pwc aerospace & defense 2012 year in review and 2013 forecast

www.pwc.com/us/aerospaceanddefense

Aerospace & defense2012 year in review and 2013 forecast

How are aerospace

and defense companies

performing today?

What challenges

and opportunities do

they face?

PwC takes a look.

http://www.pwc.com/us/en/industrial-products/aerospace-defense.jhtml

Aerospace and defense year in review 1

Commercial aerospace 7

Defense 15

Trends 20

Mergers and acquisitions 31

In summary 33

Top 100 list 34

Contents

2012 data for the largest 100 aero-space and defense (A&D) companies, by revenue, with publicly available

Consequently, several companies were not included because they had not reported results by the

A&D companies include those that generate the majority of their revenue from aerospace and defense activities

Methodologyreportable segments that derive a majority of revenue from aerospace

currencies are translated at average exchange rates for the years ending December 31, 2012 and December

Our report also offers PwC’s point of

Our viewpoints have been developed based on our interactions with our clients and other industry leaders

A&D 2012 year in review and 2013 forecast 1

reported its best year ever in 2012,

uptick came on the strength of a surging commercial aviation market that more than offset a soft defense

A&D companies reported a record-setting $695 billion in revenue and

Revenue was up 4 percent compared

margin decreased 17 basis points to

results, so these statistics slightly understate the strength of commer-cial aviation earnings as a result of the acquisitions of Goodrich and

half of Goodrich’s annual revenue, meaning that the year over year statistics do not take into account more than $4 billion of revenue

acquired by GE Aviation at the end of the year, so the year over year statis-tics do not include about $3 billion of

types of anomalies occur every year, they were particularly pronounced

Commercial aerospace companies continue to be optimistic about

and steady, driving the lucrative

increased large commercial aircraft

new record, and captured more

Aerospace and defense industry delivers a third consecutive year

Summary table (US $ billions) 2012 2011 Change

Revenue $695 $666 4%

Operating profit $59.8 $58.4 2%

Operating margin 8.60% 8.77% -17bps

Source: PwC analysis

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than 2,000 large aircraft orders for the second consecutive year and

there’s a record backlog—more than seven years at current production

In the wake of modest revenue declines reported for 2012, defense

Despite efforts by the industry and others, sequestration went into

-

nies now are bracing for the conse-quences and waiting for details

more pressure than ever to improve productivity, increase transparency, and respond to increasingly complex government regulations and over-

challenges associated with tighter schedules, and generally higher

threats, the Iranian and North Korean nuclear threats, and

geopolitical instability underscore the need for increased global security and could rapidly affect

has enjoyed steady growth in defense spending and, simultaneously, the longest up cycle in commercial

well managed the growth and achieving record results, now must

Despite efforts by the industry and

others, sequestration went into effect on

March 1, 2013. Companies now are

bracing for the consequences and waiting

for details regarding the impact on

Defense companies face more pressure than ever

to improve productivity, increase transparency,

and respond to increasingly complex government

regulations and oversight.



Some highlights from our analysis of 2012 results

Largest increase in revenue (dollars) Boeing $12,963 M

Largest increase in revenue (percentage) AVIC Aircraft Company 82%

Largest increase in operating profit (dollars) Finmeccanica $2,731 M

Largest increase in profit (percentage) Dyncorp 700%

Highest operating margin Transdigm 41.2%

Largest increase in top 100 list AVIC Aircraft Company +19 to 51

Largest decrease in revenue (dollars) BAE Systems -$2,482 M

Largest decrease in revenue (percentage) ThyssenKrupp Marine -27%

Largest decrease in profit (dollars) General Dynamics -$2,993 M

Largest decrease in profit (percentage) Engility -458%

Largest decrease in top 100 list ThyssenKrupp -12 to 68

Deleted from the 2011 list

Goodrich Acquired by United Technologies

Avio Acquired by GE Aviation

Barnes Group Segment reporting change

Loral Space & Communications Acquired by MacDonald Detwiler

Titanium Metals Acquired by Precision Castparts

Volvo Aero Acquired by GKN

Indra Security & Defense 16% decline in revenue

Added to the 2012 list

#66 Engility Spun off from L-3 Communications

#72 Korea Aerospace Did not make reported date cutoff in 2011

#77 Cytec Engineered Materials and Umeco Business combination

#80 Kratos Defense Acquisitions

#92 Nabtesco Aircraft and Hydraulic Equipment

#93 Wesco Aircraft Holdings

#99 Sumitomo Precision Products


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Companies with operating margin > 20%

#19 Precision Castparts 25.1%

#46 Hindustan Aeronautics Limited 23.7%

#49 Meggitt 24.5%

#64 Transdigm 41.2%

#69 FLIR Systems 21.65%

#93 Wesco Aircraft Holdings 20.5%

#97 Crane Aerospace & Electronics 22.3%


Another year of record deliveries and backlog for commercial aerospace

Boeing again was the industry’s

in revenue, a 19 percent increase, on the strength of commercial

the largest revenue growth,

of revenue that Boeing added in 2012 would be equivalent to the

increased revenue by 15 percent,

(6% when translated into US

-cial aerospace companies generally

Honeywell Aerospace all reported

Precision Castparts, Spirit, Babcock,

AVIC Aircraft Company reported the largest revenue percentage

the largest jump on the list, advancing

reported the largest revenue decline but improved operating income through a 100 basis point increase in operating margin, the largest of any

Boeing was also the industry’s most

billion—due to the absence of large program charges recognized in

The amount of revenue that Boeing

added in 2012 would be equivalent to

the 15th largest A&D company.



