Search
Risk Report
Continental's overall risk situation is analyzed and managed corporationwide using the risk management system.
Continental is exposed to a number of different risks that could negatively impact business and, in extreme cases, endanger the company's existence. We accept calculable risks if the resulting opportunities lead us to expect to achieve a sustainable growth in value. There are currently no risks identifiable which would endanger the existence of the company that are likely to occur.
Risk management and internal control system
Pursuant to Section 289 (5) and 315 (2) of the German Commercial Code (Handelsgesetzbuch – HGB) the main characteristics of the internal control and risk management system in respect of the accounting process must be described. All parts of the risk management system and internal control system which could have a material effect on the annual and consolidated financial statements must be included in the reporting.
A uniform corporation-wide risk management system is in place in order to ensure that risks are detected in time, their causes analyzed, and that the risks are assessed and avoided or at least minimized. It regulates the identification, recording, assessment, documentation, and reporting of risks and is integrated into the company's strategy, planning, and budgeting processes. By including risk management in the management and reporting systems, Continental ensures that risk management is an integral component of business processes in the corporation.
In order to operate successfully as a company in our complex business sector, Continental AG has created an effective, integrated internal control system that encompasses all relevant business processes. The internal control system forms an integral part of the risk management system. A summary is therefore given below. The internal control system includes reports for the Supervisory Board, the Audit Committee, the Executive Board, and the Compliance & Risk Management Committee. In its scope and organizational structure, it is focused on company-specific needs.
Continental has expressed its fundamental values and ethical standards such as integrity, honesty and compliance in its Code of Conduct, the BASICS and Corporate Governance Principles. Our corporate culture is based on these fundamental values. In addition, recent years have seen the implementation of various internal procedural guidelines and associated instruction letters, and a handbook on accounting and reporting has been written. The purpose of the compliance organization and these regulations, guidelines and instruction letters is to help avoid violating applicable legal provisions, while ensuring that these provisions are complied with in our operating activities.
Key elements of the control systems are the clear allocation of responsibilities and controls inherent in the system when preparing the financial statements. The dual control principle and segregation of functions are fundamental features of these controls. In addition, Continental's management ensures accounting that complies with the requirements of law via guidelines on the preparation of financial statements and on accounting, access authorizations for IT systems and regulations on the involvement of internal and external specialists.
The Executive Board is responsible for the risk management system and the internal control system. The Supervisory Board and the Audit Committee monitor and review its effectiveness. The risk management and internal control systems include all subsidiaries that are essential to the consolidated financial statements with their relevant accounting processes.
Risk reporting
Identifying and assessing risk
Responsibility for identifying and assessing key risks is distributed among various levels and organizational units within Continental AG.
For purposes of risk identification, assessment and reporting, the management of each unit of the corporation analyzes the material risks relating to that unit. Local management can utilize instruments for this, such as local operations management handbooks, centrally-developed function-specific questionnaires and the process and control descriptions of Compliance@ Continental Systems, which were developed for all major companies for implementing the requirements of the revised version of the 8th EU Directive. In line with this, the key controls in the business processes (e.g. purchase to pay, order to cash, HR, asset management and IT permissions) are controlled on a quarterly basis and reviewed with respect to their effectiveness.
Corporate functions such as Compliance, HR, Quality, Law, Purchasing, and Systems & Standards also conduct additional audits with respect to the implementation of the relevant corporate guidelines and analyze the processes concerned in terms of efficiency and potential weak points. The aim here is to monitor compliance with the guidelines, identify potential risks in the processes and support standardization of the operating processes.
In addition to the risk assessments carried out by the local management and the corporate functions, the internal audit department also implements further reviews.
Continental AG has set up a Compliance & Anti-Corruption Hotline to give the employees the opportunity to report violations of the fundamental values and ethical standards such as integrity, honesty and compliance within the corporation. Information on any kind of potential violations, such as bribery or antitrust behavior, but also accounting manipulation, can be reported anonymously via the hotline where permissible by law. Tips received by the hotline are passed on to Corporate Auditing where they are examined and pursued accordingly.
The risks identified within the framework described above are categorized and evaluated according to specified criteria. Risks are normally assessed according to their negative impact on the unit's operating result.
The evaluation of risks and their impact on accounting takes into account the probability of their occurrence and their impact on sales, EBIT or total assets.
Risk reporting
As with risk assessment, reporting the identified and assessed risks is also allocated to various organizational levels.
Using an extensive risk inventory, the units regularly report any changes to previously reported risks plus any new developments that could turn into material risks as part of their reporting. Any new material risks arising between regular reporting dates have to be reported immediately. This also includes risks identified in the audits of the corporate functions. Furthermore, the central controlling function analyzes the key figures provided as part of this reporting at corporation and division level also so that the causes of potential risks can be identified early.
The effectiveness of the accounting-related internal control system is evaluated in major areas through effectiveness testing of the reporting units. The results of the effectiveness tests must be recorded in the Continental Corporation's reporting systems on a quarterly basis and are then evaluated by the corporation management. If weaknesses are identified, the corporation management initiates the necessary measures.
The Compliance & Risk Management Committee informs the Executive Board of Continental on a regular basis of existing risks, their assessment and the measures taken. In addition, there is reporting to the management levels below the Executive Board according to their area of responsibility. The Supervisory Board and the Audit Committee are also informed regularly of the major risks, weaknesses in the control system and measures taken. Furthermore, the auditors are to report to the Audit Committee of the Supervisory Board regarding any weaknesses in the accounting- related internal control system which the auditors identified as part of their audit activities.
Risk management
The responsible management initiates suitable countermeasures that are also documented in the reporting systems for each risk identified and assessed as material. The Compliance & Risk Management Committee monitors and consolidates the identified risks at the corporation level. It regularly reports to the Executive Board and recommends further measures if needed. The Executive Board discusses and resolves these measures, and reports to the Supervisory Board's Audit Committee. The responsible bodies continually monitor the development of all identified risks and the progress of actions initiated. Regular audits of the risk management process by the internal auditors guarantee its efficiency and further development.
Material risks
Financial risks
Continental is exposed to a number of risks associated with the VDO loan agreement.
