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Report of the Supervisory Board

 

Dear Shareholders,

On the whole, Continental AG and the corporation coped very well with the many challenges they faced in fiscal year 2010. In the year under review, the Supervisory Board of the company fulfilled all the tasks incumbent upon it under applicable law, the Articles of Incorporation and its By-Laws. It closely monitored the work of the Executive Board, regularly advised it and carefully supervised it in the management of the company and is convinced of the legality and propriety of the management. As explained in further detail below, the Supervisory Board was directly consulted in a timely manner on all decisions of fundamental importance for the company.

In the year under review, the Executive Board provided the Supervisory Board with regular, comprehensive and timely updates in writing and verbally on all issues of relevance to the company related to planning, business strategy, significant business transactions in the company and the corporation, and the related risks and opportunities. The Supervisory Board was continuously informed in detail on the sales, results and employment development in the corporation and individual divisions as well as the financial situation of the company. Where the actual course of business deviated from the defined plans and targets, the Executive Board gave a detailed explanation with reasons to the Supervisory Board and the measures introduced were discussed with the Supervisory Board and its committees. In addition, the Supervisory Board, the Chairman's Committee and the Audit Committee dealt intensively with other key company business at their meetings and separate discussions. The members of the Supervisory Board were also available for consultation by the Executive Board outside the meetings. The chairman of the Supervisory Board in particular was in regular contact with the Executive Board and its chairman and discussed current company issues and developments with them.

Meetings of the Supervisory Board and the committees
 In 2010, the Supervisory Board held four regular meetings and two telephone conferences at which – with a few individual exceptions – all Supervisory Board members took part personally. No member was absent from more than half the meetings. The Chairman's Committee met eight times in the year under review. If, for example, individual matters required particular urgency, the Supervisory Board and the Chairman's Committee also passed resolutions outside the meetings by way of written procedure. In each case, there was sufficient opportunity to review and discuss on the basis of detailed drafts. The Audit Committee held four regular meetings and one telephone conference in 2010. The Mediation Committee under Section 27 (3) of the German Co-determination Act (Mitbestimmungsgesetz) and the Nomination Committee did not meet. There are no other committees. All committees report to the plenary session on a regular basis. Their duties are described in detail in the Corporate Governance Report (page 18 et seq.).

Key topics dealt with by the Supervisory Board, Chairman's Committee and Audit Committee
As in 2009, the Supervisory Board and its committees took part in the measures to improve the company's financial situation in the year under review. Initial significant progress made towards this includes amending the conditions for the syndicated loan agreement for the acquisition of Siemens VDO back in December 2009, entering into a forward start facility, and increasing the company's capital stock at the beginning of January 2010 with the consent of the Supervisory Board. The successful placement of several high-yield bonds, with which the Chairman's Committee and the Audit Committee were closely involved, then led to a considerable improvement of the maturity structure.

As in previous years, the Supervisory Board also dealt with the company's strategic development and orientation in general as well as the strategic planning of the divisions. Regular discussion topics of the plenary session and the committees were overcoming the consequences of the global financial and economic crisis, the effects of the unexpectedly rapid recovery of the automobile industry (which, however, also led to a shortage of precursor products, especially electronic components) and the substantial increase in prices of natural rubber and other raw materials. In addition, the Supervisory Board also dealt with the future development of hybrid and electric vehicles, with investment projects in the BRIC markets, and with the planned expansion of the retail organization within the Tire divisions.

To ensure the Supervisory Board is involved in the decisions on key company matters, the company's Articles of Incorporation and the Supervisory Board's By-Laws establish the legal transactions that require the approval of the Supervisory Board and/or its Chairman's Committee. In line with these requirements, the Supervisory Board and/or the Chairman's Committee discussed and approved the acquisition of the Flexowell business of Metso GmbH and the acquisition of the investment assets of Tianjin Xinbinhai Conveyor Belt Co., China, by the Conveyor Belt Systems unit of the ContiTech division; the acquisition of Grundfos NoNOx A/S by the joint venture Emitec; the securing of corporate company bilateral loans with various banks; the disposal of a factory site in Costa Rica that was no longer needed; as well as other matters. At its meeting on December 14, 2010, the Supervisory Board dealt with the annual planning for 2011 and long-term planning and also approved the planning and investment plans for fiscal year 2011.

