Market share gains and significant improvement of underlying profitability and margins

After the unprecedented decline during 2009, world trade bounced back in 2010 – driven by strong economic growth in most markets and global restocking of inventories – and led to a significant recovery of business volumes in Panalpina's core activities. The Company posted double-digit volume growth in both its Air and Ocean Freight businesses and managed to solidify its position within the industry. Apart from gaining back market share, Panalpina was also able to capitalize on various profitability improvement initiatives and posted a significant increase in underlying operating margins.

2010 saw a significant recovery of the world economy and a strong rebound of world trade. The International Monetary Fund estimates that global trade volumes rose 11% in 2010, with China and other emerging markets leading the way but also the “old economies” in North America and Europe gaining significant traction. As a result, the global air freight market – which tends to react more volatile than other modes of transportation to short-term economic fluctuations – grew nearly 20% and caught up a large part of the volumes lost during 2009. The ocean freight market, which also fell sharply in 2009, saw a volume increase in the range of 10% in the reporting year and thus almost reached the volume record set in 2008.

During 2010, apart from benefiting from the favorable economic climate and market share gains which had a positive impact on the volumes transported on behalf of its customers, Panalpina started to reap the benefits from several measures which were implemented early in the year. Back in March, the Company changed its organizational structure to speed up the reaction time to changes in market conditions by unifying the responsibilities for its buying and selling decisions and Operations under the Chief Operating Officer (COO). The adapted organization – which has the COO directly overseeing Sales and the three product divisions Air Freight, Ocean Freight and Logistics – is product-driven and has a strong industry-specific sales focus. It allows the Company to rapidly and consistently implement industry vertical and product specific strategies and to take critical decisions in a timely manner, which is essential considering today's volatile markets with respect to both customers' volumes and carriers' freight rates. As part of the reorganization, the number of Executive Board members was reduced from seven to five, and the Company appointed three industry experts to globally lead its core products Air Freight, Ocean Freight and Logistics, all of whom assume their responsibilities during the first quarter of 2011.

The year under review was also characterized by leveraging the real-time visibility derived from the global roll-out of the Company's new management information system (MIS) which took place in the last quarter of 2009. The new system, which was developed in-house, dramatically improved the granularity of financial information down to the individual customer, business unit and trade lane, and thus greatly enhanced and supported the decision-making processes from top management down to department heads throughout 2010.

Costs continued to be tightly managed during the reporting year. While the steep volume increases handled during the year needed to be accommodated through additional personnel, the hiring of new employees took place at a much slower pace, leading to a substantial increase of labor productivity. The amount of average shipments handled per month across all business divisions, which serves as a good indicator of the Company's overall business activity, rose 14% in 2010 versus the year before. At the same time, the average monthly number of employees, expressed in terms of full-time equivalents (FTE), increased by only 2%. As a result, the Company's productivity, measured as the average number of shipments handled per FTE during the reporting period, increased by 12% compared to the respective prior year period.

In the second half of the year under review, the Company announced a settlement with US authorities over violations of the Sherman Antitrust Act as well as the final resolution of claims against it for violations of the US Foreign Corrupt Practices Act. In particular the settlement of the latter case marked the closing of an extremely burdensome chapter in the Company's history and the end of a very demanding three-year effort to address and eliminate serious compliance concerns. The Company is now looking forward to strengthen relationships with customers who have ceased or reduced business activities with Panalpina due to the investigation. To cover all costs related to the resolution of both cases, including expenses for ongoing compliance consulting, as well as for an internal reorganization project, the Company recognized costs totaling CHF 128 million in the year under review. Panalpina has also established an industry-leading compliance organization and ongoing programs aimed at ensuring rigorous adherence to country specific anti-bribery and anti-trust laws. Designing state-of-the-art compliance policies and programs with the support of the highly-regarded Basel Institute on Governance, establishing a dedicated global compliance organization, conducting anti-corruption training both in-person and web-based, implementing systematic third-party due diligence and developing a whistleblowing program were among the specific measures implemented by the company.