To finance the takeover of Siemens VDO Automotive AG ("Siemens VDO") in 2007, Continental and a banking syndicate consisting of 39 lenders entered into a syndicated credit facilities agreement for €13.5 billion, which was amended and restated most recently on December 18, 2009 ("VDO loan agreement"). Loans and credit lines provided as part of this agreement totaled €6.48 billion as of December 31, 2010. Among other obligations, the VDO loan agreement requires Continental to meet specific financial covenants, in particular a maximum leverage ratio (calculated as the ratio of Continental's consolidated net financial indebtedness to consolidated adjusted EBITDA) and a minimum interest cover ratio (calculated as the ratio of Continental's adjusted consolidated EBITDA to consolidated net interest). The maximum leverage ratio decreases gradually from 4.75 for the reference period ended on December 31, 2009, to 3.00 for the reference period to end on June 30, 2012. The interest cover ratio must not fall below 2.25 in the period to end on March 31, 2011, or below 2.50 in the subsequent periods.
In view of the 2009 economic crisis and its effects on Continental's business activities and earnings situation if the current upswing does not prove to be long term, as well as the other market and operational risks described below, Continental may not be able to comply with the financial covenants described above. Should Continental fail in one of these obligations, the creditors are entitled to declare their facilities immediately due and payable. In this case, the facilities granted under the VDO loan agreement will become due for payment immediately and/or all credit lines will be canceled. As of December 31, 2010, the leverage ratio was 1.89 and the interest cover ratio was 4.98.
In August 2012, tranche C of a total nominal amount of €3.98 billion as well as outstanding amounts under the revolving credit facility in the VDO loan agreement will become due for payment. Continental plans to enter into refinancing negotiations with the banks granting the facilities in the course of 2011. In view of the significant deterioration in Continental's credit rating since 2008 and the high risk premiums currently prevailing in the debt markets for non investmentgrade issuers, or in the event of another substantial disruption of the global or European financial markets, Continental could fail to refinance the entire amount then due, with the result that it would be impossible for Continental to pay back the amount. In addition, any refinancing of these liabilities through further bank financing or on the capital markets (if possible at all) could lead to a material increase of Continental's net interest expense.
Furthermore, under the terms of the loan agreements, a prepayment event also occurs in the event of a change-of-control at Continental AG. Under the loan agreements, a change-of-control occurs when 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)) acquire more than 50% of the voting rights in the company or gain control of the company by means of a domination agreement (Beherrschungsvertrag) pursuant to Section 291 of the German Stock Corporation Act (Aktiengesetz – AktG). Upon occurrence of such change-of-control event, each lender may demand repayment of its participation in all outstanding loans, plus interest, and all other amounts accrued under the loan agreements.
A change-of-control could occur, in particular, if the shareholding of Schaeffler KG, Herzogenaurach, in the company's voting capital stock exceeds 50% due to Schaeffler acquiring further shares in the company or as a result of Schaeffler being regarded as acting in concert with other shareholders in the company, or if a domination agreement pursuant to Section 291 AktG is concluded between Schaeffler and the company. The loans described here could become immediately due and payable also if other financing agreements for financial indebtedness of an aggregate amount of more than €75.0 million lead to default.
Continental faces considerable liquidity risks due to its relatively high debt level and the turbulence on the financial markets.
Continental faces liquidity risks arising from tight credit markets and its existing financial liabilities. Since Continental continues to hold relatively high levels of debt (net indebtedness amounting to €7,317.0 million as of December 31, 2010), tighter credit markets (including the market for high-yield bonds) could make it difficult for the company to obtain financing on commercially reasonable terms. In addition, due to the downgrade of Continental's credit rating in June and August 2009 and in May 2010, Continental may be unable to continue its factoring programs under which it factored invoices to banks in the past or to continue to issue high-yield bonds. Continental's cash from operating activities, current cash resources, existing sources of external financing and the proceeds from the offering from the capital increase could be insufficient to meet Continental's further capital needs.
Furthermore, disruptions in the financial markets, including the insolvency or restructuring of a number of financial institutions, and the generally restricted availability of liquidity could adversely impact the availability and cost of additional financing for Continental and also adversely affect the availability of financing already arranged or committed. Continental's liquidity could also be adversely impacted if its suppliers tighten terms of payment or if its customers were to extend their normal payment terms.
Continental's credit rating was downgraded several times in the past and could be subject to further downgrades.
In connection with the acquisition of Siemens VDO in 2007, Continental's net indebtedness increased significantly, and, as a consequence, its net equity-to-debt ratio also decreased substantially. In the course of 2008 and 2009, Continental's equity ratio decreased due to the effects of the financial crisis and the resulting economic downturn on Continental's business and earnings situation as well as due to extraordinary goodwill impairments related to the Powertrain, Interior, and Chassis & Safety divisions. These developments, as well as the uncertainty about the effects of the stake held by Schaeffler in Continental's capital on its strategy and credit quality, have caused the rating agencies covering Continental to downgrade its credit rating from BBB+ (Standard & Poor's) and Baa1 (Moody's), both with stable outlook, in June 2007, to "B+ Creditwatch Negative" (Standard & Poor's) and "B1 Negative Outlook" (Moody's) in August 2009. In May 2010, Standard & Poor's reduced Continental's rating further from B+ to "B Stable Outlook", in particular due to the influence of major shareholder Schaeffler on Continental's credit standing and Continental's forthcoming financing need for 2012. After Continental successfully placed the first high-yield bond, Moody's changed its forecast in July 2010 from "negative" to "stable". Its rating downgrade makes it more difficult for Continental to refinance at economically reasonable conditions. For example, due to the rating downgrade, Continental may be unable to continue its factoring programs under which it factored trade receivables to banks in the past. This may also make it impossible for Continental to issue high-yield debt.
It is not known if the recovery of the global economy and production in the automotive sector is sustainable. If the upturn proves not to be sustainable, this could have negative effects on Continental's liquidity and lead to a further deterioration of its credit rating. Any such downgrading could have adverse effects on Continental's opportunities for obtaining funding as well as the costs and related interest expenses. A further downgrading of Continental's credit rating could also adversely impact Continental's liquidity position if its suppliers change the terms of payment offered to Continental for this reason, for example by requesting payment in advance. Any such impact could be aggravated if credit insurers were to further restrict coverage for Continental's accounts payable. In addition, a further downgrading of Continental's credit rating could cause Continental's customers to extend their normal payment terms or even to terminate their supply relationships with Continental and to engage another supplier altogether.
Continental's other financing agreements contain, and future debt obligations are likely to contain, restrictive covenants and change-of-control provisions.