the industry as a whole continues to be eluded by double-digit operating

-

Globalization

are reporting more foreign direct investment, with the rate more

investments in manufacturing, China

strength of its market size and capa-

which has developed an aerospace

top target for R&D investments, while China came in seventh, presumably because of concerns over intellectual

States was the second most popular target for aerospace and defense

0

5

10

15

20

25

30

35

40

2012201120102009200820072006200520042003200220012000

24

21

12

1813

77

6

3

695

7

2 2 13 2 3

79

64

9 106

R&D Manufacturing

Investments by top 50 global A&D companies in international markets

Source: Company reports

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2013 forecast and risks

third consecutive year of record

in commercial aviation more than offset a soft defense market and multi-billion dollar impairment charges at large defense contrac-

2013 performance are familiar, and sequestration is certain to have a negative impact on defense industry

in the US defense market, it is

growth is expected to slow to a rate of between 4 percent and

5 percent, which is approximately the percentage defense revenue is

industry revenue is expected to be

industry avoids the large impair-

there is a risk of some impairments resulting from the decline in US defense spending, the magnitude of those charges is likely to be less

in commercial aerospace should approximately offset declines in

-tial for improvement in the absence

While there is a risk of some impairments

resulting from the decline in US defense

spending, the magnitude of those charges is

likely to be less than in recent years.


In 2011, the industry set a record,

than 1,000 large aircraft; in 2012, the industry beat the previous year’s

-

601 aircraft in 2012, the second best in its history and close to its record

Airbus recorded 294 deliveries, less than half of Boeing’s tally the same

aircraft, exactly double its output of 1999, its eleventh consecutive year

time Boeing delivered more aircraft

2012 was also the third best year for -

tions, surpassing the 2,000 mark for the second consecutive year and

pushing backlog to another record of more than 9,000 aircraft, or approxi-mately seven-and-a-half years at

In 2012, Boeing aircraft programs

company booked 1,124 orders for the 737, the most for any Boeing model in a single year, bringing cumulative program orders above the 10,000

1,000 cumulative orders for the 737

program milestone, exceeding 1,000

Commercial aerospace

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Boeing’s backlog is at a record $319 billion, and Airbus’ backlog is at

IATA statistics 2012 2011 2010

Revenue passenger miles 5.30% 5.90% 8.20%

Load 79.10% 78.10% 78.40%

Cargo freight ton miles -1.50% -0.70% 20.60%

Load 45.20% 45.90% 53.80%

Source: IATA

Backlog (US $ billions) 12/31/12 12/31/11 12/31/10 12/31/09

Boeing $319 $293 $256 $250

Airbus* $638 $679 $480 $459

*At list price

Aircraft backlog (units) Boeing Airbus Total

Backlog at December 31, 2011 3,771 4,437 8,208

Net orders 1,203 833 2,036

Deliveries 601 588 1,189

Backlog at December 31, 2012 4,373 4,682 9,055

Source: Boeing annual report; Airbus annual report

reported revenue passenger growth

well for the 20-year forecast of approximately 34,000 new planes



Order activity continued to be driven in large part by the new single-aisle aircraft, 737MAX

re-engined versions of the existing models, offering at least a 15 percent

engines have achieved a 49 percent

Consequently, a 15 percent improve-ment in one generation constitutes a

Some larger orders from 2012, with approximate value

Lion Air, 230 737 MAXs and 737-900ERs $22 billion

Norwegian, 222 narrow-body split between Boeing and Airbus $22 billion

United, 150 737 MAXs and -900s $15 billion

Pegasus, 100 A320neos not disclosed

GECAS, 100 737 MAXs and -800s $7 billion

Air Lease, 75 737 MAXs $7 billion

To put this in perspective, aircraft engines

of the jet era, or about 1 percentage point

annually.

Consequently, a 15 percent improvement

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Regional aircraft

Mitsubishi reported its largest order yet for the MRJ in 2012 from

than doubled Mitsubishi’s backlog to 165 aircraft, pulling ahead of Bombardier, which has received

will formally launch its second-

Among the improvements will be Pratt & Whitney PW1700G and PW 1900G geared turbo fan engines,

complete turnabout in the regional engine market, Pratt & Whitney, once absent from the regional jet space, now dominates new produc-tion platforms, with engines on the Bombardier C-Series and Mitsubishi

Aviation deliveries 2011 2012

Global business jet deliveries 696 672

Global turboprop deliveries 526 580

Global piston aircraft deliveries 898 881

Source: General Aviation Manufacturers Association

MRJ, and its recent selection for

Business jets

Business jet deliveries and cycles

more than 10% below the pre-

are roughly the same as a decade

favorable for the long term, with strong growth in the international markets, as well as improvement in the United States, driven by an improving economy and growing

During 2012 the number of business jets in China increased

exceed 2,000, according to the



Source: FAA and UBS estimates

0

50,000

100,000

150,000

200,000

250,000

Seasonally adjusted business jet monthly cycles

00 01 02 03 04 05 06 07 08 09 10 11 12

Total orders Total deliveries

Sources: Actual deliveries from GAMA. Orders estimated from competitive intelligence, OEM guidance.Excludes Very Light Jet and Large corporate airliners segments.

