August 2015

A&D Connections

A&D sector key themes

Industry tends
Thought Leadership: A&D
industry rreports by EYs
competitors
Analysis of M&A trends
Service line articles

For internal EY use only

Contents
A&D sector key themes ................................................................................................................. 3
Industry buzz .................................................................................................................................. 6
Thought leadership: A&D industry reports by EYs competitors ............................................ 10
Analysis of M&A trends................................................................................................................ 11
Service line articles ...................................................................................................................... 15

2
A&D Connections - For internal EY use only

A&D sector key themes

This section covers the top themes discussed in the 2Q15 earnings releases of seven of the largest
US-based aerospace and defense companies Boeing, General Dynamics, Honeywell, Lockheed
Martin, Northrop Grumman, Raytheon and United Technologies.
New products and programs, improving cash flows, commercial and military market demand,
international business, and share repurchases and dividends were the key discussion themes for
A&D executives. Other focus areas included M&As and other strategic alliances, government
defense spending and macroeconomic conditions, exchange rate, production ramp up and
pensions. Raytheon discussed most of the top-ranked themes in great detail. In addition to the top
themes mentioned below, companies also discussed about restructuring, competition, research and
development, and cost control measures.
Summary matrix for the top themes in 2Q15
Boeing

General
Dynamics

Honeywell

Lockheed
Martin

Northrop
Grumman

Raytheon

United
Technologies

New products and programs

Improving cash flows
Commercial and military
market demand
International business
Share repurchases and
dividends
M&As and other strategic
alliances
Government defense spending
and macroeconomic conditions
Pensions
Exchange rate
Production ramp up

High priority themes

Moderate priority themes
Low priority themes
Themes not discussed

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A&D Connections - For internal EY use only

Description of top themes discussed by A&D executives

Rank

Theme

New products and

programs:

Description

companies are focusing on

next generation programs
such as missile systems and
bombers

Improving cash flows:

enable companies to make
strategic investments

Honeywell has entered into an agreement to

supply next generation cockpit technologies to
Dassaults Falcon 5X fighter.

Cash flows remained strong for Boeing, Honeywell,

Lockheed Martin, Northrop Grumman and
Raytheon.
General Dynamics cash flow was down quarter-onquarter due to cash deployment activities while
United Technologies cash flow declined due the
settlement of a German tax issue.

Commercial and military

market demand:

orders picking up driven by

increased demand

Growth in air traffic and airlines profitability are

driving demand for commercial aircraft and parts
while international customers are driving demand
for defense products.
Boeing won over US$50 billion orders and
commitments in the Paris Airshow held in June
2015 while Raytheon expects its overall 2015
booking to reach about US$25 billion.

International business:
Middle East and Asia Pacific
remain attractive for A&D
players

International customers represented 33% of

Boeing Defense, Space and Securitys revenue and
39% of its order backlog in 2Q15.

For Raytheon, international business represented

44% of its total backlog in 2Q15, compared to 38%
in 2Q14.

Share repurchases and

dividends:

The seven companies under consideration paid

total dividends of US$2.7 billion in 2Q15 compared
to US$2.4 billion in 2Q14.

They also repurchased US$5.9 billion of shares

during the quarter compared to US$4.5 billion in
2Q14.

Lockheed Martin announced acquisition of Sikorsky

from United Technologies helicopter business for
about US$9 billion.

Raytheon completed the formation of a JV with

Websense Inc to provide cybersecurity solutions to
its customers.

passing on value of strong

cash flows to shareholders

Raytheon completed the first test flight of its next

generation SM3 IIA missile defense system which is
expected to enter production by 2020.
Boeing, Northrop Grumman and Lockheed martin
are competing for winning the US Air Forces next
generation long-range strike bomber program
contract.

M&As and other strategic

alliances:
to grow in new markets and
segments

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Government defense
spending and
macroeconomic conditions:
companies hopeful about a
budget increase in FY16

The Congress has been supportive of the

Presidents FY16 budget proposal of moderate
increase in defense spending. However the
spending constraints imposed by the Budget
Control Act remain a challenge.

