General information / Basis of presentation

1. General information

Pirelli & C. S.p.A. is a corporation organized under the laws of the Republic of Italy.

Founded in 1872 and listed on the Milan Stock Exchange, Pirelli & C. S.p.A. is a holding company which manages, coordinates and finances the operations of its subsidiaries.

At the balance sheet date, the Group’s operations are principally represented by investments in:

  • Pirelli Tyre S.p.A. – a company operating in the tyre sector – 100 percent stake in share capital.
  • Pirelli & C. Eco Technology S.p.A. – a company active in the field of technologies for reducing emissions – 51 percent stake in share capital.
  • Pirelli & C. Real Estate S.p.A. – a listed company operating in the real estate sector – 56.45 percent stake in share capital.
  • Pirelli Broadband Solutions S.p.A. – a company operating in the field of telecommunications components, equipment and systems – 100 percent stake in share capital.
  • Pirelli & C. Ambiente S.p.A. – a company operating in the field of renewable sources of energy – 51 percent stake in share capital.

The head office of the company is located in Milan, Italy.

The consolidated financial statements are audited by Reconta Ernst & Young S.p.A., pursuant to art. 159 of Legislative Decree 58 dated February 24, 1998 and taking into account the Consob recommendation dated February 20, 1997, in execution of the resolution passed by the shareholders on April 29, 2008 which engaged the audit firm for the period 2008-2016.

The consolidated financial statements were approved by the board of directors held on March 10, 2009.

2. Basis of presentation

Although the challenging economic and financial picture has triggered a slowdown of the world economy that has had a particularly sharp impact on the automotive and real estate sectors and, consequently, has negatively affected the consolidated results for the year 2008, there are no significant doubts about the continuity of the company as a going concern.

Disclosure as to major uncertainties is summarized in the report on operations.

The market scenario facing the Group has nevertheless driven it to review its strategies and devise a decisive action plan aimed at ensuring maximum efficiency and competitiveness. The main strategic courses of action, the measures adopted and the correlated sources of available financial resources for their implementation were announced when the 2009-2011 Industrial Plan was presented to the financial community.

Accordingly, the consolidated financial statements have been prepared using accounting principles on a going concern basis.

ACCOUNTING STANDARDS ADOPTED

In accordance with Regulation 1606 issued by the European Parliament and by the Council of the European Union in July 2002, the consolidated financial statements of the Pirelli & C. Group have been prepared in accordance with International Financial Reporting Standards (IFRS) in force issued by the International Accounting Standards Board (IASB) and endorsed by the European Union as at December 31, 2008, as well as the measures emanated for the implementation of art. 9 of Legislative Decree 38/2005. The designation IFRS also includes all effective revised International Accounting Standards (IAS) and all Interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC), formerly named the Standing Interpretations Committee (SIC).

The consolidated financial statements have been prepared under the historical cost convention except for investment property (held by companies in the Real Estate sector, accounted for by the equity method), derivative financial instruments, financial assets designated at fair value and available-for-sale financial assets, which are measured at fair value.

ACCOUNTING STANDARDS AND INTERPRETATIONS ENDORSED AND IN FORCE AS FROM JANUARY 1, 2008

Amendments to IAS 39 “Financial Instruments: Recognition and Measurement” and IFRS 7 “Financial Instruments: Disclosures”: reclassification of financial assets

The purpose of these amendments is to allow – in certain rare circumstances – some financial instruments to be reclassified outside the category “at fair value through profit or loss” to another category, depending on the type of financial asset, that is:

  • financial assets held to maturity, measured at amortized cost;
  • loans and receivables, measured at amortized cost;
  • available-for-sale financial assets, measured at fair value with fair value changes recognized in equity and not through profit or loss.

Reclassification is not permitted for:

  • derivatives of any kind;
  • financial assets measured at fair value through profit or loss designated at initial recognition.

Such amendments were endorsed by the European Union in October 2008 (EC Regulation 1004/2008). The next document issued by the IASB in November 2008 (“Reclassification of Financial Assets – Effective Date and Transition”) clarifies that the effects of the reclassifications made from July 1, 2008 to October 31, 2008 are applicable beginning from July 1, 2008, whereas the effects of the reclassifications made from November 1, 2008 and thereafter are applicable starting from the date of the reclassification.

The application of these amendments did not have any impact on the consolidated financial statements.

ACCOUNTING STANDARDS AND/OR INTERPRETATIONS ISSUED BUT NOT YET IN FORCE AND/OR NOT ENDORSED

As required by IAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”, new Standards or Interpretations issued but not yet in force or not yet endorsed by the European Union and therefore not applicable are summarized and briefly described below.

