K-ML 3.13.308 serial key or number

Pirelli & C. S.p.A. — Milan

Annual financial

report 2008

Pirelli & C. S.p.A. - Milan

Annual financial

report 2008

EXTRAORDINARY SESSION CONSOLIDATED FINANCIAL STATEMENT SUSTAINABILITY REPORT DIRECTORS' REPORT PRELIMINARY INFORMATION

2 PIRELLI & C. S.p.A. MILAN

Call to the Annual General

Shareholders’ Meeting

The ordinary shareholders of Pirelli & C. Società per Azioni are

called to the ordinary and special sessions of the shareholders’

meeting to be held in Milan, Viale Sarca 214

—— at 10:30 A.M. on Monday April 20, 2009 in first call;

—— at 10:30 A.M. on Tuesday April 21, 2009 in second call to discuss

and pass resolutions on the following

AGENDA

Ordinary session

1.

2.

The financial statements at December 31, 2008. Inherent and

consequent resolutions.

Appointment of the board of statutory auditors:

— appointment of standing and alternate auditors;

— appointment of the chairman of the board of statutory auditors;

— determination of the compensation of the members of the

board of statutory auditors.

Extraordinary session

— Reduction of the revaluation reserves Law 72/1983 and Law

413/1991 to the extent of the amount used to cover the loss in

financial statements at December 31, 2008.

ANNUAL FINANCIAL REPORT 2008

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EXTRAORDINARY SESSION CONSOLIDATED FINANCIAL STATEMENT SUSTAINABILITY REPORT DIRECTORS' REPORT PRELIMINARY INFORMATION

Contents

Preliminary information 3

Call to the Annual General Shareholders’ Meeting 3

Pirelli & C. S.p.A. Board of Directors 7

Structure of Pirelli Group at December 31, 2008 8

Five-year summary of selected consolidated financial data 9

Chairman’s letter 10

Directors' report 13

Directors' report on operations 15

Significant events in 2008 17

The Group 23

Research and Development 31 / Information systems 37 / Significant events subsequent to the end

of 2008 39 / Risks and uncertainties 41 / Outlook for the current year 45

Pirelli Tyre 46

Business Consumer 50 / Business industrial 52 / Capital Expenditures 52 / Headcount 54

Outlook for the current year 54

Pirelli & C. Real Estate 55

Economic review 57 / Balance sheet and financial review 59 / Performance by division in 2008 60

Outlook for the current year 61 / Proposed share capital increase 61

Pirelli Broadband Access 62

Broadband Access 63 / Outlook for the current year 64

Other Businesses 66

Pirelli & C. Eco Technology 66 / Pirelli & C. Ambiente 67 / PZero 68

Pirelli & C. S.p.A. Summary of selected data 69

Balance sheet and financial position 69 / Income statement 72 / Compensation paid to Directors,

Statutory Auditors and General Managers 74 / Equity investments held by Directors, Statutory

Auditors, General Managers and Key Managers 75 / Stock option plans 76 /

Information on ownership structures (ex art. 123 Bis tuf) 76 / Security planning document 76

Compliance with Article 36 of Consob Regulation 16191/2007 concerning market regulations 77

Shareholders’ resolution 78

Corporate Governance Report 2008 Financial Year 84

Sustainability report 163

A note on methodology 165

Pirelli and sustainable development 167

Identification of Stakeholders and approach adopted 167 / Sustainable Governance 168

Economic dimension 185

Added value 185 / Shareholders 187 / Customers 188 / Suppliers 203

Environmental dimension 211

The Pirelli approach to the management of environmental issues 211 / Pirelli Tyre S.p.A. 212

Pirelli & C. Real Estate S.p.A. 230 / Pirelli Eco Technology S.p.A. / Technologies for Sustainable

Development 234 / Pirelli & C. Ambiente S.p.A. 239 / Pirelli Labs S.p.A. 244 / Pirelli Broadband

Solutions S.p.A. 248

Social dimension 251

Internal Community 251 / External Community 292 / Summary tables 306 / Assurance Letter 308

4 PIRELLI & C. S.p.A. MILAN

Consolidated financial statement 311

Consolidated balance sheet 312 / Consolidated income statement 313 / Consolidated statement of

recognized income and expenses 314 / Consolidated statement of cash flows 315

Notes to the consolidated financial statements 316

1. General information 316 / 2. Basis of presentation 317 / 3. Accounting policies 325 /

4. Financial risk management policies 336 / 5. Capital management policies 341 /

6. Estimates and assumptions 341 / 7. Segment information 344 / 8. Property, plant and

equipment 348 / 9. Intangible assets 352 / 10. Investments in associates and joint ventures 355 /

