Future Trends of Defense Industry Istanbul Chamber of Industry Presentation Istanbul, Turkey Joel L. Johnson Executive Director - International Teal Group Corporation www.tealgroup.com/ jjohnson@tealgroup.com October, 2017 What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

BIG PICTURE

Aerospace Markets 6

FUTURE TRENDS IN THE DEFENSE INDUSTRY Demand driven by perceived threats: Uncertainty over future actions of major regional powers Confusion over Trump administration policies Demand also a function of: Oil prices – up benefits Middle East, down benefits Asia Economic growth or lack Sovereign Wealth Funds Outlook generally for positive growth of demand for defense products Don’t overlook demand for parts and services ADAM Restitution Intermédiaire 1 BC 2 du marché 2015.35.0521

DISRUPTIVE TECHNOLOGIES

QUICK OVERVIEW New approaches to asymmetric warfare Unmanned Aerial Systems (UASs) and countermeasures Directed Energy Artificial Intelligence Additive Manufacturing Militarization of Space What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

ASYMETRIC WARFARE For 16 years US has been at war, with allies, using expensive weapons (designed to fight other powerful militaries) against insurgents using cheap, often home-made weapons F-16 at $16,504/hour firing $50,000 Maverick or Reaper at $3,700/hour firing $110,000 Hellfire to destroy small trucks and mud huts IEDs (garage door opener and explosive) require $500,000 MRAPs New approaches needed – one reason looking for disruptive technologies Large US and European companies have trouble thinking small and cheap What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

UNMANNED AERIAL SYSTEMS (UASs) How autonomous – will there always be a man in the loop? (see Artificial Intelligence) Increased use on land and sea, logistics as well as lethal missions “Wingman” – not controlled from distance, but by human in manned platform alongside Cheap “Suicide” UASs Counter UASs Should cost less than the UAS Directed energy (Boeing, Lockheed Martin) Stingers with proximity fuses (Raytheon) Jamming Cyber What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

DIRECTED ENERGY Cheaper than kinetic solutions (propellant and warhead) Likely first use maritime or ground force protection given energy requirements Anti-drone, RPG, even sniper protection Large aircraft protection (tankers, bombers, VIP transport) What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

ARTIFICIAL INTELLIGENCE Combination of big data and algorithms to analyze it Major use in civil sector – market analysis, tailored advertising, logistics (e.g. restoring flights after weather) For military, noncontroversial in using for logistics – supplying troops, deploying assets; also pattern recognition – anti-IED Ethical concern over how much “decision making” to give machines, particularly in fire-don’t fire decisions Man already out of loop in terminal air defense missiles, protection systems for armor, etc. What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

ADDITIVE MANUFACTURING (3-D PRINTING) Advantages: Reduce parts and waste Reduce stocks in marine vessels and forward deployed troops Make possible parts that could not be machined using reductive manufacturing techniques New Needs: Multi-material technology (metals, plastics, ceramics in same item) Engineers who can design from inside out Standards for machines and materials How to validate safety, quality and performance of output (different from assembly line production) Workforce trained to operate What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

MILITARIZATION OF SPACE 1967 Treaty on Principles Governing the Activities of States in the Exploration and Use of Outer Space took effect Prohibits weapons of mass destruction – but does not prohibit placement of conventional weapons Likely issues: Satellites that can use laser weapons against ICBMs or provide data for ground-based anti-missile systems Space-based logistics satellites that can observe, grapple with, or destroy other satellites What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

MARKETING INTERNATIONALLY

TURKISH ADVANTAGES Has positive relations in most of the Middle East countries compared to other major arms producing countries Can produce 80% solution at less than 80% prices compared to US & Europe (but watch Korea, Ukraine) Have comparable threat profiles as most potential customers Understand the cultures and capabilities of the Central Asian Countries and Middle East What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

SUPPLY CHAIN CHANGES Primes continue to consolidate: Northrop Grumman-Orbital ATK, Fincantiera-STX, etc. Primes also pulling some work from suppliers to own production – first and second tier suppliers tend to have higher profits than primes Primes seeking lower cost suppliers as pressed for profits by stockholders and lower prices from governments What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

PRIMES VS. SUPPLIERS Platform producers (primes) market directly to foreign military and perhaps demonstrate at trade shows However, my experience is that primes and first tier suppliers send salesmen to trade shows, not purchasing agents For US and EU markets, suppliers probably need to reach out directly to first and second tier suppliers in target country (sales boots on ground) Offsets requirements can force foreign primes to look for quality and price among Turkish supplier base What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

OFFSETS (1/2) In 2015 US companies signed 38 new agreements with 15 countries Valued at $3.1 billion Received $5 billion in credits for outstanding offset obligations Total US corporate offset obligations unknown, but probably over $200 billion Generally offset obligations don’t show on corporate annual reports Changing as some countries require performance bonds What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

OFFSETS (2/2) Offsets can be valuable tool for countries and companies. But do recognize that: Offsets impose costs on selling companies that will be recovered Offset deals that bring in business over several years may be more valuable than a short term larger deal Indirect offsets may be more valuable than direct offsets – higher volume and longer contracts Companies unlikely to offer “crown jewels” as technology transfer offsets – limited by home country export controls and desire to protect IP What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

MARKET/INVESTMENT OPPORTUNITIES (1/2) Industrial countries: Hard to market directly to militaries; easier to work with domestic companies Direct independent investment difficult, easier to find a domestic partner for a JV Primes and first tier suppliers interested in obtaining parts and components cheaper than domestic companies can produce Offset obligations a useful way to get foot in door – use offsets as stepping stones to long term relationships Note primes “wash down” offset obligations to upper tier suppliers (engine houses, radars) What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

MARKET/INVESTMENT OPPORTUNITIES (1/2) Gulf Countries All want defense industries and have money to invest Open to joint-ventures Small maritime vessels, vehicles and light armor, man-portable weapons, Hurkus Service and after-market support – have more equipment than they can maintain What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

MARKET OPPORTUNITIES (2/2) Central Asian Countries and Africa Appropriate hardware, service contracts Possible refurbished equipment in Turkish or Middle East military inventories Upgrading Soviet equipment in their inventories Possible JVs producing parts and components cheaper than possible in Turkey What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change

World Defense Market and Industry Istanbul Chamber of Industry Presentation Istanbul, Turkey Joel L. Johnson Executive Director - International Teal Group Corporation www.tealgroup.com; jljohnson@tealgroup.com October, 2017 What weird production rates How ex im eca Why irad Consequences aftermarket Irony What could change