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INDUSTRY REVIEW IVC

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InterVISTAS Consulting Inc. July 2003


THE EMERGING AIR C ANADA BUSINESS PLAN: SUSTAINABLE OR IS A RETURN TO FAILURE IN THE STAR(S)? 9 July 2003

The key: The fleet plan. Recently, the Globe and Mail released what they claim is Air Canada’s post-restructuring fleet plan. The fleet plan is generally a key to a carrier’s future business performance. For example, if it contains a faster expansion of capacity than market demand, it implies a decline in yield. This is fine, so long as the new fleet plan uses aircraft with lower unit costs. Lower costs per seat sold might be able to support lower yields. Conversely, if the fleet reduces capacity, or grows less than demand, then yields will increase, and a business plan with smaller but higher unit cost aircraft might be supportable. The fleet plan also indicates which markets the carrier intends to expand in the future.

Michael Tretheway Vice President & Chief Economist

So what about Air Canada’s fleet plan? The graph shows the fleet plan released by the Globe and Mail. As you can see, the plan calls for a somewhat smaller fleet at the end of 2003, versus what AC had prior to entering bankruptcy protection. Beginning in 2004, the fleet begins to expand again.

Restructuring Fleet Plan 400 350 300 250 200 150 100 50

Beech 1900 Dash-8 CRJ New 70/100 B737 A320/319/321 B767 A340/330 747-400

0 Stagnant Long Haul Fleet. The detail in 2003- 2003 2004 2005 2006 2007 2008 2009 Mar eoy AC’s fleet plan reveals some disturbing news. First, as seen in the dark bars at the 12 Source: Globe and Mail bottom, the long haul fleet (A340/300 and 767) declines and then remains stagnant. Why is this disturbing? As the full service network carriers are subject to increasing competition from low cost carriers, such as WestJet, they must focus on those services which provide the consumer with added value and for which they will pay a premium. Long haul intercontinental service is where the network carrier provides the best value. Short haul markets may have high volumes of origin-destination traffic, but as route distance increases, point to point traffic falls and connections beyond the gateway increase.

Yet Air Canada appears to have no plans to expand its value added long haul service. None of the other aircraft in its fleet plan are capable of intercontinental flights. This fleet plan should be especially disturbing for those airports other than Toronto. If Air Canada intends to expand intercontinental destinations or frequencies at its fortress hub at YYZ, it seems that eventually this will have to be at the expense of intercontinental services at other airports. Continuing market share battle. The centre set of bars embrace AC’s narrow body fleet plan: the A319/320/321, the remaining 737s and the proposed 70 and 100 seat regional jets. The number of aircraft in this fleet never contracts and begins to expand in size within two years. (Whether total seat capacity grows depends on the specific mix of aircraft AC decides upon.) Why is this disturbing? Air Canada has been battling to maintain its market share in the domestic market against the expansion of WestJet. By deploying excess capacity in the market, yields fell below costs and break-even load factors increased. This is something that must be reversed. Air Canada’s future requires that it get its yields above unit costs. It has won some wage and productivity concessions from its work force, a positive step. But by deciding to deploy 70 and 100 seat aircraft, its unit seat costs may be higher, offsetting most or all of its wage and other gains. Page 1

InterVISTAS Consulting Inc. July 2003


The smaller aircraft have lower total costs per flight, but higher seat costs. WestJet, on the other hand, is moving into a higher capacity 737, providing it further unit cost savings. All this could be workable for AC, if it can get its yields up. If its narrow body fleet plan called for a notable reduction in capacity, given the expansion of WestJet and other low cost carriers, a yield increase might be possible. But AC seems to be unwilling to yield an appreciable market share to the low cost carriers. It is hard to see this fleet plan as providing the recipe for a long term return to higher yields and profitability. Short haul. The short haul fleet at the top of the chart indicates that the Dash-8 turbo prop fleet will be shrunk. It seems that some of these services will be migrated to 19 seat B-1900 aircraft. Others will be migrated to 50 seat CRJ-200s. While some in the press have speculated that AC intends to operate the extra B1900s itself (it already has 20), it may be that these aircraft will be assigned to regional affiliates, as they presently are. What is confusing is why Air Canada intends to finance the fleet of its independent affiliate carriers. This fleet plan leaves a lot of questions as to whether AC can achieve a permanent and sustainable return to profitability.

Restructuring Fleet Plan April 2003

Year end 2003

2004

2005

2006

2007

2008

2009

Beech 1900

16

16

16

17

19

23

28

32

Dash-8

73

68

68

68

66

60

53

47

CRJ

35

35

45

46

47

50

52

55

-

-

-

25

40

55

70

85

B737/Bae 1446

33

20

20

-

-

-

-

-

A320 family

108

105

105

105

98

92

85

78

B767

40

35

38

38

38

38

38

38

A340/330

17

16

16

16

16

16

16

16

B747-400

6

-

-

-

-

-

-

-

328

295

308

315

324

334

342

351

New 70/110-seat

Total

Source: Globe & Mail June 2, 2003

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InterVISTAS Consulting Inc. July 2003


Air Canada Share of Seat Capacity at Major Canadian Airports*

Edmonton AC - 36% Vancouver AC - 47%

Gander

Winnipeg AC - 45% Victoria AC - 49%

Calgary AC - 45%

Montreal AC - 55%

Halifax AC - 68%

Toronto AC - 64% Ottawa AC - 67%

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Source: InterVISTAS calculations based on OAG Max, June 2003 Note: Includes Air Canada and affiliates. * Airports in excess of one million passengers.

InterVISTAS Consulting Inc. July 2003


THE COST OF AIRLINE LOYALTY WESTJET VS. AIR CANADA On 25 June 2003, WestJet announced that it would begin to offer Air Miles rewards to passengers booking via its website. This seemed to reverse its long-standing policy that its low fares were sufficient reward for passengers. This article looks at airline reward programs, and shows that the WestJet program costs the carrier a fraction of Air Canada’s costs for its Aeroplan reward system. Frequent Flyer Programs. Frequent flyer programs (FFPs) have been an industry phenomenon since American Airlines introduced its AAdvantage program in 1981. The concept of rewarding travellers with "free" flights has been enormously popular with consumers. InterVISTAS research indicates that airline passengers in Canada have been willing to pay up to a 25% airfare premium in order to collect Aeroplan points.