11. Other financial assets 359 / 12. Deferred tax assets and liabilities 361 /

13. Trade receivables 363 / 14. Other receivables 364 / 15. Tax receivables 365 /

16. Inventories 366 / 17. Securities held for trading 366 / 18. Cash and cash equivalents 367 /

19. Equity 367 / 20. Stock option plans 370 / 21. Tax payables 377 / 22. Provisions for other

liabilities and charges 377 / 23. Employee benefit obligations 378 / 24. Borrowings from banks and

other financial institutions 384 / 25. Trade payables 388 / 26. Other payables 389 / 27. Derivative

financial instruments 389 / 28. Commitments and contingencies 391 / 29. Revenues from sales and

services 394 / 30. Other income 394 / 31. Personnel costs 394 / 32. Amortization, depreciation and

impairments 395 / 33. Other expenses 395 / 34. Financial income 396 / 35. Financial expenses

397 / 36. Impairment losses on investments 397 / 37. Dividends 397 / 38. Gains (losses) from

changes in fair value of financial assets 398 / 39. Share of earnings (losses) of associates and joint

ventures 398 / 40. Income taxes 399 / 41. Income (loss) from discontinued operations 400 /

42. Earnings per share 401 / 43. Dividends per share 402 / 44. Related party disclosures 402 /

45. Significant subsequent events 404 / 46. Other information 405 / Independent auditors’ report 419

Extraordinary session 421

Report prepared by the directors 422

ANNUAL FINANCIAL REPORT 2008

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EXTRAORDINARY SESSION CONSOLIDATED FINANCIAL STATEMENT SUSTAINABILITY REPORT DIRECTORS' REPORT PRELIMINARY INFORMATION

6 PIRELLI & C. S.p.A. MILAN

Pirelli & C. S.p.A.

Board of Directors¹

Chairman 2

Deputy Chairman 2

Deputy Chairman 2

Directors:

* Independent director

° Member of the Internal Control and Corporate Governance Committee

^ Member of the Remuneration Committee

Secretary to the Board

Marco Tronchetti Provera

Alberto Pirelli

Carlo Alessandro Puri Negri

Carlo Acutis*

Carlo Angelici* °

Cristiano Antonelli*

Gilberto Benetton

Alberto Bombassei* ^

Franco Bruni* °

Luigi Campiglio*

Enrico Tommaso Cucchiani

Berardino Libonati* ^

Giulia Maria Ligresti

Massimo Moratti

Renato Pagliaro

Umberto Paolucci*

Giovanni Perissinotto

Giampiero Pesenti* ^

Luigi Roth*

Carlo Secchi* °

Anna Chiara Svelto

BOARD OF STATUTORY AUDITORS 3

Chairman

Standing auditors

Alternate auditors

Luigi Guatri

Enrico Laghi

Paolo Domenico Sfameni

Franco Ghiringhelli

Luigi Guerra

GENERAL MANAGER

Operations

INDEPENDENT AUDITORS 4

Claudio De Conto

Reconta Ernst & Young S.p.A.

MANAGER RESPONSIBLE FOR THE PREPARATION

OF THE FINANCIAL REPORTS OF THE COMPANY 5 Claudio De Conto

1 Appointment: April 29, 2008. Expiry: shareholders’ meeting called to approve the financial statements at December

31, 2010.

2 Post conferred by the board of directors’ meeting held on April 29, 2008.

3 Appointment: April 21, 2006. Expiry: shareholders’ meeting called to approve the financial statements at December

31, 2008. Paolo Domenico Sfameni was appointed by the shareholders’ meeting held on April 29, 2008 to replace

Paolo Francesco Lazzati who resigned.

4 Post conferred by the shareholders’ meeting held on April 29, 2008.

5 Appointment: conferred by the board of directors’ meeting held on April 29, 2008. Expiry: shareholders’ meeting

called to approve the financial statements at December 31, 2010.

