LATAM AIRLINES GROUP S.A. 20-F 2009
Documents found in this filing:
As filed with the Securities and Exchange Commission on June 25, 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2008
Commission File Number: 1-14728
Lan Airlines S.A.
(Exact name of registrant as specified in its charter)
Presidente Riesco 5711, 20th Floor
(Address of principal executive offices)
Gisela Escobar Koch
Tel.: 56-2-565-3944 E-mail: email@example.com
Presidente Riesco 5711, 20th Floor
(Name, telephone, e-mail and/or facsimile number and address of company contact person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Securities registered or to be registered pursuant to Section 12(g) of the Act: None
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as of the close of the period covered by the annual report: 338,790,909.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes x No ¨
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated filer x Accelerated filer ¨ Non-Accelerated filer ¨
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
Indicate by check mark which financial statement item the registrant has elected to follow:
Item 17 ¨ Item 18 x
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
TABLE OF CONTENTS
PRESENTATION OF INFORMATION
In this annual report on Form 20-F, unless the context otherwise requires, references to Lan Airlines are to Lan Airlines S.A., the unconsolidated operating entity, and references to LAN, we, us or the Company are to Lan Airlines S.A. and its consolidated subsidiaries. All references to Chile are references to the Republic of Chile.
This annual report contains conversions of certain Chilean peso amounts into U.S. dollars at specified rates solely for the convenience of the reader. These conversions should not be construed as representations that the Chilean peso amounts actually represent such U.S. dollar amounts or could be converted into U.S. dollars at the rate indicated. Unless we specify otherwise, all references to $, US$, U.S. dollars or dollars are to United States dollars, references to pesos, Chilean pesos or Ch$ are to Chilean pesos and references to UF are to Unidades de Fomento, a daily indexed Chilean peso-denominated monetary unit that takes into account the effect of the Chilean inflation rate. Unless we indicate otherwise, the U.S. dollar equivalent for information in Chilean pesos is based on the dólar observado or observed exchange rate published by Banco Central de Chile (which we refer to as the Central Bank of Chile) on December 31, 2008, which was Ch$629.11=US$1.00. The observed exchange rate on June 24, 2009, was Ch$533.8 =US$1.00. The Federal Reserve Bank of New York does not report a noon buying rate for Chilean pesos. See Key InformationExchange Rates under Item 3.
Lan Airlines and the majority of our subsidiaries (including our main cargo subsidiary Lan Cargo S.A., or Lan Cargo) maintain their accounting records and prepare their financial statements in U.S. dollars. Some of our other subsidiaries, however, maintain their accounting records and prepare their financial statements in Chilean pesos or Argentinean pesos. Our consolidated financial statements include the results of these subsidiaries translated into U.S. dollars. Generally accepted accounting principles in Chile, or Chilean GAAP, require monetary assets and liabilities to be translated at period-end exchange rates, non-monetary assets and liabilities to be translated at historical rates of exchange as of the date of acquisition or incurrence and revenue and expense accounts to be translated at the average monthly exchange rate for the month in which they are recognized. As required by Chilean GAAP, the financial statements of our subsidiaries that report in Chilean pesos are adjusted to reflect changes in the purchasing power of the Chilean peso due to inflation. These changes are based on the consumer price index published by the Chilean National Institute of Statistics.
Our consolidated financial statements are prepared in accordance with Chilean GAAP, which differs in certain significant respects from generally accepted accounting principles in the United States, or U.S. GAAP. For a description of certain significant differences between Chilean GAAP and U.S. GAAP as they relate to us, together with a reconciliation of our net income and shareholders equity to U.S. GAAP, see Note 27 to our audited consolidated financial statements.
We have rounded percentages and certain U.S. dollar and Chilean peso amounts contained in this annual report for ease of presentation. Any discrepancies in any table between totals and the sums of the amounts listed are due to rounding.
This annual report contains certain terms that may be unfamiliar to some readers. You can find a glossary of these terms on page 3 of this annual report.
This annual report contains forward-looking statements. Such statements may include words such as anticipate, estimate, expect, project, intend, plan, believe or other similar expressions. Forward-looking statements, including statements about our beliefs and expectations, are not statements of historical facts. These statements are based on current plans, estimates and projections, and, therefore, you should not place undue reliance on them. Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. These factors include, but are not limited to:
Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update publicly any of them, whether in light of new information, future events or otherwise. You should also read carefully the risk factors described in Key InformationRisk Factors under Item 3.
GLOSSARY OF TERMS
The following terms, as used in this annual report, have the meanings set forth below.
Selected Financial Data
The following table presents our summary financial and other information for each of the last five fiscal years in the period ended December 31, 2008. The summary financial information for the three fiscal years in the period ended December 31, 2008 has been derived from our audited consolidated financial statements included in this report.
You should read the information below in conjunction with our audited consolidated financial statements and the notes thereto, as well as Presentation of Information and Operating and Financial Review and Prospects.
Annual Financial Information
(table and footnotes continue on next page)
Although most of our revenues and expenses are denominated in U.S. dollars, some are denominated in different currencies, such as the Chilean peso. Fluctuations in foreign exchange rates could lead to changes in the value of these items in U.S. dollars. Nevertheless, the impact on our results stemming from any such fluctuations is significantly mitigated by the fact that 83% of our revenues and 63% of our operating expenses are denominated in U.S. dollars.
In accordance with the Chilean Corporation Law, we must pay annual cash dividends equal to at least 30% of our annual consolidated distributable net income each year (calculated in accordance with Chilean GAAP), subject to limited exceptions. As of June 24, 2009, we had declared aggregate dividends US$81.8 million with respect to income for 2004, US$73.3 million with respect to income for 2005, US$168.9 million with respect to income for 2006, US$215.8 million with respect to income for 2007 and US$201.8 million with respect to income for 2008. Dividends for 2008 include two interim dividends paid in August 2008 and January 2009, which are to be considered final dividends with respect to income for 2008, as approved at the annual general shareholders meeting held in April 2009. The table below sets forth the cash dividends per common share and per ADS, as well as the number of common shares entitled to such dividends, for the years indicated. Dividends per common share amounts have not been adjusted for inflation and reflect common share amounts outstanding immediately prior to the distribution of such dividend. On August 2007, LAN modified its ADR to common share ratio from 5:1 to 1:1.
Our board of directors has the authority to declare interim dividends. Year-end dividends, if any, are declared by our shareholders at our annual meeting. For a description of our dividend policy, see Financial InformationOther Financial InformationDividend Policy under Item 8.
We declare cash dividends in U.S. dollars, but make dividend payments in Chilean pesos, converted from U.S. dollars at the observed exchange rate two days prior to the day we first make payment to shareholders. Payments of cash dividends to holders of American Depositary Receipts, or ADRs, if any, are made in Chilean pesos to the custodian, which converts those Chilean pesos into U.S. dollars and delivers U.S. dollars to the depositary for distribution to holders. In the event that the custodian is unable to convert immediately the Chilean currency received as dividends into U.S. dollars, the amount of U.S. dollars payable to holders of ADRs may be adversely affected by a devaluation of the Chilean currency that may occur before such dividends are converted and remitted.
The following table sets forth, for the periods indicated, the high, low, average and period-end observed exchange rate for the purchase of U.S. dollars, expressed in Chilean pesos per U.S. dollar. The rates have not been restated in constant currency units.
Source: Central Bank of Chile
On June 24, 2009, the observed exchange rate was Ch$533.8 = US$1.00.
We wish to caution readers that the following important factors, and those important factors described in other reports submitted to, or filed with, the Securities and Exchange Commission, among other factors, could affect our actual results and could cause our actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf. In particular, as we are a non-U.S. company, there are risks associated with investing in our American Depositary Shares, or ADS, that are not typical for investments in the shares of U.S. companies. Prior to making an investment decision, you should carefully consider all of the information contained in this document, including the following risk factors.
Risks Related to our Operations and the Airline Industry
Our performance is heavily dependent on economic conditions in the countries in which we do business and negative economic conditions in those countries could have an adverse impact on our business.
Passenger and cargo demand is heavily cyclical and highly dependant on global and local economic growth, economic expectations and foreign exchange rate variations, among other things. In the past our business has been negatively affected by global economic recessionary conditions, weak economic growth in Chile, recession in Argentina and poor economic performance in certain emerging market countries in which we operate. The occurrence of similar events in the future could adversely affect our business. In fact, starting as of late 2008, and continuing into 2009, many of the countries we serve, including Chile, are experiencing economic slowdowns or recessions, which have translated into a substantial weakening of demand and could continue to adversely affect our business in the future. We plan to continue to expand our operations based in Latin America and our performance will, therefore, continue to depend heavily on economic conditions in the region. Any of the following factors could adversely affect our business, financial condition and results of operations in the countries in which we operate:
We are experiencing significantly weaker demand in the cargo business driven by the severe downturn in the global economy. Many of the countries we serve are experiencing economic slowdowns or recessions. We began to experience weakening demand in cargo late in 2008, and this weakness has continued into 2009. If the global economic downturn persists or worsens, demand in cargo may continue to weaken and demand for air travel may commence to decrease. No assurance can be given that capacity reductions or other steps we may take will be adequate to offset the effects of reduced cargo and/or air travel demand.
The success of our business depends upon key regulatory issues and these issues may adversely affect our business and results of operations.
Our business is highly regulated and depends substantially upon the regulatory environment in the countries in which we operate or intend to operate. For example, price controls on fares may limit our ability to effectively apply customer segmentation profit maximization techniques (passenger revenue management) (management techniques utilizing passenger demand forecasting and fare mix optimization techniques to maximize profit for an airline) and adjust prices to reflect cost pressures. High levels of government regulation may limit the scope of our operations and our growth plans, especially in the event of deterioration of the relations between the countries in which we operate or the public perception of foreign companies in local markets. Accordingly, regulatory issues could adversely affect our business and results of operations.
Our business, financial condition and results of operations could be adversely affected if we or certain aviation authorities (among them, those from Argentina, Brazil, Chile, Ecuador, Mexico, Peru, Colombia and the United States) fail to maintain the required foreign and domestic governmental authorizations. In order to maintain the necessary authorizations issued by the Chilean Junta Aeronáutica Civil, which we refer to as the JAC, and technical operative authorizations issued by the Chilean Dirección General de Aeronáutica Civil, which we refer to as the DGAC, and other corresponding local authorities of the countries in which we operate, we must continue to comply with applicable statutes, rules and regulations pertaining to the airline industry, including any rules and regulations that may be adopted in the future.
We depend on strategic alliances or commercial relationships in many of the countries in which we operate and our business may suffer if any of our strategic alliances or commercial relationships terminates.
In many of the jurisdictions in which we operate, we have found it in our interest, to maintain a number of alliances and other commercial relationships. These alliances or commercial relationships allow us to enhance our network and, in some cases, to offer our customers services that we could not otherwise offer. If any of our strategic alliances or commercial relationships and, in particular, with American Airlines, Iberia, Qantas or oneworld® deteriorates, or any of these agreements are terminated, our business, financial condition and results of operations could be negatively affected.
Our business and results of operation may suffer if we fail to obtain and maintain routes, suitable airport access, slots and other operating permits.
Our business depends upon our access to key routes and airports. Our operations could be constrained by any delay or inability to gain access to key routes or airports, including:
We operate numerous international routes, subject to bilateral agreements and also internal flights within Chile, Argentina, Peru and other countries, subject to local route and airport access approvals. Bilateral aviation agreements as well as local aviation approvals frequently involve political and other considerations outside of our control. Recently, we faced a reduction in international fifth freedom routes in Peru, which we do not expect to have a material adverse effect on our business, but which exemplifies the route changes to which we may be subject. See Information on the Company Business of the CompanyRegulationRoute Rights under Item 4.
There can be no assurance that existing bilateral agreements between the countries in which our companies are based and permits from foreign governments will continue. A modification, suspension or revocation of one or more bilateral agreements could have a material adverse effect on our business, financial condition and results of operations. The suspension of our permission to operate in certain airports or destinations or the imposition of other sanctions could also have a material adverse effect. We cannot assure that a change in a foreign governments administration of current laws and regulations or that the adoption of new laws and regulations will not have a material adverse effect on our business, financial condition and results of operations.
If we are unable to obtain favorable take-off and landing authorizations at certain high-density airports, our business, financial condition and results of operations could be adversely affected. There can be no assurance that we will be able to obtain all requested authorizations and slots in the future because, among other factors, government policies regulating the distribution of the authorizations and slots are subject to change.
A failure to successfully implement our growth strategy would harm our business and the market value of the ADSs and our common shares.
Our growth strategy involves increasing the frequency of flights to the markets we currently serve and expanding our service to new markets. In order to carry out this strategy, we must be able to identify the appropriate geographic markets upon which to focus and to gain suitable airport access and route approval in these markets. There can be no assurance that the new markets we enter or in which we are seeking to expand our operations will provide passenger and cargo traffic that is sufficient to make our operations in those new markets profitable.
The expansion of our business will also require additional skilled personnel, equipment and facilities. An inability to hire and retain skilled personnel or secure the required equipment and facilities efficiently and cost-effectively may adversely affect our ability to execute our growth strategy. Expansion of our markets and flight frequencies may also strain our existing management resources and operational, financial and management information systems to the point that they may no longer be adequate to support our operations, requiring us to make significant expenditures in these areas.
Our business may be adversely affected by a downturn in the airline industry caused by exogenous events that affect travel behavior or increase costs, such as outbreak of disease, war or terrorist attacks.
Demand for air transportation may be adversely impacted by exogenous events, such as natural disasters, epidemics, terrorist attacks, war or political and social instability. Situations such as these in one or more of the markets in which we operate could have a material impact on our business, financial condition and results of operations. Furthermore, these types of situations could have a prolonged effect on air transportation demand and on certain cost items.
As from the last week of April 2009, there has been an outbreak of H1N1 flu, also known as swine flu. At the time of this 20-F filing, the outbreak has been largely concentrated in Mexico and the United States, although cases have been confirmed in, among other locations, Chile, Argentina, Canada, Costa Rica, Spain, Israel and New Zealand. At this time, H1N1 flu would primarily have an adverse impact on our Mexican and Caribbean operations; however, the development of H1N1 flu into a regional or global pandemic and a significant spread beyond North America could have an adverse impact on all of our operations.
Terrorist attacks may also have a severe adverse impact on the airline industry. For example, the terrorist attacks in the United States on September 11, 2001 substantially affected the airline industry, particularly foreign air carriers operating international service to and from the United States. Throughout South America, passenger traffic also decreased substantially, although the decrease was less severe than that in the United States. The airline industry experienced increased costs following the September 11, 2001 terrorist attacks. Airlines have been required to adopt additional security measures and may be required to comply with more rigorous security guidelines in the future.
In addition, fuel prices and supplies, which constitute a significant cost for us, may increase as a result of any future terrorist attacks, a general increase in hostilities or a reduction in output of fuel, voluntary or otherwise, by oil-producing countries. Such increases may result in both higher airline ticket prices and decreased demand for air travel generally, which could have an adverse effect on our revenues and results of operations.
A significant portion of our cargo revenues comes from relatively few product types and may be impacted by events affecting their production or trade.
Our cargo demand, especially from Latin American exporters, is concentrated in a small number of product categories, such as salmon and produce exports from Chile and Peru, and fresh flowers from Ecuador and Colombia. Events that negatively affect the production or trade of these goods may adversely affect the volume of goods that we transport and may have a significant impact on our results of operations. Some of our cargo products are sensitive to foreign-exchange rates and, therefore, traffic volumes could be impacted by the appreciation or depreciation of local currencies.
As from mid 2007, there was an outbreak of infectious salmon anemia virus (ISA Virus) in Chile which was temporarily contained during 2008 but continued spreading during the first quarter of 2009. The outbreak of ISA Virus has caused, and may continue to cause, a significant decline in salmon exports and has had, and may continue to have, an adverse impact on our cargo operations as approximately 8% of our cargo business revenue during 2008 was related to salmon exports.
Our operations are subject to fluctuations in the supply and cost of jet fuel, which could negatively impact our business.
Higher jet fuel prices or a shortage in the supply of fuel could cause a reduction in our scheduled service and could have a materially negative effect on our business, financial condition and results of operations. Jet fuel costs have historically accounted for a significant amount of our operating expenses, and accounted for 35.6% of our operating expenses in 2008. Both the cost and availability of fuel are subject to many economic and political factors and events that we can neither control nor predict. We have entered into fuel hedging arrangements, but there can be no assurance that such arrangements will be adequate to protect us from a significant increase in fuel prices in the near future or in the long term. Also, while these hedging arrangements are designed to limit the effect of an increase in fuel prices, some of our hedging methods may also limit our ability to take advantage of any decrease in fuel prices. Although we have implemented measures to pass a portion of incremental fuel costs to our customers, our ability to lessen the impact of any increase using this type of mechanisms may also be limited.
We rely on maintaining a high daily aircraft utilization rate to increase our revenues, which makes us especially vulnerable to delays.
One of the key elements of our business strategy is to maintain a high daily aircraft utilization rate, which measures the number of flight hours we use our aircraft per day. High daily aircraft utilization allows us to maximize the amount of revenue we generate from our aircraft and is achieved, in part, by reducing turnaround times at airports and developing schedules that enable us to increase the average hours flown per day. Our rate of aircraft utilization could be adversely affected by a number of different factors that are beyond our control, including air traffic and airport congestion, adverse weather conditions and delays by third-party service providers relating to matters such as fueling and ground handling.
Furthermore, high aircraft utilization rates increase the risk that, if an aircraft falls behind schedule, it could remain behind schedule for up to two days. Such delays could result in a disruption in our operating performance, leading to customer dissatisfaction due to any resulting delays or missed connections.
We fly and depend upon Airbus and Boeing aircraft, and our business is at risk if we do not receive timely deliveries of aircraft, if aircraft from these companies becomes unavailable or if the public negatively perceives our aircraft.
As our fleet has grown, our reliance on Airbus and Boeing has also grown. As of March 31, 2009, we operated a fleet of 58 Airbus and 35 Boeing aircraft. These risks include:
The occurrence of any one or more of these factors could restrict our ability to use aircraft to generate profits, respond to increased demands, or could otherwise limit our operations and adversely affect our business.
We are often affected by certain factors beyond our control, including weather conditions, which can affect our operations.
Revenues for airlines depend on the number of passengers carried, the fare paid by each passenger and service factors, such as the timeliness of flight departures and arrivals. During periods of fog, ice, low temperatures, storms or other adverse weather conditions, some or all of our flights may be cancelled or significantly delayed, reducing our revenues.
Losses and liabilities in the event of an accident involving one or more of our aircraft could materially affect our business.
We are exposed to potential catastrophic losses in the event of an aircraft accident, terrorist incident or any other similar event. There can be no assurance that, as a result of an aircraft accident or significant incident:
Substantial claims resulting from an accident or significant incident in excess of our related insurance coverage could have a material adverse effect on our business, financial condition and results of operations. Moreover, any aircraft accident, even if fully insured, could cause the negative public perception that our aircraft are less safe or reliable than those operated by other airlines, which could have a material adverse effect on our business, financial condition and results of operations.
Insurance premiums may also increase due to an accident or incident affecting one of our airline affiliates or alliance partners or affecting other airlines.
High levels of competition in the airline industry may adversely affect our level of operations.
Our business, financial condition and results of operations could be adversely affected by high levels of competition within the industry, particularly the entrance of new competitors into the markets in which we operate. Airlines compete primarily over fare levels, frequency and dependability of service, brand recognition, passenger amenities (such as frequent flyer programs) and the availability and convenience of other passenger or cargo services. New and existing airlines could enter our markets and compete with us on any of these bases. Several of our competitors are larger than us and have greater brand recognition and greater resources than we do. Competing carriers include investor-owned, government-subsidized and national flag carriers of foreign countries as well as low-cost carriers offering discounted fares. The U.S.-Chile and other open skies agreements may subject us to further competition from international carriers. In addition to traditional competition among airline companies, we face competition from companies that provide ground transportation, especially in our domestic cargo and passenger businesses, as well as sea transportation for our cargo business. Competition could reduce our passenger traffic and cargo demand, forcing us to reduce our fare levels, which could have a material adverse effect on our revenues and level of operations.
Some of our competitors may receive external support which could negatively impact our competitive position.
Some of our competitors may receive support from external sources, such as their national governments, which may be unavailable to us. Support may include, among others, subsidies, financial aid or tax waivers. This support could place us at a competitive disadvantage and adversely affect our operations and financial performance.
If we are unable to incorporate leased aircraft into our fleet at acceptable rates and terms in the future, our business could be adversely affected.
A large portion of our aircraft are subject to long-term operating leases. Our operating leases typically run from three to twelve years from the date of delivery. We may face more competition for, or a limited supply of, leased aircraft, making it difficult for us to negotiate on competitive terms upon expiration of our current operating leases or to lease additional capacity required for our targeted level of operations. If we are forced to pay higher lease rates in the future to maintain our capacity and the number of aircraft in our fleet, our profitability could be adversely affected.
We are incorporating various new technologies and equipment and their phase-in may have a negative impact on our service and operating standards.
In recent years we have decided to incorporate a number of new aircraft, equipment and systems. The decision to incorporate these new elements has been based on their potential to enhance customer satisfaction, increase efficiency and/or streamline processes. However, the phase-in of these elements may temporarily result in lower service and operating standards which could affect how our customers perceive us and have a negative impact on our results of operations.
Our business may be adversely affected if we are unable to meet our significant future financing requirements.
We require significant amounts of financing to meet our aircraft capital requirements and may require additional financing to fund our other business needs. We cannot guarantee that we will have access to or be able to arrange for financing in the future on favorable terms. If we are unable to obtain financing for a significant portion of our capital requirements, our ability to acquire new aircraft or to expand operations could be impaired and our business negatively affected.
Our business may be adversely affected by our high degree of debt and aircraft lease obligations compared to our equity capital.
We have a high degree of debt and payment obligations under our aircraft operating leases compared to equity capital. In order to finance our debt, we depend in part on our cash flow from operations. We cannot assure you that in the future we will be able to meet our payment obligations. In addition, the majority of our property and equipment is subject to liens securing our indebtedness. In the event that we fail to make payments on the secured indebtedness, creditors enforcement of liens could limit or end our ability to use the affected property and equipment to fulfill our operational needs and thus generate revenue.
Increases in insurance costs and/or significant reductions in coverage could harm our financial condition and results of operations.
Following the 9/11 terrorist attacks, insurance companies dramatically increased airline insurance premiums and significantly reduced the maximum amount of insurance coverage available to airlines for liability to persons (other than passengers) for claims resulting from acts of terrorism, war or similar events. Although insurance costs decreased between 2004 and 2007, in 2008 we had an increase in insurance expenses. We cannot assure that these costs will not continue to increase.
In the event of additional terrorist attacks, hijackings, airline crashes or other events adversely affecting the airline industry in the markets in which we operate, airline insurers could reduce their coverage or increase their premiums. Increases in insurance costs and/or significant reductions in coverage could harm our financial condition and results of operations.
Problems with air traffic control systems or other technical failures could interrupt our operations and have a material adverse effect on our business.
Our operations, including our ability to deliver customer service, are dependent on the effective operation of our equipment, including our aircraft, maintenance systems and reservation systems. Our operations are also dependent on the effective operation of domestic and international air traffic control systems and the air traffic control infrastructure in the markets in which we operate. Equipment failures, personnel shortages, air traffic control problems and other factors that could interrupt operations could adversely affect our operations and financial results as well as our reputation.
Our financial success depends on the availability and performance of key personnel, who are not subject to non-competition restrictions.
Our success depends to a significant extent on the ability of our senior management team and key personnel to operate and manage our business effectively. Our employment agreements with key personnel do not contain any non-competition provisions applicable upon termination. Competition for highly qualified personnel is intense. If we lose any executive officer, senior manager or other key employee and are not able to obtain an adequate replacement, or if we are unable to attract and retain new qualified personnel, our business, financial condition and results of operations could be materially adversely affected.
Our business may experience adverse consequences if we are unable to reach satisfactory collective bargaining agreements with our unionized employees.
Approximately 39% of our employees, including administrative personnel, cabin crews, flight attendants, pilots and maintenance technicians are members of unions and have contracts and collective bargaining agreements which expire on a regular basis. Our business, financial condition and results of operations could be materially adversely affected by a failure to reach agreement with any labor union representing such employees or by an agreement with a labor union that contains terms that are not in line with our expectations or that prevent us from competing effectively with other airlines.
Pressure by employees could cause operating disruptions and negatively impact our business.
Certain employee groups such as pilots, flight attendants, mechanics and our airport personnel have highly specialized skills. As a consequence, actions by these groups, such as strikes, walk-outs or stoppages, could severely disrupt our operations and negatively impact our operating and financial performance, as well as how our customers perceive us.
For example, during the third quarter of 2001, members of one of our pilot unions implemented a series of actions that disrupted our services prior to the negotiation of their collective bargaining agreement, which had a negative impact on our operations and our profitability.
Increases in our labor costs, which constitute a substantial portion of our total operating costs, could directly impact our earnings.
Labor costs constitute a significant percentage of our total operating costs, and at times in our operating history we have experienced pressure to increase wages and benefits for our employees. A significant increase in our labor costs above the assumed costs could result in a material reduction in our earnings.
We may experience difficulty finding, training and retaining employees.
Our business is labor intensive. We employ a large number of pilots, flight attendants, maintenance technicians and other operating and administrative personnel. The airline industry has, from time to time, experienced a shortage of qualified personnel, specifically pilots and maintenance technicians. In addition, as is common with most of our competitors, we may, from time to time, face considerable turnover of our employees. Should the turnover of employees, particularly pilots and maintenance technicians, sharply increase, our training costs will be significantly higher. We cannot assure you that we will be able to recruit, train and retain the qualified employees that we need to continue our current operations or replace departing employees. A failure to hire and retain qualified employees at a reasonable cost could materially adversely affect our business, financial condition and results of operations.
Failure to comply with applicable environmental regulations could adversely affect our business and reputation.
Our operations are covered by environmental regulations at local, national and international levels. These regulations cover, among other things, emissions to the atmosphere, disposal of solid waste and aqueous effluents, aircraft noise and other activities incident to our business. Future operations and financial results may vary as a result of such regulations. Compliance with these regulations and new or existing regulations that may be applicable to us in the future could increase our cost base and adversely affect our operations and financial results. In addition, failure to comply with these regulations could adversely affect us in a variety of ways, including adverse effects on our reputation.
Risks Related to Chile and Other Emerging Market Countries
Developments in Latin American countries and other emerging market countries may adversely affect the Chilean economy, negatively impact our business and results of operations and cause the market price of our common shares and ADSs to decrease.
We conduct a significant portion of our operations in emerging market countries, particularly in Latin America. As a result, economic and political developments in these countries, including future economic crises and political instability, could impact the Chilean economy or the market value of our securities and have a material adverse effect on our business, financial condition and results of operations. Starting as of late 2008, and continuing into 2009, many of the countries we serve, including Chile, are experiencing economic slowdowns or recessions, which have translated in a substantial weakening of demand. Although economic conditions in other emerging market countries may differ significantly from economic conditions in Chile, we cannot assure that events in other countries, particularly other emerging market countries, will not adversely affect the market value of, or market for, our common shares or ADSs.
Fluctuations in the value of the Chilean peso and other currencies in the countries in which we operate may adversely affect our revenues and profitability.
Changes in the exchange rate between the Chilean peso and the U.S. dollar or other currencies in the countries in which we operate could adversely affect our business, financial condition and results of operations. We operate in numerous countries and face the risk of variation in foreign currency exchange rates against the U.S. dollar or between the currencies of these various countries. A significant part of our indebtedness is denominated in U.S. dollars, while 17% of our revenues and 37% of our operating expenses in 2008 are denominated in currencies other than the U.S. dollar, mainly the Chilean peso. If the value of the peso, or of other currencies in which revenues are denominated, declines against the U.S. dollar, we will need more pesos or other local currency to repay the same amount of U.S. dollars. The Chilean peso has experienced volatility in recent years, including an average nominal appreciation of 6.6% against the U.S. dollar in 2004, an average nominal appreciation of 8.6% against the U.S. dollar in 2005, an average nominal devaluation of 5.0% against the U.S. dollar in 2006, an average nominal appreciation of 1.7% against the U.S. dollar in 2007 and an average nominal appreciation of 0.1% against the U.S. dollar in 2008. The exchange rate of the Chilean peso and other currencies against the U.S. dollar may fluctuate significantly in the future. Changes in Chilean and other governmental economic policies affecting foreign exchange rates could also adversely affect our business, financial condition, results of operations and the return to our shareholders on their common shares or ADSs.
Exchange controls in Venezuela delay our ability to repatriate cash generated from operations in Venezuela and increase our exposure to exchange rate losses due to potential devaluations of the Venezuelan bolivar vis-à-vis the U.S. dollar during the period of time between the time we are paid in Venezuelan bolivares and the time we are able to repatriate such revenues in U.S. dollars.
We are not required to disclose as much information to investors as a U.S. issuer is required to disclose and, as a result, you may receive less information about us than you would receive from a comparable U.S. company.
The corporate disclosure requirements that apply to us may not be equivalent to the disclosure requirements that apply to a U.S. company and, as a result, you may receive less information about us than you would receive from a comparable U.S. company. We are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act. The disclosure required of foreign issuers under the Exchange Act is more limited than the disclosure required of U.S. issuers. Publicly available information about issuers of securities listed on Chilean stock exchanges also provides less detail in certain respects than the information regularly published by listed companies in the United States or in certain other countries. Furthermore, there is a lower level of regulation of the Chilean securities markets and of the activities of investors in such markets as compared with the level of regulation of the securities markets in the United States and in certain other developed countries.
Risks Related to our Common Shares and ADSs
Our controlling shareholders may have interests that differ from those of our other shareholders.
As of March 31, 2009 our controlling shareholders, together, beneficially owned 51.84% of our voting common shares. These controlling shareholders are in a position to elect a majority of the members of our board of directors, direct our management and control substantially all matters that are to be decided by a vote of shareholders, including fundamental corporate transactions. In addition, under the terms of the deposit agreement governing the ADSs, if holders of ADSs do not provide The Bank of New York, in its capacity as depositary for the ADSs, with timely instructions on the voting of the common shares underlying their ADRs, the depositary will be deemed to have been instructed to give a person designated by the board of directors the right to vote those common shares.
Trading of our ADSs and common shares in the securities markets is limited and could experience further illiquidity and price volatility.
Chilean securities markets are substantially smaller, less liquid and more volatile than major securities markets in the United States. In addition, Chilean securities markets may be materially affected by developments in other emerging markets, particularly other countries in Latin America. Accordingly, although you are entitled to withdraw the common shares underlying the ADSs from the depositary at any time, your ability to sell the common shares underlying ADSs in the amount and at the price and time that you wish to do so may be substantially limited. This limited trading market may also increase the price volatility of the ADSs or the common shares underlying the ADSs.