The economic recovery in the US, coupled with a

possible increase in defense budget will open up
opportunities for A&D companies to grow their
defense and well as civil business in the country.

Pensions:
FAS/CAS adjustments
contribute to companys
margins

United Technologies faced some headwinds from

higher pension expenses in the quarter while
General Dynamics expects most of its pension
funding to occur in the third quarter.

Exchange rate:
international revenue
devaluates as US dollars
strengthens

The US dollar appreciated around 24% against Euro

and 6% against Great Britain Pound, during
January 2014 to June 2015.
US companies with foreign contracts are reducing
their exchange rate exposure by pegging their
contracts to the US dollar.

Production ramp up:

due to surge in orders driven
by increasing demand

10

Boeing is ramping up production of its 787 series

wide body aircraft while Lockheed Martin is
ramping up its F-35 program. Northrop Grumman
is ramping up its LRS, F-35 and E-2D programs.
Airbus and Boeing will collectively produce about
1,900 units in 2018, up from just over 1,400 this
year and more than double the number of aircraft
delivered in 2008.

Note: The ranking of the themes was decided based on the number of companies discussing the themes. The
themes that were discussed in greater detail were tagged as high priority themes. For the themes discussed by
same number of companies, the ones with higher priority were ranked higher. The scope of this ranking was
limited to examining transcripts and presentations that were part of 2Q15 earnings conference calls.

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A&D Connections - For internal EY use only

Industry buzz
The US military preparedness
Army electronic warfare
capabilities hit by spending
cuts

House Appropriations
committee approves
$579B defense spending
plan

The US Army is struggling to fund the increasingly crucial

capabilities in the fields of electronic warfare.
Though it has over 32,000 short-range defensive jammers,
offensive electronic jammers will not be available until 2023
because of a lack of funds.

The House Appropriations Committee approved US$579

billion defense spending plan, circumventing the
sequestration budget caps.

The budget will fund a boost in the US air reconnaissance. It

also allocated US$88 billion to the US war account and fully
funded weapon programs.

US Export-Import (Ex-Im) bank reauthorization issue and its consequences

Senate votes for
reauthorization of Ex-Im,
awaits approval of the
House

Boeing, GE to shift work

overseas because of Ex-Im
shutdown

The US Senate voted for an amendment to reauthorize the

US Ex-Im bank. The amendment was added to consideration
of the multi-year Highway Trust Fund reauthorization bill.

However, the amendment is yet to be taken up by the House

as the Senate could not complete its version of the multiyear Highway bill. Therefore, the Ex-Im amendment will have
to wait until late October to be considered by the House.

GE is taking steps to shift US$10 billion worth US

manufacturing work overseas after the Government's
decision to shut down the US Ex-Im Bank at least until
September 2015. In a similar move, Boeing is considering to
move key pieces of its operations to other countries that
could offer export credits.

The Ex-Im bank has been unable to consider new financing

requests since Congress allowed the bank's charter to expire
on June 30.

In case the bank is not reauthorized, many US exporters may

struggle to compete in the global marketplace and might
eventually lead to cut down of jobs in the US.

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A&D Connections - For internal EY use only

Military developments in foreign countries

China is preparing to keep
the US out of the Pacific

Nations race for hypersonic

weapon development

China is increasingly countering the US military capabilities

and acquiring technologies to restrain the US military's
activities in the western Pacific.

As per the Pentagon, the country is acquiring capabilities to

control space-based communications and sensing and
capabilities to attack the US with cyber weapons.

The Pentagon also anticipates possibilities that China could

sell its technologies to other nations, thus creating a
challenge for the US to maintain a technological edge.

China, Russia and India are competing with the US to

develop the world's first hypersonic weapon capable to
closing in its target at a speed of 7,500 miles per hour.
If successful, it will be a game-changing technology that can
potentially disrupt warfare.

The UK reviews security

strategy in response to
Russian threat

Despite sanctions, Russia's

defense sector is booming

The country coming up with the first hypersonic weapon will

have a huge strategic advantage over its rivals in military
preparedness.

In reaction to the recent increase in aggressive actions by

Russia, the UK is refreshing its national risk assessment,
which influences the country's national security strategy.

