Despite protestations to the contrary from mainline jet manufacturers, participants at this year’s meeting of the International Society of Transport Aircraft Traders are predicting Boeing and Airbus will cut production later this year and again in 2010 and 2011 citing lack of funding availability for deliveries.

However, International Bureau of Aviation Commercial Director Owen Geach expects the majority, if not all, aircraft deliveries scheduled for this year to be funded. Indeed, U.S. airlines have been hard at work over the last several months raising capital with over $6.5 billion recounted during recent financial reporting calls. Geach based his assertions on talks with lenders during January. Related Story This tallies with Airbus and Boeing assertions that funding will not become a problem until later this year. However, ISTAT attendees told the Seattle Times production will then “fall off a cliff.”

At ISTAT’s conference, meanwhile, most acknowledged that growth will return, they also said that 2009-2011 will be tough. Avitas’s Adam Pilarski predicted a severe crash, reducing Boeing/Airbus production in 2011 to 20 percent of what it is today or 666 aircraft, according to the Times.
Meanwhile, Deloitte LLP, in its latest financial analysis on the performance of the U.S. top 20 Aerospace & Defense (A&D) companies for 2008, reported the year would have been record setting had it not been for industrial actions and the economy.

"Since 2003, the U.S. A&D industry has performed very well, with earnings growth, improvements in asset utilization and capital structure, resulting in a lean and efficient industry that is well-positioned for the current downturn," said Tom Captain, vice chairman, Deloitte LLP, and the Global and U.S. Aerospace & Defense leader. "Our analysis indicates that 2008 would have been a record-setting year for the financial performance of these companies had it not been for industry strikes and the global economic turmoil."

According to Deloitte, the industry would have grown sales revenues by 7.2 percent and operating margin would have been 11.5 percent, absent the work stoppages and the global credit crisis. Otherwise, the U.S. top 20 A&D companies had a 5.2 percent growth in sales revenues and a decrease of 9.2 percent in operating earnings. Also, additions to backlog continued at a brisk pace, albeit at a slower pace, with a book to bill ratio of 1.27x in 2008, demonstrating resilience going into the downturn.
Deloitte's report identifies four components necessary for these companies to be successful in 2009 and beyond:
1. Successful continuance of current large-scale programs under contract
2. Effective management of cost and schedule targets while achieving mission assurance for the customer
3. Executing strategic leverage in the acquisition space
4. Identifying and capturing technology direction and funding of the new administration's defense and security priorities

2009 Industry Outlook
Deloitte cited reductions in Iraq, the Obama presidency and reduced defense procurements will be balanced by increased NASA funding and more military acquisition oversight for its predction that lean years are ahead. It noted that the industry has had a six-year run of improving performance, resulting in a composite industry share price performance approximately three times better than the S&P 500 index but said it was in transition.

The large commercial aircraft sector is expected to generate most of its revenue from Asia Pacific Japan (APJ) and the Middle East, relying less on U.S. orders because of the current economic climate. In the next two decades, Boeing forecasts delivery of 29,400 new commercial aircraft worth $3.2 trillion.  In the short term, however, airline companies worldwide will continue to struggle with the global economic recession, fuel price fluctuations and the difficulty in raising ticket prices, which might have an impact on airplane and engine purchase orders in 2009. Deloitte pointed to the industry's multi-year backlog, describing it as solid with 2009 deliveries expected to number 900 large commercial airplanes.

Business aviation forecasts for the coming decade are quite robust, said the company, pointing to Honeywell’s 2008 forecast predicting 17,000 new business aircraft valued at $300 billion. However, it said the short-term financing problems will trickle down to this segment resulting in a falloff in business jet orders, production and deliveries.

