Military Sustainment Forecast and Market Trends

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1 April 6, 2016 Dallas, Texas Presented by: Glenn McDonald Manager ICF International Military Sustainment Forecast and Market Trends 0

2 Today s Agenda U.S. Budget Analysis MRO Outlook Market Trends 1

3 U.S. Budget Analysis 2 2

4 The DoD budget reached a minimum in FY15 $ Billions $800 DoD Base + OCO Funding History OCO $700 $600 $500 Base $578 $581 $560 $82 $85 $63 $580 $583 $59 $59 FY17 vs FY % $400 $300 $200 $496 $496 $497 $522 $ % $100 $0 FY13 Actual FY14 Actual FY15 Actual FY16 Enacted FY17 Request +0.4% Total 3

5 The President s FY17 Budget proposes slight increases in FY18-FY21 funding $ Billions $800 $700 $600 FY16/FY17 Proposed Budget Comparison $2,801B FY16 PB Total $2,820B FY17 PB Total $500 $400 $300 $200 $100 $0 FY17 FY18 FY19 FY20 FY21 4

6 The FY17 request shifts money from procurement to O&M U.S. Budget Commentary Total O&M budgets increase by over $6B in the FY17 request Thirteen air force squadrons that stood down under sequestration will have full flying hours restored LRS-B design work ramping up Initial Sixth-gen fighter R&D beginning Category FY16 Enacted FY17 Request % Change Military Personnel $138.5 $ % Operations and Maintenance $244.4 $ % Procurement $118.9 $ % Research, Development, Test and Evaluation Total Budget (US $ Billions) $69.0 $ % Military Construction $1.3 $ % Family Housing $6.9 $ % Revolving Funds $1.3 $ % Total $580.3 $ % 5

7 O&M budgets are increasing across the board, with the largest increase coming from DoD-wide funding $ Billions $300B $250B $200B $150B O&M Budget by Service +5.4% +2.1% DoD-Wide O&M Increased USSOCOM funding Funding for Air Force O&M Flying hour program now fully funded 10% increase in base budget depot maintenance Increased OPTEMPTO for both fighters and bombers $100B $50B $0B +2.3% +0.8% FY15 FY16 FY17 Request Navy O&M Increasing aviation depot staffing Flying hours projected to be roughly flat Increase in F-18 depot throughput Army O&M Slight decrease in base budget flying hours through decrease in OPTEMPO Army Aviation funding down significantly from Iraq/Afghanistan peak Source: DoD FY 2017 O&M Overview 6

8 Depot maintenance accounted for nearly $26B (or 35%) of the total DoD FY15 maintenance budget DoD Maintenance: In FY15, total maintenance accounted for $74B of the O&M budget, 47% of which was outsourced Depot Maintenance: Including OCO funding, total depot maintenance increased by nearly 4% in the latest budget request. In FY15, depot maintenance accounted for 35% of total DoD maintenance $ Billions Total & Depot DoD Maintenance (US $ Billions) 2015 Total $73.3 Out- Sourced $34.5 Organic $38.8 FY15 35% of Total Depot Maintenance $25.9 $25.6 $26.5 FY15 FY16 FY17 Note: Includes OCO funding Source: DoD Maintenance Factbooks, FY2017 O&M Overview 7

9 Fighter/Attack and Trainer aircraft will bear the brunt of the reductions 16,000 The DoD s FY16-45 Aviation Plan calls for a reduction in aircraft inventory from 13,900 to 12,950 by FY2025 Total Aircraft Inventory 2016 to ,000 12,000 10,000 8,000 6,000 4,000 2,000 Other ASW Attack Helicopter Trainers Fighter/Attack Airlift/Cargo/Utility 0 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25 Source: DoD Annual Aviation Plan

10 A dramatic increase in defense spending in Russia and China is driving a response from neighboring countries Country Defense Budget USA -12.0% Canada -10% Mexico +47% U.S. Budget Bottomed out in FY15 Newly Elected Canadian Government will set tone for Defense Country Defense Budget Russia +44% Poland +20.% Germany ~0.0% France ~0.0% UK +4.1% The continued fight against ISIS has stopped the defense budget freefall in some European countries, while emerging economies continue to increase budgets While falling commodity prices have affected the Russian economy, total defense spending has increased dramatically Country c Defense Budget India +8% Pakistan +43% China +75% S. Korea +33% Budget growth is rapid in Asia with a major emphasis on new weapons systems Japan passed law to allow export of defense items Indian Air Force inked deal with Dassault for $30B for Rafale Source: SIPRI. In current USD published figures Note: Data includes SIPRI estimates of total defense-related expenditures, which may differ from government 9

