has been examining the appropriateness of the conversion ratio calculatedwith regard to the merger of Kolbenschmidt Pierburg (Rheinmetall Beteiligungen). The expert appointed bythe Heilbronn District Court has now submitted his final report. He arrives at significantly deviating estimatesof the worth of the two companies, which merged in January 1998; the risks of additional cash paymentsare covered by the capital accruals formed within the framework of the merger. Kolbenschmidt Pierburg AGarranged for a review of the court-appointed expert’s findings. Based on the results of this review, Kolben-schmidt Pierburg AG sees no grounds for distancing itself from the originally calculated value comparisons.At the time of the merger of the two companies, these value comparisons were calculated by two independentaccounting companies and confirmed by a court-appointed merger and acquisitions expert. KolbenschmidtPierburg assumes that the value estimates, which were documented by three different experts, will be vindi-cated in the final ruling. So as not to prejudice the outcome of this process, we will refrain from commentingfurther on this matter.



From today’s vantage point, no fundamental economic or legal risks or other risks posing a threat to thecontinued existence of Kolbenschmidt Pierburg or its divisions are apparent, nor are any risks posing a sus-tained, significant threat to the Group's net assets, financial position or operating results.

Opportunities. The various internal and external factors influencing the company harbor not only risks butalso opportunities for growth. Here, the positive trend in global automobile sales warrants special mention.In this context, aside from the growth markets of Asia–squarely in the Kolbenschmidt Pierburg’s sights asit continues to internationalize its operations–the Group’s large-volume core markets in western Europeand the United States play a decisive role.

Other opportunities arising from the Group’s technological know-how relate to the current situation in theUS, where higher fuel prices mean that diesel engines are being discussed as an alternative to conventionalgasoline-powered engines. But in Asia too there is considerable potential for diesel technologies. More-over, innovative products for hybrid engines are already under development.

In order to take greater advantages of new opportunities in the growth markets of Asia, the KolbenschmidtPierburg Group has established a customer service center in Japan to help the divisions acquire new projectsfrom major Japanese manufacturers. Moreover, further opportunities for cooperation in the Asia-Pacificregion are constantly being examined.

The recent takeover of the pistons unit of the Mexican manufacturer Pistones Moresa in Celaya, Mexico, offersadditional scope for growth. Integrating this newly acquired production capacity into the US productionbase will open up new possibilities for optimizing the Group’s American plant structures.

Intrinsically, having a significant international presence and being close to customers offers additionalpotential for growth. For example, we see opportunities for additional orders from fast-growing Asian manufac-turers, which are still underrepresented in our customer base; moreover, thanks to the beneficial effect oncosts, this would also foster growth in our core markets. Augmenting potential in the production processby means of general process improvements and a further increase in quality, coupled with a reduction inreject rates, will support this trend. Other business opportunities arise from stronger outsourcing potentialin the pistons sector at various automobile manufacturers.

29

Significant subsequent events. Under an asset deal, the KS Pistons division took over the complete pistonmanufacturing unit of Pistones Moresa in Celaya, Mexico, from the DESC Automotive Group of Mexico City,effective January 20, 2006. For the KS Pistons division, this represents an important increase in capacityand an expansion of its global presence as well as constituting another significant step in consolidatingits position in the important North American market.

Outlook. In light of the generally optimistic economic data, automobile manufacturers are also looking forwardto the coming years with confidence. Global output of automobiles and light commercial vehicles is expectedto grow by roughly four percent in 2006 to around 64 million vehicles. Next year production growth is supposedto be even stronger. In the Triad markets–NAFTA, Western Europe and Japan–the forecasters predict rathermodest growth of one to two percent per year. By contrast, the forecast for Asia (without Japan), as well asfor Eastern and eastern Central Europe, is much brighter, with a robust upswing in production coming in thewake of an already positive trend.

The Kolbenschmidt Pierburg Group is benefiting from key trends in the automotive industry. Its productportfolio, which is strongly oriented to fuel efficiency and emission reduction, diesel engines and the useof lighter materials, offers the prospect of continuous organic growth in the future.

Based on current market predictions and assuming stable conditions for our customers and suppliers,especially with regard to raw materials and energy, Kolbenschmidt Pierburg expects sales to continue grow-ing in 2006 and 2007. Among other things, driving this growth will be Pierburg’s operations in the US market,which are scheduled to go into high gear in 2007, as well as predicted increases in the KS Piston division’smarket share in Asia. Furthermore, the start of series production of new engine blocks during the currentfiscal year in the Aluminum Technology division, and innovative new products in the Plain Bearings division,constitute further opportunities for growth in the Group. Finally, moderate growth of sales revenue in theaftermarket segment (covered by our Motor Service division) is expected for 2006 and 2007.

Kolbenschmidt Pierburg’s operating performance will remain high in fiscal 2006, though earnings are expectedto edge downwards as the result of continued expansion abroad. The Group’s policy of internationalizationaims to balance capacities within and between the individual production regions along market, competition,and cost standpoints. These measures lay the groundwork that will enable Kolbenschmidt Pierburg to meetthe higher earnings targets of the Rheinmetall Group. We expect earnings to rise again in 2007, driven byimproved cost structures and higher sales.

Just as in fiscal 2005, capital expenditure of the Kolbenschmidt Pierburg Group in 2006 will be above theaverage for recent years. This relates first and foremost to our Neckarsulm site, where extensive future-orientedinfrastructure measures were already initiated in fiscal 2005, such as a new customer center and theexpansion of processing capacity for engine blocks. Once these measures are completed, capital expenditurevolume will return to the average level of recent years. Despite the temporary increase in capital expenditurerequired in 2006 and 2007, it will be entirely financed from gross cash flow, just as in previous years.

The Kolbenschmidt Pierburg Group’s normally solid financial situation will continue to stabilize during theforecast period. In this context, it is currently assumed that no major acquisitions will be undertaken.

Future prospects


Future prospects

This Management Report contains statements concerning the future development of the KolbenschmidtPierburg Group which are based on the assumptions and estimates of its senior executives. Should theassumptions based on these forecasts prove to be inaccurate, the actual outcome may deviate from currentprojections. The factors of uncertainty include, among others, changes in the underlying political, economicand business environment, exchange rate and interest rate fluctuations, changes in raw materials and energyprices, the introduction of competing products, poor acceptance of new Kolbenschmidt Pierburg products,as well as changes in business strategy.

Düsseldorf, February 27, 2006

Kolbenschmidt Pierburg AGThe Executive Board


31


As the lead company of the Kolbenschmidt Pierburg Group, Kolbenschmidt Pierburg AG is in charge of variousGroup-level management and service activities relating to financial affairs, accounting, controlling, legalsupport, human resources, marketing and corporate communications. As opposed to the Group’s consol-idated accounts, the basis for a calculating disbursement continues to be the German Commercial Code,or HGB.

The corporation’s performance is determined by income from trade investments, income from services andcontributions, personnel and operating expenses as well as net interest income from financing operationalaffiliates.

Income from trade investments in fiscal 2005 came to €90 million, a rise of €11 million (or 14 percent) fromthe previous year. KS KOLBENSCHMIDT GmbH made a distinctly improved contribution to earnings comparedto 2004. Though still high, KS Gleitlager GmbH’s contribution was slightly lower than last year. PierburgGmbH and MSI Motor Service International GmbH made smaller contributions compared to the previousyear, though both continued to generate substantial earnings. Because of the need to set-off the existingaccumulated balance sheet deficit, KS Aluminium-Technologie AG–despite a further improvement in earn-ings in fiscal 2005–was still unable to make a contribution to profits. At €10 million, income from thetransfer of trade tax to affiliates (carried under income from trade investments) exceeded the previousyear’s figure by €4 million.

Net interest income, including other financial expenses and earnings, totaled €2 million in fiscal 2005, upfrom (€3 million) a year earlier. The accelerated redemption of high-interest bank loans in 2004, coupled in2005 with additional structural changes regarding money due on demand (driven by growth-related Group-internal financing of subsidiaries), led to a considerable improvement compared to the prior year.

Other operating earnings rose compared to 2004 by €4 million to €41 million. Apart from higher on-chargesrelating to transfer and service agreements, increased currency gains explain this positive trend. Personnelexpenses came to €11 million, down from €12 million in 2004. The €1 million-decline relates to extraor-dinary factors the year before. The other components making up personnel expenses essentially remainedunchanged. Other operating expenses rose by €4 million to €30 million. The increase is due first of all tothe release of, or allocation to, accruals as well as advertising and trade fair expenses. The latter was influencedby the International Motor Show (IAA) in Frankfurt, which takes place every two years.

In fiscal 2005, earnings before income tax reached €92 million, exceeding the previous year’s figure by€17 million. Net income for the year grew by €5 million to €64 million. After the transfer of €28 million toother revenue reserves by the Executive Board, net income for the year amounts to €36 million, which willbe proposed to the General Meeting for disbursement. This equates to a dividend of €1.30 (2004: €0.70)per Kolbenschmidt Pierburg share.

At December 31, 2005, Kolbenschmidt Pierburg AG had 40 employees, slightly up on the previous year’s figureof 39. On average, the company employed 39 persons in 2005 as opposed to an average of 38 in 2004.

