Annual report 2007
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8.5 Catering

8. Business segment performance

8.5 Catering business segment

LSG Sky Chefs confirms success course

The LSG Sky Chefs group has sustained its success. The operating result improved considerably for the third time in a row. The cost-cutting endeavours paid off in full in 2007. The operating result doubled compared with the previous year. Hence LSG Sky Chefs is creating value again. The level of on-board service in the premium classes has risen further
and airline customers are increasingly open to services and additional advise in the area
of in-flight management.

8.5.1 Business and strategy
The LSG Sky Chefs group holds a leading position in airline catering, with a global market share of around 30 per cent. It includes some 119 companies and is domiciled in 47 countries with nearly 200 local customer service centres. The group has two divisions:
"Airline Catering" supplies airlines worldwide with food, drink and other on-board items, while "In-flight Solutions" (Solutions) offers related services and products and provides comprehensive support to airlines in all areas of on-board service. The parent company for the group, LSG Lufthansa Service Holding AG, is based in Neu-Isenburg.

In a market environment which has stabilised, LSG Sky Chefs explores available opportunities for profi table growth and further differentiation. In response to the different maturities and growth stages of the regional airline catering markets, LSG Sky Chefs follows
a strategy adapted accordingly. In growth markets such as Asia, Eastern Europe and the Middle East the focus is on further geographical expansion, while in the saturated markets in Europe and America, the focus lies on the optimisation of cost structures and expansion through partnerships.

In order to further differentiate the company's portfolio, a systematic innovation process has been launched. It is proven through individual projects already, and, in the future, employees will be trained to apply it as a company standard. The process involves teams
from all divisions and external advisors going through an intensive multi-stage brainstorming process, which is based on reliable market information and generates innovative ideas as quickly as possible.

Due to its corporate structure and its history, LSG Sky Chefs is characterised by a high cultural diversity, within both individual operations and the company as a whole. In order to benefit from this, LSG Sky Chefs has developed a set of corporate values. They provide guidance internally and create a consistent company profile.
8.5.2 Markets and competition
The global airline catering market is growing at an average of 3 per cent a year, although major growth markets such as China and India are expanding much faster.

The tendency of airlines to outsource their in-flight management or other parts of the supply chain and logistics is still in evidence. This trend opens up additional market opportunities for a full-service provider like LSG Sky Chefs. In this context "SkylogistiX", a joint venture with Kühne + Nagel (a leading international logistics provider), launched in autumn 2007, will
strengthen LSG Sky Chefs’ service portfolio. With the partnership LSG Sky Chefs gets access to Kühne + Nagel’s worldwide network of distribution centres and warehouses.

Opposite to these positive aspects are the challenges created by increasing consolidation in the industry and a growing number of local and regional suppliers with low-cost, off-airport locations.

According to its own estimates LSG Sky Chefs has a global market share of 30 per cent. The company has defended its market leadership well in a tough competitive environment defined by consolidation. Within the reporting period, competitors have expanded their
service range by acquiring small or medium-sized companies with complementary products and services. Formerly local or regional suppliers are increasingly moving out of their domestic markets.
8.5.3 Sales and customers
LSG Sky Chefs has more than 300 customers, which include nearly all of the world's international airlines, but also numerous no-frills and regional carriers. The customer service representatives in nearly 200 local centres are responsible for everyday working relations
with clients. A global account manager takes care of the overall customer service. The Corporate Sales department is responsible for strategic relations with the largest customers by revenue.

In 2007, the group focused on linking the regional sales teams with the in-flight management services, who were mostly developed at headquarter level. This took place through the international expansion of the Catering Logistics division (equipment development and logistics) and the Frozen Food division into Asia and the USA.

Furthermore, expert knowledge from both the Sales and the Solutions departments was increasingly integrated into customer service. LSG Sky Chefs intends to put thecompany's capacity, which goes far beyond airline catering, onto a broader platform in order to take advantage of all market opportunities.
8.5.4 Operating performance
Last year, LSG Sky Chefs took a number of significant steps to develop a more differentiated service portfolio above its robust position as an airline caterer. These included organisational and structural reinforcements of the Solutions division, which focuses primarily on developing innovative and creative products and services in the areas of food, equipment, transport and warehouse logistics.

In accordance with its strategic guidelines, the business segment also closed and sold remaining loss-making operations. After a thorough review of alternatives, the joint venture in Paris was discontinued, the facility in Berlin-Tegel closed and an agreement signed to sell the stake in LSG Sky Chefs España S. A.

In the European and African markets, most customer contracts were extended and many new customers acquired in 2007. These included contract extensions with TUIfl y in Germany, First Choice in the UK and TAP in Portugal, as well as new contracts in different locations with SWISS, United Airlines, British Airways, Virgin America and Air New Zealand. In view of growing
competition in the European markets, the company is striving for stability and sustainability by means of broader and tailored customer relationships. Further equity stakes were purchased in Turkey, the Baltic states and the Ukraine, strengthening the company's
presence there.