The Group did not elect the early adoption of any of these Standards or Interpretations.

IFRIC 11 – IFRS 2 – Group and Treasury Share Transactions

This interpretation, endorsed by the European Union in June 2007 (EC Regulation 611/2007), provides guidance on the application of IFRS 2 “Share-based Payment” to certain types of plans that involve different units of the Group.

IFRIC 11 is applicable from January 1, 2009. The application of this interpretation is not expected to have a material impact on the consolidated financial statements.

IFRIC 12 – Service Concession Arrangements

IFRIC 12 addresses private sector operators contracted for the supply of typical public sector services (e.g. roads, airports and energy and water distribution under concession arrangements). Under these arrangements, the assets are not necessarily controlled by the private operators which, however, are responsible for constructing, operating or maintaining the public sector infrastructure. Assets under these arrangements could possibly not be recorded as property, plant and equipment in the financial statements of the private operators but rather as financial assets and/or intangible assets depending on the type of service concession arrangement.

IFRIC 12, not yet endorsed by the European Union, is applicable to the Group but is not expected to have a material impact on the consolidated financial statements.

IFRIC 13 – Customer Loyalty Programmes

IFRIC 13 addresses the accounting treatment that must be adopted by entities that grant loyalty award credits to customers who buy goods or services. It establishes that the fair value of the obligations connected with the loyalty awards must be separated from sales revenues and deferred until the entity has fulfilled its obligation to the customers.

IFRIC 13 was endorsed by the European Union in December 2008 (EC Regulation 1262/2008). The Group decided to apply this interpretation beginning January 1, 2009 but it is not expected to have a material impact on the consolidated financial statements.

IFRIC 14 – IAS 19 The Limit on a Defined Benefit Asset, Minimum Funding Requirements
and their Interaction

IAS 19 “Employee Benefits” establishes a limit on the assets of a defined benefit plan which can be recognized in the balance sheet. This interpretation provides guidance on how to assess this limit and clarifies the impact on the assets and liabilities relating to a defined benefit plan when minimum contractual or statutory funding requirements exist.

IFRIC 14 was endorsed by the European Union in December 2008 (EC Regulation 1263/2008). The Group decided to apply this interpretation beginning January 1, 2009 but it is not expected to have a material impact on the consolidated financial statements.

IFRIC 15 - Agreements for the Construction of Real Estate

This interpretation provides guidelines on determining whether an agreement for the construction of real estate units is within the scope of IAS 11 “Construction Contracts” or IAS 18 “Revenue”, defining the point in time in which revenues should be recognized.

In light of this interpretation, residential development activity falls under the scope of IAS 18 “Revenue”, requiring recognition of revenues when the deed of sale is drawn up; commercial development activity, if conducted on the basis of the technical specifications of the buyer, falls under the scope of IAS 11 “Construction Contracts”.

IFRIC 15 is not yet endorsed by the European Union. The future application of this interpretation is not expected to have a material impact on the financial statements since the Group’s accounting treatment is already in line with the above changes.

IFRIC 16 - Hedges of a Net Investment in a Foreign Operation

This interpretation clarifies certain issues relating to the accounting treatment, in consolidated financial statements, of hedges of net investments in foreign operations, explaining which types of risks have the requisites for the application of hedge accounting. IFRIC 16 specifically establishes that hedge accounting is only applicable to exchange rate differences arising between the functional currency of the foreign operation and the functional currency of the parent, and not between the functional currency of the foreign operation and the presentation currency of the consolidated financial statements.

IFRIC 16 is not yet endorsed by the European Union. The application of this interpretation is not expected to have an impact on the financial statements.

IFRIC 17 – Distribution of Non-cash Assets to Owners

This interpretation clarifies that:

  • dividends payable should be recognized when the dividends are appropriately authorized and are no longer at the discretion of the entity;
  • dividends payable should be measured at the fair value of the net assets to be distributed;
  • the difference between dividends paid and the carrying amount of the net assets distributed should be recognized in profit or loss.

This interpretation is not yet endorsed by the European Union. The future application of this interpretation is not expected to have a material impact on the consolidated financial statements.

IFRIC 18 – Transfers of Assets from Customers

This interpretation, issued in January 2009, particularly applies to companies operating in the utilities sector. It clarifies the requirements which should be followed for agreements in which an entity receives from a customer an item of property, plant and equipment that the entity must then use either to connect the customer to a network or to provide the customer with ongoing access to a supply of goods or services (such as a supply of electricity, water or gas).