32 Consolidated financial statements 2005

33

Consolidated financial statements for 2005of Kolbenschmidt Pierburg AG

Assets € million

Intangible assets

Tangible assets

Investments valued at equity

Non-current financial assets

Other non-current assets

Deferred taxes

Non-current assets

Inventories

./. Prepayments received

Trade receivables

Current financial assets

Other current receivables and sundry assets

Income tax receivables

Cash and cash equivalents

Current assets

Total assets

12/31/2005

79

634

40

1

1

47

802

266

(21)

245

231

1

24

1

49

551

1,353

Note

(6)/(7)

(6)/(8)

(9)

(10)

(13)

(11/21)

(12)

(12)

(13)

(10)

(13)

(14)

(15)

12/31/2004

82

572

30

2

1

36

723

239

(13)

226

180

5

22

1

68

502

1,225

Kolbenschmidt Pierburg GroupConsolidated balance sheet as of December 31, 2005

Equity & liabilities € million

Capital stock

Additional paid-in capital

Other reserves

Group net income attributable to Kolbenschmidt Pierburg AG stockholders

Kolbenschmidt Pierburg AG stockholder’s equity

Minority interests

Total equity

Pension accruals

Other non-current accruals

Non-current financial liabilities

Other non-current liabilities

Deferred taxes

Non-current liabilities and accruals

Current accruals

Current financial liabilities

Trade payables

Other current liabilities

Income tax liabilities

Current liabilities and accruals

Total equity & liabilities

12/31/2005

72

174

182

84

512

4

516

247

42

53

3

5

350

102

12

204

126

43

487

1,353

Note

(16)

(17)

(18)

(19)

(20)

(21)

(18)

(19)

(20)

(20)

12/31/2004

72

174

100

78

424

4

428

241

39

53

4

5

342

98

12

190

125

30

455

1,225


Consolidated income statement for fiscal 2005

35

€ million

Net sales

Net inventory changes, other work and material capitalized

Total operating performance

Other operating income

Cost of materials

Personnel expenses

Amortization/depreciation

Other operating expenses

Operating result

Net interest expense

of which interest expense

Net investment income and other financial results

of which profit shares of investees stated at equity

Net financial result

Earnings before taxes (EBT)

Income taxes

Group net income

Thereof attributable to:

Minoritiy interests

Kolbenschmidt Pierburg AG stockholders

Earnings per share (EpS) (diluted=undiluted)

EBIT 1)

EBITDA 2)

2005

2,050

24

2,074

61

(1,081)

(544)

(117)

(252)

141

(19)

(28)

5

3

(14)

127

(41)

86

2

84

3.01 EUR

146

263

Note

(22)

(23)

(24)

(25)

(6)

(26)

(27)

(28)

(29)

(30)

(31)

2004

1,941

26

1,967

52

(1,010)

(521)

(122)

(243)

123

(28)

(35)

16

15

(12)

111

(32)

79

1

78

2.79 EUR

139

261

EBT plus net interest expenseEBT plus net interest expense and amortization/depreciation/write-down

1)

2)

Kolbenschmidt Pierburg Group Consolidated statement of cash flows for fiscal 2005


€ million

Cash and cash equivalents at January 1 (BoP)

Group net income

Amortization/depreciation/write-down of fixed assets

Change in pension accruals

Cash Flow

Net result from fixed-asset disposal

Change in other accruals

Change in inventories

Change in receivables, liabilities (excluding financial liabilities) and prepaid and deferred charges

Other noncash expenses and income

Net cash provided by operating activities

Cash outflow for additions to tangible and intangible assets

Cash inflow from the disposal of tangible and intangible assets

Cash outflow in divisions

Cash outflow for additions to financial assets

Cash inflow from the disposal of financial assets

Net cash used in investing activities

Dividend payments

Financial debts raised

Financial debts redeemed

Net cash used in financing activities

Cash-based changes in cash and cash equivalents

Currency-related changes in cash and cash equivalents

Total net change in cash and cash equivalents

Cash and cash equivalents at December 31 (EoP)

The cash inflow from current operations contains

interest income

interest expenditure

tax payments

2004

43

79

122

(13)

188

(10)

9

(20)

53

2

222

(127)

10

(9)

0

24

(102)

(14)

2

(82)

(94)

26

(1)

25

68

2

15

29

2005

68

86

117

3

206

(7)

4

(9)

(32)

(12)

150

(155)

16

0

(10)

2

(147)

(21)

1

(8)

(28)

(25)

6

(19)

49

3

8

34

The consolidated statement of cash flows is discussed in Note 32.

Kolbenschmidt Pierburg Group Statement of changes in equity

37

€ million

At January 1, 2004

Dividend payments

Exchange differences

Other comprehensive income

Group net income

At January 1, 2005

Dividend payments


Other comprehensive income

Group net income

At December 31, 2005

Capitalstock

72

72

72

Additionalpaid-in capital

174

174

174

Retainedearnings

117

(14)

2

43

148

(20)

80

208

Differencesfrom

currencyconversion

(46)

(3)

(49)

23

(26)

Reservesfrom

hedgingtrans-

actions

1

1

(1)

0

Otherreserves

72

(14)

(1)

43

0

100

(20)

23

79

0

182

Group netincome

attributableto Kolben-

schmidtPierburg AG

stock-holders

42

(42)

78

78

(78)

84

84

Stock-holders’

equityof Kolben-

schmidtPierburg

Group

360

(14)

(1)

1

78

424

(20)

23

1

84

512

Minorityinterests

3

1

(1)

1

4

(1)

1

(2)

2

4

Totalequity

363

(14)

0

0

79

428

(21)

24

(1)

86

516

Equity is explained in Note 16.

NotesSegment report


Segment report by divisions (Primary Segments) € million

Segment assets

of which Goodwill

of which book values at equity

Capital expenditures

Segment liabilities

Net external sales

Intersegment transfers

Total segment sales

Amortization/depreciation/write-down

of which special write-down

Segment EBIT

of which P/L at equity

2004

410

10

16

54

368

882

7

889

(52)

(2)

67

13

2005

459

10

16

68

379

895

8

903

(46)

(1)

68

2

Air supply, emission control & pumps

Pierburg

2004

412

27

14

47

162

567

15

582

(43)

0

37

2

2005

470

26

22

58

177

626

12

638

(46)

0

39

1

Large- and small-bore pistons

KS Pistons

2004

92

4

0

12

48

149

11

160

(10)

0

17

0

2005

105

4

2

17

50

160

11

171

(10)

0

18

0

Plain bearings and continuous castings

KS Plain BearingsDivisions

Segment report by regions (Secondary Segments) € million

Net external sales by customer location

Segment assets

Capital expenditures

2004

667

640

72

2005

642

682

89

Germany

2004

843

251

38

2005

918

285

36

Other Europe

The segment reports are discussed in Note 33.

39

2004

118

1

0

13

81

182

1

183

(13)

0

5

0

2005

133

1

0

16

82

209

1

210

(12)

0

9

0

AluminumEngine blocks

KS AluminumTechnology

2004

94

5

0

7

28

160

1

161

(3)

0

13

0

2005

93

5

0

1

26

159

1

160

(3)

0

10

0

Motor Service

Aftermarket

2004

1,126

47

30

133

687

1,940

35

1,975

(121)

(2)

139

15

2005

1,260

46

40

160

714

2,049

33

2,082

(117)

(1)

144

3

2004

(6)

0

0

0

10

1

(35)

(34)

(1)

0

0

0

2005

(4)

0

0

2

10

1

(33)

(32)

0

0

2

0

Other/Consolidation/ Holding

2004

1,120

47

30

133

697

1,941

0

1,941

(122)

(2)

139

15

2005

1,256

46

40

162

724

2.050

0

2,050

(117)

(1)

146

3

Group

2004

158

73

10

2005

196

100

14

Other regions

2004

1,940

1,126

133

2005

2,049

1,260

160

Total

2004

272

162

13

2005

293

193

21

North America

Total


NotesAccounting principles

(1) General. The consolidated financial statements of Kolbenschmidt Pierburg AG and its subsidiaries forthe fiscal year 2005 have been prepared in accordance with the International Financial Reporting andInterpretation Standards (IFRS) of the International Accounting Standards Board (IASB) as they are to beapplied in the EU. In presenting these consolidated financial statements, Kolbenschmidt Pierburg AGmeets its obligation as a publicly traded company to publish IFRS consolidated accounts in accordancewith Art. 315 a (1) of the German Commercial Code (“HGB”).

The revised IAS 1 results in a change in the balance sheet structure. The consolidated financial statementsare now structured according to maturities, while the previous year’s figures have been adapted to the newbalance sheet structure. Assets and liabilities are basically considered to be current items if they have amaturity of less than one year. Pension accruals and deferred taxes are generally considered as non-currentitems. The other changes in the standards resulted in no material changes from the prior year’s presentation.

In applying the revised standards, the interim regulations have been adhered to.

Use of the published standard IFRS6 “Exploration and Evaluation of Mineral Resources”, the amendmentsto IAS 19 “Actuarial Gains and Losses”, and the IFRIC-published interpretations IFRIC 3 “Emission Rights”,IFRIC 4 “Determining whether an Arrangement contains a Lease” and IFRIC 5 “Rights to Interests arisingfrom Decommissioning, Restoration and Environmental Funds” became obligatory on January 1, 2006.Compliance with IFRS 7 “Financial Instruments: Disclosures” becomes mandatory of January 1, 2007. Appli-cation of these standards and interpretations will have no material impact on Kolbenschmidt Pierburg’sconsolidated accounts.

During the year under review, the Group elected to apply in advance two amendments to IAS39: “Use ofthe Fair Value Option” and “Financial Instruments: Recognition and Measurement–Cash Flow Hedge Account-ing of Forecast Intragroup Transactions”. Advance application of these amendments had no material impacton Kolbenschmidt Pierburg’s consolidated accounts.

The consolidated income statement was prepared in cost categories-oriented format.

The fiscal year of Kolbenschmidt Pierburg AG and its subsidiaries equals the calendar year. As an officiallylisted company with its corporate seat in Düsseldorf, Kolbenschmidt Pierburg AG is obligated pursuant to§ 291, Art. 3, No. 1 HGB to prepare statutory consolidated financial statements. Kolbenschmidt Pierburg AG’sconsolidated accounts will be included in the group accounts of Düsseldorf-based Rheinmetall AG as thehighest tier of consolidation. Rheinmetall AG’s consolidated financial statements will be deposited withthe Commercial Register of the Local Court of Düsseldorf under number HRB39401.

These consolidated accounts of Kolbenschmidt Pierburg AG were approved for publication by the ExecutiveBoard on February 27, 2006.

(2) Group of consolidated companies. Besides Kolbenschmidt Pierburg AG, the consolidated financialstatements include all German and foreign subsidiaries in which either Kolbenschmidt Pierburg AG holdsthe majority of voting rights (whether directly or indirectly) or where the Group is otherwise able to controlthe financial and business policies. Companies are initially consolidated or deconsolidated when controlof the net assets and business operations is transferred. Companies in which an interest of between 20 per-cent and 49 percent and over which significant influence is exercised (associated companies) are reportedat equity. Also carried at equity are companies in which a 50 percent stake is held and a joint managementstructure exists (joint ventures).