ANNUAL FINANCIAL REPORT 2008

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EXTRAORDINARY SESSION CONSOLIDATED FINANCIAL STATEMENT SUSTAINABILITY REPORT DIRECTORS' REPORT PRELIMINARY INFORMATION

Structure of Pirelli Group at December 31, 2008

100 %

PIRELLI

LABS S.p.A.

market trading on the milan stock exchange

8 PIRELLI & C. S.p.A. MILAN

Shares traded volume

Amount (in Euros)

Pirelli & C. S.p.A. - ordinary shares 7.869.785.649 3.754.089.026

Pirelli & C. S.p.A. - saving shares 79.065.631 39.708.121

number of shares outstanding

100%

PIRELLI

TYRE S.p.A.

100 % 51% 51%

PIRELLI BROADBAND

SOLUTIONS S.p.A.

PIRELLI & C. S.p.A.

PIRELLI & C.

AMBIENTE S.p.A.

at December 31, 2008 at March 9, 2009

Pirelli & C. S.p.A. - ordinary shares 5.233.142.003 5.233.142.003

Pirelli & C. S.p.A. - saving shares 134.764.429 134.764.429

56,5%

PIRELLI & C.

REAL ESTATE S.p.A.

PIRELLI & C.

ECO TECHNOLOGY S.p.A.

Five-year summary of selected consolidated

financial data

IAS/IFRS (in milions of Euro)

2008 2007 2006 2005 2004

Net sales 4,660 6,076 4,841 4,546 3,967

Net sales (excluding DGAG)* 4,660 4,780 4,841 4,546 3,967

Gross operating profit 252 573 614 568 470

Operating profit 43 364 401 355 269

Operating profit (loss) including earning (losses) from investments (323) 513 1,192 622 425

Total income (loss) (413) 324 (1,049) 399 304

Income (loss) attributable to the equity holders

of Pirelli & C. S.p.A (348) 165 (1,167) 327 251

Earnings per share (in Euros) (0.06) 0.03 (0.22) 0.07 0.07

Fixed assets 3,665 3,815 6,924 7,624 6,097

Net working capital 418 298 463 (48) 464

Net invested capital 4,083 4,113 7,387 7,576 6,561

Equity 2,374 3,804 4,687 5,614 3,841

Provisions 681 611 720 785 1,119

Net financial (liquidity)/debt position 1,028 (302) 1,980 1,177 1,601

Equity attributable to the equity holders

of Pirelli & C. S.p.A. 2,172 2,980 3,880 5,205 3,502

Equity per share (in Euros) 0.40 0.56 0.72 0.98 1.01

Net cash flows provided by (used for) operating activities 76 554 473 467 349

R&D expenditures 156 173 171 174 171

Depreciation 199 214 201 197 182

Capital expenditures 311 287 255 234 211

Gross operating profit/Net sales* 5.41% 11.99% 12.68% 12.49% 11.85%

Operating profit/Net sales * - ROS 0.93% 7.62% 8.28% 7.81% 6.78%

Income / equity** - ROE (13.35%) 7.63% (20.37%) 7.38% 5.77%

Operating profit / Net invested capital** - ROI 1.05% 6.33% 5.36% 5.02% 4.13%

Operating profit (post-investments)/ Net invested capital** (7.89%) 8.92% 15.93% 8.80% 6.52%

Net financial position / Equity - gearing 0.43 n.s. 0.42 0.21 0.42

Capital expenditures / Depreciation 1.56 1.34 1.27 1.19 1.16

R & D expenditures / Net sales* 3.35% 3.62% 3.53% 3.83% 4.31%

Net sales* per employee (in thousands of Euros) 148 155 172 173 162

Pirelli & C. S.p.A. Ordinary shares (no. in millions) 5,233.1 5,233.1 5,233.1 5,180.7 3,327.5

Pirelli & C. S.p.A. Savings shares (no. in milllions) 134.8 134.8 134.8 134.8 134.8

Total Pirelli & C. S.p.A. shares (no. in millions) 5,367.9 5,367.9 5,367.9 5,315.5 3,462.3

Treasury ordinary shares (no. in millions) 3.9 2.6 2.6 2.6 2.6

Treasury savings shares (no. in millions) 4.5 - - - -

Factories 23 24 24 24 74

of which discontinued operations - - - - 52

Employees (at 12/31) 31,056 30,823 28,617 26,827 24,790

of which temporary employees 2,913 3,642 3,479 3,102 2,721

* On net sales excluding DGAG

** Average amount

ANNUAL FINANCIAL REPORT 2008

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EXTRAORDINARY SESSION CONSOLIDATED FINANCIAL STATEMENT SUSTAINABILITY REPORT DIRECTORS' REPORT PRELIMINARY INFORMATION

Chairman’s letter

Shareholders,

These financial statements fall in the heart of one of the gravest

international economic crisis of the last half century, with

effects, in terms of both revenues and operating profit, also on

Pirelli & C. and its subsidiaries. But, at the same time, they record

the effects of the timely measures that were decided to tackle this

crisis and create the conditions for a turnaround.