The world economy and financial markets offer a picture marked by contradictions that points to opportunities and risks in 2011. The consensus view is that the global economy will probably continue its recovery in 2011 although at a patchy pace and at a less dynamic global growth rate. Tighter fiscal policy may have a dampening effect in many industrialized countries. There is also a gap between countries that have emerged from the crisis relatively unscathed and are now on the road to recovery and those that have their backs to the wall. Overall, world trade and global outsourcing look set to expand further in 2011 and beyond albeit with a bias to the emerging economies – particularly in Asia and Latin America – which will continue to gain in relative importance. With its global and asset-light network, coupled with the ability to offer its customers value-add, first-class supply chain management solutions, Panalpina is well prepared to take advantage of the growth opportunities ahead and to further enlarge its footprint in the global logistics market.

Net forwarding revenue (NFR)

In 2010, Panalpina's net forwarding revenue (NFR) amounted to CHF 7,164 million, up 20% from the CHF 5,958 million the year before. This substantial increase can be attributed to a variety of factors, including significantly higher freight volumes fueled by the rebound in world trade and market share gains, as well as higher average freight rates prevailing in the market as freight capacity remained tight throughout a large part of the year. Moreover, the booming world economy resulted in rising oil prices which translated into higher fuel surcharges which Panalpina passed through to its customers.

At regional level, net forwarding revenue saw double- digit growth in all four reporting regions, led by Asia Pacific (APAC) where NFR in 2010 increased by 43% to CHF 1,270 million. The booming Chinese economy and the growing importance of intraregional traffic in the region were the main drivers behind this growth.

In Europe/Middle East/Africa and CIS (EMEA), NFR increased 14% to CHF 3,640 million. This region remains Panalpina's largest in revenue terms, contributing to slightly over half of the Group's turnover. The export-oriented German economy benefited from the weak euro, and together with Panalpina's strong footprint in this market greatly supported growth in this reporting region. On the other hand, the substantial depreciation of the euro (– 9%) and also the British pound (– 5%) vs. the Swiss franc adversely affected net forwarding revenue in this region (translated into Swiss francs) by nearly 8%.

In North America (NORAM), NFR rose by 20% to CHF 1,409 million, a large part of which can be attributed to the substantial volume increases on both the transatlantic and the transpacific trade lanes which benefited particularly from the strong growth in the Automotive and Hi-Tech sectors. The US dollar, which depreciated 4% vs. the Swiss franc during the reporting period, had a negative translation effect of approximately 2% on this region's turnover.

Compared to 2009, the Group's NFR in 2010 in Central and South America (LATAM) rose 20% to CHF 845 million, which is a reflection of the strong economies and Panalpina's increased focus on the main growth markets in this region, particularly Brazil.

In 2010, the Panalpina Group generated 51% of its net forwarding revenue in Europe/Middle East/Africa and CIS, 20% in North America, 17% in Asia Pacific and 12% in Central and South America.

Preliminary estimates of the International Air Transport Association (IATA) show that international air freight volumes (measured in freight ton kilometers) grew by approximately 20% in 2010. At the same time, global volumes handled in the ocean container market rose in excess of 10% according to various market sources and nearly reached or even exceeded (in Asia and North America) the 2008 record level. Against this backdrop, together with the Group's ability to gain market share, the Group's Air Freight and Ocean Freight segments, which jointly contribute 88% to Group NFR, both recorded strong increases in net forwarding revenue in 2010. The tightness of carrier capacity that was prevalent for a large part of the year led to substantial freight rate hikes, which additionally helped increase the Group's NFR due to the pass-through character of freight rates for an asset-light service provider like Panalpina. Moreover, average jet fuel and bunker prices in 2010 were more than 20% above 2009 levels, resulting in distinctly higher fuel and bunker surcharges (essentially also items with a pass-through character) which the Group invoiced to its customers.