John Weatherill Senior Airline Analyst

However, FFPs come with a cost for airlines. Carriers have argued that the cost of the reward flight are trivial, since reward passengers are channelled into seats which would otherwise remain empty. However, this is not always the case. Air Canada’s Super Elite members can book onto flights which otherwise are expected to be sold out. In addition, FFPs have substantial costs of investing in and operating computer systems to track reward travel, training for staff, call centres for bookings, staff for sorting out disputes with customers, etc. There are administration costs both when the passenger earns points and when the passenger uses points. Aeroplan. Aeroplan has more than 6 million members in Canada. Previously an internal division of Air Canada, it is now a wholly-owned subsidiary, and is not included in AC's CCAA filing. The Aeroplan program is extremely popular, but it is costly for Air Canada. There are significant administration costs involved, including labour, technology and facilities for the company. Unredeemed Aeroplan points represent a significant liability to Air Canada. At December 31, 2002, AC recorded its loyalty program liability at $384 million. CanJet/Jetsgo. Other Canadian airlines have started to invest in loyalty programs. CanJet recently launched its SmartRewards program, while Jetsgo is offering free flights to frequent travellers with its temporary SimpliFREE campaign. WestJet. The WestJet decision to offer Air Miles was not unexpected, as WJ has been a redemption partner since May 2000. Clive Beddoe had hinted earlier in the year that WJ was feeling pressure to start a loyalty plan (although he acknowledged in the same breath that Southwest founder Herb Kelleher wishes SW had never started its Rapid Rewards program). Although it does represent a new cost item for WestJet, the use of the Air Miles system offers significant cost savings over an in-house loyalty program. WestJet will purchase Air Miles from The Loyalty Group, the Canadian company that started Air Miles in 1992. After paying the fee for Air Miles points, WestJet incurs no further costs, including administration costs, nor any liability for future travel. The Loyalty Group handles the administration of the program. When the collector wants to redeem their points, The Loyalty Group purchases the reward travel. Some of the travel might be on WestJet, and if it is WestJet is paid for the reward air ticket. Travel Page 4

InterVISTAS Consulting Inc. July 2003


redemption will be a source of revenue for WJ. By comparison, Air Canada gives its passengers Aeroplan points now, and then owes them a reward in the future. Leveraging into an existing reward base. Reward points are more attractive if you have already collected some. If WJ started an in-house program, their passengers would have to start collecting from zero. A key benefit of Air Miles is that WestJet can immediately benefit from the loyalty of the 7.6 million Canadian households that are already collecting Air Miles points. Using Air Miles to reduce Distribution Costs. WestJet only offers Air Miles for tickets purchased through their website, thereby encouraging passengers to use the least expensive distribution channel. Furthermore, WestJet customers earn Air Miles on the basis of money spent (one mile per $20), rather than on the basis of flight segments or miles flown (as with Aeroplan and SmartRewards). This subtle difference ensures that WestJet is giving the most rewards to passengers who give them the most revenue.

After paying the fee for Air Miles points, WestJet incurs no further costs, including administration costs, nor does it incur any liability for future travel. WestJet is paid by Air Miles for any reward travel that uses WJ.

The Program Costs. WestJet’s Air Miles participation costs it only a fraction of what Aeroplan costs Air Canada. Consider a passenger travelling exclusively between Vancouver and Toronto, paying an average return fare of $1,000 on Air Canada. Depending on the booking class, Air Canada offers about 4,000 Aeroplan points for each flight between these cities. An Aeroplan member can redeem 25,000 points for a free Vancouver - Toronto flight; therefore, the passenger must make 6.25 Vancouver-Toronto return trips to earn a free flight. The payout ratio for Air Canada is 0.16 (4,000 miles / 25,000 miles). By comparison, a WestJet passenger on the same routing will earn one Air Mile for every $20 spent, or 50 Air Miles per $1,000 flight. Depending on the season, between 2,800 and 4,400 Air Miles can be redeemed for a free Vancouver - Toronto flight. Excluding bonus offers or other discounts (which are common in the program), the Air Miles collector must spend between $56,000 and $88,000 to earn their free flight. The payout ratio for WestJet is 0.017 ($1000 free trip / $56,000 in spending). This is roughly one-tenth the payout ratio of Air Canada.

Comparison of WestJet and Air Canada Reward Programs Program Miles needed for YVR-YYZ Point rewards Spending needed for YVR-YYZ Administrative costs Cost of providing reward

Payout ratio: reward trips per paid trip trips needed for reward

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WestJet

Air Canada

Air Miles

Aeroplan

2,800-4,400

25,000

1 point per $20 of ticket cost

4,000 points for one YVR-YYZ

$56,000

$6,250

None

Considerable costs to track point earning and reward usage

WestJet is paid by Air Miles if reward use is on WestJet

Air Canada must provide the reward flight at Air Canada’s cost – no revenue

0.017 56

0.160 6.25

InterVISTAS Consulting Inc. July 2003


AIRLINE DATA – CANADA Traffic and Load Factors on Canada’s Major Air Carriers – June 2003 Passenger Traffic Capacity Revenue Passenger Kilometres

Air Carrier

% Change over 2002

NEW CARRIERS: LOAD FACTORS Jetsgo: 67% Zip: not reported CanJet not reported

Available Seat Kilometres

% Change from 2001

% Change over 2002

% Change from 2001

Load Factor % Change over 2002

% Change from 2001

Air Canada 1

-17.5%

-16.2%

-17.3%

-18.0%

-0.2 pts (to 76.7%)

+1.7 pts

Domestic (Mainline)

-11.1%

-12.9%

-10.7%

-8.7%

-0.3 pts (to 72.4%)