Holders of ADSs may be adversely affected by currency devaluations and foreign exchange fluctuations.
If the peso exchange rate falls relative to the U.S. dollar, the value of the ADSs and any distributions made thereon from the depositary, could be adversely affected. Cash distributions made in respect of the ADSs are received by the depositary (represented by the custodian bank in Chile) in pesos, converted by the custodian bank into U.S. dollars at the then prevailing exchange rate and distributed by the depositary to the holders of the ADRs evidencing those ADSs. In addition, the depositary will incur foreign currency conversion costs (to be borne by the holders of the ADRs) in connection with the foreign currency conversion and subsequent distribution of dividends or other payments with respect to the ADSs.
Future changes in Chilean foreign investment controls and withholding taxes could negatively affect non-Chilean residents that invest in our shares.
Equity investments in Chile by non-Chilean residents have been subject in the past to various exchange control regulations that govern investment repatriation and earnings thereon. Although not currently in effect, regulations of the Central Bank of Chile have in the past required, and could again require, foreign investors acquiring securities in the secondary market in Chile to maintain a cash reserve or to pay a fee upon conversion of foreign currency to purchase such securities. Further, future changes in withholding taxes could negatively affect non-Chilean residents that invest in our shares.
When we established our ADS facility as part of our initial public offering in 1997, there were foreign exchange controls in Chile. At that time, in order to allow the depositary and investors to be able to enter into foreign exchange transactions to repatriate from Chile amounts they received in connection with the deposited shares of common stock (including dividends and proceeds from the sale in Chile of the underlying shares of common stock and any rights with respect thereto), we entered into a foreign investment contract (the Foreign Investment Contract) with the Central Bank and the depositary. The Foreign Investment Contract guaranteed ADS investors and the depositary access to the Formal Exchange Market to convert amounts from Chilean pesos into U.S. dollars and to repatriate such amounts.
In 2001, a new Compendium of Foreign Exchange Regulations (the New Compendium) removed exchange controls and many other barriers to investment. However, even though there are no longer foreign exchange controls in Chile, all foreign investment contracts (including the Foreign Investment Contract), continue to remain in full force.
We cannot assure that additional Chilean restrictions applicable to the holders of ADRs, the disposition of the common shares underlying ADSs or the repatriation of the proceeds from an acquisition, a disposition or a dividend payment, will not be imposed or required in the future, nor could we make an assessment as to the duration or impact, were any such restrictions to be imposed or required. For further information, see Item 10Additional Information Foreign Investment and Exchange Controls in Chile.
Our ADS holders may not be able to exercise preemptive rights in certain circumstances.
The Chilean Corporation Act and Regulation thereof, Ley sobre Sociedades Anónimas No. 18,046 and the Reglamento de Sociedades Anónimas, collectively known as the Chilean Corporation Law, provide that preemptive rights shall be granted to all shareholders whenever a company issues new shares for cash, giving such holders the right to purchase a sufficient number of shares to maintain their existing ownership percentage. We will not be able to offer shares to holders of ADSs and shareholders located in the United States pursuant to the preemptive rights granted to shareholders in connection with any future issuance of shares unless a registration statement under the U.S. Securities Act of 1933, as amended, or the Securities Act, is effective with respect to such rights and shares, or an exemption from the registration requirements of the Securities Act is available. At the time of any rights offering, we will evaluate the potential costs and liabilities associated with any such registration statement in light of any indirect benefit to us of enabling U.S. holders of ADRs evidencing ADSs and shareholders located in the United States to exercise preemptive rights, as well as any other factors that may be considered appropriate at that time, and we will then make a decision as to whether we will file a registration statement. We cannot assure that we will decide to file a registration statement or that such rights will be available to ADS holders and shareholders located in the United States.
We are one of the leading passenger airlines in Latin America and the main air cargo operator in the region. We currently provide domestic and international passenger services in Chile, Peru, Ecuador and Argentina. We carry out our cargo operations through the use of belly space on our passenger flights and dedicated cargo operations using freighter aircraft through our cargo airlines in Chile, Brazil, Colombia and Mexico. In 2007, we initiated a strategy for stimulating demand for air travel in our domestic markets by offering lower-fare options to travelers, lowering our costs and increasing the aircraft utilization rates and efficiency of operations. For more information about our short-haul operations see Business of the Company Passenger OperationsBusiness Model for Domestic Operations below.
As of March 31, 2009, we serviced 15 destinations in Chile, 14 destinations in Peru, 12 destinations in Argentina, 2 destinations in Ecuador, 15 destinations in other Latin American countries and the Caribbean, 3 destinations in the United States, 1 destination in Canada, 2 destinations in Europe and 4 destinations in the South Pacific. In addition, as of March 31, 2009, through our various code-share agreements, we offered service to 63 additional international destinations. We provide cargo service to all our passenger destinations and to approximately 16 additional destinations served only by freighter aircraft. We also offer other services, such as ground handling, courier, logistics, and maintenance.
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.
History of the Company
The Chilean government founded Lan Airlines (formerly Lan Chile S.A.) in 1929. Lan Airlines was a government-owned company from 1929 until its incorporation in 1983. Lan Airlines began international service to Buenos Aires, Argentina in 1946, to the United States in 1958 and to Europe in 1970. In 1989, the Chilean government sold 51% of Lan Airlines capital stock to Chilean investors and to Scandinavian Airlines System. In 1994, our controlling shareholders together with other major shareholders acquired 98.7% of Lan Airlines stock, including the remaining stock held by the Chilean government, in a series of transactions. As of March 31, 2009, the controlling shareholders held 51.84% of our capital stock. For more information about our controlling shareholders, see Controlling Shareholders and Related Party Transactions under Item 7.
In 1997 LAN was listed on the New York Stock Exchange, becoming the first Latin American airline to trade its ADRs on this financial market.
Since this acquisition of our capital stock in 1994 and the appointment of our current management, we have grown our revenue base and maintained our profitability every year despite significant challenges. Additionally, we have created a comprehensive network across the region by forming, together with local partners, or acquiring, passenger affiliates in Peru, Ecuador, and Argentina and cargo affiliates in Brazil, Mexico and Colombia. In early 2004, we changed our corporate image and started using the LAN brand in order to better reflect the common values and attributes present in all the companies forming our network. We have complemented our own network with a set of bilateral alliances with carriers such as American Airlines, Iberia and Qantas, and have been a member of the oneworld® alliance since 2000.
LAN is a company primarily involved in the transportation of passengers and cargo. Our operations are carried out principally by Lan Airlines and also by a number of different subsidiaries. As of March 31, 2009, in the passenger business we operated through five main airlines: Lan Airlines, Transporte Aéreo S.A. (which does business under the name Lan Express), Lan Peru S.A. (Lan Peru), Aerolane Líneas Aéreas Nacionales del Ecuador S.A. (Lan Ecuador), and Lan Argentina S.A. (Lan Argentina, previously Aero 2000 S.A.).
In the passenger business we market our sales primarily under the LAN brand. As of March 31, 2009 we held a 99.9% stake in Lan Express through direct and indirect interests, a 70.0% stake in Lan Peru through direct and indirect interests, a 72.0% indirect stake in Lan Ecuador and a 90.0% indirect stake in Lan Argentina.
Our cargo operations are carried out by a number of companies, including Lan Airlines and Lan Cargo, and are complemented by the operations of certain related companies, such as Aero Transportes Mas de Carga S.A. de C.V. (MasAir), in Mexico, Aerolinhas Brasileiras S.A. (ABSA), in Brazil and Linea Aérea Carguera de Colombia S.A. (LANCO), in Colombia. As of March 31, 2009, we held direct and indirect participations in MasAir (69.2%), ABSA (73.3%), and LANCO (100%). In the cargo business, we market ourselves primarily under the Lan Cargo brand.
In addition to our air transportation activities, we provide a series of ancillary services. We offer handling services, courier services and logistics, small package and express door-to-door services through Lan Airlines and various subsidiaries.
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 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. Our international and domestic passenger and cargo operations have increased substantially over the past four years in terms of capacity, traffic and revenue. Since 2004, passenger, cargo and total traffic revenues have grown 144.6%, 91.0% and 122.8%, respectively.
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 2008, passenger revenues accounted for 63.1% of total revenues and cargo revenues accounted for 33.7% 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 51.2 cents in 2008. 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 15.2% of total costs in 2008, which we believe is a lower percentage than that of many other U.S. and European carriers. Our itineraries and aircraft rotations are designed to maximize aircraft utilization. During 2008, our long-haul aircraft (Boeing 767-300 passenger and Airbus A340-300s) operated an average of approximately fourteen hours per day. As a result of the implementation of our new business model for short-haul operations, which began operating in 2007, we have increased the utilization of our narrow body aircraft to reach more than ten hours by the end of 2008. In May 2008, we completed the phase out of the B737-200 from our fleet. Our short haul fleet is now entirely composed of Airbus A320-Family Aircraft.
Strong Brand Teamed with Key Global Strategic Alliances
In March 2004 we launched our new brand, LAN, under which we operate all of our international passenger airlines. This brand commonality enables our customers to better identify with the high standards of service and safety that are common to all of our airlines. Our new image also has improved the visibility of our brand, and the cost effectiveness and efficiency of our marketing efforts as we continue to expand in our existing and new markets. Additionally, we are a member of the oneworld® alliance, and have also entered into bilateral agreements with strategic partners such as American Airlines, Iberia and Qantas, among others, whose leading presence in the markets that they serve creates a truly global reach for our passengers. In December 2007 we implemented a commercial agreement with the Brazilian airline TAM Linhas Aereas (TAM), through which we hope to improve connectivity between Brazil and the regional markets served by LAN. Our passenger alliances and commercial agreements provide our customers with approximately 700 travel destinations, a combined reservations system, itinerary flexibility and various other benefits, which substantially enhance our competitive position within the Latin American market. On April 1, 2007, Lan Ecuador and Lan Argentina became members of the oneworld® alliance. With these new memberships, all the companies in the LAN group are now members of this alliance.
Optimized Fleet Strategy
We make optimal use of our fleet structure through a combination of fewer 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 Airbus A320-Family Aircraft. As of May 18, 2008, we stopped using Boeing 737-200
aircraft in our Chilean domestic operations. For long-haul passenger and cargo flights we operate Boeing 767-300 passenger aircraft and Boeing 767-300 Freighters, respectively. For ultra long-haul service, such as between Santiago and Madrid and between Santiago and Auckland, we use 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.
The average age of our fleet as of March 31, 2009 was 5.2 years, 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 orders of additional aircraft for delivery between 2009 and 2019 will further reduce the average age of our fleet. We believe that having a younger fleet makes us more cost competitive through reduced fuel consumption and maintenance costs. We also believe that our modern fleet has enabled us to enjoy a high degree of performance reliability.
We announced in June and July 2007 historically large orders for new passenger and freighter aircraft in order to further improve our fleet. We have scheduled four Boeing 777 Freighter aircraft (two of which will be leased and two owned) to be delivered between 2009 and 2012. We have ordered thirty-two Boeing 787 Dreamliners (six of which will be leased and twenty-six owned) to be delivered between 2011 and 2016, although production delays might require us to change the anticipated delivery schedule. These are the largest orders for these types of aircraft in the region and provide the basis for LANs commitment to remain a leader in commercial aviation in Latin America.
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. 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. In 2007, we completed a US$320 million equity offering in the domestic and international financial markets. This equity offering further strengthened our balance sheet, reduced our leverage ratio and improved our cash position, all of which better enable us to continue financing our fleet expansion and renewal plans. We also monitor and seek opportunities to reduce financial risks associated with currency, interest rate and jet fuel price fluctuations. Over the last four years, while much of the airline industry has faced significant competitive and liquidity crises, we have enjoyed a 116.7% compound growth rate in our total revenues while remaining consistently profitable.
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,
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 with the implementation of the initiatives launched in 2007 to redesign our short-haul business model, specifically in the domestic markets in Chile and Peru. 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 turn around times. Our Boeing 737-200 fleet was completely phased out in May 2008 in favor of the new Airbus 320-Family Aircraft. These initiatives have increased efficiency and improved the margins of LANs short-haul operations. In addition, the new 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 our new 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 allow us to expand operations while controlling fixed costs, spurring a reduction in overhead costs per ASK by year-end 2009. 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 three 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 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.
BUSINESS OF THE COMPANY
Airline Operations and Route Network
We are one of the main air transport operators in Latin America. As of March 31, 2009, we operated passenger airlines in Chile, Peru, Ecuador and Argentina. We are also the largest air cargo operator in the region. Our international and domestic passenger and cargo operations and services have increased substantially over the past five years in terms of capacity, traffic and revenue.
The following table sets forth our gross traffic revenues by activity for the periods indicated.
As of March 31, 2009, our passenger operations were performed through airlines in Chile, Peru, Ecuador and Argentina where we operate both domestic and international services. Between June 2003 and May 2004, we also operated international services to and from the Dominican Republic through Lan Dominicana, that we subsequently suspended due to market conditions.
As of March 31, 2009, our network consisted of 15 destinations in Chile, 14 destinations in Peru, 2 destinations in Ecuador, 12 destinations in Argentina, 15 destinations in other Latin American countries and the Caribbean, 3 destinations in the United States, 1 destination in Canada, 2 destinations in Europe and 4 destinations in the South Pacific. Within Latin America, we have routes to and from Argentina, Bolivia, Brazil, Chile, Colombia, Cuba, the Dominican Republic, Ecuador, Mexico, Peru, Uruguay and Venezuela. We also fly to a variety of international destinations outside Latin America, including Auckland, Frankfurt, Los Angeles, Madrid, Miami, New York, Toronto, Papeete (Tahiti) and Sydney. In addition, as of March 31, 2009, through our various code-share agreements, we offer service to 24 additional destinations in North America, 13 additional destinations in Europe, 25 additional destinations in Latin America and the Caribbean (including Mexico), and 1 destination in Asia.
The following table sets forth certain of our passenger operating statistics for international and domestic routes for the periods indicated.
International Passenger Operations
As of March 31, 2009, we operated scheduled international services from Chile, Peru, Ecuador and Argentina through Lan Airlines, and Lan Express in Chile, Lan Peru in Peru, Lan Ecuador in Ecuador and Lan Argentina in Argentina. International passenger traffic has grown significantly in the past couple of years due to demand growth, market share gains, increased connecting traffic to and from other Latin American countries, the launch of new routes and additional frequencies on existing routes, and expansion into new markets.
Our international network combines our Chilean, Peruvian, Ecuadorian and Argentinean affiliates. We have operated international services out of Chile since 1946, and we greatly expanded our flights out of Peru and Ecuador with the creation of Lan Peru and Lan Ecuador in 1999 and 2003, respectively. In August 2006, we expanded our international operations through Lan Argentina, which until then had only been offering domestic flights. This strategy is aimed at enhancing our value proposition by offering customers more destinations and routing alternatives, maximizing aircraft utilization, increasing load factors, leveraging complementary seasonal patterns, and optimizing our commercial efforts. We provide long-haul services out of our four main hubs in Santiago, Lima, Guayaquil and Buenos Aires. We also provide regional services from Chile, Peru, Ecuador and Argentina. Since 2004, we have grown our intra-Latin American operations out of Lima to position it as our main regional hub. The following table sets forth the destinations served from each of the aforementioned countries as of March 31, 2009:
In line with its orientation to service and permanent commitment to provide its customers with the best products on the market, in May 2009 LAN completed the retrofit of all its long-haul fleet (including its Boeing 767 and Airbus A340 passenger aircraft) with the new Premium Business class and improved Economy class. Combining the best features of the traditional First and Business classes, the new Premium Business includes 180 degrees recline full-flat seats which allow passengers to sleep with the maximum comfort and privacy. Premium Business also includes top-level personalized in-flight service. Changes in Economy class include new seats with a greater recline angle, a cushion that slides forward for increased comfort and convenience, and larger individual video monitors for each seat.
During the second half of 2008 we launched a new class called Premium Economy for our Airbus 320 Family Aircraft fleet in order to better respond to the needs of LANs business travelers flying on our regional Latin American network. We created the Premium Economy class by converting the first three rows in our short-haul Airbus fleet (which regularly have eighteen seats) into a twelve-seat area in order to provide passengers with additional comfort and privacy. We also provide pre-boarding and on-board services of a premium class level, as well as access to VIP lounges and preferred baggage claim. We retrofitted our Airbus fleet with convertible seats so that such aircraft may be easily converted from a full economy flight used on domestic routes to a Premium Economy / Economy flight flown on regional routes.
According to JAC data, Chilean international air passenger traffic increased 3.7% in 2008 as compared to 2007, to approximately 22,146 million RPKs. We had a 50.8% market share in 2008, based on RPKs, compared to 50.9% in 2007. Our international operations out of Chile can be divided into four main segments: to North America, to Europe, to the rest of Latin America, and to the Pacific. As of March 31, 2009, the other principal carriers that transport passengers between Chile and North America with direct flights included American Airlines, Delta Airlines, and Air Canada. Grupo TACA and COPA also participate in the Chile-North American markets with stopovers in their respective Central American hubs. Our main competitors on routes between Chile and Europe were Air France-KLM, Iberia and Swiss. On regional routes our main competitors were Aerolineas Argentinas, Air Canada, Avianca, GOL, TACA and TAM. We were the only airline operating between Chile and the South Pacific.
Based on the information provided by the Peruvian DGAC, international traffic to and from Peru grew 17.8% between 2007 and 2008 to approximately 4.6 million passengers. Both in 2007 and 2008, we had 36.0% of the international market share. Our Peruvian international operations can be divided into three main segments: to North America, Europe and to the rest of Latin America. As of March 31, 2009, our main competitors on direct routes to North America included American Airlines, Continental Airlines, Delta Airlines and Spirit Airlines. Grupo TACA and COPA also participate in the Peru-North American markets with stopovers in their respective Central American hubs. On routes to Europe, our main competitors were Iberia, Air Comet and Air France-KLM. The other principal carriers operating between Peru and the rest of Latin America as of that date included Aerolineas Argentinas, TACA Peru, Spirit, Avianca and GOL.
The Ecuadorian international market increased 3.1% to approximately 2.6 million passengers between 2007 and 2008. According to travel agency statistics (BSP) and our estimates, we had a 26.5% market share of the Ecuadorian international market in 2008 compared to 24.9% in 2007. Our Ecuadorian international operations can be divided into three main segments: to North America, to Europe and to the rest of Latin America. As of March 31, 2009, on direct routes to North America, our main competitors were American Airlines, Continental Airlines, Delta Airlines and Aerogal. Grupo TACA and COPA also participate in the Ecuador-North American markets with stopovers in their respective Central American hubs. On routes to Europe, our main competitors were Air Comet, Iberia, and Air France-KLM. On regional routes, our main competitors were TACA, COPA and Avianca.
Based on our internal estimates, the Argentinean international market increased 7.4% to approximately 7.9 million passengers between 2007 and 2008. Our estimated market share of the Argentinean international market was 16.4% in 2008 compared to 17.9% in 2007. Our Argentinean international operation consists of operations between Buenos Aires and Miami, the Dominican Republic, Sao Paulo, Lima, Bogotá and Santiago. As of March 31, 2009, on the Miami route, our main competitors were American Airlines and Aerolineas Argentinas. TAM, Grupo TACA and COPA also participate in the Argentina-North American markets with stopovers in their respective hubs. On the Dominican Republic route, our main competitors were COPA and Aerolineas Argentinas. On the Sao Paulo route, our main competitors were TAM, GOL and Aerolineas Argentinas. On the Lima route, our main competitor was Grupo TACA. On the Bogotá route, our main competitor was Avianca. On the Santiago route, our main competitors were Aerolineas Argentinas and Air Canada.
Business Model for Domestic Operations
In 2007 we initiated an important project to redesign our domestic business operations with the goal of increasing efficiency and improving the margins of LANs short-haul operations, specifically with respect to our domestic operations in Chile and Peru. The new business model was first tested in the last quarter of 2006. A key element of this project has been to significantly increase the utilization of our narrow body fleet, which we have been achieving through modified itineraries including more point-to-point and overnight flights. We removed Boeing 737-200 aircraft from our fleet in favor of the new more efficient Airbus A320-Family Aircraft. The Airbus A320-Family Aircraft fleet utilization increased to over ten block hours per day in 2008. The transition to a newer fleet allows for lower unscheduled maintenance costs as well as cost efficiencies achieved through operating fewer fleet types and operational efficiencies, including lower fuel consumption.
Other key elements of our new business model are the reduction in sales and distribution costs through higher Internet penetration and reduced agency commissions, a faster turn around time, and increased self-check-in service through web check-in and kiosks at airports. These initiatives, together with simplifications in back-office and support functions, will continue to allow us to expand operations while controlling fixed costs, spurring a reductions in overhead costs. We have begun to pass on these operating efficiencies to consumers through significant fare reductions, which we expect will have a strong effect of stimulating new demand.
In 2007, we implemented all aspects of this new business model in the Chilean and Peruvian domestic markets. We launched our new short-haul business model on all domestic routes in Chile in April 2007, after a marketing campaign which began in March 2007. We launched the new model in all domestic Peruvian routes in January 2007.
As a result of the implementation of this model, we increased the number of passengers transported in all domestic markets. Between 2006 and 2008, the number of passengers transported increased 40% (from 2.5 million to 3.5 million) in Chile, 76% (from 1.7 million to 3.0 million) in Peru and 150% (from 0.6 million to 1.5 million) in Argentina.
We plan to continue with the implementation of this business model in 2009 as we look for ways to increase operational efficiency, encourage direct sales and self check-in, and implement new sales strategies aimed at stimulating demand. Efficiency and productivity improvements are especially important in light of the current global macroeconomic scenario.
Operations within Chile
Through the companies Lan Airlines and Lan Express we are the leading domestic passenger airline in Chile. We have operated domestic flights in Chile since the Companys creation in 1929. As of March 31, 2009, we flew to fifteen destinations within Chile (not including Easter Island, which we consider an international destination even though it is a part of Chile, because we serve it with long-haul aircraft) as well as some seasonal destinations. Lan Airlines and Lan Express have integrated passenger operations, including operations under the same two-letter designator reservation code, and have coordinated fare structures, scheduling and other commercial matters in order to maximize cooperative benefits and revenues for the two carriers. Our strategy is based on providing frequent service to Chiles main destinations, offering a reliable and high quality service, and leveraging our strong brand position in Chile and abroad. We evaluate our network of domestic routes on an ongoing basis in order to achieve optimal operational efficiency and profitability. Our strategic objective is to maintain our leadership position in our domestic routes.
During 2008 we operated an average fleet of sixteen Airbus A320-Family Aircraft in the Chilean domestic market, and we plan to operate an average fleet of eighteen Airbus A320-Family Aircraft in 2009. Domestic operations in Chile were positively affected by the greater utilization of the latest-generation Airbus fleet and the retirement of the Boeing 737-200s, which were completely phased-out as of May 2008. The new business model was launched nationwide within Chile in April 2007. As a result, demand and capacity expanded significantly in 2008 by 17% and 11%, respectively, leading to an increase in load factor of three percentage points, which averaged 76% in 2008. During 2008 we continued to stimulate demand by decreasing fares even though the fuel surcharges were higher due to the record-high fuel prices reached in July 2008. We reduced sales costs by increasing direct sales from 66% in 2007 to 72% in 2008 (with 49% of our 2008 sales done through the Internet) and by reducing agency commissions from 6% to 1% in February 2007. We also increased fleet utilization, crew productivity and the average flight leg through schedule changes. Additionally, we simplified our processes, which helped to increase the self check-in rate from 70% in 2007 to 75% in 2008. Finally, we utilized the greater efficiency of the Airbus aircraft to reach operational efficiencies such as reducing the turn-around time, increasing our punctuality (which reached 90% in 2008) and lowering fuel consumption. As of March 2009, we operated 100% of our ASKs with our Airbus A320-Family Aircraft fleet
According to JAC data, the Chilean domestic market as a whole transported approximately 4.7 million passengers in 2008 and it had an increase of 14% in terms of RPK. Our domestic market share in Chile was 75% for 2008 and 81% as of March 31, 2009. During 2008, our main competitors in the domestic market were Sky Airlines and Aircomet Chile (formerly known as Aerolineas del Sur) which terminated operations in October 2008. Sky Airlines currently operates a fleet of nine Boeing 737-200 and one Airbus A320 and flies to thirteen destinations. In addition, Principal Airlines has announced it will launch its regular domestic operations during June 2009.
There are currently no foreign airlines participating in the Chilean domestic market. Chile permits foreign airlines to operate in Chile if the airlines home country gives similar treatment to Chilean airlines. Additionally, there are no regulatory barriers that prevent a foreign airline from creating a Chilean subsidiary and entering the Chilean domestic market using that subsidiary.
Operations within Peru
Lan Peru started operations in 1999 with domestic and international flights from Lima. During the past ten years, Lan Peru has expanded consistently, consolidating its domestic operations and coverage of relevant markets.
Regarding the domestic market, Peru has a tremendous potential in comparison to other Latin American markets based on per capita travel ratios. In 2008 the domestic market reached 3.7 million passengers and 4.0 million passengers are expected for 2009. According to data provided by the Corporación Peruana de Aeropuertos y Aviación Comercial S.A. (CORPAC), our domestic market share in Peru was 67% for 2006, 68% for 2007 and 73% for 2008. A total of 3,027,076 passengers traveled on Lan Perus domestic Peruvian routes in 2008, which represented an increase of 33.2% compared to 2007. As of March 31 2009, competitors included Star Peru and Taca.
During 2008, Lan Peru increased operations covering all fourteen main destinations in Peru (Piura, Chiclayo, Trujillo, Arequipa, Tacna, Juliaca, Cusco, Puerto Maldonado, Pucallpa, Tarapato, Iquitos, Lima, Cajamarca and Tumbes) operating two or more daily flights to each city (except the newly opened destinations: Cajamarca and Tumbes). In 2009, Lan Peru expects to continue increasing daily operations and supply to the main destinations. This growth in operations has been commercially supported with a successful demand stimulation strategy, adequate segmentation and innovative campaigns, in order to achieve high load factors.
Regarding airport services, Lan Peru has over 100 domestic daily arrivals and departures, with self-check levels growing steadily in the past years and reaching 78% (web and kiosks) by the end of 2008.
Lan Peru has one of the most modern fleets in Latin America, operating fourteen Airbus A319 (ten for domestic and four for regional operations). This fleet is ideal for the characteristics of Peruvian routes, as it maximizes available payload in high altitude airports with tail wind conditions. Regarding efficiency, a uniform fleet allows for low maintenance costs, high crew productivity and operational flexibility.
In 2008, Lan Peru was voted the preferred airline by executives in Lima and the leading company in web sales in Peru through Lan.com. In addition, Lan Peru was recognized with the Gold Effie Award in the new services category for its Lan.com Payment Options campaign.
Regarding safety standards, in 2008 Lan Peru obtained an IATA Operational Safety Audit (IOSA) recertification, ensuring that our operations are aligned with International Air Transport Association (IATA) norms and procedures. During the second half of 2009, Lan Peru intends to launch Area Navigation (RNAV) technology in our domestic flights in order to improve the precision and safety of our flights, as well as fuel efficiency.
Operations within Argentina
Lan Argentina initiated services in June 2005, covering two Argentine domestic destinations from Buenos Aires, Cordoba and Mendoza. Between 2005 and 2007, Lan Argentina increased the number of Argentine domestic destinations to nine adding Bariloche, Iguazu, Comodoro Rivadavia, Rio Gallegos, Ushuaia, Calafate and Salta. In June 2008, Lan Argentina initiated services to Neuquen and in September 2008 to San Juan. In April 2009, Lan Argentina initiated services to Tucuman.
From June to November 2006, Lan Argentina replaced all its Boeing B737-200 fleet, which consisted of five aircraft, with four Airbus A320 aircraft. We use these aircraft in both domestic and regional operations. The replacement of these aircraft enabled Lan Argentina to increase the scope, size and efficiency of its operations. By the end of December 2008, we operated a fleet of eight Airbus A320 in our domestic operations.
In the domestic Argentine market, Lan Argentina operates in a regulated environment in which fares sold to Argentine passengers are subject to minimum and maximum prices that vary per route. In August 2006, by presidential decree, both the floor and ceiling of the regulated price range were increased by 20%. The decree delegated to the Transportation Secretary the authority to change prices, which up to then could only be done by presidential decree, and liberalized foreign ownership of Argentinean airlines, previously capped at 49%. In April 2008, a new presidential decree increased both the floor and ceiling of the regulated price range by 18%. In May 2008, a presidential decree further lifted the floor and the ceiling of the domestic price range by an additional 18%. Together, these two increases resulted in a rise of almost 40% in domestic fares.
Our domestic market share in Argentina, based on our internal estimates for December 2008 amounted to 30%. Our competitors in the Argentinean market during 2008 were Aerolineas Argentinas and its affiliate Austral. Together, these two companies held substantially the entire remaining share of the domestic Argentine market.
Operations within Ecuador
At the end of 2008, Ecuadors National Civil Aviation Council (NCAC) granted us authorization to operate domestic flights in Ecuador. In April 2009, we started operations between Quito and Guayaquil, currently offering forty-nine weekly flights. In the near future, we will incorporate the city of Cuenca and the Galapagos Island to our domestic routes. Our competitors in the Ecuadorian domestic market are TAME, Icaro and Aerogal.
Passenger Alliances and Commercial Agreements
The following are our passenger alliances and partnerships as of March 2009:
Passenger Marketing and Sales
Even though we market our services under the common LAN brand, we differentiate our marketing strategies between our long-haul and short-haul services.
Our long-haul marketing strategy emphasizes attributes valued by our international customers, including reliability, high quality on-board and ground service, comfort, comprehensive coverage of key South American markets and frequent service to major overseas gateways such as New York, Los Angeles, Miami, Madrid and Sydney. In order to strengthen our market position, we have continued improving our passenger cabins and service and constantly monitor our corporate image. As such, in 2006 we launched a retrofit program for all of our Boeing B767-300 passenger aircraft, which merges our Business and First Classes into a Premium Business Class featuring full-flat seats, new entertainment units for both Premium Business and Economy cabins, together with a new on-board service. In 2008, LAN received awards for Best Business Class in Latin America, from Business Traveler and Global Traveler confirming the positioning achieved by the Company. Our aim is to give our long-haul
passengers a sense of a shorter and more pleasant flight. For our Business passengers, our cabin features and on-board service aimed at providing the passenger with more time to rest, and for our Economy Class passengers, our upgraded entertainment units aim to make the flight a more enjoyable one. The retrofit program for our Boeing 767-300 for the new configuration was completed in December 2008. From October 2008 to May 2009 we retrofitted our Airbus A340-300 fleet, merging the Business and First Classes cabins into a Premium Business Class. We invested US$126 million in this retrofit program for all our long haul passenger aircraft.