It is the first time since 2010 that the UK has reviewed its
national security strategy, known formally as the Strategic
Defence and Security Review.

Despite the pressure of Western sanctions, the sharp

devaluation of the Russian ruble, and high inflation in the
country, Russian defense firms reported surging revenues in
2014.
The surge in revenues was driven by increasing exports and
the high level of defense procurement by the Russian
Government.
Russian firms exported a record US$13.2 billion worth of
military hardware abroad in 2014 while the Governments
military procurement hit a new high, with about 2 trillion
rubles (US$33.2 billion).

Iran signs nuclear deal with

world powers

Iran reached a nuclear deal with six major world powers, the
US, the US, France, Germany, Russia, and China to curb its
nuclear program in return for relief from economic sanctions
imposed on the country. The deal is still subject to approval
from the US Congress.
However, Iran will be allowed to carry out R&D activities in
nuclear power for exclusively peaceful purposes while it will
be prohibited from stockpiling large amounts of enriched
uranium.

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A&D Connections - For internal EY use only

Japan cautiously
approaches arms export
policies

Japan has allowed its defense firms to bid on an Australian

submarine contract, after the Japanese Prime Minister
Shinzo Abe lifted the prohibition on military exports last
year.
The lifting of the ban was part of loosening of restrictions on
Japans military power that were put in place after its defeat
in World War II.
To facilitate military exports, the country is offering financial
aids such as credit guarantees to buyers of Japanese
weapons.

Major updates from US based defense contractors

Lockheed Martin acquires
Sikorsky and considers
spinning off IT and
Technical Services
businesses

GE Aviation wins over

US$19 billion orders and
commitments in Paris
Airshow

The company is also considering to spin off its IT and

Technical Services businesses division to streamline its
services. Lockheed Martin executives plan to review the
Information Systems & Global Solutions and Missiles and Fire
Control business segments and consider a spinoff or a sale.

Aircraft engines market leader, GE Aviation and its JVs won

orders and commitments worth over US$19 billion in the
Paris Airshow held in June 2015.

The order wins include major orders from emerging markets

in the Middle East and Asia, including countries such as
Qatar, China and Myanmar.
GE Aviations backlog stood at about US$140 billion just
before the Airshow, a record high for the company. The new
order wins in the Paris Airshow further enhanced the
companys backlog, giving it a competitive advantage over
its peers, Pratt & Whitney and Rolls Royce.

Boeing wins US$50.2

billion of business at Paris
Airshow

Lockheed Martin entered a definitive agreement to acquire

Sikorsky, a market leader in military and commercial
helicopters, for US$9 billion.
The acquisition will help the company to expand its core
business into helicopter production, which is a growing area.
The acquisition is subject to securing regulatory approvals,
and is expected to close by end of 2015 or early 2016.

Boeing won orders and commitments for 331 aircraft worth

US$50.2 billion at the Paris Airshow, compared to its
Europe-based competitor Airbus's 421 aircraft tally worth
US$57 billion.
Of the total win, 145 aircraft worth $18.6 billion were firm
orders, with the balance being commitments for already
existing orders.

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A&D Connections - For internal EY use only

Defense revenues down for

top defense contractors

Lagging defense spending and the large-scale reduction of

the US troops presence in the Middle East led to decrease in
revenues of defense contractors.
Lockheed Martin, the worlds top defense contractor,
reported 2014 defense revenues of US$40.1 billion (total
revenue of US$45.6 billion, including non-defense
businesses), a US$0.4 billion decrease from the previous
year.

Of the top ten defense firms, only United Technologies

reported improvements in defense revenues with US$13.0
billion revenue in 2014, a 9.5% over the previous year.

However, despite the years-long downturn, the defense

firms adapted themselves to the new spending landscape
and took opportunistic business decisions to pursuit M&As
and implement measures to improve operating efficiency.

Sources:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.