These are difficult financial statements that speak of downsizing,

cutbacks, sacrifices and reconversions. Note is taken of the recession,

with realism and a sense of responsibility. But, foremost, the

gaze is to the future.

Values, production models and consumption, in fact, change. Relationships

between finance and company are reshaped. Yes, the

reflection is on the need to have open markets, but also markets

kept well under control, based on principles of transparency and

accountability. Above all, both economically and socially, industry

is again taking a prominent role, relaunching a characteristic

in which Italian companies boast positions of excellence: the

quality of a manufactured product with high value-added. An innovative

industry, with a global reach, strong in its growing commitment

to research and closely connected with technologically

advanced services.

10 PIRELLI & C. S.p.A. MILAN

In this process, Pirelli continues to hold leading positions and

prospects. The Pirelli Group, in actual fact, reorganizes the productive

processes of all its businesses, at all times, oriented toward

competitiveness. It invests in new products, adapted to conquering

growing spaces on markets that are ever-more discerning

and selective. And it has an ambitious objective, in terms of environmental

and social sustainability, to push the green proportion

of our products from the current 20 percent to 40 percent within

a space of three years.

The Pirelli Group is therefore concentrating on tyres and particulate

filters, for a mobility that joins safety to environmental

sustainability. Now and for the next three years it will invest in

technological development and innovation. It is reorganizing the

activities of Pirelli Real Estate to better manage the real estate

portfolio of prestige properties and margins. It looks to the renewable

energy segment with commitment.

In the course mapped out in the three-year plan 2009-2011, investments

will also be oriented, both abroad and in Italy, where a

decisive impulse will be given by the new Settimo Torinese Hub:

the most modern tyre factory in the world, with a much reduced

environmental impact and with processing and products of excellence.

An example that will serve to inspire the other productive

operations of the group.

Our commitment lies right here: confront the crisis with consciousness,

competence and in keeping with strategies aimed at

development.

ANNUAL FINANCIAL REPORT 2008

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Directors'

report

EXTRAORDINARY SESSION CONSOLIDATED FINANCIAL STATEMENT SUSTAINABILITY REPORT DIRECTORS' REPORT PRELIMINARY INFORMATION

14 PIRELLI & C. S.p.A. MILAN

Directors' report

on operations

Shareholders,

In 2008, the Pirelli & C. Group suffered as a result of the international

financial crisis which signaled a sharp downturn of the

global economy that had serious repercussions on the automotive

and real estate sectors. In order to confront this scenario, during

the year the group launched a far-reaching restructuring process

which was accelerated in the fourth quarter in the light of the

prospects for 2009 which again made it necessary to implement

measures that could ensure efficiency and competitiveness.

The negative performance of the financial markets caused the value

of financial assets to decline. This resulted in an impairment on

the stakes held in listed companies, in reference to the investments

held in Telecom Italia S.p.A., RCS Mediagroup S.p.A. and Avanex

Corporation of Euros 263 million.

On the whole, the Group ended the year with a slight fall in revenues,

on a like-for-like basis, (taking into account the assets classified

to discontinued operations and the sales made in 2007 for

the deconsolidation of DGAG and the foreign exchange effect).

The Group also reported an operating profit, even after restructuring

expences of Euro 144.2 million, although it was considerably

lower than in 2007. The bottom line is a loss of Euros 412.5

million which includes the impairment loss on real estate assets

for Euros 136 million and the impairment loss on financial assets

for Euros 263 million.

The net financial position at December 31, 2008 is a net debt position

of Euros 1,028 million with equity of Euros 2,374 million. It

should be noted that financial investments were made during the

year for the purchase of the 38.9 percent stake in Pirelli Tyre (Euros

835 million) and minority stakes in the companies in Turkey

(Euros 43 million). These investments are part of the strategy to

boost the tyre business.

ANNUAL FINANCIAL REPORT 2008

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With regard to its core businesses, Pirelli Tyre closed 2008 with

slightly higher revenues on a like-for-like basis, despite the very

negative economic situation. Margins were affected by raw material

price increases which, in 2008, brought higher costs of about

Euros 200 million, and also by the crisis in the car market which

hit the Original Equipment channel.