Our short-haul operations are designed to better match the customers needs in those routes, which are punctuality, reliability, higher frequencies, modern aircraft and efficient operations. As such, these routes now feature modern planes, most with all-leather seats, increased frequencies with more point-to-point flights, improved punctuality and streamlined processes including Internet sales, web check-in and airport self-check-in. We have already completed the phase-out of our Boeing B737-200 fleet and replaced it with modern Airbus Family Aircraft such as A320, A319 and A318.
We are constantly focused on delivering the services and flight items valued by customers in order to maintain high levels of customer satisfaction and we continuously monitor our customers preferences through surveys and perception studies. As a result, we created the new Premium Economy class on some regional routes in response to comments made by our business travelers. The Premium Economy program grants our customers preferential check-in and boarding, access to our VIP lounges, priority baggage claim, exclusive cabins with only twelve passengers, and personalized attention by our cabin attendants, among other benefits.
As mentioned above, we implemented a new business model initiative in the domestic Chilean and Peruvian market that seeks to make air travel accessible to more people through discounts and the lowest fares supported by the efficiency of operations.
During 2008 and the first quarter of 2009, LAN has received several awards confirming LANs market position. These awards included Best Airline Based in Central/South America & Caribbean (Official Airline Guide); Best Airline in South America (Skytrax); and Best Airline in Latin America (Latin Trade magazine).
In March 2004, we launched our new LAN brand which brought together all of our passenger services that we previously operated under the local brands such as Lan Chile, Lan Peru and Lan Ecuador. We developed our new brand and corporate image after an extensive process supported by a leading global branding agency. Our corporate image is based on two core concepts: reliability and warmth. We expect that using a single brand will enable our customers to better understand the common service and operating standards that exist among our airlines. Additionally, we believe that our new image will improve the visibility of our brand, enhance flexibility, and increase the efficiency of our marketing efforts.
This marketing program involved changing our corporate image, including our logo and aircraft livery. As a result, all of our marketing efforts are now done using audiovisual elements based on the LAN brand. During 2005 and 2006, we focused on advancing the transition to our new brand. This included the gradual repainting of our fleet, which was completed in the second quarter of 2006. Our commercial strategy, centered on exploiting the LAN alliance concept, has been widely recognized, as exemplified by Airline Business magazines recognition of us in 2004 with its Airline Strategy Award, Marketing.
Even though we now offer different products for our long-haul and short-haul operations, both products are marketed under the same brand, as the corporate values behind our umbrella brand encompasses attributes applicable to both operations. This decision will result in significant savings as we only have to promote one brand, thereby increasing the efficiency of our marketing efforts.
We use direct and indirect distribution channels. In the past few years, we have focused on streamlining our distribution strategy in order to reduce costs and enhance the effectiveness of our commercial efforts. This effort has resulted in efficiency gains, and we believe it should lead to further benefits in the future.
Travel agents conduct indirect sales that accounted for approximately 55% of passengers during 2008. We paid these travel agents standard commissions ranging from 0% to 9% depending on the market. Consistent with our efforts to reduce commission costs, and in line with current market practices, in recent years we have reduced standard commissions in several markets. However, we are now charging a fee to customers for sales done through our own ticket offices or call centers in most countries, leaving the Internet as the only free-of-charge distribution channel.
Travel agents obtain airline travel information and issue airline tickets through Global Distribution Systems, or GDSs, that enable them to make reservations on flights from a large number of airlines. We participate actively in all major international GDSs, including Sabre, Amadeus, Galileo and Worldspan. In return for access to these systems, we pay transaction fees that are generally based on the number of reservations booked through each system.
Direct channels refer to sales by our own ticket offices, contact-centers and website. In 2008, direct bookings accounted for approximately 45% of all of our passengers.
We have an extensive sales and marketing network in over thirty countries consisting of more than one hundred domestic and international points-of-sale owned by us and approximately twenty general sales agents.
Our contact-centers support the growth of our operations constituting a sales and a multi-service channel. During 2008, we continued the consolidation of our main contact-center located in Santiago (with 700 agents of which 300 are home based), and the growth of our center in Lima (with 150 agents). We complement our contact-centers operations with third-party service providers that add approximately 350 agents who are located in Santiago, Lima and Buenos Aires. In total, all the centers handle more than 25,000 calls/contacts a day mainly originated from all the regions where we fly (South America, North America, Europe and Australasia) and covering four languages (Spanish, English, Portuguese and German). We have continually upgraded our systems by incorporating technological advances to enhance efficiency and customer service.
Our website, www.lan.com, is an integral part of our commercial, marketing and service efforts. Together with other direct sales initiatives, our website provides us with an important tool to reduce our distribution costs. Our Internet-related sales have increased significantly in recent years, rising 89% in 2008 compared to 2007, and amounting to US$426.3 million in 2008. We are continually improving our website, a key element of our new short-haul model, so that the technological platform can support the expected future growth.
Besides serving as a sales channel, we have utilized our website as a tool to provide value-added services and enhance communications. We send weekly promotional e-mails to more than 1.8 million subscribers. Members of our frequent flyer program receive their monthly balances and other information by e-mail and can access the data and redeem awards through our website. We have an active online marketing program which brings visitors to the website from search engines and travel-related websites.
During 2008 we continued promoting our web-based check-in service for domestic flights, allowing passengers to obtain their boarding passes from their home or office. The system allows those passengers who are not checking-in bags, to go directly to the gate, and the remaining checked-in passengers, to leave their bags at a special bag drop counter and proceed to the gate. In addition to web-based check-in, we have self-check kiosks in 9 airports in Chile, 5 airports in Peru and 2 airports in Argentina. As of March 31, 2009, the kiosk and web check-in utilization rate had increased to 72% for domestic routes in Chile, 71% for domestic routes in Peru and 41% for domestic routes in Argentina.
During the last two years, 75% of the LAN Pass awards have been redeemed online, because it is easier for our customers to find available seats and no service fees are charged.
In 1997, we introduced electronic tickets, commonly referred to as e-tickets, and have since worked to increase their use. E-tickets are a key element of our sales efforts through the Internet and our call centers and they also produce important simplifications in our back-office, enabling us to significantly reduce distribution costs. In 2008, e-ticketing reached a 100% penetration in all LAN routes.
Although in mid-2005 we completed the implementation of this feature with all of our oneworld® partners, there are still some exceptions for interline e-ticketing that are expected to be resolved during 2009.
Advertising and Promotional Activities
Our advertisement and promotional efforts are aimed at enhancing our brand positioning and supporting specific aspects of our commercial efforts. Our advertising and promotional activities include the use of television, print and radio advertisements as well as direct and online marketing. The utilization of a single brand among our airlines has enabled us to launch regional campaigns focused on highlighting key attributes such as network reliability and warmth.
During 2008, we carried out two regional campaigns. The first one was aimed at advertising our new in-flight entertainment system on all our long haul fleet, highlighting the fact that a rich and unique entertainment experience shortens the perceived flight time. This campaign used local television and print in Argentina, Chile, Ecuador and Peru, as well as regional media. The second campaign promoted the advantages of shopping online at www.lan.com, and was aired in Chile and Peru.
On a country-specific level, the new model for domestic operations in Chile, launched in April 2007, has benefited from the third episode of the Ventana o Pasillo (Window or Aisle) ad campaign, supported by intense marketing efforts involving television, radio and print.
In Peru and Argentina, we launched campaigns to enhance awareness of attributes such as reliability and service quality. Furthermore, a specific campaign was implemented in Argentina to raise awareness of the oneworld® alliance and its benefits, which included the painting of an Airbus A320 plane with the oneworld® livery. Additionally, specific advertisement campaigns were implemented to stimulate Internet sales, web-based check-in and service redemption, and low-season travel.
In February 2009 we launched the marketing campaign Campaña Temporada Irresistible (Irresistible Season) to aggressively stimulate traffic during the lowest season of the year. For example, LANs international passenger business used the 2x strategy and the domestic passenger business in Chile developed the concept of Chile for little money. These campaigns finalized on May 31, 2009 and succeeded in increasing traffic.
LAN has built a comprehensive database that includes valuable information such as flying preferences, demographic and other relevant customer information, which is used for passenger revenue management (including targeted promotions to different customer segments), thereby reducing dilution and maximizing response rates. This type of information is also a source for customer metrics and monitoring and provides significant management information. The skills involved in profitably exploiting these resources were strengthened in 2008 with the incorporation of key teams to act locally in Peru, Argentina and the United States, in close collaboration with the head office.
Frequent Flyer Program
Our frequent flyer program is called LANPASS. LANPASS objective is to generate incremental revenue and customer retention through customer loyalty and targeted marketing. Worldwide, LANPASS has approximately 2.9 million members.
Customers earn kilometers in their LANPASS accounts based on distance flown and class of ticket purchased. Based on an award schedule, customers can redeem kilometers for free tickets or upgrades. Under our current frequent flyer program, our passengers are grouped into one standard level and three different elite levels based on each passengers flying behavior. These different groups determine which benefits customers are eligible to receive, such as free upgrades on a space-available basis, VIP lounge access and preferred boarding and check-in.
LANPASS has highly rated partners, including other airlines, hotels, car rental agencies, retailers, and credit card issuers from the main financial institutions in Chile, Peru, Ecuador and Argentina, which give additional kilometers to customers for using their services. As an active member of the oneworld® alliance, we have reciprocal frequent-flyer agreements with all oneworld® carriers. In addition, we have reciprocal agreements with other carriers, such as Alaska Airlines, Aeromexico, Mexicana and TAM, that allow us to benefit from the loyalty of their customers, as they can accrue miles under their frequent flyer program when traveling on LANs flights.
The LANPASS frequent flyer program aims to be the leading loyalty program in all of LANs home markets. In the past couple of years, we have implemented a number of marketing initiatives to increase the penetration of the program outside Chile. In 2008, membership in LANPASS grew 27% in Peru, 73% in Ecuador and 41% in Argentina.
The following table sets forth certain of our cargo operating statistics for domestic and international routes for the periods indicated.
Our cargo business generated revenues of US$910.5 million in 2005, US$1,072.7 million in 2006, US$1,154.3 million in 2007 and US$1,527.1 million in 2008. This represented 36.3%, 35.4%, 32,7% and 33.7% of our operating revenues, respectively. Cargo revenues grew 42.4% between 2006 and 2008 primarily due to the addition of new routes and improvement in yield. Our international cargo routes to, from and within Latin America accounted for around 97.0% of total cargo revenues for 2005, 2006, 2007 and 2008.
Our cargo business generally operates on the same route network used by our passenger airline business, which is supplemented by freighter-only operations. Overall, it consists of eighty-four destinations (sixty-eight operated by passenger and/or freighter aircraft and approximately sixteen operated only by freighter aircraft). We complement our own operations through coordination with our regional affiliates, MasAir in Mexico and ABSA in Brazil, which started its domestic operations in the Brazilian market in March 2009. In addition, we launched a new cargo subsidiary in Colombia which began operations in March 2009. We carry cargo for a variety of customers, including other international air carriers, freight-forwarding companies, export oriented companies and individual consumers. For information about our fleet, see FleetGeneral below.
We transport cargo in four ways: (i) in the bellies of our passenger aircraft, (ii) in our own dedicated freighter fleet, (iii) in belly space that we purchase from other airlines and, (iv) in aircraft that we charter or lease pursuant to ACMI contracts (Aircraft, Crew, Maintenance and Insurance), which are also known as wet-leases, in which the lessor operates the aircraft and provides the aircraft, crew, maintenance and insurance, pursuant to short- and medium-term contracts.
Our international cargo operations are headquartered in Miami, whose geographical location positions it as the natural gateway for Latin American imports and exports to and from the United States, and since 2001, are located in our 380,000 square-foot facilities within the Miami International Airport. The United States accounts for the majority of the cargo traffic to and from Latin America. Besides being the main market for Latin American exports by air, the United States is also the main supplier of goods, such as high-tech equipment or spare parts, transported by air to Latin American countries. To complement our own cargo operations to the United States, we have negotiated commercial agreements with American Airlines on some routes from Miami to Brazil.
We operate to three gateways in Europe: Madrid, which we serve via passenger aircraft (using our flights from Santiago, Lima and Guayaquil), Frankfurt (through both passenger flights and freighter operations since October 2002, when we signed our partnership with Lufthansa Cargo (for more information on this agreement see Cargo Agreements below)), and Amsterdam (through freighter operations since October 2005).
In Latin America, the principal origins of our cargo are Chile, Ecuador, Peru, Argentina and Brazil, which represent a large part of our northbound traffic. And for our southbound flights, Brazil is the main import market.
Our international cargo traffic increased 28.6% between 2004 and 2008, from 2,259.4 million cargo revenue ton kilometers in 2004 to 2,906.7 million cargo revenue ton kilometers in 2008. International cargo traffic increased 6.0% in 2005, 8.0% in 2006, 4.9% in 2007 and 7.7% in 2008, and accounted for around 97.0% of our total cargo revenues during 2005, 2006, 2007 and 2008.
We believe that the primary reasons for the growth in cargo operations are:
In general terms, cargo flows are unidirectional. This characteristic is a key determinant in the structure of cargo operations as well as in the commercial conditions in the cargo business. This is especially relevant in markets featuring structural imbalances between inbound and outbound flows or during specific periods of such disequilibrium. Lack of demand in one particular direction may force airlines to rely on different markets in order to maximize loads on return flights. Furthermore, demand weakness in one direction may limit the capacity that is profitable to allocate to some routes, therefore creating pressure on fares in order to compensate for weaker revenues in one particular direction. The evolution of our international cargo operations has always been affected by the flow imbalances of the Latin American cargo markets, resulting in a dramatic shift in the relative weight of southbound and northbound cargo flows throughout the years. From 2002 to 2003, our international operations were characterized by very strong export traffic out of Latin America, but gradual increases in import demand, as well as the deceleration of export growth, led to more balanced cargo flows during 2004. Further extension of this trend led to excess demand on southbound routes since 2005.
We have designed our operations, route network and commercial strategies with the flexibility required to respond to changing conditions. As such, during 2003 we allocated additional capacity to northbound routes and adjusted fares on northbound routes in response to excess demand. During 2004 we gradually adjusted our operations to leverage a more balanced demand environment by performing an increased number of direct roundtrips between key export and import markets. However, weakness in exports since 2005 has driven us to support the northbound segment of certain routes with stop-overs in additional export markets, to reduce northbound fares to stimulate demand and to raise southbound fares.
Despite some initial challenges, during 2008 we continued a series of measures and projects that led to improved margins. Among other things, we consolidated our new fleet model, reducing wet lease utilization in favor of a more efficient owned fleet. We reduced wetlease capacity as a percentage of total cargo capacity from 13% in 2006 to 10% in 2007. Nevertheless, during 2008, due to strong growth in import markets, a record seed export season and the preparation for the Companys entry into new markets, we increased our wetleases to approximately 20% of our cargo capacity in order to respond to the increasing demand. We also emphasized the most profitable routes in expanding our network. We carried out significant improvements in our information system as part of our constant search to enhance customer service. Among other initiatives, we integrated our system with those of our major customers, and we also developed a new and improved web-based e-tracking tool. Those innovative initiatives help to differentiate the product we offer to our clients and reinforce our commitment to maintain leadership and world-class service standards.
During the last five years, we also improved our competitive position as key operators reduced their operations, and competitors such as UPS and FedEx either downsized their operations or exited some markets. Since mid-2004, competition increased as regional carriers added capacity, but despite this increase in competition, we have been able to maintain solid market shares in large part because of the efficient utilization of our fleet and network. Today, on Latin America-United States routes, our main competitors are Cielos del Perú S.A., Transportes Aereos Mercantiles Panamericanos S.A., or TAMPA, Arrow, and Polar Air, and on the Latin American-Europe routes, our main competitors are Cargolux, Lufthansa Cargo, Martinair and Air France-KLM.
Since 2002, Lan Cargo and Lufthansa Cargo have had a block space agreement between Europe and Latin America. As part of this agreement, Lan Cargo allocates space to Lufthansa Cargo on its flights between selected cities in Latin America and Europe, and Lufthansa Cargo allocates space to Lan Cargo on its flights between Europe and Brazil and Argentina.
We also have agreements with Asian carriers such as Korean Airlines, JAL, China Airlines, Air China and Cathay Pacific through which Lan Cargo receives space allocations from these airlines to move our cargo from Seoul, Tokyo, Taipei, Shanghai and Hong Kong to Los Angeles and Miami connecting with our network. In exchange, Lan Cargo provides them with space from these same two hubs in the United States to all Latin American destinations and also feeds them with westbound cargo.
Marketing and Sales
Our sales and marketing efforts are carried out either directly when we have a local office or through general sales agents. In Latin America we have our own offices in all key markets. In the United States we have our own offices in Miami, New York and Los Angeles, and work with representatives in various other cities. In Europe we have offices in Frankfurt and Madrid and use agents in other key cities. Finally, in Asia all our sales efforts are done through general sales agents. In total, we maintain a network of more than forty independent cargo sales agencies domestically and internationally.
Our cargo marketing strategy emphasizes our combination of freighter and passenger aircraft cargo capacity, which allows customers to ship large, bulky freight, as well as smaller, high-density cargo, fresh products, express shipments, and other types of cargo. Our cargo marketing strategy also emphasizes our high-quality services, scheduling flexibility and punctuality. On some routes, Lan Cargo offers special, value-added products such as Positive Flight Specific or FS, which enables the customer to choose a specific passenger flight to transport its goods.
In February 2006 the European Commission, in conjunction with the Department of Justice of the United States (DOJ), initiated a global investigation of a large number of international cargo airlines (among them LAN Cargo S.A., LANs cargo subsidiary) for possible price fixing of cargo fuel surcharges and other fees in the European and United States air cargo markets. On December 26, 2007, the European competition authorities notified LAN Cargo S.A. and LAN of the initiation of proceedings against twenty-five cargo airlines, among them LAN Cargo S.A., for allegations of anti-competitive behavior in the airfreight business. Given the current stage of the proceedings, it is not possible at this time to anticipate with any precision their outcome, although it is expected to be a lengthy judicial process. Notwithstanding the above, in the fourth quarter of 2007, LAN recorded, and maintains, a US$25.0 million reserve in Other Non-Operating Expenses in relation with the European investigation.
The investigation by the DOJ prompted the filing of numerous civil class actions by freight forwarding and shipping companies against many airlines, including Lan Cargo and Lan Airlines, including fifty-four in the United States and four in Canada. The cases filed in the United States were consolidated in the United States District Court, Eastern District of New York and the original complaint was subsequently amended to include additional airlines, including ABSA. On January 21, 2009, Lan Cargo announced that it had reached a plea agreement with the DOJ in relation to the DOJs ongoing investigation regarding price fixing of fuel surcharges and other fees for cargo shipments. Under the plea agreement, Lan Cargo agreed to pay a fine of US$88 million. In addition, ABSA reached a plea agreement with the DOJ and agreed to pay a fine of US$ 21 million. These amounts will be paid over a five-year payment schedule and have been recorded as of December 31, 2008, within Other Current Liabilities (US$19 million) and Other Creditors (US$90 million). It is not possible at this time to anticipate with any precision the outcome of the four civil actions that were filed in Canada against Lan Cargo, among other airlines.
On April 5, 2008, Brazilian authorities notified ABSA of the initiation of administrative proceedings before the Conselho Administrativo de Defesa Econômica against several cargo airlines and airline officers, among them ABSA, for allegations of anticompetitive practices regarding fuel surcharges in the air cargo business. Given the current stage of the proceedings, it is not possible at this time to anticipate with any precision their outcome, although it is expected to be a lengthy process. This investigation and the related proceedings do not imply that ABSA has been charged with or has engaged in any prohibited activity.
The New Zealand Commerce Commission also initiated an investigation into potential anti-competitive activities in the international air cargo markets and requested information and documentation from LAN, which LAN duly submitted. On December 15, 2008, the New Zealand Commerce Commission announced it would focus its investigation on ten airlines and excluded LAN from further investigation.
In June 2008, the Korean Fair Trade Commission notified LAN of an investigation into the air cargo industry and its non-compliance with the Monopoly Regulation and Fair Trade Act and has requested information and documentation from LAN, which LAN duly submitted. Given the current stage of the investigation, it is not possible at this time to anticipate with any precision its outcome.
As of March 31, 2009, we operated a fleet of 93 jet aircraft, comprised of 84 passenger aircraft and 9 cargo aircraft, as set forth in the following chart.
The daily average hourly utilization rates of our aircraft for each of the periods indicated are set forth below.
We operate different aircraft types as we perform various different missions ranging from short-haul domestic trips to long-haul trans-continental flights. We have selected our aircraft based on the ability to effectively and efficiently serve these missions while trying to minimize the number of aircraft families we operate.
During the first quarter 2009, we initiated the process of incorporation of winglets, advanced technology devices, in all our Passenger and Freighter Boeing 767-300 aircraft. Winglets are placed on the wings of an aircraft causing a more efficient use of fuel. The reduction in usage equals approximately 450,000 tons of fuel per year which translates in approximately a 5% decrease in fuel consumption. The investment in this project amounts to approximately US$70 million and is expected to be finalized in the third quarter of 2010.
Historically, we have also utilized between one and six cargo aircraft pursuant to short-term ACMI leases. These contracts enable us to adjust capacity on a short- to medium-term basis in order to manage the volatility of the
demand for cargo services and increase access to certain cargo destinations resulting from increased capacity and access to destinations outside the Lan Cargo network. As of March 31, 2009, we were utilizing two Boeing 747 Freighter under ACMI leases. Our current ACMI contracts are structured for periods of less than twelve months.
Fleet Leasing and Financing Arrangements
Our financing and leasing methods include borrowing from financial institutions and leasing under financial leases, tax leases and operating leases.
In 2000, to finance our Airbus aircraft, we entered into a US$1.3 billion umbrella credit facility with a syndicate of international financial institutions under which we borrowed in the form of separate loans in connection with the specific financing requirements of each Airbus aircraft (including pre-delivery and long-term financing). This umbrella facility provided for guarantees from the English, French and German export credit agencies. Our repayment profile for each aircraft financed under the facility was for a period of up to eighteen years. Under this financing package we incorporated Airbus aircraft into our fleet through operating leases, financial leases and tax leases. Even though this facility covered the aircraft scheduled to be delivered under our 1998/9 Airbus purchase agreements through December 31, 2006, we decided to fund the 2006 deliveries with a new facility negotiated in 2006. This new facility financed the acquisition of
This new US$920 million facility is similar to the previous one as we drew separate loans in connection with the specific financing requirements of each Airbus aircraft. This facility is based on support guarantees from the European export credit agencies. Under this financing package we incorporated into our fleet Airbus aircraft through operating leases, financial leases and tax leases. The facility covers 85% of the purchase price of each aircraft plus the associated export credit agencies premium. The remaining 15% will be funded directly by us. There is no remaining availability under this facility.
Between 2004 and 2006, LAN ordered fifteen Boeing 767-300 Passenger aircraft and Freighters for delivery between 2005 and 2008. In 2004 the Company structured a new syndicated facility for US$260 million to finance the entire cost of the two Boeing 767-300 Freighters delivered in 2005 and the first Boeing 767-300 Passenger aircraft delivered in 2006. In 2005, LAN finalized the syndicated facility to fund the purchase of four Boeing 767-300 Passenger and Freighter aircraft for delivery in 2006. Between 2005 and 2006, LAN also finalized two additional syndicated facilities to fund the purchase of the remaining eight Boeing 767-300 Passenger aircraft. Three of these aircraft were delivered in 2007, and five were delivered in 2008. Each loan with respect to these aircraft is guaranteed by the Ex-Im Bank with a twelve-year profile for the financing of 85% of the aircraft value.
On June 12, 2005, we made the final payment with respect to a Boeing 767-200 aircraft we held under a capital lease. We subleased this aircraft to a third party at market rate and extended this sublease until June 2010.
In 2006, LAN structured a pre-delivery payments facility for three of the Boeing 767-300 aircraft with deliveries in 2007 and 2008. Payments under this facility were completed during 2008.
In 2006, LAN also ordered three additional Boeing 767-300 passenger aircraft for delivery between 2009 and 2010. We plan to finance these aircraft partially by a new Ex-Im Bank guaranteed facility and partially with funds generated from operations.
In April 2007, we entered into two lease agreements with GE Commercial Aviation Services for the lease of two B777-200LR Freighters, for delivery in 2009. In October 2007, we signed a purchase agreement with the Boeing Company for two additional B777-200LR Freighters to be delivered in 2011 and 2012.
In the second half of 2007, the Company decided to acquire thirty-two new Boeing 787 Dreamliner aircraft with delivery initially scheduled between 2011 and 2016. The Company entered into a purchase agreement with the Boeing Company for 26 of these aircraft, while the Company entered into leasing agreements with the International Lease Finance Corporation for the remaining six aircraft.
During 2008, LAN decided to exercise fifteen options to acquire A320-Family Aircraft. We intend to finance the exercise of such options in part through a facility similar to the facility described above, and partially with funds generated from operations. Six of these aircraft are schedule to be delivered in 2010 and the remaining nine during 2011.
As of March 31, 2009, we held thirty-two aircraft under operating leases. Under the terms of our operating leases, we are required to return the aircraft in an agreed upon condition at the end of the lease. Although the title to the aircraft remains with the lessor, we are responsible during the lease term for the maintenance, servicing, insurance, repair and overhaul of the aircraft. As of December 31, 2008, aggregate future minimum lease payments required under our aircraft operating leases were US$1,348.9 million. Our operating leases have terms ranging from three months to twelve years from the date of delivery of the aircraft. For more information, see Note 18 to our audited consolidated financial statements.
For more information on our expected future capital expenditures in connection with aircraft purchases see Capital Expenditures under Item 5.
Our heavy maintenance, line maintenance and component shop are equipped to service our entire fleet of Airbus and Boeing aircraft. Our maintenance capabilities allow us flexibility in scheduling airframe maintenance, offering us an alternative to third-party maintenance providers.
Our facilities at Comodoro Arturo Merino Benítez International Airport in Santiago, Chile are among the most extensive in Latin America and have been certified according to IOSA standards and as a FAA approved repair station. Our hangars and components shops at our Santiago repair station can service the Boeing 767, Airbus 340 and Airbus 320 Family Aircraft fleet.
In addition, we have facilities for designing and manufacturing galleys, structures and composite materials, and we have the capability to retrofit aircraft interiors, including sophisticated in-flight entertainment equipment, and blended winglets in the Boeing 767 fleet.
Our engineering and maintenance division is supervised by the DGAC and subjected to several recurrent external audits from civil aviation authorities and international entities such as the FAA, the Argentine Dirección Nacional de Aeronavegabilidad (DNA), the Brazilian Agencia Nacional de Aviacao Civil (ANAC), IOSA (from IATA) and the International Civil Aviation Organization (ICAO), in order to strictly comply with applicable regulations. The audits are conducted in connection with each countrys certification procedures and enable us to continue to perform maintenance for aircraft registered in the certificating jurisdictions. Our repair station holds FAA Part-145 certifications under these approvals.
We also rely on third-parties for certain maintenance support for our aircraft and engines. Lufthansa Technik provides our Airbus A320-Family Aircraft and A340 Aircraft component support on a power-by-the-hour basis under a long-term contract, which runs until 2019. International Aero Engines provides the A320 and A319 engine support on a power-by-the-hour contract, which runs for twelve years once each engine is received. Pratt and Whitney provides the A318 engine support on a power-by-the-hour basis contract, which runs for ten years once an engine is received. General Electric provides the maintenance of our Airbus A340 engines under a similar contract, which also runs for twelve years once an engine is received. General Electric, which services have been contracted until 2014, provides the maintenance of most of our Boeing 767 engines. Third-parties also provide certain additional engine maintenance services. Air France-KLM, which services have been contracted until 2015, provides the maintenance of our Boeing 767-300 components.
We occasionally perform certain maintenance services for other airlines. Our aircraft maintenance personnel participate in extensive training programs at the jointly-operated Lufthansa LAN Technical Training S.A., located in Santiago, Chile.
Safety and Security Corporate Direction
The Safety and Security Corporate Direction (SSCD) is an internal division in charge of the management of security matters related to flight operations and operative and administrative buildings, and of the organization and coordination of emergency response matters.
The SSCD reports directly to LANs Chief Executive Officer (CEO), which reflects the firm commitment that the Companys senior management has with its employees. The SSCD is comprised of three independent reporting management areas: safety management, security management and emergency response management.
We give high priority to providing safe and reliable air service, as it is considered a fundamental asset to LAN and one of the basic pillars for the development of our Company. We have uniform safety standards and safety-related training programs that cover all of our operations. LAN has implemented a Safety and Quality Management System (SMS) throughout the operational areas of the Company, which is certified by the Chilean DGAC. The SMS provides clear definitions of the functions and responsibilities regarding operational safety for all persons involved, from the top to the bottom of the operational structure of the airline. It strengthens the commitment and knowledge required from everyone in the Company regarding any and all actions that could affect safety.
The Operational Safety Director (OSD) is responsible for the Operational Safety Oversight and the implementation of the SMS. The OSD supervises a staff of approximately twenty-one safety specialists of different backgrounds, including pilots, aeronautical engineers, aircraft maintenance engineers, a psychologist, and dangerous goods and ground handling safety specialists.
Our corporate operational safety organization consists of four main areas:
The main safety programs, elements and procedures include:
We also have an operational safety committee, composed of senior executives and key operational managers, responsible for the initiation of safety-related actions.
All of our B767, A320 and A340 fleets are equipped with an enhanced ground proximity warning system, a traffic collision avoidance system, a wind shear detection system and reduced vertical separation minimum capabilities.
Since 1991, we have had no accidents involving major injury to passengers, crew or aircraft.
The main policy and the essential principle of the Company is to ensure an adequate security protection to all its flights, aircraft, passengers, crew members, ground personnel, airport facilities and other services related to the commercial civil aviation against any threat or unlawful action.
The Company has implemented corporate policies and a quality management system through the operational system to detect any lack of security in its operations. Audits and assessments are used to assign different levels of security to international and domestic operations.
The Corporate Security Manager (CSM) has the responsibility to evaluate, analyze and assign threat levels (high, medium, low) to international and domestic operations, proposing security procedures for each scenario. The CSM leads an organization of five security managers and approximately fifteen security specialists. The current CSM is a former police officer with more than fifteen years of experience in the civil aviation.
The corporate security organization has five main areas:
Each of the five areas is subdivided in internal investigations, fraud, training, cargo security, security of facilities and quality control.
Since 2002, the Companys Corporate Security Manual unified international and domestic security procedures:
Emergency Response Management
The emergency response area is responsible for the administration of the Emergency Response Plan (ERP). It has been developed for the effective management of accidents and serious incidents with the purpose of mitigating any impacts on the passenger, their relatives and the operations.