Ex-Im Bank round-up. And the next step, Aerospace Industries Association, 29 July 2015, via AIA
Daily News
GE may ship $10 billion in work overseas as U.S. trade bank languishes, Reuters, 30 July 2015, via
AIA Daily News
Pentagon officials cite challenges in maintaining technological edge, Military Times, 28 July 2015,
via AIA Daily News
"Hypersonic weapons race gathers speed", National Defense Magazine, 28 July 2015, via AIA Daily
News
"UK Shifting Strategy After Russian Invasions", Breaking Defense, 28 July 2015, via AIA Daily News
"Defense installation utilities at risk of cyber attack", Military Times, 25 July 2015, via AIA Daily News
Russia's defense sector is booming, Defense News, 27 July, via AIA Daily News.
"Army electronic warfare capabilities are badly delayed amid spending cuts", Breaking Defense, 21
July 2015, via AIA Daily News
Iran and major powers reach nuclear deal, CNBC website, www.cnbc.com/2015/07/14/iran-andmajor-powers-reach-nuclear-deal-report.html, accessed 7 July 2015;
House Panel sends DoD spending bill to floor", Defense News, 2 June 2015, via AIA Daily News
GE and its joint ventures receive more than $19 B in orders/commitments at 2015 Paris Air Show,
Dow Jones Institutional News, 18 June 2015, via Factiva.
Boeing wins $50.2 bln of business at Paris Airshow, Reuters, 18 June 2015, via Factiva.
Japan cautiously approaches arms export policies, National Defense Magazine, 2 June 2015, via
AIA Daily News.
"Top 100: Defense Revenues Down, but Industry Prevailing", Defense News, 27 July 2015, via Early
Bird Brief.
"Lockheed bids $9B for Sikorsky; May spin Off IT, Tech Services", Breaking Defense website,
breakingdefense.com/2015/07/lockheed-bids-9b-for-sikorsky-may-spin-off-it-tech-services/,
accessed 25 August 2015.

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A&D Connections - For internal EY use only

Thought leadership: A&D industry reports by EYs competitors

The table lists thought leadership reports on the A&D industry. These reports were published by
EYs competitors during 2Q15. They cover a variety of themes such as industry outlook, regulatory
compliance, training, emerging markets, M&A and business strategy:
Theme
Industry
outlook
Strategy
M&A

Publishing
firm

Month of
publication

Title of the report

Region in
focus

KPMG

June 2015

Global aerospace and defense outlook

Global

KPMG

April 2015

Profitable growth: Aerospace and

defense

Americas

PwC

May 2015

Mission control

Global

Other though leadership reports

The Aerospace Industries Association (AIA) and Computer Sciences Corporation (CSC)
jointly published a survey report titled 2015 A&D Market Survey covering the
perspectives of A&D leaders on some of the trends in the industry such as pricing pressures
and government regulations, growing demand for product innovation and modernization,
cybersecurity threats and costs rise, and skills shortage. Please click here to read the full
report.

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A&D Connections - For internal EY use only

Analysis of M&A trends

A&D highlights 20151
Deal value
YTD 2015 deal value is US$52.9 billion, 43% higher than the combined yearly total of
US$37.1 billion for the years 2012-2014.
The US$31.6 billion acquisition of Precision Cast parts by Berkshire Hathaway in 3Q15 is
now the largest mega deal since the United Technology/ Goodrich transaction in 3Q11 at
US$16.2 billion.
The second largest transaction announced in 3Q15 was the US$9 billion acquisition of
United Technologies Sikorsky Aircraft unit by Lockheed Martin.
A&D deals yearly view (2011-YTD2015*)
300
250
200

243

261

221

$50.0
$40.0

31

160

150
100

16

12

2011

2012

$30.0
$20.0

10

50
0

$60.0

53

244

$10.0

2013

2014

A&D Value (US$b)

$-

YTD 2015

A&D deals

45
40
35
30
25
20
15
10
5
0

42.7
83

70
70

68

47

5.6

67

55

50

19.8

44
2.4

3.0

1.8

1.8

70

64
55

51

52

48

0.9

3.5

A&D Value (US$b)

2.8

2.6

3.3

6.8
0.8

67

60

9.4

6.6
1.3

75

2.3

3.4

A&D deals

*Updated to 10 August 2015

Source: Thomson One- (01 January 2011- 30 April 2015)