2011201020092008200720062005200420032002-1,000-800-600-400-200

-0200400600800

1,0001,2001,4001,6001,800

Industry orders and deliveries—Units, 2002–2011

All graphs represent business jet data

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Commercial aerospace 2013 forecast

between 635 and 645 deliveries, a 6 percent to 7 percent increase, and Airbus is expected to achieve another year of record deliveries of 600 to 610 units, a 2 percent to

While these growth rates are more

in original equipment manufac-turer (OEM) deliveries in 2012, the industry continues to establish new

output levels create considerable strain on an industry that arguably has the most complex supply chain and the one with the longest lead

previous supply chain issues while

industry previously has faced raw materials shortages, late deliveries, out-of-sequence work, overtime, and rush shipments throughout the supply chain, all of which erode the

-lenges in 2013, and in the longer term, as capacity constraints bump

and suppliers are encouraged to perform thorough supplier capacity

it is unlikely that orders will main-tain the manic pace of 2011 and

of 2013, Airbus booked 431 orders and Boeing recorded 220 orders, a combined rate of 2,600 orders annu-

Ryan Air ordered 175 737s, Lufthansa

not expect this pace to continue or for orders to exceed 2,000 for the third

orders to exceed the approximately 1,250 deliveries predicted for 2013, pushing backlog to another new high


grown to represent about half of

leasing companies have about 16 percent of the current backlog,

become even more important as their more stable business models,

-tively higher grade ratings ease

Economic risks include the potential for slowing global growth, resulting in part from government spending

sovereign debt crisis has the poten-

may be mitigated through increases

in our recent report, “Aviation

as global risks are re-priced, the

aircraft may intensify, and the cost

the industry as a whole to be able to attract funding, but new sources of

Export Credit Agency (ECA)

has become the funding source of

the new Aircraft Sector Under-standing (ASU), which governs

effect in 2013, resulting in consid-erable premium increases for this

Overall, modest growth in commer-

Space

Space-related initiatives are

missions to the International Space Station (ISS) and Orbital Sciences

with the ISS under the Commercial

research and development continues under the Commercial Crew Devel-

SpaceX, United Launch Alliance, and Sierra Nevada are among the compa-nies receiving NASA funding for

on these and other space programs

Long-term forecast

-cial OEM aircraft is about 34,000

-

some observers have questioned whether these forecasts are overly optimistic, they are nevertheless based on well-founded assumptions about global economic growth and

-erate the demand for replacement

more than 1,500 aircraft per year and current production rates at


about 1,200 per year, the industry can look to future growth and a lot of cushion between forecasted demand and current production to

Perhaps a key competitive advan-tage will go to the company that can effectively raise production rates

At the same time, new competi-tors are trying to take advantage

-cial Aircraft Corporation of China (COMAC) has launched its C919

more than 2,000 planes, capturing

In addition, Irkut of Russia has launched a narrow-body aircraft, and Bombardier is marketing its

launch its next-generation E-Jet in 2013, but it has not announced any plans to compete in the narrow-

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Growth in business jets

elusive and slower than was expected at the beginning of the

still more than 10 percent below

Companies are reporting that business jet backlogs have been cut approximately in half since the

in business jets is expected to align with the overall Western economic

recovery, which continues to be

for aircraft remain challenged, given the lack of demand, leaving many owners, operators, and their

business jets should expect another

medium to long term, business jets

driven by economic growth and adapting regulations in Asia and the

The business jet rebound remains

elusive and slower than was expected

at the beginning of the year.

Companies are reporting that business jet

backlogs have been cut approximately in half

since the start of the recession.


-nies reported revenue decreases of about 4 percent, and an increase in

-tics exclude the results of General

reported large impairment charges

3 of the top 12 companies reported revenue increases, with Boeing up 3 percent, Lockheed Martin up 1

-

Martin, 10 percent; BAE Systems, 2

Northrop Grumman reported the best

double-digit operating margins

improvements in operating margin were reported by BAE Systems, at 100

However, some investors are asking whether the margin improvements are sustainable or are a temporary result of cost reduction preceding a

Sequestration went into effect on

--

that include reduction and furlough

DefenseDefense contractors brace for sequestration

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Defense

of civilian staff and cutbacks in base

remains about the impact of seques-

but the defense industry should

During 2012, European defense ministries began responding to the consequences of budgetary reduc-

programs and reducing platform

-cant uncertainty in the supply base as companies struggle to manage both the impact of known reductions and the risk of uncer-

to preserve capability at the same or lower cost have burgeoned in Germany, Sweden, Norway, the UK,

growing appetite for capability and cost-sharing between nations—initiatives that remain at the discus-

seeks to achieve this for the Alliance, and bilateral arrangements such

encourage collaboration in a range of activity, from military opera-

Backlog (US $ billions) 12/31/2012 12/31/2011

EADS Defense $64 $73

Lockheed Martin $82 $81

Finmeccanica $57 $64

BAE Systems $67 $58

Boeing Defense, Space & Security $71 $60

Thales $32 $33

Northrop Grumman $41 $40

General Dynamics (exc. Gulfstream) $36 $40

Raytheon $36 $35

L-3 $11 $10

Total $497 $494

Source: Company reports

-lighted the importance of having the capability to respond to unexpected events—the “return to contin-

European capabilities able to be

the Libyan operation was relatively

and surveillance systems) that

European defense companies are responding to declines in their traditional markets and are simul-taneously pursuing opportunities in growth markets, including the

-

in those regions are strong competi-

Exports

has led to a record backlog of $327

in excess of 13,000 active cases with more than 165 countries and

$327 billion, said Vice Admiral Bill

1

1 Bloomberg, Gopal Ratnam, “Pentagon Has $327 Billion Export Backlog, Sees Drone Demand,” June 10, 2011.


Defense

US defense export authorizations spiked at $264 billion in 2011, the most recent year for which data

and a 394% increase compared with

was disclosed at $327 billion at mid-year 2011, is now estimated at

growth in defense exports should help soften the impact of US defense

this period has been in Asia, due to concerns about China’s growing military power and tensions between North Korea and South Korea, and in the Middle East, due to concerns

the United States is not the only

countries, Israel, South Korea, and Russia are all gaining from increased

US foreign military sales (FMS) agreements and direct commercial sales authorizations2,3

USD Billions

0

50

100

150

200

250

300

2011201020092008200720062005200420032002200120001999

238

154123

107

8967

52676253525547

11 11 12 12 13 13 18 18 29 30 24 269

Foreign military sales (FMS) agreements Direct commercial sales authorizations

On March 7, 2013, the White House sent its export control reform

categories on the US Munitions List (USML), with oversight responsi-bility for some categories moving from the State Department to the

reforms, which have been supported by industry, are designed to simplify and streamline the export process and may lead to further increases in

2 US Department of Defense, “Fiscal Year Series,” http://www.dsca.mil/programs/biz-ops/factsbook/ Fiscal%20Year%20Series%20-%2030%20September%202011.pdf, Sept. 30, 2011.