In addition to the risks related to the VDO loan agreement, Continental also faces risks in connection with its other financing agreements, especially a loan from the European Investment Bank ("EIB"), which amounted to €300.0 million as of the end of 2010, a promissory note of €110.0 million, the bond of €750.0 million (due for repayment in 2015) that Continental issued in July 2010, the bond of €1,000.0 million that Continental issued in September 2010 (due in 2017), and the two bonds issued in October 2010 of €625.0 million each (due in 2016 and 2018, respectively). These other financing agreements also contain numerous covenants that limit Continental's operations and require Continental to maintain specific financial ratios, as well as change-of-control provisions. Under the covenants of the loan agreement with the EIB, an example of a change-of-control is when one person or several persons acting in concert (pursuant to Section 2 (5) WpÜG) acquire more than 50% of the voting rights in the company or gain control of the company by means of a domination agreement pursuant to Section 291 AktG. In this case, the EIB may request information on the change-of-control from the company. If the EIB sees its interests affected by the change-of-control, it may demand repayment of the outstanding amount under the EIB loan plus interest within 30 days.
Any debt financing incurred by Continental in the future is likely to contain similar restrictive covenants and change-of-control provisions. If Continental fails to comply with any of these covenants or if a change-of-control occurs, and Continental is unable to obtain a waiver from the respective lenders, a default could result under the relevant debt instrument, which would then become immediately due and payable. In addition, the EIB can declare its loan immediately due and payable if other financing agreements exceeding €40.0 million lead to default.
Continental is exposed to risks associated with interest rate changes and hedging.
Continental is exposed to risks associated with changes in variable interest rates, as a number of Continental's credit facilities (in particular the facilities granted under the VDO loan agreement) bear interest at a floating rate. Therefore, an increase or decrease in interest rates would affect Continental's current interest expenses and its future refinancing costs. These risks are monitored and evaluated as part of our interest rate management activities and managed by means of derivative interest rate hedging instruments. In 2008, Continental hedged a substantial part of tranche C of the VDO loan agreement due for maturity in August 2012 (altogether hedging a loan volume of €3,125 million at an average rate of 4.19% plus margin) in order to mitigate Continental's exposure to fluctuating interest rates. However, the future use of derivative interest rate hedging instruments is generally dependent on the availability of adequate credit lines. Currently, the availability of additional credit lines is negatively affected by the disruptions in the financial markets, Continental's high level of financial indebtedness and the downgrading of its credit rating. As a result, Continental could be unable to use derivative financial instruments in the future and Continental's hedging strategy could therefore ultimately be negatively impacted. Moreover, any hedging transactions executed in the form of derivative financial instruments could result in losses.
Risks related to the markets in which Continental operates
Continental could be exposed to significant risks in connection with a global financial and economic crisis.
Continental generates a large percentage (approximately 72%) of its sales from OEMs. The remainder of Continental's sales is generated from the replacement or industrial markets, mainly in the replacement markets for passenger tires, light truck tires, van tires, and truck tires, and to a lesser extent in the non-automotive end-markets of the other divisions.
During the most recent global economic crisis, automotive sales and production deteriorated substantially, resulting in a sharp decline in demand for Continental's products from its OEM customers. At present it is not known if the current upturn is sustainable. If this is not the case, automobile production could fall again and remain at a low level for an extended period of time, especially in Europe and the NAFTA region, where Continental generated approximately 79% of its sales in 2010. A prolonged weakness in or deterioration of the global automotive markets or consumer credit markets is likely to adversely affect Continental's sales and results of operations. Tax increases that reduce consumers' disposable income could be another factor to weaken global demand on the vehicle markets. Especially in the member countries of the European Union, tax increases are a likely reaction to the increase in public debt due to the various aid programs for banks and the EU's "rescue parachute" for its member states. Furthermore, Continental's five largest OEM customers (BMW, Ford, Daimler, VW and General Motors) generated approx. 39% of the Continental Corporation's sales in 2010. A combination of significantly lower global production levels, tightened liquidity and increased cost of capital have caused severe financial distress among a number of OEMs and have forced these companies to implement restructuring measures, including reorganization under bankruptcy laws. There can be no assurance that any of these restructuring measures will be successful. If one or more of Continental's OEM customers is lost or terminates a supply contract prematurely, the original investments made by Continental to provide such products or outstanding claims against such customers could be wholly or partially lost. In numerous markets important to Continental, governments introduced scrapping programs in 2009, such as the Car Allowance Rebate System (CARS) in the United States and the Car Scrapping Bonus (Umweltprämie) in Germany, intended to provide economic incentives to car owners to trade in older vehicles and purchase new vehicles. Most of these programs, which were designed to stimulate the economy by boosting vehicle sales, have lapsed. As these scrapping programs may have led to increased sales by bringing forward potential demand from later years rather than adding incremental demand in the relevant markets, vehicle sales may decline in the short term with likely negative consequences for production volumes on which Continental depends.
Continental operates in a cyclical industry.
Global production of vehicles and, as a result, sales to OEM customers (from whom Continental currently generates approximately 72% of its sales) are cyclical. They depend, among other things, on general economic conditions and consumer spending and preferences, which can be affected by a number of factors, including fuel costs and the availability of consumer financing. As the volume of automotive production fluctuates, the demand for Continental's products also fluctuates, as OEMs generally do not commit to purchasing minimum quantities from their suppliers, or to fixed prices. It is difficult to predict future developments in the markets Continental serves, which creates problems in estimating the requirements for production capacity. Since its business is characterized by high fixed costs, Continental risks underutilization of its facilities (in particular, in the Automotive Group) or having insufficient capacity to meet customer demand if the markets in which Continental is active either grow or decline faster than Continental has anticipated. Underutilization of Continental's facilities could result in idle capacity costs, write-offs of inventories and losses on products due to falling average sale prices. Furthermore, falling production volumes can produce declines in sales and margins, as well as earnings.
The automotive supply industry is characterized by intense competition, which could reduce Continental's sales or put continued pressure on its sales prices.
The automotive supply industry is highly competitive and has been characterized by rapid technological change, high capital expenditures, intense pricing pressure from major customers, periods of oversupply and continuous advancements in process technologies and manufacturing facilities. As OEMs are increasingly affected by innovation and cost-cutting pressures from competitors, they seek price reductions in both the initial bidding process and during the term of the contract with their suppliers. In particular, vehicle manufacturers expect lower prices from suppliers for the same, and in some cases even enhanced functionality, as well as a consistently high product quality. Should Continental be unable to offset continued price reductions through improved operating efficiencies and reduced expenditures, price reductions could impact profit margins. Furthermore, Continental's existing competitors, in particular its competitors from Asia, may pursue an aggressive pricing policy and offer conditions to customers that are more favorable than Continental's. Furthermore, the markets in which Continental is active are characterized by a trend towards consolidation. Increased consolidation among Continental's competitors or between Continental's competitors and any of its OEM customers could allow competitors to further benefit from economies of scale, offer more comprehensive product portfolios and increase the size of their serviceable markets. This could require Continental to accept considerable reductions in its profit margins and the loss of market share due to price pressure. Furthermore, competitors may gain control over or influence on suppliers or customers of Continental by shareholdings in such companies, which could adversely affect Continental's supplier relationships.
