Continental depends on its ability to develop and bring to the market innovative products in a timely manner, which includes providing sufficient funds for this purpose. The future success of Continental depends on its ability to develop and launch new and improved products in a timely manner. The automotive market in particular is characterized by a trend toward 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 toward 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 re- quires a substantial amount of funding. If Continental is unable to provide sufficient funding to finance its development activi- ties, it could lose its competitive position in a number of im- portant and rapidly growing sub-markets. Continental spends significant resources on research and development, especially in the divisions of its Automotive Group, but also in the Rubber Group. In the business year, Continental’s research and devel- opment (R&D) expenses in relation to total sales accounted for more than 6%. 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.
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 suppli- ers in the Rubber Group as well as with respect to certain prod- ucts manufactured in the Automotive Group. Since Continen- tal’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 economic crisis in 2009, in addition to the natural disasters in Japan and Thailand, have shown how quickly the financing strength and ability of some automotive suppliers to deliver can be impaired, even resulting in insolvency. This mainly affected
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Tier-2 and Tier-3 suppliers (suppliers who sell their products to Tier-1 or Tier-2 suppliers respectively), while Tier-1 suppliers (suppliers who sell their products to OEMs directly) were not affected to the same degree. Such developments and events can cause delays in the delivery or completion 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, which could make it im- possible 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 claims and proceedings alleging violations of due care, violation of warran- ty obligations or material defects, and claims arising from breaches of contract due to recall campaigns or government proceedings. Any such lawsuits, proceedings and other claims could result in increased costs for Continental. Moreover, defec- tive products could result in loss of sales and of customer and market acceptance. Such risks are insured up to levels consid- ered economically reasonable by Continental, but its insurance coverage could prove insufficient in individual cases. Additional- ly, any defect in one of Continental’s products (in particular tires and other safety-related products) could also have a considera- ble adverse effect on the company’s reputation and market perception. This could in turn have a negative impact on Conti- nental’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 speci- fications and quality requirements. If the products manufac- tured and delivered by Continental do not meet the require- ments stipulated by its OEM customers at the agreed date of delivery, production of the relevant products is generally dis- continued until the cause of the product defect has been identi- fied 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 mar- ket 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, other qualified executives, and employees in key functions. The loss of executives or key employees could have a material ad- verse effect on the market position and prospects of Continen- tal. 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 Conti- nental 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 interesting development perspectives and performance- based remuneration systems.
Continental is exposed to risks in connection with its pension commitments.
Continental provides defined benefit pension plans in Germany, the U.S.A., the U.K. and certain other countries. As of December 31, 2014, the pension obligations amounted to €5,265.6 mil- lion. These existing obligations are financed predominantly through externally invested pension plan assets. In 2006, Conti- nental established legally independent trust funds under con- tractual trust arrangements (CTAs) for the funding of pension obligations of certain subsidiaries in Germany. In 2007, Conti- nental assumed additional pension trust arrangements in con- nection with the acquisition of Siemens VDO. As of December 31, 2014, Continental’s net pension obligations (pension obliga- tions less pension plan assets) amounted to €3,229.9 million.
Continental’s externally invested pension plan assets are funded through externally managed funds and insurance companies. While Continental generally prescribes the investment strate- gies applied by these funds, it does not determine their individ- ual investment alternatives. The assets are invested in different asset classes including equity, fixed-income securities, real es- tate and other investment vehicles. The values attributable to the externally invested pension plan assets are subject to fluc- tuations 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 pen- sion 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 Continen- tal have entered into obligations to make contributions to
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healthcare costs of former employees and retirees. Accordingly, Continental is exposed to the risk that these costs will increase in the future.
If the discount rates used to calculate net pension obligations were to decrease by 0.5 percentage points, ceteris paribus, this would lead to a rise in net pension obligations in a range from €300 million to up to €400 million.
Continental is exposed to risks in connection with its interest in MC Projects B.V. and its interests in other companies.
Continental and Compagnie Financière du Groupe Michelin, “Senard et Cie”, Granges-Paccot, Switzerland (Michelin), each hold a 50% stake in MC Projects B.V., Maastricht, Netherlands, a company to which Michelin contributed the rights to the Uni- royal 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 concluded in this connection, 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 Continental Barum s.r.o., Otro- kovice, Czech Republic – Continental’s largest tire plant in Eu- rope – to 51%. These events could have an adverse effect on the business, financial and earnings position of Continental’s Tire division.
Furthermore, Continental conducts its business in part via companies in which it does not hold a 100% interest. Continen- tal’s ability to fully exploit the strategic potential in markets in which it operates through associated companies would be impaired if it were unable to agree with its partners or other interest groups on a strategy and the implementation thereof. Moreover, Continental could be subjected to fiduciary obliga- tions to its partners or other shareholders, which could prevent or impede its ability to unilaterally expand in a business area in which the company in question operates. Additionally, there is a risk that the transfer of know-how and/or trade secrets to part- ners in the context of such collaborations could result in a drain of expertise from Continental. In particular, after a potential separation from a 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 infor- mation technology systems and networks to support business processes, as well as internal and external communications. These systems and networks are potentially vulnerable to dam- age or interruption from a variety of sources. Although Conti- nental 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 par- ty’s facilities and networks. Continental’s systems and networks are also subject to the risk that third parties could attempt to spy on confidential information that is saved, processed or communicated in the systems and networks. If the precautions taken by Continental to provide adequate protection of its sys- tems, networks and information are insufficient, the knowledge or use of its information by third parties could result in disad- vantages for Continental.
Continental could be adversely affected by property loss and business interruption.
Fire, natural hazards, terrorism, power failures, or other disturb- ances at Continental’s production facilities or within Continen- tal’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. In particular, as a result of the current conflict over the Ukraine, there is a risk that Russia will respond to the sanctions imposed by the EU and the U.S.A. by imposing counter-sanctions. In the past fiscal year, Continen- tal’s sales in Russia and in the Ukraine represented less than 1% of its consolidated sales. Continental’s fixed assets in this region also correspond to less than 1% of its total assets. Furthermore, the risks arising from business interruption, loss of production, or the financing of facilities are insured up to levels considered economically reasonable by Continental, but its insurance cov- erage 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.
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