Commercial Programs No Longer Innovative
“Commercial aircraft production began as a unique business that had premium value – and pricing,” said Deloitte. “As passenger traffic has increased and competitors have entered the market, however, commercial airplanes have become more commoditized, requiring companies to improve differentiation.
To make money in 2009 and beyond, aircraft manufacturers not only must continue to relentlessly chase the cross-curve, they must promote product and process innovation,” it continued. “The new Boeing 787 Dreamliner is a good example: It will be the first major aircraft to use composite materials for most of its construction. Featuring an estimated 20 percent lower direct operating cost, better passenger comfort via higher air pressure and humidity, larger windows and less-frequent maintenance requirements, the 787 has become the most successful aircraft product launch in aviation history, as measured by number of aircraft ordered prior to first flight.”

Deloitte also said that airlines must realize the potential for technology advances to address the “growing pains of product and process innovation.” The entire aerospace industry, it added, “will need to continue attacking structural cost reduction opportunities via industry-wide implementation of digital product definition tools and processes, as well as outsourcing parts manufacturing to lower-cost countries.”

Deloitte predicted an “interesting” year for merger and acquisition activity, mostly smaller deals by larger A&D firms to fill in capability gaps – particularly in the security, defense electronics and aftermarket services business areas. European companies could use high-value euros to buy undervalued U.S. assets, it said, adding U.S. defense firms may see opportunities in credit-squeezed markets to pick up U.S. assets at historically low price earning multiples.

Noting a trend toward aftermarket services, Deloitte pointed to Pratt & Whitney and Rolls-Royce, saying they get 50 percent of revenues and 60 percent of profits from their services business. “A&D contractors are learning how to take on, measure and internalize risk and to make support and services offerings profitable,” said the company. “This includes understanding how to service the equipment they manufacture, and assembling the necessary infrastructure, capabilities and people to operate it. Companies are also leveraging strong balance sheets to grow organically and acquire new services business. As product development transitions to production program deliveries, it is anticipated that companies will ramp up their services businesses and profitability should improve.”

Coincidentally, GE Aviation Services said this morning that its business is providing stable, long-term revenues while helping customers cope with the challenging environment. "More customers are seeking predictable maintenance and material costs, access to technology upgrades and increased engine residual value that GE Aviation offers," Tom Gentile, vice president and general manager of GE Aviation's Services business.

GE Aviation's long-term maintenance and material solutions, branded as OnPointSM solutions, are tailored to the operational and financial needs of customers for any size fleet. GE's backlog of OnPoint solution agreements reached $55 billion in 2008, up more than 9 percent from 2007. In addition, the Services business has a pipeline of almost $30 billion of new orders for other service products. Backed by GE's global network, OnPoint services include overhaul, on wing support, new and used-serviceable parts, component repair, technology upgrades, engine leasing, integrated systems support and diagnostics and integrated systems.

GE Aviation has an installed base of more than 8,000 engines in service, while CFM International, a 50/50 joint company of GE and Snecma (SAFRAN Group), has more than 13,000 engines in service. They are the foundation for GE Aviation's Services, with 2008 revenues approaching $7 billion. Only 40 percent of the GE and CFM installed fleet have had their first shop visit, and the revenue generated from servicing them through their 30+year operating life can approach seven times the revenue from the original engine sale. With such a young engine fleet, much of this revenue has yet to be realized. Several large fleets, such as CFM56-5B and -7B engines for narrow-body aircraft, are entering their maintenance period, with service activity growing at about 15 percent annually.

GE Aviation has invested more than $150 million between 2007 and 2009 in its 11 overhaul and repair operations for upgraded technologies and equipment to ensure customers receive the latest component and maintenance repairs in a timely manner. GE is also expanding its network of airline and third-party service providers, which are committed to utilizing GE's material and licensed repair technologies. It pointed out that, in the last year, ST Aerospace, Aveos, TEXL (a unit of the Swire Group) and Iberia have joined Air France/KLM, JAL, Standard Aero, MTU, EGAT (Taiwan) and IHI as global network service providers for GE and CFM engines.

"As GE Aviation's Services business has grown, we have developed a more customer-focused global services strategy, based on our extensive global network of providers," said Gentile. "Customers can have their engines maintained at a GE Aviation's Services facility or at one of GE's global network providers. Either way, these customers have access to the same high-quality OEM (original equipment manufacturer) parts and repair services."