--3.4 pts

Jazz

+3.5%

n/a

-9.1%

n/a

+7.8% (to 64.5%)

n/a

International & Charter

-18.6%

-15.9%

-20.5%

-22.3%

+0.1 pts (to 79.6%)

+4.5 pts

-4.4 pts -7.2 pts (to 72%) Note: n/a – As Jazz was not reported separately in 2001, a percentage change from 2001 could not be calculated. WestJet

+35%

+116%

+44%

+137%

Air Canada Domestic Mainline 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25%

Air Canada International International 30%

Jazz data is not included in this graph

20% 10%

Dom RPK Dom ASK

0%

Int'l RPK Int'l ASK

-10% -20% -30%

Jul- Aug Sep Oct N o v Dec Jan- Feb Mar Apr May Jun 02 03

-40%

Jul- Aug Sep 02

Oct

Nov

Dec Jan- Feb Mar 03

Apr May Jun

Analysis: • •

1

WestJet WestJet Air Canada continues to be in negative traffic 80% 70% growth territory due to the impacts of SARS, the 60% Iraq War and its bankruptcy. 50% RPK 40% However, there appears to be some recovery, as ASK 30% both capacity and traffic improves relative to the 20% previous two months. More international 10% 0% capacity has been cut than traffic has dropped, Jul- Aug Sep Oct Nov Dec Jan- Feb Mar Apr May Jun 02 03 improving its load factor on international services. WestJet continues to grow, but at a lower rate of growth. While a year ago, it was posting year over year growth rates in the 45 to 55+% range, this month, traffic grew only 35%. To some extent this is expected – as its traffic base gets larger each year, the percentage increase of new steady additions to capacity becomes smaller. As can be seen, its growth rate has been declining almost steadily since January. WestJet’s capacity growth continues to outpace its traffic growth. Load factor in June 2003 was 7 percentage points lower than a year ago. As actual load factor moves down toward the break even load factor, its profits decline.

Air Canada Mainline consists of all Air Canada with the exception of Jazz.

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InterVISTAS Consulting Inc. July 2003


AIRLINE DATA – U.S.

U.S. Airlines Release June 2003 Traffic Figures Airline

1

2

3

Load Factor

Traffic ( RPMs – millions)

(ASMs – millions)

Capacity

78.8%

10,862

13,779

á 3.6 pts

â 3.2%

â 7.7%

81.4% 3

1,334

1,725

â 0.6 pts

á 14.8%

á 16.3%

81.0%

5,382

6,644

á 2.3 pts

â 1.5%

â 4.3%

80.5%

8,809

10,940

á 3.2 pts

â 5.3%

â 9.1%

87.0%

969

1,115

á 1.3 pts

á 62.7%

á 60.4%

81.8%

5,976

7,308

á 0.3 pts

â 10.2%

â 10.5%

74.6%

4,428

5,938

á 1.1 pts

á 5.2%

á 3.7%

82.0%

9,082

11,074

á 4.0 pts

â 9.8%

â 14.2%

78.6%

3,539

4,505

á 1.3 pts

â 5.8%

â 7.3%

Notes: 1. 2. 3.

Includes American Airlines and American Eagle Load factor includes scheduled service only Does not include Express Jet

Source: Carrier financial and traffi c reports

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InterVISTAS Consulting Inc. July 2003


.Summary of Total Year-Over-Year Passenger Traffic Performance at Selected Airports Toronto