As a result of these developments, the Group's NFR generated with air freight activities increased by 29% to CHF 3,503 million and was the segment which saw the greatest rebound. In the Ocean Freight segment, NFR advanced by 17% to CHF 2,771 million. In the third segment, Logistics (which the Group renamed from the previously used term “Supply Chain Management”), NFR saw an increase of 1% to CHF 890 million. Next to consolidating and globally standardizing the various activities in this segment (mainly warehousing and distribution services) during 2010, demand remained weak in the Group's oil and gas and projects business where the market was lagging the general economic recovery, which slowed progress in this segment.

In 2010, the Panalpina Group generated 49% of its net forwarding revenue with Air Freight, 39% with Ocean Freight and 12% with Logistics.

Gross profit (GP)

Gross profit, a better measure for actual sales performance than net forwarding revenue in the forwarding industry, increased by 7% from CHF 1,377 million in 2009 to CHF 1,480 million in 2010. In local currencies, the increase was 11%. This 4% difference, which had a negative impact on GP of CHF 54 million, is largely due to the adverse movement of the euro and the US dollar against the Swiss franc. In addition to the strong rebound of world trade which boosted global trade volumes, Panalpina's market share gains were another important factor behind the increase in the Group's gross profit. The unit profitability (gross profit per ton of air freight and per TEU of ocean freight), a measure of the pricing power of a freight forwarder, also showed a sequential improvement every quarter (in currency neutral terms), although the 2010 average remained below the prior year levels which were distorted by an unusually high volatility of carrier freight rates.

Europe/Middle East/Africa and CIS (EMEA) is also the most important region within Panalpina in terms of gross profit generation, representing more than half of the Group's gross profit. In 2010, gross profit generated in EMEA increased by 4% to CHF 760 million, supported by higher freight volumes on all major trade lanes. Similar to net forwarding revenue, the currency development in this region adversely affected gross profit, mainly due to the euro but also the British pound, with both significantly depreciating against the Swiss franc.

In North America (NORAM), gross profit rose 4% to CHF 266 million, which is a reflection of the higher volumes handled in this region on the back of the recovering North American economies and restocking which additionally boosted global trade flows. In this region, particularly the weakness of the US dollar adversely impacted the Group's gross profit when translated into Swiss francs.

Asia Pacific (APAC) and Central and South America (LATAM) recorded the highest increases in GP, which management attributes to the relatively better economic development of these regions in 2010 that manifested itself in strong intraregional and interregional trade flows in and between these parts of the world. In LATAM gross profit rose 8% to CHF 156 million, while gross profit in APAC increased 22% to a total of CHF 298 million and thereby overtaking NORAM as the Group's second largest region in terms of gross profit.

In 2010, the Panalpina Group generated 51% of its gross profit in Europe/Middle East/Africa and CIS, 18% in North America, 20% in Asia Pacific and 11% in Central and South America.

The varying volume and pricing dynamics in the Group's core business segments during the reporting year becomes evident when looking at the development of gross profit. The air freight market recorded the strongest growth rate of all transport modes in 2010, resulting in relatively stronger volume growth for Panalpina in this segment. In addition, despite the tight carrier capacity which led to rising freight rates for a large part of the year, the Group managed to restore a significant fraction of its gross profit per transported cargo unit during the course of the year which started at very depressed levels. The Group's gross profit realized through air freight forwarding services increased by 19% in 2010, reaching CHF 667 million versus CHF 562 million the year before.

In the Ocean Freight segment, GP saw a slight contraction of 1% to CHF 453 million. Panalpina's volume growth rate was above that of the global ocean freight market which registered strong volume growth during the first half of the year, before cooling off in the second half in the absence of a peak season. Until late summer, many ocean carriers were successful in implementing several rounds of considerable rate increases, making it more difficult for the Group to lift its unit profitability more rapidly from the historically low levels at the beginning of the year due to the time lags involved in passing on rate increases to customers.

In 2010, the Panalpina Group generated 45% of its gross profit with Air Freight, 31% with Ocean Freight and 24% with Logistics.

