2016 Annual Conference October 26-27, 2016 Orlando, Florida

Presented by:

Jonathan M. Berger Vice President  Aerospace & MRO Advisory [email protected]

MRO Market Update & Industry Trends 0

Today’s Agenda Bizarro Aviation       

The “CRABS” Meet the Frackers These are the Good Old Days Follow the Money Amazon the Air Cargo Disruptor March of the Middle East Titans A New Golden Age of Aircraft Cabin Interiors

MRO & OEM Alternative Material Forecast 1

1

“Bizarro Aviation”

2

2

Four external macro-economic forces are having a significant impact on the aviation industry and the MRO supply chain

The “CRABS”

Source: ICF analysis

3

3

The dramatic increase in oil & gas market supply and reduced demand for commodities has led to a strong US Dollar

The “CRABS”: Countries with economies that are heavily dependent on commodity exports Global Currency Exchange Rates vs USD % Value Change, September 2014 – September 2016

10% Russian Ruble -37.6%

FOREX Impact  Partially offsets the positive impact of low fuel costs for operators  Increases the cost of dollar based flight hour agreements (and parts/material in general)

 Cost of labor for in-country MROs is cheaper driving up margins for US dollar based contracts  Buying/leasing aircraft becomes more expensive

Brazilian Real -24.6%

S. African Rand -19.1%

Can Dollars -15.3%

Aus Dollars -12.5%

Euro -11.7%

Indian Rupee -7.8%

Chinese Yuan -7.8%

0%

-10%

-20%

S

A

B

-30%

-40%

C

R

-50%

Source: USForex, ICF analysis

4

4

Commercial aircraft OEM production backlog remains at historical record levels driven by:

Commercial Aircraft OEM Production Backlog

Order Backlog

Backlog/ % Active Fleet

16,000

70%

 Emerging market growth

14,000

60%

 Low interest rates

12,000

 Previously high oil and commodity prices

10,000

 Introduction of new technology aircraft/engines

50% 40%

8,000 30% 6,000 4,000 2,000 0

Source: CAPA, ICF Analysis

20%

10% 0%

5

5

Low fuel costs appear to be reversing aircraft retirements trends

1,200

3.5%

Industry Impact:

1,000

3.0%

 MRO Suppliers - Positive: Increased spend on older airframes & engines  Surplus Market - Negative: Reduced part-out “feed stock” - OEMs: Improved new part sales - Distributors: Improved used part values / pricing - Operators: Increased material costs

Commercial Air Transport Annual Aircraft Retirements % Installed Fleet

# Retirements

Retirement as % of installed fleet

800

2.5% 2.0%

600 1.5% 400

1.0% 2000-2009 Average: 473

200

0.5% 1991-1999 Average: 203

0

Source: CAPA, Airline Monitor, ICF analysis

0.0%

6

6

Airline return on invested capital (ROIC) is clearly correlated with the drop in fuel costs

Fuel Price as a % of Airline Operating Expenses % of Airline Operating Expenses

Crude Oil Price/BBL

40%

120 100

30% 80 20%

60 36% 28%

10%

22% 17%

0%

Source: IATA, ICF Analysis

30%

28%

28%

31%

33%

33%

32% 28%

40 20%

20 0

7

7

Airline return on invested capital (ROIC) is clearly correlated with the drop in fuel costs

Fuel Price and Global Airline Return On Invested Capital (ROIC) Jet Fuel Price ($/barrel)

Airline ROIC (%)

$140 $120

12.0%

Jet Fuel Price

10.0%

$100

8.0%

$$$

$80

6.0% $60 $40

4.0%

Airline ROIC

$20

2.0%

$0

0.0%

Source: IATA, ICF Analysis

8

8

Driven by low fuel costs and consolidation, airline the industry is on target to achieve record profitability in 2016 of almost $40B USD

These are the “good old days: - for some airlines… Global Airline Profitability, 1996 - 2016F $USD Billions $40

$39.4B Africa, ($0.5B) Latin America, $0.1B

$30 Middle East, $1.6B

$20

Asia Pacific, $7.8B

$10

Europe, $7.5B

$0

North America, $22.9B

-$10 -$20 -$30

Source: IATA, ICF analysis

9

9

However, profit margin improvement has been largely limited to carriers in North America

…but not all – many airlines continue to struggle Global Airline EBIT Margin by Region 20.0%