11 Many countries in the Middle East and Asia drastically increased defense spending between 2010 and % 175% 150% 125% 100% 75% 50% 25% 0% -25% Total Defense Spending Percentage Changes (All Countries >$8B in 2014 Defense Spending) Europe MENA North America Asia Pacific Latin America -50% Italy Spain USA Netherlands Canada Brazil Germany France UK India Israel Australia Taiwan Poland Singapore Colombia Turkey UAE South Korea Pakistan Russia Mexico China Saudi Arabia Oman Algeria Iraq Source: SIPRI Note: Includes all countries with total defense spending > $8b 2014 USD 10

12 MRO Forecast 11 11

13 In 2015, global military MRO spending nearly returned to the 2012 peak of $69B $70B $66B $64.1 $64.7 Global MRO Demand $65.4 $66.0 $69.3 $66.3 $68.4 $68.8 $62B $58B $54B $50B Note: Current year USD 12

14 North America and Asia Pacific have the largest active fleets Military Aircraft Fleet Commentary Includes most Western turbine-powered aircraft, and Eastern turbine-powered aircraft where data is available Asia Pacific has eclipsed Europe as 2 nd largest region Helicopters make up over 35% of the active fleet by units GA / Utility Transport - Lt/Med Trainer / Light Attack Rotary Wing - Attack 8% 12% 7% 2015 Global Military Aircraft Fleet* Other Latin Africa Fighter / America Attack 6% 4% 7% 6% Middle East 29% 34% 10% 51,104 Aircraft 29% Rotary Wing - Transport / Utility Europe 22% 51,104 Aircraft 26% North America Asia Pacific By Aircraft Type By Global Region Source: ICF, FlightGlobal World AirForces directory 2016 Note: Other includes Special Mission, Tanker, and Heavy Transports 13

15 MRO spending reached $68.8B in 2015, with 50% being field maintenance Engine 15% 2015 Global MRO Demand 50% Field Africa Middle East 9% Latin America 43% North America $68.8B 21% $68.8B 16% Asia Pacific Component 19% Europe 22% Airframe By MRO Segment By Global Region Source: ICF International 14

16 The UH-60/S-70, F-35, and AH-64 will each deliver more than 1,000 units between 2015 and ,500 2,000 1,500 Military Aircraft Deliveries Aircraft Deliveries The AH-64 and CH-47 will continue deliveries of new and remanufactured airframes F-35 Block 3F capability will spur rate increases and help firm international orders 1, Eurofighter and Rafale both experiencing limited export success S-70 F-35 AH-64 CH-47 NH90 C-130J V-22 EC145 PC-21 EUROFIGHTER RAFALE T-50 F-16 F-18 KING AIR P-8/737 A400M T-6 GRIPEN CH-53K Source: ICF analysis. Note: Western-aircraft only 15

17 The global military fleet will grow slowly at 1% per year Fleet Outlook Global fleet growth is driven by Asia Pacific and Middle Eastern operators India, South Korea, and Japan are driving Asia Pacific $0 $0 $0 $0 10 Year Global Fleet Growth Africa Latin America Middle East Europe Asia Pacific North America 51,104 55,765 CAGR 8.2% 0.7% 1.1% (0.3%) Saudi Arabia and Iraq account for over 500 of the net 550 aircraft increase in Middle East $0 $0 0.7% $0 0.2% $ % Avg. Source: ICF International; Forecast in 2015 $USD, exclusive of inflation 16

18 Military MRO will grow at 1.5% per annum until 2024 MRO Outlook Africa, Middle East, and Asia Pacific have the highest overall MRO growth rate North America will have the largest increase in value, from $29.5B in 2015 to $32.5B in 2024 $100 $90 $80 $70 $60 $50 $40 $30 10 Year Global MRO Demand Growth Latin America Africa Middle East Asia Pacific Europe North America $68.8B $78.8B CAGR 2.1% 9.6% 2.1% 1.2% 0.9% Middle Eastern MRO is driven by largely by increases in Saudi Arabia, Israel, and UAE $20 $10 1.1% $ % Avg. Source: ICF International; Forecast in 2015 $USD, exclusive of inflation 17

19 Utility helicopters account for approximately half of the total increase in MRO spend between 2015 and 2024 $6.0 $5.0 $4.0 $3.0 $2.0 $1.0 $0.0 Difference in MRO Spend, 2024 vs By Aircraft Type $ USD Billions $4.9 Rotary Wing - Transport / Utility $1.5 Transport - Lt/Med $1.0 $0.9 Fighter / Attack Rotary Wing - Attack $0.8 Trainer / Light Attack $0.5 Special Mission $0.2 $0.2 $0.1 Transport - Heavy General Aviation/Utility Tanker Percent Change: 37% 21% 3% 23% 27% 12% 11% 13% 4% Source: ICF analysis 18

20 Trends 19 19

21 Shifting fleet demographics and the continued drive for cost reduction are the most important trends impacting military MRO Fleet Demographics The introduction of new platforms and consolidation of MRO spend into fewer large platforms will drive change Establishing capability on growth platforms will be key for suppliers Drive for Cost Reduction Countries are more likely to use PMA/DER, and surplus material to support legacy fleets Increased outsourcing and use of performance based contracts 20

