State of Washington Governor’s Aerospace Conference Museum of Flight Briefing June 25, 2008 Museum of Flight Briefing June 25, 2008 Tom Captain, Vice Chairman

State of WashingtonGovernor’s Aerospace ConferenceState of WashingtonGovernor’s Aerospace Conference

Museum of Flight BriefingMuseum of Flight Briefing

June 25, 2008June 25, 2008Museum of Flight BriefingMuseum of Flight Briefing

June 25, 2008June 25, 2008

Tom Captain, Vice Chairman Aerospace & Defense Industry PracticeDeloitte LLP

Copyright © 2008 Deloitte Development LLC. All rights reserved. 2

Acknowledgments

• Grant County Economic Development Council

• enterpriseSeattle

• Economic Development Board for Tacoma-Pierce County

• Greater Spokane Incorporated

• Economic Development Council of Snohomish County

• Aerospace Futures Alliance of Washington


• Three premises

• Industry background

• Business imperative

• Compelling argument

Agenda


Three Premises

• Regional competitiveness should not be singularly focused on “winning” final assembly for the 737 replacement aircraft program

• World has moved beyond the success of “Action Washington” 787 initiative– Why did Washington “lose” Global Aeronautica, Spirit

Aerospace, Bombardier & Rolls Royce deals?

– Is Washington still competitive?

• The business imperative is to create & maintain regional competitiveness in the A&D industry:– Benefits are “defensive” as much as about job creation

– Not just about commercial airplanes


Industry Background


Grand Total Global Industry Spend – 2007

Defense Budgets $1,158 B* 86.6%

Commercial Aircraft $117 B 8.8%

Commercial MRO $51 B 3.8%

Commercial Space $11 B 0.8%

Total $1,337 B 100.0%

* 2006 estimatedCommercial MRO reflects civil, regional, business, and general aviation. Commercial Space reflects non-military satellites and launch vehicles..Estimates for Global Defense Budgets from 2006 and 2007. Other data estimates from 2007.

Market estimates based on various sources and Deloitte analysis.

Contrary to common understanding, A&D on a global basis is mostly “Defense”, as opposed to commercial aircraft

Industry Background


2006(e) spend: $1.158 Trillion

Global Defense Spend by Region

Source: SIPRI (Stockholm International Peace Research Institute)

North America 48%

Africa 1%

Middle East 6%

Central & Eastern Europe

5%

Western Europe 22%

Asia and Oceania 15%

South America 3%

Data reflect all defense budget line items including Procurement, R,D,T&E, O&M, etc…

Industry Background

The US DoD has the largest spend of any country


Global A&D Procurement

Commercial Aircraft26%

Military Aircraft12%

Naval Platforms5%

Missiles7%

Defense Electronics10%

ILS15%

Commercial MRO11%

Land-Based Platforms10%

Space4%

Of the $1.337 Trillion global A&D industry spend, expenditures are mostly defense related, and further, most is spent on personnel, O&M and related services. Procurement is only 34%

Total Procurement: $449 Billion; 34% of total

Market estimates based on various sources and Deloitte analysis. Estimates are for 2007

Total Industry:$1.337 Billion

State of Washington Target Market

Industry Background


Industry Product Structure

Global A&D OEM Structure

CommercialAircraft

MilitaryAircraft

Naval Platforms

SpaceLand

Platforms

C4ISR & Defense

Electronics

Missiles& Systems

ILS & MRO

Large Regional Business & VLJGeneralAviation

Helicopters

Fighters Reconnaissance Bombers Transports Trainers Helicopters

AircraftCarriers

Destroyers Submarines

LaunchVehicles

CommercialSatellites

MilitarySatellites

Tanks Artillery/MunitionsPersonnel

Carriers

UAV/Drones

Industry Background

$449 Billion


US A&D Industry Consolidation

50 firms in 1985, consolidated down to 5 key US A&D companies within 20 years

199

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liam

Per

ry “

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Industry Background


US A&D Industry Employment History

672.6

708.5

587.1

637.3

400

450

500

550

600

650

700

750

800

850

Em

plo

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Industry Background

Source: 2007 AIA Study

• Industry consolidation, higher efficiency, automation, retirements and outsourcing has resulted in reductions