41

During the year under review, KS International Investment of Southfield, Michigan, USA, founded two whollyowned subsidiaries. The two new companies are Kolbenschmidt de Mexico LLC., located in Celaya, Mexico,and KSUS International LLC. in Marinette, USA.

Disposals from the group of consolidated companies relate to the liquidated company KS Winston Ltd. ofPurfleet, UK, as well as to the sale of the Group’s stake in KS Motor Servis CZ s.r.o. of Trmice, Czech Republic.The impact of these disposals on the consolidated accounts and income statement is negligible, meaningthat additional details have been dispensed with.

Additions to investments stated at equity relate to the following circumstances:

– Effective November 4, 2005, the joint venture ABM Advanced Bearing Materials LLC. was founded in theUnited States. The Group paid for its stake in the new company through contributions in kind amoun-ting to €2 million.

– Kolbenschmidt Pierburg AG’s increased stake in Shriram Pistons & Rings Ltd. of India. From December 27,2005 onwards, this investee had to be stated at equity.

The main subsidiaries and the main investees stated at equity which are included in the consolidatedfinancial statements of Kolbenschmidt Pierburg AG are listed on page 66. A comprehensive listing of theshareholdings of Kolbenschmidt Pierburg AG will be deposited with the Commercial Register of the LocalCourt of Düsseldorf (HRB34883).

(3) Consolidation principles. The financial statements of consolidated German and foreign companies areprepared in accordance with group-wide uniform accounting and valuation methods. In the case of investeesstated at equity, valuation of the Group’s holdings adheres to the same principles.

Subsidiaries included in the consolidated accounts for the first time have been consolidated according to thepurchase method, using the entirely full revaluation method (IFRS3). Here, the acquisition costs are of theassets acquired compared with the asset values, debts and contingency debts of the subsidiary (stated atfair value) at the time of acquisition. The acquisition costs are the fair values of the purchased assets, thedebt taken over and the equity instruments issued by the purchaser, as well as related costs. The differencebetween the two will be shown as goodwill under intangibles. A residual difference which would be carried asa badwill is immediately transferred to the consolidated income statement under other operating income.For acquisitions made prior to January 1, 2004, the previous form of consolidation will be maintained,i.e. the book value method.

Group of consolidated companies

Fully consolidated companies

of which in Germany

of which abroad

Investees stated at equity

of which abroad

Disposals

2

--

2

--

--

12/31/2005

41

18

23

4

4

01/01/2005

41

18

23

2

2

Additions

2

--

2

2

2


The value of goodwill is regularly examined in an annual impairment test, unless evidence of a loss of valueemerges in the intervening period. In the process, the book value is compared with the recoverable amount.The recoverable amount is calculated through the value in use. If this is worth less than the book value, acheck is made to determine if the stated fair value (minus the selling expenses) will not result in a higheramount. The value in use of the cash-generating units is calculated according to the discounted cashflow (DCF) method. Here, based on company planning, a detailed planning period of three years is used. Cor-porate planning in the Kolbenschmidt Pierburg Group is done from the bottom up based on past experienceand taking into account current forecasts. Core planning assumptions are anchored in sales planning derivedfrom sector forecasts for global automobile sales, engine program plans of automakers, firm customercommitments regarding individual projects and company-specific adjustments which also contain plannedproduct innovations and cost savings.

Unchanged from the previous year, the discount rate is based on the current weighted average cost ofcapital (WACC), 9.0 percent. For the period subsequent to the last planning year, a growth allowance is notapplied as a corrective for the risk-specific discount rate before tax. During the period under review, thegoodwills of six cash-generating units were examined with regard to their value retention. The cash-generatingunits correspond to the primary segments. A decline in the value of goodwill disclosed by the impairment testis immediately transferred to the consolidated income statement under amortization.

Shares of nongroup shareholders are disclosed as minority interests in the consolidatable capital of sub-sidiaries, including the profit or loss proratable to such minority interests. For acquisitions the pro rata hiddenreserves and burdens and the accompanying share of earnings are shown in minority interests.

Expenses and income as well as claims, liabilities and contingencies between consolidated companiesare offset against each other. The intercompany supply of products and services is conducted on the basisof market prices as well as intercompany transfer prices, which regularly correspond to market prices. Unlessthey are significant, intermediate results are eliminated. Accruals for deferred taxes are accrued based onthe temporary, consolidation-induced differences in debt consolidation, the elimination of expenses andincome, and the elimination of intermediate results.

Associated companies and joint ventures are carried at equity. Taking as point of departure the costs ofacquisition at the time of purchase of these interests, the respective book value of the trade investmentincreases or decreases with changes in the equity of the associated companies or joint ventures, to the extentthat these relate to the share in these companies owned by the Kolbenschmidt Pierburg Group.

Goodwill for investments calculated according to the equity method is calculated in accordance with theprinciples applying to full consolidation contained in IFRS3; activated goodwill is carried under investmentsand is subject to an annual impairment test.

(4) Currency translation. The consolidated financial statements are presented in euros (€), current- andprior-year amounts being indicated in million; the euro is the functional currency. The functional currencyconcept has been adopted to translate the annual financial statements of non-German group companiesinto euros. The functional currency is the currency of the primary economic environment in which the companyoperates. Therefore, assets and liabilities are translated at the mean current rates and the income statements


43

(5) Accounting and valuation methods.

Historical and production costs. Intangible and tangible assets and inventories are valued at historical orproduction costs. Included in the historical costs are the price of purchase as well as all other costs directlyassociated with the purchase or production. The costs of internally produced tangible assets, which theGroup is likely to benefit from in the future and which can reliably be evaluated, include costs directly relatedto manufacturing and an appropriate share of factory overheads. The latter contain inter alia the materialand manufacturing overhead costs including production-related depreciation and social security costs.Calculation is based on normal employment. Financing costs are not activated as part of historical or pro-duction costs.

Subsidies and grants. Public-sector subsidies and customer grants, whose characteristics cause them tofall into the category of investment subsidies, are shown separately from the respective investments andcarried as assets. Non-investment related subsidies and grants for expenses are stated as deferred liabilityitems which are realized at the time of expenditure. If the interest effect of discounting is significant, long-term deferred liability items are stated at their discounted settlement amount on the balance sheet date.

Impairment. If certain factors suggest that impairment of a tangible or intangible asset is imminent, andthe recoverable amount is below depreciated cost, the asset is written down. For the impairment test, assetvalues are summarized at the lowest level for which cash flows can be separately identified. Wherever thereason for write-down has ceased to exist, the charge is reversed and the asset written up accordingly. Themethod for determining the value retention of goodwill is described under (3) Principles of Consolidation.

Intangible assets. Purchased intangible assets are capitalized at acquisition or production cost. R&Dcosts are generally expensed. Development costs, however, are capitalized and amortized on a straight-linebasis if the IAS38 capitalization criteria are met. A differentiation is drawn between intangible assets withan unlimited period of utilization and those whose period of use is time-limited. Intangible assets with a time-limited period of utilization are depreciated according to the straight-line method from the time utilizationbegins throughout the duration of its economically useful life. Intangible assets with unlimited periods ofutilization are those having no foreseeable limitations on their utilization. There is no planned amortizationof these assets. This applies exclusively to goodwill.

at the annual average rates. The resulting translation differences, as well as those from translating prior-yearcarryovers are recognized in, and only in, equity. Goodwill created from the capital consolidation of newlyacquired non-German companies is carried in the functional currency of the company acquired and trans-lated at the current spot rate pertaining on the balance sheet date. For acquisitions made prior to December31, 2003, goodwill is carried at historical costs minus accumulated amortization. In the local-currency finan-cial statements of consolidated companies, currency receivables and payables as well as cash and cashequivalents are all translated at the current spot rate. Currency translation differences are duly recognizedin the net financial result.

Due to the stable economic situation in Turkey, where the average inflation rate over the past three yearshas been less than 100%, starting this year accounts will no longer be prepared in accordance with IAS29“Financial Reporting in Hyperinflationary Economies”.


Leases. Capital leases of leased tangible assets are either activated at their historical cost at current mar-ket value or the lower of the net present value of the minimum leasing payments, which are depreciated on alinear basis over the expected useful life or over the shorter lifetime of the contract duration (IAS17). Everyleasing payment is split up into an interest and a repayment part, so that the leasing liability is continu-ously interest bearing. Leases in which most of the risks and opportunities arising from the ownership ofthe leased item remain with the lessor are classified as operating leases. The installment payments arecarried as costs for the duration of the lease.

Financial assets. Shares in non-consolidated associated companies and in affiliates not stated at equity,as well as other long-term securities, invariably belong to the category “available for sale” and are carriedat their fair values. If their fair value cannot be reliably determined, valuation is at historical cost. Changes infair value are accounted for in the reserve from hedging transactions. However, if there is substantial andsustained evidence of an impairment, the changes in the fair value are recognized in net income. Upondisposal, such gains or losses are duly recognized in the income statement.

Initial valuation occurs on the day of settlement.

In accordance with IAS39, loans are carried at historical cost, amortized using the effective interest method.

Receivables and sundry assets. Receivables and sundry assets are capitalized at cost. Adequate allowancesprovide for bad debts and doubtful accounts. Receivables which are sold under an ABS program are bookedat their nominal value from accounts receivable, since all risks and opportunities connected with the propertywere transferred.

Inventories and payments received. Inventories are carried at acquisition cost or production cost. Risksinherent in inventories due to reduced utility are adequately allowed for. If the net realizable value (NRV)of any inventories at balance sheet date is below their carrying value, such inventories are written down

Useful life

Buildings

Other structures

Production plant and machinery

Other plant, factory and office equipment

Years

20–77

8–20

3–20

2–23


Useful life

Concessions, franchises, industrial property rights

Development costs

Goodwill

Years

2–15

5

unlimited

Tangible assets. Tangible assets are carried at historical costs less any write-down. Tangible assets aredepreciated on a straight-line basis over their estimated useful lives unless in exceptional cases anothermethod better reflects the pattern of use.

45

to NRV. These write-downs are carried as an increase in the cost of materials (raw materials and supplies)or as a decrease in inventories of finished products and work in process (WIP). If the NRV of inventoriespreviously written down has risen, the ensuing write-up is offset against cost of materials (raw materials andsupplies) or shown as an increase in inventories of finished products and work in process (WIP).