Continental is exposed to fluctuations in prices of raw materials, electronic components and energy.
For the divisions of the Automotive Group, cost increases could result, in particular, from rising steel and electronic components prices, while the divisions of the Rubber Group are mainly affected by the development of oil and natural rubber prices. In the recent past, steel and electronic components prices as well as oil and natural rubber prices have fluctuated on a worldwide basis. Continental does not actively hedge against the risk of rising prices of electronic components or raw materials by using derivative financial instruments. Therefore, if Continental is not able to compensate for or pass on its increased costs to customers, such price increases could have a material adverse impact on Continental's results of operations.
While the lower prices for natural and synthetic rubber in 2009 had a positive impact on Continental's earnings situation, price increases since the third quarter of 2009 have led to increased costs of €405 million at a price level of over $3 per kilogram of natural rubber and over $80 per barrel of crude oil. As long as Continental is able to pass on these additional costs by increasing its selling prices, it is possible that the positive effects of the price increases will not end until after the period of additional costs. In this case, the additional costs may not be compensated for at the time they arise. As a manufacturer dependent on large quantities of energy for production purposes, Continental is also affected by changes in energy prices. If Continental is unable to compensate for or pass on its increased costs resulting from rising energy prices to customers, such price increases could have a material adverse impact on Continental's earnings situation.
Continental generates by far the greatest share of its total sales in Europe and, in particular, in Germany.
In 2010, Continental generated 60% of its total sales in Europe, of which 27% were generated in Germany. By comparison, 19% of Continental's total sales in 2010 were generated in NAFTA, 16% in Asia, and 5% in other countries. As a consequence, in the event of an economic downturn in Europe or in Germany in particular, Continental's business and earnings situation may be more affected than its competitors'. Furthermore, the automotive and tire markets in Europe and NAFTA are largely saturated. Continental aims to generate more sales in emerging markets, in particular in Asia, to mitigate the risks resulting from Continental's strong focus on Europe and Germany. In the current global economic situation, adverse changes in the geographical distribution of automotive demand could also cause Continental to suffer. The current recovery in automotive production is driven mainly by strong demand from the Asian and North American markets, while the demand in Europe is relatively low. It is unknown if the strong demand from Asia and North America is sustainable. If demand falls there and is not compensated for by an increase on another regional market, this could adversely impact demand for Continental products.
Continental is exposed to risks associated with the market trends and developments that could affect the vehicle mix sold by OEMs.
Continental currently generates approximately 72% of its sales from OEMs, mainly in its Automotive Group. Global production of vehicles and, as a result, sales to OEM customers are currently subject to a number of market trends and technical developments that may affect the vehicle mix sold by OEMs.
- Due to increasingly stringent consumption and emission standards throughout the industrial world, including the European Union (EU), the U.S.A. and Japan, as well as oil price fluctuations and the resulting significant increase in fuel costs, car manufacturers are increasingly forced to develop environmentally- friendly technologies aimed at lower fuel consumption and a reduction of CO2 emissions. These developments have caused a trend towards vehicles with lower fuel consumption, in particular smaller cars, in these markets.
- Over the past years, the market segment of "affordable" cars (referring to favorably priced cars costing less than $10,000/€7,000) has been increasing steadily, in particular in emerging markets such as China, India, Brazil and Eastern Europe.
- Over the past decade, hybrid electric vehicles, combining a conventional internal combustion engine propulsion system with an electric propulsion system, have become increasingly popular. Their market share may increase further in the coming years. Furthermore, according to recent industry publications, a number of market participants are currently developing "pure-play" electric vehicles, using (only) one or more electric motors for propulsion. If the industry is able to develop functional electric vehicles that suit the consumer's taste, these might gain a material market share in the medium or long term.
As a consequence of the above-listed market trends and technical developments, the vehicle mix sold by Continental's customers has shifted significantly over the past two years and may further shift in the future.
Continental is exposed to risks associated with changes in currency exchange rates and hedging.
Continental operates worldwide and is therefore exposed to financial risks that arise from changes in exchange rates. Currency exchange fluctuations could cause losses if assets denominated in currencies with a falling exchange rate lose value, while at the same time liabilities denominated in currencies with a rising exchange rate appreciate. In addition, fluctuations in foreign exchange rates could enhance or minimize fluctuations in the prices of raw materials, since Continental purchases a considerable part of the raw materials which it sources in foreign currencies. As a result of these factors, fluctuations in exchange rates could affect Continental's earnings situation. External and internal transactions involving the delivery of products and services to third parties and companies of the Continental Corporation result in cash inflows and outflows which are denominated in currencies other than the functional currency of the respective member of the Continental Corporation ("transaction risk"). Continental is particularly exposed to fluctuations in the U.S. dollar, Czech koruna, Chinese yuan, Romanian leu, and Hungarian forint. To the extent that cash outflows of the respective member of the Continental Corporation in any one foreign currency are not offset by cash flows resulting from operational business in the same currency, the remaining net foreign currency exposure is hedged against on a case-by-case-basis by using appropriate derivative financial instruments, particularly currency forwards, currency swaps and currency options with a term of up to twelve months. Moreover, Continental is exposed to foreign exchange risks arising from external and internal loan agreements, which result from cash inflows and outflows in currencies which are denominated in currencies other than the functional currency of the respective member of the Continental Corporation. These foreign exchange risks are in general hedged against by using appropriate derivative financial instruments, particularly currency forwards/swaps and cross-currency interest-rate swaps.
Continental's hedging strategy could ultimately be unsuccessful. Moreover, any hedging transactions executed in the form of derivative financial instruments can result in losses. Continental's net foreign investments are generally not hedged against exchange rate fluctuations. In addition, a number of Continental's consolidated companies report their results in currencies other than the euro, which requires Continental to convert the relevant items into euros when preparing Continental's consolidated financial statements ("translation risk"). Translation risks are generally not hedged.
Risks related to Continental's business operations
Continental is encountering significant challenges in its Powertrain division and it may not achieve a timely turnaround.
Continental is encountering significant challenges in its Powertrain division. In 2007, Continental acquired Siemens VDO from Siemens AG and established three new divisions, including the Powertrain division, mainly consisting of former Siemens VDO businesses. The Powertrain division was initially structured into seven business units (Gasoline Systems, Diesel Systems, Electronics, Transmission, Hybrid Electric Vehicle, Sensors, Actuators/Motor Drives and Fuel Supply) and a number of ancillary projects and businesses.