2008

15.4%

15.0%

2012

10.0% 5.0%

2016F

8.4%

3.4%

5.6%

4.7%

2.3% 0.1% 0.7%

0.0%

3.0% 2.8%

2.6% 1.0%

-0.4%-1.1% -0.9%

-1.8%

-5.0%

1.5%

-4.7%

-10.0%

Source: IATA, ICF Analysis

10

10

Brexit has clearly had an impact on European airline stock performance; specifically UK based carriers

Share Performance of European Airlines Since Brexit 23 June 2016 – 13 October 2016 Easy Jet, -41.5% IAG, -28.1%

Air France-KLM, 24.8% Wizz, -23.2% Norwegian, -16.5% Ryan Air, -16.2% Lufthansa, -15.2% SAS, -6.3%

-50%

Source: Company websites

-40%

-30%

-20%

-10%

0%

11

11

Follow the Money: Airlines are spending their hard earned profits in three primary areas

Airline Profit Spend Analysis Debt Repayments 16%

1. Labor ~ 20%:  Profit sharing  Wage increases

2. Capex ~ 38%:  Fleet renewal & cabin upgrades

Stock BuyBack & Dividends 26%

Other capex 10%

Investors, 42% Labor, 20% Capex, 38%

 Facilities, offices, lounges  Equity partner investments

Profit Sharing 15%

3. Investors ~ 42%:  Stock buy-backs  Dividends

 Debt repayment

Equity Investments 5%

Source: Company Reports, ICF Analysis

Fleet 23%

Wage Increases 5%

12

12

After positive signs in 2014, air cargo supply continues to exceed demand

Global Freight Traffic (FTK) and Capacity Growth (AFTK) Year-Over-Year Percent Change 8%

Traffic (FTK)

Capacity (AFTK) 6%

6.3%

6.0%

5.4% 5.0%

4%

6.3%

(- $$$)

3.7% 3.0%

2%

2.3% 0.4%

2.1%

0.6%

0%

-0.9% -2%

Source: IATA, ICF Analysis

13

13

Amazon is very well positioned to lead a major disruption of the air cargo industry

Amazon’s Growing Revenue & Shipping Costs $B USD

Shipping Costs as a Percentage of Revenue

Amazon Quarterly Revenue

$40

14%

$35

12%

$30 $25

10% 8%

$20 $15 $10

6% 4%

$5

2%

$0

0%

Source: Amazon SEC Filings

14

14

March of the Middle East Titans:

European Secondary Airports Average Number of Seats per Departure in 2016 500

Middle East carriers have been very effective in capturing valuable business passenger traffic from European secondary airports

Gulf Carriers

Non-Gulf Carriers

450

408 400

400

400

400

394

400

370

363

343

350

306 300 250 200 150

180 148 128

163

146 121

149 117

135

149

100

“…Lufthansa’s Frankfurt hub has lost nearly a 3rd of its market share on routes between Europe and Asia since 2005, with more than three million people now flying annually via Gulf hubs” – The Economist Source: OAG Data, ICF Analysis

15

15

Trend Watch: A New Golden Age of Aircraft Cabin Interiors

16

16

Modifications growth is driven by airlines seeking differentiation in the cabin and customer experience

Commercial Air Transport Modifications Forecast $USD Billions $8 $7

MRO modification market growth drivers include:  Premium lie-flat seats are now the minimum standard  Premium economy  Wi-fi, on-board connectivity

$6

AD/SB** PTF Conversions* Painting Avionics Upgrades Interiors

$7.4B $0.5 $0.4 $0.5

CAGR 3.6% 0.0%

3.7%

$1.1 $5 $4 $3

6.9%

$4.4B $0.3 $0.4 $0.4

5.9%

$0.6

$4.9

 Coming soon: ADS-B Mod program

$2

 Capacity (ASM/K) increase

$1

$2.7

$0

5.3% Avg. 2015

Modifications demand includes labor and material spend *Passenger-To-Freighter Conversions **Airworthiness Directives / Service Bulletins Source: ICF analysis, constant 2015 US$

2025 17

17

Cabin “densification” has emerged as cost effective strategy for airlines to increase capacity and drive bottom line growth Cabin Upgrades:  Slim seats

