Description and Business Strategy

Description

LAN Airlines is one of the leading airlines in Latin America. "LAN" makes reference to the consolidated entity that includes LAN Airlines, LAN Express, LAN Peru, LAN Ecuador, LAN Argentina and Aires in Colombia, as well as LAN Cargo and its affiliates. As of February 28, 2011, LAN serviced 15 destinations in Chile, 14 destinations in Peru, 4 destinations in Ecuador, 14 destinations in Argentina, 24 destinations in Colombia, 14 destinations in other Latin American countries and the Caribbean, 5 destinations in the United States, 1 destination in Canada, 3 destinations in Europe and 4 destinations in the South Pacific. In addition, through our various code-share agreements, LAN offer service to 25 additional destinations in North America, 16 additional destinations in Europe, 25 additional destinations in Latin America and the Caribbean (including Mexico) and 2 destinations in Asia. We provide cargo service to all our passenger destinations and to approximately 20 additional destinations served only by freighter aircraft. We also offer other services, such as ground handling, and maintenance.
LAN Airlines is a member of oneworld (TM), the world's leading global airline alliance. It has bilateral commercial agreements with oneworld partners American Airlines, British Airways, Iberia and Qantas, as well as with Alaska Airlines, AeroMexico, Mexicana, TAM and Korean Air. For more information visit www.lan.com or www.oneworldalliance.com.

Lan Airlines S.A. is a publicly-held stock corporation (sociedad anónima abierta) incorporated under the laws of Chile. Our principal executive offices are located at Presidente Riesco 5711, 20th floor, Las Condes, Santiago, Chile and our general telephone number at this location is (56-2) 565-2525.

Competitive Strengths

Our strategy is to maximize shareholder value by increasing revenues and profitability through leveraging the operational efficiencies between our cargo and passenger divisions, thoroughly planning for our expansion efforts and carefully controlling costs. We plan to accomplish these goals by both focusing on our existing competitive strengths and implementing new strategies to fuel our future growth. We believe our most important competitive strengths are:

Leading Presence in Key South American Markets
We are one of the main international and domestic passenger airlines in Latin America, as well as the largest cargo operator in Chile and most of the South American markets that we serve. We hold the largest market share of passenger traffic to and from Chile, Peru and Ecuador, as well as the largest market share of domestic passenger traffic in both Chile and Peru. More recently, we have also achieved a solid and growing position in the Argentine domestic market through Lan Argentina and in the Argentine international market through Lan Argentina and our other passenger airlines. We are also strengthening our presence in the Ecuadorian market, where we began domestic passenger operations on April 6, 2009. We entered the Colombian domestic and international market through the acquisition of Aires on November 26, 2010. We are also the leading air cargo operator within, to and from South America, and we are consolidating our leadership through new cargo operations in Colombia and in the Brazilian domestic market, as well as through an increased presence in routes between South America and Europe. Our international and domestic passenger and cargo operations have increased substantially over the past four years in terms of capacity, traffic and revenue. Between 2005 and 2010, our passenger capacity grew 78.8% and our cargo capacity grew 28.2%.

 Diversified Revenue Base from both Passenger and Cargo Operations
We believe that one of our distinct competitive advantages is our ability to profitably integrate our scheduled passenger and cargo operations. We take into account potential cargo services when planning passenger routes, and also serve certain dedicated cargo routes using our freight aircraft, when needed. By adding cargo revenues to our existing passenger service, we are able to increase the productivity of our assets and maximize revenue, which has historically covered fixed operating expenses per flight, lowered break-even load factors and enhanced per flight profitability. Additionally, this revenue diversification helps offset seasonal revenue fluctuations and reduces the volatility of our business over time. As of December 2010, passenger revenues accounted for 68.8% of total revenues and cargo revenues accounted for 28.3% of total revenues.

 Attractive Cost Structure with High Utilization of our Assets and Productive Personnel
We believe that we have a highly competitive cost structure with a cost per ATK of 43.7 cents in 2010. Our cost advantage arises mainly from our productive and committed employees, high aircraft utilization, modern and fuel-efficient fleet and cost-conscious culture. Our wages and labor costs accounted for approximately 20.4% of total costs in 2010, which we believe is a lower percentage than that of many other U.S. and European carriers.
Furthermore, our itineraries and aircraft rotations are designed to maximize aircraft utilization. During 2010, our long-haul aircraft (Boeing 767-300 passenger and Airbus A340-300s) operated an average of approximately fourteen hours per day. We also implemented a new business model for short-haul operations in 2007; as a result, by the end of 2010 we increased the utilization of our narrow body aircraft to reach 9.5 hours per day.  In May 2008, we completed the phase out of the Boeing B737-200 from our fleet.  Our short haul fleet is now entirely composed of Airbus A320-Family Aircraft with the exception of the recently acquired Aires fleet.