Down payments for orders in situations where manufacturing costs have already arisen in connection witha given contract, are capitalized and carried separately from inventories. All other payments are stated asliabilities.

Deferred taxes. Under the terms of IAS 12, deferred taxes are duly recognized on temporary differencesbetween the values of assets and liabilities in the consolidated balance sheet and those in the individualcompanies’ tax accounts. Deferred tax assets also include tax reduction claims from the expected futureutilization of tax loss carryovers, always provided that their realization is reasonably certain. If the recenthistory of a company shows a series of losses, deferred tax assets from unutilized tax losses or credits areonly recognized to the extent that the company reports sufficient taxable temporary differences or that conclu-sive substantive evidence exists which suggests with reasonable assurance that sufficient taxable incomewill be earned by the company to utilize the hitherto unused tax losses or credits. Deferred taxes are deter-mined by applying the local tax rates current or announced in each country at balance sheet date.

The calculated rate of deferred taxation in Germany remained unchanged at 40 percent (including the corpo-ration tax, solidarity surtax and municipal trade tax on income). Deferred taxation rates outside of Germanyranged between 24 and 40 percent (2004: 26 to 40 percent). In the Czech Republic a new tax rate came intoforce.

Deferred tax netting is based on the rules of IAS12.

Accruals. Accruals for pensions and similar obligations are measured according to the internationallyaccepted projected unit credit (PUC) method, except for performance-oriented plan. In calculating the scopeof the Group’s obligations, a number of factors are taken into account, including life expectancy, expectedfuture pay and pension trends, the variation in retiree assumption rates, interest rate trends, but also furtheractuarial and other parameters. Actuarial gains and losses outside a 10 percent corridor of the DBO are distrib-uted over the average residual service years of employees. The fair market value of any existing plan or pensionfund assets is deducted from pension accruals. Service cost is treated as personnel expense while the interestportion of pension provisions in the fiscal year is shown within the net financial result. Contributions to definedcontribution plans (DCPs), under which the company incurs no obligation other than the payment of contribu-tions to earmarked pension funds or appropriated plans, are expensed in the year of their incurrence.

The remaining accruals according to IAS37 provide at balance sheet date for all identifiable legal and construc-tive commitments and obligations to third parties if based on past transactions or events and if theiramount, due date or maturity is uncertain. Accruals are measured at the best estimate of the settlementamount. Noncurrent accruals are shown, if the effect of discounting is significant, at the settlement amountdiscounted as of balance sheet date. The settlement amount also contains the cost increases to be takeninto account.

Liabilities. Initial valuation is based on stated current value. Pursuant to IAS 39, liabilities are stated atamortized cost (using the effective interest method), which as a rule equals their repayment amounts. Liabili-ties under capital leases are recognized at the present value of future rents.


Contingent liabilities. Contingent liabilities are potential or existing liabilities whose existence must firstbe confirmed by the subsequent occurrence of one or more future events, and which are linked to pastevents or to cases where a fund outflow is unlikely.

Contingent liabilities are stated with their probable realization amounts.

Income and expenses. Net sales and other operating income are recognized upon performance of the contractfor goods/services or upon passage of risk to the customer. Operating expenses are recognized when causedor when the underlying service, etc. is used. The accrual basis of accounting is applied to interest incomeand expenses.

Financial derivatives. The companies of the Kolbenschmidt Pierburg Group use financial derivatives tohedge against currency and interest rate risks from operations. In accordance with IAS39 “Financial Instru-ments”, all financial derivatives are recognized at cost and thereafter fair-valued as of the balance sheetdate. Financial derivatives with a positive or negative fair value are disclosed as sundry assets or sundryliabilities, respectively. Fundamentally, any changes in the fair value of financial derivatives are immediatelyrecognized in net income unless an effective hedge exists that satisfies the criteria of IAS39. If the derivativeis a cash flow hedge (CFH) and hence used to effectively hedge expected future cash flows, changes in thefinancial derivative’s fair value are recognized in equity only, under reserves from hedging transactions. Inthis case, the changes in the derivative’s value would not impact on net income until after the hedged under-lying transaction has fallen due or been settled. Changes in the value of financial derivatives used in fair valuehedges (FVHs) to effectively hedge the fair value of recognized assets and liabilities are posted to net incomeas are any changes in the hedged assets or liabilities (where appropriate, by adjusting their book values), withthe result that the compensatory effects are all reflected in the income statement. The ineffective part ofa hedge transaction is carried in the consolidated income statement.

Estimates. Certain assumptions have been drawn and estimates employed in preparing these consolidatedaccounts. These have had an impact on the amounts and presentation of the assets and liabilities, incomeand expenses as well as contingent liabilities. The assumptions and estimates are essentially based onexpectations of useful economic life, the valuation of accruals and the likelihood of future tax relief measures.Moreover, assumptions and estimates form part of the goodwill impairment test. With regard to the receiv-ables sold under the ABS program, it is assumed that the essential risk consists of delayed payments bycustomers. By means of a fixed discount on the receivables sold, the risk is transferred to the purchasingcompany. Premises based on the most recent data underpin the individual assumptions and estimates. Whenactual developments deviate from earlier assumptions and lie outside management’s sphere of influence,this can result in amounts that diverge from earlier estimates. As soon as a discrepancy becomes apparent,such deviations are taken into account in calculating the Group’s performance.


47

Notesto the consolidated balance sheet

(6) Development of tangible and intangible assets € million

Gross values:

January 01, 2004

Additions

Disposals

Book transfers

Currency translation differences

December 31, 2004

Amortization/deprecia-tion/write-down:

January 01, 2004

Fiscal year

Disposals

Book transfers


December 31, 2004

Net values:

December 31, 2004

Gross values:

January 01, 2005

Additions

Disposals

Book transfers


December 31, 2005

Amortization/deprecia-tion/write-down:

January 01, 2005

Fiscal year

Disposals

Book transfers


December 31, 2005

Net values:

December 31, 2005

Develop-ment costs

and otherinternally

created in-tangibles

24

5

0

0

0

29

11

3

0

0

0

14

15

29

6

1

0

0

34

14

3

1

0

0

16

18

Concessions,franchises,

industrialproperty

rights and licences

29

10

1

1

0

39

14

6

1

0

0

19

20

39

3

1

(3)

1

39

19

6

0

0

0

25

14

Goodwill

75

0

27

0

(1)

47

26

0

25

0

(1)

0

47

47

0

1

0

0

46

0

0

0

0

0

0

46

Prepay-ments ontangibles

1

0

0

(1)

0

0

0

0

0

0

0

0

0

0

1

0

0

0

1

0

0

0

0

0

0

1

Total

129

15

28

0

(1)

115

51

9

26

0

(1)

33

82

115

10

3

(3)

1

120

33

9

1

0

0

41

79

Land,equivalent

titles andbuildings

(incl. build-ings on

leased land)

323

5

5

2

(2)

323

144

10

2

0

(1)

151

172

323

18

6

8

6

349

151

11

5

0

2

159

190

Productionplant and

machinery

1,104

48

57

38

(16)

1,117

819

76

54

0

(11)

830

287

1,117

55

54

31

43

1,192

830

76

49

0

29

886

306

Other plant,factory and

officeequipment

278

18

25

10

(1)

280

214

27

23

0

(1)

217

63

280

20

16

10

8

302

217

21

14

0

6

230

72

Prepay-ments ontangibles

8

6

0

(5)

1

10

0

0

0

0

0

0

10

10

7

0

(6)

0

11

0

0

0

0

0

0

11

Construc-tion in

progress

45

41

0

(45)

(1)

40

0

0

0

0

0

0

40

40

52

0

(40)

3

55

0

0

0

0

0

0

55

Total

1,758

118

87

0

(19)

1,770

1,777

113

79

0

(13)

1,198

572

1,770

152

76

3

60

1,909

1,198

108

68

0

37

1,275

634

Intangible assets Tangible assets

2006-2009



(7) Intangible assets. In fiscal 2005, R&D costs amounted to €110 million (2004: €102 million), of which 104million (2004: €97 million) are charged as expenditure. Included in the disposal of goodwill is a correctionof the goodwill for subsequently activated deferred taxes from losses carried forward amounting to €1 million(2004: €1 million).

(8) Tangible assets. Extraordinary depreciation of €1 million (2004: €2 million) is included in depreciation dueto cancellation of contracts. The duration of the capital leasing contracts of those assets which are capital-ized under assets, varies between four and ten years. The interest rate of these contracts varies between3.5 percent and 7.5 percent (2004: 5.9 percent and 8.0 percent) according to the prevailing market condi-tions at the time of the conclusion of the contract. Most of the contracts include a favorable purchase option.

Joint Ventures 1)€ million

Assets 2)

of which non-current

Equity

Debts 3)

of which non-current

Income

Expenses

Net income

2004

32

17

21

11

4

50

43

7

These figures do not include Shriram Piston & Rings Ltd. or ABM Advanced Bearing Materials LLC.Including income tax and prepaid expenses and deferred chargesAccruals, lliabilities, income tax and deferred income

2005

41

23

24

17

1

42

41

1

1)

2)

3)

Fixed assets and capital leases € million

Real property and equivalent rightsand buildings

Technical equipment and machinery

Total

Gross book values DepreciationNet book

values

01/01/2004

12

88

100

0

0

0

12/31/2004

12

87

99

01/01/2004

3

66

69

1

8

9

0

1

1

12/31/2004

4

73

77

12/31/2004

8

14

22

Fiscal year

Real property and equivalent rightsand buildings

Technical equipment and machinery

Total

01/01/2005

12

87

99

0

6

6

12/31/2005

22

81

103

01/01/2005

4

73

77

1

5

6

1

5

6

12/31/2005

4

73

77

12/31/2005

18

8

26

Rents in subsequent years–Finance leasing € million

Rents

Discount

Present values

2004 2005

16

5

11

18

4

14

Total

41

10

31

2007-2010

13

4

9

19

4

15

Total

37

9

28

(9) Investments valued at equity.