2015 - 2025 Capacity Bridge

6.2T

2015 ASMs

84%

Fleet Growth

Longer Stage Lengths

Example: Delta A320 Interior Modification Program

Total = 150 Seats

Total = 164 Seats

12 Seats

16 Seats

18 Seats

18 Seats

120 Seats

130 Seats

8%

 Slim lavatories  Slim galleys

Increased Seat Density

8%

 Slim coat closets 8.8T

2025 ASMs

0

2

4

6

8

10

Available Seat-Miles (ASMs), Trillions New seats, outlets, IFE, overhead bins Source: ICF analysis, delta.com

Space-saving galleys to add a row of seats 18

18

MRO Forecast

19

19

The current commercial air transport fleet consists of over 27K aircraft; over half are narrowbody aircraft

2015 Global Commercial Air Transport Fleet

Middle East

Regional Jet

14%

Narrowbody Jet

Latin America

North America

5% 5% 8%

Turboprop

14%

27,114 Aircraft

31%

27,114 Aircraft

53% Europe

25%

19% Widebody Jet

27% Asia Pacific

By Aircraft Type

Source: CAPA 2015

By Global Region

20

20

The combination of strong air travel demand and the need to replace ageing aircraft will drive fleet growth at a healthy 3.4% annually

10 Year Global Air Transport Fleet Growth

# Aircraft

40,000 35,000 30,000

Africa Middle East Latin America Europe Asia Pacific North America

CAGR

37,900 6% 8%

5.1% 5.3% 3.8%

27,100

25,000

5% 8%

20,000

25%

15,000

23%

2.5%

32%

5.2%

26%

1.6%

27% 10,000 5,000

31%

0

3.4% Avg. 2015

Source: ICF analysis: CAPA 2015

2025 21

21

Current commercial air transport MRO demand is $64.3B; with Asia equivalent to North America and Europe in market size

2015 Commercial Air Transport Global MRO Demand

Africa

Modifications

Airframe

7%

Latin America

Engines

North America

6% 4%

Middle East

8%

14%

29%

40%

$64.3B 17%

$64.3B Europe

Line

22%

26%

28% Asia Pacific

Components

By MRO Segment Source: ICF analysis; Forecast in 2015 $USD, exclusive of inflation

By Global Region 22

22

The global MRO market is expected to grow by 4.1% per annum to $96B by 2025

10 Year Global Commercial Air Transport MRO Demand Growth

$USD Billions $100 $90 $80

 Engine and component MRO markets remain the largest segments

$70

 Modifications market will see the strongest growth (e.g. interiors, connectivity)

$50

 Airframe market slows due to reduced man-hour intensity and increased check intervals as new fleets are introduced

$30

Modifications Airframe Line Component Engine

$64.3B

$96.0B

CAGR 5.3%

13%

2.8%

16%

3.6%

22%

4.3%

41%

4.4%

$60

14% 17% $40

22%

$20 $10

40%

$0

4.1% Avg. 2015

Source: ICF analysis; Forecast in 2015 $USD, exclusive of inflation

2025 23

23

There two primary reasons operators are aggressively seeking non-OEM supplied parts;

Three alternatives to purchasing OEM-supplied parts: Surplus

1. Cost savings

Three types of surplus material:

2. Part availability

1. Used Serviceable Material (USM) 2. New Material 3. Used, unserviceable material

Lower Source: ICF analysis

DER Repair

 DER (Designated Engineering Representatives), FAA approved engineers who can approve technical data for repairs and modifications outside the CMM  Design Organization Approval (DOA), a blanket approval for an MRO organization to develop internal repairs

Perceived Risk

PMA

 PMA (Parts Manufacturer Approval) is approval granted by the FAA to a non-OEM manufacturer of aircraft parts

 Two types of PMA: 1.

Licensed

2.

Competitive

Higher 24

24

The alternative material market is concentrated on the back half of mature aircraft lifecycle (1725 years old aircraft) and early sunset aircraft

SUNSET

MATURE

GROWTH

ERJ-140 MD11

CRJ-7/9/1000 A330

ERJ-170/190

A320* (Old)

737 NG

737-3/4/500 A320* (New)

777-2LR/3ER

A300-600/310

747-400 A340

CRJ-1/2/400

777

767

757

A380 MD80 SSJ 100

Alternative Material

747-8 787

A300

747-1/2/300 DC10

A350

737-1/200

A320neo

0

Bubble size proportional to MRO spend

10

Limited OEM Alternatives Source: ICF analysis

Years since Entry into Service

Growth Phase

25

* New: CFM56-5B / V2500-A5 / PW6000 Old: CFM56-5A / V2500-A1

Healthy OEM Alternative Market 25

25

In 2015, operators spent over $32B on OEM new parts and an additional $13B on alternatives

