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Group Management Report 2008 of Austrian Post

Overall business framework

The Austrian economy is in the midst of a downturn, unleashed by the financial crisis. The Austrian Institute of Economic Research (WIFO) and the Institute for Advanced Studies (HIS) now expect the Austrian economy to expand less than originally forecast. Both institutes expect a growth rate of 1.8% for the year 2008.

All major Western markets are expected to endure an economic recession in 2009. Current forecasts predict negative economic growth in Austria in 2009, with WIFO expecting a contraction of 0.5% and IHS of 1%. However, due to the strong dependence on export markets (particularly Germany) and the unpredictable reactions of private consumers, there is a disproportionately wide spectrum of different scenarios that could play out. The global crisis has also negatively impacted markets in South Eastern, Central and Eastern Europe. Lower growth rates are also expected in these markets in 2009 (e. g. Slovakia +2.5%, Hungary –2.7%, Croatia –1.2%, Serbia +1.5%).

The declining rates of economic growth will likely be accompanied by lower inflation. The consumer price index is expected to rise by just 1.5% in 2009 according to IHS, or 1.2% according to WIFO, compared to the 2008 inflation rate of 3.2%.

Population development and the increase in the number of households are key indicators determining the development of the letter mail and parcels markets in a country. The 0.4% increase in the Austrian population in 2008 should drive higher mail volumes for letters, direct mail items
and parcels.

The trend towards electronic substitution of letter mail is expected to continue. The current economic situation has also led to changes in the advertising market, which is a crucial factor in the development of mail volumes transported by Austrian Post. In contrast to other advertising channels, the use of direct communication instruments is expected to grow. Direct mailings to end customers will play an increasingly important role in future communication activities. The dynamic growth of parcel volumes will lose momentum in line with the general economic trend. Competition is expected to remain intense.

At the beginning of 2008, the European Union approved the Third Postal Directive (2008/6/EG), mandating the complete liberalisation of European postal markets. Most EU member states, including Austria, will be required to fully open their markets to free competition as of January 1, 2011.

The issue of how to finance the cost-intensive provision of postal services to rural regions will automatically arise. The EU directive foresees various alternatives. Austrian Post advocates compensation for universal postal services by means of an equalisation fund, as stipulated in the new EU postal guidelines. A free postal market will also require greater flexibility on the part of Austrian Post in terms of pricing for business customers and selecting the optimal business model for branch offices. Unified quality measurement and control systems, as well as fair employment conditions, are other essential pre-requisites supported by Austrian Post.

Austrian Post remains committed to providing comprehensive postal services throughout Austria without qualification, and to maintaining its high quality of service, and has presented its ideas and requests for the reorganisation of postal services in Austria to political decisionmakers. During a round-table discussion held at the Ministry of Finance on November 19, 2008, the new Austrian Federal Government pledged to adapt the legal framework underlying the provision of postal services in Austria by mid 2009.

Business development 2008

Changes in consolidation

At the end of April 2008, Austrian Post acquired a 100% stake in HSH Holding, Belgium. HSH serves as the holding for two fully consolidated legal entities: MIT Transport and DISTRA. These companies operate in the field of pharmaceutical logistics, focusing on the health care sector in Belgium. On August 31, 2008, Austrian Post purchased a 30% shareholding in D2D – direct to document GmbH, Vienna. This company operates in the field of output services (printing, enveloping and data transfer services). Effective September 1, 2008, Austrian Post acquired
a 100% shareholding in Cont-Média Hun gary Kft, Budapest. Cont-Média Hungary specialises in the delivery of unaddressed advertising mail in Hungary. On October 2, 2008, Austrian Post acquired a 100% shareholding in the parcel services company, 24VIP, in Bosnia and Herzegovina.

There is limited comparability between figures in the income statement for the 2008 financial year and those of the previous year, which is primarily due to the meiller direct companies only being included in the consolidated financial statements of Austrian Post from August 2007 onwards.

Business development revenue and earnings
The 2008 financial year presented a major challenge for Austrian Post given the increasingly serious international fi nancial crisis and the loss
of two large mail order customers in the Austrian parcels business at the end of 2007. Despite these challenges, Austrian Post succeeded in increasing total revenue by 5.4% to EUR 2,441.4m. The revenue improvement included organic growth (+EUR 19.0m), but was primarily the result of the integration of new subsidiaries (+EUR 106.7m).

