A New Year and A New Administration:What will it mean for the U.S. Defense and Security

Markets?

David Fishering, Industry Analyst

Lindsay Voss, Industry Analyst

Aerospace and Defense

January 15, 2009

2

Focus Points

Economic Impact on Defense and Security

Key Defense Issues for the New Administration

Defense Budget Forecasts and Breakdown

Trends, Challenges, and Growth Areas for Defense

Security Budget Forecasts and Breakdown

Trends, Challenges, and Growth Areas for Security

Defe

nse a

nd

Secu

rity

Fin

din

g o

pp

ort

un

ity i

n 2

009

an

d B

eyo

nd

New Security Administration Policies and Changes

Conclusions

3<GPS>

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2001 2002 2003 2004 2005 2006 2007 2008P

erc

en

t (%

)

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

2001 2002 2003 2004 2005 2006 2007 2008

$ B

illio

n

Economic Impact on Defense and Security

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Spendin

g (

$ B

illio

n)

Defense Spending Supplemental Spending

0.0

2,000.0

4,000.0

6,000.0

8,000.0

10,000.0

12,000.0

14,000.0

16,000.0

2001 2002 2003 2004 2005 2006 2007 2008

$ B

illio

n

GDP Growth 2001-2007Defense/Security Budget 2001-2008 GDP Real Growth Rate 2001-2007

Defense Security

Historical Defense Spending, 1960-2008

Source: Frost & Sullivan

Source: Frost & SullivanSource: Frost & SullivanSource: Frost & Sullivan

4<GPS>

Key Defense Issues for the New Administration

Reequipping the Ground Forces and National Guard

Expanding Intelligence Capabilities While Improving Oversight

Building Secure Relationships with Allies

Determining the Appropriate Course for Soldier Modernization

Build the Non-Military Aspect of National Security

Stabilizing Operations in Iraq

New Focus in Afghanistan

ISR on the Pakistan Border

Acquisition Reform

Continuation of Supplemental Funding

Formation of More Joint Programs

Expanding the SOF

5<GPS>

94.0

96.0

98.0

100.0

102.0

104.0

106.0

108.0

110.0

112.0

114.0

116.0

2008 2009 2010 2011 2012

Fu

nd

ing (

$ B

illion

)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Gro

wth

(%

)

Funding Growth

58.0

60.0

62.0

64.0

66.0

68.0

70.0

72.0

74.0

76.0

78.0

2008 2009 2010 2011 2012

Fu

nd

ing

($

Billio

n)

-9.0

-8.0

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0G

row

th (

%)

Funding Growth

150.0

155.0

160.0

165.0

170.0

175.0

180.0

185.0

190.0

195.0

2008 2009 2010 2011 2012

Fu

nd

ing (

$ B

illion

)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Gro

wth

(%

)

Funding Growth

U.S. RDT&E Budget Projection

U.S. O&M Budget ProjectionU.S. Defense Budget Growth

U.S. Procurement Budget Projection

Defense Budget Forecast

• The overall U.S. Defense budget is expected to increase slowly over the next three years with a CAGR of 1.1 percent

• O&M will increase with a 2.9% CAGR

• RDT&E will face notable reductions with a (4.9%) CAGR

• Procurement will increase overall with a 1.8% CAGR

• Increases in procurement are expected due to efforts to reequip the ground forces

• RDT&E will be reduced as several major aircraft programs transition to procurement, and other large and immature R&D programs are cutback

Source: Frost & Sullivan

Source: Frost & Sullivan Source: Frost & Sullivan

6<GPS>

32.9%

8.0%

35.3%

14.1%

2.0%7.7%

Aircraft Weapons Ships

Other Procurement Ammunition USMC

17.2%

6.8%

12.7%

9.1%

52.1%

2.1%

Aircraft Missiles Weapons & Vehicles

Ammunition Other Procurement JIEDDO

U.S. Navy/USMC Procurement Breakdown (2008)

U.S. Army Procurement Breakdown (2008)

U.S. Air Force Procurement Breakdown (2008)

Defense Budget Breakdown

36.7%

15.2%

45.6%

2.6%

Aircraft Missiles Other Procurement Ammunition

0.0

100.0

200.0

300.0

400.0

500.0

600.0

2007 2008 2009 2010 2011 2012

Fun

din

g (

$ B

illio

n)

Navy/USMC Air Force Army Joint

U.S. Budget Breakdown by Service

Source: Frost & Sullivan

Source: Frost & Sullivan Source: Frost & Sullivan

Source: Frost & Sullivan

0.0

100.0

200.0

300.0

400.0

500.0

2007 2008 2009 2010 2011 2012 2013

Spendin

g (

$ M

illio

n)

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Gro

wth

Rate

(%

)