This interpretation is not yet endorsed by the European Union. The future application of this interpretation is not expected to have an impact on the consolidated financial statements.

IFRS 8 – Operating Segments

This standard, endorsed by the European Union in November 2007 (EC Regulation 1358/2007), supersedes IAS 14 (Segment Reporting) and aligns segment disclosure with the requisites of US GAAP (SFAS 131 Disclosures about Segments of an Enterprise and Related Information), introducing the approach whereby the segments are identified in the same way they are identified in internal reports for management.

IFRS 8 is applicable from January 1, 2009. The application of this standard is not expected to have a material impact on the Group’s disclosures in the financial statements.

Amendments to IAS 23 “Borrowing Costs”

These amendments, which are part of the project for convergence with US GAAP (SFAS 34 Capitalization of Interest Cost), remove the option of immediately expensing borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset. Therefore, borrowing costs are required to be capitalized as part of the cost of that asset.

These amendments, endorsed by the European Union in December 2008 (EC Regulation 1260/2008), are applicable from January 1, 2009. The application of these amendments is not expected to have an impact on the consolidated financial statements since the Group does not avail itself of the option that was eliminated.

Revision to IAS 1 “Presentation of Financial Statements”

IAS 1 has undergone a revision which is not one of substance but requires a change in the name of some of the statements forming the full set of financial statements and the introduction of a new statement (“statement of changes in equity”). The information in this statement had previously been disclosed in the notes. The amendments of the new IAS 1 also apply to comparative figures presented together with the period financial statements.

These amendments, endorsed by the European Union in December 2008 (EC Regulation 1274/2008), are applicable from January 1, 2009. The application of these amendments is not expected to have a material impact on the consolidated financial statements.

Amendments to IFRS 2 “Share-based Payment: vesting conditions and cancellations”

The amendments to IFRS 2 aim to clarify the following aspects that are not explicitly dealt with in the current standard:

  • vesting conditions: vesting conditions refer only to service conditions (whereby a party should complete a specific period of service) and performance conditions (whereby it is necessary to reach specific targets). Other conditions, on which the current standard makes no explicit statements, should not be considered vesting conditions;
  • cancellations: all cancellations, whether by the entity or by other parties, should receive the same accounting treatment. The current IFRS 2 describes the accounting treatment in the case of cancellation by the entity but does not provide any indication in the case of cancellation by parties other than the entity.

These amendments, endorsed by the European Union in December 2008 (EC Regulation 1261/2008), are applicable from January 1, 2009. The application of the amendments is not expected to have a material impact on the consolidated financial statements.

Amendments to IAS 32 “Financial Instruments: Presentation” and IAS 1 “Presentation
of Financial Statements”: puttable instruments and obligations arising on liquidation.

These amendments refer to the accounting treatment of certain particular types of financial instruments which have characteristics similar to ordinary shares, but are currently classified as financial liabilities, since they give the holder of the instrument the right to request redemption by the issuer.

In accordance with these amendments, the following types of financial instruments must be classified as equity instruments on condition that they have particular characteristics and satisfy specific conditions:

  • puttable financial instruments (financial instruments redeemable upon the request of the holder), for example certain types of shares issued by cooperative companies;
  • instruments which give rise to an obligation for the entity to deliver to another party a pro-rata share of the net assets of the entity only on liquidation – for example certain partnerships and certain types of shares issued by limited duration companies.

These amendments, endorsed by the European Union in January 2009 (EC Regulation 53/2009), are applicable from January 1, 2009. The application of these amendments is not expected to have an impact on the financial statements.

Revision of IFRS 3 “Business Combinations”

This revision is also part of the project for convergence with US GAAP and has the purpose of aligning the accounting treatment of business combinations. The main changes over the previous version refer to:

  • recognition in the income statement – when incurred – of the expenses relating to business combination transactions (legal, advisory, valuation and audit fees and professional fees in general);
  • the option of recognizing minority interests at fair value (full goodwill); this option can be elected for each single business combination transaction;
  • specific rules for the recognition of step acquisitions: in the case of the acquisition of control of a company in which a minority interest is already held, the previously held investment must be measured at fair value, recognizing the effects of this adjustment in the income statement;
  • contingent consideration, that is, the obligations of the acquirer to transfer additional assets or shares to the seller in the case certain future events or specific conditions arise, must be recognized and measured at fair value at the date of acquisition. Subsequent changes in the fair value of such agreements are normally recognized in the income statement.