• Despite rising defense budgets, and commercial aircraft orders on a long term basis, the trend for industry employment is stable to slightly declining


US DoD Top 15 Aircraft Program

Source: US DOD Budget; Note: Figures include procurement and R,D,T &E

Industry Background


Commercial Airplane Customer’s Condition

(30,000.0)

(25,000.0)

(20,000.0)

(15,000.0)

(10,000.0)

(5,000.0)

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15,000.0

20,000.0

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Cumulative Profits

Annual IndustryOperating Profit

• Lockheed, McDonnell Douglas, Boeing and Airbus were/are selling airplanes to a cumulatively non-profit industry

• Cost and innovation are the key differentiator

Global Airline Profits 1978-2008

Industry Background

Annual and Cumulative Airline Industry Profits


• Washington is the highest per capita aerospace employer at 44 jobs per

1,000 workers

• Seattle SMSA has highest concentration of aerospace companies in world

• Aerospace accounts for nearly one-sixth of Washington’s Gross State Product

• Washington’s aerospace cluster is represented throughout the

production value chainSources: AFA, Washington Department of Community, Trade and Economic Development

2006 estimates

Washington’s Aerospace Industry – Economic Impact

Industry Background


Washington’s Aerospace Industry – Employment

Source: AFA

Strong correlation between changes in aerospace industry employment and total employment.

Industry Background


Washington’s Aerospace Industry – Impact on Counties

Source: Washington State Office of Financial Management

Overall Average Wages by County

Industry Background

Average wages in counties with high aerospace industry concentration: King, Snohomish, Pierce and Spokane—are among the highest in Washington


Renton 737 Operations Impact on Washington State

Sources: Various Sources, Deloitte Analysis2007 estimates

The Renton operations account for nearly $7 billion (2.7%) of Washington’sGross State Product and over 45 thousand direct and indirect jobs.

Industry Background


Renton’s Dependence on the 737 Operations

Boeing 737 operations account for only about 30 percent of Renton’s employment base, about half what it was in the early 90s.

Source: City of Renton Economic Forecast, 2007-09

Industry Background


Business Imperatives


Market Growth Drivers

• Armed conflicts– Equipment replenishment– Defensive buildup in global hot spots

• Defense modernization – net-centric warfare• War on terror and homeland security – R&D• Technology driven modernization; e.g.,

– Air traffic management– Composites & materials– Propulsion efficiency– UAV’s

• Long term air travel growth - pax & freight• Long term procurement commitments



Competitive Environment

• Government support - Driven by need for power projection, prestige & economic revitalization

• Technology - Design anywhere, build anywhere, allowed by the digital product design revolution– Enables global low cost sourcing

– Poland, Mexico, Czech Republic key beneficiaries

• Growing economies - Rise of China, Russia, India and Japan

• US regional competitiveness– South Carolina, Alabama, North Carolina

– Kansas, Texas



Regional A&D Competitive BenchmarksBusiness Imperatives

• Mobile, Alabama is highly competitive with attractive wage rates and cost of living, outpacing King County

Source; US Bureau of Labor Statistics

Key Statistics US Average King County Mobile, ALKing CountyGap

Unemployment Rate 4.8% 4.2% 3.9%

Engineer Manager $110,030 $129,710 $110,560 -17%

Computer Programmer $69,500 $86,880 $43,510 -100%

Elementary School Teacher $48,700 $52,370 $38,510 -36%

City population --- 1,826,732 192,830

High School Graduation Rate 80.4% 90.3% 80.5%

Bachelors degree or higher 24.0% 40.0% 25.0%

Median Home Value $119,600 $236,900 $81,400 -191%

Average Commuting time in minutes 26 27 22

Union Membership 12.1% 20.2% 9.5%

Annual Salary


Regional A&D Competitive Benchmarks

• Charleston, South Carolina is also a highly competitive location, with attractive wage rates and cost of living, outpacing King County by a considerable margin