2015 OEM New Material Demand vs. Alternatives

$35B $30B

~ $32.4B

$25B “…the OEM’s increasingly tight grip on the aftermarket means Delta’s spares costs double about every seven years.” “Without TechOps parting-out engines to bolster spares and coming up with other alternatives to OEM-supplied support, that increase could be even steeper…” …“We’re pretty good at sourcing outside the OEMs…and we’re always working to develop those alternatives.” - Richard Anderson CEO Delta Air Lines Keynote Speech, MRO Americas April 2013

41%

$20B $15B

~ $13.4B

$10B

PMA ($0.54B)

$2.2B

DER Repairs

$3.9B

Surplus

$6.8B

OEM Manual Repairs

$5B $0B

OEM new

Source: ICF analysis

Alternatives

26

26

There are nearly 1.1 million total PMA parts that are FAA approved, of which over 75% are for Boeing aircraft

FAA Approved PMA Part Numbers, by OEM

Bombardier 3%

P&W 1%

Other 5%

Boeing 76%

Airbus 15%

1,077,971

Source: Federal Aviation Administration

27

27

The volume of PMA approvals has been steadily growing since 1990, with over about 440,000 new approvals granted since 2011

FAA Approved PMA Part Numbers, by Year Approved

500,000 420,051 400,000

301,905 300,000 204,570

200,000

85,238

100,000 41,030

22,421 0

Source: Federal Aviation Administration

28

28

Surplus material usage has risen sharply over the past few years, driven by tangible cost savings and minimal perceived risk

Typical Material Price Bands, By Part Type % OEM List

120

OEM Catalogue List Price

100

80

60

40 “Surplus parts have increased the demand for component DER… because the unserviceable surplus parts must repaired. The biggest customer for DER is ourselves.” - Major PMA / DER Supplier

20

0 OEM New

Lower Source: ICF analysis

New Surplus

Used Serviceable Surplus

Perceived Risk

As Removed / Unserviceable

PMA

Higher 29

29

Numerous regional factors influence operator PMA consumption to include:  Fleet age  Mix of lease vs owned aircraft

Virtually every major carrier leverages PMA parts as an OEM alternative Estimated PMA Demand by Major Region

46 - 56%

28 - 38%

 Technical capability & experience

5 - 8%

 Airline procurement historical practices and culture

12 - 18%

4 - 7%

Source: ICF analysis

30

30

In Summary…  In order to control and reduce material spend, airlines must have a comprehensive OEM alternative strategy  PMA parts, DER repairs, and surplus material are valuable material sourcing solutions that drive tangible cost savings and improve part availability  Safety concerns with regards to OEM alternative material usage have demonstrated to be meritless; yet clearly perceptions of risk remain  As long as certain airlines continue to have restrictive PMA policies, Lessors will continue to include conservative language in their lease agreements  Continued education is the only solution 31

31

2016 Annual Conference October 26-27, 2016 Orlando, Florida

THANK YOU! For questions regarding this presentation, please contact:

Jonathan M. Berger Vice President  Aerospace & MRO Advisory [email protected]  +1 404.819.7669

32

ICF provides a full range of Aerospace & MRO advisory services 

Market Research & Analysis



Airline Maintenance Benchmarking



M&A Commercial Due Diligence



OEM Aftermarket Strategy



Aviation Asset Valuations & Appraisals



MRO Information Technology (IT) Advisory



Strategic Sourcing & Supply Chain Mgt.



LEAN Continuous Process Improvement



Military Aircraft Sustainment

33

33

ICF is one of the world’s largest and most experienced aviation and aerospace consulting firms

Airports • Airlines • Aerospace & MRO • Aircraft  53 years in business (founded 1963)  80+ professional staff − Dedicated exclusively to aviation and aerospace − Blend of consulting professionals and experienced aviation executives  Specialized, focused expertise and proprietary knowledge  Broad functional capabilities  More than 10,000 private sector and public sector assignments  Backed by parent ICF International (2015 revenue: 1.13 billion USD)  Global presence –– offices around the world

joined in 2007

joined in 2011

joined in 2012

joined in 2014

New York • Boston • Ann Arbor • London • Singapore • Beijing • Hong Kong

34 34