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Challenging Assumptions About MRO Growth

Challenging Assumptions About MRO Growth

PHOENIX, Ariz., Wednesday, April 9, 2014

Pratt & Whitney Aftermarket President Matthew Bromberg delivered the keynote address to a packed crowd on Day 2 of the MRO Americas 2014 conference.

In his remarks, Bromberg discussed industry forces that have shaped today's MRO environment and trends influencing the future of the industry.

To succeed in this challenging market, Bromberg said that Pratt & Whitney will continue to drive three key metrics for our customers: quality, speed and value.

Remarks for MRO Americas

Pratt & Whitney Aftermarket President Matthew F. Bromberg

April 9, 2014

"Challenging Assumptions About MRO Growth"

Steel Manufacturing, Wind Turbine Development, Auto Manufacturing, Ocean Shipping, Airline Transport, Semiconductor Fabrication, and Telecom Infrastructure.

What do these industries have in common?

They all have, at one point, struggled with overcapacity.

The results vary, but the causes have some similarities. In each case, the balance between supply and demand changed, and the participants were slow to respond by adjusting investment. In some cases, the industry missed the impact of government intervention. In all cases, the industry missed an inflection point.

Are there relevant lessons here?

Is the Maintenance Repair and Overhaul Industry at an inflection point?

Over the next 30 minutes, I hope to answer these questions by sharing our perspective on our industry and some of the underlying drivers.

Before I do, I will spend a moment introducing Pratt & Whitney.

First, I'd like to thank Joe Anselmo and Ed Hazelwood for the invitation to address this conference, and I'd also like to recognize and thank our partners, our suppliers, and most importantly, our customers.

It's great to be here with you today. It's also a great time to be in the industry and a great time to be at Pratt & Whitney.

MRO is a $60 billion business and growing, and Pratt & Whitney is proud to participate and honored to be a leader in this industry.

Pratt & Whitney's 85-year MRO history started with our first products, the Wasp engine family. In the early days, we had a two-man service department. The service guys would put spare parts and tools in a suitcase, fly off to the engine, and fix it, right then and there. In fact, two mechanics could remove a Wasp engine in 15 minutes. A test cell was a Ford flat bed truck with an engine mount. Maintenance was on location, flexible and cost effective.

Sounds pretty good even today.

Today, MRO is a multi-billion-dollar business for Pratt & Whitney. We have five engine centers, 15 repair facilities, 65 field offices, and 6,000 professionals. We serve over 500 large-engine customers in 136 countries, and we resolve over 40,000 customer issues each year through our state-of-the art Global Operations Center.

Dependable Engines is job one.

Looking into the future, we are thrilled with the success of our Geared Turbofan engine, which has already sold more than 5,000 engines. This revolutionary engine family, which will enter service in 2015, was designed to handle the uncertainty of today's marketplace. Its game changing architecture not only promises industry leading fuel burn advantages, but also promises to set the industry standard for maintainability and cost-of-ownership.

This new family of engines, our PurePower family, when combined with our strong installed base of more than 12,000 engines, will propel Pratt & Whitney's customers and our aftermarket to new heights over the next 20-30 years.

Given our bright future, we are very interested in the question at hand.

Is our industry at an inflection point? To answer this question, let's look at the economics of the industry, and let's analyze MRO supply and demand.

First, let's look at MRO demand drivers. Traditionally, MRO growth has been larger than OEM growth. This has been driven by both an increasing installed base and also by aging platforms. Ten years ago, we estimated OEM growth of 3–4 percent per year, and we estimated MRO growth to be 6–8 percent.

What is today's outlook?

It is common knowledge that we are riding an amazing bow wave of new aircraft deliveries – the installed base of aircraft is projected to reach more than 41,000 by 2030. These aircraft are needed for our emerging markets, and to replace the aging fleet in North America. In light of this production schedule, OEM growth is forecast at 6–8 percent for the next decade.

One would expect MRO growth to follow.

However, it is not. There is solid consensus that the global MRO spend will grow at only 3–4 percent per year over the next decade.

What happened?

One explanation is that as the fleet grows, it is getting younger.

Today the average aircraft age is 15 years. That happens to be the oldest fleet ever. Over the next decade, this will drop as new aircraft are introduced, and it will drop as older aircraft are retired. Since younger aircraft require less maintenance, the demand for MRO services will also drop.

A second explanation is that this new fleet is getting more reliable. Pratt & Whitney is inserting cutting-edge technologies such as our geared architecture, advanced materials, and 3D aerodynamics to stretch engine performance. Engine time on wing and aircraft reliability have both increased by 30 percent over the past 10 years.