These revisions are not yet endorsed by the European Union. The impact on the financial statements in the year of first-time application of the new standard cannot be determined at this time.

Amendments to IAS 27 “Consolidated and Separate Financial Statements”

The revision of IFRS 3 “Business Combinations” also required amendments to IAS 27 “Consolidated and Separate Financial Statements”, which can be summarized as follows:

  • changes in the equity interests of a subsidiary, which do not entail the loss of control, qualify as equity transactions. In other words, the difference between the price paid/received and the share of net assets acquired/sold must be recognized in equity;
  • in the event of the loss of control, but where an interest is retained, such interest must be measured at fair value at the date in which the loss of control is established.

These amendments are not yet endorsed by the European Union. The impacts on the financial statements in the year of first-time application of the new standard cannot be determined at this time.

“Improvements” to IFRS

Under the project begun in 2007, the IASB has issued a series of amendments to IFRS in force. The amendments bring about accounting changes for presentation, recognition and measurement and also terminology changes. Such amendments are not yet endorsed by the European Union. The future application of these amendments is not expected to have a material impact on the financial statements.

Amendments to IFRS 1 “First-time Adoption of International Financial Reporting Standards” and IAS 27 “Consolidated and Separate Financial Statements” – Cost of an investment in a subsidiary, jointly controlled entity or associate

The amendments establish that at the date of the first-time adoption of IFRS in its separate financial statements, an entity may choose to use a deemed cost option to account for the cost of an investment in a subsidiary, jointly controlled entity or associate.

At the date of transition to IFRS, the deemed cost can be the fair value – measured in accordance with IAS 39 – or the previous GAAP carrying amount.

Moreover, any distribution by the subsidiary, associate or joint venture is allowed to be recognized as income in the separate financial statements whether the distribution is from pre-acquisition or post-acquisition reserves.

These amendments, endorsed by the European Union in January 2009 (EC Regulation 69/2009), are applicable from January 1, 2009. The application of these amendments is not expected to have a material impact on the financial statements.

Amendments to IAS 39 “Financial Instruments: Recognition and Measurement”
– eligible hedged items

This amendment provides clarification on what can be designated as a hedged item in certain particular situations:

  • designation of a one-sided risk item as a hedged item, that is, when only the changes in the cash flows or fair value of a hedged item above or below a specified value, instead of the total change, are designated as a hedged item;
  • designation of inflation as a hedged item.

These amendments are not yet endorsed by the European Union. The future application of these amendments is not expected to have a material impact on the financial statements.

In conformity with the provisions of art. 5, paragraph 2, of Legislative Decree 38 dated February 28, 2005, these consolidated financial statements have been prepared in euros, the presentation currency.

FINANCIAL STATEMENT FORMATS

The company has applied the provisions of Consob Resolution 15519 dated July 27, 2006 with regard to the formats of the financial statements and Consob Communication 6064293 of July 28, 2006 in respect of corporate disclosure.

The consolidated financial statements consist of the balance sheet, the income statement, the statement of recognized income and expense, the statement of cash flows and the notes, together with the report on operations by the directors on the operating performance.

The format adopted for the balance sheet classifies assets and liabilities between current and non-current.

The income statement applies the classification of costs by nature.

The format for the changes in equity is entitled “Statement of recognized income and expense” and includes the result for the year and, by homogeneous categories, the income and expenses which, under IFRS, are recognized directly in equity. The amounts of transactions with equity holders and movements during the year in the earnings reserves are presented in the notes.

In the statement of cash flows, cash flows from operating activities are presented using the indirect method where the income or loss for the year is adjusted by the effect of non-monetary transactions, by any deferral or accrual of previous or future operating collections or payments and by revenues or costs connected with cash flows from investing or financing activities.

Compared to the published consolidated financial statements at December 31, 2007, the caption of the line item in the income statement “Raw materials and consumables used” has been changed to “Raw materials and consumables used (net of change in inventories)” and the caption of the line item “Financial instruments” has been changed to “Derivative financial instruments”.

The consolidated financial statements show the comparative figures of the previous year. Compared to the published balance sheet at December 31, 2007, the amount of Euros 117,098 thousand has been reclassified from “Current borrowings from banks and other financial institutions” to “Non current borrowings from banks and other financial institutions”. This reclassification has no effect on the result for the year or equity.

In the income statement for the year ended December 31, 2008 and in the comparative figures for the year ended December 31, 2007, the income or loss from discontinued operations, in reference to the sale of the INTEGRA FM B.V. Group (formerly Pirelli RE Integrated Facility Management B.V.) and PGT Photonics S.p.A., is shown separately from the results from continuing operations. Accordingly, the income statement data presented in the consolidated financial statements for the year ended December 31, 2007 have been reclassified.