Fiscal year

Additions

Additions

Disposals

Disposals

Disposals

Disposals

from 2010 from 2011

0

1

1

10

0

10

2005

7

1

6

2006

5

1

4

49

Loss carryovers are stated on the basis of corporate planning data at the amount of budgeted future tax-able income. During the course of the year, €6 million of deferred taxes (2004: €4 million) were stated asincome.

Over and above the deferred tax assets from loss carryovers and tax credits, German and foreign tax losscarryovers exist at a total of €143 million (2004: €143 million), and foreign tax credits of €2 million(2004: €2 million), which were not recognized. The loss carryovers amount to €60 million (2004: €60 million)in Germany, with another €83 million (2004: €83 million) existing abroad. Domestic loss carryovers are notsubject to expiration. Of the foreign loss carryovers, €2 million (2004: €5 million) expire within the nextthree years; €1 million (2004: €1 million) expire within four to eight years; while €77 million (2004:€77 million) expire in the next nine to 25 years. The non-reported foreign loss carryovers contain tax creditsof €2 million (2004: €2 million) either have no expiration date or will expire over the next four to 15 years.Deferred taxes amounting to €5 million adjusted in prior periods were written up (2004: €4 million). Thechange in the write-downs of deferred tax assets in 2005 amounts to (€1 million), compared to (€1 million)the year before.

Development of investments valued at equity € million

Joint Ventures

Associated affiliates

30

8

38

0

0

0

0

8

8

7

0

7

7

0

7

30

0

30

AdditionsBook value

01/01/2004 Disposals P/L shareDividend

paymentsBook value

12/31/2004

Joint Ventures

Associated affiliates

30

0

30

2

8

10

0

0

0

2

1

3

3

0

3

31

9

40

AdditionsBook value

01/01/2005 Disposals P/L shareDividend

paymentsBook value

12/31/2005

(10) Financial assets.

Financial assets € million

Securities

Loans

Receivables from financing

Guarantee trust

non-current

1

1

0

0

2

current

0

0

1

4

5

non-current

0

1

0

0

1

current

0

1

0

0

1

2004 2005

Deferred taxes (assets) € million

Deferred taxes

from temporary differences

from loss carryforward and tax credits

2004

20

16

36

2005

24

23

47

(11) Deferred taxes.


The book value of inventories stated at the lower NRV totals €13 million (down from €18 million in 2004).There were no significant write-downs or revaluations in fiscal 2005. Inventories are not used to collateralizeliabilities.

Inventories € million

Raw materials and supplies

Work in process

Finished products and merchandise

Prepayments made

Prepayments received

2004

72

64

101

2

239

(13)

226

2005

77

83

104

2

266

(21)

245

(12) Inventories.

Receivables and sundry assets € million

Trade receivables of which due from

related parties

Joint Ventures and associated companies

All other receivables and sundry assets

non-income taxes

derivative financing

investment grants/allowances

Other

non-current

0

0

0

1

0

0

0

1

current

180

4

1

8

3

2

9

22

non-current

0

0

0

1

0

0

0

1

current

231

4

2

9

2

3

10

24

2004 2005

(13) Receivables and sundry assets.

Under an ABS program, among others the Kolbenschmidt Pierburg Group sells trade receivables on a revolvingbasis up to a maximum volume of €170 million (2004: €175 million). As of December 31, 2005, the receiv-ables sold had a par value of €114 million (up from €127 million). Owing to an exemption, statement of acontinuing involvement was not necessary. The book values shown include receivables from financialderivatives as well as financial assets approximating their stated fair value.

Income tax assets € million

Income tax refundable by the tax authorities

of which included in the consolidated income statement

2004

1

1

2005

1

1

(14) Income tax liabilities.


51

Pension accruals–calculation parameters in %

Discount rate

General pay rise

Pay rise (firm commitment)

Pension rise

Health care cost rise

Expected return on plan assets

Germany

4.75

3.00

1.25–0.5

1.25

--

--

USA

5.60

4.00

--

--

11.0–5.0

8.50

Germany

4.25

2.75

0.50

1.25

--

--

USA

5.60

4.00

--

--

11.0–5.0

8.50

12/31/2004 12/31/2005

(15) Cash and cash equivalents.

Cash and cash equivalents € million

Cash in banks, cash on hand and checks

2004

68

2005

49

As in the previous year, the availability of cash and cash equivalents was not subject to limitation. Cash andcash equivalents consist of cash on hand and balances with banks.

(16) Equity. Just as last year, Kolbenschmidt Pierburg AG’s capital stock amounts to €72 million and isdivided into 28,003,395 no-par bearer shares of fully voting common stock. No unpaid capital is subscribed.The reserve from hedging transactions and the differences from the fair value valuation of individual currencyforward transactions (concluded to hedge planned purchases of material through to 2007) have a neutralimpact on earnings. Valuation is at current fair value. Due to its minor significance, a detailed presentationhas been dispensed with.

The proposed dividend of Kolbenschmidt Pierburg AG for fiscal 2005 amounts to €36 million (2004: €20million), corresponding to a dividend per share of €1.30 (2004: €0.70).

(17) Accruals for pensions. These accruals provide for obligations under vested rights and current pensionspayable to eligible active and former employees and their surviving dependants. Such commitmentsprimarily encompass pensions, both basic and supplementary. The individual confirmed pension entitlementsare based on benefits that vary according to country and company and, as a rule, are measured accordingto service years and employee pay. The accrued health care obligations to the retirees of some US Groupcompanies are also included in the pension accruals recognized hereunder. The company pension systemconsists of both defined-contribution and defined-benefit plans. In the year under review, a total €27 million(up from €21 million) was paid to DCPs.

As a result of the downward drift of interest rates in the German capital market, the interest rate for Germanpension obligations was reduced by 0.50 percentage points.



The present value of funded pension obligations at December 31, 2005, came to €115 million (2004:€104 million). The unrecognized actuarial losses of €77 million (up from €54 million) are substantiallythe result of adjusted discount rates and of the deviating actual vs. expected return on plan assets. In2005, actual investment income of the plan assets came to €4 million, (2004: €6 million), prior to a foreigncurrency loss with a neutral impact on earnings.

Pension accruals € million

Balance at January 1

Pension payments and contributions to plan

Service cost

Past service costs/revenue

Amortized insurance-related gains and losses

Compounding of expected pension obligations


Exchange differences/other

Balance at December 31

2004

257

(35)

5

(1)

2

19

(5)

(1)

241

2005

241

(17)

6

(1)

4

18

(6)

2

247

Pension accruals–transition € million

Analysis of the DBO’s present value

Present value of DBO at January 1


Service cost

Interest cost

Pension payments

Actuarial gains/losses

Plan assets at fair value at December 31

Development of plan assets

Present value of DBO at Januar 1



Contributions to plan

Pension payments of plan

Actuarial gains/losses

Present fair value of DBO at December 31

Unfunded pension obligations at December 31

Unrecognized actuarial gains/losses

Unrecognized past service returns/costs

Pension accrual at December 31

Germany

220

0

4

12

(12)

22

246

0

0

0

0

0

0

0

(25)

0

221

Abroad

124

(9)

1

7

(15)

4

112

58

(6)

5

21

(12)

(1)

65

(29)

2

20

Total

344

(9)

5

19

(27)

26

358

58

(6)

5

21

(12)

(1)

65

(54)

2

241

Germany

246

0

4

11

(12)

20

269

0

0

0

0

0

0

0

(45)

0

224

Abroad

112

15

2

7

(13)

2

125

65

9

6

4

(12)

0

72

(32)

2

23

Total

358

15

6

18

(25)

22

394

65

9

6

4

(12)

0

72

(77)

2

247

2004 2005

53

The interest portion in the 2005 pension provision, as well as the expected return on plan assets, are shownwithin net interest expense, the remaining items being included in personnel expenses.

Pension expenses € million

Current service cost

Amortized actuarial gains/losses

Past service cost/revenue

Expected return on assets

Compounding of expected pension obligations

2004

5

2

(1)

(5)

19

20

2005

6

4

(1)

(6)

18

21

Pension accruals–plan assets € million

Equities

Government and corporate bonds

Cash & cash equivalents

Plan assets

2004

36

18

11

65

2005

45

24

3

72

(18) Other accruals.

Other accruals € million

Balance at January 1, 2005

Utilized

Released

Added/newly provided

Compounded

Exchange differences/other

Balance at December 31, 2005

Payments due

>5 years

1–5 years

<1 year

Warran-ties

24

(6)

(6)

10

0

0

22

0

8

8

14

22

Personnel

75

(44)

(2)

56

0

2

87

7

19

26

61

87

8

(4)

(1)

2

0

0

5

0

0

0

5

5

4

(1)

(1)

1

0

0

3

0

3

3

0

3

4

(2)

0

1

0

0

3

0

1

1

2

3

22

(7)

(5)

12

1

1

24

0

4

4

20

24

Total

137

(64)

(15)

82

1

3

144

7

35

42

102

144

Restruc-turing

Identifiablelosses Other

Accruals for obligations to personnel essentially provide for accrued vacation, overtime and flextime at atotal of €21 million; for pre-retirement part-time work at €15 million; and for termination benefits at€12 million. Other accruals consist of various small accruals with an individual value of less than €2 million.As in 2004, no refunds are expected from accruals.

Environ-mental risks



The financial debts under leases include accounts payable by the special-purpose leasing firms to banksat €21 million (2004: €21 million). Of liabilities to banks, €0 million (2004: €1 million) were collateralizedby plant and machinery.

Due under capital leases

WeightedTerms rate (in%) Currency

fixed 5.9 €

fixed 5.9 €

fixed 6.5 €

fixed 6.5 €

fixed 6.5 €

fixed 6.5 €

fixed 3.5 €

fixed 7.5 €

Book value€ million

2

4

4

3

1

2

0

11

Market value€ million

2

4

5

4

1

2

0

13

Rates fixeduntil

2005

2006

2008

2010

2011

2012

2020

2020


0

2

3

3

1

1

7

10


0

2

4

3

1

2

7

13

12/31/2004 12/31/2005

(19) Financial liabilities.