As an example, 40 years ago we saw in-flight shutdown rates in the range of 40 per 100,000 engine flight hours. Today, the industry targets rate closer to one shutdown per 1,000,000 flight hours. An improvement of almost 400 times. Engines are more reliable.

Finally, aircraft and engines are designed for reduced maintenance. The Geared Turbofan engine has 2,000 fewer airfoils and six fewer LLP stages than a conventional turbofan. The engine has a 50 percent improvement in on-wing inspection intervals with many previous tasks being eliminated. Engines are designed for less maintenance and for easier maintenance. This also reduces MRO demand.

In summary, MRO demand growth is decreasing:

  • • Demand is decreasing as the fleet becomes younger.
  • • Demand is decreasing as the fleet becomes more reliable.
  • • Demand is decreasing through system design.

So is this change in growth rate, this slowing demand, a problem? No one is going to complain about the industry growing from $60 billion to $85 billion over the next 10 years.

Now let's look at supply. Here as well, our views have changed over the past decade. I see three key drivers: fleet diversity, globalization, and outside investment.

First, look at fleet diversity. As the fleet grows, it is becoming less diverse. Over the past decade, Boeing and Airbus models have reduced from 13 platforms to seven. Today, 75 percent of all aircraft are narrow-body, and 90 percent of those are the Boeing 737 and the Airbus A320. Even with the strong deliveries from Bombardier and Embraer, and even with new models from Mitsubishi, Comac and Irkut, the worldwide fleet is becoming less diverse—more common.

In the long run, this creates economies of scale across the MRO landscape. Consequently, the industry will require less diversity among parts, tools, and shops. The industry requires less capacity to deliver the same MRO services.

Second, I'll comment on globalization. Thirty years ago, airlines all had internal MRO capability. Fifteen years ago, many airlines were outsourcing MRO, but on a local or regional level. Today, airlines have a different view. Every airline I meet tells me they care about quality, speed and value. Not geography. Whereas we previously thought many shops served captive regional or national markets, today we know that all shops compete on a global scale.

Finally, let's look at outside investment. Motivated by the strong OEM market fundamentals, not only are airlines and existing MRO providers adding capacity, but outside investors such as private equity firms, continue to pour money and people into the MRO marketplace.

In some cases, new investors often consolidate facilities as they buy and integrate separate companies. In other cases, these investors often add MRO facilities or reposition OEM aerospace firms for the aftermarket. Over the past decade, the private equity community has invested more than $30 billion into aerospace and defense in the U.S. alone. In a large, global industry, the landscape of players and investments is never static. Will outside investors be net capacity creators or reducers?

In some cases, new investors often consolidate facilities as they buy and integrate separate companies. In other cases, these investors often add MRO facilities or reposition OEM aerospace firms for the aftermarket. Over the past decade, the private equity community has invested more than $30 billion into aerospace and defense in the U.S. alone. In a large, global industry, the landscape of players and investments is never static. Will outside investors be net capacity creators or reducers?

It is clear that we are at an inflection point. The demand for MRO services is strong, but its growth is slowing. On the other hand, the capacity to deliver MRO services is sufficient, yet its base is increasing.

As an industry, we should continue to push for open and free MRO markets, letting innovation and efficiency dictate where work is performed.

Sometimes we look to governments to solve market problems—we need to resist that temptation. Slowing down or taxing imports and exports hurts airlines through higher costs and slower maintenance. Likewise, restricting foreign repair stations does not improve quality; it penalizes the end customer.

As MRO providers, we should compete aggressively in the global marketplace, challenging ourselves to execute core strategies through operational excellence. I believe competition is good. It is the lifeblood of our industry, it makes for healthy customers, and it challenges everyone to improve.

As an airline, you should seek out the best service provider worldwide, demand the best service, expect the lowest cost. However, not all services are created equal. An airline should not have to trade maintenance cost with dispatch reliability, total cost of ownership with risk management, or technical support with customer service. Many airlines mistakenly trade one for the other. Find a provider that can deliver comprehensive, dependable services.

Finally, as an airline, you are facing a challenging decision—in light of a radically evolving MRO landscape, should you enter or expand your existing MRO footprint? It is tempting. It is a big industry. It is a high-tech industry. It offers exciting careers for some of the most capable members of our workforce. A successful enterprise can generate strong returns.

Should an airline enter the MRO industry today? In my experience, airlines enter for one of three reasons: (1) a national or corporate mandate, (2) cost of ownership considerations, or (3) a desire to grow revenues through a logical adjacency.

Working with many airlines over the past decade, I believe there is no perfect maintenance strategy. Successful airlines include those that operate full-service MROs and those that have outsourced everything. However, if cost-of-ownership is the prime objective, there are other, more flexible methods of driving down maintenance cost than expanding internal MRO capability.

