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Earnings, Financial and Net Assets Position

of the Parent Company

In addition to the report on the overall development of the corporation, the following summarizes the financial performance and position of the parent company separately.

Unlike the consolidated financial statements, the annual financial statements of Continental AG are prepared in accordance with the German commercial law (German Commercial Code or Handelsgesetzbuch – HGB, and German Stock Corporation Act or Aktiengesetz – AktG). The management report of Continental AG has been combined with the consolidated report of the Continental Corporation in accordance with Section 315 (3) of the HGB since the future development and related risks and opportunities of the parent company and its key research and development activities are integrally combined with the corporation as a whole. Further, the following separate summary of the parent company's stand-alone results, net assets and financial position as part of the consolidated management report, provides the basis for understanding the Executive Board's proposal for the distribution of the parent company's net income.

Net assets and financial position of Continental Aktiengesellschaft
  Dec. 31, 2010 Dec. 31, 2009
Assets in € millions    
Intangible assets 6.6 16.3
Property, plant, and equipment 3.3 3.5
Investments 11,075.4 11,108.9
Non-current assets 11,085.3 11,128.7
Inventories 0.4 0.8
Receivables and other assets 7,019.9 6,103.9
Short-term securities 0.0 332.3
Cash and cash equivalents 325.1 201.4
Current assets 7,345.4 6,638.4
Prepaid expenses and deferred charges 57.5 89.2
Total assets 18,488.2 17,856.3
     
Shareholders' equity and liabilities in € millions    
Common stock 512.0 432.6
Capital reserves 4,179.1 3,144.6
Revenue reserves 54.7 54.7
Accumulated profits (PY: Accumulated losses) 61.1 −993.7
Shareholders' equity 4,806.9 2,638.2
Provisions 645.5 696.2
Liabilities 13,035.7 14,521.9
Deferred income 0.1 –
Total equity and liabilities 18,488.2 17,856.3
     
Gearing ratio in % 119.4 292.2
Equity ratio in % 26.0 14.8
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Due to the carve-out of Continental AG's tire activities into a subsidiary in the previous year, the income statement for fiscal year 2010 can be compared with that of the previous year to a very limit extent only, since sales, the cost of sales and key other operating expenses in connection with the operating tire business in fiscal year 2010 are no longer included in the income statement of Continental AG. In 2009, these figures for January 1 to July 31, 2009 were still included in the income statement. In contrast, the profit transfer from Continental Caoutchouc-Export-GmbH reported in the financial result of Continental AG includes the profit transfer from Continental Reifen Deutschland GmbH in the amount of €232.2 million (PY: €37.8 million). After the tire activities were carved out in the previous year, Continental AG mainly took on the holding functions for the Continental Corporation.

Total assets increased year-on-year by €631.9 million to €18,488.2 million (PY: €17,856.3 million), mostly due to the increase in receivables from associated companies by €910.1 million and the increase in cash and cash equivalents by €123.7 million. Contrary to this, current securities fell by €332.3 million.

Financial assets fell by €33.5 million year-on-year to €11,075.4 million (PY: €11,108.9 million) and now make up 59.9% of total assets after 62.2% in the previous year.

Prepaid expenses fell by €31.7 million to €57.5 million.

On the liabilities side, liabilities to banks decreased by €4,882.2 million year-on-year to €4,171.5 million (PY: €9,053.7 million), corresponding to 53.9%. This reduction is partly due to the capital increase against cash contributions resolved by the Executive Board of Continental AG and approved by the Supervisory Board on January 6, 2010. The net proceeds of €1,056.0 million were used to repay part of tranche B of the VDO loan due in August 2010. Liabilities to banks were also reduced due to the four bonds issued via Conti-Gummi Finance B.V., Amsterdam, Netherlands, which were placed on the market with a total volume of €3.0 billion. These were provided to Continental AG via corporation loans, thus increasing liabilities to associated companies by €3,384.5 million. Liabilities were therefore reduced by net €1,486.2 million as of the balance sheet date.

Statement of income of Continental Aktiengesellschaft in € millions
  2010 2009
Sales 27.6 1,191.1
Cost of sales 26.4 924.3
Gross margin on sales 1.2 266.8
Selling expenses 0.1 91.3
General and administrative expenses 60.3 79.0
Other operating income 95.1 171.2
Other operating expenses 337.9 318.5
Net income from financial activities 1,443.5 −512.7
Earnings before taxes 1,141.5 −563.5
Extraordinary result −2.7 –
Income taxes −84.0 −90.5
Net income (PY: Net loss) 1,054.8 −654.0
Accumulated losses brought forward from the previous year −993.7 −339.7
Accumulated profits (PY: Accumulated losses) 61.1 −993.7
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Subscribed capital increased by €79.4 million and capital reserves increased by €1,034.5 million due to the capital increase against cash contributions.