3 US Department of State, “Section 655 Annual Military Assistance Reports,” http://www.pmddtc.state.gov/reports/655_intro.html

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Defense

Defense forecast

Due to sequestration, the initial effects of which will be felt during 2013, our expectation is that defense revenue will decline by about 5 percent, based on our calculation of the defense portion of seques-tration for about seven to eight

may be mitigated, because as the industry contracts, many of the costs to reduce capacity and restruc-ture or terminate programs will be

in margins in 2012, despite modest

our estimates, the industry will

before considering potential impair-

expectations are that some compa-nies will be susceptible to impair-

ment charges, similar in nature, although not necessarily magni-tude, to those reported by General

Market contraction, coupled with increasing certainty about the nature and amount of defense budget cuts and the impact on

-

been toward spin-offs and divesti--

tions have included the Huntington-Ingals split from Northrop

scheduled to complete a spin-off

of spin-offs looks to be nearing its end, to be followed by a period of

industry is already highly concen-trated, resulting from consolidation

Market contraction, coupled with increasing certainty

about the nature and amount of defense budget cuts and


Defense

Defense Department has opposed any further consolidation among major prime contractors, but that position could soften, depending

whether the major prime contractors consolidate further, expectations are

Contractors may also continue to respond to market conditions

remains on affordability, and the Defense Department now lists affordability among its procurement

focused on improving productivity, as the industry is beginning a period

time, there is a need to recapitalize

shift from new platforms to plat-

Electronics and C4ISR, including unmanned aerial vehicles and cybersecurity, will likely be among

Many companies are exploring commercial applications for their

-tors, and their investors, have approached commercial markets cautiously because of mixed experi-ences, weighted toward the nega-

-rience, though, is dated; defense contractors have had ample opportu-nities in their core markets for more

the industry’s largest commercial markets have their roots in defense and space technologies, such as computers, computer networking,

forward, defense contractors are expected to seek commercial appli-cations for their technologies, even if it means licensing or supplying

in North Korea’s and Iran’s nuclear weapons programs, instability in the Middle East, and other factors could bring rapid changes in defense

During 2013, the European defense markets will likely begin to stabi-lize as defense ministries address the budget cuts initiated two years

expected until 2015, and it may be necessary to pare some defense

budgets, still further if the Euro-zone’s austerity measures need

has announced plans to roll out a

program will provide clarity for OEMs after some years of uncer-

-

will likely start to manifest itself in rationalizing in-theater equipment and logistic support and an increase in logistic movement as military

the next few years will likely bring an acceleration of equipment refur-bishment, although the extent and its effect on the industry has yet to

European nations will likely continue various transformation programs aimed at preserving capability at lower cost and will import many of the ideas and concepts pioneered in the United Kingdom a few years ago; expectations also are for an increase in availability contracting for land, sea, and air platforms, plus an increasing appetite for industry-led solutions in the provision of training, infrastructure, and back-

industry will likely take on more complex and broader roles, and the United Kingdom’s Advanced Materials strategy may prove to be a

exports will also likely continue and

global defense industry competes in

So while the traditional, platform, and equipment-based defense markets in Europe remain under intense pressure, opportunities exist for industry to more broadly deliver service-based capabilities in many

the whole of the defense support services market is projected to be worth an estimated £16 billion per year by 2020, or approximately 75 percent of total MoD spend with industry; these trends will accelerate

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1 Strategy

While strategy is continually evolving, -

sion making is expected to accelerate due to a rapidly changing environ-

in US defense spending, companies will likely make strategic decisions regarding prioritization of markets

defense spending is expected to

• Lifetime affordability

•

• Upgrades and sustainability of existing platforms

• Command, control, computers, communication, intelligence, surveillance and reconnaissance (C4ISR)

•

Many strategic decisions have been made in anticipation of these changes; many actions have been in the form of spin-offs and dives-

to shift toward industry consolida-

failed merger between EADS and BAE Systems might be viewed as a

the governments involved will allow mergers among any of the major prime contractors may depend on

Regardless of whether major primes

TrendsEight trends to watch in A&D for 2013 and beyond


Trends

In addition, companies are expected to have a greater focus on inter-national markets, in order to help compensate for the decline in US

However, companies will increas-ingly focus on international strate-gies, which may include a more

control reforms proposed by the -

nies will likely focus on adjacent

many organizations are expected to approach commercial markets cautiously, they are expressing greater interest in commercializa-

2 Innovation

Innovation is another area that

companies, innovation is the single most important success factor, as

than 20 executives from leading A&D companies, who collectively ranked innovation as the highest

Innovation, therefore, is a major risk to be addressed when examining

compliance risks, when a failure to

Perhaps innovation is not under-stood as a risk because companies

-cial and compliance risks, including

opportunity cost and the effective-ness of research and development

reduced government funding for research and development, defense companies look to be making greater investments in independent research

challenge for the defense and space industry is to become more commer-

Commercial aerospace is enjoying

only is demand of the end markets strong, but successful innovations with dramatic improvements to

-lenge lies in gaining the resources, both human and economic, to keep up with the accelerating pace of innovation and product develop-

described it, “We have more oppor-tunities with good business cases

Commercial aerospace and defense companies should gain greater productivity from research and devel-opment activities as well as prioritize

partly on viewing innovation as a

about PwC’s perspective on achieving innovation excellence, please visit www.pwc.com/us/gainingaltitude.

