Canadian Airlines and Oneworld

Head Table Guests

Catherine Steele, Vice-President (Toronto) and Partner, Gervais Gagnon Covington & Associates and a Director, The Empire Club of Canada; Reverend Kim Beard, Rector, Christ Church Brampton and a Director, The Empire Club of Canada; Elaine Chan, Grade 12 Student; Allan Tremblay, Director, International Markets, Canadian Airlines International; Charles S. Coffey, Executive Vice-President, Business Banking, Royal Bank; Malcolm Freeman, Vice-President and General Manager for Canada, British Airways; John Smith, Senior Manager, Global Private Banking, Royal Bank of Canada and President, British Canadian Chamber of Trade and Commerce; and Gareth Seltzer, Vice-President, Private Wealth Management, Guardian Capital Inc. and Immediate Past President, The Empire Club of Canada.

Introduction by George L. Cooke

Our guest speaker today is Mr. Kevin Benson, the President and Chief Executive Officer of Canadian Airlines International Ltd; a position to which he was appointed in 1996 after eight months serving in the role of Senior Vice-President and Chief Financial Officer.

In yesterday's news, the caption "one world" appeared. Many readers, I'm sure, initially thought "but we have only one world"--and we in fact do! But as we listened or read on, we learned that "one world" is an alliance of five airline carriers intended to offer more service while improving cost control. The announcement appears to have been met with accolades and scepticism, depending on the source. I am certain that Mr. Benson is not a sceptic, and will leave today's lunch with all of us firmly in his camp.

Mr. Benson was born in South Africa and immigrated to Canada in 1977. He is a chartered accountant and has an extensive financial and operating background. Prior to joining Canadian Airlines Mr. Benson was Chief Executive Officer of Trizec Corporation. He is also a member of the Boards of Directors of Manulife Financial and The Jim Pattison Group, Inc.

He and his wife, Ann, live in Calgary.

A long-time fan of anything involving speed, Mr. Benson has interests in Indycar and TransAm motor racing teams, is a keen skier and held a private pilot's license for many years.

He also holds at least one other very important distinction--that of being the only speaker to our Club last year who has agreed to an immediate return engagement. Mr. Benson, its just like the Airlines--customer retention matters! Welcome!

Kevin Benson

Good afternoon and thank you for joining me. It is 11 months since I stood here in front of the Empire Club. I take it as a good sign that you asked me back. I am certainly glad to be here as the alternative is not good.

The past year has been a busy one as we chased the goals I described to you in October of last year. During that time we also had to fight the effects of a chill caused by the Asian flu, but I feel we made good progress.

Now we are nearing the half-way mark of our four-year plan and today I would like to outline our progress to date, talk about the exciting news announced on Monday and discuss plans for our next year of the plan. I hope you will leave with some of the excitement we feel as we move from the always painful cost-cutting phase of our plan to the more aggressive growth mode.

In 1996 we were faced with a number of challenges. It was essential that we sorted out our operational difficulties and developed a network that was sustainable in the long term. We also had to restore credibility and show that this was not another short-term plan to buy time, but one that fixed the fundamentals.

Step one was to find the solution that would restore the network while at the same time ending our history of financially and emotionally crippling losses. We developed confidence from our relationship with American Airlines from both the traffic we delivered to each other's system as well as from our ability to offer American Airlines a north-west gateway to Asia. We also recognised the strength of the alliance network that we had developed over the years--a network that included British Airways, Qantas and Japan Airlines, some of the world's most respected and successful airlines.

But we first had to improve the bottom line by $180-200 million. Planning models showed that the network changes would improve earnings over time, but in the first year, most of the improvement would have to come from cost reductions.

We laid out a four-year plan that required support from employees, governments and AMR Corporation. With that support, we achieved the objective of break-even in 1997 despite substantial weakening of the top markets of Japan and Hong Kong.

So our key focus in 1998 and 1999 is revenue growth, a big challenge when so few resources have been focused on marketing in the past years. It was here that the changes to the network were key. In 1997 we overhauled the network with a number of underlying objectives:

?Every route had to be profitable or contributory to the network as a whole;

?We had to end our reliance on the Japan and Hong Kong markets;

?We had to look for opportunities to strengthen our Vancouver and Toronto hubs;

?We wanted to optimise our relationship with American Airlines by focusing on trans-border flying into its hubs;

?We had to do the same with British Airways by concentrating European flying into Heathrow while cancelling losing routes to France and Germany;

?We had to build Vancouver into a primary gateway to Asia for American Airlines.