Vancouver

MontrealDorval

Calgary

Edmonton

Ottawa

Winnipeg

Halifax

Victoria

Kelowna

Saskatoon

Regina

St. John’s

-9.3%

-9.5%

-2.3%

-4.9%

-11.4%

-5.7%

-4.7%

-5.1%

-3.8%

-3.0%

-7.2%

-7.3%

June

-7.4%

-9.8%

-4.0%

-7.0%

-12.3%

-6.0%

-1.2%

-7.4%

-8.8%

-9.7%

-13.2%

-16.8%

nd

2 Quarter

-8.6%

-10.9%

-3.8%

-6.7%

-12.3%

-6.9%

-6.0%

-6.3%

-6.1%

-8.7%

-11.1%

-11.9%

July

-7.2%

-8.3%

-3.6%

-9.4%

-6.6%

-5.1%

+4.4%

-13.1%

-6.3%

-9.5%

-13.0%

-7.0%

August

-7.7%

-7.9%

-2.3%

-7.5%

-8.8%

-2.8%

+7.5%

-8.8%

-1.7%

-13.6%

-10.5%

-8.0%

September

+12.6%

+22.4%

+20.1%

+7.6%

+23.7%

+16.4%

+26.1%

+13.2%

+11.8%

+12.6%

+10.5%

+20.0%

3rd Quarter

-2.5%

-0.2%

+2.9%

-4.4%

+0.50%

+1.2%

+11.2%

-4.8%

+0.2%

-5.4%

-5.8%

-0.8%

October

+12.5%

+15.3%

+14.3%

-0.1%

+6.4%

+5.9%

+7.9%

+0.1%

+5.7%

+1.7%

+4.4%

-0.7%

November

+4.7%

+5.3%

+0.6%

+9.4%

+3.0%

+5.7%

+5.7%

+0.1%

-1.4%

+0.2%

+1.2%

-2.3%

+8.2%

+4.3%

+7.8%

+6.9%

+11.7%

+6.3%

+15.2%

+8.1%

+1.4%

+4.3%

+1.5%

+3.2%

+2.2%

n/a

+7.2%

+9.7%

+7.5%

+6.9%

-5.1%

+8.9%

+7.3%

+0.5%

+3.0%

+1.1%

+3.0%

-0.3%

Full Year

-7.5%

-3.9%

-4.3%

+1.2%

-4.1%

-5.1%

-3.8%

+0.1%

-4.8%

-1.3%

-5.1%

-5.5%

-5.7%

January

+5.7%

+3.8%

+7.2%

+6.3%

+3.5%

+6.2%

+13.0%

+4.5%

+2.9%

+4.0%

+6.8%

-0.3%

-5.8%

February

+4.6%

-0.6%

+3.7%

+5.6%

+3.0%

+3.9%

+12.7%

+13.8%

+7.5%

+2.0%

+6.0%

+8.8%

n/a

+5.0% +3.7% -0.6% -1.0%

-3.7% +3.1% -3.9% n/a

-4.2% +1.3% -1.6% -1.6%

n/a n/a n/a n/a

December 4th Quarter

2003

March +0.4% -1.3% -1.8% +3.7% -0.3% +2.2% +5.1% +11.6% +0.2% st +3.4% +0.6% +2.9% +5.2% +2.0% +4.0% +10.1% +10.0% +3.3% 1 Quarter April -15.1% -13.5% -10.2% +1.7% +1.1% -7.6% +4.4% +6.1% -0.9% -17.3% -13.5% n/a -1.4% +5.3% -3.9% -0.5% -1.2% +0.4 May Note: Toronto traffic data provided by Toronto Pearson International Airport. Data not available for St. John’s due to labour strike.

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CANADIAN AIRPORTS

2002

May

InterVISTAS Consulting Inc. July 2003


DECREASE IN AIR CANADA ’S SEAT C APACITY 10 July 2003

Jennifer Tso Project Analyst

State of AC Post Restructuring. Since Air Canada filed for bankruptcy protection under the Companies’ Creditors Arrangement Act (CCAA) on April 1, the carrier has made significant cuts to capacity and flight offerings. Air Canada is the dominant airline in the Canadian airline industry. It currently accounts for 51% of all flights and 52% of all seats departing from Canada’s top 100 airports. In the domestic market, AC operates 56% of flight frequencies and 58% of seats, compared to 67% of flights and 72% of seats pre-restructuring. As shown below, AC’s overall seat capacity and flight frequency declined 18% and 20% respectively in June 2003, compared to June 2002. Excluding Zip and Tango, AC flights have been reduced by 19% and seat capacity is down 14% in 2003 from 2002. AC Tango operations have shrunk significantly with seat capacity down 52% and frequency down 58% compared to June 2002. AC Mainline’s seat capacity to Asia was heavily impacted, declining 70% between June 2003 and June 2002, although some of this reduction may have been due to SARS. Other AC sectors severely impacted include Domestic transcontinental (-24%), Regional services (-23%) and transborder (-19%). Air Canada Capacity Changes June 2003 vs. June 2002 % Change

Carrier

Flights -11.4% -58.2% -19.6%

Mainline1

Air Canada reported an 18% drop in seat capacity and 20% drop in flight frequencies postrestructuring.

Air Canada Zip2 Tango Total Seat Capacity

Seats -19.0% -51.5% -17.6%

Source: OAG Max June 2002 and June 2003. 1Jazz included in AC Mainline. 2 Zip did not have operations in 2002 and a percentage change could not be computed. 3 One week sample of flights in June 2002 and June 2003

Airports Losing Capacity. The impact of AC’s restructuring has affected the top airports in Canada. Of the top ten airports, Halifax has the greatest reduction in seat capacity, followed by Edmonton and Vancouver. Air Canada Capacity Reductions at Top Ten Airports Airport

Capacity Change Flights

Seats

Toronto Vancouver Montreal Calgary Edmonton Ottawa Halifax Winnipeg Victoria

-19% -16% -14% -9% -19% -11% -22% -9% -4%

-15% -18% -11% -7% -20% -15% -22% -13% -1%

Hamilton Total

0% -16%

0% -15%

Source: OAG Max June 2002 and June 2003.

As AC continues with its restructuring activities, further adjustments to its flights and seat capacities are expected as AC moves towards a smaller fleet. Page 9

InterVISTAS Consulting Inc. July 2003


NEWS ARTICLES AIR CANADA UPDATE AIR CANADA CUTS FARES TO MATCH RIVALS

Air Canada Tango cut the price of some of its airfares by 50% during the summer season. Some one-way fares were sold for as low as $12. The move to reduce fares was a result of the fare reduction by rival Jetsgo. The sale ended on June 19 for travel completed by July 16.

AIR CANADA PILOTS UPSET OVER ARBITRATOR’S RULING On June 26, the Chairman of the Canada Industrial Relations Board gave a mixed decision regarding the merger of the seniority list of the former Canadian Airlines and Air Canada pilots. An initial arbitration decision by arbitrator Morton Mitchnick, which strongly favored the original AC pilots, was appealed by the former CAI pilots. Both pilot groups agreed to binding arbitration for the appeal. The recent appeal decision by Brian Keller gave back some benefit to the CAI pilots, but did not award the strict date-of-hire seniority list they wanted -- AC pilots still receive some preference. Although it was a binding arbitration, the AC pilots were upset with the appeal ruling and petitioned the CIRB, which agreed to a "limited" review of the seniority integration once again. However, the CIRB chair denied a request that the Keller seniority list not be made operational. Thus the Keller seniority list is now in use while the CIRB conducts its limited review.

AIR CANADA COMPLETES FIRST NEGOTIATIONS WITH LESSORS, REACHES FINANCING AGREEMENT On June 20, Air Canada completed the first renegotiation of lease terms with aircraft lessor GATX Capital over three Airbus A-321 aircraft. GATX has agreed to the rates and terms consistent with Air Canada’s restructuring plan. The carrier has also reached a tentative agreement worth C$1.8 billion with General Electric Capital Aviation Services (GECAS) on all GECAS financed and managed aircraft as well as new exit and aircraft financing when Air Canada emerges from creditor protection. As Page 10

part of the agreement, GECAS has also agreed to a C$575 million secured loan and to provide a maximum of C$1.3 billion to finance up to 43 regional aircraft.