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Trends

3 Talent management

Demographics

senior personnel and the need to -

ment levels for 2011 remained low, retirement eligibility—double-digit in most job categories—is growing by one to two percent annually and

small decreases, as well as possible declines among the youngest workers, more than 45 percent of workers under 35 plan to switch

With defense spending cuts on the way, expectations are for declines

faces a challenge similar to that faced by companies during the post-

avoid losing the next generation of A&D talent?4

A skilled work force

-nology, engineering, and mathematics

the pool of scientists and design engi-neers are particularly pronounced, with demand expected to show

-more, a majority of industry jobs are in defense and security, where US citizenship is required, further

According to the Aerospace Indus-tries Association, only 44,000 of the 70,000 engineers that graduate each year in the United States are quali-

suggesting the need for stronger partnerships between universities and A&D in order to identify the skills

companies also face competition from organizations and other industries

is mirrored in other developed

playing an increasingly strategic role

programs and training initiatives, designed to help retain key knowl-edge and skills, are growing in

talent, and recruiting partnerships are being developed to deliberately

management are knowledge capture

management programs are increas-ingly critical in minimizing the effects

attention to the organizational design elements that compromise project execution and cross-functional collab-oration, which may be particularly

4 Aviation Week, Carole Rickard Hedden, “Aviation Week Workforce Study”, Aug. 13, 2012.


Trends

Engineering talent and US citizenship

In Europe, for example, only about 10,000 graduates from technical universities choose to work within A&D, while the industry needs at

5

Global/US citizenship

US companies to focus increasingly

have historically attracted engi-neering talent from countries such as India and Russia, several forces have slowed the promise of an interna-

for A&D has resulted in increased competition from countries like China

the US government’s restrictions on the number of H-1B visas, a special

--

ally, US talent is typically preferred in organizations like the US Defense Department, where security clear-ance requirements rule out inter-national talent, while laws such as

technical data and knowledge with

5 Aviation Week, Carole Rickard Hedden, “Aviation Week Workforce Study”, Aug. 13, 2012.

-cant, making immigration reform

According to a 2007 study by the Woodrow Wilson School of Public and International Affairs at Princeton, two countries in particular, India and China, with their vast, educated, low-wage workforces, attracted more than 100,000 H-1B visa holders in

controls may serve to constrict this

management, please visit us online at www.pwc.com/us/peopleandchange.

The growth of international markets

for A&D has resulted in increased

competition from countries like China

for skilled labor.

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Trends

4 Productivity and affordability

affordability, including it as a

Accordingly, defense contractors have strategized to reduce costs and

defense companies with companies in the Dow Jones Industrial Average (DJIA) on the basis of revenue per employee, using data from company earnings statements and

that revenue per employee is an imperfect measure and that a better measure would be value added per employee, but since that data is not available, we have used revenue per employee as a reasonable surro-

that defense contracts are about

believe there are some valid reasons why defense companies have lower

• Much of defense revenue is under cost-reimbursable, or cost-

• Development of leading technolo-

Defense contractors are frequently developing cutting-edge technologies, which are inherently manually intensive and involve some degree of trial

• Many defense contracts are for single units or quantities measured in the dozens or hundreds, compared with commercial enterprises that typically measure

-ally intensive manufacturing and assembly and low absorption of

• regulated, which can increase compliance costs, including compliance with federal acqui-

accounting standards (CAS), and

The industry is highly regulated,

which can increase compliance costs.


Trends

Despite these inherent limitations, the industry recognizes there is room for improvement in produc-

taking action to reduce overhead costs, including workforce reduc-tions, early retirements, and facili-

We believe the following areas offer

• Program management/short-ened development cycle

• Supply chain management

• Information technology

• Knowledge management

Improving the speed and effective-ness of program development typi-cally produces the biggest gains

are the biggest factor in budget

pride in their program manage-ment abilities, the industry should seek continuous improvement, including unbiased, independent

-

more of the total value of production is rooted in a technically complex,

-ingly, any productivity improvement initiative should address suppliers,

longer accept long lead times and

marginal supplier performance as

challenge itself to get much closer to

might consider adopting leading-edge risk management practices to regain visibility into the supply chain that

Information technology represents one of the biggest areas for discre-tionary spending at most companies,

companies have invested millions in systems implementations but haven’t yet realized the full capabilities and productivity enhancements that these

-tions are still spending most of their time in legacy system maintenance

should unlock the full capabilities of

from costly maintenance toward strategic initiatives and competitive

management will likely become

a factor due to demographics, has been accelerated by early retirements

-nies should identify the key people and knowledge in their organiza-tions and capture that information

Organizations should also create a knowledge management culture that promotes and rewards the effective

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Trends

5 Supply chain

In 2013, two major trends are

Commercial aircraft production rate ramp-up

• Previously, we discussed the commercial aircraft production rate ramp-up of historic propor-

increase over the prior year,

long term, demand is projected to be about 1,700 aircraft annually, meaning that annual production rates may continue to

production levels will likely strain a supply chain that can be considered to have the most complex and longest lead time

Defense spending reductions

•

defense spending cuts will drive

Some of these suppliers may be sole source or produce unique

supply chain could be left with a shortage of critical parts and long lead times to qualify new

Both commercial aerospace and defense contractors should reeval-uate supply chain strategy and

-tive on the supply chain, please visit www.pwc.com/us/gainingaltitude.