Financial liabilities € million

Financial liabilities

due to banks

under leases

other

non-current

10

41

2

53

current

5

6

1

12

non-current

7

43

3

53

current

7

5

0

12

2004 2005

Liabilities due to banks


fixed 1.0 ¥

fixed 1.0 ¥

fixed 5.2 €

fixed 3.0 US$

Variable €/Rs


1

1

8

3

2


1

1

8

2

2

Rates fixeduntil

2005

2006

2007

2008

2005


0

0

7

2

5


0

0

7

2

5

Liabilities due to banks of special-purpose leasing firms


fixed 4.9 €


22


23

Rates fixeduntil

2008


21


23

12/31/2004 12/31/2005

12/31/2004 12/31/2005

The stated market values were determined on the basis of the interest rates pertaining at the balance sheetdate for the corresponding remaining duration/repayment schedule.

55

There were no liabilities to joint ventures or associated affiliates. The carrying values of trade payables andall other liabilities approximate their fair values.

(20) Trade payables and other liabilities.

Sundry liabilities € million

Trade payables

Other liabilities

Prepayments received on orders

Outstanding invoices

Monies in transit

Non-income taxes

Social security

Due to employees

Other liabilities

Deferred items

of which subsidies

non-current

0

0

0

0

1

1

0

0

2

2

4

current

190

17

18

50

8

13

6

6

7

1

125

non-current

0

0

0

0

0

1

0

0

2

1

3

current

204

18

12

50

10

14

10

4

7

1

126

2004 2005

(21) Deferred taxes. For temporary differences in the case of shares held in subsidiaries and associatedcompanies amounting to €2 million, no deferred tax liabilities are reported, since the reverse effect canbe controlled, and neither a disbursement nor a sale of the companies is likely within the foreseeable future.

Composition of deferred tax assets and liabilities € million

Loss carryforwards and tax credits

Tangible and intangible assets

Pension accruals

Other accruals

Liabilities

Sundry

Subtotal

Offset

Consolidated balance sheet

assets

16

3

16

12

1

6

54

(18)

36

liabilities

0

(19)

(1)

0

(1)

(2)

(23)

18

(5)

assets

23

11

17

12

4

4

71

(24)

47

liabilities

0

(24)

(1)

0

0

(4)

(29)

24

(5)

2004 2005


Notesto the consolidated income statement

Pension expense primarily reflects the annual provision for accrued pension liabilities and the DCP contri-butions, as well as statutory pension contributions amounting to €27 million (2004: €25 million).

(22) Net inventory changes, other work and material capitalized.

Net inventory changes, other work and material capitalized € million

Change in inventories of finished products and work in process

Other work and material capitalized

2004

13

13

26

2005

10

14

24

(23) Other operating income.

Other operating income € million

Income from the disposal of plant and equipment

Income from the release of accruals

Income from investment grants and subsidies

Income from credit notes for prior periods

Income from customer reimbursements

Income from the reimbursement for prototypes and tools

Income from the sale of leftover material

Income from the payment of bad debts charged off and the reversal of bad-debt allowances

Rental Income

Income from damages / claims

Other income

2004

4

9

5

5

6

7

3

2

3

1

7

52

2005

8

15

5

10

2

5

4

2

3

1

6

61

Cost of materials € million

Cost of raw materials, supplies, and merchandise purchased

Cost of services purchased

2004

921

89

1,010

2005

979

102

1,081

Personnel expenses € million

Wages and salaries

Social security contributions

Expenses for pensions and related employee benefits

2004

416

72

33

521

2005

433

75

36

544

(24) Cost of materials.

(25) Personnel expenses.

57

Income from the release of accruals was offset at €11 million (2004: €11 million) against other operatingexpenses.

Other operating expenses € million

Maintenance and repair

Data processing

Selling, promotion and advertising

Other general administration

Rents

Other payroll incidentals

Legal and consultancy fee

Travel

Severance packages, termination benefits, pre-retirement part-time work

Research and development

Non-income taxes

Insurances

Formation of other accruals

Group allocations and service fees

Outsourced support services

Project costs

Losses on fixed-asset disposal

Other expenses

2004

52

27

23

17

12

10

9

10

15

8

8

7

5

6

5

4

3

22

243

2005

58

28

26

14

12

12

11

11

9

8

8

8

8

6

6

3

1

23

252

Annual average headcount

Kolbenschmidt Pierburg Group

2004

11,453

2005

11,542

(26) Other operating expenses.

Net interest expense € million

Interest income

From pension funds

Other interest and similar income

Interest expense

From capital leases

Compounding from pensions

Other interest and similar income

2004

5

2

7

2

19

14

35

(28)

2005

6

3

9

2

18

8

28

(19)

(27) Net interest expense.


Notesto the consolidated income statement

The table below reconciles the expected to the recognized tax expense, which is determined by multiplyingEBT by an unchanged tax rate of 40 percent. This tax expense comprises German corporate income tax, thesolidarity surtax thereon, and municipal trade tax. Expected tax expenses are matched against the effectiveincome tax burden.

(28) Net investment income and other financial results.

Net investment income and other financial results € million

Net investment income

From investments valued at equity

From associated affiliates

Other financial results

From foreign exchange

From financial derivatives

Other financial expenses/income, net

2004

7

8

15

0

2

(1)

1

16

2005

3

0

3

2

0

0

2

5

Income taxes € million

Actual income tax expenses

Tax expenses not relating to the period

Deferred tax income

2004

31

5

(4)

32

2005

41

6

(6)

41

(29) Income taxes.

Reconciliation of expected to effective tax expenses € million

EBT

Expected tax expense

Differences from German tax rates

Differences from foreign tax rates

Effects from loss carryovers and changes in provisions

Reduction of taxes due to loss carry forwards not yet used

Taxfree income

Nondeductible expenses

Nondeductible goodwill amortization

Adjustment for non-period income taxes

Other

Effective tax expense

Effective tax rate in %

Expected tax rate in %

2004

111

44

0

(2)

(6)

(4)

(8)

2

1

5

1

32

29

40

2005

127

51

(1)

(4)

(6)

(5)

(2)

2

0

6

0

41

32

40

59

(30) Minority interests. Minority interests in profit came to €2 million (2004: €1 million) and in loss to€0 million (2004: €0 million).

Earnings per share (EpS)

Group earnings (after minority interests) €

Weight average number of shares

Earnings per share (EpS) €

2004

78,079,571

28,003,395

2.79

2005

84,430,048

28,003,395

3.01

(31) Earnings per share (EPS). EPS is obtained by dividing the weighted average number of shares issuedand outstanding in the fiscal year into the Group’s earnings. Neither at December 31, 2005 nor December31, 2004 were any shares outstanding that could dilute earnings per share.

(33) Segment reports. In accordance with the Kolbenschmidt Pierburg Group’s internal controlling organ-ization, the Group breaks down into five primary divisions, viz.:

– Air Supply, Emission Controls and Pumps– Large and Small Pistons– Plain Bearings and Continuous Casting– Aluminum Engine Blocks– Aftermarket

The “Others/Consolidation” column includes, apart from the Group’s parent (Kolbenschmidt Pierburg AG),further companies not allocable to any defined segment, including property companies and consolidations.In accordance with its industrial affiliation, one property company was distributed between the Large andSmall Pistons segment and the Plain Bearings and Continuous Casting segment. Prior year figures havebeen recalculated to enable comparison.

Responsibilities are clearly separated between the segments and Kolbenschmidt Pierburg AG, which performsthe functions of a strategic management holding company, the management of the company and its internalreporting procedures have been structured accordingly. In line with the Kolbenschmidt Pierburg Group’sshareholder value concept, segment assets comprise assets necessary for operations excluding cash and cashequivalents and income tax assets, while segment liabilities exclude equity, financial debts and income taxliabilities.

The intersegment transfers principally indicate sales among divisions and are priced as if at arm’s length. Capital expenditures refer to tangible and intangible assets.


Notesto the consolidated statement of cash flowsand to the segment reports

(32) Consolidated cash flow statement. Capital expenditures have been corrected by the amount of anon-cash increase of a property from capital leases against the increase of financial liabilities (€7 million).Dividends of affiliated companies and investments amounting to €2 million (2004: €7 million) as well asrepayments of loans are included in the disposals of financial assets. Included in capital expenditures arethe purchase of shares in Shriram Pistons & Rings Ltd. and the incorporation of ABM Advanced BearingMaterials LLC.

61

Additional Notes

(34) Contingent liabilities. Since 1998, a court of arbitration has been examining the appropriateness of theconversion ratio calculated with regard to the merger of Kolbenschmidt Pierburg (Rheinmetall Beteiligungen).The expert appointed by the Heilbronn District Court has in 2005 submitted his final report. The expert arrivesat deviating estimates of the worth of the two companies, which merged in January 1998, the risks of addi-tional cash payments are covered by the additional paid in capital within the framework of the merger. Kolben-schmidt Pierburg AG has arranged for a court-appointed expert to review the report. On account of the resultsof this review, Kolbenschmidt Pierburg AG sees no grounds for distancing itself from the originally calculatedvalue comparisons. At the time of the merger of the two companies, these value comparisons were calculatedby two independent accounting companies and confirmed by a court-appointed merger and acquisitionsexpert. Kolbenschmidt Pierburg assumes that the value estimates, which were documented by three differentexperts, will be vindicated in the final ruling. So as not to prejudice the outcome of this process, we will desistfrom commenting further on this matter.

(35) Other financial obligations. At December 31, 2005, the commitments to purchase tangible assets totaled€26 million (2004: €23 million), chiefly relating to orders of technical equipment and machinery as wellas construction activities. In addition, a purchasing price commitment of €6 million exists, resulting fromthe planned purchase of the DESC Automotive Group of Mexico City, Mexico. An obligation relating to ITframework contracts also exists; it amounts to €7 million (2004: €8 million).

The rents for land and buildings chiefly refer to a long-term property lease that includes neither a purchaseoption nor a firmly agreed passage of title and is therefore an operating lease.

Rents in subsequent years–Operating leasing € million

Buildings

Production plant and machinery

Other leases

2005

3

2

1

6

9

4

1

14

22

0

0

22

2006

3

4

2

9

8

5

3

16

23

0

0

23

20052004

2006–2009 after 2009 2007–2010 after 2010

There were no subleases.

(36) Significant subsequent events. Effective February 3, 2006, KS Mexico acquired the complete originalequipment division of the Mexican piston manufacturer Pistones Moresa in Celaya, Mexico from DESC Auto-motive Group of Mexico City.