AIR CANADA LABOUR CONTRACTS COMPLETE Air Canada has completed the ratification of all labour contracts and will achieve permanent cost reductions of C$1.1 billion a year. Over the past three weeks agreements were completed with the International Association of Machinists and Aerospace Workers, Canadian Union of Public Employees, Canadian Auto Workers and Canadian Airline Dispatchers Association. The Air Canada Pilots Association was the last to reach an agreement. The pilots union voted in favour of a new six-year contract that will save the carrier C$257 million a year through about 300 layoffs, paycuts of 15% and more flexible working conditions. Agreements were also ratified with all unions representing Air Canada Jazz employees. Jazz was able to achieve total annualized labour and management cost reductions of C$110 million.

TRANSPORT CANADA DESIGNATES AIR CANADA TO SERVE CUBA On July 11, David Collenette designated Air Canada to operate scheduled Canada-Cuba service. Air Canada will operate flights from Calgary, Halifax, London, Moncton, Montréal, Ottawa and Toronto to Havana, Varadero, Holguin and one other city to be chosen by Canada.

AIR CANADA EXECS TO TAKE PAY CUTS LESS THAN EXPECTED Air Canada executives will be receiving salary cuts of 10%, less than the 15% that was expected. Only CEO Milton is taking a 15% cut. The airline’s pilots are taking a 15% pay cut and had expected all executives to equal that cut.

BANKRUPTCY PROTECTION EXTENDED FOR AIR CANADA Justice Farley has extended the stay period for Air Canada to September 30, 2003. The extension will allow the carrier to complete renegotiations with lessors and to commence the process of raising C$1.35 billion in exit financing. InterVISTAS Consulting Inc. July 2003


NEWS ARTICLES OTHER CANADIAN AIRLINES WESTJET OFFERS NEW GANDER AND ST. JOHN’S SERVICE

On June 16, WestJet began its new service to St. John’s. The carrier offers four weekly flights between St. John’s and Moncton. On June 17 WestJet initiated service to Gander offering three weekly flights between Gander and Ottawa. The carrier also announced the following new and enhanced services that will begin September 15: New Services Winnipeg - Toronto Winnipeg - Vancouver Montréal - Halifax Gander - Ottawa St. John’s - Ottawa Calgary - Ottawa Toronto - Thunder Bay Ottawa - Edmonton

Enhanced Services Winnipeg - Saskatoon Winnipeg - Thunder Bay Halifax - Ottawa

WESTJET OFFERS FREQUENT FLYER PROGRAM

On July 25, WestJet introduced its frequentflyer program. The carrier will offer Air Miles® reward points on tickets booked on the Internet. Passengers can earn one reward mile on every $20 spent on an online booking, excluding taxes and airport fees.

WESTJET ENTERS C$100 MILLION PENSION PLAN EQUITY LINE

WestJet has entered a deal with the Ontario Teachers’ Pension Plan that would require the pension plan to purchase up to C$100 million of WestJet’s common shares. Under the terms of the agreement, the Plan is not required to purchase shares exceeding 30% of WestJet’s outstanding capital.

aircraft deliveries. WestJet plans to offer the service free of charge until all of its 700-series aircraft are configured.

CANJET TO BEGIN HALIFAX-ST. PETERSBURG SERVICE

On November 1, CanJet Airlines will begin a weekly non-stop service between Halifax and St. Petersburg.

ZOOM AIRLINES DESIGNATED TO OPERATE BETWEEN CANADA AND UK

On June 5, David Collenette announced the designation of Zoom Airlines Inc. to operate scheduled flights between Canada and the UK. The carrier will offer flights between CalgaryGlasgow, Vancouver/Edmonton-London (Gatwick), Vancouver/Calgary-Manchester, Toronto-Belfast, and Toronto-Birmingham.

HAWKAIR TO RAISE EQUITY

Hawkair is currently placing $4.5 million in preferred shares to raise new equity. The proceeds will be used to pay down debt and lease additional Dash 8 - 100 aircraft to allow it to expand into new markets. Hawkair currently serves four routes to Vancouver: Terrace, Prince Rupert, Dawson Creek and Smithers. The company has stated its long term objectives as a) profitably expanding fleet and market coverage to include destinations in BC, Alberta, SE Alaska and Northern Washington, and b) to seek a 'liquidity event' for its shareholders within 5 years. The private placement is being handled by Dundee Securities. A copy of the offer memorandum is available to interested investors from the Company or Dundee.

WESTJET FIRST CANADIAN AIRLINE TO FEATURE SATELLITE TV WestJet and LiveTV, a subsidiary of JetBlue, have signed a thirteen-year agreement for the installation of the satellite system on 40 aircraft, with the option to install the system on future Page 11

InterVISTAS Consulting Inc. July 2003


NEWS ARTICLES U.S. & INTERNATIONAL AIRLINES US AIRWAYS STOPS DELIVERY OF 25 RJS

Due to a contract dispute with its pilots, US Airways will not take delivery of 25 75-seat Bombardier CRJ-705 planes. The carrier plans to contract with affiliate Mesa Airlines to fly 25 and possibly up to 55 regional 70-seat jets under the US Airways Express banner.

in international cargo. Total freight traffic for the month decreased 2.8% from the previous year.

YVR CARGO DOWN IN MAY Vancouver International Airport reported a 15.4% drop in cargo for the month of May and a 7% drop for year-to-date.

CABINET RESCINDS CANADA-EUROPE CARGO FLIGHTS

LUFTHANSA OFFERS MUNICHMONTRÉAL SERVICE

On June 14, Lufthansa introduced a threetimes weekly service between Munich and Montréal. The service will be operated with an Airbus A340-300.

The Cabinet has rescinded Canadian Transportation Agency permits for a charter cargo service from Halifax to Europe which was to be operated by MK Airlines Limited. Back in May, the carrier had applied to the Canadian Transportation Agency, and was granted the right to operate 5 th freedom charter cargo flights between Canada and Europe. Cabinet rescinded the decision noting that the proposed flights were 7 th, not 5 th, freedom services.