In addition, during 2009 we continued with the implementation of LEAN, a system that seeks to improve our processes by eliminating activities that do not add value (thus increasing the value of each activity and suppressing those that are superfluous), which reduces costs, improves efficiency and increases customer satisfaction. The adoption of this system constituted a redesigning of processes that permits solving problems that may occur during the execution of any process, such as aircraft maintenance. The foregoing renders the daily tasks and processes carried out within the Company more efficient. Due to its implementation, during 2010 we achieved a 30% reduction in the time that an aircraft remains in the hangar and we were also able to reduce the period needed to install winglets from 58 to 18 days.  LEAN also allowed us in 2011 to support the Company’s high growth, by streamlining the pilot training process, which resulted in more pilots trained during that year.  Finally, it allowed the Company to reduce CO2 emissions, by redesigning processes in various areas that result in fuel consumption. In addition, by establishing clear roles, challenges and achievements, the implementation of LEAN has had an important benefit in terms of employee motivation. See Item 4. “Information on the Company—Business of the Company—Maintenance.”

Strong Brand Teamed with Key Global Strategic Alliances
In March 2004 we launched the “LAN” brand, under which we operate all of our international passenger airlines (except for Aires, which is working towards being rebranded to “LAN”).  Brand uniformity enables our customers to better identify us with the high standards of service and safety that are common to all of our airlines. This corporate image has also improved the cost effectiveness and efficiency of our marketing efforts as we continue to expand in our existing and new markets. Additionally, LAN and our entire passenger affiliates (with the exception of Aires) are a member of the oneworld® alliance. We have also entered into bilateral agreements with strategic partners such as American Airlines, Iberia and Qantas, among others, whose leading presence in their respective markets creates a truly global reach for our passengers. Our passenger alliances and commercial agreements provide our customers with approximately 750 travel destinations, a combined reservations system, itinerary flexibility and various other benefits, which substantially enhance our competitive position within the Latin American market.

Optimized Fleet Strategy
We make optimal use of our fleet structure through a combination of minimal aircraft types, modern aircraft and staggered lease maturities. We carefully select our aircraft based on their ability to effectively and efficiently serve our short- and long-haul flight needs, while still striving to minimize the number of aircraft types we operate. For short-haul flights we operate the Airbus A320-Family Aircraft and the recently acquired Aires fleet in the Colombian market.  As of May 18, 2008, we stopped using Boeing 737-200 aircraft in our Chilean domestic operations. For long-haul passenger flights we operate the Boeing 767-300 passenger aircraft and for long-haul cargo flights we operate the Boeing 767-300 Freighters. For ultra long-haul service, such as between Santiago and Madrid and between Santiago and Auckland, we use the Airbus A340-300 aircraft. Having a fleet with minimal aircraft types reduces inventory costs, as fewer spare parts are required, and reduces the need to train our pilots to operate different types of aircraft.  LAN’s strategic fleet renewal plan involves the sale of five Airbus A318 aircraft in 2011, five in 2012 and five in 2013.
The average age of our fleet as of February 28, 2011 was 6.1 years (excluding the recently acquired Aires fleet), making our fleet one of the most modern in Latin America. The phasing out of our Boeing 737-200s, our oldest aircraft, which was completed in May 2008, contributed to reducing the average age of our fleet. Additionally, we expect that our purchase of additional aircraft, to be delivered between 2011 and 2018 will further reduce the average age of our fleet. Having a younger fleet makes us more cost competitive because it reduces fuel consumption and maintenance costs, and enables us to enjoy a high degree of performance reliability. In addition, a modern and fuel efficient fleet reflects our strong commitment to the environment as new aircraft incorporate the industry’s latest technology, allowing for a substantial reduction in emissions, while also decreasing noise levels.

Additionally, our leased fleet is structured with staggered lease maturities over time to create the strategic flexibility to expand or reduce capacity according to market conditions. We believe that our aircraft and the flexibility of our fleet allow us to maximize aircraft utilization by adapting rapidly to changes in passenger and cargo demand in the markets that we serve.

Strong Financial Position with Track Record of Growth and Profitability
We have historically managed our business to maintain financial flexibility and a strong balance sheet in order to accommodate our growth objectives while being able to respond to changing market conditions. We are one of the few investment-grade rated airlines in the world and we maintained this status during 2010. We have built our strong financial position by preserving our financial liquidity and continuing to structure long-term financing for newly acquired aircraft. Our financial flexibility has allowed us to secure large aircraft orders, including an important part of our current re-fleeting program at attractive financing rates.  We also monitor and seek opportunities to reduce financial risks associated with currency, interest rate and jet fuel price fluctuations. Over the last five years, while much of the airline industry has faced significant competitive and liquidity crises, we have remained consistently profitable.