Our strategy was to win a bigger share of the U.S. market, using our ties with American as well as with Japan Airlines and Qantas.

We had a valuable opportunity because while we carry about 33 per cent of Canada/Asia travel, we have less than 1 per cent of the U.S./Asia market, one that is six to eight times that of Canada. Picking up only 20 per cent of American Airlines' potential share would more than double the current passenger numbers and each 1 per cent gained is worth approximately $30 million in revenue.

This objective was facilitated by Vancouver's location on the great circle routes that aircraft fly to Asia. Even flights from Los Angeles and San Francisco to Asia fly north past Vancouver as they head for their destinations. This means that from many cities in the U.S. without direct flights to Asia, travelling over Vancouver can result in savings in travel time of between one and three hours versus other West Coast gateways.

So we redid our network by concentrating on building routes into the key cities of Toronto and Vancouver and also on flowing trans-border traffic through Vancouver to Asia. Our focus was those U.S. cities which had good traffic flows to Asia but no direct or effective service and on cities where Canadian or American Airlines were traditionally strong allowing faster growth on new routes. This meant we had to have additional capacity on routes to New York, Chicago, Miami, Dallas, Raleigh-Durham, and Boston and we are looking at a number of other opportunities in the East for start up in 1999. In the West we have added routes to Los Angeles, San Francisco, Dallas, Chicago, Boston, San Diego, San Jose, Las Vegas, Portland and Seattle. The results show that flow traffic is growing, and we are being recognised as a competitive alternative for U.S. travellers to Asia.

We are adding new routes to Asia to supplement the network. In the next few months we will be starting direct flights to Shanghai with Osaka to follow in the new year.

In addition we worked closely with British Airways to optimise service to Heathrow from all points in Canada. In June we started day liner service to Heathrow from Toronto and a new service to Heathrow from Ottawa, both in co-operation with British Airways.

The U.S. markets are starting to see us as an alternative to Asia and the Vancouver hub is starting to work as hoped. The number of our U.S. passengers connecting through Vancouver is up from 15,000 in 1995 to over 100,000 this year.

As we look at 1998, a number of assumptions have proved sound. Our relationship with British Airways has meant great success on U.K. routes, loads higher than ever and the yield up. The Beijing and Taiwan routes have built up very well (Beijing up 31 per cent January to July 98 and Taipei up 22 per cent even though the overall market was flat). Hong Kong mounted a steady comeback after a very slow 1997, but the yield was thin with heavy discounting by a number of carriers.

But a few things did not work out as planned. The loss of the American Airlines code on trans-border flights until January '99 hurt our loads and yield. (I am happy to tell you that American Airlines and its pilots have done a deal to see dual codes back on all routes by January 1 next year.) The benefit of lower fuel prices was lost to a weaker Canadian dollar as fuel, spare parts, many aircraft leases and third-party services are priced in U.S. dollars. The Japan traffic was down 13 per cent from January to July, '98 versus '97, turning what was the most profitable route into break-even for '98.

However, the airline now is much more resilient and is able to weather setbacks. We draw confidence from the fact that changes made as part of our four-year plan are effective and delivering results. Some ongoing tweaking is required as conditions change, but the path we are on is fundamentally sound. We will end year two pretty close to where we wanted to be. We know that our focus must be the cautious growth of the network to win back our fair share of high-yield traffic by improving the age and quality of our fleet and combining this with superior service.

We appreciate the help given to us by a competitor. Some of you may not be aware that one of our national carriers recently faced a work stoppage. It was a challenge for us to fill the vacuum left with a loss of over 50-per-cent domestic capacity on one of the busiest weekends of the year. It was a challenge employees took on with enthusiasm. They volunteered to work through the holidays, and the absentee rate fell lower than usual and more than 300 extra flights were completed in two weeks of stoppage (There was not one sick call on the holiday Monday). I actually believe Air Canada should send us a cheque for getting their pilots to see reason quicker than the negotiating committee.

The reality is that short-term work stoppages like these are not really a financial windfall as revenue gains made were more than offset by the following "come to mother" sale mounted by the carrier--one that of course we matched with a sale that will win your heart. We hope that our customers remember the different level of service and return as long-term supporters and we are ready to pick up slack again when the flight attendants go out.