CO, DL, NW ALLOW MILES REDEMPTION

FEDEX PROFITS INCREASE IN FISCAL YEAR

On July 15, frequent flyer members of Continental, Delta and Northwest were able to redeem miles on one another’s flights to 374 destinations. Delta Song and Delta Connection flights operated by American Eagle are excluded.

CONTINENTAL DELAYS 737 ORDER On July 14, Continental Airlines announced that it will defer firm deliveries of 36 Boeing 737 aircraft that were originally scheduled for delivery in 2005, 2006 and 2007. NORTHWEST LAUNCHES DETROITHALIFAX SERVICE On July 4, Northwest Airlines and its affiliate, Mesaba Aviation Inc., initiated direct service between Detroit and Halifax. The service will operate with a 69-seat passenger Avro RJ85 regional jet.

CARGO U.S. DOMESTIC CARGO DECREASES

U.S. Air Transport Association figures for May show a 2.3% decrease in revenue ton miles for domestic cargo and a 3.3% decrease Page 12

For fiscal year ending May 31, FedEx Corp. reported net income of US$830 million, an increase of 17% from last year. Operating income increased 11% to US$1.5 billion.

NORTHWEST CARGO SIGNS DEAL WITH CANADIAN SALES AGENTS

Northwest Cargo has signed a deal with two Mississauga companies to market and sell its services throughout Canada. CAS Cargo & Travel Inc., will be the general sales agent in Eastern Canada, and Ralph Porter Enterprises Inc. will be the agent in Western Canada.

ATLAS AIR CONSIDERS CHAPTER 11 FILING

Atlas Air Worldwide Holdings may file for Chapter 11 bankruptcy protection to complete its debt restructuring program that began in March. The company is negotiating with its remaining secured creditors and lessors.

VOLGA DNEPR INCREASES USE OF GANDER INTERNATIONAL

Volga Dnepr Airlines has increased its use of Gander International Airport. After operating fewer than 5 flights a quarter previously, the carrier was up to over 20 flights in Q1 2003. InterVISTAS Consulting Inc. July 2003


NEWS ARTICLES AIRPORT TORONTO PORT AUTHORITY GETS ISLAND BRIDGE

PEOPLE IN THE NEWS CATSA WELCOMES NEW REGIONAL MANAGERS

June 23rd marked the end of construction on Denver’s new three-mile runway, which is expected to increase capacity by 18%. The first commercial use will begin in mid-September.

Bob Gosse has been appointed CATSA regional manager for the Newfoundland and Labrador region. Gosse has 30 years of expertise in airport maintenance and aerospace operations and was the former president of CHC Composites. John Murphy has been appointed CATSA regional manager for the Ontario Region. Before joining CATSA in April 2003, Murphy was the Manager of the Grand Bahama International Airport and has worked with Transport Canada for over 25 years in airport design.

AIRCRAFT MANUFACTURERS

NEW MANAGING DIRECTOR FOR ONEWORLD

On June 17, Toronto City Council members voted in favour to pay C$48.6 million to the Toronto Port Authority for the construction of a bridge link to the island’s airport.

NEW RUNWAY CONSTRUCTION ENDS AT DENVER

AIRBUS CONFIRMS MAJOR EMIRATES ORDER

Airbus has confirmed a major order from Emirates for 41 planes. The deal is worth US$9 billion and includes twenty-one 555-seat A380s. The carrier is also purchasing long range A340500s and A340-600s. Delivery of the A340500s will begin next year, followed by the A340600s in 2007 and the A380s in 2009.

John McCulloch has been appointed the new Managing Partner for oneWorld. oneWorld is headquartered in Vancouver.

BOEING LANDS AIRTRAN ORDER

AirTran Airways has placed an order for 100 new CFM56-7B powered 737-700s and 800s, 50 of which are firm orders and the rest options. The carrier also placed an order for up to 10 additional 717s, keeping its production line open.

BOEING MAY END 757 PRODUCTION

The Seattle Post Intelligencer reported that Boeing’s order log for the 757 is down to 18 aircraft, all but two of which are for Continental, and may decide to end the production line in 2005 or earlier.

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InterVISTAS Consulting Inc. July 2003


SARS – THE END OF A CRISIS

Doris Mak Senior Market Analyst

“Hong Kong International Airport is clearly emerging from the woods. The latest figures show that we are well on track to making a full recovery. July looked set to continue the trend: daily passenger traffic figures for the first week were already up to about 70% of pre-SARS levels",

