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Notes to the Consolidated Income Statements

9. Net Interest Expense

 

in € millions 2011 2010
Interest income 29.2 22.6
Interest and similar expenses -649.4 -747.2
Financial lease cost -5.7 -5.6
Losses/gains from foreign currency translation -105.4 33.0
Gains from changes in the fair value of derivative instruments 0.3 6.9
Gains from financial assets available for sale 1.9 0.7
Interest cost for long-term provisions and liabilities -6.7 -9.1
Capitalized interest 0.3 1.5
Interest expenses -764.7 -719.8
Net interest expense -735.5 -697.2
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The net interest expense rose by €38.3 million year-on-year to €735.5 million (PY: €697.2 million). This is essentially due to the negative development in the exchange rate effects that were not fully offset by the lower interest expenses described below.

The negative trend in the exchange rate effects, which were down €138.4 million year-on-year from €33.0 million to -€105.4 million as of December 31, 2011, was due to the performance on the currency markets in the second half of 2011. A key factor in this was the strong devaluation of the Mexican peso as against the U.S. dollar. Devaluation of the Hungarian forint against the euro also squeezed net interest.

Interest expenses, not including the effects of foreign currency translation, changes in the fair value of derivatives and gains from the disposal of financial assets available for sale, which primarily result from the utilization of the syndicated loan and the bonds issued in the third quarter of 2010 by Conti-Gummi Finance B.V., Maastricht, Netherlands, declined by €98.9 million as against the figure for the previous year to €661.5 million (PY: €760.4 million). In particular, in addition to the significant drop in net indebtedness as of the end of 2010, the decrease is due to the lower margins for the syndicated loan than in the previous year. Both effects by far more than compensated for the expenses due to higher average market interest rates in 2011 and the four bonds issued by Conti-Gummi Finance B.V., Maastricht, Netherlands, in the third quarter of 2010. The margin reduction and its link to the Continental Corporation's leverage ratio (net indebtedness/EBITDA, as defined in the syndicated loan) were agreed as part of the successful renegotiation in late March 2011 of the syndicated loan originally due in August 2012. In the third quarter of 2011, a further margin reduction was already achieved for this loan as a result of the improved leverage ratio as of June 30, 2011. In 2011, interest expenses for the syndicated loan amounted to €342.4 million (PY: €595.9 million). The bonds issued in the third quarter of 2010, with higher nominal interest rates due in particular to the longer terms, resulted in total interest expenses of €227.4 million (PY: €73.6 million).

Interest income amounted to €29.2 million in 2011, €6.6 million higher than the previous year's level (€22.6 million).

Gains from changes in the fair value of derivative instruments amounting to €0.3 million (PY: €6.9 million) include total expenses of €29.7 million from the termination of cash flow hedge accounting and the resulting fair values changes of the affected derivatives to be recognized in profit or loss. Please see the comments in Note 29.

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Continental Value Contribution (CVC). The CVC represents the absolute amount of additional value created, and the Delta CVC represents the change in absolute value creation over the prior year. This change in the absolute contribution measured by Delta CVC allows us to monitor the extent to which management units generate value-creating growth or resources must be employed more efficiently. The CVC is measured by subtracting the weighted average cost of capital (WACC) from the ROCE and multiplying this by the average operating assets for the fiscal year. The weighted average cost of capital calculated for the Continental Corporation corresponds to the required minimum return. The cost of capital is calculated as the weighted average ratio of the cost of equity and borrowing costs.

Currency swap. Swap of principal payable or receivable in one currency into similar terms in another currency. Often used when issuing loans denominated in a currency other than that of the lender.

Defined Benefit Obligation (DBO). DBO is defined as the present value of all vested and non-vested benefits calculated on the basis of estimated salary levels at retirement. The only actuarial method that may be used to calculate the DBO is the projected unit credit method. DBO corresponds to PBO (projected benefit obligation).

Derivative financial instruments. Transactions used to manage interest rate and/or currency risks.

Dividend payout ratio. The dividend payout ratio is the ratio between the dividend for the fiscal year and the earnings per share.

EBIT. Earnings Before Interest and Taxes. EBIT represents the results of operations. Since 2002, when the amortization of goodwill was discontinued, EBITDA has been equal to EBIT.

EBITA. EBIT before scheduled goodwill amortization.

EBITDA. Earnings before interest, taxes, depreciation and amortization.

Finance lease. Under a finance lease, the lessor transfers the investment risk to the lessee. This means that the lessor bears only the credit risk and any agreed services. The lessee is the beneficial owner of the leased asset. Finance leases are characterized by a fixed basic term during which the lease may not be terminated by the lessee.

Gearing ratio. The gearing ratio represents the net indebtedness divided by total equity, expressed as a percentage.

Hedging. Securing a transaction against risks, such as fluctuations in exchange rates, by entering into an offsetting hedge transaction, typically in the form of a forward contract.

IAS. International Accounting Standards.

IASB. International Accounting Standards Board. The authority that defines the International Financial Reporting Standards.

IFRIC. International Financial Reporting Interpretations Committee. Committee that reviews and determines appropriate treatment of accounting issues within the context of IFRS and IAS.

IFRS. International Financial Reporting Standards. The accounting standards issued by the IASB.

Interest rate cap. An interest rate cap sets an upper limit for a variable interest rate in relation to a notional debt amount. To the extent that the variable interest due on the underlying debt exceeds the cap amount, the holder of the cap receives income as compensation in the amount of the difference to the cap. An up-front premium is paid as consideration for the cap.

Interest rate swap. An interest rate swap is the exchange of interest payments between two parties. For example, this allows variable interest to be exchanged for fixed interest, or vice versa.

Net indebtedness. The net amount of interest-bearing liabilities as recognized in the balance sheet, cash and cash equivalents, the positive fair values of the derivative financial instruments as well as other interest-bearing investments.

Operating assets. Operating assets are the assets less liabilities as reported in the balance sheet, without recognizing the net indebtedness, discounted trade bills, deferred tax assets, income tax receivable and payable, as well as other financial assets and debts.

Operating lease. A form of lease that is largely similar to rental. Leased assets are recognized in the lessor's balance sheet and capitalized.

PPA. Purchase Price Allocation. PPA is the process of breaking down the purchase price and assigning the values to the identified assets, liabilities, and contingent liabilities following a business combination. Subsequent adjustments to the opening balance sheet – resulting from differences between the preliminary and final fair values at the date of initial consolidation – are recognized as "PPA adjustments".

Rating. Standardized indicator for the international finance markets that assesses and classifies the creditworthiness of a debtor. The classification is the result of an economic analysis of the debtor by specialist rating companies.

ROCE. Return On Capital Employed. We define ROCE as the ratio of EBIT to average operating assets for the fiscal year.

SIC. Standing Interpretations Committee (predecessor to the IFRIC).

US GAAP. United States Generally Accepted Accounting Principles. These principles are subdivided into binding and guiding principles.

Weighted Average Cost of Capital (WACC). The WACC represents the weighted average cost of the required return on equity and net interest-bearing liabilities.