6 Globalization

Globalization is driving the boom

more aircraft deliveries, in units and value, over the next 20 years than North America and Europe

• Developing economies, particu-larly in the BRIC countries (Brazil, Russia, India, and China) are growing faster than devel-

is becoming more knowledge based, with businesses increas-ingly relying on the global deployment of human capital, a requirement for operating a

strong demand for aviation, as well as resiliency for the

hyper-cyclical industry, overre-

that dynamic has fundamen-tally changed, as demonstrated

While aviation demand did take an extreme downturn during the


Trends

recession, demand rebounded faster than the overall economy and more quickly than in previous economic cycles, rapidly returning to pre-reces-sion levels and demonstrating that aviation demand has become much less elastic than

• Consumer air travel once was largely a privilege of the

air travel has declined, it has become highly accessible to the middle class and not readily relinquished, even during a

will likely continue to be driven by the growing middle class in

• Aviation is viewed as a strategic industry in emerging market

promote aviation, airports, and the associated infrastructure, own direct or indirect stakes in many national carriers, enabling them to

As a result, aviation is expected to grow about 2 percentage points faster than global GDP for the fore-

is creating tremendous growth and opportunity for the industry, it is also driving challenges that require

• industry and lure of high tech-nology in aerospace is attracting such new competitors as Comac of China, Irkut of Russia, and

regional jet makers are increasing the size and range of their jets, competing at the smaller end of

• Globalization of customers and suppliers is driving numerous

industry once was principally a domestic industry relying on

base and supply chain have -

nies increasingly are operating

While globalization is creating tremendous

growth and opportunity for the industry,

it is also driving challenges that require

new strategies.

internationally in order to drive intimacy with customers and suppliers, improve responsive-ness and service, satisfy offset and industrial participation requirements, and, in some cases, take advantage of interna-

Globalization, not limited to commercial aerospace companies,

authorizations (for future deliveries) have increased more than four-fold since 2005, from $61 billion to $264 billion in 2011, as seen in the chart

destined for the Middle East and

are expected to continue to focus on international markets and develop

In a recent PwC study, aerospace and defense companies cited the following as the greatest obstacles

• Safeguarding intellectual property

• Export control compliance

• Creating ethical cultures

•

• Managing offset and industrial participation requirements

to address globalization opportuni-ties and risks, please refer to A&D

Insights: Accelerating global growth.

PwC28

Trends

7 Cybersecurity

Given their role in developing cutting-edge technologies with military applications, A&D compa-nies have long faced heightened

and interconnected information

every phase of the A&D industry, companies face complex challenges to the security and integrity of their operations and reputation, including ongoing efforts to steal intellectual property and other sensitive business data, as well as attempts to sabotage opera-tions and tarnish reputations by

Economic espionage.

A&D remains the industrial sector most targeted by economic espio-

nage conducted by nation-states’

supporting unmanned aerial vehi-cles (drones) may get particular attention from economic spies because of their highly publicized use for intelligence gathering and

Intrusions into A&D companies’

-atically stolen hundreds of terabytes from at least 141 organizations…

been created by hackers linked to a

appear to have been designed to

networks, where they are typically

6

• It is likely that every company in the A&D sector has been targeted

• Many US A&D companies have

Cyber Security/Information Assurance Program, under the aegis of the Department of Defense (DoD) and Homeland Security (DHS), is a forum letting A&D companies volun-tarily report cyberintrusions and letting federal authorities share

• Cybertools are not the only means of conducting economic

of disgruntled or corrupted

Chung, who worked on the B-1 bomber, space shuttle, and other A&D projects for nearly 30 years, was convicted in 2010 of economic espionage on behalf of

in the A&D sector, with compa-nies increasingly relying on joint ventures, partnerships, and manu-facturing and R&D facilities in expanding markets—potentially opening new points of access for intruders—adds to the challenge of

6 Mandiant, “APT1: Exposing One of China’s Cyber Espionage Units”, www.mandiant.com, Feb. 19, 2013.


Trends

Disruption and sabotage.

companies attractive to spies also make them targets for cyberdisrup-tion campaigns by terrorists, rogue

Hacktivists, who have already

companies, could conduct distrib-uted denial of service campaigns

publicizing sensitive data about

Similarly, kinetic strikes using a particular weapons system against a rogue state or terrorist group could lead to retaliatory cyberattacks designed to disable or disrupt the computer networks of the weapon’s

Unique and evolving regulatory environment.

Because most of the largest A&D

military-related projects, many of their processes for handling sensitive information are subject to unusually

companies should be prepared for regulatory changes, which are in the

a White House executive order (EO), “Improving Critical Infrastructure’s

of a framework to reduce cyber-risk to critical infrastructure, as well as provisions letting federal agencies share more threat information with

calls on the secretary of Homeland Security to identify “critical infra-

-cant military contracts—and to let the owners of such organizations

of the details of the order will be

In addition, the Cyber Intelligence-Sharing and Protection Act has been reintroduced in the House of Representatives, and this year’s draft is expected to receive White

necessary for the complete imple-

One particular concern of many companies is to obtain protection from legal liability that could result from voluntary information-sharing

including most major A&D compa-nies, must soon develop insider threat programs and enhance their capa-bilities to detect and prevent these threats, in accordance with Executive

and establishing a national policy and minimum standards for insider threat mitigation programs across federal

Looking ahead.