Key Statistics US Average King County Charleston, SCKing County Gap





City population --- 1,826,732 118,492






Annual Salary


Regional A&D Competitive Benchmarks

• Kinston, North Carolina, after many attempts, has become an increasingly competitive location, with attractive wage rates and cost of living



Key Statistics US Average King County Kinston, NCKing County Gap





City population --- 1,826,732 22,729






Annual Salary


• Wichita Kansas has incumbency and continues to be highly competitive with attractive wage rates and cost of living, outpacing King County by a considerable margin

Regional A&D Competitive BenchmarksBusiness Imperatives


Key Statistics US Average King County Wichita, KSKing County Gap





City population --- 1,826,732 357,698






Annual Salary


Competitiveness Data Points

• Mexico wins Bombardier aero-structures plant 5/08

• $250M investment resulting in 1,000 new jobs– New aerospace plant in Mexico to build composite parts for new

Learjet 85

– Program ramp-up over 7 years, will employ 1,000 people, in addition to those already employed by the company at its aerospace complex in the central state of Queretaro.

– Bombardier's existing plant will make electrical harnesses. Final assembly will be done at Bombardier's facility in Wichita, Kansas.

– "This new investment implies a significant transfer of technology. There is no doubt that the use of composite technology is strategic for the aerospace industry," the official said.

– Cited as having a "good and flexible workforce," as well as federal and state government support, for the company's decision to bring the technology to Mexico.




• South Carolina wins Global Aeronautica plant, opened in December, 2006– Located in North Charleston, the 334,000 square-foot facility is

where Global Aeronautica assembles, integrates, tests and applies surface finishes to 60 percent of 787’s fuselage

• Vought opened a 342,000 square-foot production facility in 2006. Vought fabricates and assembles fuselage sections 47 and 48 for the 787.– Facility employs 300, with two-third in a manufacturing capacity.

Vought employs about 600 people at its South Carolina facility, targeting 775 by 2011.

• A separate 14,000 square-foot training facility serves both nearby Vought and Global Aeronautica operations

• Boeing in process of purchasing Vought’s JV interest




• Kinston, North Carolina wins Spirit Aerospace composite aero-structures plant in 2Q08– Initial production for Airbus A350-XWB barrel sections. – Spirit will design and manufacture Section 15 center fuselage

frame section, a composite structure approximately 65 feet long, 20 feet wide and weighing nearly 9,000 pounds.

• Facility will cost about $570 million and result in the creation of 1,031 jobs over the next six years.

• According to Spirit President and CEO Jeff Turner: “The State of North Carolina met our requirements for financial incentives and this location offers a strong industrial base, a runway and port access, a growing labor force and an excellent technical training system.”




• Late June 08, US GAO rules in favor of Boeing protest over selection process in NOC/EADS KC45A contract

• Initially, Mobile, Alabama won Northrop Grumman Air Force tanker based on Airbus A330 platform– Initial award of $35 billion was made on February 29, now tbd.

– Located at Brookley Field, plant consists of two buildings and initially employ 1,500 workers,

– The longer term economic benefit to Mobile area expected to be far greater than that directly associated with Tanker work.

• EADS, Northrop Grumman’s partner, agrees to perform production work on commercial A330 freighter at facility – Would be 1st new manufacturing center for large commercial

aircraft built in the U.S. in last 40 years.