As an OEM, what should Pratt & Whitney do?

Pratt & Whitney is focused on balancing supply and demand, and we are laser focused on helping our customers.

How will we accomplish this?

To start, we are listening to our customers, and our customers have high expectations. Our customers expect operational improvements and cost reduction. Our customers expect technical expertise and customer service. And, our customers expect MRO breadth and flexibility. Our customers expect value.

We believe we can provide the solution.

However, the solution requires us to rapidly mature our MRO business. While we are proud of our history, and realistic about our present capabilities, the industry and our customers demand a faster, worldwide network that delivers not only spare parts and overhauls, but complete engine services as well –

  • • Services that enable the highest standards of safety and higher standards of reliability.
  • • Services that are tailored to our customer requirements and that leverage our program partners.
  • • Services that account for the shop and the line maintenance burden.
  • • Services that address cost and provide value.
  • • Services that are Dependable.

So how do we transform a global organization?

Step one, we will continue to drive three key metrics for our customers: quality, speed and value.

To drive speed, we will reorganize our business around our customers giving them a simplified way to work with Pratt & Whitney. One Company, One Contact.

To create value, we will introduce more innovation into the MRO business. This is critical, because I think Pratt & Whitney, and the industry, are slow to adopt technologies. Don't misunderstand me—there are some sophisticated repairs across the industry. However, walk into any MRO facility, including those at Pratt & Whitney, and you see mountains of paper, job tickets, boxes of inventory, and hardbound engine manuals.

Did you know that over the past decade, engine turnaround time across the industry has actually increased from 62 days to 71 days—a 15 percent erosion?

More rapid adoption of technology enables the MRO industry to drive productivity. We have access to great resources like electronic work instructions, real time feedback from tools, and visual recognition technology. We need to use them. We also need to commit to paperless environments, truly integrated supply chains, and data sharing across the value stream. As we are about to introduce the most sophisticated engines in aviation history, we need to introduce the most sophisticated MRO processes.

Pratt & Whitney will relentlessly speed up, providing faster overhaul services, recognizing that every day an engine is in our shop, it is not generating revenue for our customers.

Step two, we will transform into a comprehensive service organization.

We have offered Pratt & Whitney Engine Services to PW2000, PW4000, and V2500 customers since the late 1990s. We see customer demand increasing for broader, more comprehensive services.

For the PW4000, about 45 percent of the world's fleet is under a service contract. For the V2500, more than 60 percent of the world's fleet is under a service contract. And for the PurePower engine family, which will enter service next year, 85 percent of the operators have selected Pratt & Whitney Engine Services to support not only their entry-into-service, but their total maintenance as well.

But our customers also want choices. That's why, for the PurePower engine, we are investing so heavily in our partnership network. We are committed to a global network of facilities and partners that includes and supports airline shops. The network will provide customers choice and flexibility. And the network will ensure that we have the capacity for rapid support of engines around the world. Our partners and customers will play a big part in this network.

In this model, our incentive is aligned with that of our customers: keep the engine in service and operating efficiently. This means reducing the number of shop visits, and also reducing the cost of ownership. We don't want only to sell spare parts; we want to provide customers with increased time-on-wing, higher dispatch reliability, and everything in between.

That's what we're doing today.

What will tomorrow bring?

Pratt & Whitney has launched the most advanced engine in commercial aviation. Our game-changing geared architecture will set an industry standard in terms of performance and reliability. For instance, the engine will result in 15 percent lower fuel burn than a conventional engine. This will save operators 15 billion gallons of fuel, and it will save our environment 150 megatonnes of CO2 over the next decade. This is equivalent to taking 3 million cars off the world's highways.

Game-changing architecture demands game-changing MRO technologies. As you know, today's aircraft and engines are generating more real-time data than ever before.

Big Data enables us to capture and share this data in a fashion never before thought possible.

Pratt & Whitney is using Big Data technologies to predict engine in-flight-shut-downs. We are using Big Data technologies to improve our technical support. Looking forward, we believe Big Data will connect the entire MRO network. It will align airlines, MROs and OEMs. Together we will anticipate repairs before the aircraft lands.

In the near future, we will use this data to enable Pratt & Whitney Intelligent Workscopes—workscopes tailored to the engine, operator and environment. This will provide operators with an optimized maintenance solution.

Looking forward, Pratt & Whitney will provide industry leading technical and customer support to allow our customers to focus on their operations, not ours.

Another trend being discussed this week is additive manufacturing, also known as 3D printing. It is transforming manufacturing worldwide, and will have a pronounced impact on the aviation industry.

Pratt & Whitney has been a leader in additive manufacturing for the past 25 years. The PurePower engine family will be the first to include production hardware that will be printed, not machined.