Our ERP consists mainly of:
Fuel costs comprise the major portion of our operating expenses. Over the last years, our fuel consumption and operating expenses have increased due to the significant growth in our operations and to the increase in fuel prices as a result of worldwide economic and political factors. In 2008, the total fuel costs represented 35.6% of our total operating expenses explained mainly by the record high fuel prices reached in 2008. The into-wing (fuel price plus taxes and transportation costs) 2008 average final price was of 3.20 dollars per gallon, accumulating a 39.5 % increase from the 2007 average. We can neither control nor accurately predict the volatility of fuel prices. Despite the foregoing, it is possible to partially offset the price volatility risk through our hedging and fuel surcharge programs in place in both our passenger and cargo business. For more information, see Quantitative and Qualitative Disclosures About Market Risk Risk of Fluctuations in Jet Fuel Prices under Item 11.
The following table details our consolidated fuel consumption and operating costs (which exclude fuel costs related to charter operations in which fuel expenses are covered by the entity that charters the flight) during the five last years.
We have entered into fuel contracts to serve operations to more than sixty international and domestic destinations around the world. Contractual terms and conditions vary for each location depending on market conditions, logistics network, volume, economic and political factors, among others. In 2008, approximately 22.9% of our total fuel consumption was originated in Chile where we maintain a long-term commercial relationship with a joint venture between Air BP and Copec, and we have entered into specific supply contracts with Exxon Mobil Aviation and Shell Aviation. We have more than twenty additional suppliers in our network such as Repsol YPF, Cepsa, Primax, Chevron, Air Total, Q8 Aviation and Petrobras. In our secondary hubs we have the following fuel suppliers: Shell Aviation (Miami), Repsol YPF and Exxon Mobil Aviation (Lima and Buenos Aires) and Primax (Guayaquil).
Ground Facilities and Services
Our main operations are based at the Comodoro Arturo Merino Benítez International Airport in Santiago, Chile. We also operate from various other airports in Chile and abroad. We operate hangars, aircraft parking and other airport service facilities at the Comodoro Arturo Merino Benítez International Airport and other airports throughout Chile pursuant to concessions granted by the DGAC. We also maintain one customs warehouse at the Comodoro Arturo Merino Benítez International Airport, additional customs warehouses in Chile (Iquique, Antofagasta, and Punta Arenas) and Argentina (Aeroparque) and operate cargo warehouses at the Miami International Airport to service our cargo customers. Our facilities at Miami International Airport include corporate offices for our cargo and passenger operations and temperature-controlled and freezer space for imports and exports.
We have VIP lounges at the Comodoro Arturo Merino Benítez International Airport. The 7,500 square foot Neruda lounge, which represented an investment of approximately US$550,000 in 2001, has been widely acclaimed. In 2005, Latin Trade magazine selected it as the Best Airline Lounge in Latin America.
Finally, we incur certain airport usage fees and other charges for services performed by the various airports where we operate, such as air traffic control charges, take-off and landing fees, aircraft parking fees and fees payable in connection with the use of passenger waiting rooms and check-in counter space.
Ancillary Airline Activities
In addition to our airline operations, we generate revenues from a variety of other activities. In 2008, LAN generated other revenues of US$148.2 million.
Our total revenue from aircraft leases (including subleases to certain of our cargo affiliates, dry-leases, wet-leases and capacity sales to alliance partners) and charter flights amounted to US$41.5 million in 2008.
LAN also provides cargo-related services such as courier, warehousing, value-added door-to-door services and customs services, through various subsidiaries. Through our subsidiary Blue Express Intl. (formerly Lan Courier) (Blue Express) we operate vans and trucks and offer distribution and warehouse services throughout Chile. By using tracking and Internet technology, Blue Express customers have real-time access to data regarding the status of their parcels. During 2008, our logistics and courier businesses generated revenues of US$32.2 million. We also have storage and customs brokerage operations that generated revenues of US$25.4 million in 2008.
During 2008, we had revenues of US$8.3 million for ground services and US$15.9 million for duty-free in-flight sales. The balance of our operating revenues, US$25.0 million in 2008, was generated by sales to third parties by Amadeus Chile CRS (computer reservation system), aircraft maintenance services to third parties, our security services business, tour operations, and other activities. This represented a decrease with respect to 2007s revenues (which amounted to US$50.6 million) caused by the sale of our affiliates Amadeus Chile CRS (computer reservation system) and Empresa de Seguridad Aérea S.A. (Segaer), in May and August 2008, respectively. In addition, in 2008 we received US$5.9 million compensation from Airbus related to a change in the delivery schedule for certain Airbus A318 aircraft, compared to US$18.6 million received in 2007.
We carry hull insurance that includes, among other coverage, all risk, war and allied risks, spares and liability for passengers, cargo, mail, baggage and third-parties. We renew our insurance coverage yearly, and are subject to deductibles that vary depending on the coverage type and the loss type. Our deductibles are US$1,250 for loss or damage associated with passengers baggage liabilities, US$10,000 for loss or damage associated with cargo liabilities and between US$500,000 and US$1.0 million for hull all risk insurance (depending on the aircraft type).
Additionally, we have hull deductible coverage to reduce the net hull deductible to US$100,000 per occurrence (aircraft and/or engine).
Since December 2006, we have negotiated common terms for Hull All Risk, Aviation Legal Liabilities and Spares coverage, together with British Airways, which allows us to obtain premium reductions and coverage improvements.
Our insurance coverage has a one-year term starting in April of each year. The aggregate cost of our insurance coverage for the 2008 calendar year was US$ 14.5 million, which represents an 14.2% increase in insurance expenses and a 2.2% increase in average insurance rates compared to the 2007 calendar year.
We use information technology in almost every aspect of our business.
With the exception of our reservations, departure control (check-in), inventory, flight planning and baggage tracing systems, which are operated by Amadeus, Sabre, Iberia and SITA, we operate our internal systems from two data center facilities in Santiago, Chile. In 2006, we implemented a Disaster Recovery Plan between those two sites in order to ensure the functionality of our critical systems, with a recovery time objective of four days. The line of business infrastructure currently has a recovery time of, on average, two hours for 80% of our systems and, on average, two days for the remaining 20%.
Third-party suppliers provide us with the following technical infrastructure elements:
Basic Infrastructure Operation
Since early 2003, we have outsourced our IT infrastructure management to EDS. This service includes the administration and support of the data centers and desktop equipment. EDSs assistance has enabled us to:
We have used the latest technology available with regard to our global telecommunications network. Our network has the capacity to transport voice, data, and video with the quality required by the Company, combining traditional private data channels with virtual private networks through the Internet.
During 2002, we deployed new systems to support our sales personnel. These systems provide the employees who have a direct contact with our customers with additional tools to improve service, enhance customer information and increase efficiency. During 2004 and 2005, we implemented these systems at our airport counters and our call centers.
Since 2005, we have favored a strategy of encouraging and facilitating self service alternatives for customers, through improving the functionality of the www.lan.com website as well as implementing self check-in kiosks in airports.
Enterprise Resource Planning
In 2002, we purchased an enterprise resource planning (EREP) system from SAP. This system was fully implemented in the second quarter of 2004 for Lan Airlines and almost all of its subsidiaries. This EREP system includes modules covering areas such as: finance, accounting, inventory management, human resources, business warehouse, as well as a user-friendly portal. We are currently working in optimizing and simplifying this system, and in leveraging it to increase the efficiency of our back-office processes.
Development and Maintenance System
With respect to new development needs, our first choice is to acquire existing packaged software, but we outsource this service when such software is not available in the market. Since early 2007, we have outsourced our IT system development to three principal vendors: TATA Consultancy Services, Everis and Indra. Thanks to this outsourcing initiative, we have achieved:
We are implementing a new customized application and a new online system in order to provide the processes that our engineering, maintenance and materials (components) areas develop every day, with technological solutions. This project has allowed us to establish and automate simple and integrated processes, standardize processes for the Company (including our subsidiaries and related companies), facilitate handling of materials and maintenance, make relevant information available in a full, unique and consistent way to all users, and optimize distribution and execution (planned and non planned), among other benefits.
Chilean Aeronautical Regulation
Both the DGAC and the JAC oversee and regulate the Chilean aviation industry. The DGAC reports directly to the Chilean Air Force and is responsible for supervising compliance with Chilean laws and regulations relating to air navigation. The JAC is the Chilean civil aviation authority. Primarily on the basis of Decree Law No. 2,564, which regulates commercial aviation, the JAC regulates the assignment of international routes, and the compliance with certain insurance requirements, and the DGAC regulates flight operations, including personnel, aircraft and security standards, air traffic control and airport management. We have obtained and maintain the necessary authority from the Chilean government to conduct flight operations, including authorization certificates from the JAC and technical operative certificates from the DGAC, the continuation of which is subject to the ongoing compliance with applicable statutes, rules and regulations pertaining to the airline industry, including any rules and regulations that may be adopted in the future.
Chile is a contracting state, as well as a permanent member, of the ICAO, an agency of the United Nations established in 1947 to assist in the planning and development of international air transport. The ICAO establishes technical standards for the international aviation industry, which Chilean authorities have incorporated into Chilean laws and regulations. In the absence of an applicable Chilean regulation concerning safety or maintenance, the DGAC has incorporated by reference the majority of the ICAOs technical standards. We believe that we are in material compliance with all relevant technical standards.
Domestic Routes. Chilean airlines are not required to obtain permits in connection with carrying passengers or cargo on any domestic routes, but only to comply with the technical requirements established by the DGAC. Non-Chilean airlines are permitted to provide domestic air service between destinations in Chile, provided that the country in which the foreign airline is based grants a reciprocal right to Chilean airlines. There are no regulatory barriers that would prevent a foreign airline from creating a Chilean subsidiary and entering the Chilean domestic market using that subsidiary.
International Routes. As an airline providing services on international routes, Lan Airlines is also subject to a variety of bilateral civil air transport agreements that provide for the exchange of air traffic rights between Chile
and various other countries. There can be no assurance that existing bilateral agreements between Chile and foreign governments will continue, and a modification, suspension or revocation of one or more bilateral treaties could have a material adverse effect on our operations and financial results.
International route rights, as well as the corresponding landing rights, are derived from a variety of air transport agreements negotiated between Chile and foreign governments. Under such agreements, the government of one country grants the government of another country the right to designate one or more of its domestic airlines to operate scheduled services to certain destinations of the former and, in certain cases, to further connect to third-country destinations. In Chile, when additional route frequencies to and from foreign cities become available, any eligible airline may apply to obtain them. If there is more than one applicant for a route frequency the JAC awards it through a public auction for a period of five years. The JAC grants route frequencies subject to the condition that the recipient airline operate them on a permanent basis. If an airline fails to operate a route for a period of six months or more, the JAC may terminate its rights to that route. International route frequencies are freely transferable. In the past, we have generally paid only nominal amounts for international route frequencies obtained in uncontested auctions. In January 2008, Lan Airlines participated in a public auction for seven frequencies between Santiago and Lima, obtaining six of them for a period of eighteen months.
In March 2007, the Chilean and Peruvian governments entered into a bilateral agreement temporarily reducing the number of flights that Peru grants to Chilean airlines using fifth freedom rights, or the rights to carry passengers from Chile to Peru and from Peru to a third country, from fourteen weekly frequencies to eight weekly frequencies. As a result of this regulatory change. Lan Airlines reduced the number of flights that used these rights from Lima to the United States and replaced some of these flights with direct flights from Santiago to the United States. The bilateral agreement between Chile and Peru also provides for the restoration of three fifth freedom rights frequencies in 2008 (which have already been restored) and the three remaining additional frequencies in 2009.
In March 2007, the Venezuelan authorities revoked LAN Perus traffic rights for flights between Caracas and Bogota. The Venezuelan authorities have granted LAN Peru traffic rights to operate in the Lima-Caracas route.
Air Fare Pricing Policy. Chilean airlines are permitted to establish their own domestic and international fares without government regulation, as long as they do not abuse any dominant market position they may enjoy. For more information, see Antitrust Regulation below. Airlines may file complaints before the Antitrust Court with respect to monopolistic or other pricing practices by other airlines that violate Chiles antitrust laws. In 1997, the Antitrust Commission approved and imposed a specific self-regulatory fare plan for our domestic operations consistent with the Antitrust Commissions directive to maintain a competitive environment. According to this plan, we must file notice with the JAC of any increase or decrease in standard fares on routes deemed non-competitive by the JAC and any decrease in fares on competitive routes at least twenty days in advance. We must file notice with the JAC of any increase in fares on competitive routes at least ten days in advance. In addition, the Chilean authorities now require that we justify any modification that we make to our fares on non-competitive routes. We must also ensure that our average yields on a non-competitive route are not higher than those on competitive routes of similar distance. As of March 31, 2009, 64% of the domestic routes that we operate had been classified as non-competitive and were subject to the requirements described above.
Registration of Aircraft. Aircraft registration in Chile is governed by the Chilean Aeronautical Code (CAC). In order to register or continue to be registered in Chile, an aircraft must be wholly owned by either:
The Aeronautical Code expressly allows the DGAC to permit registration of aircraft belonging to non-Chilean individuals or entities with a permanent place of business in Chile. Aircraft owned by non-Chileans, but operated by Chileans or by an airline which is affiliated with a Chilean aviation entity, may also be registered in Chile. Registration of any aircraft can be cancelled if it is not in compliance with the requirements for registration and, in particular, if:
Safety. The DGAC requires that all aircraft operated by Chilean airlines be registered either with the DGAC or with an equivalent supervisory body in a country other than Chile, so long as that country is a member of the Warsaw Convention. All aircraft must have a valid certificate of airworthiness issued by either the DGAC or an equivalent non-Chilean supervisory entity. In addition, the DGAC will not issue maintenance permits to a Chilean airline until the DGAC has assessed the airlines maintenance capabilities. The DGAC renews maintenance permits annually, and has approved our maintenance operations. Only DGAC-certified maintenance facilities or facilities certified by an equivalent non-Chilean supervisory body in the country where the aircraft is registered may maintain and repair the aircraft operated by Chilean airlines. Aircraft maintenance personnel at such facilities must also be certified either by the DGAC or an equivalent non-Chilean supervisory body before assuming any aircraft maintenance positions.
Security. The DGAC establishes and supervises the implementation of security standards and regulations for the Chilean commercial aviation industry. Such standards and regulations are based on standards developed by international commercial aviation organizations. Each airline and airport in Chile must submit an aviation security handbook to the DGAC describing its security procedures for the day-to-day operations of commercial aviation and procedures for staff security training. Lan Airlines has submitted its aviation security handbook to the DGAC. Chilean airlines that operate international routes must also adopt security measures in accordance with the requirements of applicable bilateral international agreements.
Chilean Airport Policy. The DGAC supervises and manages airports in Chile, including the supervision of take-off and landing charges. The DGAC proposes airport charges, which are approved by the JAC and are the same at all airports. Since the mid-90s, a number of Chilean airports have been privatized, including the Comodoro Arturo Merino Benítez International Airport in Santiago. At the privatized airports, the airport administration manages the facilities under the supervision of the DGAC and JAC.
Environmental and Noise Regulation. There are no material environmental regulations or controls imposed upon airlines, applicable to aircraft, or that otherwise affect us in Chile, except for environmental laws and regulations of general applicability. There is no noise restriction regulation currently applicable to aircraft in Chile. However, Chilean authorities are planning to pass a noise-related regulation governing aircraft that fly to and within Chile. The proposed regulation will require all such aircraft to comply with certain noise restrictions, referred to in the market as Stage 3 standards. LANs fleet already complies with the proposed restrictions so we do not believe that enactment of the proposed standards would impose a material burden on us.
Regional Aeronautical Regulation (Brazil, Ecuador, Mexico, Colombia, Argentina and Peru)
Our subsidiaries and affiliates operate throughout the Latin American region under the routes granted by the relevant authorities in each jurisdiction where they are based.
International Routes. Under Brazilian, Ecuadorian, Mexican, Colombian, Argentinean and Peruvian laws, international route rights, as well as the corresponding landing rights, are granted under air transport agreements negotiated directly between the relevant home jurisdiction and foreign governments.
Domestic Routes. Under Chilean regulation, domestic airlines are not required to obtain permits in connection with carrying passengers or cargo on any domestic routes. Peruvian and Argentinean law requires the consent of Peruvian and Argentinean authorities to fly domestic routes. Cabotage operations are exclusive of national airlines. Ecuadorian law requires the airline to obtain a specific concession to fly domestically. In Brazil the Comissão de Coordenação de Linhas Aéreas Regulares reviews all requests by airlines to fly domestic routes based on economic and safety considerations.
U.S. Aeronautical Regulation
General. Flight operations between Chile and the United States by airlines licensed by either country are governed generally by the open skies air transport agreement that Chile and the United States signed in October 1997. Under the open skies agreement, there are no restrictions on the number of destinations or flights that either a U.S. or a Chilean airline may operate between the two countries or on the number of U.S. and Chilean airlines that may operate. Operations to the United States by non-U.S. airlines, such as Lan Airlines, are subject to Title 49 of the U.S. Code, under which the DOT and the FAA exercise regulatory authority. The U.S. DOJ also has jurisdiction over airline competition matters under the federal antitrust laws.
Authorizations and Licenses. The DOT has jurisdiction over international aviation with respect to the United States and related route authorities, subject to review by the President of the United States. The DOT also has
jurisdiction with respect to unfair practices and methods of competition by airlines and related consumer protection matters. Lan Airlines is authorized by the DOT to engage in scheduled and charter air transportation services, including the transportation of persons, property (cargo) and mail, or combinations thereof, between points in Chile and points in the United States and beyond (via intermediate points in other countries). We hold the necessary authorizations from the DOT in the form of a foreign air carrier permit, an exemption authorization and statements of authorization to conduct our current operations to and from the United States. Exemptions and statements of authorization are temporary in nature and are subject to renewal and therefore there can be no assurance that any particular exemption or statement of authorization will be renewed. Our foreign air carrier permit has no expiration date, while our exemption authorization (which includes the open skies traffic rights) is set to expire on April 10, 2010. Such exemption authorization is automatically extended until such time as the DOT issues the renewal order. We plan to request an amendment to our foreign air carrier permit to include the open skies rights, which would eliminate our need to renew the exemption authority in the future.
In the United States, we are subject to the FAAs regulation with respect to safety matters, including aircraft maintenance and operations, equipment, aircraft noise, ground facilities, dispatch, communications, personnel, training, weather observation and other matters affecting air safety. The FAA requires each foreign air carrier to obtain certain operations specifications that authorize it to operate to particular airports on approved international routes using specified equipment. Lan Airlines currently holds FAA operations specifications under Part 129 of the Federal Aviation Regulations. We believe that we are in compliance in all material respects with all requirements necessary to maintain in good standing our operations specifications issued by the FAA. The FAA can amend, suspend, revoke or terminate those specifications, or can suspend temporarily or revoke permanently our authority if we fail to comply with the regulations, and can assess civil penalties for such failure. A modification, suspension or revocation of any of our DOT authorizations or FAA operations specifications could have a material adverse effect on our business.
The FAA also conducts safety audits and has the power to impose fines and other sanctions for violations of airline safety regulations. We have not incurred any material fines related to operations.
Security. On November 19, 2001, the Congress of the United States passed, and the President signed into law, the Aviation and Transportation Security Act, also referred to as the Aviation Security Act. This law federalized substantially all aspects of civil aviation security and created the Transportation Security Administration, or TSA, which took over security responsibilities previously held by the FAA. The TSA is an agency of the U.S. Department of Homeland Security. The Aviation Security Act requires, among other things, the implementation of certain security measures by airlines and airports, such as the requirement that all passenger bags be screened for explosives. Funding for airline and airport security required under the Aviation Security Act is provided in part by a US$2.50 per segment passenger security fee, subject to a US$10 per roundtrip cap; however, airlines are responsible for costs in excess of this fee. Implementation of the requirements of the Aviation Security Act has resulted in increased costs for airlines and their passengers. Since the events of September 11, 2001, Congress has mandated and the TSA has implemented numerous security procedures and requirements that have imposed and will continue to impose burdens on airlines, passengers and shippers.
Noise Restrictions. Under the Airport Noise and Capacity Act of 1990 (ANCA), and related FAA regulations, aircraft that fly to the United States must comply with certain Stage 3 noise restrictions, which are currently the most stringent FAA noise requirements. All of our aircraft that fly to the United States meet the Stage 3 requirements.
Under the direction of the ICAO, governments are considering the creation of a new and more stringent noise standard than that contained in the ANCA. The ICAO adopted new noise standards in 2001 that established more stringent noise requirements for aircraft manufactured after January 1, 2006. In the U.S., legislation known as the Vision 100Century of Aviation Reauthorization Act, which was signed into law in December 2003, required the FAA to issue regulations implementing Stage 4 noise standards consistent with recommendations adopted by the ICAO. FAA regulations require all aircraft designed and certified after January 1, 2006 to comply with Stage 4 noise restrictions.
FAA regulations also require compliance with the Traffic Alert and Collision Avoidance System, approved airborne wind shear warning system and aging aircraft regulations. Our entire fleet meets these requirements.
Airport Slot Restrictions. Four U.S. airportsChicago OHare, LaGuardia (New York), John F. Kennedy International (New York) and Reagan National (Washington, D.C.)have been designated by the FAA as high
density traffic airports. Operations at these airports are or have been subject to slot restrictions during certain periods of the day. A slot is an authorization to take off or land at a designated airport within a specified time window. Legislation passed in March 2000 resulted in the elimination of slot restrictions at Chicago OHare on July 1, 2002 and at LaGuardia and Kennedy International on January 1, 2007. While the FAA has reinstated analogous operating slot restrictions at both Chicago OHare and LaGuardia airports, it has not imposed such restrictions at JFK airport, where we operate. We do not currently operate in airports in which we have to obtain slots or operating authorizations. Nevertheless, government policies regulating slots and the analogous operating authorizations are affected by matters such as flight delays, noise exposure and ground congestion, and any one or more of those factors could lead to the reinstatement of slot or analogous operating limitations at airports in which we operate.
Proposed Laws and Regulations. Additional U.S. laws and regulations have been proposed from time to time that could significantly increase the cost of airline operations by imposing additional requirements or restrictions on airline companies. Laws and regulations have been considered from time to time that would prohibit or restrict the ownership and transfer of airline routes or slots. There can be no assurance that laws and regulations currently enacted or enacted in the future will not adversely affect our ability to maintain our current level of operating results.
Regulatory Authorizations in Connection with Strategic Alliances
The alliance between Lan Airlines and American Airlines includes three major components: a frequent flyer agreement, a reciprocal code-share agreement and the coordination of pricing, scheduling and other functions. The last two of these items required the approval of regulatory authorities in both Chile and the United States. With respect to the code-share agreement, the open skies agreement between Chile and the United States expressly permits code-sharing operations by U.S. and Chilean airlines. With regard to the coordination of pricing and scheduling, Lan Airlines and American Airlines filed a joint application with the DOT in December 1997, requesting approval of their alliance agreement and immunity from the application of all U.S. antitrust laws pursuant to Title 49 of the U.S. Code. Lan Airlines and American Airlines received approval and antitrust immunity from the DOT in September 1999, and implemented the code-share agreement in October 1999. In accordance with the terms of the DOTs 1999 approval, Lan Airlines and American Airlines were required to resubmit their alliance agreement to the DOT for review within three years after the DOTs grant of approval. Lan Airlines and American Airlines resubmitted the agreement in September 2002 and did not receive any comments from the DOT.
Lan Peru was also granted antitrust immunity by the DOT on October 13, 2005 with respect to a reciprocal code-share agreement and the coordination of pricing, scheduling and other functions with Lan Airlines and American Airlines. In accordance with the terms of the DOTs 2005 approval, Lan Airlines, Lan Peru and American Airlines are required to resubmit their alliance agreement to the DOT for review within five years after the DOTs grant of approval.
The Chilean antitrust authority, which we refer to as the Antitrust Court (previously the Antitrust Commission), oversees antitrust matters, which are governed by Decree Law No. 211 of 1973, as amended, or the Antitrust Law. The Antitrust Law prohibits any entity from preventing, restricting or distorting competition in any market or any part of any market. The Antitrust Law also prohibits any business or businesses that have a dominant position in any market or a substantial part of any market from abusing that dominant position. An aggrieved person may sue for damages arising from a breach of Antitrust Law and/or file a complaint with the Antitrust Court requesting an order to enjoin the violation of the Antitrust Law. The Antitrust Court has the authority to impose a variety of sanctions for violations of the Antitrust Law, including termination of contracts contrary to the Antitrust Law, dissolution of a company and imposition of fines and daily penalties on businesses. Courts may award damages and other remedies (such as an injunction) in appropriate circumstances. Lan Airlines, Lan Express and Lan Cargo must comply with Chilean Antitrust Law that prohibits a carrier from abusing a dominant position in the market. As described above under Route RightsAir Fare Pricing Policy, in October 1997, the Antitrust Court approved a specific self-regulatory fare plan for us consistent with the Antitrust Courts directive to maintain a competitive environment within the domestic market and, in 2001, imposed a new obligation on us to justify any modification that we make to our fares.
At the request of the Antitrust Court, an investigating attorney was appointed to review our self-regulatory fare plan that has been in effect since 1997. The resulting report delivered to us in 2003 by the attorney was generally favorable as to our fulfillment of our obligations under the self-regulatory fare plan, and did not find any anticompetitive behavior. While the attorney recommended that we separate our domestic cargo and domestic passenger businesses, this recommendation is neither binding on the Antitrust Court nor on us.
On January 30, 2004, the Antitrust Court imposed a fine of 500 Unidades Tributarias Mensuales (equal to approximately US$30,000) on each of Lan Airlines and Lan Express for minor breaches of the self-regulatory fare plan to which they are subject. The Company had argued that such breaches were mainly caused by the impossibility of maintaining the fare plan. Other entities also submitted amendment proposals. The Antitrust Courts pronouncement on amendments to the self-regulatory fare plan took place on July 14, 2005 and is now in force and effect. We believe we are in material compliance with the new self-regulatory provisions.
For more recent information regarding regulatory proceedings see Other Financial InformationLegal and Arbitration Proceedings under Item 8.
Our main facilities are located on approximately five acres of land near the Comodoro Arturo Merino Benítez International Airport. The complex includes approximately 150,695 square feet of office space, 32,292 square feet of conference space and training facilities, 9,688 square feet of dining facilities and mock-up cabins used for crew instruction. In 2004, we adapted part of this building to meet our expanding training needs. This process included developing new rooms for technical instruction, in-flight and airport services.
During the fourth quarter of 2003, we moved some of our executive offices into a new building in a more central location in Santiago, Chile, where we initially occupied a total of four floors. In the first half of 2005 we added three more floors to accommodate our growth requirements. In 2007, in order to accommodate the Companys growth, LAN leased two floors in an adjacent building (totaling 1,700 square meters), where some of LAN staff moved in February 2008.
Our 877,258-square feet maintenance base is located on a site that we own inside the grounds of the Comodoro Arturo Merino Benítez International Airport. This facility contains our aircraft hangar, warehouses, workshops and offices, as well as a 559,720 square feet aircraft parking area capable of accommodating up to seventeen short-haul aircraft. We have a five-floor, 53,820 square feet office building plus a 10,000 square feet office and workshop space. This facility is certified by several civil aviation authorities, including the United States FAA. As such, we are permitted to perform maintenance work for third parties at the facility. The FAA periodically inspects the facility to ensure its compliance with FAA standards. In 2005, we finalized the construction of an additional hangar, as well as 75,000 square feet of aircraft parking space, for US$2.1 million. During 2006 we started a new investment plan at this facility that includes building 64,580 square feet of additional aircraft parking space, a new 15,340 square foot building for offices and maintenance shops, a new 16,680 square feet engine shop and storage facility, and additional warehousing and external work space. The plan also included the upgrade of some of the current facilities, increasing parking space and building a new access road. Further, in 2006 we completed construction of an engine workshop with eight work stations and capacity for thirty-six engines, for a total investment of US$820,000. We also lease from the DGAC 193,750 square feet of space inside the Comodoro Arturo Merino Benítez International Airport for operational and service purposes.
In 2007, LAN approved a two-year capital expenditures plan earmarking approximately US$7 million for preparing our buildings and plants for the future growth of the Company and of its fleet.
During 2008 we finalized the construction of a 4,300 square feet warehouse especially designed for the storage of oil and flammable supplies which complies with all the security standards required for its operation. We also upgraded some facilities such as bathrooms and dressing rooms in our maintenance base increasing the total area in 15,000 square feet.
Additionally, as of today, we are constructing a new five-story building in our maintenance base which will have a total surface of 49,500 square feet and is expected to be finalized by the end of 2009. This building will have space available for several workshops, a new food court and new offices. Also, as of today, we have begun a new extension of our engine workshop which will allow us to have more space to store and work on the new engines for the B-777 fleet.
We occupy a 36.3-acre site at the Miami International Airport that has been leased to us by the airport under a concession agreement. Our facilities include a 48,000 square foot corporate building, a 380,000 square foot cargo warehouse and a 783,000 square foot aircraft parking platform, which were constructed and are now leased to us under a long-term contract by a North American developer. We began using these new facilities in September 2001 for our passenger and cargo offices (with the exception of our reservations and ticket offices). We converted 21,528 square feet of the warehouse into fully furbished offices during 2004.
We own a building and sixteen acres of land on the west side of the Comodoro Arturo Merino Benítez International Airport that houses a flight-training center. As of March 2007, this facility features three full-flight simulators for Boeing 767, Airbus A320 and Boeing 737 aircraft. We rent this flight-training center under a long-term lease to CAE Inc. (a leading Canadian company in the flight training business).
We own a 661,980-square foot warehouse in Santiago, which includes 91,493 square feet of space for offices and other administrative facilities and 45,000 square foot distribution center. We use this facility to support Blue Express door-to-door cargo transport business.
In 2004, Fast Air Almacenes de Carga S.A. (Fast Air), one of our subsidiaries which operates import customs warehouses, began utilizing an import warehouse and office building at the Comodoro Arturo Merino Benítez International Airport. This 172,000 square foot building was developed in conjunction with two other operators.
We have also developed a recreational facility for our employees with Airbus support. The facility, denominated Parque LAN, is located near the Comodoro Arturo Merino Benítez International Airport. Parque LAN includes amenities such as a gymnasium, synthetic fields for multiple uses and swimming pools.
During 2008, we acquired a 43,000 square feet piece of land in Chile, which represented a US$12 million investment, for the purpose of constructing our new corporate building.
During 2008, we acquired a 161,000 square feet piece of land near the Lima airport, which will host new facilities for the company.