Continental has identified a number of problem areas within the Powertrain division (consisting mainly of Siemens VDO businesses acquired in 2007), including a number of unprofitable long-term supply contracts, technical and quality problems involving product design, materials and mechanical parts, organizational problems and a high fixed cost base. Continental has initiated a turnaround program and several restructuring measures, involving among other things several changes at the division's management level and a reduction of the organizational structure. Continental has not yet succeeded in remedying all of the problems identified within the Powertrain division by implementing these measures. In particular, the technical and quality issues encountered by the Powertrain division have led in the past, and continue to lead, to cost-intensive application engineering. Moreover, the problems encountered by the Powertrain division were intensified due to the 2009 global recession and its consequences, since the Powertrain division's high fixed cost base prevented a quick adjustment of the cost structure to lower production volumes caused by the sharp decline in demand.
After the Powertrain division's adjusted EBIT passed the break-even point in 2010, the medium-term objective remains to generate a reported EBIT margin of 8% in this division by 2015. However, the problems described could make achieving this goal more difficult. The technical quality issues encountered by the Powertrain division with respect to product design, materials and mechanical parts could cause warranty or product liability claims which exceed customary standards by far and which may not be covered by Continental's insurance policies. Moreover, defective products could result in a loss of sales, contracts, customers or market acceptance. Furthermore, Continental could still be forced to dedicate a considerable amount of additional management capacity to solve these problems. Any failure or delay in solving the operational issues at the Powertrain division could affect Continental's competitive position in a number of important and rapidly growing market segments, such as the market for efficient engine management systems for gasoline and diesel engines and the hybrid electric or the electric vehicle market. As a consequence, the goodwill recorded for the Powertrain division could be subject to further significant impairments in the future.
Continental is exposed to risks in connection with the sale and transfer of shares in ContiTech AG to Continental Pension Trust e.V.
On August 19, 2009, Continental AG, ContiTech Universe Verwaltungs-GmbH (a 100% subsidiary of the company; "ContiTech Universe"), ContiTech AG and Continental Pension Trust e.V. (the trustee of the contractual trust arrangements (CTAs) for Continental AG, Continental Reifen Deutschland GmbH and Continental Teves AG & Co. OHG) entered into an agreement concerning the sale and transfer of 22,148,273 shares (representing 24.9% of the capital stock of ContiTech AG) by ContiTech Universe to Continental Pension Trust against payment of a purchase price of €475.6 million. Among other stipulations, the purchase agreement contains a number of regulations on the sale and transfer of the shares to ContiTech AG. Under certain conditions, these authorize the Continental Pension Trust (i) to obligate ContiTech Universe to repurchase the ContiTech shares at a purchase price of at least €475.6 million, (ii) to sell its ContiTech shares to a third party, (iii) to sell its ContiTech shares to a third party which acquires the ContiTech shares held by ContiTech Universe, or (iv) to obligate ContiTech Universe to sell its ContiTech shares to a third party which acquires the ContiTech shares held by Continental Pension Trust.
Continental depends on its ability to develop and bring to the market innovative products in a timely manner, which includes securing sufficient funds for this purpose.
The future success of Continental depends on the company's ability to develop and bring to the market new and improved products in a timely manner. The automotive market in particular is characterized by a development towards higher performance and simultaneously more fuel-efficient, less polluting and quieter engines, growing demands by customers and stricter regulations with respect to engine efficiency and by the trend towards affordable cars and hybrid and electric vehicles. These new developments could entail technical challenges, the mastering of which could be very time-consuming for Continental. Consequently, Continental may be unable to develop innovative products and adapt them to market conditions quickly enough. Furthermore, developing new and improved products is very costly and therefore requires a substantial amount of funding. The general lack of liquidity caused by the disruptions in the financial markets, combined with Continental's high level of indebtedness and the downgrading of its credit rating, is adversely impacting the availability and cost of additional credit for Continental and could also limit the availability of credit already arranged or committed. Should Continental be unable to secure sufficient funding to finance its development activities, it could lose its competitive position in a number of important and rapidly growing sub-markets. Furthermore, Continental spends significant resources on research and development, especially in the divisions of its Automotive Group, but also in the Rubber Group. Over the past years, Continental's R&D expenses in relation to total sales accounted for more than 5%. If Continental devotes resources to the pursuit of new technologies and products that fail to be accepted in the marketplace or that fail to be commercially viable, all or part of these significant R&D expenses may be lost and Continental's business may suffer.
Continental depends on a limited number of key suppliers for certain products.
Continental is subject to the risk of unavailability of certain raw materials and production materials. Although Continental's general policy is to source input products from a number of different suppliers, a single sourcing cannot always be avoided and, consequently, Continental is dependent on certain suppliers in the Rubber Group as well as with respect to certain products manufactured in the Automotive Group. Since Continental's procurement logistics are mostly organized on a just-in-time or just-in-sequence basis, supply delays, cancellations, strikes, insufficient quantities or inadequate quality can lead to interruptions in production and, therefore, have a negative impact on Continental's business operations in these areas. Continental tries to limit these risks by endeavoring to select suppliers carefully and monitoring them regularly. However, if one of Continental's suppliers is unable to meet its delivery obligations for any reason (for example, insolvency, destruction of production plants or refusal to perform following a change in control), Continental may be unable to source input products from other suppliers upon short notice at the required volume. The recent economic downturn has led to a significant deterioration of financial health among automotive suppliers and caused a rise in insolvencies, mainly amongst Tier 2 suppliers (suppliers that sell their products to Tier 1 suppliers) and Tier 3 suppliers (suppliers that sell their products to Tier 2 suppliers), whereas Tier 1 suppliers (suppliers that sell their products directly to OEMs) are not affected to the same extent. This could cause delays in delivery or finalization of Continental products or projects and could result in Continental having to purchase products or services from third parties at higher costs or even to financially support its own suppliers. Furthermore, in many cases OEM customers have approval rights with respect to the suppliers used by Continental, making it impossible for Continental to source input products from other suppliers upon short notice if the relevant OEM customer has not already approved other suppliers at an earlier point in time. All of this could lead to order cancellations or even claims for damages. Furthermore, Continental's reputation amongst OEM customers could suffer, with the possible consequence that they select a different supplier.
Continental is exposed to warranty and product liability claims.