The Audit Committee was continuously informed in detail by the Executive Board on the sales, results and employment development in the corporation and individual divisions as well as the financial situation of the company. Before publication of the half-year and quarterly financial reports, the Audit Committee discussed and reviewed them, paying special attention to the results for the relevant reporting period as well as the outlook for the year as a whole. The Audit Committee also dealt with the audit of the consolidated financial statements as of December 31, 2008, by the German Financial Reporting Enforcement Panel (Deutsche Prüfstelle für Rechnungslegung e.V.) and agreed with the Executive Board's acceptance of the error finding. The Audit Committee is closely involved in compliance und risk management also. The Executive Board regularly reported to the committee with regard to significant events and internal auditing work. The head of internal auditing was also directly available to provide information to the Audit Committee and its chairman in consultation with the Executive Board. In addition, the other material risks covered by the risk management system were presented in the Audit Committee along with the corresponding measures resolved by the Executive Board. The Audit Committee is convinced of the effectiveness of the internal control system, the risk management system and the internal audit system.

Conflicts of interest and corporate governance
No conflicts of interest among the members of the Executive Board or the Supervisory Board arose in the year under review. The Supervisory Board does not share the opinion of certain shareholders who instituted proceedings against the resolution of the 2009 Annual Shareholders' Meeting to elect Mr. Rolf Koerfer to the Supervisory Board and against the confirmation of this resolution by the 2010 Annual Shareholders' Meeting on the grounds that, among other reasons, they consider Mr. Koerfer to be subject to an irresolvable permanent conflict of interest as the legal advisor of our major shareholder, the Schaeffler Group. We believe that membership by shareholders, representative officers or employees of a major shareholder is in accordance with German stock corporation law and the recommendations of the German Corporate Governance Code. This opinion has been confirmed by renowned experts. The situation can be no different for the legal advisor of the major shareholder. If a conflict of interests arises in an individual matter, the stock corporation law and the rules of corporate governance provide adequate procedures to ensure that detrimental effects for the company are avoided. However, these rules did not have to be applied in the past year. Against this background, both the Supervisory Board and the Executive Board resolved to file an appeal against the judgment of the Hanover District Court (Landgericht) ruling in favor of the complaints against the resolutions of the 2009 Annual Shareholders' Meeting and to defend against the complaints against the resolutions of the 2010 Annual Shareholders' Meeting. After Mr. Koerfer's resignation from the Supervisory Board, the parties have declared the matter moot and the proceedings are terminated. In its opinion, the Supervisory Board also had a sufficient number of independent members at all times in the period under review.

In 2010, the Supervisory Board again carried out the regular efficiency review of its activities. In this review, an external consultant interviewed all members of the Supervisory Board and the Executive Board, analyzed the results, compared this information with information from other companies, developed recommendations for further improving the Supervisory Board's activities, and presented these to the Supervisory Board. The plenum of the Supervisory Board discussed the results and will adopt the consultant's recommendations.

In its fall 2010 meeting, the Supervisory Board also dealt with the amendments to the German Corporate Governance Code resolved by the Government Commission in May 2010. The Supervisory Board decided to follow the new regulations and suggestions. In this context, the Supervisory Board asked the Chairman's Committee to prepare set objectives for the future composition of the Supervisory Board that take into account such matters as diversity and especially providing for sufficient female participation. The Supervisory Board and Executive Board agreed a corresponding updated declaration in accordance with Section 161 of the German Stock Corporation Act (Aktiengesetz – AktG) on October 18, 2010. More details can be found in the Corporate Governance Report (page 18 et seq.).