In March 2009, we began the construction of a new maintenance base in Argentina. The project includes a new hangar of 26,900 square feet with 9,600 square feet of offices, 1,070 square feet of workshops and an exterior platform of 5,300 square feet. This will comprise a US$3.2 million investment and is expected to be completed by the end of 2009.
You should read the following discussion of our financial condition and results of operations together with our audited consolidated financial statements and the accompanying notes beginning on page F-5 of this annual report.
Our financial statements have been prepared in accordance with Chilean GAAP, which differs in certain respects from U.S. GAAP. A discussion of the principal differences between Chilean GAAP and U.S. GAAP as they relate to us is described in Note 27 to our audited consolidated financial statements.
The principal and most distinctive aspect of our business model is the way in which we integrate our passenger and cargo activities. Our sophisticated service-oriented approach to combining passenger and cargo traffic enables us to better utilize our aircraft, reduce our break-even load factors on passenger flights, and diversify our revenue streams. These benefits have helped us maintain strong profitability and expand our operations during the period between 2006 and 2008.
97% of our revenues are generated by our air transport activities. We generate the balance of our operating revenues from airport ground services, customs and storage brokerage operations, aircraft leases, courier services, on-board sales, tour operator services, third-party maintenance, ground handling, storage, charter operations, credit card co-branding, CRS services and airline-related security services.
Between 2006 and 2008 our operating environment continued to be subject to certain conditions that had a mixed effect on our results. Specifically, we faced:
Passenger demand grew consistently during this period, fueled by positive economic conditions in our main markets. Cargo demand also experienced strong growth, especially on southbound routes, driven by positive economic conditions in Latin America and the strengthening of local currencies, although it continued to experience significant imbalances between northbound and southbound routes. While competition on both passenger and cargo routes has grown gradually since 2005, changes in competitive conditions in specific markets generated opportunities for us to expand. Certain factors outside of our control, such as fuel prices that have risen consistently since 2002, reaching historically record-high levels in mid-2008, have also generated significant cost pressures.
Our results for the period between 2006 and 2008 reflect our efforts in recent years to expand and diversify our revenue base while maintaining an efficient cost base. We have aimed to effectively respond to the opportunities and challenges presented by the expansion and diversification of our revenue base. This process included expanding our domestic passenger operations in Peru and supporting the launch of Lan Argentina. As a consequence, we have significantly increased our passenger capacity and redeployed our assets in response to specific opportunities. In the cargo business, we have adjusted our routes and our capacity mix to adapt to changing cargo flows. We have also launched initiatives to enhance customer preference and increase efficiency. These initiatives have enabled us to maintain a solid market position and to develop new mechanisms to sustain high levels of profitability despite facing unprecedented high fuel prices during 2008. As a consequence, net income amounted to US$241.3 million in 2006, US$308.3 million in 2007 and US$335.7 million in 2008.
In general, our passenger revenues are driven by international and country-specific political and economic conditions, competitive activity, the attractiveness of the destinations that we serve, and the capacity we allocate among our different routes.
Passenger demand has grown in the last years, driven by positive economic conditions in Latin America. Economic growth and improved customer confidence have led to an expansion in both business and leisure traffic to and from Latin America. Increased interest in travel into South America from Europe and the United States has been another factor positively impacting overall passenger traffic. As a consequence, passenger volumes in markets such as Chile, Peru, Argentina and Ecuador grew significantly between 2006 and 2008. LANs especially strong traffic
growth during 2008, which reached 12.3%, was also based on a historical capacity expansion plan driven by the delivery of nineteen new passenger aircraft during the year and new configurations with more seats per aircraft. Despite the global macroeconomic slowdown and the outbreak of H1N1 flu, during the first quarter of 2009 our passenger traffic registered an 8.9% increase with respect to the first quarter of 2008.
Competitive activity on both our domestic and international passenger routes has also varied over the last several years. On our international routes, competition gradually increased as both incumbent and new competitors expanded their operations. Nevertheless, we have maintained our market share in most of our international markets since 2005 and have gradually increased our presence in the domestic markets of Chile and Peru, as well as in the Argentine domestic and international routes, in addition to initiating domestic operations in Ecuador in April 2009.
Overall, market conditions on the passenger business provided us with opportunities to advance on our strategic development plans and expand our operations. We addressed these by taking advantage of our integrated business model, efficient operations, continued customer focus, and flexible capacity management. Customer focus has provided a key tool to address competitive challenges as well as to successfully enter new markets.
We also took advantage of our flexibility to adapt capacity quickly in response to demand shocks or market opportunities. We actively manage our capacity by transferring capacity between routes or adding new aircraft when necessary. This enabled us to rapidly respond by adding capacity in the Peruvian domestic market during 2004 and supporting the launch of Lan Argentinas domestic operations in 2005, as well as launching the latters international operations in October 2006, and launching domestic operations in Ecuador in April 2009.
These opportunistic actions fit in with our long-term development strategy which is aimed at consolidating LAN as the preferred carrier in the Southern Cone. This plan incorporates development of domestic, regional and intercontinental routes in the markets we serve. Continuous monitoring of demand trends and competitive activity has allowed us to identify opportunities and, as a consequence, additional capacity has also been allocated to operations to the South Pacific, Europe and the United States, as well to specific regional routes. We also shifted capacity among our routes in order to better match seasonal patterns in flights to the United States and to other destinations. Further refinements to our itineraries were also implemented in order to improve connectivity between our operations and those of our partners.
We have also enhanced our regional network by selectively adding new destinations and launching new routes. Since 2004, we have been developing an intra-regional hub in Lima. We have launched several routes that enable us to effectively use Lima as a connecting point for passengers traveling between Mexico City, Bogota, Caracas, Guayaquil, Quito, Buenos Aires, La Paz, Santa Cruz, Sao Paulo and Santiago de Chile. In 2007 we began direct service between Lima and Madrid, in 2008 we began service to Medellin, Colombia (with one stop in Quito), and in 2009 we began direct service to Cartagena de Indias, Colombia. We plan to continue growing our operation in Lima by increasing the number of flight frequencies we operate on these routes and also by adding new destinations.
Our domestic operations have also grown between 2006 and 2008. In both the Chilean and Peruvian domestic markets, total domestic traffic increased significantly during 2008, driven mainly by new fare structures in line with the implementation of our new model for short haul operations. Between 2005 and 2009, Lan Argentina increased the number of Argentine domestic destinations to thirteen and, based on our internal estimates, our market share increased to approximately 30%. By the end of 2008, Ecuadors NCAC granted the airline permission to operate domestic flights within the country. These operations started in April 2009 with flights between the cities of Quito and Guayaquil and currently offering forty-nine weekly flights.
Our cargo business depends on exports from and imports to South America and is, therefore, affected by economic conditions, foreign exchange rates, changes in international trade, the health of particular industries, competition and fuel prices (which we usually pass on to our customers through a cargo fuel surcharge). The relative size of inbound and outbound flows to a particular market or route is a key element in cargo operations as the unidirectional nature of freight flows requires airlines to create routes that combine origin-destination pairs that feature complementary freight flows. Changes in macroeconomic conditions may lead to major fluctuations in cargo flows to and from Latin America, therefore requiring continuous route and capacity adjustments.
During the period between 2006 and 2008, the appreciation of local currencies such as the Brazilian real and the Chilean peso had a significant impact on cargo flows as imports into South America exceeded exports.
While high oil prices generated upward pressure in yields in both directions, excess demand on southbound routes caused southbound fares to rise more in relative terms. Competition has varied between 2006 and 2008, although high oil prices limited the industrys capacity growth since high levels of efficiency were required to maintain profitability. Towards the end of 2008 and the first quarter of 2009, our cargo business began experiencing the impact of the global macroeconomic slowdown, registering significant declines in traffic (20.1% with respect to the first quarter of 2008) that were in line with the downward trend in global air cargo traffic.
We responded to these changing conditions in several ways. We closely monitored demand and redesigned our freighter itineraries accordingly. The flexibility of our freighter operations enabled us to accommodate lower demand and avoid unprofitable routes by combining service to several destinations in the same trip. For instance, we increased the number of trips we performed to and from the Atlantic coast of South America in 2003 and 2004 as exports boomed, but as they decelerated we swiftly added stopovers in export-heavy markets in the Pacific to the northbound trips. We adjusted our capacity through the return of wet-leased freighter aircraft in order to avoid idle capacity during periods of low demand. In recent years we have also been replacing the wet-leased freighter aircraft with our own modern Boeing 767 Freighters and, since 2009, also with our new Boeing 777 Freighters. Our expanded route network led to increased diversification and helped us, by allowing us to shift capacity across routes, to partially compensate for reductions in traffic to specific markets. Our cost-effective operations and operating network also gave us a competitive advantage that allowed us to increase market share in certain markets as other competitors reduced the scale of their operations. Overall, these adjustments enabled us to successfully deal with a complicated environment and ultimately led to an improved market position.
Cost controls were critical to maintaining our profitability over the period from 2006 to 2008, especially as we faced record-high fuel prices during 2008. In absolute terms, the main drivers of our costs are the size of our operations, fuel prices, fleet costs and exchange rates.
As an airline, we are subject to fluctuations in costs that are outside our control, particularly fuel prices and exchange rates. However, we manage part of our exposure to changes in fuel prices through a fuel-hedging policy and the use of pass-through mechanisms on both the passenger and cargo businesses. For more information see Quantitative and Qualitative Disclosures About Market RiskRisk of Fluctuations in Jet Fuel Prices under Item 11. Personnel expenses are another significant component of our overall costs. Because a significant portion of our labor costs is denominated in pesos, appreciation of the peso against the dollar as well as increases in local inflation rates can result in increased costs in dollar terms and can negatively affect our results. However, this cost pressure is mitigated by the partial natural hedge between the currencies of denomination of our total operating revenues and expenses.
Commissions to travel and cargo agents also compose a significant cost to us. We compete with other airlines over the amount of commission we pay per sale, particularly in connection with special programs and marketing efforts, and to maintain competitive incentives with travel agents. In February 2007 we reduced commissions paid to agents in Chile for economy class ticket sales from 6% to 1%. Between 2007 and 2008, commissions were also reduced to 1% in Ecuador, Argentina and Peru.
Fleet related expenses, basically aircraft rentals and depreciation, are another significant cost. These costs are mainly fixed and can be reduced on a per unit basis by achieving higher daily aircraft utilization rates.
Fuel prices rose consistently between 2006 and 2008 generating significant cost pressure. During 2008, fuel prices rose to record-high levels, which led to US$404.5 million in additional expenses and contributed to a 20.0% rise in cost per ATK (a key industry metric). Excluding fuel costs, the rise in cost per ATK over this period was 10.5%. Please refer to GAAP/Non-GAAP Reconciliation for further details regarding cost per ATK.
Apart from fuel costs, the main causes for the increase in cost per ATK were personnel growth, traffic and revenue growth outpacing capacity growth and a stronger Chilean peso. Wages and benefits and training costs increased in excess of capacity growth because the expansion of our operations required the anticipated incorporation and training of new personnel and because the Chilean peso has appreciated since 2006. Revenue and traffic growth similarly impacted commissions, distribution costs and passenger services.
Despite these challenges, our cost structure remained highly competitive due to careful cost management and more efficient asset utilization. For example, we were able to partially offset these cost increases by implementing important reductions in passenger commissions and increasing our aircraft utilization rates.
Higher aircraft utilization has been an important source of improved efficiency. Our long-haul passenger and cargo aircraft are used, on average, approximately fourteen hours per day. Our utilization strategy in 2008 was designed in concert with the addition of new routes to our network, which enabled us to leverage our human and physical assets for increased efficiency. This was especially the case in our domestic operations in Chile and Peru, where we increased aircraft utilization as a result of the itineraries of our new short haul business model, as well as due to the phasing out of the older Boeing 737-200 aircraft on Chilean domestic routes. Utilization of our narrow body fleet of Airbus A320-Family Aircraft has increased to approximately ten block hours per day per aircraft.
We have also worked consistently to improve our cost structure. This process has included initiatives such as the modification of short-haul service standards, which were implemented in late 2005 and modified further in 2007 as a result of the new business model on domestic routes, enabling us to reduce passenger service expenses. The key elements of this new business model have been the reduction in sales and distribution costs through higher Internet penetration and reduced agency commissions, a faster turnaround time, and increased self check-in service through web check-in and kiosks at airports.
Our long-term strategy is aimed at consolidating LANs position as the main passenger and cargo airline in South America. We will continue to expand our network by further developing our existing routes, adding new destinations, developing new alliances, and entering new markets. We expect our brand recognition and a continuous effort to improve service standards to drive increased customer preference, ultimately leading to strong market shares in the markets we serve. Our product and service design is aimed at providing passengers and cargo customers with differentiated offerings that provide valuable solutions to the needs of each of our customer types. We also aim to have products and services that evolve together with changes in technology, market conditions and competitive actions. We plan to maintain a highly competitive cost structure by leveraging our cost-conscious culture, incorporating new technologies and practices, and by identifying and implementing adequate cost-reduction initiatives. We believe that a focus on flexibility will enable us to adequately react to changing market conditions. Finally, a healthy financial structure will allow us to effectively fund our growth, enhance our strategic development and reinforce our customer appeal.
Our results will be mainly determined by the expansion of our current network, the evolution of our market share in our main markets, our level of success in entering new markets, the continued implementation of new efficiency-related programs, the implementation of our new business model for short-haul operations, and fuel price levels.
Our financial performance will also be highly dependent on the evolution of jet fuel prices, which rose significantly until mid-2008 and led to a sharp rise in our fuel expenditures, but have substantially declined as from August 2008. Although we have devised and implemented a number of strategies to mitigate the impact of the volatility of fuel prices, including financial hedging and the use of fuel surcharges, it is impossible for us to predict if we will be able to fully protect ourselves against the volatility of fuel costs.
Overall, we believe that these initiatives will enable us to successfully respond to growth opportunities, maintain a solid competitive position, and enhance our distinct cost performance.
The following table sets forth certain income statement data for Lan Airlines.
2008 Compared with 2007
Our net income increased 8.9% from US$308.3 million in 2007 to US$335.7 million in 2008. This increase is mainly due to a 29.7% increase in operating income as compared to 2007, partially offset by a 195.1% increase in non-operating expenses.
Operating income increased to US$536.2 million in 2008 from US$413.3 million in 2007 as a 28.6% increase in operating revenues outpaced a 28.5% growth in operating expenses. Revenue growth reflected strong capacity expansion and an improvement in demand in the passenger business, growth in import routes into South America in the cargo business, moderate competitive activity and a strong market position, the entrance into new markets, and the expansion of our routes network. Operating costs grew mainly due to high fuel prices, capacity growth, sales growth and the appreciation of local currencies.
In 2008 we recorded a US$134.6 million non-operating expense compared to a US$45.6 million non-operating expense in 2007. This change reflected higher interest expenses due to increased debt associated with our fleet expansion plan, partially offset by the recognition of interest related to the financing of pre-delivery payments (PDP), as a consequence of a change in the accounting policy regarding these PDPs (see Note 27(p) to the audited consolidated financial statements of the Company). In addition, other non operating income declined 640.0% as a result of a provision of US$109 million in relation to a plea agreement signed with the DOJ regarding the cargo
business investigation (see Item 4. Information on the Company Business of the Company Cargo Operations Cargo Related Investigations), partially offset by a US$35.4 million gain in fuel hedging and a gain of US$14.0 million derived from the recognition of interest related to the financing of PDPs for years prior to 2008, as a consequence of a change in the accounting policy regarding these PDPs.
Finally, income tax expense increased by 8.2% to US$64.7 million in 2008, mainly as a result of higher pre-tax income, as the effective tax rate remained at approximately 16.2%.
Revenues in 2008 totaled US$4,534.3 million, a 28.6% increase over revenues of US$3,524.9 million in 2007. Our consolidated passenger revenues grew 30.1% to US$2,858.9 million in 2008 from US$2,197.2 million in 2007, due to a 12.3% increase in passenger traffic, together with a 15.9% increase in yields (from US¢9.2 to US¢10.6). Passenger traffic (as measured in RPKs) increased primarily because of higher demand at key points of sales, expansion on long-haul and regional routes, expansion in the Argentine domestic market and growth in the Peruvian and Chilean domestic market driven by the implementation of LANs new domestic business model. Passenger yields increased 15.9% mainly due to better revenue management, nominal fare increases, higher fuel surcharges from higher West Texas Intermediate (WTI) market prices and the impact of the appreciation of the Chilean peso on domestic fares.
Domestic passenger revenues in Chile, Peru and Argentina, which accounted for 32.0% of our total passenger revenues in 2008 and 29.0% in 2007, increased 43.8% to US$915.1 million in 2008 from US$636.5 million in 2007. Domestic passenger traffic (as measured in RPKs) increased 30.5%, while domestic passenger capacity (as measured in ASKs) increased 28.1%, resulting in an increase in load factor from 74.6% in 2007 to 76.0% in 2008. Domestic passenger yield increased 10.2% from US¢11.16 in 2007 to US¢12.29 in 2008, mainly due to higher fuel surcharges driven by higher fuel prices.
International passenger revenues, which accounted for 67.1% of total passenger revenues in 2008 and for 70.7% of passenger revenues in 2007, increased 21.8% to US$1,870.0 million in 2008 from US$1,535.6 million in 2007. International passenger traffic (as measured in RPKs) increased 6.6%, while passenger capacity (as measured in ASKs) increased 6.1% in 2008, resulting in an improvement in load factor from 76.5% in 2007 to 76.9% in 2008. Total international passenger yield (based on RPKs) increased 16.8% to US¢9.96 in 2008 from US¢8.53 in 2007, driven by higher fuel surcharges and nominal fare increases.
Cargo revenues grew 32.3%, to US$1,527.1 million in 2008 from US$1,154.3 million in 2007, as traffic increased 7.6% and yields increased 23.0% to US¢52.5 from US¢42.7. International cargo revenues accounted for nearly 98% of total cargo revenues. Cargo traffic increased mainly due to the growth of imports into Latin America. Cargo yields increased mainly due to the continued implementation of certain revenue management strategies on southbound routes and higher fuel surcharges. Capacity during the period increased 12.3% as load factors decreased from 74.4% to 71.2%, due to the fact that volume growth in some northbound export markets was negatively affected by stronger local currencies and higher fuel prices.
Other revenues decreased 14.5% to US$148.2 million in 2008 from US$173.4 million in 2007, as increased revenues from aircraft rentals and courier services were more than offset by lower onboard sales, lower revenues from maintenance service rendered to third-parties and lower revenue from tours and travel services. In addition, the 2007 other revenues item included a non-recurrent US$18.6 million compensation from Airbus related to a change in the delivery schedule of certain A318 aircraft, while in 2008, this compensation decreased to US$5.9 million.
Expenses in 2008 totaled US$3,998.1 million, a 28.5% increase over expenses of US$3,111.6 million in 2007. System capacity, measured in system ATKs, increased 9.0% between 2007 and 2008. Excluding the impact of higher fuel prices, which resulted in US$404.5 million of additional expenses compared to 2007, operating costs increased 9.6%. Unit costs (measured as operating costs and interest expenses minus other revenues, per ATK) increased 20.0% in 2008. Excluding fuel, unit costs increased 10.5% in 2008. As a percentage of total revenues, consolidated expenses decreased from 88.3% in 2007 to 88.2% in 2008.
Wages and benefits expenses grew 24.3% to US$608.5 million in 2008 from US$489.6 million in 2007, mainly driven by the impact of inflation on local currency-denominated wages and by the increase of headcount, in-line with the expansion of the Companys operations.
Aircraft fuel expenses in 2008 totaled US$1,423.9 million, a 53.1% increase over aircraft fuel expenses of US$930.2 million in 2007. Fuel expenses rose due to a 39.7% increase in average fuel prices and a 9.6% increase in fuel consumption. To reflect our operational results more clearly, the gains and losses incurred due to fuel hedging activities are classified as a non-operating item.
Commissions to agents (related to both passenger and cargo sales) increased 19.7% to US$481.9 million in 2008 from US$402.6 million in 2007, due to a 30.9% increase in traffic revenues (passenger and cargo), which was offset by a 1.0% reduction in average commissions. This reduction was mainly related to a change in the commission structure in the cargo business, and lower commissions in the passenger business in Chile.
Depreciation and amortization expenses increased 19.0% to US$183.2 million in 2008 from US$153.9 million in 2007. Depreciation and amortization increased mainly due to the incorporation of 5 new Boeing 767 aircraft, 2 Airbus A320, 2 Airbus A319 and 10 Airbus A318 aircraft to LANs fleet during 2008. For further information on depreciation policies, refer to Critical Accounting Policies below, and Note 2 to our audited consolidated financial statements.
Other rental and landing fees increased 23.0% to US$450.6 million in 2008 from US$366.4 million in 2007. This increase resulted mainly from the impact of increased operations on landing fees and handling expenses, as well as an increase in the use of variable aircraft rentals (or ACMI leases) in the cargo business.
Passenger service expenses totaled US$85.2 million in 2008 and US$71.8 million in 2007. This represented an 18.6% increase driven mainly by the 19.4% increase in the number of passengers transported during the period, in addition to higher costs associated with passenger compensations.
Aircraft rental expenses decreased 5.0% to US$150.9 million in 2008 from US$158.9 million in 2007 as higher average lease rates were offset by a decrease in the average number of leased aircraft.
Aircraft maintenance expenses decreased 2.2%, from US$159.1 million in 2007 to US$155.6 million in 2008, as additional costs resulting from increased fleet utilization and the escalation in maintenance contracts were compensated by lower maintenance provisions resulting from the phase out of the Boeing 737-200 fleet.
Other operating expenses increased 20.9% to US$458.3 million in 2008 from US$379.1 million in 2007. Other operating expenses include sales-related expenses, training, communication, distribution and data processing costs, and banking and non-collectable account expenses. Other operating expenses increased in 2008 due to increased operations driven mainly by higher sales and distribution costs and higher marketing and advertising expenses.
Operating income increased 29.7% to US$536.2 million in 2008 from US$413.4 million in 2007. Operating margins increased from 11.7% in 2007 to 11.8% in 2008 as a 28.6% increase in total operating revenues outpaced a 28.5% increase in operating expenses. For the full year, revenues per ATK (passengers and cargo) grew 20.1% (from US¢47.7 to US¢57.3), as costs per ATK increased 20.0% (from US¢42.7 to US¢51.2).
Other Income (Expense)
Other expenses increased from US$45.6 million in 2007 to US$134.6 million in 2008. Interest income decreased 10.1% to US$16.2 million from US$18.0 million due to lower average cash balances and lower market interest rates as compared to 2007. Interest expenses increased 8.5% to US$82.7 million in 2008 from US$76.2 million in 2007 due to increased average long-term debt related to fleet financing, offset by the recognition of interest related with the financing of PDPs during 2008 (see Note 27(p) to the audited consolidated financial statements of the Company). Other expense/income-net decreased 640.0% to a net expense of US$68.1 million in 2008 from a net income of US$12.6 million in 2007. This was mainly due to the fact that in 2008 this item included a US$109 million provision in relation to a plea agreement signed with the DOJ regarding the cargo business investigation (see Item 4. Information on the Company Business of the Company Cargo Operations Cargo-Related Investigations). In addition, this included a US$7.9 million foreign-exchange loss in 2008 compared to a US$15.7 million gain in 2007. This was partially offset by the fact that LAN recorded a fuel hedging gain of US$35.4 million in 2008 compared to a US$28.2 million gain in 2007, as well as a US$ 14.0 million gain corresponding to the recognition of interest related with the financing of PDPs for years prior to 2008.
Income tax expense increased 8.2%, amounting to US$64.7 million in 2008 as compared to US$59.8 million in 2007. This was mainly the result of an 8.8% increase in pre-tax income, as the average tax rate remained at 16.2% in 2008. For more information, see Critical Accounting PoliciesDeferred Income Taxes below and Note 14 to our audited consolidated financial statements.
2007 Compared with 2006
Our net income increased 27.8% from US$241.3 million in 2006 to US$308.3 million in 2007. This increase is mainly due to a 36.6% increase in operating income as compared to 2006, offset by a 189.7% increase in non-operating expenses.
Operating income increased to US$413.3 million in 2007 from US$302.6 million in 2006 as a 16.2% increase in operating revenues outpaced a 13.9% growth in operating expenses. Revenue growth reflected strong capacity expansion and an improvement in demand in the passenger business, growth in import routes into South America in the cargo business, moderate competitive activity and a strong market position, the entrance into new markets, and the expansion of our route network. Operating costs grew mainly due to capacity growth, sales growth, the appreciation of local currencies and high fuel prices.
In 2007 we recorded a US$45.6 million non-operating expense compared to a US$15.7 million non-operating expense in 2006. This change reflected higher interest expenses due to increased debt associated with our fleet expansion plan, offset in part by higher interest income as a result of higher cash balances resulting from our equity offering completed in June 2007. In addition, Other Non Operating Income declined 66.0% as a result of a non-recurrent pre-tax benefit of US$40.3 million recorded in 2006 due to the change in the accounting policy governing LANs aircraft maintenance expenses.
In the fourth quarter of 2007, LAN recorded a US$25.0 million reserve in Other Non-Operating Expenses in relation with a European investigation of cargo price-fixing. In February 2006 the European Commission, in conjunction with the DOJ, initiated a global investigation of a large number of international cargo airlines among them LAN Cargo S.A., LANs cargo subsidiary for possible price fixing of cargo fuel surcharges and other fees in the European and United States air cargo markets. On December 26, 2007, the European competition authorities notified LAN Cargo S.A. and LAN of the initiation of proceedings against twenty-five cargo airlines, among them LAN Cargo S.A., for allegations of anti-competitive behavior in the air freight business. Given the current stage of the European proceedings, it is not possible at this time to anticipate with any precision their outcome, although it is expected to be a lengthy judicial process. For an update on the status of the European proceedings and the DOJs investigations, please see section 2008 Compared with 2007 above and Item 4. Information on the Company Business of the Company Cargo Operations Cargo-Related Investigations.
Finally, income tax expense increased by 27.6% to US$59.8 million in 2007, mainly as a result of higher pre-tax income, as the effective tax rate remained at approximately 16.2%.
Revenues in 2007 totaled US$3,524.9 million, a 16.2% increase over revenues of US$3,034.0 million in 2006. Our consolidated passenger revenues grew 21.2% to US$2,197.2 million in 2007 from US$1,813.4 million in 2006, due to a 23.1% increase in passenger traffic, partly offset by a 1.6% decline in yields (from US¢9.3 to US¢9.2). Passenger traffic (as measured in RPKs) increased primarily because of higher demand at key points of sales, expansion on long-haul and regional routes, expansion in the Argentine domestic market and growth in the Peruvian and Chilean domestic market driven by the implementation of LANs new domestic business model. Passenger yields decreased 1.6% due to fare decreases on regional and domestic routes related to the new business model for short-haul operations, partly offset by nominal fare increases, improved passenger revenue management and fuel-related fare increases in the fourth quarter of 2007.
Domestic passenger revenues in Chile, Peru and Argentina, which accounted for 29.0% of our total passenger revenues in 2007 and 29.8% in 2006, increased 17.7% to US$636.3 million in 2007 from US$540.9 million in 2006. Domestic passenger traffic (as measured in RPKs) increased 28.5%, while passenger capacity (as measured in ASKs) increased 14.8%, resulting in an increase in load factor from 66.6% in 2006 to 74.6% in 2007. Domestic passenger yield declined 8.40% from US¢12.19 in 2006 to US¢11.16 in 2007, driven mainly by the implementation of LANs new business model in the domestic market.
International passenger revenues, which accounted for 69.8% of total passenger revenues in 2007 and for 68.8% of passenger revenues in 2006, increased 22.9% to US$1,533.4 million in 2007 from US$1,247.7 million in 2006. International passenger traffic (as measured in RPKs) increased 21.5%, while passenger capacity (as measured in ASKs) increased 21.1% in 2007, resulting in an improvement in load factor from 76.3% in 2006 to 76.5% in 2007. Total international passenger yield (based on RPKs) increased 0.9% to US¢8.53 in 2007 from US¢8.45 in 2006, driven by nominal fare increases, improved passenger revenue management and fuel-price related fare increases.
Cargo revenues grew 7.6%, to US$1,154.3 million in 2007 from US$1,072.7 million in 2006, as traffic increased 4.8% and yields increased 2.7% to US¢42.7 from US¢41.6. International cargo revenues accounted for nearly 98% of total cargo revenues. Cargo traffic increased mainly due to the growth of imports into Latin America. Cargo traffic growth decelerated during the year mainly due to the weakening of export traffic out of South America. Cargo yields increased mainly due to strong demand on southbound routes and to the implementation of certain passenger revenue management initiatives as well as fuel cost pass-through mechanisms.
Other revenues increased 17.3% to US$173.4 million in 2007 from US$147.9 million in 2006, driven by increased revenues from on-board sales and aircraft rentals, maintenance and storage, custom brokerage and handling services to third parties, partially offset by the sale in the second quarter of 2007 of the subsidiaries of Lan Logistics Corp, which were not part of the Companys core airline business. In addition, the Company received US$18.6 million from Airbus related to a change in the delivery schedule of certain Airbus A318 aircraft.
Expenses in 2007 totaled US$3,111.6 million, a 13.9% increase over expenses of US$2,731.3 million in 2006. System capacity, measured in system ATKs, increased 10.6% between 2006 and 2007. Excluding the impact of higher fuel prices, which resulted in US$78.5 million of additional expenses compared to 2006, operating costs increased 11.0%. Unit costs (measured as operating costs and interest expenses minus other revenues, per ATK) increased 2.8% in 2007. Excluding fuel, unit costs increased 2.8%. As a percentage of total revenues, consolidated expenses decreased from 90.0% in 2006 to 88.3% in 2007.
Wages and benefits expenses grew 10.5% to US$489.6 million in 2007 from US$443.0 million in 2006, mainly driven by increased headcount in line with the expansion in the Companys operations, together with the impact of stronger local currencies and inflation on local currency-denominated wages.
Aircraft fuel expenses in 2007 totaled US$930.2 million, a 21.8% increase over 2006 aircraft fuel expenses of US$764.0 million. Fuel expenses rose due to a 9.2% increase in average fuel prices and an 11.5% increase in fuel consumption. To reflect our operational results more clearly, the gains and losses incurred due to fuel hedging activities are classified as a non-operating item.
Commissions to agents (related to both passenger and cargo sales) decreased 0.3% to US$402.6 million in 2007 from US$403.9 million in 2006, despite significant revenue growth, due to the fact that the 16.1% increase in traffic revenues (passenger and cargo) was offset by a 2.0 percentage point reduction in average commissions. As a percentage of traffic revenues (passenger and cargo), commissions to agents fell from 14.0% to 12.0%. This reduction was mainly related to a change in the commission structure in the cargo business, lower commissions in the passenger business in Chile, and a rise in passenger revenues relative to cargo revenues (average cargo commissions are higher than passenger commissions). Specifically, the weight of passenger revenues on total revenues increased from 59.8% to 62.3%.