Sales were down €1,163.5 million to €27.6 million (PY: €1,191.1 million), corresponding to a decrease of 97.7% (PY: decrease of 54.1%) due to the carve-out of the tire activities. The sales reported for fiscal year 2010 are due to the activities of the Chassis & Safety division at the site in Hanover-Stöcken, Germany.

The cost of sales decreased by €897.9 million to €26.4 million (PY: €924.3 million) due to the carve-out of the tire activities. The gross margin on sales fell by 99.5% or €265.6 million to €1.2 million (PY: €266.8 million).

As in the previous year, other operating income and other operating expenses particularly include expenses and income from corporate overheads or cost credits and charges from or for other subsidiaries.

Income from investments mainly consisted of profit transfer agreements. Profit transfers from Formpolster GmbH, Hanover (€259.3 million), Continental Automotive GmbH, Hanover (€524.9 million) and Continental Caoutchouc-Export-GmbH, Hanover (€1,323.7 million) offset loss assumptions from UMG Beteiligungsgesellschaft mbH, Hanover (€104.4 million). In fiscal year 2010, Continental Caoutchouc-Export-GmbH, Hanover, received a one-time dividend distribution of €1.0 billion from Continental Global Holding Holding Netherlands B.V., Amsterdam, Netherlands, via the profit transfer from CAS-One Holdinggesellschaft mbH, Hanover.

The deterioration of the net interest expense by €72.0 million to €581.5 million is due to the higher (compared with the previous year) margin of the VDO loan agreement and the forward start facility resulting from the rating downgrades over the course of 2009 and the renegotiation of the conditions of the VDO loan concluded in May 2010 and December 2009. The net interest amount was also influenced by the issue of four loans via Conti-Gummi Finance B.V., Amsterdam, Netherlands, and the related corporate loan, while the fact that the market interest rate was lower as compared with the previous year had a positive effect.

Tax expense of €84.0 million is a result of current expenses in Germany and a lack of applicable volumes of non-imputable foreign withholding tax. After taking into account this tax expense, Continental AG posted net income for the year of €1,054.8 million (PY: net loss of €654.0 million). The after-tax return on equity was 21.9% (PY: -24.8%).

After the inclusion of the retained losses brought forward from the previous year (€993.7 million), net retained earnings were €61.1 million.

A proposal will be made to the Annual Shareholders' Meeting on April 28, 2011 that no dividend be paid for fiscal year 2010.

We expect a continued positive development of the subsidiaries' operating results in fiscal year 2011. Net interest will be at the same level as the previous year against the background of the repayment of parts of the VDO loan via bonds and the resulting slight increase in the interest burden despite the targeted debt reduction.

Report Pursuant to Section 289 (4) and Section 315 (4) of the German Commercial Code (Handelsgesetzbuch – HGB)

  1. The subscribed capital of the company amounted to €512,015,316.48 as of the balance sheet date and was divided into 200,005,983 no-par-value shares. These shares are, without exception, common shares; different classes of shares are not contemplated. Each share carries voting and dividend rights from the time it is issued. Each no-par-value share entitles the holder to one vote at the Annual Shareholders' Meeting (Article 20, Paragraph 1 of the Articles of Incorporation).
  2. As part of Continental AG's investment agreement with Schaeffler KG, Mrs. Maria-Elisabeth Schaeffler and Mr. Georg F. W. Schaeffler concluded on August 20, 2008, the Schaeffler Group is required to limit its shareholding in Continental AG to a maximum of 49.99% of the voting capital stock until August 31, 2012 ("maximum shareholding"), unless the Executive Board of Continental AG agrees to a higher shareholding. In addition, as part of this agreement Schaeffler KG undertook, in the event it resells parcels of its maximum shareholding by August 31, 2012, to grant a pre-emptive right to a buyer nominated by the guarantor specified in the agreement, if the sale to such buyer is in the best interest of Continental AG and Schaeffler KG. According to Schaeffler KG, it resold Continental shares whose acquisition, on conclusion of the takeover offer to the Continental AG shareholders, would have resulted in a holding exceeding the maximum shareholding, to financial institutions.