Dr. David J Pang, Chief Executive Officer Airport Authority Hong Kong

10 July 2003 The End of the Outbreak! The SARS outbreak, which began in March, and propelled the travel industry into yet another crisis, may now be coming to an end. The World Health Organization (WHO) declared the containment of the SARS virus in all affected countries. At the end of June and early July, Beijing and Toronto were removed from the WHO SARS affected list as no new cases were reported for 20 days. On July 5, Taiwan, the only remaining affected area, was removed from the list. However, the WHO has two cautions: while there have been no new outbreaks for two incubation cycles, there are still individuals infected with SARS in quarantine in Canada, China, Taiwan, etc. Further, the WHO does not know whether SARS is a seasonal illness like the flu. Either of these leave concerns that SARS could break out again. Airport Traffic Recovering! Many Asian airports have started to see recovery of passenger traffic. In June, an average of 200 flights per week were reinstated at Hong Kong International Airport and further increases in flights are expected for July. Tokyo’s Narita Airport is also seeing a recovery in the number of flights operating after passenger numbers declined 43% and 36% in May and June. On July 5, Taipei Chiang Kai-shek International Airport reported a 535% increase in passenger levels from a recorded daily low of 5,676 on May 19. According to Amadeus Asia Ltd., daily bookings from 32 Asia Pacific countries and territories have reached pre-SARS levels. Airlines Adding Back Capacity! Every day, air carriers are announcing the restoration of flights, frequencies and capacity and recording traffic recovery. • Cathay Pacific’s CEO indicated that the carrier is pursuing a strategy of restoring flights to a full schedule as fast as possible, rather than only incrementally add flights which are fully profitable. It will be more difficult for the market to recover without its former service convenience. He expects passenger levels in July and August to reach 27,000 to 30,000 passengers per day. The carrier will operate a full schedule by September. It has already restored four flights between New York and Hong Kong. On July 1, the carrier added one more weekly San Francisco-Hong Kong flight. By the fall, Cathay plans to return to pre-SARS levels of 28 flights a week from three U.S. cities. • China Airlines (Taiwan) announced it plans to restore full capacity on services to Hong Kong by August 1. • China Southern Airlines is predicting a net profit of C$83 million in the last eight months of 2003. It has resumed twice-weekly service from Xiamen to Kuala Lumpur and from Guangzhou to Ho Chi Minh City. It has also relaunched three weekly flights from Shantou to Hong Kong and resumed twice-weekly service from Sanya to Hong Kong. The carrier plans to relaunch its preSARS schedule of three weekly flights between Los Angeles and Guangzhou and relaunch twice weekly flights from Shantou to Bangkok and five weekly flights from Guangzhou to Seoul. • China Eastern Airlines saw passenger loads returning to normal levels. It now carries 16,000 passengers a day, a significant increase compared to a low of 5,400 a day in May. It is operating 72% of its flights, up from 33% in May. • Singapore Airlines reinstated daily service from Los Angeles to Singapore on July 1. The carrier will have 39 flights a week, down from a peak of 45 but up from a low of 21 during the SARS scare. • United Airlines plans to add back 54 flights in July including some seasonal service changes and reinstate some Pacific flights that were cancelled due to SARS. • Northwest Airlines plans to increase its internal Asia/Pacific network capacity by replacing all Airbus A320s with Boeing 757s. • Continental Airlines will resume four of its five weekly flights between Newark and Hong Kong beginning August 1. Although SARS has left a scar on the airline industry, recovery is apparent and as China Eastern Airlines stated “bookings have improved. The recovery in passenger traffic is faster than expected.” Page 14

InterVISTAS Consulting Inc. July 2003


ECONOMIC OUTLOOK 15th July 2003

Employment in Canada (Millions, Seasonally adjusted)

Is the Canadian economy slowing?

15.6

15.4

15.2

Mar

May

Jan

Nov

Jul

Sep

Mar

2003

May

Jan

Nov

Jul

Sep

2002

May

Mar

2001

Jan

15.0

Source: Labour Force Survey, Statistics Canada

Canadian GDP (Monthly % Change, Seasonally adjusted) 1.0

Similarly GDP output for the month of April fell by 0.2%, the first monthly decline since September 2001. This softening in the economy has been put down to factors such as SARS, mad cow disease and the strong Canadian dollar impacting exports and tourism.

0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 Apr

Mar

Jan

Feb

Dec

Oct

Nov

Sep

Jul

Aug

Jun

Apr

2003

May

2002

Mar

-1.0

Jan

Manager, Economic Analysis

Recent economic data for the Canadian economy shows that the “Northern Tiger” may be slowing. Statistics Canada reported that employment dropped in April and May after a year and a half of steady gains. June was better, with 49,000 new jobs created though almost all were parttime. Nearly 84,000 new jobs were created in the first half of the year, well below the 304,000 created in the same period of 2002.

Feb

Ian Kincaid

15.8

Trend or Blip? However, at this stage it is not clear whether this is the start of a trend or just a blip. There are still plenty of positives for the Canadian economy. The U.S economy (Canada’s biggest export market) shows signs of improving, with increases in consumer confidence and robust GDP growth (although the U.S. recovery is failing to generate any new jobs). Source: Statistics Canada

In Canada, consumer confidence, as measured by research company Decima, rebounded strongly in May following the end of the Iraq war and the subsidence of SARS in Canada. The Bank of Canada has decided to provide fresh stimulus to the economy by cutting interest rates by a quarter point. Inflation, which was a concern of the central bank, has dropped to 2.9%, within the bank’s target range of 1-3%; the core rate which excludes volatile items such as food and energy dropped to 2.3%. This gave the central bank some room to cut interest rates.

At this stage it is not clear whether the Canadian slowdown is start of a trend

The picture should become clearer with one or two months additional data. A key indicator to watch over the next two months is employment. If positive numbers year-over-year results are reported in July and August, then it is likely that we are merely experiencing a blip rather than a trend.

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InterVISTAS Consulting Inc. July 2003


CARGO CAPERS 02 July 2003 InterVISTAS and the Canadian Airports Council have been active advocates of an improved Canadian FTZ regulatory environment. This effort paid dividends with the implementation of the Export Distribution Centre (EDC) program. The program is beginning to take off, with 25 EDC certificates now in effect, and airport authorities such as Gander, Hamilton and Vancouver marketing their own EDC capabilities. This month we look at what is happening elsewhere to put the developing Canadian EDCs in the global context.

Robert Andriulaitis Director, Transportation & Logistics Studies

Concerns about the future of FTZs. Some observers have wondered about the future role of FTZs in a world where tariffs are being lowered and even eliminated. This is clearly a valid point – after all, FTZs were originally established to get around some of the problems that tariffs created. No tariffs – no problems, right? If only it were that simple! FTZs are here to stay – at least for some time to come. For starters, tariffs have not disappeared, and will likely be with us for some years yet. Moreover, tariff rates tend to not come down uniformly – and the resultant distortion this implies (i.e., inverted tariffs) is in part what FTZs were created to deal with in the first place! Also, FTZs can help deal with other trade impediments – tariffs are not the only form of trade barrier! Even if tariffs were eliminated entirely, FTZs would still have a valuable (i.e., time and cost saving) role to play. Without them, a distribution centre in Canada would have to formally import goods to Canada (paperwork), pay the GST (increased cash flow burden and extra financing costs), export the goods from Canada (more paperwork), and then import the goods into the U.S. or Mexico (again, paperwork). With a Canadian FTZ, the first two paperwork items are eliminated or greatly simplified and expedited, and the remaining money item is eliminated. FTZs are not only about duty relief – after all, we have had programs for that for years. The CAC FTZ initiative was primarily about GST relief and the elimination of costly paperwork. Finally, as the volume and scope of world trade continues to increase dramatically, this suggests a potential for an even greater use of conventional FTZs for the foreseeable future. “New” developments in FTZs. The underlying assumption above is that FTZs continue in their existing format (i.e., as a mechanism to “get around” tariff and trade barriers). The trend over the past few years, however, has been to marry up FTZ capabilities with supply chain management activities to create full service international trade logistics centres.