Depreciation and amortization expenses increased 25.3% to US$153.9 million in 2007 from US$122.8 million in 2006. Depreciation and amortization increased mainly due to the incorporation into LANs fleet of 3 new Boeing 767 aircraft, 2 Airbus A320 and 5 Airbus A318 aircraft during 2007. For further information on depreciation policies, refer to Critical Accounting Policies below, and Note 2 to our audited consolidated financial statements.
Other rental and landing fees increased 8.8% to US$366.4 million in 2007 from US$336.8 million in 2006. This increase resulted mainly from the impact of increased operations on landing fees and handling expenses, partially offset by lower variable aircraft rentals as a result of lower ACMI leases in the cargo business, as well as the termination of certain cargo allotment agreements.
Passenger service expenses totaled US$71.8 million in 2007 and US$56.1 million in 2006. This represented a 28.1% increase driven mainly by the 24.9% increase in the number of passengers transported during the period, in addition to higher costs associated with passenger compensations.
Aircraft rental expenses increased 0.8% to US$158.9 million in 2007 from US$157.7 million in 2006 as a decrease in the average number of leased aircraft was offset by higher average lease rates and by the incorporation of an additional Airbus A340 into LANs fleet.
Aircraft maintenance expenses increased 35.7%, from US$117.2 million in 2006 to US$159.1 million in 2007, mainly as a result of the expansion in operations, a larger fleet and increased utilization of the fleet, as well as higher maintenance rates per hour due to an escalation in maintenance contracts.
Other operating expenses increased 14.9% to US$379.1 million in 2007 from US$329.9 million in 2006. Other operating expenses include sales-related expenses, training, communication, distribution and data processing costs, and banking and non-collectable account expenses. Other operating expenses increased in 2007 due to increased operations, which resulted in increased sales and distribution costs, higher advertising and marketing expenses, and costs related to the Companys on board sales. This was partially offset by the de-consolidation of the costs related to the subsidiaries of Lan Logistic Corp, which were sold during the second quarter of 2007.
Operating income increased 36.6% to US$413.4 million in 2007 from US$302.6 million in 2006. Operating margins increased from 10.0% in 2006 to 11.7% in 2007 as a 16.2% increase in total operating revenues outpaced a 13.9% increase in operating expenses. For the full year, revenues per ATK (passengers and cargo) grew 5.0% (from US¢45.5 to US¢47.7), as costs per ATK increased 2.8% (from US¢41.5 to US¢42.7).
Other Income (Expense)
Other expenses increased from US$15.7 million in 2006 to US$45.6 million in 2007. Interest income increased 128.5% to US$18.0 million from US$7.9 million due to higher average cash balances resulting from the equity offering completed in June 2007. Interest expenses increased 25.5% to US$76.2 million in 2007 from US$60.7 million in 2006 due to an increase in average debt related to fleet financing and higher average interest rates. Other income-net decreased 66.0% to US$12.6 million in 2007 from US$37.1 million in 2006. This was mainly due to the fact that in 2007 this item included a US$25.0 million reserve related to the ongoing investigation by the European Commission for allegations of anti-competitive behavior in the cargo business. In 2006, this item included a US$40.3 million pre-tax, one-time gain related to a change in the Companys aircraft maintenance accounting policy, a US$6.4 million pre-tax one-time charge related to severance payment charges and a US$8.1 million provision related to the phase-out of the Boeing 737-200 fleet. In addition, LAN recorded a fuel hedging gain of US$28.2 million in 2007 compared to a US$12.9 million gain in 2006, as well as a US$15.7 million foreign-exchange gain compared to a US$5.5 million gain in 2006.
Income tax expense increased 27.6%, amounting to US$59.8 million in 2007 as compared to US$46.8 million in 2006. This was mainly the result of a 27.8% increase in pre-tax income, as well as a 0.1% decrease in the average tax rate which reached 16.2% in 2007 as compared to 16.3% in 2006. For more information, see Critical Accounting PoliciesDeferred Income Taxes below and Note 14 to our audited consolidated financial statements.
U.S. Dollar Presentation and Price-Level Adjustments
Lan Airlines and most of our subsidiaries maintain their accounting records and prepare their financial statements in U.S. dollars. For purposes of preparing the audited consolidated financial statements, we translate monetary assets and liabilities denominated in currencies other than U.S. dollars to U.S. dollars at the exchange rate prevailing at the applicable balance sheet date, and we translate income statement accounts at the exchange rate prevailing on the dates on which the revenues and expenses were received, paid or accrued.
Chilean GAAP requires that financial statements prepared in Chilean pesos recognize the effects of inflation. Accordingly, unless we indicate otherwise, we have restated all financial information of our subsidiaries that maintain their accounts in Chilean pesos to eliminate the distorting effects of changes in inflation on non-monetary assets, liabilities and shareholders equity. We have then translated this financial information to U.S.
dollars, as described above, for purposes of consolidating it into our audited consolidated financial statements. The general price-level gain or loss we record in the income statement under Other Income (Expense) indicates the effect of inflation on our subsidiaries net holdings of monetary assets and liabilities during a period of inflation. We consider assets and liabilities monetary for purposes of general price-level accounting if their amounts are fixed by contract or otherwise in terms of number of currency units, regardless of changes in specific prices or in the general price level. Examples of monetary assets and liabilities include accounts receivable, accounts payable and cash.
Effects of Exchange Rate Fluctuations
Our functional currency is the U.S. dollar in terms of the pricing of our products, composition of our balance sheet and effects on our results of operations. Most of our revenues (83% in 2008) are in U.S. dollars or in prices pegged to the U.S. dollar and a substantial portion of our expenses (63% in 2008) is denominated in dollars or pegged to the U.S. dollar, in particular fuel costs, landing and overflight fees, aircraft rentals, insurance and aircraft components and supplies. Almost all of our liabilities are denominated in U.S. dollars (93% as of December 31, 2008), including bank loans, air traffic liabilities, and certain amounts payable to our suppliers. As of December 31, 2008, 91% of our assets were denominated in U.S. dollars, principally aircraft, cash and cash equivalents, accounts receivable and other fixed assets. Substantially all of our commitments, including operating leases and purchase commitments for aircraft, are denominated in U.S. dollars.
Although we generally maintain our international passenger fares and cargo prices in U.S. dollars or at prices pegged to the U.S. dollar, we are exposed to foreign exchange losses and gains due to exchange rate fluctuations. We recorded a net foreign exchange gain of US$5.5 million in 2006, a net foreign exchange gain of US$15.7 million in 2007 and a net foreign exchange loss of US$7.9 million in 2008, which are set forth in our income statement under Other Income (Expense). For more information, see Notes 2(e) and 22 to our audited consolidated financial statements. Our exchange gains in 2006 and 2007 were mainly associated with the appreciation of Latin American currencies, primarily that of the Chilean peso against the U.S. dollar. The loss incurred in 2008 was mainly related to the depreciation of the Chilean peso against the U.S. dollar.
We use Cost per ATK and Cost per ATK excluding fuel price variations in analyzing operating costs on a per unit basis. ATKs (available ton kilometers) measure the number of tons of capacity available for the transportation of revenue load (passengers and/or cargo) multiplied by the kilometers flown. To obtain our unit costs, which are used by our management in the analysis of our results, we divide our total costs by our total ATKs. Total costs are calculated by starting with operating costs as defined under Chilean GAAP and making certain adjustments for interest costs and other revenues. The cost component is further adjusted to obtain costs per ATKs excluding fuel price variations, in order to remove the impact of changes in fuel prices for the year. Cost per ATK and Cost per ATK excluding fuel price variations do not have a standardized meaning, and as such may not be comparable to similarly titled measures provided by other companies. They are not Chilean GAAP-based measures of performance or liquidity. These metrics should not be considered in isolation or as a substitute for operating costs or as indicators of performance or cash flows as a measure of liquidity.
The table below reconciles operating costs as defined by Chilean GAAP to costs used in the calculation of Cost per ATK and Cost per ATK excluding fuel price variations.
In addition, we use revenues per ASK or ATK, as applicable, in analyzing revenues on a per unit basis. To obtain our unit revenues, which are used by our management in the analysis of our results, we divide our passenger revenues by our total ASKs and our cargo revenues by our total ATKs. We use our revenues as defined under Chilean GAAP for purposes of the calculation of this metric. Revenues per ASK or ATK, as the case may be, do not have a standardized meaning, and as such may not be comparable to similarly titled measures provided by other companies. It is not a Chilean GAAP-based measure of performance or liquidity. This metric should not be considered in isolation or as a substitute for revenues or as indicators of performance or cash flows as a measure of liquidity.
The table below shows the calculation of our revenues per ASK or ATK, as applicable, in each of the periods indicated:
Our operating revenues are substantially dependent on overall passenger and cargo traffic volume, which is subject to seasonal and other changes in traffic patterns. Our passenger revenues are generally higher in the first and fourth quarters of each year, during the southern hemispheres (Chile and Argentina) spring and summer, than in the second and third quarters. Since Peru and Ecuador have different seasonal patterns, the expansion into those markets has led to stronger passenger revenues in the second and third quarters, therefore moderating the overall seasonality of our passenger business. Our cargo revenues generally are higher in the fourth quarter, which correspond to the harvest season in the southern hemisphere.
Critical Accounting Policies
A summary of our significant accounting policies is included in Note 2 to our audited consolidated financial statements. We believe that the consistent application of these policies enables us and our subsidiaries to provide readers of the financial statements with more useful and reliable information about our operating results and financial condition. The preparation of financial statements requires management to make certain estimates and assumptions. The following are the accounting policies that we believe are the most important to the portrayal of our financial condition and results of operations and require our most difficult, subjective or complex judgments.
The amount of passenger ticket sales not yet recognized as revenue is reflected as air traffic liability. Commissions related to such unearned revenue are shown net of the air traffic liability. Air traffic liability includes estimates of the amount of future refunds and exchanges, net of forfeitures for all unused tickets once the flight date has passed. We perform periodic evaluations of this estimated liability based on historical experiences. Any adjustments, which can be significant, are included in the results of operations for the periods in which the evaluations are completed. These adjustments relate primarily to the differences between our estimation of certain revenue transactions and the related sales price, as well as refunds, exchanges and other items for which final settlement occurs in periods subsequent to the sale of the related tickets at amounts other than the original sales price.
Events and circumstances outside of historical fare sale activity or historical customer travel patterns can result in actual refunds, exchanges or forfeited tickets differing significantly from estimates. We evaluate our estimates periodically. If actual refunds, exchanges or forfeitures fall outside of this range, we review our estimates and assumptions and adjust Air traffic liability and Passenger revenue as necessary. Our estimation techniques have been consistently applied from year to year; however, as with any estimates, actual refund and exchange activity may vary from estimated amounts. Furthermore, we believe it is unlikely that materially different estimates for future refunds, exchanges and forfeited tickets would be reported.
Property and Equipment
The key judgments we must make under the property and equipment policy include the estimation of the useful lives of our various asset types, expected residual values, the election to utilize primarily the straight-line method for recording depreciation, managements judgment regarding appropriate capitalization or expensing of costs related to fixed assets, and our determination that no impairment exists.
Property and equipment are stated at cost and are depreciated by the straight-line method based on the estimated useful lives of the assets. In estimating the lives and expected residual values of our aircraft, we have primarily relied upon actual experience with the same or similar aircraft types and recommendations from the manufacturers of the aircraft we operate. Aircraft estimated useful lives are based on the number of hours flown and cycles flown (a cycle is one take-off and landing). We have made a conversion into years based on both our historical and anticipated future utilization of the aircraft.
We also enter into capital lease agreements relating to aircraft and certain buildings and equipment, which have bargain purchase options at the end of each contract. These assets are not our legal property, because we cannot dispose of them until the purchase option is exercised. These assets are recorded at their fair value on the date of the lease agreement, which is determined by discounting the amounts payable in installments and the purchase option at the interest rate implicit, or explicit, in the contract. The corresponding leasing obligations are presented under long-term liabilities and under the current portion of long-term leasing obligations, net of the corresponding deferred interest.
Property and equipment assets are evaluated for possible impairment, as applicable. Factors that would indicate potential impairment may include, but are not limited to, significant decreases in the market value of long-lived assets, a significant change in the long-lived assets physical condition and operating or cash flow losses associated with the use of the long-lived asset. This process requires our estimate of future cash flows generated by each asset or group of assets. For any instance where this evaluation process indicates impairment, the appropriate assets carrying values are written down to net realizable value and the amount of the write-down is charged against the results of continuing operations.
Expenditures that substantially improve and/or increase the useful life of facilities, engines and equipment are capitalized. Minor and other unscheduled maintenance costs of aircraft and engines are charged to income as incurred. Costs of major programmed maintenance for leased aircraft are accrued based on the use of the aircraft and engines (flying hours). Our estimation of this accrual and the evaluation of whether an expenditure related to property and equipment substantially improves and/or increases the useful life of an asset and is appropriately capitalized as an addition to the assets cost basis or is expensed as normal maintenance and repair expense can significantly affect results of operations for a given period, as well as our financial position.
Effective January 2006, the Company decided to change the method of accounting for heavy aircraft and engine maintenance costs related to its owned aircraft. Under the new method, these costs incurred will be capitalized and amortized to the next overhaul while all other minor maintenance costs will be expensed as incurred. The cumulative effect of this change on net income for the year 2008 is an increase in non-operating income by US$ 40.3 million. For more information see Notes 2(p) and 3 to our audited consolidated financial statements.
Derivative Instruments Used For Aircraft Fuel
We utilize financial derivative instruments to manage the price risk of changing aircraft fuel prices and interest rates. As a portion of our financial derivative instruments is not traded on a market exchange, we estimate their fair values by the use of present value methods or standard option value models, with assumptions about commodity prices based on those observed in underlying markets. In addition, as there is no reliable forward market for jet fuel, we must estimate the future prices of jet fuel in order to measure the effectiveness of the hedging instruments in offsetting changes to those prices. Forward jet fuel prices are estimated by observing similar commodity futures prices (such as crude oil) and adjusted based on variations to those like commodities. As the majority of our fuel hedges settle within eighteen months, the variation between estimates and actual prices are recognized in a short period of time.
Deferred Income Taxes
Effective January 1, 2000, the effects of deferred income taxes arising from temporary differences between the basis of assets and liabilities for tax and financial statement purposes are recorded in accordance with Technical Bulletin No. 60 of the Chilean Institute of Accountants. The effects of deferred income taxes at January 1, 2000, which were not previously recorded, are recognized in income beginning in 2000 as the temporary differences reverse. Under Technical Bulletin No. 60, deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. In making this determination, we consider both positive and negative evidence and make certain assumptions, including projections of taxable income. Changes in these assumptions may have a material impact on results. See Note 14(d) to our audited consolidated financial statements.
Liquidity and Capital Resources
In recent years, we have been able to meet our working capital and capital expenditure requirements through cash from our operations, proceeds of long-term bank loans, loans from related parties and gains from financial transactions.
Our cash and cash equivalents totaled US$401.4 million as of December 31, 2008, US$445.6 million as of December 31, 2007 and US$199.5 million as of December 31, 2006. Additionally, we held US$8.6 million as of December 31, 2008, US$22.4 million as of December 31, 2007 and US$20.4 million as of December 31, 2006 in marketable securities not considered to be cash equivalents under Chilean GAAP, which consisted mainly of bonds. In 2006, 2007 and 2008 we were able to invest a portion of our cash balance in such items. We hold significantly all of our cash and cash equivalents in U.S. dollars or U.S. dollar-based instruments. We generally only hold cash and cash equivalents in currencies other than dollars to fulfill short-term obligations that are denominated in local currencies. The decrease in our cash and cash equivalents in 2008 as compared to 2007 was primarily due to the posting of collateral to third counterparties in order to offset our exposure to these counterparties arising from fuel and interest rates derivatives.
As of December 31, 2008, we had a working capital deficit (that is, our current liabilities exceeded our current assets) of US$28.0 million. As of December 31, 2007, we had a working capital deficit of US$32.8 million. In December 31, 2006, we had a working capital deficit of US$170 million. Our working capital deficit in 2008 was mainly related to our air traffic liability and accounts payable. Our air traffic liability refers to tickets that we have sold but which have not yet been used for travel. We recognize the price paid for the ticket as revenue when the tickets are flown. Except in the case of refunds, most of our air traffic liability will not result in cash outflows. Both liabilities arise in our ordinary course of business and, although they fluctuate mainly due to seasonal factors, they are generally proportional to our revenues. We believe this kind of working capital deficit presents no major constraint to our operations or growth strategy.
Net cash inflows from operating activities were US$729.1 million in 2008, US$707.0 million in 2007 and US$490.3 million in 2006, and are derived primarily from providing air passenger and cargo transportation to customers. Operating cash outflows are primarily related to the recurring expenses of operating our airline. Net cash inflows increased in 2008 mainly due to an increase in the collection of trade account receivables.
Net cash used in investing activities was US$832.1 million in 2008, US$844.3 million in 2007 and US$905.7 million in 2006. Cash capital expenditures were US$831.7 million in 2008, US$839.9 million in 2007 and US$920.4 million in 2006 mainly reflecting the partial acquisitions of property and equipment.
Our capital expenditures for 2008 were mainly composed of:
Our capital expenditures for 2007 were mainly composed of:
Our capital expenditures for 2006 were mainly composed of:
For more information about current and future capital expenditures, see Capital Expenditures under Item 5. The difference between net cash used in investing activities and cash capital expenditures during 2006 and 2008 relates mainly to the investment in and sale of financial instruments.
Net cash inflows from financing activities were US$58.8 in 2008, compared to net cash provided by financing activities of US$383.4 million in 2007 and US$503.7 million in 2006. In 2008, our main uses of cash were US$102.6 million in loan payments, US$222.8 million in dividends payments and US$177.8 mainly related to derivative contracts collateral. With respect to the said collateral, during the first and second quarter of 2009, the Company issued stand-by letters of credit for approximately US$98.0 million for the partial replacement of the US$177.8 million cash collateral. The issuance of such letters of credit and the increase of the price of crude oil in the first and second quarters of 2009, have resulted in the Company having no cash pledged to any financial institution for margin purposes as of May 31, 2009. In 2007, our main uses of cash were US$205.5 million in loan payments and dividends payments for a total of US$210.9 million. In 2006, our main uses of cash were US$223.4 million in loan payments and dividends payments for a total of US$84.9 million. Net cash inflows from financing activities decreased mainly due to a higher amount of collateral related to our hedge contracts.
We have generally been able to arrange for short-term loans with local Chilean and international banks when we have needed to finance working capital expenditures or increase our liquidity. As of December 31, 2008, we maintained US$355 million in short-term credit lines with both local and foreign banks.
During the first quarter of 2009, the Board of Directors of the Company approved a total of US$250 million in loans with different local financial institutions. As of March 31, 2009 the Company borrowed the equivalent of US$40 million of a Chilean peso denominated facility. In order to have U.S. dollar cash flows, the Company entered into a cross currency swap for such amount with the same financial institution. As of April 30, 2009, the Company entered into three additional facilities with three different local banks for a total amount of US$152 million (of which US$50 million are U.S. dollar denominated and US$102 million are denominated in Chilean pesos with a corresponding cross currency swap).
We have contractual obligations and commitments primarily related to the payment of debt, lease arrangements and for the future incorporation of aircraft to our fleet. As of December 31, 2008 we have financed the acquisition of fourteen Boeing 767-300 passenger aircraft and eight Boeing 767-300 Freighters through syndicated loans provided by international financial institutions with the support of partial guarantees issued by the Ex-Im Bank with repayment profiles of either twelve or fifteen years. The Ex-Im Bank guarantees support 85% of the net purchase price and are secured with a first priority mortgage on the aircraft in favor of a security trustee on behalf of Ex-Im Bank. The documentation for each loan follows standard market forms for this type of financing, including standard events of default. We have financed the remaining 15% of the net purchase price with commercial loans or with our own funds. Our Ex-Im Bank supported financings amortize on a quarterly basis, are denominated in U.S. dollars and, while some have fixed interest rates, others bear interest at a floating rate linked to U.S. dollar LIBOR. Through the use of interest rate swaps, we have effectively converted almost all of our floating rate debt under these loans into fixed rate debt. Between 2004 and 2008, LAN sold its ownership in the entities borrowing some of these loans and they were therefore reclassified as financial leases. As of December 31, 2008, the total amount outstanding under our Ex-Im Bank-supported financings totaled US$1,148.5 million. See Quantitative and Qualitative Disclosures About Market RiskRisk of Fluctuations in Interest Rates under Item 11 for more information.
In 2000, to finance our Airbus aircraft, we entered into a US$1.3 billion umbrella credit facility with a syndicate of international financial institutions under which we borrowed in the form of separate loans in connection with the specific financing requirements of each Airbus aircraft (including pre-delivery and long-term financings). This umbrella facility provided for guarantees from the English, French and German export credit agencies and contained customary terms for the industry, including standard events of default. Loans under the facility were denominated in U.S. dollars and bore interest at floating rates linked to LIBOR. The majority of these loans were converted into fixed rate loans through interest rate swaps. All the aircraft acquired under this facility were delivered by the end of 2005. In late 2005, we decided to negotiate a US$920 million facility to finance the acquisition of the 32 Airbus A320-Family Aircraft that were received in 2006, 2007 and in the first quarter of 2009. The new facility, arranged in early 2006, provided us with guarantees from the export credit agencies for 85% of the net purchase price of each aircraft. The remaining 15% of the net purchase price was funded internally. As of March 31, 2009, all the aircraft acquired under this new facility have been delivered and there are no remaining availabilities thereunder.
Our total long-term debt (including capital leases) as of December 31, 2008 was US$2,055 million compared to US$1,646 million in 2007. The increase in long-term debt during 2008 relates mainly to the incorporation of debt-financed fixed assets. We have minimum lease payment obligations primarily associated with our aircraft leases. As of December 31, 2008, we had thirty-two aircraft under operating leases, and we had minimum lease payment obligations of US$1,348.9 million compared to US$676.2 million as of December 31, 2007. Minimum lease payment obligations increased as the effect of the incorporation of new aircraft under lease agreements and the extension of several lease contracts was offset by the consumption of one year of lease-payments. The average interest rate of our long-term debt was 5.24% as of December 31, 2008. 96.2% of our debt effectively accrues interest at a fixed rate (either through a stated fixed interest rate or through our use of interest rate swap agreements) or is subject to interest rate caps. As of March 31, 2009, we also had purchase obligations for
amounting to a combined total of US$5,052.3 million, with delivery between 2009 and 2019.
The following table sets forth our material expected obligations and commitments as of December 31, 2008.
During 2009, we expect our operating environment to continue to be subject to certain conditions that will substantially affect our results. Specifically, we expect to face:
In 2009, we expect to continue expanding and diversifying our revenue base through the expansion of our network by further developing our existing routes, adding new destinations, developing new alliances, and entering new markets. For example, in the first quarter of 2009, we received a total of three A319 aircraft designated for passenger domestic and regional operations and we expect to receive two additional passenger aircraft (both Boeing 767s designated for long-haul passenger operations) during the fourth quarter of 2009. In addition, in April 2009 we initiated operations in the domestic market of Ecuador.
In the cargo business, we will continue adjusting our routes and our capacity mix to adapt to changing cargo flows. We intend to closely monitor demand and redesign our freighter itineraries accordingly. The flexibility of our freighter operations will enable us to accommodate lower demand and avoid unprofitable routes by combining service to several destinations in the same trip. During 2009 we expect to continue benefiting from our expanded route network to increase diversification and shift capacity across routes, to partially compensate for reductions in traffic to specific markets. For example, in March 2009, we started operations in LANCO, our new Colombian affiliate, and ABSA, our Brazilian affiliate, began domestic cargo operations within Brazil covering the route between Sao Paulo and Manaus.
We continue to have a significant amount of flexibility to adjust the size of our fleet. Between 2009 and 2011, we will have three operating lease expirations each year, which can be exercised without cost, and in 2010, we will begin to have part of our Boeing 767 fleet fully paid for, providing us with additional flexibility.
We also intend to lower our cost structure and offset reductions in demand through careful cost management and more efficient asset utilization and we aim at increasing efficiency by streamlining our support processes, reducing commercial costs, and by continuing with the implementation of our new business model for short-haul operations.
We expect jet fuel prices will continue to be volatile in 2009 and expect to continue using fuel hedging programs and fuel surcharge mechanisms in both the passenger and cargo businesses, to help protect us against short term movements in crude oil prices. For instance, we have hedged approximately 44% of our estimated fuel requirements for the second quarter 2009, 39% for the third quarter, and 48% for the fourth quarter, as well as 10% of our estimated fuel requirements for the first quarter of 2010. These hedging instruments are zero-cost collars with a floor between US$92 and US$104 per barrel and a ceiling of US$140 per barrel. In addition, for the third and fourth quarters of 2009, we also acquired call options with a strike price of US$70.
Over the last three years our cash capital expenditures were US$920.4 million in 2006, US$839.9 million in 2007 and US$831.7 million in 2008, which mainly reflect our acquisition of aircraft and aircraft-related equipment, IT equipment and support infrastructure, and the funding of pre-delivery deposits.
The following chart sets forth our estimate, as of March 31, 2009, of our future capital expenditures for 2009, 2010, 2011, 2012 and 2013:
The expenditures set out in the table above reflect payments for purchases and other fleet-related items, as well as for information technology and other items. See Business of the Company Fleet under Item 4 above. Principally, we have projected our capital expenditures based on:
We expect that cash generated from operations, short-term credit-lines and the long-term syndicated loans already negotiated with various banks will be sufficient to meet our cash requirements in the foreseeable future, although events that materially affect our operating results could also have a negative impact on our liquidity.
Credit Card Receivables Securitization
We have raised a total of US$100.0 million through two similar transactions involving the private placement of certificates backed by our credit card receivables. In these transactions, we sold our right to receive certain present and future U.S. dollar payment obligations, referred to as future credit card receivables, arising from the purchase of passenger tickets and related services in the United States through American Express, Diners Club, Discover, Visa and MasterCard to Pelican Finance Ltd. (Pelican). In the first transaction, completed in March 1999, we sold US$60.0 million of our future credit card receivables to Pelican which then issued notes to a United States trust, backed by payments received on these payment obligations, which in turn issued trust certificates, backed by payments received on the notes, to investors. This transaction had a term of seven years and our sale of these receivables authorized Pelican to collect payments on them until March 2006. Final payment for this transaction was made in June 2006. In August 2002, we entered into a similar sale of future credit card receivables to Pelican for an additional US$40.0 million. This transaction has a term of seven years, with a four year grace period on principal payments. Our sale of these receivables authorizes Pelican to collect payments on them until the earlier of the date the notes issued by Pelican are fully redeemed and August 2009. Final payment for this transaction is expected to be made on June 30, 2009.
Off-Balance Sheet Arrangements
We record payments made under operating leases as expenses, and none of our operating lease obligations are reflected on our balance sheet. We are responsible for all maintenance, insurance and other costs associated with operating these aircraft. We have not made any residual value or similar guarantees to our lessors. We have made certain guarantees and indemnities to other unrelated parties that are not reflected on our balance sheet, but we believe that these will not have a significant impact on our results of operations or financial condition.
We have no other off-balance sheet arrangements. See Notes 1 and 23 to our audited consolidated financial statements for a more detailed discussion of contingencies, including guarantees.
Differences between Chilean GAAP and U.S. GAAP
Our audited consolidated financial statements are prepared in accordance with Chilean GAAP, which differs in certain significant respects from U.S. GAAP. See Note 27 to our audited consolidated financial statements for a discussion of these differences and their effect on our results of operations.
Our net income determined under U.S. GAAP would have been US$316.4 million in 2008, US$322.0 million in 2007 and US$201.6 million in 2006, as compared with net income under Chilean GAAP of US$335.7 million in 2008, US$308.3 million in 2007 and US$241.3 million in 2006. These differences could be material to the financial information presented in accordance with Chilean GAAP. The main differences affecting the determination of net income include the different treatment of expenses for amortization of goodwill, adjustments for differences in the deferred tax provision as calculated under U.S. GAAP, the ineffectiveness of certain derivative instruments resulting in additional adjustments under Chilean GAAP; and, certain expenses related to derivative instruments that do not qualify as hedging relationships under U.S. GAAP. In 2008, the main difference affecting the determination of net income was the effect of adjusting the capitalization of interest related with the financing of PDPs.
Shareholders equity determined under U.S. GAAP would have been US$863.3 million as of December 31, 2008, US$1,010.7 million as of December 31, 2007 and US$658.3 million as of December 31, 2006 as compared with shareholders equity under Chilean GAAP of US$1,118.0 million as of December 31, 2008, US$988.0 million as of December 31, 2007 and US$626.3 million as of December 31, 2006, principally due to differences in purchase accounting adjustments, adjustments for the provision for deferred income taxes, and goodwill amortization.
Directors and Senior Management
The administration of Lan Airlines is conducted by its board of directors which, in accordance with Lan Airlines by-laws, consists of nine directors who are elected every two years for two-year terms at annual regular shareholders meetings, and may be re-elected. The board of directors may appoint replacements to fill any vacancies that occur during periods between elections. Scheduled meetings of the board of directors are held once a month and extraordinary board of directors meetings are called when summoned by the chairman of the board of directors and two other directors, or when requested by a majority of the directors.
The current board of directors was elected at the annual shareholders meeting held on April 10, 2008. Its term expires in April 2010. The following are Lan Airlines directors and senior management as of March 31, 2009:
Set forth below are brief biographical descriptions of Lan Airlines directors and senior management.
Mr. Jorge Awad Mehech, 63 years old, has served as chairman and member of Lan Airlines board of directors since July 2001. Mr. Awad had previously served as chairman of our board of directors from 1994 to October 2000. Mr. Awads current term as chairman ends on the date of the annual shareholders meeting to be held in 2010. He held the position of Senior Vice President of Fast Air from 1979 to 1993. Mr. Awad currently serves on the boards of directors of several other Chilean companies, including Banco de Chile, Envases del Pacifico S.A., Edyce S.A. and Universidad de Talca. He is also a board member of ICARE (Instituto Chileno de Administracion Racional de Empresas), a Chilean organization seeking to promote private enterprise. As of March 31, 2009, according to shareholder registration data in Chile, Mr. Awad shared in the beneficial ownership of Lan Airlines, through Inversiones y Asesorías Fabiola S.A., of 201,784 common shares (0.06% of Lan Airlines outstanding shares).
Mr. Darío Calderón González, 62 years old, has served on Lan Airlines board of directors since 1994. Mr. Calderóns term as a director ends on the date of the annual shareholders meeting to be held in 2010. Mr. Calderón
has been a partner in Calderón y Cía., a Chilean law firm, since 1970. Mr. Calderón currently serves on the board of directors of other Chilean companies, including Integramedica S.A., Imprenta A Molina Flores S.A., Inmobiliaria Cumbres S.A., and Calzados Gino S.A.