To combat this scenario, the company launched restructuring

measures which were accelerated in the last quarter in the presence

of a further deterioration of the market. The aim of these

measures is to strengthen the competitiveness of the industrial

operations in Europe and reduce the costs of central structures

and thus produce an impact on the income statement of Euros

100 million.

The operating profit before restructuring expenses is Euros 250.7

million, with a reduction of 30 percent compared to Euros 358.1

million in 2007. If restructuring expenses are also taken into account,

the operating profit is equal to Euros 150.7 million.

In Real Estate, the market suffered from a year of serious international

crisis. Falling prices, fewer transactions and the credit

crunch penalized all companies in the sector. To contrast the

changed scenario, the Pirelli & C. Real Estate group (henceforth

referred to as ‘Pirelli RE’) implemented a program to reduce costs

and reorganize its operations. The program, which focuses on the

two macro-geographical areas of Italy and Germany/Poland, aims

to relaunch activities and capitalize on the quality of the assets

in the real estate portfolio.

In this scenario, real estate sales are down 48 percent overall from

last year, the operating result including earnings (losses) from investments,

before restructuring expenses and impairment losses/

reversals, is an operating loss of approximately Euros 59.7 million

against an operating profit of Euros 83.6 million in 2007 (net of the

temporary contribution by DGAG of Euros 21.4 million). The operating

loss was then impacted by impairment losses of Euros 135.8 million

and restructuring expenses of Euros 44.2 million in connection

with the rationalization of the structures and the organization.

With regard to other businesses, Pirelli Broadband Solutions,

the company that is active in broadband access systems,

continued to grow, with an increase in revenues and growth in

profit results. As far as Environment and Sustainable Mobility

activities are concerned, investments continued during the

year in Romania for the production of particulate filters, where

operations began at the end of the year.

The Parent, Pirelli & C. S.p.A., closed the year with a loss of

Euros 189.5 million, having been directly or indirectly affected by

the impairment losses recognized on listed companies for Euros

263 million.

16 PIRELLI & C. S.p.A. MILAN

Significant events in 2008

With regard to the transaction for the reduction of share capital

approved by the Pirelli & C. S.p.A. special shareholders’ meeting

held on December 12, 2007 and the Pirelli & C. S.p.A. special

shareholders’ meeting of the savings shareholders held on December

14, 2007, the savings shareholders that did not approve

the above resolution had until January 5, 2008 to exercise their

withdrawal right. At the end of that time, the withdrawal right

had been exercised for a total of 4,546,093 shares.

In accordance with the law, such shares were offered to all Pirelli

& C. S.p.A. shareholders from January 28 to February 27, 2008 at

a per share price of Euros 0.8055 (equal to the arithmetic mean of

the stock market price over the previous six months).

At the end of the placement period, 54,324 shares had been purchased.

The remaining 4,491,769 shares were offered on the stock

market between March 18 and March 26, 2008 inclusive, always at

the per share price of Euros 0.8055. This offer ended without any

purchases being made.

On March 27, 2008, Pirelli & C. S.p.A. therefore purchased all the

4,491,769 remaining shares that had not been placed at the per

share price of Euros 0.8055, for a total amount of about Euros 3.6

million, by using available reserves.

On April 3, 2008, the “extraordinary dividends” of Euros 0.154 per

each ordinary and savings share were then paid, for a total of Euros

826 million.

After this transaction, the share capital of Pirelli & C. S.p.A. is

equal to Euros 1,556,692,865.28. The total number of shares remains

unchanged (5,233,142,003 ordinary shares and 134,764,429

savings shares), whereas the par value per share went from Euros

0.52 to Euros 0.29.

In October 2008, Pirelli & C. S.p.A. purchased 1,250,000 treasury

shares on the market (equal to 0.02 percent of total ordinary

shares issued) for Euros 0.4 million.

At December 31, 2008, Pirelli & C. S.p.A. holds 3,867,500 ordinary

treasury shares (equal to 0.07 percent of share capital) and

4,491,769 savings treasury shares (equal to 0.08 percent of share

capital).