Program Management is Key
Deloitte said program management will be the major challenge, especially for commercial aircraft programs which have run late owing to global supply chain or design problems. On military programs the challenge is cost over-runs, it said, pointing to a to a March 2008 Government Accountability Office (GAO) finding research and development (R&D) activities were over budget by an average of 40 percent. Total budget overruns for the programs were $295 billion – up from $42 billion for a similar study conducted seven years earlier. Acquisition costs were over budget by an average of 26 percent, and the average schedule delay was 21 months. Only one-third of programs were on schedule. “This track record of poor performance is alarming, and the trend line appears to be getting worse,” it said.

It found five route causes for A&D program problems:
• Technical complexity – Today’s A&D programs rely on the use of leading-edge, still-maturing software-based technologies, which require infinitely higher levels of functionality, interoperability and integration. This technical complexity has resulted in increased development time vs. historical programs. As an example, the Manhattan Project (1945) took 2.5 years from contractor start to first use. A recent fighter jet program (2005), in contrast, took 14 years from contractor start to first use, and is now 30 percent over budget. Industry and government have a shared role in resolving the issues around technical complexity. Potential solutions include dividing programs into less-complex work packages and shorter program lengths; delaying approval of systems development and demonstration (SDD) contracts until the underlying technology is proven; and developing budgets that reflect technical complexity risk with realistic, not optimistic, assumptions.

• Talent crisis – Twenty-seven percent of A&D employees will be eligible for retirement in the next five years.7 In addition, the National Science Foundation expects the number of science, technology and engineering (ST&E) retirements to increase threefold annually in the next 10 years.8 Unfortunately, the A&D industry may not be able to attract sufficient new talent to make up the deficit. A lower percentage of U.S. college students are pursuing ST&E degrees, and even though China and India are producing large numbers of engineering graduates, foreign nationals are not permitted by law to hold U.S. defense jobs. Additionally, A&D companies are facing rising competition for ST&E talent from other industries, such as high technology. In response, defense contractors and the DoD are employing tactics such as creating financial incentives to retain “baby boomer” engineers and technicians and their much-needed experience; promoting math and science among middle- and high-school students; and modernizing their Human Resources (HR) programs to balance compensation, benefits, career and work issues.

• Supply chain challenges – The A&D supply chain management model is transitioning to a global, super-supplier model for the Tier 1 suppliers and original equipment manufacturers (OEMs). These organizations are shedding manufacturing and subsystem assembly work, relying on super- or middle-tier suppliers to take on increasingly complex design and manufacturing tasks. This business model shift has experienced growing pains, which has resulted in manufacturing delays. To address the problem, the industry is taking steps to streamline supply chains and realize efficiency gains to better manage program performance. For example, some OEMs are identifying key suppliers and building collaborative, risk-sharing relationships as opposed to the more traditional, arm’s-length transactional model.

• Politics – A&D programs span multiple years but are budgeted annually. In times of economic stress, other government priorities may prompt cuts in multiyear projects in the form of number of units. This approach typically results in increased fly-away unit costs. As evidenced by the recent Senate Armed Services Committee hearings, Pentagon auditor initiatives, and other regulatory activities, A&D contractors can expect to see heightened oversight by Congress, resulting in greater accountability in contracting and increased rules on disclosure of overpayment and fraud. Indeed, there are calls for peer reviews for programs exceeding $1 billion in costs, which will provide a higher level of risk mitigation around costs and schedule performance.

• Program management challenges – Many A&D program schedules are based on a “sunny day” scenario, rather than a more realistic “cloudy day” scenario that contemplates program delays, technical difficulties, supply chain problems and changing requirements. These program management challenges and associated cost overruns need to be addressed by improving cost, schedule, and risk management processes and techniques. Competitions for programs need to generate realistic estimates for design and manufacturing products, including adequate contingency time for unanticipated technical complexities, testing difficulties and unforeseen uncertainties during the development and production life cycle. Also, the government should rely more on fixed-price contracts with strong change order management processes. Cost-plus development contracts should be evaluated more on budget, schedule, risk management and scope control and less on low-bid criteria.