In the interim we are moving ahead with a number of other developments--and one is of particular importance. Providing a comprehensive network is complicated by the fact that Canada is a big country with a relatively small population base. Yet the business traveller expects regular service to all parts of the world. Alliances are the only realistic way to meet that requirement at competitive cost which is why Monday's announcement of oneworld, is so important to us.

This is a full interactive relationship of five carriers--some airlines that we have worked with for many years, like, American Airlines, British Airways, Qantas but also a new name to our group, Cathay Pacific. This is not a specific route, code-sharing arrangement, but a relationship that makes travel for all our customers seamless around the world. Oneworld will offer customers access to the networks of all five airlines. It is much more than a frequent flyer or lounge-access programme. It is also more than another airline recognising our premium customers. It is about five airlines seeing premium customers of all five as their own--offering interactive technology and real-time access to each others' systems to book, track or facilitate travel arrangements anywhere on any one of the five. It has taken a few years to develop software to the point this can occur and will take a few more months to train employees but by the spring of next year, it will be fully operational around the world.

We have seen benefits of our relationship with American Airlines and British Airways and know that as the smallest of the five, we stand to gain the most from oneworld. Despite the fact that our relationship with American Airlines is only three years old and that with British Airways is less than two, operations are deeply linked. Now we code-share 9100 flights a week with American Airlines and 650 with British Airways. Annually we put 600,000 passengers on American Airlines' planes and they put over 750,000 on ours. We also put 44,000 per year onto British Airways and they put 72,000 onto us. We see this growing still more with the addition of Cathay Pacific and the growth of our relationship with Qantas from a single route of Vancouver to Sydney to every route either of us fly. A number of carriers have expressed interest in joining oneworld and we expect to see membership grow in the next year.

We are working on a number of other relationships too. We are close to completion of a plan with Japan Airlines that will see shared codes on all routes to Japan. Open skies between U.S.A. and Japan will also allow American Airlines' code to go onto all Canada/Japan flights giving three strong points of sale. And we are not finished. We are working on a couple of other North American relationships to add to our customer's options.

To meet the need for this extra capacity and to develop our domestic network, we have started to grow our fleet again. In the past 16 months we have added 12 F28s, 55seat business jets used to open and grow new routes. The next step is to add bigger jets. We must review our fleet plan with the objective of reducing the number of types operated from five to four. We see A320s and B767s as part of a long-term fleet plan and so we are focusing on these for now. We are also looking for five to seven-year-old aircraft freed up from the slow down in Asia, as often there is an opportunity to do good deals for Canadian.

At the same time we are fine-tuning operations in Vancouver to improve options and connections for travellers across Canada. We will be adding a second international hub there and significantly improving trans-border and domestic flights throughout the day. We will give more options to anyone travelling between North America and points we serve in Asia. This will allow us to continue to build transcontinental service and connections into Toronto and Ottawa.

We then turned our attention to our onboard product. We responded to customers' comments by changing our

business class seats on all A320s to state-of-the-art "millennium" seats. After months of research and testing we will be introducing a new food service to all flights of three hours or more in December. We are going to try to see what can be done in the air when the best chefs in the country get together. We will also be adding computer power to all seats in every aircraft in the fleet and offering alternative food service when work takes priority on the trip. Behind the scenes, we've increased training, improved support equipment and are developing new customer recognition software--all focused on understanding and then exceeding customer expectations.

We know that there is always concern re the airline's ability to stay the course--to have sufficient cash reserves to cover the peaks and valleys in what is a very cyclical industry. In June we completed US$175-million secured financing and six weeks ago completed unsecured financing for another US$100 million. We will close the year with cash on hand in excess of $400 million. We had hoped to do an equity issue some time this year, but at present prices and in this market, this is unlikely. We are also comfortable that liquidity now is more than adequate.

So by the end of 1998 we can be confident that we can maintain progress in the year to come, but know the need to be cautious and wary of some challenges. We can see signs that North American economies are feeling the effects of the Japan and Russian economic collapses and believe that in the next year this impact will also be felt to a much greater extent than to date.

We will plan growth carefully and draw comfort from the fact that Canadian has one of the lowest operating costs of any airline in North America. We know we have got a way to go but we also know that when we look back, we have come a long way from the dark days of 1996. To our faithful customers in the audience, thank you for your confidence and support. To those who have not tried us, why not spoil yourself on your next trip?

Thank you.

The appreciation of the meeting was expressed by John Smith, Senior Manager, Global Private Banking, Royal Bank of Canada and President, British Canadian Chamber of Trade and Commerce.