• Virginia wins Rolls Royce engine plant in 1Q08• Will build/test RB262 regional and corporate jet engines

– To convince Rolls Royce, the governor and his team put together an incentive package that included “generous” tax breaks

– As part of the deal, and with state subsidy, UVA will construct the Commonwealth Center for Advanced Manufacturing on land donated by Rolls Royce, near the new plant

– James M. Guyette, president & CEO for Rolls-Royce's North American operation, said company's decision to locate plant in Virginia has to do with its people and strong education system

• The facility, located in the Tri-City area and set to open in 2009, and will require an initial investment of $170 million with an initial 100 skilled workers and 500 jobs overall

• The jobs are expected to have an average salary of $48,000, above Prince George County average.



Canada retains Pratt & Whitney Canada, providing more than $1.6 Billion1 in assistance from 1982 To 2006

Source: Industry Canada, Canadian Taxpayers Federation; 1) Amount of economic assistance is likely larger if economic assistance to tier 1 and tier 2 suppliers are considered. Financial amounts expressed in US$ in the year when aid was authorized based on historic CAN$/US$ exchange rates. Value of economic assistance in historic CAN$: 2B; Value of economic assistance in inflation-adjusted US$: 2.27B (based on 3.25% historic average). 2) DIPP: Defence Industry Productivity Program until ; TPC: Technology Partnerships Canada; SADI: Strategic Aerospace & Defense Initiative. 3) Terminology used by Canadian government

Source: Industry Canada, Canadian Taxpayers Federation; 1) Amount of economic assistance is likely larger if economic assistance to tier 1 and tier 2 suppliers are considered. Financial amounts expressed in US$ in the year when aid was authorized based on historic CAN$/US$ exchange rates. Value of economic assistance in historic CAN$: 2B; Value of economic assistance in inflation-adjusted US$: 2.27B (based on 3.25% historic average). 2) DIPP: Defence Industry Productivity Program until ; TPC: Technology Partnerships Canada; SADI: Strategic Aerospace & Defense Initiative. 3) Terminology used by Canadian government

– Pratt Canada has received economic assistance for at least 25 years for engine development. US$329M (CAN$350M) was recently granted for next generation technology

– Although most aid is provided by the Canadian federal government, significant regional aid is provided by Investissement Quebec (loan of $61M in 2005 for engine development repayable in 2030)

– Succession of programs2, have offered assistance:• DIPP was phased out and eliminated right out grants

• TPC offered increasingly conditionally repayable contribution3

• SADI was launched in 2007 to succeed TPC partly to increase transparency and economic return on aid

– Tier 1 and tier 2 suppliers also receiving economic assistance

Economic Assistance Authorized (1982-2006)

2272 53

283

64139

266

774

0100200300400500600700800900

1982-86 1987-91 1992-96 1997-01 2002-06

Grant Conditionally Repayable Contribution

Competitiveness Data PointsBusiness Imperatives


• Missouri news report:

– Bombardier is shopping for final assembly location for new C-Series next-gen regional jet production

– Government officials hoping to land Bombardier plant

– Missouri's governor and economic development officials visited Montreal in May 2008 to convince Bombardier to locate an airplane assembly plant in Kansas City, MO

– Gov. Matt Blunt already has signed legislation authorizing up to $240 million in tax credits for Bombardier Aerospace to locate in Missouri




What’s Important to A&D Companies

• Inevitable march towards commoditization, means product cost, and its value chain, is of paramount importance– Wages, benefits and entitlements

– Cost of living

– Transportation and infrastructure

• Innovation environment– Academic and government partnerships

– Skills and educated workforce

• Purchased parts– Cost

– Supplier co-location

– Schedule commitments

– Design, reliability and quality



Compelling Argument


Washington’s Aerospace Industry – What is at Risk

Industry CharacteristicsEconomic Concentration: Aerospace is fundamental to the state economy and key determinant of state’s economic welfare

Wealth Generator: Aerospace in Washington is highly export-intensive and benefits the larger state economy through the multiplier process. Each aerospace job indirectly supports 2.2 other jobs on average

Major Employer: Aerospace accounts for nearly 25% of Washington’s manufacturing employment