A year of transition
“In this tough economic environment, A&D customers – both government and commercial – will be forced to set priorities and make difficult trade-offs about what programs they can really afford,” said the organization. “This will likely produce more intense competition for fewer but larger awards, potentially leading to more award protests. In addition, the government is moving from a cost-plus to a fixed-price procurement environment to reduce spend and obtain more value, which will place more risk on contractors’ shoulders.”

###

New Base for Comair
Comair is opening a new crew base at Kennedy at which some 300 pilots and 150 flight attendants will be based. The move reduces Comair’s Cincinnati operations to 22 percent of its flights with other Delta Connection carriers back filling the flights at CVG for Delta. Meanwhile, Mesa’s Freedom Airlines, currently embroiled in a lawsuit with Delta, will pick up the slack at CVG when it moves 16 of its aircraft from JFK. The move will be completed by April 30 when the Phoenix-based airline will have 22 aircraft at Cincinnati.

The move could signal the settlement of the suit brought by Mesa when Delta tried to cancel Freedom’s Delta Connection contract. Mesa was able to gain a stay of that action last year although Delta was able to remove six aircraft from Northeast flying which Comair is now replacing. Related Story Delta moved against Freedom and Pinnacle last year in an effort to improve operations claiming the two airlines did not meet the operational standards required of the mainline carrier. While the Pinnacle dispute has long since been settled, the Mesa suit is still pending. Delta also moved against SkyWest reducing its payments to the St. George, UT-based carrier in a dispute over irregular operations. Related Story

The mainline carrier pointed out that while it is moving some of Comair operations to support its Kennedy operations after Mesa bowed out of the weather-and-delayed plagued Northeast, it is also increasing CVG service to 269 daily departures this summer. Although it will not call back the furloughed pilots, Comair is gaining 10 percent more overall flying in April and 12 percent in May, over Delta’s original plan, while service to Boston, LaGuardia, JFK and Washington National will make up 67 percent of overall operations.

JAL, Embraer Ink Parts Deal
A decade-long parts contract was signed by Embraer Asia Pacific (EAP), Embraer’s subsidiary in Singapore, with Japan Airlines to cover the airline’s order for 10 ERJ 170s. The airline has also optioned five additional aircraft and the agreement covers around 350 part numbers for all ERJ 170s operating by JAL’s wholly owned regional airline subsidiary J-Air. Based in Nagoya J-AIR operates 66 flights per day on 17 routes.

The pool program provides the airline with replacement parts, reducing warehousing and inventory management costs. Besides the Pool program, EAP also has 22 pilots in Japan who will be operating the E- Jets for three years under the Pilot Lease Agreement between Embraer and J-AIR.
The Pool replacement parts program is a reliable tool that manages assets and component repairs, allowing Embraer customers to reduce costs and guarantee the availability of parts that are essential to the aircraft (“no go” and “go if”) at the time and place they are needed. With onsite storage and parts exchange, Embraer keeps a varied number of high-demand components on hand, guaranteeing that they are always available for replacements, thus minimizing worries about a quick turn-around-time for requests. The Pool program also offers operators repair management, warranty coverage, and a significant reduction in storage costs, including replacement parts, excess materials, insurance, and others.

“J-AIR expects Embraer to provide excellent one-stop shopping service through the pool program, and hopes to have a good relationship with Embraer,” said Tatsuo Yamaguchi, director, Material Planning, J-AIR. Embraer’s E-Jets family has enjoyed outstanding success in the world’s commercial aviation market.

On December 31, 2008, the E-Jets had logged 876 firm orders and 810 options. With more than 500 aircraft delivered, the family of E-Jets had surpassed 2.4 million flight hours, carrying over 100 million passengers.

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