Annual and consolidated financial statements
 The annual financial statements as of December 31, 2010, prepared in line with the requirements of the German Commercial Code (Handelsgesetzbuch – HGB), the 2010 consolidated financial statements and the Management Reports for the company and the corporation were reviewed in terms of the accounting, the accounting-related internal control system and the system for early risk recognition by KPMG AG Wirtschaftsprüfungsgesellschaft, Hanover ("KPMG"). The report by the Executive Board on relationships with affiliated companies in accordance with Section 312 AktG (dependent company report) was also reviewed by KPMG. The 2010 consolidated financial statements of Continental AG were prepared in accordance with the International Financial Reporting Standards (IFRS). The auditor issued unqualified audit opinions. In terms of the system for early risk recognition, the auditor found that the Executive Board had taken the necessary measures under Section 91 (2) AktG and that the company's system for early risk recognition is suitable for identifying developments at an early stage that pose a risk to the company as a going concern. KPMG issued the following unqualified audit opinion on the dependent company report in accordance with Section 313 (3) AktG:

"Based on the results of our statutory audit and evaluation we confirm that:

  • the actual information included in the report is correct,
  • payments by the company in connection with the legal transactions listed in the report were not unduly high or that disadvantages had been compensated for, and
  • there are no circumstances in favor of a significantly different assessment than that made by the Executive Board in regard to the measures listed in the report."

The documents relating to the annual financial statements, including the dependent company report, and the audit reports were discussed with the Executive Board and the auditor in the Audit Committee meeting on February 21, 2011. They were also discussed at length at the Supervisory Board's meeting to approve the annual financial statements on March 11, 2011. The required documents were distributed to all members of the Audit Committee and the Supervisory Board in good time before these meetings so that the members had sufficient opportunity to review them. The auditor was present at these discussions. The auditor reported on the main results of the audits and was available to provide additional information to the Audit Committee and the Supervisory Board. Based on its own review of the annual financial statements, the consolidated financial statements, the company management report, the corporation management report and the dependent company report including the final declaration of the Executive Board, and based on the report and the recommendation of the Audit Committee, the Supervisory Board agreed with the results of the auditor's audit. There were no objections. The Supervisory Board approved the annual financial statements and the consolidated financial statements. The annual financial statements are thereby adopted.

Personnel changes on the Supervisory Board and Executive Board
Dr. Thorsten Reese, the Supervisory Board member representing the executive staff, retired effective April 30, 2010, and therefore stepped down from the Supervisory Board. His elected replacement Mr. Artur Otto, sales and marketing director of Continental Engineering Services, succeeded him on May 1, 2010, as a member of the Supervisory Board. Mr. Hartmut Meine was elected as an Audit Committee member to replace Dr. Reese. On November 29, 2010, Mr. Rolf Koerfer resigned as a Supervisory Board member with immediate effect. The Hanover Local Court (Amtsgericht) appointed Prof. Siegfried Wolf on December 6, 2010, to succeed him. At its meeting on December 14, the Supervisory Board elected Mr. Georg F. W. Schaeffler as the additional shareholder representative on the Chairman's Committee to replace Mr. Koerfer. The Supervisory Board would again like to thank Dr. Reese and Mr. Koerfer for their considerable contributions to the success of the company. More information on the Supervisory Board members and the members of its committees who were in office in the year under review can be found on pages 248 and 249.

There were no changes to the Executive Board in 2010. The additional Executive Board members appointed by the Supervisory Board on October 19, 2009 – Mr. Wolfgang Schäfer (Finance, Controlling, IT and Law) and Mr. José A. Avila (Powertrain division) – entered office on January 1, 2010.

The Supervisory Board extends its thanks to the Executive Board, all the employees and the employee representatives for their excellent work in the past year. They have taken up diverse challenges and put the company back on the path to success.

Hanover, March 11, 2011

For the Supervisory Board


Sincerely,

Signature Prof. Dr. Wolfgang Reitzle

Prof. Dr. Wolfgang Reitzle
Chairman

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Prof. Dr. Wolfgang Reitzle, Chairman of the Supervisory Board

Prof. Dr. Wolfgang Reitzle
Chairman of the Supervisory Board

 

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.