Earnings before interest, taxes,

depreciation and amortization (EBITDA)

The Group's EBITDA was substantially hit by a charge of CHF 128 million (contained in the category “other operating expenses”) which the Company recognized to cover all costs arising from the settlement of the two legal claims in the United States (FCPA, anti-trust) and associated compliance consulting costs as well as from an internal reorganization project. The Group's EBITDA decreased by 22% at actual exchange rates (–18% in local currencies) from CHF 80 million in 2009 to CHF 62 million in 2010. Apart from these non-recurring costs, operating expenses which directly influence EBITDA developed as follows:

The gross profit margin (gross profit as a percentage of net forwarding revenue) decreased from 23.1% to 20.7%, mostly due to the markedly higher average fuel surcharges and freight rates, which had a positive effect on net forwarding revenue while having a relatively neutral effect on gross profit as these are normally pass-through items (subject to a certain time lag) for freight forwarders.

Gross profit generated through the Group's Logistics activities posted a small growth of 1% to reach a total of CHF 360 million. While this segment was also able to benefit from higher transported volumes, particularly the oil and gas and projects businesses were still lagging the recovery.

Regional development

The Company assesses segmental operating performance primarily from a geographical perspective, as the Group's operations are predominantly managed by geographical location. A useful measure to assess the operating performance by region is EBITDA. The segmental EBITDA provided in the financial accounts excludes the non-recurring charges incurred in 2010 related to fines and related expenses as well as reorganization costs in order to make a comparison with prior year more meaningful. Moreover, the following extraordinary costs had an influence on the EBITDA per region during the reporting period:

Current assets

The Group's cash and cash equivalents amounted to CHF 529 million on December 31, 2010 and thus remained virtually unchanged from the CHF 532 million on December31, 2009. The substantial recovery of business volumes resulted in an increase of the net working capital, which was largely offset by the increase in profitability of the operating business.

Trade receivables and unbilled forwarding services increased by CHF 93 million, from CHF 940 million at the end of 2009 (equivalent to 49% of total assets) to CHF 1,033 million at the end of 2010 (equivalent to 52% of total assets). The increase in trade receivables can mainly be attributed to the strong increase in turnover.

In total, net working capital intensity (defined as net working capital as a percentage of gross forwarding revenue) ended the reporting year with a record low level of 1.6%.

Non-current assets

The Group's non-current assets declined slightly from CHF 326 million on December 31, 2009 to CHF 303 million on December 31, 2010. The reduction is primarily a result of the decrease in property, plant and equipment due to a lower level of capital expenditures and the strength of the Swiss franc versus major foreign currencies.

Other current assets remained relatively stable and amounted to CHF 125 million at the end of the reporting period 2010 compared to CHF 127 million at the end of the reporting period 2009.

Balance sheet

Borrowings (short-/long-term)

Other liabilities

Total equity

The most significant change in shareholders' equity is the change in reserves which – as a result of the negative net result for the reporting year, an adverse currency translation effect as well as recognized actuarial losses on pension valuation amouting to CHF 12 million – declined from CHF 999 million on December 31, 2009 to CHF 950 million on December 31, 2010. Total equity decreased by CHF 52 million during the reporting period, from CHF 864 million on December 31, 2009 to CHF 812 million on December 31, 2010.

Cash flow

Free cash flow

The free cash flow, calculated as net cash from operating activities and adding the net cash flow from investing activities, accordingly decreased from CHF 226 million in 2009 to CHF 6 million in 2010.

The Group's other liabilities increased significantly from CHF 369 million at year-end 2009 to CHF 471 million at year-end 2010. The major reasons for the increase are provisions remaining on the balance sheet at the end of the year amounting to CHF 94 million in connection with the charges arising from the settlement of the two legal claims in the United States (FCPA, anti-trust) and associated compliance consulting costs as well as for an internal reorganization project.

Total borrowings were further reduced from CHF 13 million at year-end 2009 to CHF 10 million at year-end 2010.