(37) Hedging policy and financial derivatives. As an internationally active group, the operations and financialtransactions of Kolbenschmidt Pierburg are exposed to financial risks, especially with regard to liquidity risk,default risk, raw materials price risk as well as exchange rate volatility and interest rate fluctuations. In accor-dance with the Group-wide risk management system of Kolbenschmidt Pierburg AG, such risks are not onlyidentified, analyzed and measured but also managed and limited through derivative financial instruments.

No such derivatives may be acquired for speculation. All transactions involving financial derivatives aresubject to stringent monitoring, which is particularly ensured by the strict segregation of the contracting,settlement and control functions.

Liquidity risk. The Kolbenschmidt Pierburg Group ensures sufficient liquidity at all times mainly througha liquidity forecast based on a fixed planning horizon as well as through existing, yet unutilized credit facilities.

Default risk. The Kolbenschmidt Pierburg Group primarily supplies customers of top standing and is hencehardly affected by any bad debts or uncollectibles, and even these are covered by hedging tools and adequateallowances according to what the Group is aware of presently. Moreover, the Kolbenschmidt Pierburg has notmaterially concentrated its credit facilities in one or only few lenders. The default risk emanating from financialderivatives consists in a failure of the counterparty and is therefore limited to the instrument’s positive fairvalue to the counterparty. Kolbenschmidt Pierburg companies contract financial derivatives solely withGerman and foreign banks of impeccable standing, thus minimizing default risks.

Raw materials price risk. Volatile prices for purchasing raw materials must be seen as a price risk for theKolbenschmidt Pierburg Group. Thanks to a series of material price escalation agreements with customers,the risk from rising, but also the advantage of falling, metal prices has been largely shifted to the customers.For other metals for which agreements of this type could not be concluded, the use of long-term agreementswith suppliers is currently being investigated, as is the use of other instruments.

Currency risk. Due to the international nature of the Kolbenschmidt Pierburg Group’s business, certain oper-ational currency risks arise from the fluctuating parity of the euro to other currencies. Open positions exposedto a currency risk are principally hedged through financial derivatives. Generally currency forwards or futures.To a large extent the Kolbenschmidt Pierburg Group benefits from a natural hedge. Foreign currency peaksnot covered by this natural hedge, especially those in US dollars, are covered by additional currency forwardsor futures in Germany. All intercompany financing transactions in foreign currencies are covered by currencyswaps. The lower limit of the hedge ratio amounts to 75 percent.

Interest rate risk. The Kolbenschmidt Pierburg Group’s financing activities also use such funding tools asfloating-rate facilities. Interest rate hedges such as caps/floors/collars and interest rate swaps contain therisks ensuing from market rate changes. These interest rate options are used to redesign variablerate intofixed-rate agreements. These hedges are contracted centrally by Kolbenschmidt Pierburg AG. Participationin the ABS program of the Rheinmetall Group results in a risk of interest rate change. In order to limit this risk,interest rate caps (among other instruments) are employed. Currently, about half of these risks are covered;however, the ratio can vary depending on the volume of receivables sold.


Additional Notes

63

(38) Related-party transactions. The subsidiaries consolidated by Kolbenschmidt Pierburg AG directly orindirectly maintain ordinary business relations with associated affiliates and joint ventures. Any and alltrade transactions conducted in the scope of ordinary day-to-day business with related companies conformto the arm’s length principle. In addition, Rheinmetall AG as Kolbenschmidt Pierburg AG’s majority stock-holder as well as Rheinmetall service companies provide extensive services to companies of the Kolben-schmidt Pierburg Group, including (for example) legal, tax, and PR consultancy and support, the exemptionfor the ABS program and insurance services. As apart of the cash management system of majority stockholderRheinmetall AG, the Kolbenschmidt Pierburg Group invests and/or borrows cash and cash equivalents withinthe Rheinmetall Group. All cash management business is transacted as if at arm’s length.

Financial derivatives € million

Currency hedges

Currency forwards/futures

Credit Default Hedges

Credit Default Swap

Interest rate hedges

Swaps

Other derivatives

99

0

11

60

95

29

17

60

29

6

51

53

1

0

1

1

(1)

1

0

1

Fair market valuesMaturing afterNotional volume

12/31/2004 12/31/2005 (in months) 12/31/2004 12/31/2005

The nominal volumes are shown as gross amounts and therefore represent the amounts of all the individualcontracts. Being marked to the market at December 31, the fair values of financial derivatives correspondto prices in arm’s length transactions.

Details of service transactions with related companies € million

Rheinmetall AG

Other related companies

Associated companies

Joint Ventures

2004

0

0

0

3

2005

2

0

6

6

2004

6

1

0

2

2005

5

0

0

4

Volume of services rendered Volume of services utilized

No reportable transactions were carried out with persons closely associated with the KolbenschmidtPierburg Group.

Compensation for senior executives € million

Ongoing renumeration during the fiscal year

Pension expenses

2004

5.2

0.4

2005

4.6

0.7

(39) Auditor compensation. Compensation for the audit of the annual accounts in 2005 by Pricewater-houseCoopers Aktiengesellschaft amounted to €1.1 million compared to €1.2 million the previous year.Auditing and consulting services performed by other auditing companies were only of marginal significance.

(40) Supervisory and Executive Boards.

Executive Board. For their duties performed on behalf of the parent company and its subsidiaries, in theyear under review the Executive Board members received a total of €0.9 million in fixed remuneration(2004: €0.9 million) and €1.1 million in bonuses (2004: €1.5 million). A new incentive program, oriented tothe absolute increase in value of the Rheinmetall Group, accounted for €0.4 million (2004: €0.4 million).In addition, members of the Executive Board received payments in kind amounting €0.1 million, largelyconsisting of company car use and grants for social security insurance. Thus, total remuneration paid tomembers of the Executive Board in 2005 amounted to €2.5 million (2004: €2.9 million).

A total of €0.5 million (2004: €0.4 million) was paid to former Executive Board members and their survivingdependants. Moreover, for the accrued pension obligations to former Executive Board members and theirsurviving dependants, a total of €5.0 million has been provided (2004: €5.2 million). Under the SAR program,former members of the Executive Board still hold 10,000 shares of phantom stock from 2001.

Supervisory Board. Supervisory Board fees amounted to €0.2 million in fiscal 2005 (2004: €0.2 million).No further compensation was paid, nor were any benefits granted, to Supervisory Board members forpersonally rendered advisory or agency services in the year under review.

Shareholdings. As of December 31, 2005, none of Kolbenschmidt Pierburg AG’s Supervisory or ExecutiveBoard members held any shares in the company.

(41) Corporate Governance. Since November 2005, Kolbenschmidt Pierburg AG, pursuant to Art. 161 AktG,has published a declaration of conformity to the German Corporate Governance Code on the Internet atwww.kspg-ag.com, thus making it available to its stockholders.

Regarding the consolidated financial statements of Rheinmetall AG, a declaration of conformity under theterms of Art. 161 AktG has been published since December 2002 on the Internet at www.rheinmetall.de.

Düsseldorf, February 27, 2006

The Executive Board



Additional Notes

65

Auditor’s Report

We have audited the consolidated financial statements prepared by the Kolbenschmidt Pierburg Aktienge-sellschaft, Düsseldorf, comprising the balance sheet, the income statement, statement of changes in equity,cash flow statement and the notes to the consolidated financial statements, together with the group manage-ment report for the business year from January 1. to December 31, 2005. The preparation of the consolidatedfinancial statements and the group management report in accordance with the IFRSs, as adopted by the EU,and the additional requirements of German commercial law pursuant to § (Article) 315a Abs.(paragraph) 1 HGB(“Handelsgesetzbuch”: German Commercial Code are the responsibility of the parent Company’s Board ofManaging Director. Our responsibility is to express an opinion on the consolidated financial statementsand on the group management report based on our audit.

We conducted our audit of the consolidated financial statements in accordance with § 317 HGB and Germangenerally accepted standards for the audit of financial statements promulgated by the Institut der Wirtschaft-sprüfer (Institute of Public Auditors in Germany) (IDW). Those standards require that we plan and performthe audit such that misstatements materially affecting the presentation of the net assets, financial positionand results of operations in the consolidated financial statements in accordance with the applicable financialreporting framework and in the group management report are detected with reasonable assurance. Knowledgeof the business activities and the economic and legal environment of the Group and expectations as topossible misstatements are taken into account in the determination of audit procedures. The effective-ness of the accounting-related internal control system and the evidence supporting the disclosures in theconsolidated financial statements and the group management report are examined primarily on a test basiswithin the framework of the audit. The audit includes assessing the annual financial statements of thoseentities included in consolidation, the determination of the entities to be included in consolidation, theaccounting and consolidation principles used and significant estimates made by the Company’s Board ofManaging Director, as well as evaluating the overall presentation of the consolidated financial statements andthe group management report. We believe that our audit provides a reasonable basis for our opinion.

Our audit has not led to any reservations.

In our opinion based on the findings of our audit the consolidated financial statements comply with theIFRSs as adopted by the EU, the additional requirements of German commercial law pursuant to § 315aAbs. 1 HGB and give a true and fair view of the net assets, financial position and results of operations ofthe Group in accordance with these requirements. The group management report is consistent with theconsolidated financial statements and as a whole provides a suitable view of the Group’s position and suit-ably presents the opportunities and risks of future development.