Continental is constantly subject to product liability lawsuits and other proceedings alleging violations of due care, violation of warranty obligations or material defects, and claims arising from breaches of contract, recall campaigns or fines imposed by governments. Any such lawsuits, proceedings and other claims could result in increased costs for Continental. Moreover, defective products could result in loss of sales and of customer and market acceptance. Such risks are insured up to levels considered economically reasonable by Continental, but its insurance coverage could prove insufficient in individual cases. Additionally, any defect in one of Continental's products (in particular tires and safety-related products) could also have a considerable adverse effect on the company's reputation and market perception. This could in turn have a significant negative impact on Continental's sales and income. Moreover, vehicle manufacturers are increasingly requiring a contribution from their suppliers for potential product liability, warranty and recall claims. In addition, Continental has long been subject to continuing efforts by its customers to change contract terms and conditions concerning warranty and recall participation. Furthermore, Continental manufactures many products pursuant to OEM customer specifications and quality requirements. If the products manufactured and delivered by Continental do not meet the requirements stipulated by its OEM customers at the agreed date of delivery, production of the relevant products is generally discontinued until the cause of the product defect has been identified and remedied. Furthermore, Continental's OEM customers could potentially claim damages, even if the cause of the defect is remedied at a later point in time. Besides this, failure to fulfill quality requirements could have an adverse effect on the market acceptance of Continental's other products and its market reputation in various market segments.
Continental's operations depend on qualified executives and key employees.
Continental's success depends on its Executive Board members and other qualified executives and employees in key functions. The loss of executives or key employees could have a material adverse effect on the market position and prospects of Continental. Considerable expertise could be lost or access thereto gained by competitors. Due to the intense competition in the automotive industry, there is a risk of losing qualified employees to competitors or being unable to find a sufficient number of appropriate new employees. There is no guarantee that Continental will be successful in retaining these executives and the employees in key positions or in attracting new employees with corresponding qualifications. Continental tries to retain the commitment of its qualified executives and key employees through performance-based remuneration systems. There is a risk that such employees could leave Continental, especially in view of the uncertainty about the effects of the stake held by Schaeffler on the corporate strategy.
Continental is exposed to risks in connection with its pension commitments.
Continental provides defined benefit pension plans in Germany, the U.S.A., the UK and certain other countries. As of December 31, 2010, the pension obligations amounted to €3,342.8 million. These existing obligations are financed predominantly through externally invested pension plan assets. In 2006, Continental established legally independent trust funds under contractual trust arrangements for the funding of pension obligations of certain subsidiaries in Germany. In 2007, Continental assumed additional pension trust arrangements in connection with the acquisition of Siemens VDO. As of December 31, 2010, Continental's net pension obligations (pension obligations less pension plan assets) amounted to €1,563.0 million.
Continental's externally invested pension plan assets are funded through externally managed funds and insurance companies. While Continental generally prescribes the investment strategies applied by these funds, it does not determine their individual investment alternatives. The assets are invested in different asset classes including equity, fixed-income securities, real estate and other investment vehicles. The values attributable to the externally invested pension plan assets are subject to fluctuations in the capital markets that are beyond Continental's influence. Unfavorable developments in the capital markets could result in a substantial coverage shortfall for these pension obligations, resulting in a significant increase in Continental's net pension obligations.
Any such increase in Continental's net pension obligations could adversely affect Continental's financial condition due to an increased additional outflow of funds to finance the pension obligations. Also, Continental is exposed to risks associated with longevity and interest rate changes in connection with its pension commitments, as an interest rate decrease could have an adverse effect on Continental's liabilities under these pension plans. Furthermore, certain U.S.-based subsidiaries of Continental have entered into obligations to make contributions to healthcare costs of former employees and retirees. Accordingly, Continental is exposed to the risk that these costs will increase in the future.
Continental is exposed to risks in connection with its joint venture with Michelin and its interests in other joint ventures and other associated companies.
Continental and Compagnie Financière Michelin, Granges-Paccot, Switzerland, ("Michelin"), each hold a 50% stake in MC Projects B.V., Amsterdam, Netherlands, a joint venture company, to which Michelin contributed the rights to the Uniroyal brand for Europe as well as for certain countries outside Europe. In turn, MC Projects B.V. licensed to Continental certain rights to use the Uniroyal brand on or in connection with tires in Europe and elsewhere. Under the terms of the agreement governing the joint venture, both the agreement and the Uniroyal license can be terminated if a major competitor in the tire business acquires more than 50% of the voting rights of Continental AG or of its tire business. Furthermore, 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 spol. s. r. o. in Otrokovice, Czech Republic – Continental's largest tire plant in Europe – to 51%. These events could have an adverse effect on the business, financial situation and earnings situation of Continental's Tire divisions. Furthermore, Continental conducts its business in part via other joint ventures and associated companies in which Continental holds an interest.
Continental's ability to fully exploit the strategic potential in markets in which it operates through joint ventures or associated companies would be impaired if it were unable to agree with its joint venture partners or other interest groups on a strategy and the implementation thereof. Moreover, Continental could be subjected to fiduciary obligations to its joint venture partners or other shareholders, which could prevent or impede its ability to unilaterally expand in a business area in which the joint venture or associated company in question operates. Additionally, there is a risk that the transfer of know-how and/or trade secrets to partners in the context of joint ventures and other collaborations could result in a drain of expertise from Continental. In particular, after a potential separation from a joint venture or collaboration partner, there is no guarantee that the know-how and/or trade secrets transferred to such partner will not be used or disclosed to third parties, thereby adversely affecting Continental's competitive position.
Continental's operations rely on complex IT systems and networks.
Continental relies heavily on centralized, standardized information technology systems and networks to support business processes, as well as internal and external communications. These systems and networks are potentially vulnerable to damage or interruption from a variety of sources. Although Continental has taken precautions to manage its risks related to system and network disruptions, an extended outage in a data center or telecommunications network or a similar event could lead to an extended unanticipated interruption of Continental's systems or networks. Furthermore, Continental has outsourced all its SAP operations and certain other business-critical systems to an external service provider, making it and thus Continental vulnerable to damage and loss caused by fire, natural hazards, terrorism, power failure, or other disturbance at such third party's facilities and networks.
Continental could be adversely affected by property loss and business interruption.
Fire, natural hazards, terrorism, power failure, or other disturbance at Continental's production facilities or within Continental's supply chain – with customers and with suppliers – can result in severe damage and loss. Such far-reaching negative consequences can also arise from political unrest or instability, especially in emerging economies. The risks arising from business interruption and loss of production are insured up to levels considered economically reasonable by Continental, but its insurance coverage could prove insufficient in individual cases. Furthermore, such events could injure or damage individuals, third party property or the environment, which could, among other things, lead to considerable financial costs for Continental.