On January 16, 2008, Acea and Pirelli Ambiente announced that

the 50-50 A.PI.C.E. joint venture will operate in the sector of

sources of renewal energy from waste and will combine Acea’s

expertise and territorial roots with Pirelli Ambiente’s experience

and technology to carry out projects aimed at the manufacture of

CDR-Q, a fuel derived from quality waste, which will be used in

thermo-electric power plants and cement factories.

On January 17, 2008, Pirelli unveiled the new Cinturato Pirelli.

The tyre that set the pace for traveling in style in Italy and the

world starting from the mid-fifties was revisited in a new version

which combines all of the very best in state-of-the art technologies,

safety and ecosustainability.

On February 22, 2008, the Piedmont Region, the Province of Turin,

the City of Settimo Torinese, the Politecnico University of

ANNUAL FINANCIAL REPORT 2008

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18 PIRELLI & C. S.p.A. MILAN

Slatina, Romania – Car tyre factory

Turin and the Pirelli Group sealed a collaboration agreement

aimed at developing research and innovation programs under the

project to build a new Pirelli industrial hub in Settimo Torinese.

Pirelli plans to invest about Euros 140 million in the Settimo Torinese

project.

On March 11, 2008, Pirelli & C. S.p.A. reached an agreement to acquire

the entire share capital of Speed S.p.A., a company in which

interests are held by leading financial institutions (Intesa San-

Paolo, Gruppo Banca Leonardo, UniCredit, One Equity Partners

- JP Morgan Group, Lehman Brothers and Mediobanca), and, the

holder, since August 2006, of the 38.9 percent stake in Pirelli Tyre

S.p.A., for Euros 434.4 million which was financed by the company’s

liquid resources. The price takes into account a loan by

Speed S.p.A. of Euros 401.1 million. Following the acquisition of

the equity of the minority shareholders, the Group owns 100 percent

of Pirelli Tyre S.p.A..

On April 22, 2008, the Pirelli Group and Politecnico University of

Milan sealed an agreement to set up a chair on “Chemical Foundations

of Rubber and Compounds Technology”.

The new professorship will study innovative materials and the use

of nanotechnology for the development of new-generation tyres.

Pirelli will also fund five PhD research scholarships under this

agreement over a period of 10 years in the Chemical, Materials

and Chemical Engineering “G. Natta” Department at Politecnico

University of Milan.

On June 3, 2008, the Pirelli Group announced its intention to increase

production in Egypt thanks to a new investment of U.S.

$65 million to expand the capacity of the radial tyre factory for

trucks and buses in Alessandria in Egypt. The new investment

will enable this Egyptian factory to raise its annual production to

one million pieces and become the largest radial tyres production

facility for industrial vehicles in the MEA area (Middle East and

Africa).

On June 16, 2008, Pirelli & C. S.p.A. sold the remaining stake in

Intek S.p.A. (6,149,354 ordinary shares equal to 1.768 percent of

the company’s ordinary share capital) to Quattroduedue Holding

B.V. for approximately Euros 5 million. The transaction reflects

the execution of the put&call agreement between the two companies

sealed on January 9, 2007.

On July 10, 2008, the Italian Ministry for the Environment signed

an agreement with the City of Beijing to begin an experiment in

the Chinese capital on the particulate filter technology developed

by Pirelli Eco Technology. Such filters are capable of reducing

fine particle diesel engine emissions by more than 95 percent.

The agreement calls for the installation of Pirelli filtering systems

on heavy vehicles (mainly buses, but also trucks and later

snow ploughs and tractors) that will be supplied to the local public

transport company. The first filtering systems were installed

before the start of the Olympics in August 2008.

On July 24, 2008, an agreement was signed between Pirelli and Cy-

Optics Inc. to integrate PGT Photonics S.p.A., a photonics com-

ANNUAL FINANCIAL REPORT 2008

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EXTRAORDINARY SESSION CONSOLIDATED FINANCIAL STATEMENT SUSTAINABILITY REPORT DIRECTORS' REPORT PRELIMINARY INFORMATION

pany in the Pirelli Group, resulting from the spin-off of Pirelli

Broadband Solutions and Pirelli Labs activities, in CyOptics, a

privately-owned American company which is a leader in the field

of optical components based on indium phosphide technology. At

the same time, Pirelli subscribed to a CyOptics capital increase

with a cash contribution of U.S. $20 million.

Following the operation, Pirelli holds a 34.5 percent stake in the

new CyOptics.