In the 2008 fi nancial year, revenue of the Mail Division rose 5.7%, with good revenue development in all three business areas. Revenue of the Letter Mail Business Area was virtually stable, despite the ongoing trend toward electronic substitution, while the Infomail (addressed and unaddressed direct mail items) and Media Post Business Areas both registered solid organic growth.

Revenues of the Parcel & Logistics Division climbed by 6.4% to EUR 785.9m, partly attributable to higher revenues derived from the Premium Parcel service (parcel delivery within 24 hours) in Austria and internationally. The increased revenues were also related to growth generated by the newly acquired subsidiaries. The 0.1% rise in revenues by the Branch Network Division was related to the good performance of financial services.

Austrian Post’s performance in the fourth quarter of 2008 also showed an increase in revenues compared to Q4 2007. Revenues rose 1.3%, or EUR 8.3m, to EUR 656.8m. Revenues in the Mail Division were up 0.6% year-on-year, while the Parcel & Logistics Division improved by 1.8%, and Branch Network Division revenues rose by 3.3%.

After a 5.4% rise in total revenues, the income statement of Austrian Post also shows higher expenses for raw materials, consumables and other services used rose by 12.4% in 2008, to EUR 778.2m. This increase of EUR 86.0m was primarily related to the consolidation of the acquired subsidiaries (+EUR 58.7m), as well as higher fuel and transport costs (+EUR 23.4m).

Staff costs amounted to EUR 1,119.2m in 2008, representing 46% of total revenues, making them the largest operating expense item. The average number of employees (full-time equivalents) rose to 27,002 from 25,764 in the preceding year. In the 2008 fi nancial year, expenditure relating to termination benefits, particularly in the third and fourth quarters, led to higher staff costs. Termination benefit expenses rose from EUR 16.9m in 2007 to EUR 24.5m in 2008.

As in previous years, staff costs also included changes to the provisions for employee underutilisation. In the 2008 financial year, these provisions were reduced by a total of EUR 23.1m (use of EUR 27.3m).

The allocation of the provision for employee underutilisation is based on determining the individual under-utilisation of an employee for all staff costs up to retirement or early termination of services, as long as the surplus capacity can not be reduced for tenured employees.

If the individual level of under-utilisation is reduced in subsequent years, or if the employee in question is reintegrated into normal business operations this leads to a reversal of the provision created in previous periods. The provision for a specific employee is completely reversed if the employment relationship of that employee with the company is terminated.

On the basis of the ongoing internal adjustment processes tailored to constantly changing market conditions, there may be a continual process of tenured employees terminating their work for the operational divisions and service units. The development of provisions is signifi cantly impacted by current capacity requirements, employee fluctuation and subsequently by the reintegration costs in the company.

In the fourth quarter of 2008 in particular, employees took increased advantage of the incentives offered by Austrian Post to leave the company; including voluntary termination benefits and stopgap measures in line with the social plan. Moreover, organisational measures were im plemented in order to reintegrate a greater number of employees into the company’s operations. As a result, the required provision for employee under-utilisation was reduced in the 2008 financial year.

Other operating income rose to EUR 81.0m, related to the newly consolidated subsidiaries. The largest single items included in this category are income from rents and leases (EUR 23.9m) and gains on the disposal of property, plant and equipment (EUR 16.0m).

Other operating expenses rose by 7.2% to EUR 304.5m. The largest single items were leasing and rental payments (EUR 70.5m) and maintenance expenses (EUR 46.7m).

Earnings before interest, tax, depreciation and amortisation (EBITDA) rose by 9.9% to EUR 321.7m. The EBITDA margin therefore stood at
13.2%. The rise in EBITDA was driven by improved results in the Other/Consolidation segment. The reintegration of employees and the related reduction of the provision for employee under-utilisation had a positive effect in this regard.

Depreciation, amortisation and impairment losses rose to EUR 152.2m in 2008. Impairment losses on goodwill and customer relationships were necessary because of the economic downturn and the diminished market expectations of the company’s subsidiaries. Depreciation, amortisation and impairment losses are therefore mainly comprised of depreciation for property, plant and equipment as well as amortisation for intangible assets amounting to EUR 104.7m, impairment losses of EUR 6.7m for property, plant and equipment and EUR 40.8m for intangible assets (comprised of EUR 14.2m for customer relationships, EUR 24.8m for goodwill and EUR 1.8m for trademark rights).