Over the next decade, the A&D industry will likely remain a high-priority target of threat actors due to economic factors as well as mili-

-ments is to be determined, but two

smartphones, tablets, and other devices that can connect to the Internet are becoming ubiquitous and, with the move to a cloud computing paradigm, will likely drive opportunities for theft and manipulation of companies’ sensi-

individual stakeholders can expect ever greater access to companies’

personal devices and from locations

New threat factors are also likely to

• Governments seeking to jump-

could be tempted to sponsor cyber-intrusions and other efforts to pilfer the intellectual property and know-how of

• Similarly, the nature of criminal hacking may evolve, with social networking tools potentially facilitating a new black market

creating powerful incentives for newcomers to attack corporate

-rity, please visit PwC’s Information

security, privacy, and risk

PwC30

Trends

8 The regulatory environment

is a key challenge facing the defense

Several reforms may help improve the environment for defense

Acquisition reform

Attempts to improve the current defense acquisition process have

that reforms have sought to place ever-increasing regulations on the

how Congress funds long-term programs on a short-term basis, and the manner in which the customer

-

• stability of requirements

• Establishing realistic budgets and funding based on the inherent risks of developing advanced technologies

• -vation in the bid and proposal process

• Using contract structures appropriate to risk

• Promoting international cooperation and cost sharing

The Defense Contract Audit Agency

Audit Agency (DCAA) is to protect the government and taxpayers from

are some considerations that could improve the effectiveness and

• Benchmark the audit approach against commercial practices, such as those regulations established under the American Institute

(AICPA) and Public Company Accounting Oversight Board

• Establish mate-

widely accepted in commercial practice that it is impractical and cost-prohibitive to build a control

• Third-party reliance

standards allow for reliance on

DCAA could consider establishing standards for third-party reliance that promote such use where the third party is objective and compe-

-

Export control reform

Many observers believe current export control regulations are outdated and drive a competitive disadvantage for

technologies that are broadly used in commercial application are still

On March 7, 2013, the White House sent its proposal for export reform to

be effective in promoting US exports and preserving key skills in the indus-


15 percent below the preceding

Based on our methodology, the 2012 statistics include the announcement that Hawker Beechcraft would be purchased by Superior Aviation Beijing; however, the deal subsequently was aban-

Overall, commercial aerospace

the defense sector did not generate even one mega deal (above $1 billion) in 2012, while 2011 brought four mega deals in defense, totaling

In 2012, the defense sector faced potential US sequestration and uncertainty in defense spending,

there is more certainty—or at least less uncertainty—regarding the future of defense budgets and

the defense industry will be able to value companies and better

this period begins, defense M&A is expected to become much more dynamic and could lead to some

Defense M&A is facing a “perfect

balance sheets and cash positions, and, most importantly, the neces-sity to consolidate in response to

Mergers and acquisitions

PwC32

Mergers and acquisitions

the attempted merger between EADS and BAE Systems in 2012 as a harbinger of further defense

defense prime contractors will continue to be challenging, due to concerns by government stake-holders, some transformative M&A transactions are expected in defense once the cloud of uncertainty is

Looking ahead, four trends are likely to affect M&A activity in the

• Increasing consolidation in response to a contracting defense market and cost pressures

While mergers among global defense prime

contractors will continue to be challenging…

some transformative M&A transactions

are expected in defense once the cloud of

uncertainty is lifted in the United States.

• chains by big manufacturers, in both civil and military segments, as they seek to gain better control of their large program pipelines

• Continuing growth in the secu-rity, surveillance, and homeland security sector

• Greater investment in and competition from fast-growing markets, most notably China

We believe these trends will provide the context for growth in


companies is a barometer for the health

disciplined management over the past

Aviation has become a critical part of

cannot operate effectively without

Aviation is increasingly inelastic, and it demonstrated its resiliency during

dwarfed by sea and land freight, an increasingly larger portion of the global

the impact of sequestration in the United

is still not clear how defense budget cuts

dynamic and could rapidly change

must respond to the affordability chal-

for commercial aerospace is optimistic,

faster than the overall economy because of its critical role in the global economic infrastructure, bolstered by economic growth in Asia, the Middle East,

Defense faces challenges, including an extended period of budget battles and

another strong year for the industry, and possibly another record year, as avia-tion growth continues to offset a weaker

In summary

PwC34

In summary

Revenue (US $ millions)

Operating Profit (US $ millions)

# Company 2012 2011 Change 2012 2011 Change1 Boeing 81,698 68,735 19% 6,311 5,844 8%2 EADS 72,587 68,328 6% 2,809 2,359 19%3 Lockheed Martin 47,182 46,499 1% 4,434 4,020 10%4 General Dynamics 31,513 32,677 -4% 833 3,826 -78%5 United Technologies 29,089 24,826 17% 3,245 3,466 -6%6 BAE Systems 28,263 30,745 -8% 2,599 2,536 2%7 Northrop Grumman 25,218 26,412 -5% 3,130 3,276 -4%8 Raytheon 24,414 24,791 -2% 2,989 2,830 6%9 Finmeccanica 22,128 24,086 -8% (587) (3,318) 82%