LSG Sky Chefs won major tenders in the USA and intensifi ed its relationships with both established US carriers and new airlines. Of particular note are the renewed contract with American Airlines at its hub in Dallas, more business with US Airways / America West,
United Airlines and Alaska Airlines, and the successful start-up for newcomer Virgin America. The sales team in Latin America was able to close a worldwide catering contract with Varig, following the acquisition of the Brazilian airline by the no-frills carrier GOL.

In the Asia / Pacific region, cooperation with Chinese airlines, in particular, was intensified based on the successful existing partnerships. The focus of activities there was to develop the company's presence in the growth markets India and China. A total of eight new locations were established. The new frozen-food facility in China will enable LSG Sky Chefs, from spring 2008, to satisfy the increasing demand in the region.
8.5.5 Revenue and earnings development
Revenue and income Revenue picked up by 5.2 per cent year on year to reach EUR 2.4bn. External revenue accounted for EUR 1.9bn, an increase of 5.2 per cent compared with the previous year. Of the total rise in revenue, 1.8 per cent results from changes in the group of consolidated companies, while exchange rate effects depressed growth by 2.6 per cent as expressed in euros. In their local currencies, all regions were able to report higher revenue in 2007, which is gratifying. Thanks to new orders and higher volumes, European business grew, particularly in the UK, Italy, Germany and Scandinavia. The growth markets Asia / Pacific, Latin America and Eastern Europe expanded even faster than average. In the USA, revenue also went up due to new customer wins, but the persistent weakness of the dollar led to a decline in revenue on a euro basis. In addition to the core business of airline catering, the solutions division was also able to expand.

Other operating income sank by 26.1 per cent to EUR 82m. This is principally due to the fact that greater income was derived last year from exchange rate gains.

Total operating income therefore only went up by 3.7 per cent to EUR 2.5bn.

Operating expenses were only slightly above last year's at EUR 2.4bn (+ 1.7 per cent). Higher revenue and price increases for basic foodstuffs and energy led to a higher
cost of materials and services at EUR 1.1bn (+ 8.5 per cent). Companies consolidated for the first time accounted for 1.8 per cent of this rise. The increase also contains a higher volume of outsourcing, underlining the group’s determination to increase its flexibility.

Staff costs went down by 3.0 per cent year on year to EUR 886m, despite higher revenue. In addition to significant efficiency gains in all countries, the weakness of the dollar against the euro also played a role, as did the fact that the one-off payment as part of the new
wage settlement in the USA no longer had an impact and the agreed measures began to take effect. These factors more than made up for increased staff costs due to the larger group of consolidated companies. New recruitment took place in growth markets especially.
The average number of employees increased to 29,880 (+ 5.5 per cent).

Depreciation and amortisation declined by 9.5 per cent to EUR 57m, largely due to the weak dollar.

Other operating expenses dropped by 3.5 per cent compared to the previous year, amounting to EUR 354m.

The operating result doubled to EUR 100m compared with the previous year, driven both by significant revenue growth and successful cost cutting. Other segment income sank by 59.1 per cent to EUR 9m and other segment expenses also dropped considerably from EUR 8m to EUR 4m. The segment result went up by EUR 43m year on year to EUR 116m.
Segment capital expenditure
In the year under review, the Catering segment had segment capital expenditure of EUR 153m. This is EUR 82m (+ 115.5 per cent) above the figure for the previous year. The funds were mainly invested in building a new catering facility at Frankfurt Airport, which is due for completion by mid 2008. LSG Sky Chefs also sees an increasing demand for frozen meals in the catering market and has invested in production facilities for frozen food in Qingdao in China and Pittsburgh in the USA.

Long-term overview of earnings position
LSG Sky Chefs is successfully pursuing its profitable course. Strict cost management and clear internal return targets mean that increasing revenue is disproportionately reflected in the operating result. Over recent years, the Catering segment has increased its result sustainably.

8.5.6 Outlook
In autumn 2007, the company started the programme named "LSG Sky Chefs - Upgrade to Industry Leadership", based on the initiative launched by the Lufthansa Group and tailored to the Catering segment. This is intended to generate further improvements in growth and
profi tability. The previous cost-reduction program mes "Triangle" and "Lean Total Direct Cost" were integrated into the Upgrade initiative. This company-wide programme is based on the strict pursuit of the activities taken in the individual regions, countries and locations,
and on involving the whole company in broad-based initiatives with which performance is to be increased. These include the elements "Customer care", "Innovation and Environment ", "Quality" and "Lean", "Future business models", " Corporate values" and "People".

For 2008, LSG Sky Chefs is expecting both further revenue growth and another increase in the operating result, given continued growth in the markets and the ongoing integration of In-fl ight Solutions into the regional operations. In 2009, results are to improve still further.
LSG Sky Chefs considers the further consolidation of the industry, and a number of contracts which are on tender, as risks. The measures taken to optimise the cost structures should more than balance out these risks, however.

LSG Sky Chefs will continue to evaluate expansion opportunities in the growth markets of Eastern Europe, Asia and the Middle East, and take advantage of them as appropriate.