Mr. José Cox Donoso, 54 years old, has served on Lan Airlines board of directors from April 1994 to June 1995 and from September 1995 to the present. Mr. Coxs term as a director ends on the date of the annual shareholders meeting to be held in 2010. Mr. Cox has also served as chairman of the board of directors of Lan Cargo since September 1995. In addition, Mr. Cox has served on the board of directors of another Chilean company, CMB-Prime Asset Managing Corp., since September 1993. Mr. Cox is also chairman of the Chilean Electronic Stock Exchange. As of March 31, 2009, according to shareholder registration data in Chile, Mr. Cox shared in the beneficial ownership of Lan Airlines, through Asesorías e Inversiones Ilihue Limitada, 2,654,324 common shares of Lan Airlines (0.78% of Lan Airlines outstanding shares).
Mr. Juan José Cueto Plaza, 49 years old, has served on Lan Airlines board of directors since 1994. Mr. Cuetos term as a director ends on the date of the annual shareholders meeting to be held in 2010. Mr. Cueto currently serves as Executive Vice President of Inversiones Costa Verde S.A., a position he has held since 1990, and serves on the boards of directors of Forestal Copihue S.A. and Minera Michilla S.A. Mr. Cueto is the son of Mr. Juan Cueto Sierra, a director of Lan Airlines, and the brother of Messrs. Enrique and Ignacio Cueto Plaza, Chief Executive Officer and Chief Operating Officer of Lan Airlines, respectively. Mr. Cueto is a member of the Cueto Group (one of Lan Airlines Controlling Shareholders). As of March 31, 2009, Mr. Cueto shared in the beneficial ownership of 86,383,567 common shares of Lan Airlines (25.5% of Lan Airlines outstanding shares) held by the Cueto Group. For more information see Item 7. Controlling Shareholders and Related Party Transactions.
Mr. Juan Cueto Sierra, 79 years old, was one of the founders of Fast Air in 1978 and has served on Lan Airlines board of directors since 1998. Mr. Cuetos term as a director ends on the date of the annual shareholders meeting to be held in 2010. Mr. Cueto has wide experience in a range of business activities. Mr. Cueto is the father of Messrs. Juan José, Enrique and Ignacio Cueto Plaza, Director, Chief Executive Officer and Chief Operating Officer of Lan Airlines, respectively. As of March 31, 2009, Mr. Cueto shared in the beneficial ownership of 86,383,567 common shares of Lan Airlines (25.5% of Lan Airlines outstanding shares) held by the Cueto Group. For more information see Item 7. Controlling Shareholders and Related Party Transactions.
Mr. Ramón Eblen Kadis, 64 years old, has served on Lan Airlines board of directors since June 1994. Mr. Eblens term as a director ends on the date of the annual shareholders meeting to be held in 2010. Mr. Eblen has served as President of Comercial Los Lagos Ltda., Inversiones Santa Blanca S.A., and TJC Chile S.A. Mr. Eblen is a member of the Eblen Group (a major shareholder of Lan Airlines). As of March 31, 2009, Mr. Eblen shared in the beneficial ownership of 31,778,049 common shares of Lan Airlines (approximately 9.38% of Lan Airlines outstanding shares) held by the Eblen Group. For more information see Item 7. Controlling Shareholders and Related Party Transactions.
Mr. Andrés Navarro Haeussler, 60 years old, joined Lan Airlines board of directors in April 2004. Mr. Navarros term as a director ends on the date of the annual shareholders meeting to be held in 2010. Mr. Navarro holds a Civil Engineering degree from Universidad Católica de Chile. He is the president and founder of Sonda S.A., a leading IT services provider in Latin America, which has operations in eleven Latin American countries, including Mexico, Brazil, Argentina, Chile and Colombia. This company had its IPO during 2006 and is listed in the Santiago Stock Exchange. He is also the Chairman of the Board of Clínica Las Condes and of Inmobiliaria y Constructora Aconcagua S.A. and member of the board of Fundación Teleton, a non-profit organization.
Mr. Ignacio Guerrero Gutiérrez, 56 years old, joined Lan Airlines board of directors in April 2008. Mr. Guerreros term ends on the date of the annual shareholders meeting to be held in 2010. Mr. Guerrero holds an MBA degree from Harvard Business School and an Economics degree from Catholic University in Santiago, Chile. Mr. Guerrero has extensive experience in the banking and financial fields, having worked as a commercial banker for Banco de Chile and as an investment banker for Citibank N.A. and for NMB Bank, New York. From 1990 to 1994, he served as CFO of Codelco Chile, one of the largest copper mining companies in the world. Mr. Guerrero is currently a partner at CMB Chile, an investment company focused on asset management and private equity.
Bernardo Fontaine Talavera, 44 years old, has served on Lan Airlines board of directors since April 2005. Mr. Fontaines term ends on the date of the annual shareholders meeting to be held in 2010. Mr. Fontaine has held various responsibilities on the financial services branch of Falabella, a major Chilean retailer, and served as Executive Director of CMR Falabella and Vice-Chairman of the Board of Banco Falabella. Mr. Fontaine also served
as head of the M&A Corporate Finance division of Citicorp-Citibank Chile. Mr. Fontaine currently serves on the boards of Almagro S.A., Loginsa S.A. and Polygon S.A. He is also the general manager of Tres Mares S.A., which owned, together with other related holding companies, as of March 31, 2009, 7,222,593 shares of Lan Airlines S.A. (2.1% of Lan Airlines outstanding shares).
Mr. Enrique Cueto Plaza, 50 years old, is Lan Airlines Chief Executive Officer, and has held this position since 1994. From 1993 to 1994, Mr. Cueto served on Lan Airlines board of directors. From 1983 to 1993, Mr. Cueto was Chief Executive Officer of Fast Air, a Chilean Cargo airline. Mr. Cueto has in-depth knowledge of passenger and cargo airline management, both in commercial and operational aspects, gained during his 22 years in the airline industry. Mr. Cueto is an active member of the oneworld® Alliance Governing Board, the IATA (International Air Transport Association) Board of Governors. He is also member of the Board of the Federation of Chilean Industry (SOFOFA) and of the Board of the Endeavor foundation, an organization dedicated to the promotion of entrepreneurship in Chile. Mr. Cueto is the son of Mr. Juan Cueto Sierra, a member of the board of Lan Airlines, and the brother of Messrs. Juan José and Ignacio Cueto Plaza, member of the board and President and Chief Operating Officer of Lan Airlines, respectively. Mr. Cueto is also a member of the Cueto Group (one of Lan Airlines Controlling Shareholders). As of March 31, 2009, Mr. Cueto shared in the beneficial ownership of 86,383,567 common shares of Lan Airlines (25.5% of Lan Airlines outstanding shares) held by the Cueto Group. For more information see Item 7. Controlling Shareholders and Related Party Transactions.
Mr. Ignacio Cueto Plaza, 45 years old, is Lan Airlines President and Chief Operating Officer. Until being promoted to his current position in 2005, Mr. Cueto served as Chief Executive Officer-Passenger Business, a position he assumed in 1999. Mr. Cueto served on the board of directors of Lan Airlines and Ladeco from 1995 to 1997 and from 1994 to 1997, respectively. In addition, Mr. Cueto served as Chief Executive Officer of Fast Air from 1993 to 1995 and as President of the LanCargo Group from 1995 to 1998. Between 1985 and 1993, Mr. Cueto held several positions at Fast Air, including Service Manager for the Miami sales office, Director of Sales for Chile and Vice President of Sales and Marketing. Mr. Cueto is the son of Mr. Juan Cueto Sierra, director of Lan Airlines, and the brother of Messrs. Juan José and Enrique Cueto Plaza, Director and Chief Executive Officer of Lan Airlines, respectively. Mr. Cueto is also a member of the Cueto Group (one of Lan Airlines Controlling Shareholders). As of March 31, 2009, Mr. Cueto shared in the beneficial ownership of 86,383,567 common shares of Lan Airlines (25.5% of Lan Airlines outstanding shares) held by the Cueto Group. For more information see Item 7. Controlling Shareholders and Related Party Transactions.
Mr. Alejandro de la Fuente Goic, 50 years old, is Lan Airlines Chief Financial Officer, and has held this position since October 1995. Mr. de la Fuente joined Lan Airlines in April 1995. Prior to joining Lan Airlines, Mr. de la Fuente served as Chief Financial Officer of Chiquita Frupac Ltd., a subsidiary of Chiquita Brands Inc., beginning in 1992. As of March 31, 2009, Mr. de la Fuente owned 37,383 common shares of Lan Airlines (0.01% of Lan Airlines outstanding shares).
Mr. Armando Valdivieso Montes, 46 years old, is Lan Airlines Chief Executive Officer-Passenger, a position he assumed in 2006. Between 1997 and 2005 he served as Chief Executive Officer-Cargo Business. From 1994 to 1997, Mr. Valdivieso was President of Fast Air. From 1991 to 1994, Mr. Valdivieso served as Vice President, North America of Fast Air Miami. As of March 31, 2009, according to shareholder registration data in Chile, Mr. Valdivieso owned 59,704 common shares of Lan Airlines (0.02% of Lan Airlines outstanding shares).
Mr. Cristian Ureta Larrain, 46 years old, is Lan Airlines Chief Executive Officer-Cargo, a position he assumed in 2005. Mr. Ureta has an Engineering degree from Pontificia Universidad Catolica and a Special Executive Program from Stanford University. Between 2002 and 2005 Mr. Ureta served as Production Vice President for Lan Cargo. Between 1998 and 2002 he was Lan Cargos Planning and Development Vice President. Prior to that, Mr. Ureta served as General Director and Commercial Director at MAS Air, and as Service Manager for Fast Air.
Mr. Roberto Alvo Milosawlewitsch, 40 years old, is Lan Airlines Senior Vice-president Strategic Planning and Development, a position he assumed in 2008. Prior to holding his current position, Mr. Alvo served as CFO of Lan Argentina from 2005 until 2008, as Vice-president of Development of Lan Airlines from 2003 until 2005 and Vice-president of Treasury of Lan Airlines from 2001 until 2003. Before 2001 Mr. Alvo held various positions at Sociedad Química y Minera de Chile S.A., a leading non-metallic Chilean mining company. Mr. Alvo is a civil engineer and obtained an MBA from IMD in Lausanne, Switzerland.
Mr. Cristian Toro Cañas, 38 years old, is Lan Airlines Senior Vice President, Legal, a position he assumed in January 2008. Mr. Toro has a law degree from Pontificia Universidad Catolica de Chile (1993), as well as a masters law degree (MCJ 97) from New York University. Prior to joining Lan Airlines, Mr. Toro served as General Counsel for Citibank Chile, where he worked and held various positions from 1997 until 2007. He also worked as an international trainee at Shearman & Sterling in New York (1999).
Mr. Enrique Elsaca Hirmas, 41 years old, is Lan Airlines Senior Vice President, Strategic Planning, a position he assumed in July 2004. Mr. Elsaca has a degree in industrial engineering from Pontificia Universidad Catolica de Chile, as well as a Master in Business Administration from Massachusetts Institute of Technology. Prior to joining Lan Airlines, Mr. Elsaca served as Real Estate and Development Manager of Cencosud, Chiles second largest retail group. From 1997 to 1999, Mr. Elsaca worked at Booz Allen & Hamilton in Latin America, and from 1991 to 1995, Mr. Elsaca held various positions in Esso Chile, a subsidiary of Exxon.
Mr. Emilio del Real Sota, 44 years old, is Lan Airlines Senior Vice President Human Resources, a position he assumed in August 2005. Mr. del Real has a Psychology degree from Universidad Gabriela Mistral. Between 2003 and 2005, Mr. del Real was the Human Resource Manager of DYS, a Chilean retail company. Between 1997 and 2003 Mr. del Real served in various positions in Unilever, including Human Resource Manager for Chile, and Training and Recruitment Manager and Management Development Manager for Latin America.
Mr. Eduardo Opazo Preller, 57 years old, is Lan Airlines Senior Vice President, Corporate Affairs, a position he assumed in June 2008. Mr. Opazo has a degree in Business Administration from IPEVE, as well as an MBA from University Adolfo Ibáñez and AMP IESE. Prior to joining Lan Airlines, Mr. Opazo served as Head of Global Internal Communications for Santander Group, Madrid. From 1987 to 2008, Mr. Opazo worked at Santander Group.
For the year ended December 31, 2008, the aggregate amount of compensation we paid to all executives and senior managers was US$53.8 million, which did not include US$12.0 million paid as bonuses. Our variable compensation plan is based on our corporate profits, and team and individual performance.
Under Chilean law, Lan Airlines must disclose in its annual report details of all compensation paid to its directors during the relevant fiscal year, including any amounts that they received from Lan Airlines for functions or employment other than serving as a member of the board of directors, including amounts received as per diem stipends, bonuses and, generally, all other payments. Additionally, pursuant to regulations of the Superintendencia de Valores y Seguros (the SVS), the annual report must also include the total compensation and severance payments received by managers and principal executives, and the terms of and the manner in which board members and executive officers participate in any stock option plans.
Lan Airlines directors are paid 24 UF per meeting (56 UF for the chairman of the board). Lan Airlines also provides certain benefits to its directors and executive officers, such as free and discounted airline tickets and health insurance. We do not have contracts with any of our directors to provide benefits upon termination of employment.
On April 5, 2007, the extraordinary shareholders meeting approved a capital increase of 22,090,910 shares. The same meeting designated 10% of the approved capital increase (2,209,091 shares) for purposes of a proposed employee stock option compensation plan. The shareholders meeting authorized our board of directors to elaborate the compensation plan.
As set forth in further detail in the following table, in 2008 the members of our board of directors currently in office received fees and salaries in the aggregate amount of US$132,415.03.
As required by Chilean law, Lan Airlines makes obligatory contributions to the privatized pension fund system on behalf of its senior managers and executives, but it does not maintain any separate program to provide pension, retirement or similar benefits to these or any other employees.
Board of Directors Committee and Audit Committee
Pursuant to Chilean Corporation Law, as amended by Law No. 19705, Lan Airlines must have a board of directors committee composed of no less than three board members. Lan Airlines has established a three-person committee of its board of directors, which, among other duties, is responsible for:
Under Chilean law we are required, to the extent possible, to appoint a majority of independent directors to the board of directors committee. The corresponding independence requirements are set forth in Chilean Corporation Law, as amended by Law No. 19705, and relate to the relationship between the directors and the shareholders that control a corporation. A director is considered independent when he or she can be elected regardless of the voting of the controlling shareholders.
Pursuant to U.S. regulations, we are required to have an audit committee of at least three board members, which complies with the independence requirements set forth in Rule 10A-3 under the Securities Exchange Act of 1934. Given the similarity in the functions that must be performed by our Board of Directors Committee and the audit committee, our Board of Directors Committee serves as our Audit Committee for purposes of Rule 10A-3 under the Securities Exchange Act of 1934.
As of March 31, 2009, all of the members of our Board of Directors Committee, which also serves as our Audit Committee, were independent under Rule 10A-3 of the Securities Exchange Act of 1934. As of March 31, 2009, the committee members were Mr. Jorge Awad Mehech, Mr. José Cox Donoso and Mr. Ramón Eblen Kadis. We pay each member of the committee 24 UFs per meeting.
The following table sets forth the number of employees in various positions at Lan Airlines, Lan Cargo and our other subsidiaries.
We have a performance-related pay structure for our administrative, management and flight personnel (such as cabin crew members, airport and sales agents, call-center employees, and some back office employees) including performance-based bonuses and pay scales that reward foreign language proficiency among counter, technical and administrative personnel. During 2008, over 90% of our employees were eligible to receive performance related bonus payments that are linked to personal, team and corporate performance.
We provide our employees with medical insurance complementary to the coverage of the private health system, and also grant other benefits, such as free and discounted airline tickets, to our permanent employees. In 2008, a stock option compensation plan was offered to key senior executives. For a detailed description of the stock option compensation plan, please see Note 19(g) to our audited consolidated financial statements for the fiscal year ended December 31, 2008.
As required by Chilean law, we make obligatory contributions to the privatized pension fund system on behalf of our employees, but we do not maintain any separate program to provide pension, retirement or similar benefits to these or any other employees. However, the pilots´ collective bargaining agreement includes a clause that permits resignation with severance payment, in case a pilot reaches a certain age and is still providing services to the company.
One of our main goals for 2008 was to complete the first stage of the communication of our four principal values (safety and security, achievement, efficiency and warmth) to our employees. The campaign included internal training sessions, internal memoranda and posters to explain the meaning of each value and how employees can further these values in their daily work.
Some of our populations, such as the flight operations, maintenance and customer ground operations personnel undergo training when they join the Company and throughout their employment with us. We invested US$7.1 million in 2006, US$8.0 in 2007 and US$12.5 million in 2008. We generally recruit our pilots from the Academia de Ciencias Aeronáuticas (at the Universidad Técnica Federico Santa María), aeroclubs and the armed forces. Before being promoted to the position of captain, first officers must have logged at least 4,000 flight hours and received the approval of a special pilots committee. We provide ground-school training in Santiago, as well as in Lima and Quito for our Peruvian and Ecuadorian crews. We maintain an agreement with CAE (a Canadian firm specializing in flight simulators and training centers) to develop a pilot training center in Santiago de Chile. This training center includes 2 Airbus A320 and 1 Boeing 767 Full Flight simulators plus 1 MFTD A320/340 simulator. Our pilot staff also receives simulator training at sites in the United States and Brazil.
Our pilots are rated for only one aircraft type by local aeronautical authorities, and they are not cross-qualified between two or more aircraft types. Chilean regulations require pilots to be licensed as commercial pilots for a first officer position and as an airline transport pilot for a captain position, with specific type, function and special ratings for each aircraft to be flown, and to be medically certified as physically fit. Licenses and medical
certifications are subject to periodic reevaluation, including flight simulator recurrent training, ground recurrent training, annual emergency procedures training, safety and security training and recent flying experience. Our pilots receive a variety of training, such as lectures, simulations and gaming and computer based training. Cabin crew must have initial and periodic competency fitness training.
Aircraft mechanics and maintenance supervisory personnel must be licensed by the DGAC and other corresponding authorities in other countries in which we operate. We train our technicians (Mechanics, Specialists, Inspectors and Maintenance Supervisors) in all programs required by both local authority (DGAC) and international authorities and aviation associations, such as the FAA, the European Aviation Safety Agency (EASA), IATA rules and regulations, those required by aircraft manufacturers and the training needs that we identify during our annual reviews. The program of study contains initial and continuing training. Initial training is level III ATA SPEC 104 and lasts forty to fifty days depending on the aircraft types and continuing training lasts up to five to six days.
During 2008, we continued training sales and administrative personnel in areas such as service and sales quality. We also continued delivering learning programs to develop leadership skills and others with different methodologies including e-learning.
We have negotiated longer-term labor contracts with the labor unions in anticipation of their scheduled expirations, which under Chilean law are limited to a period of four years. In general, the expiration of our labor agreements with the several unions that represent our pilots and other personnel are staggered in a way that we avoid being in the position of having to renegotiate contract terms with substantially all of our pilots or other personnel at the same time.
The collective bargaining agreement between Lan Express and its pilots union was renewed in November 2008. Three collective contracts are in place between Lan Airlines and its pilots (either through a union or employee groups). These contracts were negotiated in February 2009 and expire between August 2012 and January 2013. Lan Cargo is also a party to an employment agreement with its pilots that expires in November 2012.
Lan Airlines has also entered into collective bargaining agreements covering the majority of its flight attendants that expire at various times, ranging from August 2009 to October 2011. Lan Airlines renewed the collective bargaining agreements with its maintenance personnel in June 2008 for a period of four years. The collective bargaining agreement with maintenance personnel working for Lan Express, one of our Chilean subsidiaries, will expire in 2011. The agreement with the union representing our administrative personnel from Lan Airlines expires in August 2009.
The majority of Lan Argentinas employees belong to industry-wide unions. Currently, labor relations are stable. In 2005, Lan Argentina hired employees from another airline and agreed to maintain their employment conditions and labor stability. The conditions and labor relations that Lan Argentina had to maintain expired on September 2008, a situation that did not generate any conflict for the company. During 2009, we expect to renew the collective agreements with pilots and maintenance personnel; the negotiations have already started with a fluid dialogue between the parties.
We believe we generally have good relations with our employees and the unions, and expect to continue to enjoy good relations with our employees and the unions in the future. We also believe that we have built a solid base among our employees that will support and facilitate our growth plans. We can provide no assurance, however, that our employee compensation arrangements may not be subject to change or modification after the expiration of the contracts currently in effect, or that we will not be subject to labor-related disruptions due to strikes, stoppages or walk-outs.
Pursuant to agreements signed in July 2004, two shareholder groups control the Company. These shareholder groups are:
We collectively refer to these shareholder groups as Controlling Shareholders. As of March 31, 2009, our Controlling Shareholders owned 51.84% of our voting common shares. While the common shares owned by the Controlling Shareholders do not have different voting rights than the common shares owned by our other shareholders, these Controlling Shareholders are entitled to elect a majority of the members of our board of directors and are in a position to direct our management and to control substantially all matters that are to be decided by a vote of shareholders.
The agreements signed by our Controlling Shareholders provide for a joint-action agreement and a right of first refusal agreement in connection with 45.0% of our common shares. Under the joint-action agreement, the Controlling Shareholders agreed to coordinate their actions on all matters pertaining to the Companys management, both at shareholders meetings and meetings of the board of directors. Under the right of first refusal agreement between the groups, the shares included under this agreement are subject to reciprocal rights of first refusal in connection with any future sale to a third-party.
As of March 31, 2009, a third shareholder group, which includes our director Ramón Eblen Cadiz, owned 9.38% of our common shares. Because this group can influence our management, we have classified this group as a Principal Shareholder.
The table below sets forth the beneficial ownership of common shares as of March 31, 2009, broken down between our Controlling Shareholders, other principal shareholder, and minority shareholders.
On January 10 and January 11, 2007, the SVS publicly announced the initiation of an administrative investigation to determine whether the purchase of shares of LAN on July 24, 2006 made by Juan José Cueto, through Inversiones Mineras del Cantábrico S.A., and by Sebastian Piñera Echenique, through Inversiones Santa Cecilia S.A., respectively, had breached an obligation not to acquire shares of LAN until the financial statements became publicly available. The Company was not a party to these investigations. On July 6, 2007, the SVS fined Sebastian Piñera Echenique 19,470 UF (approximately US$690,000) and fined Juan José Cueto 1,620 UF (approximately US$58,000) for allegedly violating, through certain affiliates, Article 165, paragraph 1 of the Securities Market Law. The SVS ruled that, though neither Mr. Piñera nor Mr. Cueto had used any privileged information, the Companys financial statements should be considered to be privileged information per se and thus created a duty to abstain from trading the securities prior to the disclosure of the financial statements.
As of March 31, 2009, investors outside of Chile held 9.28% of our capital stock in the form of ADSs, and other minority investors held 29.52% in the form of common shares. It is not practicable for us to determine the number of ADSs or common shares beneficially owned in the United States. As of March 31, 2009, we had 1,217 record holders of our common shares. It is not practicable for us to determine the portion of shares held in Chile or the number of record holders in Chile.
Related Party Transactions
We have engaged in a variety of transactions with our affiliates, including entities owned or controlled by certain of our controlling shareholders. It is our policy not to engage in any transaction with or for the benefit of any shareholder or member of the board of directors, or any entity controlled by such a person or in which such a person has a substantial economic interest, unless the transaction is related to our business and the price and other terms are at least as favorable to us as those that could be obtained on an arms-length basis from a third party.
In the ordinary course of our business we render to and receive from related companies services of various types, including aircraft leases, aircraft interchanges, freight transportation and reservation services. Such transactions, none of which is individually material, are summarized in Note 15 to our audited consolidated financial statements for the fiscal year ended December 31, 2008.
Consolidated Financial Statements
See Item 18, Financial Statements and pages F-1 through F-69.
Other Financial Information
Legal and Arbitration Proceedings
We were involved in routine litigation and other proceedings relating to the ordinary course of our business. On July 30, 1997, the Chilean Antitrust Commission imposed a fine on us of US$345,000 in connection with a complaint filed by DAP Airlines, or DAP, alleging that we employed anti-competitive tactics by reducing our prices on certain of our routes and refusing to perform maintenance services on DAP aircraft. On January 8, 1998, DAP filed a demand for indemnification against Lan Airlines, National Airlines and Lan Cargo, jointly and severally, in the amount of Ch$6.4 billion (US$10.2 million according to the observed exchange rate as of December 31, 2008). In June 2000, the courts ruled in favor of DAP and we appealed the decision before the Supreme Court of Justice. The Supreme Court confirmed the first ruling in favor of DAP in an amount of Ch$500 million (US$0.8 million according to the observed exchange rate as of December 31, 2008). We appealed the amount fixed by the Supreme Court, contending that the amount was based on certain miscalculations and requested a final amount of Ch$650 million (US$1.0 million according to the observed exchange rate as of December 31, 2008). DAP simultaneously appealed and contended that the final amount should be Ch$2 billion (US$3.2 million according to the observed exchange rate as of December 31, 2008). While both appeal processes were pending, on November 20, 2008 DAP filed a suit in an ordinary court in order to obtain the payment of the total amount decided by the Supreme Court. On December 22, 2008, the parties reached an extrajudicial settlement which established that Lan Airlines and Lan Cargo would pay to DAP the total amount of Ch$650 million (US$1.0 according to the observed exchange rate as of December 31, 2008). This litigation has concluded.
In February 2006, the European Commission, in conjunction with the DOJ, initiated a global investigation of a large number of international cargo airlines among them LAN Cargo S.A., LANs cargo subsidiary for possible price fixing of cargo fuel surcharges and other fees in the European and United States air cargo markets. On December 26, 2007, the European competition authorities notified LAN Cargo S.A. and LAN of the initiation of proceedings against twenty-five cargo airlines, among them LAN Cargo S.A., for allegations of anti-competitive behavior in the airfreight business. Given the current stage of the European proceedings, it is not possible at this time to anticipate with any precision their outcome, although it is expected to be a lengthy judicial process. Notwithstanding the above, in the fourth quarter of 2007, LAN recorded, and maintains, a US$25.0 million reserve in relation with the European investigation.
The investigation by the DOJ prompted the filing of numerous civil class actions by freight forwarding and shipping companies against many airlines, including Lan Cargo and Lan Airlines, including fifty-four in the United States and four in Canada.
The cases filed in the United States were consolidated in the United States District Court, Eastern District of New York and the original complaint was subsequently amended to include additional airlines, including ABSA. On January 21, 2009 Lan Cargo announced that it had reached a plea agreement with the DOJ in relation to the DOJs ongoing investigation regarding price fixing of fuel surcharges and other fees for cargo shipments. Under the plea agreement, Lan Cargo agreed to pay a fine of US$88 million. In addition, ABSA reached a plea agreement with the DOJ and agreed to pay a fine of US$21 million. These amounts will be paid over a five-year payment schedule and have been recorded as of December 31, 2008 within Other current liabilities (US$19 million) and Other creditors (US$90 million).
On April 5, 2008, Brazilian authorities notified ABSA of the initiation of administrative proceedings before the Conselho Administrativo de Defesa Econômica against several cargo airlines and airline officers, among them ABSA, for allegations of anticompetitive practices regarding fuel surcharges in the air cargo business. Given the current stage of the proceedings, it is not possible at this time to anticipate with any precision their outcome, although it is expected to be a lengthy process. This investigation and the related proceedings do not imply that ABSA has been charged with or has engaged in any prohibited activity.
The New Zealand Commerce Commission initiated an investigation into potential anti-competitive activities in the international air cargo markets and requested information and documentation from LAN, which LAN duly submitted. On December 15, 2008, the New Zealand Commerce Commission announced that it would focus its investigations on ten airlines and excluded LAN from further investigation.
In June 2008, the Korean Fair Trade Commission notified LAN of an investigation into the air cargo industry and its non-compliance with the Monopoly Regulation and Fair Trade Act and requested information and documentation from LAN, which LAN duly submitted. Given the current stage of the investigation, it is not possible at this time to anticipate with any precision their outcome.
In January 2007 we announced that we had provided, through our wholly owned subsidiary, Atlantic Aviation Investments LLC (AAI), a total of US$17.1 million in financing to Brazilian company VRG LINHAS AEREAS S.A. (New Varig), convertible into shares of New Varig. On March 28, 2007, GOL announced that it was acquiring 100% of the equity participation in New Varig. Pursuant to the terms of the relevant loan agreements, upon the sale of New Varig to GOL, we sought repayment of the principal of the loans plus interest from Varig Logistica S.A. (VarigLog), the parent company of New Varig. VarigLog failed to respond to our demands for repayment and we subsequently filed a lawsuit in New York State court on August 29, 2007, seeking repayment of the outstanding principal plus interest. On October 10, 2008, the Court granted summary judgment in our favor for the full principal amount of the loans, US$17.1 million and entered a final judgment on December 1, 2008. The Court also held that AAI was entitled to collect the interest due under the loan agreement along with reasonable attorneys fees, which a special referee has recommended be approved by the Court in the amount of US$1.9 million. Final determination by the New York court is still pending. On March 3, 2009, VarigLog filed an insolvency proceeding (recuperação judicial) before the bankruptcy court in Brazil, and on March 31, 2009, VarigLog filed a Chapter 15 petition in bankruptcy court in Florida seeking recognition of its Brazilian filing. The Florida court has entered an order, based upon AAIs stipulation with VarigLog pursuant to which there would be no stay against the continuation and commencement of legal actions by AAI against VarigLog and any of its affiliates but AAI would not be able take any action against two discreet VarigLog assets located in the United States. AAI continues its enforcement efforts to recover the amounts owed to it by VarigLog under the loan agreements.
In accordance with Chilean law, Lan Airlines must distribute cash dividends equal to at least 30% of its annual consolidated net income calculated in accordance with Chilean GAAP, unless otherwise decided by a unanimous vote of the holders of all issued shares and unless and except to the extent it has accumulated losses. If there is no net income in a given year, Lan Airlines can elect but is not legally obligated to distribute dividends out of retained earnings. The board of directors may declare interim dividends out of profits earned during such interim period. Pursuant to Lan Airlines by-laws, the annual cash dividend is approved by the shareholders at the annual ordinary shareholders meeting held between February 1 and April 30 of the year following the year with respect to which the dividend is proposed. All outstanding common shares are entitled to share equally in all dividends declared by Lan Airlines.