Spending Grow th Rate

Look to Defense’s Top Growth Areas for Opportunities

Provide End-Users Practical Solutions Focus on Integration, Training and Services

Participate in the HOT C4ISR Programs

Source: Frost & Sullivan

Growth Areas in Defense

UAVs & S&R: Top Defense Growth Areas UAVs & S&R: Top Defense Growth Areas

Commercial SATCOM Near SpaceAEHF DTNWGS HawkeyeWIN-T/JBC-P AESATACSAT Targeting PodsCommercial Imagery SIAPReset and new manufacture SINCGARS SDR Interim setsNextGen/CANESRadar Wideband CommsForeign Government and Commercial Space Radar

UAS Services are an expanding market Segment Defense Technologies Meeting the Need

Unmanned

Systems

Unmanned

Systems

Weapons

Systems

Key Defense Industry Trends and Challenges

Ground

Vehicles

Military

MRO

Ships

Training

Simulation

• Increased focus on unmanned systems capabilities and less focus on the platform (Sensors, Data Links, Navigation, GCSs) • Companies are looking to expand their Unmanned Systems product offerings through partnering and acquisition • The UAS industry in the U.S. is increasingly becoming consolidated with approximately 80 percent of the market held by four

companies

• Significant budget resources will be allocated to upgrade programs for fire control systems• Missiles will have improvements to the seeker and control technology and will have “re-pours” or new propulsion packages

procured

• Army vehicle reset is having a profound impact on the U.S. Defense vehicle industry for both manufacturers and suppliers • Reset and refurbishment will positively impact vehicle procurement for the next 3-5 years • The Joint Light Tactical Vehicle program could face setbacks however since the U.S. Army is consistently placing orders for new

HMMWVs

• Parts Manufacturing Authority (PMA) parts manufacturers are increasingly be challenged by original equipment manufacturers in the military aircraft MRO space

• High aircraft engine cost in an emerging challenge for the military aircraft MRO market • The aging military aircraft fleet however is increasing the potential for MRO revenue over the next 5-10 years

• Budget constraints and an inability to sustain funding sources for T&S programs has been restraining the market• As resources are pulled to support ongoing conflicts in Iraq and Afghanistan, training and simulation has become less of a priority• The growth in popularity of unmanned systems is helping to spur T&S for this market area, particularly in the UAS market segment

• Despite being on the chopping block for the last two years, programs such as the Navy’s Littoral Combat Ship (LCS) will have some support from President elect Obama in 2009 and beyond

• It is expected however that the U.S. Navy’s acquisition system will change and this will have an impact on not only ship programs but other naval acquisitions programs as well

C4ISR

• Reequipping and expanding the ground forces and SOF will be key in 2009• Technology focuses will be on communications, Intelligence, and Surveillance • Possible funding shifts from the AF and the Navy to help rebuild the Army and the USMC • Programs facing cutbacks in 2009 and beyond: FCS, TSAT, JTRS, and Manned Airborne ISR

9

Security Budget Forecast

The DHS budget is expected to be up about 5%

from last year (the budget is still pending and

DHS is operating under a CFR)

Growth in the budget is expected to have a

CAGR of 4.5% between FY 2008-2012

Despite economic uncertainties and the Obama

Administration’s understatement of HLS thus

far, Frost & Sullivan sees very little change in

the trends of DHS budget authority

0

10

20

30

40

50

60

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Fiscal Year

Fundin

g (

$ M

illio

n)

0

2

4

6

8

10

12

14

16

Gro

wth

(%

)

Total Budget Authority Growth

CBP

22.0%

TSA

13.9%

A&O

1.0%

USCG

19.0%

NPPD

3.0%

Dept. Ops.

1.0%

ICE

10.9%

DNDO

1.0%

S&T

2.0%

FLETC

1.0%

USCIS

5.1%USSS

3.0%

FEMA

12.9%

FEMA Grants

4.0%

Source: Frost & Sullivan

Source: Frost & Sullivan

0.7% 4.8%

13.3%

81.2%

Management and

Operations

Research and

Development, Training,

and Services

Protection, Preparedness,

Response, and Recovery

Security, Enforcement,

and Investigations

Source: Frost & Sullivan

DHS Budget Breakdown by Category, FY 2009 DHS Budget Breakdown by Agencies and Offices, FY 2009

DHS Budget Forecast, FY 2007-2012

10

U.S. Security Market

Homeland Security Market Revenues by Segment

(U.S.), 2007-2012

0.0

3,000.0

6,000.0

9,000.0

12,000.0

15,000.0

18,000.0

2007 2008 2009 2010 2011 2012

Mill

ion

US

D

$11.0 Billion $15.5 Billion

2007 2012

10%

11%

38%8%

11%

4%

18%

The U.S. homeland security market is expected to witness modest growth over the next five years. High growth segments include CIP, Seaport, and Emergency Response

18.2%

4.5%

10.0%

9.1%

36.4%

11.8%

10.0%

18.6%

3.8%

11.6%

7.1%

38.6%

10.4%

9.9%

Land Border

Aviation CIP Maritime Seaport Mass Trans.