Business Strategy

The principal areas in which we plan to focus our efforts going forward are as follows:

  • Continue to Grow Both our Passenger and Cargo Networks

    We currently intend to continue to expand our capacity over the next several years to accommodate robust long-term growth in both passenger and cargo demand in the markets we target. We plan on expanding our operations not only in the markets we currently serve but also into new South American markets where we believe demand exists for our combination of passenger and cargo services. To meet this growth,

      as of February 28, 2011, we had an order book of 82 latest generation Airbus A320-Family Aircraft to be delivered between 2011 and 2016 and nine Boeing 767-300 wide body passenger aircraft to be delivered between 2011 and 2012;
      as of February 28, 2011, we had orders for two Boeing 777-200 Freighter aircraft to be delivered in 2012; and
      we also have outstanding orders for 32 Boeing 787 Dreamliner passenger aircraft, currently expected to start to be delivered in 2012.

    We will continue to leverage the benefits of combining our passenger and cargo operations. Our passenger and cargo operations are equally important aspects of our business, and we dedicate the necessary resources, employees, facilities, management and fleet to enable both operations to provide high-quality service and to compete effectively in their respective markets.

  • Enhance the Profitability of our Short-Haul Operations through Our New Business Model
    We plan to continue implementing the business model launched in 2007 to increase the efficiency of our domestic and short-haul operations, specifically in the domestic markets in Chile and Peru. This model is also being applied in the domestic markets in Ecuador and Argentina, as well as in our recently acquired passenger operations in Colombia. In Argentina, the implementation of the model is subject to certain regulatory restrictions as a result of the fare bands in place in the Argentinean domestic market. In addition, we are evaluating the application of these initiatives on certain regional routes within Latin America. A key objective of this program has been to increase the utilization of our fleet through modified itineraries that include more point-to-point and overnight flights and faster turnaround times. Our Boeing 737-200 fleet was completely phased out in May 2008 in favor of the new Airbus A320-Family Aircraft, which we currently operate on all domestic and regional routes except those served by Aires.  These initiatives have increased efficiency and improved the margins of our short-haul operations. In addition, our modern fleet allows for lower unscheduled maintenance costs, lower fuel consumption, and operational and cost efficiencies achieved through operating fewer fleet types. Other key objectives of this business model include a reduction in sales and distribution costs through increased Internet penetration, reduced agency commissions, and increased self check-in service through web check-in and airport kiosks. We expect that these initiatives, together with simplifications in back-office and support functions, will continue to help us expand operations while controlling fixed costs, spurring a reduction in overhead costs per ASK. We have begun to pass on a portion of these operating efficiencies to consumers through fare reductions, which has stimulated additional demand and enhanced our overall profitability.
  • Maintain Excellent Customer Satisfaction
    In both our passenger and cargo businesses, we focus on delivering high quality services that are valued by our customers. In our passenger businesses we strive to achieve high on-time performance, world-class on-board service on long-haul flights, attractive and convenient pricing and quick check-in for short-haul flights, and the comfort afforded by a modern fleet. During the first half of 2009 we completed the reconfiguration of the cabins of all our long-haul aircraft, including both the Boeing 767 and the Airbus A340 passenger aircraft, in order to incorporate our new Premium Business Class including full-flat seats, as well as improvements in economy class which include a state-of-the-art on-board entertainment system. Our frequent flyer program, LANPASS, provides travel benefits and rewards to almost 4.3 million loyal customers in Chile, Argentina, Peru and Ecuador as well as in other countries where we operate. In the cargo business, we focus on providing reliable service, taking advantage of our ability to handle different types of cargo as well as significant cargo volumes, and leveraging our facilities in key gateways, such as Miami, to ensure optimal handling of our customers’ needs. We continually assess opportunities to incorporate service improvements in order to respond effectively to our customers’ needs.

  • Continued Emphasis on Safety
    Our top priority is safety, and we have structured our operations and maintenance to focus on safe flying. Our main maintenance facilities are certified by the Federal Aviation Administration (“FAA”), DGAC and other civil aviation authorities. Our flight and maintenance safety procedures are certified under ISO 9001-2000 standards. We have programs in place to train our crews and mechanics to world-class standards both at facilities abroad or at our training centers, which we have developed in association with high-quality partners.

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