High Wages: Aerospace industry has recorded high productivity growth rate which in turn has allowed aerospace companies to pay increasingly higher wages

Compelling Argument


Key Messages

• Washington is getting outgunned, and is no longer competitive, according to the data and the recent deals

• Can’t do much about cost of living and wage rates

• Governments and academia can become gap closure weapons

• Commercial aerospace is only 37% of the entire industry; defense and military A&D is important, representing a key opportunity

• Cost of change and inertia keeps companies from moving, but it is getting easier to do so

• Regions have to pay to “play”, and have to pay to “stay” competitive in the economic development game

Compelling Argument


Opportunities

• The Euro-USD FX rate differential currently favors US aerospace industry manufacturers– Airbus desperately needs to “dollarize” its content

– Finmeccanica, EADS Defense, Thales, Dassault, BAE Systems, Safran, MTU, and Rolls Royce reportedly have, or are looking, to invest in new efficient, low cost plants

• North American A&D firms continue to scan for lower life cycle cost locations– Lockheed Martin, Raytheon, Bell and other Texas based

businesses continue to stress the importance of costs*

– East coast defense contractor businesses of GD, UTX, TXT, Harris have also stated the importance of competitiveness*

• Logistics and transportation costs naturally favor incumbent final assembly sites

Compelling Argument

*Opinions based on company annual reports and comments by CEO, CFO’s and others at industry conventions


Some Ideas to Explore Further

• Land grants, with buildings built to spec, leased on favorable terms

• Additional B&O tax rate reductions for aerospace industry

• B&O tax holiday incentive for industry, pending deal completion, with clawbacks

• Incentives to link software skill base with defense electronics marketplace

• Direct linkage of State hardware & software engineering and schools to applied research for A&D industry

• Increased marketing budget for State CTED-Aerospace

• Effective direct marketing and capture strategy and pursuit program

Compelling Argument


Summary

• Inevitable realities– Difficult to cost justify on direct job creation

– Highly ambitious and well financed competitors

• Time to take the gloves off and protect your franchise

• Government economic and academic incentives for industry needs reconsideration– Close the gap

– Consider the ideas presented

– Proactive pursuit campaigns required

– Work together as a region

• Becoming competitive all around will get Washington in fighting shape for eventual narrow body replacement program

Compelling Argument


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Disclaimer

Report subject to conditions of engagement agreement email dated June 12, 2008 the between Deloitte Consulting LLP and Economic Development Council of Snohomish County (client). This report is intended for the exclusive use of Grant County Economic Development Council, enterpriseSeattle, Economic Development Board for Tacoma-Pierce County, Greater Spokane Incorporated, Economic Development Council of Snohomish County, and Aerospace Futures Alliance of Washington. Written permission must be obtained from Deloitte Consulting LLP for further use.

This report does not constitute a recommendation regarding the acquisition or financing of any business, assets, liabilities, or securities; (ii) a market or financial feasibility study; (iii) a fairness or solvency opinion; or (iv) an examination or compilation of, or the performance of agreed upon procedures with respect to prospective financial information in accordance with standards established by the AICPA, the PCAOB, or other regulatory body. The Services are not intended to be, and shall not be construed to be, “investment advice” within the meaning of the Investment Advisers Act of 1940. It is understood that the Deloitte US Entities have not provided, nor will the Deloitte US Entities be responsible for providing, legal advice hereunder. In addition, it is understood that the data contained herein is based on industry research, experience and calculations conducted on a best efforts basis. The Deloitte US Entities have no responsibility for the accuracy or completeness of the information provided by, or on behalf of client. No other party is entitled to rely on this report for any purpose whatsoever and we accept no duty of care or liability to any other party who is shown or gains access to this report.

Documents

State of Washington Governor’s Aerospace Conference Museum of Flight Briefing June 25, 2008 Museum of Flight Briefing June 25, 2008 Tom Captain, Vice Chairman