On July 28, 2008, the consortium formed by RREEF, Generali and

Borletti completed the acquisition of a 49 percent stake in Highstreet,

an investment company that owns properties leased to the

German Karstadt department store chain. Highstreet has a portfolio

of properties throughout Germany with a total gross area

of 3.2 million square meters (the gross sales area is 2.1 million

square meters). The enterprise value at the date of acquisition

is equal to approximately Euros 4.6 billion, with about Euros 3.5

billion of loans secured by the properties.

On August 21, 2008, Pirelli Tyre S.p.A. purchased the minority

stakes in the two subsidiaries through which it operates in

Turkey from Isbank. The group acquired 25.75 percent of Pirelli

Turk Lastikleri A.S. (which manufactures and markets car and

industrial vehicle tyres) and 48 percent of Celikord A.S. (which

manufactures and markets steelcord). As part of the transaction,

Pirelli also acquired another 1 percent stake in Celikord from

other shareholders. The total amount of the transactions is about

Euros 43 million, with a positive impact on the result for the year

of Euros 27.3 million owing to the fact that the cost of acquisition

is lower than the relative accounting net assets acquired. Following

the agreement, Pirelli holds 95.35 percent of Pirelli Turk

Lastikleri and 100 percent of Celikord. The operation strengthens

the group’s position in a country that is strategic in terms of

manufacturing, marketing and logistics.

On October 20, 2008, Pirelli Eco Technology S.p.A., the company

in the Pirelli Group which operates in the field of technologies for

controlling emissions from diesel engines, announced that it was

the first in Italy to obtain homologation from the Italian Ministry

of Infrastructures and Transportation for five types of particulate

filters for existing light and heavy trucks. The Pirelli particulate

filters, developed using silicon carbide technology, can reduce

fine-particle diesel engine emissions by more than 95 percent, and

can make a significant contribution to improving air quality.

As a result of homologation, vehicles fitted with Pirelli’s particulate

filters will have a better category of exhaust from the standpoint

of the Euro standards (the range is Euro0 - Euro5) and will

also be allowed to circulate freely in urban areas where vehicles

that produce greater pollution are denied access.

On October 21, 2008, the bonds of Euros 500 million issued by

Pirelli & C. S.p.A. in 1998 with a fixed rate of 4.875 percent were

repaid, in accordance with the contractual maturity date.

On November 5, 2008, the Pirelli RE board of directors approved

the terms and conditions of the contract for the sale, to Manutencoop

Facility Management, of its 50 percent stake in Pirelli Re

20 PIRELLI & C. S.p.A. MILAN

Yanzhou, China – Mixing department

ANNUAL FINANCIAL REPORT 2008

21

EXTRAORDINARY SESSION CONSOLIDATED FINANCIAL STATEMENT SUSTAINABILITY REPORT DIRECTORS' REPORT PRELIMINARY INFORMATION

Integrated Facility Management, a 50-50 joint venture with Intesa

Sanpaolo which, through its investment holdings, supplies

project management and facility management services. The closing

of the transaction and the announcement to the market, once

all the conditions precedent had been satisfied and the necessary

authorization were obtained from the Antitrust Authority,

took place on December 23, 2008. The sales price of 100 percent

of Pirelli RE Integrated Facility Management, including the 50

percent interest held by Intesa Sanpaolo, was equal to Euro 137.5

million and divided between the two seller companies Pirelli RE

and Intesa Sanpaolo, against an Enterprise Value of Euros 270

million. For the Pirelli RE group, the impact on the net financial

position, excluding Pirelli RE shareholder loans, was an approximate

positive Euros 91 million.

On November 6, 2008, Pirelli & C. S.p.A. and Russian Technologies

sealed an agreement for a new industrial joint venture between

the two companies that will start production of tyres in Russia

within the next two to three years, compatible with the evolution

of the macroeconomic scenario. To date, the agreements signed

between the two companies call for the building of a new site for

the manufacture of car and truck tyres in the Samara region with

initial production capacity of about 4.2 million pieces, for a joint

investment of approximately Euros 300 million.

During 2008, Pirelli & C. S.p.A. purchased 1,184,468 Pirelli & C.

Real Estate S.p.A. shares on the market for a total outlay of Euros

22.1 million. At December 31, 2008, Pirelli & C. S.p.A. directly

holds 24,046,432 Pirelli & C. Real Estate S.p.A. shares equal to

56.45 percent of share capital.