Continental is exposed to risks from performance bonds that were granted to customers of its divested Public Transport Solutions business.
In the past, Continental has regularly granted performance bonds in connection with orders received from customers in its Public Transport Solutions business. On August 31, 2009, four subsidiaries of Continental AG, as sellers, entered into a framework agreement, which was closed on November 2, 2009, concerning the sale of the Public Transport Solutions business to subsidiaries of Trapeze Software Inc., Ontario, Canada ("Trapeze"). Under this framework agreement, Trapeze did not assume liability under any performance bonds issued by Continental to secure obligations under the contracts entered into with customers of the Public Transport Solutions business before or after the sale of the business.
Trapeze is obliged to indemnify Continental, should Continental make a payment in response to a performance bond. However, Continental's recourse is limited, unless the claim of the customer under the performance bond was made due to Trapeze's willful deceit or other intentional breach of the relevant customer contract. As a consequence, Continental may still be held liable under the performance bonds and has only limited recourse vis-à-vis Trapeze, although Continental can no longer influence the way in which the obligations towards the customer are fulfilled.
Legal, environmental and taxation risks
Continental could be held liable for soil, water or groundwater contamination or for risks related to hazardous materials.
Many of the sites at which Continental operates have been used for industrial purposes for many years, leading to risks of contamination and the resulting site restoration obligations. Moreover, Continental could be responsible for the remediation of areas adjacent to its sites if these areas were contaminated due to Continental's activities, that is, if Continental were to be found the polluter of these areas. Furthermore, soil, water and/or groundwater contamination has been discovered at a number of sites operated by Continental in the past, including Mayfield (Kentucky, U.S.A.), Adelheidsdorf (Germany), Culpeper (Virginia, U.S.A.), Gifhorn (Germany), Mechelen (Belgium) and Várzea Paulista (Brazil). For example, since the closure of the Mayfield plant in 2005, the competent environmental authority has sought to establish new requirements, in particular the submittal of an appropriate remedial plan, which should include inter alia proposals for the groundwater sampling. The responsible authorities could assert claims against Continental, as the owner and/or tenant of the affected plots, for the examination or remediation of such soil and/or groundwater contamination, or order Continental to dispose of or treat contaminated soil excavated in the course of construction. Continental could also be sued for damages by the owner of plots leased by Continental or of other properties, if the authorities were to pursue claims against the relevant owner of the property and if Continental had caused the contamination.
On several of the sites where contamination has been discovered, remediation activities have already taken place upon order by or agreement with the competent authorities. Costs typically incurred in connection with such claims are generally difficult to predict. Moreover, if any contamination were to become a subject of public discussion, there is a risk that Continental's general reputation or its relations with its customers could be harmed.
Furthermore, at some of the sites at which Continental operates, hazardous materials were used in the past, such as asbestos-containing building materials used for heat insulation. The health and safety of third parties (for example former employees) may have been affected due to the use of such hazardous materials and Continental could therefore be exposed to related damage claims in the future.
Continental faces similar risks with respect to former sites which it has since sold. Even if Continental has contractually excluded or limited its liability vis-à-vis a purchaser, it could be held responsible for currently unknown contamination on properties which it previously owned or used. Likewise, there can be no assurance that environmentally hazardous substances will not pollute the environment or that Continental will not be called upon to remove such contamination.
Continental could become subject to additional burdensome environmental or safety regulations and additional regulations could adversely affect demand for Continental's products and services.
Continental, as a worldwide operating corporation, must observe a large number of different regulatory systems across the world that change frequently and are continuously evolving and becoming more stringent, in particular with respect to the environment, chemicals and hazardous materials, as well as health regulations. This also applies to air, water and soil pollution regulations and to waste legislation, all of which have recently become more stringent through new laws, particularly in the EU and the U.S.A. Moreover, Continental's sites and operations necessitate various permits and Continental has to comply with the requirements specified therein. In the past, adjusting to new requirements has necessitated significant investments and Continental assumes that further significant investments in this regard will be required in the future.
Furthermore, any additional regulations restricting or limiting car traffic with the aim of managing global warming (climate change) could lead to a material decrease in car sales and consequently adversely affect demand for Continental's products and services.
Continental could be unsuccessful in adequately protecting its intellectual property and technical expertise.
Continental's products and services are highly dependent upon its technological know-how and the scope and limitations of its proprietary rights therein. Continental has obtained or applied for a large number of patents and other industrial property rights that are of considerable importance to its business. The process of obtaining patent protection can be lengthy and expensive. Furthermore, patents may not be granted on currently pending or future applications or may not be of sufficient scope or strength to provide Continental with meaningful protection or commercial advantage. In addition, although there is a presumption that patents are valid, this does not necessarily mean that the patent concerned is effective or that possible patent claims can be enforced to the degree necessary or desired.
A major part of Continental's know-how and trade secrets is not patented or cannot be protected through industrial property rights. Consequently, there is a risk that certain parts of Continental's know-how and trade secrets could be transferred to joint venture partners, collaboration partners, customers and suppliers, including Continental's machinery suppliers or plant vendors. This poses a risk that competitors will copy Continental's know-how without incurring any expenses of their own.
Furthermore, prior to the acquisition of Siemens VDO by Continental, Siemens AG (i) contributed to Siemens VDO industrial property rights, know-how and software that were exclusively attributed to the business unit "Siemens VDO Automotive", (ii) granted to Siemens VDO non-exclusive rights to use industrial property rights, know-how and software that were not exclusively attributed to the business unit "Siemens VDO Automotive" as of the contribution date, including certain industrial property rights of Siemens AG related to electric motors and voice recognition systems, and (iii) granted to Siemens VDO exclusive rights to use certain industrial property rights of Siemens AG related to the piezo fuel injection system. At the same time, Siemens AG retained non-exclusive, irrevocable, unrestricted, transferable and royalty-free rights to use such contributed industrial property rights, inventions on which such rights are based, know-how and software. As a consequence, Siemens AG may still use the industrial property rights, inventions on which such rights are based, know-how and software which were contributed to Siemens VDO, or for which non-exclusive rights of use were granted to Siemens VDO, to compete with Continental on the market or could license such industrial property to third parties, thereby materially adversely affecting Continental's competitive position.