Earnings before interest and tax (EBIT) amounted to EUR 169.5m, up from EUR 162.8m in 2007. The reduction of the provision for employee
underutilisation had a positive effect. In contrast, impairment losses on property, plant and equipment, goodwill, customer relationships and trademark rights had a negative effect. Exceptional and oneoff effects leading to higher operating expenses also burdened results, including higher transport and fuel costs, increased expenditure in respect of the employee social plan, and costs relating to the integration of the new subsidiaries.

In addition, Austrian Post was faced with a decline in revenues and earnings in the Austrian parcels segment. The loss of the two largest mail order customers represented a significant share of Austrian Post’s B2C parcels business. However, the downsizing of the logistics operations proceeded as planned. A third of the parcel delivery bases were closed and letter mail and parcel logistics merged when possible.

Capacity utilisation of the sorting centres is designed to ensure compliance with regulatory stipulations relating to delivery speed within Austria
(delivery of 95% of all letters on the next working day, and 90% of all parcels within two working days). At peak times, primarily the pre-Christmas period, transported mail volumes generally rise by up to 50%.

The earnings contributions of the various divisions reflect individual one-off effects. The Mail Division, which was subject to minor impairment losses, generated an EBIT of EUR 254.5m. The Parcel& Logistics Division was affected by impairment losses of EUR 33.4m and the integration costs of new subsidiaries, posting a negative EBIT of EUR 25.5m. EBIT of the Branch Network Division rose to EUR 14.5m, while the EBIT loss of the Other/Consolidation segment was reduced to EUR 74.0m.

The Other/Consolidation segment encompasses non-allocated costs for central departments, expenses in connection with unused properties and for the employee social plan, the change in the provision for employee under-utilisation as well as income from rents and leases and gains on the disposal of property, plant and equipment.

The financial result declined from a positive EUR 2.1m in 2007 to minus EUR 11.3m in 2008. This was primarily due to an impairment loss of EUR 20.0m relating to Austrian Post’s shareholding in the consortium BAWAG PSK, the valuation of which was revised as a result of the international financial crisis.

Earnings before tax declined by 4.0% to EUR 158.2m. After deducting income tax of EUR 39.3m, Group net profit corresponding to profit after tax for the period amounted to EUR 118.9m.

Assets and finances
Austrian Post pursues a riskaverse business strategy. This is demonstrated by the high equity ratio, the low level of financial liabilities and the investment of cash and cash equivalents at the lowest possible risk. The international financial and economic crisis has led Austrian Post to continue to carefully evaluate the value of its assets. Lower market expectations resulted in impairment losses on property, plant and equipment, intangible assets and fi nancial investments.

The analysis of the balance sheet of Austrian Post by item shows a considerable level of financial resources on the asset side.
Austrian Post had cash and cash equivalents of EUR 248.1m as at December 31, 2008, and finanial investments in securities amounting to EUR 92.5m. The investment policy of Austrian Post is based on the lowest possible risk. Against the backdrop of the international financial crisis, a revision of the valuation of Austrian Post’s 5% shareholding in the consortium acquiring BAWAG PSK was carried out, which led to an impairment of EUR 20.0m recognised in the income statement. Furthermore, the market valuation carried out on the balance sheet date led
to a reduction in the value of the stake directly in equity of an additional EUR 20.0m.

The largest asset items are property, plant and equipment, intangible assets and goodwill of EUR 1,002.1m.

On the equity and liabilities side, the main items are capital and reserves (39.6%) and provisions (31.2%). The provisions for employee under-utilisation contained in this item declined by EUR 23.1m in 2008 to EUR 307.8m.

The majority of the current and non-current financial liabilities of EUR 146.8m are related to additions arising through acquisitions.

Due to the fact that the existing liquidity on the balance sheet exceeds financial liabilities, Austrian Post does not intend to make use of external
funding, and therefore does not require a credit rating at the present time.

Total assets of Austrian Post amounted to EUR 1,874.6m. Non-current assets predominate on the assets side, accounting for 66.8% of
total assets, or EUR 1,252.1m.