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A&D Connections - For internal EY use only

90
80
70
60
50
40
33 30
20
10
0

# of Deals

Deal value US($b)

A&D deals quarterly view (1Q11-3Q15*)

Top countries- The US top target and acquirer country 2015

Top three acquirer countries by total
deal value

US (US$50 billion), UK (US$1.6 billion), and China (US$1.1

billion)

Top three acquirer countries by

number of deals

US (74), UK (16), and China (15)

Top three target countries by total

deal value

US (US$48.9 billion), China (US$1.1 billion), and Germany

(US$800 million)

Top three target countries by number

of deals

US (67), UK (18), and China (13)

Top acquirors in 2015

TransDigm Group acquired three companies in the US, two in Germany and one in Norway
Number of
deals

Deal value
US$ million

Buyer

Buyer Country

TransDigm Group Inc

US

1,621

Raytheon Co

US

1,900

GKN PLC

UK

783

Precision Castparts Corp

US

560

Meggitt PLC

UK

244

Rockwell Collins Inc

US

64

Jiangsu Tongda Power Tech Co

China

19

Parrot SA

France

Air Industries Group Inc

US

AVIC Intl Hldg Corp

China

HEICO Corp

US

NA

Novaria Group Inc

US

NA

Teledyne Technologies Inc

US

NA

Warburg Pincus LLC

US

NA

Delta Drone SA

France

NA

KB-1

Russian Fed

NA

Kontsern Kalashnikov

Russia

NA

KTRV

Russia

NA

Owen MacFarlane

UK

NA

EQT Partners BV

Sweden

NA

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A&D Connections - For internal EY use only

Top Buyers 2015, by deal value

Deal value
US$ million

Buyer

Buyer Country

Number of deals

Berkshire Hathaway Inc

US

31,595

Lockheed Martin Corp

US

9,000

Harris Corp

US

4,561

Raytheon Co

US

1,900

TransDigm Group Inc

US

1,621

Top 3 target EY sub-sectors by number of deals

Aerospace manufacturing (87), Defense contract manufacturing (11) and Communication
equipment (7)
Top 5 deals 2015 by deal value *
Date
announced
10 Aug 15

Deal value
US$billion
31.6

Buyer

Target

Targetcountry
US

Berkshire
Hathaway

Precision
Castparts

20 Jul 15

9.0

Lockheed
Martin

United
TechnologiesSikorsky

US

06 Feb 15

4.6

Harris
Corp

Exelis Inc.

US

20 Apr 15

1.9

Raytheon
Corp

Vista Equity
Partners LLCWebsense Inc.

US

Comment
Ive admired P.C.C.s
operation for a long time. For
good reasons, it is the
supplier of choice for the
worlds aerospace industry,
one of the largest sources of
American exports- Warren
Buffett
Sikorsky is a natural fit for
Lockheed Martin, and it
complements our broad
portfolio of world-class
aerospace and defense
products and technologies.Marillyn A. Hewson,Chairman
and CEO, Lockheed Martin
Harris agreed to acquire
Exelis, a manufacturer of
command, control,
intelligence, surveillance,
and reconnaissance related
products.
Raytheon and Vista Equity
Partners will form a JV
combining Websense with
Raytheon Cyber Products. It
will leverage Raytheon's
defense-grade cyber security
solutions, and Websense's
market position in cyber
security. Raytheon will own
80.3% of the JV and
Websense will own19.7%.

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18 Mar 15

0.9

Xinjiang
Mach
Research
Inst Co

Shifang Mingri
Yuhang Ind Co

China

Shifang is a manufacturer
and wholesaler of aircraft
and electronic parts.

For additional details on global A&D transactions, please refer to the following file (based on
ThomsonOne data):

Copy of Global AD_

transactions _ (11 Feb 15)_final.xlsm

Additional material
Aviation, Aerospace & Airports M&A Quarterly Q1 2015 (09 June 2015) produced by
mergermarket and ICF International.
Q1 2015 highlights:

Aircraft finance: deals continue between leasing companies,

Airlines: aviation in-flight technology remains active
Aerospace metals continue to be acquisition targets.