Stuttgart, February 28, 2006PricewaterhouseCoopersAktiengesellschaftWirtschaftsprüfungsgesellschaft

Staudacher AdamaszekGerman Public Auditor German Public Auditor

Group of consolidated companies at December 31, 2005 Main subsidiaries and investees


Group of consolidated companies at December 31, 2005

Kolbenschmidt Pierburg AG, Düsseldorf

Pierburg

Pierburg GmbH, Neuss 1)/4)

Carbureibar S.A., Abadiano, Spain

Pierburg S.à r.l., Basse-Ham (Thionville), France

Pierburg S.p.A., Lanciano, Italy

Kolbenschmidt Pierburg Shanghai NonferrousComponents Co. Ltd., Shanghai, China 2)

KS Pistons

KS Kolbenschmidt GmbH, Neckarsulm 1)/4)

KS Pistões Ltda., Nova Odessa, Brazil

Karl Schmidt Unisia Inc., Marinette, USA

Metal a.s., Usti, Czech Republic

Société Mosellane de Pistons S.A.S., Basse-Ham (Thionville), France

Kolbenschmidt Shanghai Piston Co. Ltd., Shanghai, China 2)

KS Plain Bearings

KS Gleitlager GmbH, St. Leon-Rot 1)/4)


KS ATAG GmbH, Neckarsulm 4)

KS Aluminium-Technologie AG, Neckarsulm 1)

Werkzeugbau Walldürn GmbH, Walldürn 3)

Motor Service

MSI Motor Service International GmbH, Neckarsulm 1)/4)

MSD Motor Service Deutschland GmbH, Neckarsulm 3)

Interest held (%)direct indirect

100

100

100

100

50

100

100

92

100

100

50

100

100

100

100

100

100

P&L transfer agreement with Kolbenschmidt Pierburg AG, application of the exemption clause under § 264 art 3 HGB and § 264 b.Consolidated at equity.Profit pooling agreement with controlling company of the division, application of the exemption clause under § 264 art 3 HGB.Application of the exemption clause under § 291 HGB.

1)

2)

3)

4)

67

Fiscal year 2005 € million

Income from investments

Net interest income

Net financial result

Other operating income

Personnel expenses

Amortization/depreciation/write-down

Other operating expenses

Earnings before taxes (EBT)

Income taxes

Net income

Transfer to reserves retained from earnings

Net earnings

2005

90

2

92

41

(11)

0

(30)

92

(28)

64

(28)

36

2004

79

(3)

76

37

(12)

0

(26)

75

(16)

59

(30)

29

Balance Sheet and Income statement ofKolbenschmidt Pierburg AG for the year ended December 31, 2005 (based on HGB)

Assets € million

Assets

Financial assets

Current assets

Receivables and sundry assets

Due from Group companies

Sundry assets

Cash & cash equivalents

Total assets

12/31/2005

378

378

136

2

5

143

521

12/31/2004

356

356

114

2

32

148

504

Equity & liabilities € million

Equity & liabilities

Stockholders’ equity

Capital stock

Reserves retained from earnings

Net earnings

Accruals

Accruals for pensions and similar obligations

Other accruals

Liabilities

Due to banks

Due to Group companies

Sundry liabilities

Total equity & liabilities

12/31/2005

72

174

94

36

376

13

35

48

7

89

1

97

521

12/31/2004

72

174

57

29

332

13

23

36

8

128

0

136

504


Supervisory Board of Kolbenschmidt Pierburg AG 2005

Klaus EberhardtDüsseldorf

Chairman of the Executive Board

ChairmanRheinmetall AG, Düsseldorf

Member of further supervisory boards:

Rheinmetall Defence Electronics GmbH, Bremen(Chairman)

Rheinmetall Landsysteme GmbH, Kiel(Chairman)

Rheinmetall Waffe und Munition GmbH, Ratingen(Chairman)

Oerlikon Contraves AG, Zurich, Switzerland(President of the Administrative Board)

Nitrochemie AG, Wimmis, Switzerland(President)

Nitrochemie Wimmis AG, Wimmis, Switzerland(President)

Hirschmann Electronics Holding S.A., Luxembourg(Chairman)

MAN AG, Munich(from June 3, 2005)

Dr. Rudolf Luz *)

Weinsberg

Vice chairman

1st Delegate of the German Metalworkers Union (“IG Metall”), Heilbronn/Neckarsulm office, Neckarsulm


Rheinmetall AG, Düsseldorf

Bechtle AG, Neckarsulm(Member of the supervisory board)

Member in comparable German and foreign supervisory boards:

Wirtschaftsfördergesellschaft Raum Heilbronn GmbH, Heilbronn(Member of the supervisory board )

Dr. Andreas BeyerSindelfingen

Director with general power to represent the companyRheinmetall AG, Düsseldorf


Jagenberg AG, Neuss

Pierburg GmbH, Neuss

Bachofen+Meier AG, Bülach, Switzerland

Dr. Herbert MüllerDüsseldorf

Member of the Executive BoardRheinmetall AG, DüsseldorfFinance and Controlling


Rheinmetall DeTec AG, Düsseldorf(until July 19, 2005)

Dr. Bernd M. HönleWeisenheim a.S.

Managing Director Röchling Industrie Verwaltung GmbH, Mannheim


Rheinmetall AG, Düsseldorf(until December, 31st 2005)

Rheinmetall DeTec AG, Ratingen (until July 19, 2005)

BEA Holding AG, Düsseldorf

DeTeWe-Deutsche Telephonwerke Beteiligungs AG, Berlin

Francotyp-Postalia Beteiligungs AG, Birkenwerder (until April 20, 2005)

PFEIFFER&MAY Großhandel AG, Karlsruhe

Seeber Beteiligungs AG, Mannheim

69

Burkhard LeffersBad Homburg v.d.H.

Member of the Regional Executive Board Commerzbank AG

Member in comparable German and foreign supervisory boards:

AFFINE S.A., Paris, France(Membre du Conseil d’Administration)

Goodyear Dunlop Tires Germany GmbH, Hanau(Member of the supervisory board)

Commerzleasing und Immobilien AG (CLI)(Member of the supervisory board from May 13, 2005)

Prof. Dr. Dirk ZumkellerMunich

Full Professor of Transport & TrafficTechnical University of Karlsruhe


Rheinmetall AG, Düsseldorf(until July 31, 2005)

Advisory board, Gebr. Röchling KG

Shareholders’ committee, Röchling Industrie-Verwaltung GmbH

Dr. Ludwig Dammer *)

Düsseldorf


Member of a further supervisory board:


Heinrich Kmett *)

Fahrenbach/Robern

Works Council Chairman KS Kolbenschmidt GmbH, Neckarsulm



Erich Hüskes *)

Nettetal

Member of the Works CouncilNettetal PlantPierburg GmbH, Neuss

Dietrich Termöhlen *)

Hinte

1st Delegate of IG MetallNeuss Office


Aluminium Norf GmbH, Neuss

Pierburg GmbH, Neuss(deputy chairman)

Gerhard Grasmeier *)

Waghäusel

Chairmain of the Works Council of the St. Leon-Rotplant of KS Gleitlager GmbH, St. Leon-Rot


KS Gleitlager GmbH, St. Leon-Rot

Staff representative*)


Executive Board of Kolbenschmidt Pierburg AG 2005

Dr. Gerd KleinertGottmadingen

Chairman Strategy, Marketing, Operations

Member of the following supervisory boards:

Pierburg GmbH, Neuss(Chairman)

KS Kolbenschmidt GmbH, Neckarsulm(Chairman)

KS Gleitlager GmbH, St. Leon-Rot(Chairman)

KS Aluminium-Technologie AG, Neckarsulm(Chairman)

KS ATAG GmbH, Neckarsulm(Chairman)

Läpple AG, Heilbronn(Chairman from December 8, 2005)

Läpple Holding AG, Heilbronn(Chairman from December 8, 2005)

Member of the following comparable German and foreign supervisory boards:

KS International Investment Corp., Southfield, USA

Kolbenschmidt Pierburg Shanghai Nonferrous ComponentsCo. Ltd., Shanghai, China (KPSNC)(Vice Chairman)

KS Piston Shanghai Co. Ltd., Shanghai, China (KSSP)

Dr. Peter P. MertenHerrsching

Finance/Controlling, IT



KS Kolbenschmidt GmbH, Neckarsulm


KS Aluminium-Technologie AG, Neckarsulm

KS ATAG GmbH, Neckarsulm



Dr. Jörg-Martin FriedrichLudwigsburg

Human Resources, Legal Affairs



KS Kolbenschmidt GmbH, Neckarsulm


KS Aluminium-Technologie AG, Neckarsulm

KS ATAG GmbH, Neckarsulm




List of addresses


Kolbenschmidt Pierburg AGKarl-Schmidt-Straße74172 Neckarsulm, GermanyPhone (+49-7132) 330Fax (+49-7132) 332889www.kspg-ag.com

Pierburg division

Pierburg GmbHAlfred-Pierburg-Straße 141460 Neuss, GermanyPhone (+49-2131) 5201Fax (+49-2131) [email protected]@kolbenschmidt-pierburg.com

KS Pistons division

KS Kolbenschmidt GmbHKarl-Schmidt-Straße74172 Neckarsulm, GermanyPhone (+49-7132) 330Fax (+49-7132) [email protected]

KS Plain Bearings division

KS Gleitlager GmbHAm Bahnhof 1468789 St. Leon-Rot, GermanyPhone (+49-6227) 560Fax (+49-6227) [email protected]

KS Aluminum Technology division

KS Aluminium-Technologie AGHafenstraße 2574172 Neckarsulm, GermanyPhone (+49-7132) 331Fax (+49-7132) [email protected]

Motor Service division

MSI Motor-Service International GmbHUntere Neckarstraße74172 Neckarsulm, GermanyPhone (+49-7132) 33 33 33Fax (+49-7132) [email protected]

Kolbenschmidt Pierburg AGRheinmetall Allee 140476 Düsseldorf, GermanyPhone (+49-211) 4 73 47 18Fax (+49-211) 4 73 41 57www.kspg-ag.com

73

Imprint

© 2006Kolbenschmidt Pierburg AktiengesellschaftRheinmetall Allee 140476 Düsseldorf, Germany

Contacts

Corporate Communications AutomotiveFolke HeyerPhone (+49-2131) 520-3010Fax (+49-2131) 520-2014 [email protected]

Investor RelationsFranz-Bernd ReichPhone (+49-211) 473-4777Fax (+49-211) [email protected]

All rights reserved and subject to technical alteration. Theterms employed in this annual report may be brand names,which, if used by third parties for their own purposes, couldinfringe the rights of the owners.

Copies of this annual report, which is also available in aGerman version, can be obtained by contacting the company;or can be downloaded at www.kspg-ag.com.

In cases of doubt, the German version takes precedence.

ProductionSchmitz-Design, Düsseldorf

PrinterDruckerei Meinke, Neuss


Rheinmetall Allee 140476 Düsseldorf, Germany

Phone +49 211 473-4718Fax +49 211 473-4157

www.kspg-ag.com

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