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InterVISTAS Consulting Inc. July 2003


CARGO CAPERS - CONTINUED Danzas AEI opened a full service logistics centre in the Bogata Columbia FTZ. U.S.-based industrial real estate owner/operator AMB Property Corporation developed a 234,000 ft2 multi-tenant logistics facility at the Airport Logistics Park of Singapore, located in the Changi airports FTZ. Menlo Worldwide Logistics became the first tenant. Emirates SkyCargo opened a SkyCargo Centre in the Ras Al Khaimah Free Zone. Airborne Logistics, APL Logistics, Emery, Exel, and Nippon Express Logistics also operate at various FTZs. Successful FTZs like Singapore, Incheon, and Hamburg are increasingly marketing themselves as logistics centres with FTZ capabilities, rather than simply as FTZs. We have seen evidence of this closer to home as well. The media reported that when TradePort began to explore establishing an FTZ at Hamilton International Airport, PBB Global Logistics expressed an interest in a logistics role in the facility. 3PLs are getting very good at combining logistics and FTZs to achieve superior results. Exel achieved significant cost and service improvements to Compaq’s reverse logistics processes by utilizing FTZs. Hillwood, the operator of the cargo centre/industrial park at Fort Worth Alliance Airport, set up a subsidiary, Alliance Operating Services (AOS), to provide its tenants with third-party logistics services to enable them to get maximum benefit out of the FTZ. In addition to AOS, DSC Logistics, Ryder, Trans-Trade, UPS Logistics, and Value and Service Logistics all operate at Alliance. The relationship between FTZs and logistics appears to be getting even stronger. Commodity Logistics chose to establish its headquarters in the Columbus Ohio FTZ and Excel set up its regional headquarters in the Dubai Airport Free Zone. FTZs are now positioning themselves not just as a means of avoiding duties and taxes, but as key components of logistics centres that improve upon existing supply chains using the unique duty and tax saving attributes of FTZs. It appears that to be successful requires both the FTZ capabilities and strong logistics services. With Canada’s favourable geographic location as a gateway to the NAFTA marketplace from Europe and Asia, Canadian airports establishing full service logistics EDCs should be able to attract a share of the growing transatlantic and transpacific trade and logistics activity. As such, despite a late start in the FTZ industry, the future of Canada’s EDCs looks promising.

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InterVISTAS Consulting Inc. July 2003


OTTAWA REPORT 10 July 2003 Parliament is on Recess – not prorogued. Both Houses of Parliament recessed in mid-June, and many sighs of relief were heard in the transportation sector. But Bills C-26 and C-27 are still active. The Prime Minister could have decided to prorogue Parliament, thereby terminating any bills which had not passed. However, by choosing to simply recess for the summer both the Canada Airports Act (C-27) and the changes to the Canada Transportation Act (C-26) are alive and of concern. Both houses are scheduled to resume sitting during the week of September 15th. What was the status of the two bills at time of recess? C-26, which has few changes for the air transport sector, had completed second reading in the House and was referred to the House Standing Committee on Transportation. The Standing Committee had indicated it wanted to hold hearings on the bill, especially in regard to the rail provisions. The committee never got to the bill itself, as it was preoccupied with hearings on CATSA and other issues.

Martin Copeland Vice President Airline Marketing & Planning

C-27, the Airports Act, still had not completed second reading debate and thus had not been referred to the Standing Committee. At least some members of the Committee would like to hold extensive hearings on the bill, if it should ever be referred to them. It remains to be seen what happens in the fall. One view is that the Minister will continue to push these two bills through Parliament. Another is that all parliamentary business will be stalled as the lame duck Prime Minister loses control of the caucus as the leadership convention looms. The lame duck, however, could pull a few surprises out of his sleeve, ranging from calling an election to resigning during the summer. In the meantime, the two bills remain on the order paper. The MK Air Case. As reported elsewhere in Industry Review, the Governor-in-Council reversed a decision of the Canada Transportation Agency allowing MK Airlines Limited to operate cargo services from Spain to Halifax. MK Air (based in Ghana) had requested permission to operate 5th freedom freighter services between Europe and Canada on an entity charter basis. (However, the services would not be originating in Ghana, and thus were 7th freedom services.) Their application included triangle services from Luxembourg to Connecticut to Halifax on behalf of Panalpina and LuxembourgAlabama-Mirabel flights on behalf of Morganair. The Agency recently solicited comments from Canadian carriers, but none were received, although Air Canada had objected to an earlier award of authorisation to MK Airlines. The authorisation was granted on 29 May 2003. On June 2, cabinet rescinded the CTA decision. The order simply stated that the service was a 7th freedom service, not a 5th freedom service originating in Ghana. A subsequent application by MK Airlines was turned down by the CTA, citing the GIC order. Authorities in Halifax indicated that the consequence is a loss of business for them and a gain in business for Boston where the fish are now being trucked. They indicated the business did not move to Air Canada bellyspace. Ottawa Airport. WestJet has announced a significant increase in Ottawa Airport operation starting in mid September with new daily non-stops to Calgary and Edmonton (one less than daily) as well as an additional daily Halifax frequency and new Gander/St. John non-stops. This is a collection of information gathered from public sources, such as press releases, media articles, etc., information from Confidential sources, and items heard on the street. Thus some of the information is speculative and may not materialize. Prepared by InterVISTAS Consulting Inc.

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InterVISTAS Consulting Inc. July 2003

CAIR Issue No. 7 - July 2003  

InterVISTAS Canadian aviation intelligence report.

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