Lastly, the cash flows from discontinued operations (and the corresponding amounts for the prior year) are disclosed in the notes, whereas in the consolidated financial statements at December 31, 2007, such cash flows were reported in the statement of cash flows.

SCOPE OF CONSOLIDATION

The scope of consolidation includes the subsidiaries, the associates and the investments in joint ventures.

Subsidiaries are considered all the companies and entities in which the Group has the power to determine the financial and operating policies; this circumstance is generally considered to occur when more than half of the voting rights is held. The financial statements of subsidiaries are included in the consolidated financial statements from when control over such subsidiaries commences until the date that control ceases. The equity and income (loss) attributable to the minority interests are shown separately, respectively, in the consolidated balance sheet and consolidated income statement.

Associates are considered all the companies in which the Group exercises a significant influence as defined by IAS 28 – Investments in associates. Such influence is presumed to exist when the Group holds a percentage of voting rights between 20 and 50 percent, or when – even with a lower percentage of voting rights – it has the power to partecipate to the determination of the financial and operating policies by virtue of specific legal relationships for example, participation in shareholders’ agreements combined with other forms of exercising a significant influence over governance rights.

Joint ventures are considered those companies in which, under a contractual agreement or in accordance with the bylaws, two or more parties undertake an economic activity subject to joint control.

The main changes in the scope of consolidation during 2008 refer to the sale of INTEGRA FM B.V. group (formerly Pirelli Real Estate Integrated Facility Management B.V.) and PGT Photonics S.p.A. to the United States registered company CyOptics, an associated company of the Group.

Consolidation

For consolidation purposes, the financial statements used are those of the companies included in the scope of consolidation, prepared at the reporting date and adjusted, where necessary, to conform to IAS/IFRS as applied by the Group.

The financial statements expressed in foreign currencies have been translated into euros at rates prevailing at the year-end for the balance sheet and at the average exchange rates for the income statement.

The differences arising from the translation of opening equity at year-end exchange rates have been recorded in the reserve for translation differences, together with the difference between the result for the year translated at the year-end rate compared to the average rate. The reserve for translation differences is recognized in the income statement upon the disposal of the company that generated the reserve.

The consolidation principles can be summarized as follows:

  • Subsidiaries are consolidated on a line-by-line basis according to which:
  • the assets and liabilities and revenues and costs of the financial statements of the subsidiaries are assumed in full, regardless of the percentage of ownership;
  • the carrying amount of the investments is eliminated against the underlying share of equity;
  • the balance sheet and income statement transactions between companies consolidated line-by-line, including dividends distributed within the Group, are eliminated;
  • the equity or income (loss) attributable to the minority interest is presented separately in equity and in the income statement;
  • investments in associates and joint ventures are accounted for by the equity method on the basis of which the carrying amount of the investments is adjusted by:
  • the share of the post-acquisition results of the associate or joint venture;
  • the adjustments from movements in equity that were not recognized in the income statement, in accordance with benchmark principles;
  • dividends paid by the associate or joint venture;
  • when the group’s share, if any, of the losses of the associate exceeds the carrying amount of the investment in the financial statements, the carrying amount of the investment is reduced to nil and the share of any further losses is recognized in the “Provisions for other risks and charges” to the extent that the Group has a binding obligation to cover the losses;
  • unrealized gains on sales transactions made by subsidiaries to joint ventures or associates are eliminated to the extent of the Group’s interest in the joint ventures and associates;
  • gains arising on sale transactions of properties made by one joint venture to other joint ventures or associates are recognized to the extent of the lower of the Group’s interest in the buyer company compared to that of the seller company, that is, only to the extent of the gain realized with third parties;
  • gains arising on sales transactions of properties from associates to other associates are recognized to the extent of the gain realized with third parties;
  • at the time of acquisition of subsidiaries, associates or joint ventures, the price paid is allocated according to the purchase method in the manner described below:
  • determining the cost of acquisition in accordance with IFRS 3;
  • determining the fair value of the assets and liabilities acquired (both actual and contingent);
  • allocating the price paid to the fair value of the assets acquired and liabilities assumed;
  • recognizing any residual amount in goodwill, consisting of the excess of the cost of acquisition over the net fair value of the Group’s share of the identifiable/assumed net assets and liabilities;
  • immediately recognizing the negative goodwill, if any, directly in the income statement if the fair value of the net assets acquired exceeds the cost of acquisition.