3D printing dramatically reduces time from design to production. It decreases manufacturing waste, reduces inventory, and virtually eliminates lead-time. For engine parts, it can account for a 30 percent weight reduction, improve fuel burn, and lower cost-of-ownership.

For the MRO industry, the impacts will be significant. One day, overhaul shops will print their replacement parts. That is an exciting concept: no inventory, no lead time. Yet questions remain regarding certification, regulation and intellectual property.

Looking outside commercial MRO, I am watching the defense industry. As worldwide defense spending is reduced, defense contractors struggle to find growth. During previous down cycles, consolidation was the ticket. However, after decades of consolidation, few opportunities remain. The defense companies are coming—they will enter commercial aerospace, they will enter commercial MRO. They are capable competitors.

Finally, I am watching our outside investors. Recall that Private Equity has invested $30 billion into U.S. aerospace and defense over the past decade. As a result of this investment, many aerospace companies are owned by financial investors. In fact, 30 major aerospace companies, which are privately owned, generate aftermarket revenues in excess of $8 billion. Think about that—in a $60 billion industry, more than 15 percent of the action is owned by financial firms.

As you may know, private equity firms are in the business of providing transitionary capital. This means the firms have stated objectives to sell their business in 5 to 7 years. We live in an industry that requires long-term strategic alliances, partnerships and joint ventures. Investment returns are not measured in months, but in years. How do we assess risk and options when one in five MRO dollars is changing hands before we realize a return?

There are many other trends worthy of discussion if we had more time: labor rates are converging and general managers are highly mobile. Global logistics are improving and the surplus market is becoming a dominant force in the industry. And financial firms are finding more creative ways to support the aviation industry as well. For example, in the not too distant future, airlines may not need to own an engine. In major cities, people don't own cars, they just rent them. Zip Cars. It is more efficient. In our global aviation city, this could also work. Think about it—"Zip Engines." Fully interchangeable. No turnaround time. No spares.

So, let's bring the discussion back down to today, and the challenges we face.

The MRO industry is healthy and has a strong outlook given the fundamental demand for air travel. Daily, I marvel at the fact that 85 percent of the world's population has never flown in an aircraft. Think about that when you fly out of Phoenix later this week.

In any case, globalization will drive air travel, and air travel will drive MRO. However, the fundamental relationships have changed over the past decade. The installed base is getting younger, and these new aircraft and engines, which have been designed to reduce the maintenance burden, are more reliable, and more cost effective. MRO demand is no longer a multiple of OEM growth, but a fraction.

On the other hand, two aircraft types dominate the MRO landscape permitting significant economies of scale. In addition, the global market has brought MRO facilities closer together. Aircraft and engines are crossing the globe in search of the best service provider. Finally, new investment continues.

Clearly we are at an inflection point. Demand growth for MRO services is slowing, and the capacity to provide those services is growing. In itself, this is a major challenge. However, we also face challenges such as government regulations, new entrants, and emerging technologies. Rest assured the pace of this change will continue, making strategic planning even more critical. The ones who will do well are the ones who innovate, create more efficient processes, and provide the best customer value.

Without a doubt, it's a very exciting time to be in the aftermarket. At Pratt & Whitney, just as we are leading the industry with our new engine, we will lead the industry with the quality, speed and value of our performance. We will lead with a flexible network providing Pratt & Whitney Engine Services.

Remember the two mechanics removing an engine in 15 minutes? Their principles are relevant today: on wing, rapid, cost-effective and customized maintenance.

This is our heritage, this is our future.

Looking forward, our Dependable Engines will be met with Dependable Services.

Thank you. Are there any questions?

-END-

This speech includes 'forward-looking statements' and projections. These matters are subject to risks and uncertainties. Important factors that could cause actual results to differ materially from those anticipated or implied in forward looking statements include deterioration in global economic conditions; declines in end market demand in residential and building construction; declines in demand in both the commercial and defense segments of the aerospace industry; fluctuation in commodity prices, interest rates, foreign currency exchange rates, and the impact of weather conditions; and company-specific factors including the availability and impact of acquisitions; the rate and ability to effectively integrate these acquired businesses; the ability to achieve cost reductions at planned levels; challenges in the design, development, production and support of advanced technologies and new products and services; delays and disruption in delivery of materials and services from suppliers; labor disputes; and the outcome of legal proceedings. For information identifying other important economic, political, regulatory, legal, technological, competitive and other uncertainties related to United Technologies Corporation, see UTC's SEC filings, including but not limited to, the information included in UTC's 10-K and 10-Q Reports under the headings "Business," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Cautionary Note Concerning Factors that May Affect Future Results," as well as the information included in UTC's Current Reports on Form 8-K."

Matthew F. Bromberg - Biography