Emerg. Resp.

Source: Frost & Sullivan

11© 2008 Frost & Sullivan

www.frost.com

Key Security Industry Trends and Challenges

Border

Aviation

Critical Infrastructure

Maritime

Seaport

Emergency Response

Mass Transport

• COTS solutions to improve situational awareness are likely to replace the SBInet concept in the near-term• Immigration policy will be a major focus in the next administration, this may take away from a focus on technology deployment• Deadlines for programs such as US-VISIT are expected to be extended again in the future, despite large-scale rollout of biometric

passports and other identification methods

• Global development of small to mid- size airports (over 400 by 2028) is expected to increase demand for security measures• An average passenger growth of over 5 percent per year through 2012 will necessitate the deployment of more security technology• The potential increases in baseline international airport security standards could create growth opportunities• TSA procurement can lead to “false hope”, only a few technology deployments have led to sustainable business

• Mandates for increased security in the chemical industry along with infrastructure security grant programs have created demand in a segment that is extremely dependent on the occurrence of events

• Infrastructure is expected to be a focus of the next administration but spending could be targeted at improving rather than securing• DHS has nearly $300 million that has been marked for cyber security; potentially lucrative this segment still has many uncertainties

• Having taken control of the Deepwater program Congress has now stripped the Coast Guard of its management rights, setting the program even further behind schedule

• Maritime Domain Awareness remains a top priority and there is a major push to deploy integrated C4ISR systems to fill this gap

• Mandates for 100 percent scanning and screening of cargo have necessitated the development of this market.• Advanced technologies are meeting staunch resistance by government, putting deployment opportunities in question• Supply chain security, trusted shipper and verification programs have become a favorite of lawmakers over inspection technology• Shipping container traffic is expected to grow about 9 percent year over year by 2015 creating a need for more security systems

• Mass transport systems are increasingly being seen as “soft” targets for both criminal and terrorist activity. Intelligent & durable surveillance systems within “rolling stock” are key revenue generators.

• Emphasis on low TCO, self-diagnosing CCTV systems, automatic wireless image downloads and innovative passenger screening technologies will push R&D efforts within this threat domain.

• Interoperability remains an issue at the state and local level. Governance and budgets have become the biggest restraint despitethe availability of solutions. CBRNE detection technology is facing major challenges in the absence of a major CBRNE event

• At the strategic level, emergency managers are demanding integrated C3 systems to improve situational awareness and response• The emergence of USNORTHCOM and its three incident response units could make it a key influencer, despite its support only role

Provide Solutions for Today’s Security Problems

Understand and Meet the Needs of the End-UserIntegration of COTS Solutions

Tap Into the Global HLS Market

Hot Spots in Security

Sensors System of Systems

Systems

Communications

Cyber Security

Critical Infrastructure Protection

New Administration Policies and Challenges

Stated Policy Goals

• Defeat Terrorism Worldwide

• Prevent Nuclear Terrorism

• Strengthen American Biosecurity

• Improve Intelligence Capacity and Protect Civil

Liberties

• Protect Critical Infrastructure

• Modernize America’s Aging Infrastructure

Likely DHS Focus Under Napolitano

• Developing CONOPS for the National Guard

and NORTHCOM

• Redeveloping and Executing the Virtual Fence

Concept on the Border

• Enhancing Federal, State and Local

Cooperation

Challenges

• Maintaining Focus and Execution Through the

Transition Process

• Developing a More Mature Acquisition

Process to help increase the Likelihood of

Success

• Supporting R&D Activities for Innovative

Technologies and Small Businesses

• Strengthening the Public-Private Partnership

• Securing the Border and Overhauling the

Immigration System

• Creating Interoperability of C4ISR Systems

across the Federal State and Local Agencies

• Fulfilling Mandates for 100 percent scanning of

air and sea cargo

• Understanding and Defining the role of the

Military in Homeland Security

Conclusions

Defense and Security Funding will be stable through 2010

Top Factors Driving Growth in the Defense Market will be Reequipping the troops and Ongoing Wartime Operations

Top Factors Driving Growth in the Security Market will be the fulfillment of unmet needs from the last administration and the ever present demands for security in times of uncertainty

The Downturn in the Global Economy is expected to have a minimal Impact on the U.S. Defense and Security Markets

Any major changes in Defense and Security policy or spending are unlikely in the near-term: Technologies and Programs that are getting the job done will be well positioned under the new administration

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