In December 2008, Pirelli Finance (Luxembourg) S.A. sold

5,000,000 Telecom Italia S.p.A. ordinary shares on the market for

total proceeds of Euros 5.8 million. At December 31, 2008, Pirelli

& C. S.p.A. holds 177,113,185 Telecom Italia S.p.A. ordinary shares

equal to 1.32 percent of voting stock (directly and indirectly

through the subsidiary Pirelli Finance (Luxembourg) S.A.).

Subsequently, in January 2009, Pirelli Finance (Luxembourg) S.A.

sold 8,490,000 Telecom Italia S.p.A. ordinary shares on the market

for total proceeds of Euros 10 million.

Therefore, Pirelli & C. S.p.A. now holds 168,623,185 Telecom Italia

S.p.A. ordinary shares equal to 1.26 percent of voting stock

(directly and indirectly through the subsidiary Pirelli Finance

(Luxembourg) S.A.).

22 PIRELLI & C. S.p.A. MILAN

The Group

ALTERNATIVE PERFORMANCE MEASURES

In this report on operations, in addition to the financial performance

measures established by IFRS, certain non-IFRS measures

originated from the latter are presented although they are not

required by IFRS (Non-GAAP Measures).

These performance measures are presented for purposes of a better

understanding of the trend of operations of the group and

should not be construed as a substitute for the information required

by IFRS.

Specifically, the Non-GAAP Measures used are described as follows:

——

Gross operating profit: this financial measure is used by the

group as the financial target in internal business plans and

in external presentations (to analysts and investors). It represents

a useful unit of measurement for the evaluation of the

operating performance of the group as a whole and for each

single segment, in addition to the Operating Profit. The Gross

Operating Profit is an intermediate performance measure represented

by the Operating Profit from which depreciation and

amortization are excluded.

——

Earnings (losses) from investments: earnings (losses) from

investments consist of all the effects recorded in the income

statement referring to investments that are not consolidated

line-by-line. These include dividends, the share of the earnings

(losses) of companies accounted for using the equity method,

impairment losses on available-for-sale financial assets and

gains (losses) on the disposal of available-for-sale financial assets.

Changes in the fair value of available-for-sale financial

assets which are recognized directly in equity are excluded.

——

Net financial (liquidity)/debt position: this performance

measure is represented by the gross financial debt less cash

ANNUAL FINANCIAL REPORT 2008

23

EXTRAORDINARY SESSION CONSOLIDATED FINANCIAL STATEMENT SUSTAINABILITY REPORT DIRECTORS' REPORT PRELIMINARY INFORMATION

and cash equivalents as well as other interest-earning financial

receivables. The Notes present a table that shows the balance

sheet amounts used to calculate the net financial (liquidity)/

debt position.

The Five-year summary of selected consolidated financial data

published at the beginning of the report includes other measures

formed by an aggregation of IFRS performance measures.

In particular:

——

Fixed assets: this measure is the sum of the line items “Property,

plant and equipment”, “Intangible assets”, “Investments in

associates and joint ventures” and “Other financial assets”.

——

Provisions: this measure is the sum of the line items

“Provisions for other liabilities and expenses (current and

non-current)”, “Employee benefit obligations” and “Deferred

tax liabilities”;

——

Net working capital: this measure is formed by all other line

items not included in the two above measures, in “Equity” and

the “Net financial position”.

INCOME (LOSS) FROM DISCONTINUED OPERATIONS

The Photonics business and the Integrated Facility Management

business of Pirelli RE which were sold during the

course of 2008 are considered "discontinued operations" and

consequently contribute solely to the net result for the year.

Therefore, for purposes of comparison, the income statement

figures relating to 2007 are presented excluding the results of the

discontinued operations.

24 PIRELLI & C. S.p.A. MILAN

GROUP CONSOLIDATION

The highlights of the Group’s consolidated financial statements for

the year ended December 31, 2008 can be summarized as follows:

(in millions of euro)

12/31/2008 12/31/2007

Net sales 4,660.2 6,075.6

Net sales (excluding DGAG deconsolidation) 4,660.2 4,780.0

Gross operating profit before restructuring expenses 396.1 572.8

% of net sales (excluding DGAG deconsolidation) 8.5% 12.0%

Operating profit before restructuring expenses 187.4 364.0

% of net sales (excluding DGAG deconsolidation) 4.0% 7.6%

Restructuring expenses (144.2) -

Operating profit 43.2 364.0

% of net sales (excluding DGAG deconsolidation) 0.9% 7.6%

Earnings (losses) from investments (366.5) 148.6