Moreover, Continental has concluded a number of license, cross-license, collaboration and development agreements with its customers, competitors and other third parties under which Continental is granted rights to industrial property and/or know-how of such third parties. It is possible that license agreements could be terminated, inter alia, in the event of the licensing partner's insolvency or bankruptcy and/or in the event of a change-of-control in either party, leaving Continental with reduced access to intellectual property rights to commercialize its own technologies.
There is a risk that Continental could infringe on the industrial property rights of third parties.
There is a risk that Continental could infringe on industrial property rights of third parties, since its competitors, suppliers and customers also submit a large number of inventions for industrial property protection. It is not always possible to determine with certainty whether there are effective and enforceable third-party industrial property rights to certain processes, methods or applications. Therefore, third parties could assert claims (including illegitimate ones) of alleged infringements of industrial property rights against Continental. As a result, Continental could be required to cease manufacturing, using or marketing the relevant technologies or products in certain countries or be forced to make changes to manufacturing processes and/or products. In addition, Continental could be liable to pay compensation for infringements or could be forced to purchase licenses to continue using technology from third parties.
Continental could be threatened with fines and claims for damages for alleged or actual antitrust behavior.
In 2007, the European Commission and the U.S. Department of Justice ("DoJ") initiated their investigations into antitrust behavior in the marine hose market. The European Commission found Continental AG, ContiTech AG and Dunlop Oil & Marine Limited ("DOM") liable – among other companies – for infringements of competition law. The proceedings of the European Commission and the DoJ against the company were completed in 2009. Following the initiation of the European Commission and the DoJ's investigations, additional investigations against DOM for the infringement of national competition law were opened in other jurisdictions (Brazil, Japan, Australia, South Korea and Canada). Apart from the ongoing proceedings in Brazil, all other proceedings have been concluded or, as in the case of Canada, have not been pursued. In Brazil, DOM may be subject to fines to be imposed by the national competition authorities in relation to the marine hose cartel. Further proceedings in relation to the marine hose cartel may be opened in other countries with the risk of fines for the infringement of antitrust law. In addition, DOM may be subject to claims for damages by third parties due to the infringement of antitrust law as a result of the marine hose cartel. In the U.S.A., DOM agreed to a settlement of $6.5 million with the plaintiffs in a U.S. class-action lawsuit. Proceedings have also been initiated in the English High Court and further claims in the United Kingdom have been threatened. There is also a risk that claims for damages may be filed in other countries (e.g. Japan, South Korea, Australia and Brazil).
In May 2005, the Brazilian competition authorities opened investigations against Continental's Brazilian subsidiary Continental Brasil Industria Automotiva ("CBIA") following an allegation of anticompetitive behavior in the area of commercialization of tachographs. On August 18, 2010, the Brazilian national competition authorities determined an "invitation to cartel" and imposed a fine of BRL12 million (about €5.3 million) on CBIA. CBIA dismisses the accusations and has filed an appeal at the responsible court. However, third parties may also claim damages from CBIA resulting from the infringement of Brazilian antitrust law. On October 2, 2006, South African antitrust authorities received a complaint from a third party accusing several South African tire manufacturers of alleged antitrust behavior, including Continental Tyre South Africa (Pty.) Limited ("CTSA"), a joint venture that is 74% owned by Continental. On August 31, 2010, the South African antitrust authorities came to the conclusion that CTSA had violated South African antitrust law and referred the matter to the responsible antitrust court for a decision. CTSA denies the allegation of infringements of South African antitrust law. However, the antitrust court could impose a fine of up to 10% of CTSA's sales. In addition, third parties may also claim damages from CTSA resulting from the infringement of South African competition law.
On February 24, 2010, the European Commission conducted searches at several companies which manufacture wire harnesses for automotive purposes, including S-Y Systems Technologies Europe GmbH ("S-Y"), Regensburg, Germany. S-Y is a joint venture in which Continental and the Japanese company Yazaki, a wire harness manufacturer, each own 50%. The European Commission announced that it has indications that the companies in question have violated EU antitrust law. However, it is not clear whether the European Commission will impose fines against S-Y or Continental. Searches are a preliminary step in investigations into antitrust behavior and are not indicative of the outcome. If the European Commission determines that S-Y or Continental can be accused of antitrust behavior, it could impose a fine based on the severity and the duration of the violations not to exceed 10% of the previous year's sales of the participating company. Even if the European Commission determines that only S-Y exhibited antitrust behavior, it cannot be ruled out that the parent companies may be included in the fine due to joint and several liability. Continental has conducted internal audits in certain business units to check compliance with antitrust law. These audits revealed anticompetitive behavior with respect to one product group. Continental took measures to end this behavior. There is a risk that antitrust authorities may conduct investigations due to this behavior and impose fines and that third parties, especially customers, may file claims for damages. The amount of such fines and any subsequent claims is unknown from the current perspective, but could be significant. It also cannot be ruled out that future internal audits may reveal further actual or potential violations of anti-trust law that in turn could result in fines and claims for damages. In addition, alleged or actual antitrust behavior could seriously disrupt the relationships with our business partners.
Continental might be exposed to tax risks regarding the use of tax loss and interest carryforwards in connection with changes in the shareholder structure of the company.
Section 8c of the German Corporate Income Tax Act (Körperschaftssteuergesetz – KStG) provides for prorata elimination of tax loss and interest carryforwards and current losses as a rule in cases where more than 25% and up to 50% of the shares in a company have been acquired within a five-year period by an individual purchaser. If more than 50% of the shares have been acquired by an individual shareholder, carryforwards and current losses are as a rule eliminated completely.
Continental could be subject to tax risks attributable to previous tax assessment periods.
Additional tax expenses could accrue at the level of the company or its subsidiaries in relation to previous tax assessment periods which have not been subject to a tax audit yet. The last completed tax audit for the company and its German subsidiaries related to the assessment periods up to and including 2003. A routine tax audit for the company and its German subsidiaries is currently being conducted by the German tax authorities for the assessment periods of 2004 to 2007. Tax audits are also pending in foreign jurisdictions for essentially the same assessment periods. As a result of the aforementioned tax audits, a material increase in the company's or its subsidiaries' tax burden is currently not expected. It cannot however be ruled out that tax audits may lead to an additional tax burden.
Furthermore, Continental is exposed to risks in connection with the takeover of Siemens VDO in 2007, since the tax indemnity provided by the seller of Siemens VDO does not cover the entire tax exposure potentially materializing for pre-acquisition periods.
Continental is exposed to risks from legal disputes.
Companies from the Continental Corporation are involved in a number of legal and arbitration proceedings and could become involved in other such proceedings in future. These proceedings could involve substantial claims for damages or other payments, particularly in the U.S.A. Further information on legal disputes can be found in Note 34