22 Changing fleet demographics are influencing parts buying behavior, spurring global investments in new capabilities, and shifting the key platforms driving MRO spend New Capability Investments Retirements Driving Surplus Availability Shift In Key Platforms 21

23 A wave of retirements will create opportunities in the secondary market Older F-16, AH-64, F-18, and CH-47 models will be retired as Tier 1 countries buy new aircraft and upgraded variants Some of these will likely find new secondary operators Those aircraft that are retired will be candidates for partouts A growing cadre of suppliers are focusing on military aircraft surplus F-16 AH-64 S-70 F-18 UH-1 OH-58 CH-47 F-5 A-10 AH-1 Total Retirements by Platform Source: ICF analysis 22

24 While overall market growth will be steady, underlying shifts in the installed base will cause dramatic changes in MRO spend at the platform level F-16 F-18 KC-135 A-10 CH-53 (legacy) F-35 S-70 V-22 C-130J CH MRO Changes (Top 5 Declining & Top 5 Growing Platforms) -$2.0 -$1.0 $0.0 $1.0 $2.0 $3.0 $4.0 The top five growth platforms will drive a $7.5B increase in MRO demand, while the five platforms with the greatest decline will decrease MRO demand by over $3B by 2024 The shift in key platforms will force suppliers to establish new capabilities and partnerships and reevaluate strategies to ensure success on the emerging generation of aircraft Source: ICF analysis Note: Assumes aircraft retirements with no secondary/tertiary operators 23

25 The F-35 is driving the establishment of new MRO facilities across the globe F-35 Initial Global MRO&U Locations In late 2014, initial MRO&U centers announced by JSF Program Office Netherlands TBD AIM Norway Turkey (engines) and Alenia (airframe) in Italy will establish initial capabilities by 2018 Additional maintenance tenders in bidding process South Korea, Israel hope to establish MRO centers ICF estimates the F-35 will generate nearly $15B in MRO demand between 2015 and 2024 Airframe Japan Japan Australia Australia Engine UK TBD Alenia Turkey Source: JSF Program Office 24

26 The Better Buying Power program may drive a further shift away from traditional cost-plus and fixedfee contracts BBP 3.0 Originally launched in 2010, Better Buying Power is the DoD s umbrella cost reduction & productivity improvement initiative BBP 3.0 is the newest iteration of the policy implemented in 2015 Focuses on using effective contracting to align supplier and DoD goals, less burdensome contracting requirements, and use of commercial best practices where appropriate Source: DoD BBP 3.0 Themes and Goals Ensure effective use of Performance-Based Logistics Align profitability more tightly with Department goals Employ appropriate contract types, but increase the use of incentive-based contracts 25

27 In certain instances, the military has embraces commercial cost reduction measures like PMA, surplus, and DER repairs KC-10 CLS The KC-10 CLS contract was awarded to Northrop Grumman in 2009 Chromalloy and MTU are engine maintenance partners Contract is currently in the process of re-bid The Air Force has indicated its preference to continue using PMA & DER in response to bidder questions The KC-10 program has served as a case study for alternative MRO materials When compared to the previous engine contract, we are pleased that the U.S. Air Force is saving more than $1M per engine shop visit. $500,000 of savings per engine is attributable to the use of alternative materials and repairs - Chromalloy 2011 In response to bidder questions regarding concerns over the amount of PMA & DER that has been introduced to the engines over the past few years, the Air Force answered: The government understands the use of Parts Manufacturing Authority (PMA) parts and Designated Engineering Representative (DER) repairs. The government has no requirement to return the engine to original OEM state KC-10 Engine CLS RFP Source: Northrop Grumman, Chromalloy, FedBizOpps 26

28 April 6, 2016 Dallas, Texas THANK YOU! For questions regarding this presentation, please contact: Glenn McDonald Manager Aerospace & MRO

29 ICF provides a full range of MRO advisory services Market Research & Analysis Airline Maintenance Benchmarking M&A Commercial Due Diligence OEM Aftermarket Strategy Aviation Asset Valuations & Appraisals MRO Information Technology (IT) Advisory Strategic Sourcing & Supply Chain Mgt. LEAN Continuous Process Improvement Military Aircraft Sustainment 28

30 Aerospace & MRO Aircraft Asset Advisory Airline Advisory Airports ICF is one of the world s largest and most experienced aviation & aerospace consulting firms 53 years in business (founded 1963) 100+ professional staff Dedicated exclusively to aviation and aerospace Blend of consulting professionals and experienced aviation executives Specialized, focused expertise and proprietary knowledge Broad functional capabilities More than 10,000 private and public sector assignments Backed by parent company ICF International (2014 revenue - $1.05B) Global presence offices around the world joined ICF in 2011 joined ICF in 2007 New York Boston Ann Arbor London Singapore Beijing Hong Kong 29