To access the complete report, click here

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Service line articles

Tax update
The OECD Base Erosion and Profit Shifting (BEPS) project has significant implications for all
multinational companies (MNCs). In particular, Action 13-Transfer Pricing Documentation and
Country by Country (CbC) Reporting relates to increased transparency with respect to the global
activities of MNCs. The CbC reporting template covers key economic and tax data for an MNCs
activities in every country in which it does business. The intent is to provide a view of the MNCs
entire global footprint to tax authorities in all countries where an MNC operates. Implementation of
the CbC reporting template will begin with the 2016 reporting year.
Data to be provided in the CbC reporting template includes headcount, revenues (split between
related and unrelated party revenues), earnings before tax, stated capital and accumulated
earnings, tangible assets (excluding cash and cash equivalents), cash tax paid and current tax
charge. MNCs will also be required to detail all entities, stating places of residence and main
business activities. Some of this information may be easily obtained from consolidation working
papers or other existing data sources; some will be more difficult to gather systematically. It is
therefore important to consider now what information will need to be gathered, the form in which it
will need to be reported and the ease of access to the data from the companys reporting systems
in order to develop an efficient and sustainable reporting process.
We expect tax authorities will use the C by C information to conduct assessments based on key
comparative ratios, such as effective tax rate, profit margins and income generated per employee.
We are working with clients now on such C by C issues as evaluating potential information sources;
addressing entity classification questions that will impact how group companies are shown on the
template; and using the data to create comparative ratios to see how a companys profile may look
to tax authorities. Evaluating what the CbC reporting template would look like in advance of the
requirement to provide it to tax authorities allows companies the opportunity to prepare
explanations or remedies as appropriate to prevent surprises and reduce queries (and associated
management time) and, ultimately, controversy and the potential for double taxation.
This reporting is a concern for many of our government contracting clients. Their argument is that
it is not in the interest of national security or for the well-being of contactors operating in foreign
jurisdictions to report any of the requested information to foreign countries or in an open
environment. Several contractors have expressed intentions to contact the Department of Defense
and other government agencies on this issue.
Please contact Maison Miscavage, Nate Lavelle, or Derrick Wagler for additional information.

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Government Contract Services (GCS) newsletter

Recent Raytheon cases establish precedence regarding CAS and Allowability issues
The Armed Services Board of Contract Appeals (ASBCA) recently issued two far-reaching decisions
related to Cost Accounting Standards (CAS) and unallowable costs. Both decisions involved
Raytheon and its ongoing disputes with the Government related to questioned costs and allegations
of CAS noncompliance. The decision relating to CAS, involves the calculation of cost impacts for
voluntary changes to contractor cost accounting practices while the decision related to unallowable
costs addresses the applicability of penalties.
Please refer to the attached document to read in further details.

GCS - AD
Contribution August 2015 - Raytheon Decisions.pdf

Other CAS news

On July 2, 2015, the FAR council issued a Final Rule revising the threshold for certified cost or
pricing data per the Truth in Negotiations Act (TINA) and the CAS applicability. The Final Rule
raises the TINA and CAS applicability threshold from $700,000 to $750,000. The effective date
for the new threshold is October 1, 2015.
For questions related to these topics or other Government Contract accounting, compliance and
pricing matters, contact Bob Malyska, Sajeev Malaveetil or Robin Schulze

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Key contacts
Name

Role

Contact number

George Quinn

Americas Assurance Leader, A&D

+1 703 747 1290

Bill Colbert

Americas Advisory Leader, A&D

+1 703 747 0778

Nate Lavelle

Americas Tax Leader, A&D

+1 703 747 0714

Paul Feeko

Americas Transactions Leader, A&D

+1 703 747 1274

Bob Malyska

Government Contract Services Leader

+1 214 969 8628

JP Klaffky

Americas Sector Resident, A&D

+1 703 747 0688

Sandipan Maiti

EY Knowledge A&D analyst

+91 124 619 2750

If you have any questions or suggestions about this newsletter, please contact
George Quinn at +1 703 747 1290, EY/Comm 8947846; or JP Klaffky at +1 703 747 0688.

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