The largest non-current asset items are property, plant and equipment, totalling EUR 725.9m, as well as fi nancial investments in securities and other financial assets, at EUR 132.2m.

The principal current asset items are receivables, at EUR 347.8m, and cash and cash equivalents, at EUR 248.1m. The majority of the current and non-current financial liabilities of EUR 146.8m are related to additions arising through acquisitions. On the equity and liabilities side, the main items are capital and reserves and non-current liabilities, which together make up 69.0% of the balance sheet. Non-current liabilities of EUR 551.8m largely consist of provisions totalling EUR 446.2m. The provisions for employee under-utilisation contained in this item amount to EUR 307.8m.

Current liabilities totalling EUR 581.3m primarily consist of trade payables (EUR 215.9m).

Austrian Post has a net debt position of EUR 270.2m. This is defi ned as the difference between interestbearing assets (securities, other
financial assets and cash and cash equivalents) amounting to EUR 385.8m, and interest-bearing debt (financial liabilities, other interest-bearing liabilities, social capital and provisions) totalling EUR 655.9m. The ratio of net debt to EBITDA is 0.84.

On the basis of the existing liquidity and the solid cash flow from operating activities, Austrian Post is able to self-fund its current financing requirements. The company does not plan to make use of borrowed capital at the present time. The capital management of Austrian Post aims to ensure an appropriate capital structure as a basis for achieving its growth targets and ensuring a sustainable enhancement in shareholder value. On a mid-term basis, Austrian Post aims to achieve a ratio of net debt/EBITDA of up to 2.0, which is customary in the postal sector.

Within the context of its dividend policy, Austrian Post aims to achieve a dividend payout ratio of at least 75% of the net profi t in coming years, assuming a continuation of the company’s successful business development and that no extraordinary circumstances arise.

In 2008, operating cash flow before changes in working capital amounted to EUR 237.0, below the comparable level for 2007.
At an operational level, cash flow was negatively impacted by the loss of two major parcel customers in Austria, higher transport and fuel costs, increased expenditure in respect of the employee social plan and the costs of integrating new subsidiaries. Austrian Post also had higher tax back payments in 2008.

The cash flow from changes in working capital amounted to minus EUR 3.5m in 2008, which relates to increased receivables from other postal
companies. On balance, the cash fl ow from operating activities totalled EUR 233.4m.

The cash flow from investing activities at minus EUR 23.1m includes the purchase of property, plant and equipment amounting to EUR 102.9m, the acquisition of subsidiaries, including the acquisition of minority interests totalling EUR 30.5m, the proceeds from the disposal of property, plant and equipment of EUR 40.0m, as well as the proceeds from the sale of fi nancial investments in securities amounting to EUR 52.9m. Total free cash flow rose from EUR 153.5m in 2007 to EUR 210.3m in 2008, corresponding to EUR 3 per share.

The cash flow from financing activities included the payment of a basic dividend of EUR 98.0m, a special dividend by EUR 70.0m, and the reduction of financial liabilities by EUR 37.1m. The acquisition of treasury shares as part of the share buy-back programme resulted in a payment of EUR 56.7m.

Capital expenditure
Capital expenditure amount ed to EUR 106.7m. Approximately 25% of total investments related to commercial real estate, buildings and assets under construction, including a sorting centre in Bratislava (EUR 8m), the acquisition of a commercial property in Zagreb (EUR 3m), the Vienna Letter Centre (EUR 6m) and building investments of Austrian Post AG (EUR 10m).

Investments in technical plant and machinery (about 11%) primarily involved enveloping, shrink wrap and digital printing machines for the meiller
companies, sorting facilities for the trans-o-fl ex companies as well as letter mail and parcel-conveyor equipment in the Vienna, Kalsdorf and Linz sorting centres.

The largest single item was office equipment, fixture and fittings, which accounted for over 40% of total capital expenditure. Investments primarily focused on a delivery vehicle replacement programme (EUR 16m) and sorting tables (EUR 7m) for the Mail Division, as well as equipment, fixture and fittings for post office branches and various office equipment, vehicle investments, electric and diesel vehicles and other machinery and equipment for the trans-o-fl ex companies.

In the 2008 financial year, Austrian Post paid a total of EUR 30.5m to acquire subsidiaries, minority interest as well as associates (HSH, Cont-Média, 24VIP, 30% share in D2D, remaining 23.85% for trans-o-fl ex Germany, and the remaining 49% stake in Scanpoint).