    As part of the company's capital increase in January 2010, Schaeffler KG undertook vis-à-vis the banks accompanying the capital increase neither to offer nor sell shares or rights that allow conversions in or subscriptions to shares of Continental for a period of twelve months after the new shares issued from the implementation of the capital increase are admitted to trading. This does not include OTC transactions, sales to companies affiliated with Schaeffler KG or sales as part of a public takeover offer, under the condition in each case that the respective buyer is subject to similar obligations. Another exception is the transfer of share ownership in the event the lienholder utilizes the lien on the shares. M.M.Warburg & CO KGaA, Hamburg, and B. Metzler seel. Sohn & Co. KGaA, Frankfurt am Main, are subject to similar selling restrictions for a period of six months after the new shares are admitted to trading.

    To the best of the Executive Board's knowledge, there are no other restrictions which apply to the voting rights or to the transfer of the shares, including those that are the result of agreements between shareholders.
  3. For details of the direct equity interests exceeding ten percent of the voting rights (reported level of equity interest), please refer to the notice in accordance with the German Securities Trading Act (Wertpapierhandelsgesetz) under Note 39 to the consolidated financial statements.
  4. Shares with privileges that grant controlling powers do not exist.
  5. The company is not aware of any employees with shareholdings not directly exercising control of voting rights.
  6. Appointment and dismissal of the members of the Executive Board are carried out in accordance with Section 84 of the German Stock Corporation Act (Aktiengesetz – AktG) in conjunction with Section 31 of the German Co-determination Act (Mitbestimmungsgesetz). Accordingly, the Supervisory Board is responsible for the appointment and dismissal of members of the Executive Board. It reaches its decisions with a majority of two-thirds of its members. If this majority is not reached, the so-called Mediation Committee must submit a nomination to the Supervisory Board for the appointment within one month following the voting. Other nominations may also be submitted to the Supervisory Board in addition to the Mediation Committee's nomination. A simple majority of the votes is sufficient when voting on these nominations submitted to the Supervisory Board. In the event that voting results in a tie, a new vote takes place where the chairman of the Supervisory Board has the casting vote in accordance with Section 31 (4) of the Mitbestimmungsgesetz.

    Amendments to the Articles of Incorporation are made by the Shareholders' Meeting. In Article 20, Paragraph 3 of the Articles of Incorporation, the Shareholders' Meeting has made use of the possibility granted in Section 179 (1) Sentence 2 of the Aktiengesetz to assign to the Supervisory Board the power to make amendments soley affecting the version of the Articles of Incorporation.

    In accordance with Article 20, Paragraph 2 of the Articles of Incorporation, resolutions of the Shareholders' Meeting to amend the Articles of Incorporation shall be adopted by a simple majority as a rule and, insofar as a majority of the capital stock is required, by a simple majority of the capital stock represented unless otherwise required by mandatory law or by the Articles of Incorporation. The law prescribes a mandatory majority of three quarters of the capital stock represented when resolutions are made, for example, for amendments to the Articles of Incorporation involving substantial capital measures, such as resolutions concerning the creation of authorized or contingent capital.
    1. The Executive Board may issue new shares only on the basis of resolutions by the Shareholders' Meeting.
      1. In line with Article 4, Paragraph 2 of the Articles of Incorporation, the Executive Board is authorized, with the approval of the Supervisory Board, to increase the share capital by up to an amount of €66 million by issuing new shares until April 22, 2014.
      2. In line with Article 4, Paragraph 3 of the Articles of Incorporation, the Executive Board is authorized, with the approval of the Supervisory Board, to increase the share capital by up to an amount of €70.6 million by issuing new shares until April 23, 2012.
      3. On the basis of the resolution by the Annual Shareholders' Meeting on May 5, 2006, and the resolution amending this which was made by the Annual Shareholders' Meeting on April 25, 2008, the Executive Board is authorized – with the approval of the Supervisory Board – to issue bonds with warrants and/or convertible bonds up to a total amount of €4.5 billion until May 4, 2011, in accordance with the authorization resolutions cited. In this context, the Annual Shareholders' Meeting approved contingent capital of up to €111.5 million. If the Executive Board issues bonds with warrants or convertible bonds on the basis of its authorization, new shares would be issued in accordance with the conditions of these bonds.
      4. On the basis of the resolution by the Annual Shareholders' Meeting on April 25, 2008, the Executive board is authorized – with the approval of the Supervisory Board – to issue convertible bonds, bonds with warrants and/or income bonds up to a total nominal amount of €1.5 billion until May 4, 2011. In this context, the Annual Shareholders' Meeting approved contingent capital of €37.5 million. If the Executive Board issues convertible bonds, bonds with warrants and/or income bonds on the basis of this authorization, new shares would be issued in accordance with the conditions of these bonds.
      5. On the basis of the resolution by the Annual Shareholders' Meeting on April 23, 2009, the Executive Board is authorized – with the approval of the Supervisory Board – to issue convertible bonds, bonds with warrants and/or income bonds as well as other financial instruments up to a total nominal amount of €0.85 billion until April 22, 2014. In this context, the Annual Shareholders' Meeting approved contingent capital of €43.5 million. If the Executive Board issues convertible bonds, bonds with warrants and/or income bonds or similar financial instruments on the basis of this authorization, new shares would be issued in accordance with the conditions of these bonds.
      6. Finally, the Executive Board is entitled to issue new shares to the beneficiaries of the stock option plans of 2004 and 2008 adopted by the respective Shareholders' Meeting in accordance with the conditions of these stock option plans.
    2. The Executive Board may only buy back shares under the conditions codified in Section 71 of the Aktiengesetz. The Annual Shareholders' Meeting has not granted an authorization to the Executive Board under Section 71 (1) Number 8 of the Aktiengesetz.
  8. The following material agreements are subject to a change of control at Continental AG:

    The contract governing a syndicated loan in the original amount of €13.5 billion – which was concluded in August 2007 in connection with the acquisition of Siemens VDO Automotive AG and was amended in the agreements of January 23, 2009 and December 18, 2009 – grants every creditor the right to prematurely terminate his share of the credit line and the loan granted as part thereof and to demand repayment of it, if a person or persons acting in concert acquire control of Continental AG and subsequent negotiations concerning a continuance of the loan have not led to an agreement. The €600.0 million loan agreement with the European Investment Bank also allows for the right of the bank, in cases where there is a "change of control event", to demand talks concerning the situation and, if the negotiation deadline expires with no result, to demand early repayment. The terms "control" and "change of control event" are defined as holding more than 50% of the voting rights and/or if Continental AG concludes a domination agreement as defined under Section 291 of the Aktiengesetz with Continental AG as the dominated company.

    The bonds issued by a subsidiary of Continental AG, Conti-Gummi Finance B.V. Amsterdam, Netherlands ("issuer"), on July 16, 2010, September 13, 2010 and October 5, 2010 at a nominal amount of €750 million, €1,000 million, €625 million and €625 million respectively and guaranteed by Continental AG allow each bondholder to demand that the issuer redeem or acquire the bonds held by the bondholder at a price established in the bond conditions in the event of a change of control at Continental Aktiengesellschaft. The bond conditions define a change of control as one person or several persons acting in concert (pursuant to Section 2 (5) of the German Securities Acquisition and Takeover Act (Wertpapiererwerbs- und Übernahmegesetz – WpÜG) holding more than 50% of the voting rights in Continental AG by means of acquisition or as a result of a merger or other form of combination with the participation of Continental AG. The holding of voting rights by Schaeffler GmbH, its legal successor or its associated companies is not a change of control within the meaning of the bond conditions.

    Should a change of control occur as outlined in the agreements described above and a contractual partner exercises his respective rights, it is possible that required follow-up financing may not be approved under the existing conditions, which could therefore lead to higher financing costs.

    In 1996, Compagnie Financière Michelin and Continental AG founded the 50/50 joint venture MC Projects B.V. in the Netherlands, to which Michelin contributed the rights to the Uniroyal brand for Europe. MC Projects B.V. licenses these rights to Continental. According to the agreements in connection with this joint venture, this license can be terminated for cause, if a major competitor in the tire business acquires more than 50% of the voting rights of Continental. In this case Michelin also has the right to acquire a majority in MC Projects B.V. and to have MC Projects B.V. increase its minority stake in the manufacturing company of Barum Continental s. r. o. in Otrokovice, Czech Republic, to 51%. In the case of such a change of control and the exercise of these rights, there could be losses in sales of the Tire divisions and a reduction in the production capacity available to them.
  9. No compensation agreements have been concluded between the company and the members of the Executive Board or employees providing for the case that a takeover bid takes place.

Remuneration of the Executive Board

The total remuneration of the members of the Executive Board comprises a number of remuneration components. Specifically, these components comprise the fixed salary, the bonus including components with a long-term incentive effect, as well as additional benefits, including post-employment benefits. Further details including the individual remuneration are specified in the Remuneration Report contained in the Corporate Governance Report starting on page 23. The Remuneration Report is a part of the Management Report.

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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.