10 GE Aviation 19,994 18,859 6% 3,747 3,512 7%11 Rolls Royce 19,273 17,856 8% 2,176 1,904 14%12 Thales 18,196 18,120 0% 1,191 1,010 18%13 Safran 17,427 16,214 7% 1,826 1,613 13%14 L-3 Communications 13,146 13,158 0% 1,351 1,442 -6%15 Honeywell Aerospace 12,040 11,475 5% 2,279 2,023 13%16 SAIC 10,587 10,921 -3% 311 947 -67%17 Textron 9,122 8,387 9% 853 722 18%18 Bombardier Aerospace 8,628 8,594 0% 382 502 -24%19 Precision Castparts Corp. 7,215 6,220 16% 1,817 1,503 21%20 Huntington Ingals 6,708 6,575 2% 358 100 258%21 Mitsubishi Aerospace 6,216 5,923 5% (137) (43) -220%22 Embraer 6,178 5,803 6% 612 318 92%23 CSC North American Public Sector 5,703 6,002 -5% 132 528 -75%24 Exelis 5,522 5,839 -5% 561 535 5%25 Harris Corp 5,451 5,418 1% 559 600 -7%26 Spirit AeroSystems 5,398 4,864 11% 92 356 -74%27 Serco UK & Europe and Americas 5,252 5,559 -6% 396 380 4%28 Singapore Technologies 5,108 4,755 7% 527 483 9%29 Dassault Aviation 5,065 4,597 10% 703 524 34%30 Babcock International Group 4,865 4,339 12% 521 442 18%31 Rockwell Collins 4,726 4,806 -2% 859 846 2%32 Alliant Techsystems 4,618 4,842 -5% 496 526 -6%33 Zodiac 4,422 3,804 16% 610 512 19%34 MTU Aero Engines 4,343 4,078 6% 481 456 5%35 Delta Tucker Holdings / DynCorp International 4,044 3,719 9% 96 12 700%36 Oshkosh Defense 3,951 4,365 -9% 237 543 -56%37 CACI 3,774 3,578 5% 300 251 20%38 IHI Aero Engines and Space Operations 3,752 3,438 9% 75 73 3%39 Saab 3,547 3,615 -2% 300 452 -34%40 Triumph Group 3,408 2,905 17% 515 314 64%41 Israeli Aerospace Industries 3,300 3,436 -4% 78 133 -41%42 Hindustan Aeronautics Limited (HAL) 3,126 3,279 -5% 622 604 3%43 BE Aerospace 3,085 2,500 23% 540 428 26%44 Rheinmetall Defence 3,001 2,978 1% 224 310 -28%45 Elbit Systems 2,889 2,817 3% 203 116 75%46 GKN Aerospace 2,813 2,377 18% 269 266 1%47 Cobham 2,772 2,977 -7% 374 420 -11%48 Kawasaki Aerospace 2,588 2,472 5% 98 38 160%49 ManTech International 2,582 2,870 -10% 171 227 -25%50 Meggitt 2,545 2,335 9% 625 578 8%


In summary

Revenue (US $ millions)

Operating Profit (US $ millions)

# Company 2012 2011 Change 2012 2011 Change51 AVIC Aircraft Company 2,474 1,361 82% 34 19 79%52 MOOG 2,470 2,331 6% 243 219 11%53 QinetiQ 2,329 2,731 -15% 256 233 10%

54Allegheny Technologies High Performance Metals

2,191 1,956 12% 372 365 2%

55 BBA Aviation 2,179 2,137 2% 163 181 -10%56 Teledyne Technologies 2,173 1,942 12% 243 227 7%57 Parker Hannifin Aerospace 2,103 1,922 9% 290 247 17%58 Curtiss-Wright 2,098 2,017 4% 161 187 -14%59 AAR 2,064 1,805 14% 131 134 -2%60 Trimble 2,040 1,644 24% 213 156 37%61 Esterline Technologies 1,992 1,718 16% 189 198 -5%62 RUAG 1,856 1,932 -4% 122 124 -2%63 CAE 1,822 1,649 10% 302 286 6%64 Eaton Aerospace 1,719 1,648 4% 213 244 -13%65 TransDigm Group 1,700 1,206 41% 700 487 44%66 Engility 1,655 2,071 -20% (329) 92 -458%67 Hexcel 1,578 1,392 13% 249 192 30%68 ThyssenKrupp Marine Systems 1,526 2,076 -27% (18) 296 -106%69 Orbital Sciences 1,437 1,346 7% 113 80 41%70 FLIR Systems 1,405 1,544 -9% 303 313 -3%71 Cubic Corporation 1,381 1,296 7% 128 114 12%72 Korea Aerospace Industries 1,367 1,163 18% 112 96 17%73 Kongsberg Gruppen Defense and Protech 1,294 1,443 -10% 172 178 -3%74 Ultra Electronics 1,206 1,174 3% 141 159 -12%75 Chemring Group 1,173 1,162 1% 59 162 -64%76 Bharat Electronics 1,066 1,164 -8% 201 247 -19%77 Cytec Engineered Materials & Umeco 1,054 789 34% 166 125 33%78 Fuji Aerospace 1,006 1,039 -3% 36 27 34%79 GenCorp 995 918 8% 35 39 -10%80 Kratos Defense & Security Solutions 969 714 36% (50) 30 -267%81 SIA Engineering 937 879 7% 104 108 -4%82 Aselsan 907 899 1% 113 140 -20%83 Heico Corporation 897 765 17% 163 138 18%84 Woodward Governor Aerospace 896 843 6% 130 130 0%85 MacDonald Dettwiler & Associates 880 761 16% 127 117 9%86 Ball Aerospace 877 785 12% 85 80 6%87 ViaSat 864 802 8% 2 39 -95%88 Latecoere 827 801 3% 34 62 -45%89 Smiths Detection 823 819 0% 109 105 4%90 Alion Science and Technology 817 787 4% 40 35 14%91 OHB Technology 813 773 5% 40 38 6%92 Nabtesco Aircraft and Hydraulic Equipment 805 742 9% 77 70 9%93 Wesco Aircraft Holdings 776 711 9% 159 162 -2%94 Ducommun 747 581 29% 55 (34) 262%95 Senior Aerospace 746 614 21% 108 88 23%96 Magellan Aerospace Corp 705 699 1% 61 60 2%97 Crane Aerospace & Electronics 701 678 3% 156 146 7%98 Aeroflex 673 729 -8% (21) 53 -140%99 Sumitomo Precision Products 655 706 -7% 53 63 -17%

100 Jamco Corp 624 539 16% 13 25 -45%

Total 694,763 665,969 4% 59,752 58,427 2%

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Scott ThompsonUS Aerospace & Defense Leader

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