Earnings and key performance indicators
As at the balance sheet date of December 31, 2008, the capital employed by Austrian Post amounted to EUR 952.5m, compared to EUR 992.2m at the end of 2007. This indicator primarily consists of intangible assets and goodwill (EUR 276.2m), property, plant and equipment (EUR 725.9m), receivables (EUR 356.7m) and non-interest bearing debt (minus EUR 477.1m). The return on capital employed improved to 17.4%
in 2008, up from 16.9% in the previous year.

Non-financial indicators

Delivery speed
Austrian Post aims to be a provider of high quality postal services. In particular, prevailing legal regulations stipulate high standards relating to delivery speed for letters and parcels. In 2008, Austrian Post managed to deliver 96.1% of all letters on the next working day, above the 95% level stipulated by law. Austrian Post also delivered 95.0% of all parcels within two working days, clearly surpassing the statutory target of 90%.

Innovation management
Developing innovative products which fulfi l customer requirements and launching them on the marketplace are key factors contributing to the success of a company facing ever-changing market conditions. In the 2008 financial year, Austrian Post implemented a broad range of such solutions. Examples include the online parcel receipt form (Paketaufgabeschein Online) in the Parcel & Logistics Division and the sending of mail via one’s own post offi ce box (Postaufgabe über Postfach) in the Branch Network Division enabling customers to save time. The ongoing
improvement of equipment and machinery has helped reduce costs while improving working conditions for employees. For Austrian Post, innovation management also means creating a conducive business environment.

During the period under review, the average number of full-time employees at Austrian Post rose by 4.8%, or 1,238, to 27,002. This increase
is related to the acquisition of new subsidiaries. The increased number of employees in the Other/Consolidation segment refl ects the changing reporting structure for employees on permanent sick leave.

In the Austrian domestic market, Austrian Post reduced the average number of employees by approximately 400 year-on-year. Most of Austrian Post’s labour force (22,667 full-time equivalent employees) is employed by the parent company, Österreichische Post AG. The remaining 4,335 employees are employed by subsidiaries.

Ongoing professional training and career development
The targeted training of executives is an important cornerstone of the comprehensive professional training and career development
measures implemented by Austrian Post. Executive training sessions were held in all three divisions during the course of 2008, focusing on
the business development goals of the particular division. In order to further improve practical training, executives also took advantage of individual coaching opportunities. In addition to investment in internal IT training, employees in direct contact with customers also received intensive training. Professional education and continuing education courses totalled about 21,000 person days. 2008 also marked the first group-wide management curriculum for promising young managers. The specially selected participants completed a comprehensive 18-day training programme spread throughout the year covering important topics relating to their future management responsibilities.

Health and occupational safety
Job safety, health protection and the promotion of occupational health care are key components of Austrian Post’s corporate policies. Employee motivation is also particularly important to ensure the effective operation of a nationwide logistics concept based on human manpower. For this reason, Austrian Post carried out numerous measures to promote the well-being of its employees and create the
basis for a healthy and safe working environment. Occupational health-care and job safety are important aspects of the daily business operations in all segments. Compared to 2007, the number of occupational accidents resulting in sick leave rose slightly, by 3.3%.

Environmental protection
Within the context of its corporate social responsibility, Austrian Post is committed to contributing to a prudent use of natural resources. Environmental protection measures and initiatives designed to limit the consumption of natural resources are implemented wherever
they are technically possible and economically feasible. Within the context of its participation in Post Europe, Austrian Post has made a commitment to cut its CO2 emissions by 10% within the next five years (by the end of 2012). These reductions will be made possible by means of an optimal mix of partnerships with cutting edge companies, investments in reliable technologies and the use of public grants.

For some time, initiatives have been undertaken in respect of the vehicle fleet to sustainably reduce fuel consumption and thus exhaust gas emissions. These measures include the purchase of an additional 25 natural gas-driven delivery vehicles, the ongoing route optimisation in daily delivery schedules, the use of fuel-effi cient lorries compatible with higher environmental standards, and driver training focusing on cutting fuel consumption. An ongoing reduction in energy consumption and thus CO2 emissions has also been achieved at the company’s commercial properties by converting heating to district, local or gas heating systems within the context of required maintenance work on existing installations.