Holders of ADSs will be entitled to receive dividends on the underlying common shares to the same extent as holders of common shares. Holders of ADRs on the applicable record dates will be entitled to receive dividends paid on the common shares represented by the ADSs evidenced by such ADRs. Dividends payable to holders of ADSs will be paid by us to the depositary in Chilean pesos and remitted by the depositary to such holders net of foreign currency conversion fees and expenses of the depositary and will be subject to Chilean withholding tax currently imposed at a rate of 35% (subject to credits in certain cases as described under Chilean TaxationCash Dividends and Other Distributions under Item 10). Owners of the ADSs will not be charged any dividend remittance fee by the depositary with respect to cash dividends.
Chilean law requires that holders of shares of Chilean companies that are not residents of Chile register as foreign investors under one of the foreign investment regimes established by Chilean law in order to have dividends, sale proceeds or other amounts with respect to their shares remitted outside Chile through the Formal Exchange Market (Mercado Cambiario Formal). Under our Foreign Investment Contract, the depositary, on behalf of ADS holders, will be granted access to the Formal Exchange Market to convert cash dividends from pesos to U.S. dollars and to pay such U.S. dollars to ADS holders outside Chile.
Stock Price History
The principal trading market for our common shares is the Santiago Stock Exchange. The common shares have been listed on the Santiago Stock Exchange under the symbol LAN since 1989, and the ADSs have been listed on The New York Stock Exchange under the symbol LFL since November 7, 1997. The common shares also trade on the Bolsa de Valores de Valparaíso and the Bolsa Electrónica de Chile. The outstanding ADSs are identified by the CUSIP number 501723100. The following table sets forth, for the periods indicated, the high and low closing sale prices on the Santiago Stock Exchange for the common shares and the high and low closing prices on The New York Stock Exchange for the common shares represented by ADSs. The information set forth in the table below reflects actual historical amounts and has not been restated in constant Chilean pesos.
Source: Santiago Stock Exchange and the New York Stock Exchange.
As of March 31, 2009, a total of 338,790,909 common shares were outstanding, including 31,439,633 common shares represented by ADSs.
The Chilean stock market, which is regulated by the SVS under Law 18,045 of October 22, 1981, as amended, which we refer to as the Securities Market Law, is one of the most developed among emerging markets, reflecting the particular economic history and development of Chile. The Chilean governments policy of privatizing state-owned companies, implemented during the 1980s, led to an expansion of private ownership of shares, resulting in an increase in the importance of stock markets. Privatization extended to the social security system, which was converted into a privately managed pension fund system. These pension funds have been allowed, subject to certain limitations, to invest in stocks and are currently major investors in the stock market. Some market participants, including pension fund administrators, are highly regulated with respect to investment and remuneration criteria, but the general market is less regulated than the U.S. market with respect to disclosure requirements and information usage.
The Santiago Stock Exchange is Chiles principal exchange and accounts for approximately 86.8% of securities traded in Chile. Approximately 12.8% of equity trading is conducted on the Chilean Electronic Stock Exchange, an electronic trading market created by banks and non-member brokerage houses. The remaining equity trading is conducted on the Valparaíso Stock Exchange.
Equities, closed-end funds, fixed-income securities, short-term and money market securities, gold and U.S. dollars are traded on the Santiago Stock Exchange. In 1991, the Santiago Stock Exchange initiated a futures market with two instruments: U.S. dollar futures and Selective Shares Price Index, or IPSA, futures. Securities are traded primarily through an open voice auction system; a firm offers system or daily auctions. Trading through the open voice system occurs on each business day between 9:30 a.m. to 4:30 p.m. The Santiago Stock Exchange has an electronic system of trade, called Telepregón, which operates continuously for stocks trading in high volumes from 9:30 a.m. to 4:30 p.m. The Chilean Electronic Stock Exchange operates continuously from 9:30 a.m. to 4:30 p.m. (or 5:30 p.m., depending on the period of the year) on each business day. In February 2000, the Santiago Stock Exchange Off-Shore Market began operations. In the Off-Shore Market, publicly offered foreign securities are traded and quoted in U.S. dollars.
Memorandum and Articles of Association
Set forth below is information concerning our share capital and a brief summary of certain significant provisions of our by-laws and Chilean law. This description contains all material information concerning the common shares but does not purport to be complete and is qualified in its entirety by reference to our by-laws, the Chilean Corporation Law and the Securities Market Law, each referred to below. For additional information regarding the common shares, reference is made to our by-laws, a copy of which is included as Exhibit 1.1 to this annual report on Form 20-F.
Organization and Register
Lan Airlines is a publicly held stock corporation (sociedad anónima abierta) incorporated under the laws of Chile. Lan Airlines was incorporated by a public deed dated December 30, 1983, an abstract of which was published in the Chilean Official Gazette (Diario Oficial de la República de Chile) No. 31.759 on December 31, 1983, and registered on page 20,341, No. 11,248 of the Chilean Real Estate and Commercial Registrar (Registro de Comercio del Conservador de Bienes Raices y Comercio de Santiago) for the year 1983. Our corporate purpose, as stated in our by-laws, is to provide a broad range of transportation and related services, as more fully set forth in Article Four thereof.
Shareholders rights in a Chilean company are generally governed by the companys by-laws. Article 22 of the Chilean Corporation Law states that the purchaser of shares of a company implicitly accepts its by-laws and any
agreements adopted at shareholders meetings. Additionally, the Chilean Corporation Law regulates the government and operation of corporations (sociedades anónimas, or S.A.) and provides for certain shareholder rights. Article 137 of the Chilean Corporation Law provides that the provisions of the Chilean Corporation Law take precedence over any contrary provision in a corporations by-laws. The Chilean Corporation Law and our by-laws also provide that all disputes arising among shareholders in their capacity as such or between us or our administrators and the shareholders may either be submitted to arbitration in Chile or to the courts of Chile at the election of the plaintiff initiating the action. Finally, Decree-Law 3500, which allows pension funds to invest in the stock of qualified corporations, indirectly affects corporate governance and prescribes certain rights of shareholders. The Chilean Corporation Law sets forth the rules and requirements for establishing publicly held corporations. Article 2 of the Chilean Corporation Law defines publicly held corporations as corporations:
The framework of the Chilean securities market is regulated by the Chilean exchange entity, the SVS, under the Securities Market Law and the Chilean Corporation Law, which imposes certain disclosure requirements, restricts insider trading, prohibits price manipulation and protects minority investors. Both the Chilean Corporation Law and the Securities Market Law state rules and requirements for establishing publicly held corporations. In particular, the Securities Market Law establishes requirements for public offerings, stock exchanges and brokers and outlines disclosure requirements for corporations that issue publicly offered securities.
Under Article 12 of the Securities Market Law and Circular 585 of the SVS, certain information regarding transactions in shares of publicly held corporations must be reported to the SVS and the Chilean stock exchanges on which the shares are listed. Since the ADRs are deemed to represent the shares underlying the ADSs, transactions in ADRs will be subject to those reporting requirements. Among other matters, beneficial owners of ADSs will be required to report to the SVS and the Chilean stock exchanges within two stock exchange business days:
In addition, majority shareholders must state in their report whether their purpose is to acquire control of the company or if they are making a financial investment.
Under Article 54 of the Securities Market Law and under SVS regulations, persons or entities that intend to acquire control, whether directly or indirectly, of a publicly traded company, must follow certain notice requirements, regardless of the acquisition vehicle or procedure or whether the acquisition will be made through direct subscriptions or private transactions. The potential acquiror must first send a written communication to the target corporation, any companies controlling or controlled by the target corporation, the SVS and the Chilean stock exchanges on which the securities are listed, stating, among other things, the person or entity purchasing or selling and the price and conditions of any negotiations.
The potential acquiror must also inform the public of its planned acquisition at least ten business days prior to the date on which the transaction is to close, and in any event, as soon as negotiations regarding the change of control begin (i.e., when information and documents concerning the target are delivered to the potential acquiror). Notice is made through a filing with the SVS, the relevant Chilean stock exchanges and any companies controlling or controlled by the target corporation and through a notice published in two Chilean newspapers, and must also state, among other things, the person or entity purchasing or selling and the price and conditions of any negotiations.
In addition to the foregoing, Article 54A of the Securities Market Law requires that within two business days of the completion of the transactions pursuant to which a person has acquired control of a publicly traded company, a notice shall be published in the same newspapers in which the notice referred to above was published and notices shall be sent to the same persons mentioned in the preceding paragraphs.
A beneficial owner of ADSs intending to acquire control of Lan Airlines will be subject to the foregoing reporting requirements.
The provisions of the aforementioned articles do not apply whenever the acquisition is being made through a tender or exchange offer.
Title XXV of the Securities Market Law on tender offers and SVS regulations provide that the following transactions shall be carried out through a tender offer:
Article 200 of the Securities Market Law prohibits any shareholder that has taken control of a publicly traded company from acquiring, for a period of twelve months from the date of the transaction that granted it control of the publicly traded company, a number of shares equal to or higher than 3.0% of the outstanding issued shares of the target without making a tender offer at a price per share not lower than the price paid at the time of taking control. Should the acquisition from the other shareholders of the company be made on the floor of a stock exchange and on a pro rata basis, the controlling shareholder may purchase a higher percentage of shares, if so permitted by the regulations of the stock exchange.
Title XV of the Securities Market Law sets forth the basis for determining what constitutes a controlling power, a direct holding and a related party.
Under Chilean law, the shareholders of a company, acting at an extraordinary shareholders meeting, have the power to authorize an increase in the companys share capital. When an investor subscribes for issued shares, the shares are registered in that investors name, even without payment therefore, and the investor is treated as a shareholder for all purposes except with regard to receipt of dividends and return of capital, provided that the shareholders may, by amending the by-laws, also grant the right to receive dividends of distribution of capital. The investor becomes eligible to receive dividends once it has paid for the shares, or, if it has paid for only a portion of such shares, it is entitled to receive a corresponding pro rata portion of the dividends declared with respect to such shares, unless the companys by-laws provide otherwise. If an investor does not pay for shares for which it has subscribed on or prior to the date agreed upon for payment, the company is entitled under Chilean law to auction the shares on the appropriate stock exchange, and it has a cause of action against the investor to recover the difference between the subscription price and the price received for the sale of those shares at auction. However, until such shares are sold at auction, the investor continues to exercise all the rights of a shareholder (except the right to receive dividends and return of capital). Shares issued but not paid for within the period determined by the extraordinary shareholders meeting for their payment (which in any case cannot exceed three years from the date of such shareholders meeting which authorizes the increase in capital) will be canceled and will no longer be available for issuance by us. Fully paid shares are not subject to further calls or assessments or to liabilities of Lan Airlines.
As of March 31, 2009, our share capital consisted of 338,790,909 common shares, all of which were subscribed and fully paid. Chilean law recognizes the right to issue common and preferred shares. To date, we have issued and are authorized by our shareholders to issue only common shares. Each share of stock is entitled to one vote.
Preemptive Rights and Increases in Share Capital
The Chilean Corporation Law requires Chilean companies to offer existing shareholders the right to purchase a sufficient number of shares to maintain their existing percentage of ownership in a company whenever that company issues new shares for cash. Under this requirement, any preemptive rights will be offered by us to the depositary as the registered owner of the common shares underlying the ADSs, but holders of ADSs and shareholders located in the United States will not be allowed to exercise preemptive rights with respect to new issuances of shares by us unless a registration statement under the Securities Act is effective with respect to those common shares or an exemption from the registration requirements thereunder is available.
We intend to evaluate at the time of any preemptive rights offering the costs and potential liabilities associated with the preparation and filing of a registration statement with the Securities and Exchange Commission, as well as the indirect benefits of enabling the exercise by the holders of ADSs and shareholders located in the United States of preemptive rights and any other factors we consider appropriate at the time. No assurances can be given that any registration statement would be filed. If preemptive rights are not made available to ADS holders, the depositary may sell those holders preemptive rights and distribute the proceeds thereof if a secondary market for such rights exists and a premium can be recognized over the cost of such sale. In the event that the depositary does not sell such rights at a premium over the cost of any such sale, all or certain holders of ADRs may receive no value for the preemptive rights. The inability of holders of ADSs to exercise preemptive rights in respect of common shares underlying their ADSs could result in a change in their percentage ownership of common shares following a preemptive rights offering.
Under Chilean law, preemptive rights are exercisable, freely transferable or waived by shareholders during a thirty-day period commencing upon publication of the official notice announcing the start of the preemptive rights period in the newspaper designated by the shareholders. The preemptive right of the shareholders is the pro rata amount of the shares registered in their name in the shareholders registry as of the fifth business day prior to the date of publication of the notice announcing the start of the preemptive rights period. During such thirty-day period (except for shares as to which preemptive rights have been waived), Chilean companies are not permitted to offer any newly issued common shares for sale to third-parties. For that thirty-day period and an additional thirty-day period, Chilean publicly held corporations are not permitted to offer any unsubscribed common shares for sale to third-parties on terms that are more favorable to the purchaser than those offered to shareholders. At the end of such additional thirty-day period, Chilean publicly held corporations are authorized to sell non-subscribed shares to third-parties on any terms, provided they are sold on a Chilean stock exchange.
Our by-laws provide for a board of nine directors. Compensation to be paid to directors must be approved by vote at the annual shareholders meeting. We hold elections for all positions on the board of directors every two years. Under our by-laws, directors are elected by cumulative voting. Each shareholder has one vote per share and may cast all of his or her votes in favor of one nominee or may apportion his or her votes among any number of nominees. These voting provisions currently ensure that a shareholder owning more than 10% of our outstanding shares is able to elect at least one representative to our board of directors.
Under the Chilean Corporation Law, transactions in which a director is interested (including a transaction in which a director has an indirect interest) must be conducted on an arms-length basis and must satisfy certain disclosure requirements. These transactions include transactions involving a directors spouse or close relatives, transactions involving other companies on whose board such director also serves or transactions with other companies where the director controls 10% of such company (directly or indirectly). Corporations may enter into transactions in which a director is interested if the transaction has been previously approved by the board of directors (which must be disclosed at the next shareholders meeting) and is consistent with standards of fairness similar to those that normally prevail in the market. Transactions which do not meet these conditions are valid and enforceable, but each director who approved the transaction is jointly and severally liable for damages suffered by the company, the shareholders or any interested third-parties, and the director who directly or indirectly benefits from the transaction must pay all benefits received from such transaction to the corporation. The directors are also subject to fines and administrative sanctions.
Whenever a transaction in which a director is interested exceeds 1% of the net worth of the company and exceeds the equivalent of 2,000 UF (approximately US$78,000 as of the date of this annual report) or whenever such a transaction exceeds 20,000 UF, the board of directors of the company must determine whether the transaction
complies with arms-length conditions similar to those prevailing in the market. If the board of directors is unable to determine those conditions, the board, without the vote of the interested director, may approve or reject the transaction or may appoint two independent experts to provide an opinion. The experts reports must indicate the terms of the transaction and in the case of non-cash assets, must indicate the planned method of payment. Experts valuation reports must be made available to the shareholders and to the board of directors for a period of twenty business days. The board of directors may decide to approve or reject the proposed transaction only after this twenty-day period has expired. If shareholders representing 5% of the voting shares determine, within the twenty-day period, that the transaction is not favorable to the corporations interests or that the reports of the experts are substantially different, those shareholders may require the board of directors to call an extraordinary shareholders meeting. Approval of the transaction then requires the affirmative vote of two-thirds of the voting shares of the company.
Shareholders Meetings and Voting Rights
The Chilean Corporation Law requires that an ordinary annual meeting of shareholders be held within the first four months of each year (generally they are held in April, but in any case following the preparation of our financial statements, including the report of our auditors, for the previous fiscal year). Lan Airlines by-laws further provide that the ordinary annual meeting of shareholders must take place between February 1 and April 30. The shareholders at the ordinary annual meeting approve the annual financial statements, including the report of our auditors, the annual report, the dividend policy and the final dividend on the prior years profits, elect the board of directors (in our case, every two years or earlier if a vacancy occurs) and approve any other matter that does not require an extraordinary shareholders meeting. The most recent ordinary annual meeting of our shareholders was held on April 17, 2009. Extraordinary shareholders meetings may be called by the board of directors, if deemed appropriate, and ordinary or extraordinary shareholders meetings must be called by the board of directors when requested by shareholders representing at least 10% of the issued voting shares or by the SVS.
Notice to convene the ordinary annual meeting or an extraordinary meeting is given by means of three notices which must be published in a newspaper of our corporate domicile (currently Santiago, Chile) designated by the shareholders at their annual meeting and, if the shareholders fail to make such designation, the notice must be published in the Chilean Official Gazette pursuant to legal requirements. The first notice must be published not less than fifteen days and not more than twenty days in advance of the scheduled meeting. Notice also must be mailed not less than fifteen days in advance of the meeting to each shareholder and to the SVS and the Chilean stock exchanges. Currently, we publish our official notice in the newspaper La Tercera.
The quorum for a shareholders meeting is established by the presence, in person or by proxy, of shareholders representing a majority of our issued common shares. If a quorum is not present, the meeting can be reconvened, and at a second meeting the shareholders present are deemed to constitute a quorum regardless of the percentage of the common shares that they represent.
Only shareholders registered with us on the fifth business day prior to the date of a meeting are entitled to attend and vote their shares. A shareholder may appoint another individual (who need not be a shareholder) as his proxy to attend and vote on his behalf. Proxies addressed to us that do not designate a person to exercise the proxy are taken into account in order to determine if there is a sufficient quorum to hold the meeting, but the shares represented thereby are not entitled to vote at the meeting. Every shareholder entitled to attend and vote at a shareholders meeting has one vote for every share subscribed.
The following matters can only be considered at an extraordinary shareholders meeting:
The matters referred to in the first four items listed above may only be approved at a meeting held before a notary public, who shall certify that the minutes are a true record of the events and resolutions of the meeting.
The by-laws establish that resolutions are passed at shareholders meetings by the affirmative vote of an absolute majority of those voting shares present or represented at the meeting. However, under the Chilean Corporation Law, the vote of a two-thirds majority of the outstanding voting shares is required to approve any of the following actions:
Amendments to the by-laws that have the effect of establishing, modifying or eliminating any special rights pertaining to any series of shares require the consenting vote of holders of two-thirds of the shares of the affected series.
In general, Chilean law does not require a publicly held corporation to provide the level and type of information that the U.S. securities laws require a reporting company to provide to its shareholders in connection with a solicitation of proxies. However, shareholders are entitled to examine the books of the company and its subsidiaries within the fifteen-day period before the scheduled meeting. No later than the first notice summoning an ordinary shareholders meeting, the board of directors of a publicly held corporation shall send to every shareholder a copy of the annual report and the financial statements of the company. However, the SVS may authorize companies that have a large number of shareholders to limit the sending of such documents only to those shareholders who have a number of shares exceeding a certain number, and, in any case, to any shareholder that has required of the company such sending. Shareholders who do not fall into this category but who request it must be sent a copy of our annual report. In addition to these requirements, we regularly have provided, and currently intend to continue to provide, together with the notice of shareholders meeting, a proposal for the final annual dividend for shareholder approval. See Dividend and Liquidation Rights below.
The Chilean Corporation Law provides that, whenever shareholders representing 10% or more of the issued voting shares so request, a Chilean companys annual report must include such shareholders comments and proposal in relation to the companys affairs. Similarly, the Chilean Corporation Law provides that whenever the
board of directors of a publicly held corporation convenes an ordinary meeting of the shareholders and solicits proxies for that meeting, or distributes information supporting its decisions or other similar material, it is obligated to include as an annex to its annual report any pertinent comments and proposals that may have been made by shareholders owning 10% or more of the companys voting shares who have requested that such comments and proposals be included.
Dividend and Liquidation Rights
In accordance with Chilean Law, Lan Airlines must distribute an annual cash dividend equal to at least 30% of its annual net income calculated in accordance with Chilean GAAP, unless otherwise decided by a unanimous vote of the holders of all issued shares, and unless and except to the extent it has accumulated losses. If there is no net income in a given year, Lan Airlines can elect but is not legally obligated to distribute dividends out of retained earnings. All outstanding common shares are entitled to share equally in all dividends declared by Lan Airlines.
Lan Airlines may grant an option to its shareholders to receive any dividend in excess of 30% of net income in cash, in its own shares or in shares of publicly held corporations held by it. Shareholders who do not expressly elect to receive a dividend other than in cash are legally presumed to have decided to receive the dividend in cash. A U.S. holder of ADSs may, in the absence of an effective registration statement under the Securities Act or an available exemption from the registration requirement thereunder, effectively be required to receive a dividend in cash. See Preemptive Rights and Increases in Share Capital above.
Dividends that are declared but not paid within the appropriate time period set forth in the Chilean Corporation Law (as to minimum dividends, thirty days after declaration; as to additional dividends, the date set for payment at the time of declaration) are adjusted to reflect the change in the value of the UF. The UF is a daily indexed, Chilean peso-denominated accounting unit designed to discount the effect of Chilean inflation and it is based on the previous months inflation rate as officially determined. Such dividends also accrue interest at the then-prevailing rate for UF-denominated deposits during such period. The right to receive a dividend lapses if it is not claimed within five years from the date such dividend is payable. After that period, the amount not claimed is given to a non-profit organization, the Junta Nacional de Cuerpos de Bomberos de Chile, or the National Corporation of Firefighters.
In the event of Lan Airlines liquidation, the holders of fully paid common shares would participate pro rata in the distribution of assets remaining after payment of all creditors. Holders of shares not fully paid will participate in such distribution in proportion to the amount paid.
Approval of Financial Statements
The board of directors is required to submit our consolidated financial statements to the shareholders for their approval at the annual ordinary shareholders meeting. If the shareholders reject the financial statements, the board of directors must submit new financial statements not later than sixty days from the date of that meeting. If the shareholders reject the new financial statements, the entire board of directors is deemed removed from office and a new board is elected at the same meeting. Directors who approved such financial statements are disqualified for re-election for the ensuing period.
Right of Dissenting Shareholders to Tender Their Shares
The Chilean Corporation Law provides that, upon the adoption at an extraordinary meeting of shareholders of any of the resolutions enumerated below, dissenting shareholders acquire the right to withdraw and to compel the company to repurchase their shares, subject to the fulfillment of certain terms and conditions. However, such right shall be suspended if we are declared bankrupt or are subject to a creditors agreement pursuant to Title XII of Book IV of the Commerce Code. In the case of holders of ADRs, however, in order to exercise such rights, holders of ADRs would be required to first withdraw the common shares represented by the ADRs pursuant to the terms of the deposit agreement. Such holders of ADRs would need to perfect the withdrawal of the common shares on or before the fifth business day prior to the date of the meeting.
Dissenting shareholders are defined as those who attend a shareholders meeting and vote against a resolution which results in the withdrawal right, or, if absent at such a meeting, those who state in writing to the company their opposition to such resolution within the following thirty days. Dissenting shareholders must perfect their withdrawal rights by tendering their stock to the company within thirty days after adoption of the resolution.
The price paid to a dissenting shareholder of a publicly held corporation is the weighted average of the sales prices for the shares as reported on the Chilean stock exchanges on which the shares are quoted for the two-month period preceding the event giving rise to the withdrawal right. If, because of the volume, frequency, number and diversity of the buyers and sellers, the SVS determines that the shares are not shares actively traded on a stock exchange (acciones de transaccion bursátil), the price paid to the dissenting shareholder is the book value. Book value for this purpose equals paid capital plus reserves and profits, less losses, divided by the total number of subscribed shares (whether entirely or partially paid). For the purpose of making this calculation, the last annual balance sheet is used and adjusted to reflect inflation up to the date of the shareholders meeting that gave rise to the withdrawal right.
The resolutions that result in a shareholders right to withdraw are the following:
In addition, shareholders of publicly held corporations have the right to withdraw if a person acquires two-thirds or more of the outstanding shares of such corporation with the right to vote (except as a result of other shareholders not having subscribed and paid a capital increase) and does not make a tender offer for the remaining shares within thirty days after acquisition.
Under Article 69(bis) of the Chilean Corporation Law, the right to withdraw also is granted to shareholders (other than pension funds that administer private pension plans under the national pension law), under certain terms and conditions, if a company were to become controlled by the Chilean government, directly or through any of its agencies, and if two independent rating agencies downgrade the rating of its stock from first class because of certain actions specified in Article 69(bis) undertaken by the company or the Chilean government that affect negatively and substantially the earnings of the company. Shareholders must perfect their withdrawal rights by tendering their shares to the company within thirty days of the date of the publication of the new rating by two independent rating agencies. If the withdrawal right is exercised by a shareholder invoking Article 69(bis), the price paid to the dissenting shareholder shall be the weighted average of the sales price for the shares as reported on the stock exchanges on which the companys shares are quoted for the six-month period preceding the publication of the new rating by two independent rating agencies. If, as previously described, the SVS determines that the shares are not actively traded on a stock exchange, the price shall be the book value calculated as described above.
There is no legal precedent as to whether a shareholder that has voted both for and against a proposal (such as the depositary) may exercise withdrawal rights with respect to the shares voted against the proposal. As such, there is doubt as to whether holders of ADRs who have not surrendered their ADRs and withdrawn common shares on or before the fifth business day prior to the shareholder meeting will be able to exercise withdrawal rights either directly or through the depositary with respect to the shares represented by ADRs. Under the provisions of the deposit agreement the depositary will not exercise these withdrawal rights.
Registration and Transfers
The Depósito Central de Valores, or the DCV, acts as Lan Airlines registration agent. In the case of jointly owned common shares, an attorney-in-fact must be appointed to represent the joint owners in dealings with us.
On March 31, 2006, we entered into supplemental agreement No. 22, to purchase agreement No. 2126 dated as of January 30, 1998 (Purchase Agreement No. 2126), whereby we agreed to purchase a total of three Boeing 767-300 aircraft. Five passenger aircraft were delivered in 2008 pursuant to Purchase Agreement No. 2126. We had the option to convert some of the orders from the passenger version to the freighter version or vice versa with certain notice. The estimated gross value (at list prices) of the Boeing aircraft for which we had firm commitments to take delivery under this contract was US$0.5 billion.
On December 14, 2006, we entered into a supplemental agreement No. 23 to purchase agreement No. 2126 dated as of January 30, 1998 (Purchase Agreement No. 2126) for the acquisition of three additional Boeing 767-300 passenger aircraft. Delivery is scheduled to take place in 2009 and 2010.
On March 6, 2007, we entered into amendment No. 3 to the First A340 purchase agreement with Airbus S.A.S. for the cancellation of two A340 aircraft, and amendment No. 3 to the Second A320-Family purchase agreement with Airbus S.A.S. for the conversion of fifteen options to purchase aircraft into firm orders. The net increase in capital expenditures related to these agreements is US$315 million.
On April 30, 2007, we also entered into an Aircraft Lease Common Terms Agreement with GE Commercial Aviation Services Limited and two Aircraft Lease Agreements with Wells Fargo Bank Northwest N.A., as owner trustee, for the lease of two Boeing B777-200LRF aircraft.
On July 3, 2007, we entered into a purchase agreement with the Boeing Company for the acquisition of two Boeing 777-Freighter aircraft. Delivery is scheduled to take place in 2011 and 2012.
On October 29, 2007, we entered into a purchase agreement with the Boeing Company for the acquisition of twenty-six Boeing 787-8 and 787-9 aircraft to be delivered between 2012 and 2016. This purchase agreement provides us with the option of purchasing ten additional aircraft to be delivered in 2017 and 2018.
Finally, on November 10, 2008, we entered into a supplemental agreement to the purchase agreement entered into with the Boeing Company for the acquisition of four additional Boeing 767-300 passenger aircraft. Delivery is scheduled to take place in 2012. The estimated gross value (at list prices) of these aircraft is US$636 million.
For more information, see Information on the CompanyFleetFleet Leasing and Financing Arrangements under Item 4.
Foreign Investment and Exchange Controls in Chile
The Central Bank of Chile is responsible, among other things, for monetary policies and exchange controls in Chile. Equity investments, including investments in shares of stock by persons who are non-Chilean residents, have been generally subject in the past to various exchange control regulations restricting the repatriation of their investments and the earnings thereon.
Article 47 of the Central Bank Act and Chapter XXVI of the Central Bank Foreign Exchange Regulations regulated the foreign exchange aspects of the issuance of ADSs by a Chilean company until April 2001. According to Chapter XXVI, the Central Bank of Chile and the depositary had to enter into an agreement in order to gain access to the formal exchange market. The issuers of the shares underlying the ADSs and the custodian could also be parties to these agreements and we are party to such agreement.
On April 16, 2001, the Central Bank of Chile agreed that, effective April 19, 2001:
The main objective of these amendments, as declared by the Central Bank of Chile, is to facilitate movement of capital in and out of Chile and to encourage foreign investment.
In connection with the change in policy, the Central Bank of Chile eliminated the following restrictions:
Under the new regulations, only the following limitations apply to these operations:
The Central Bank of Chile also eliminated Chapter XXVI of the Compendium of Foreign Exchange Regulations, which regulated the establishment of an ADR facility by a Chilean company. Pursuant to the new rules, it is no longer necessary to seek the Central Bank of Chiles prior approval in order to establish an ADR facility nor to enter into a foreign investment contract with the Central Bank of Chile. The establishment of an ADR facility is now regarded as an ordinary foreign investment, and simply requires that the Central Bank of Chile be informed of the transaction pursuant to Chapter XIV of the Compendium of Foreign Exchange Regulations and that the transaction be conducted exclusively through the Formal Exchange Market.
However, all contracts executed under the provisions of Chapter XXVI (including the foreign investment contract among Lan Airlines, the Central Bank of Chile and the ADS depositary, or the Foreign Investment Contract), remain in full force and effect and continue to be governed by the provisions, and continue to be subject to the restrictions, set forth in Chapter XXVI at the time of its abrogation. Our Foreign Investment Contract guarantees ADS investors access to the Formal Exchange Market to convert amounts from Chilean pesos into U.S. dollars and repatriate amounts received with respect to deposited common shares or common shares withdrawn from deposit or surrender of ADRs (including amounts received as cash dividends and proceeds from the sale in Chile of the underlying common shares and any rights arising from them).
The guarantee of access to the Formal Exchange Market under the Foreign Investment Contract requires compliance of the following conditions:
The following is a summary of material provisions of the Foreign Investment Contract, a form of which was filed as an exhibit to the registration statement on Form F-1 (File No. 333-7750) that we filed on October 10, 1997 in connection with our November 6, 1997 offering. This summary is not complete and is qualified in its entirety by reference to Chapter XXVI and the Foreign Investment Contract.
Under Chapter XXVI and the Foreign Investment Contract, the Central Bank of Chile agreed to grant to the depositary, on behalf of ADR holders, and to any investor not residing or domiciled in Chile who withdraws common shares upon surrender of ADRs, access to the Formal Exchange Market to convert Chilean pesos into U.S. dollars (and to remit those dollars outside Chile) in respect of common shares represented by ADSs or withdrawn shares, including amounts received as: