These are good times for Nicholas Howley. TransDigm, the airplane-parts maker he cofounded, has sidestepped allegations of excess profits of as much as 4,436%, the stock has hit record highs, and Forbes has determined that Howley’s net worth now has three commas.
By Jeremy Bogaisky Forbes Staff
Lawmakers had a lot of questions at a January 2022 congressional hearing into what they called price-gouging in military contracting, featuring parts-supplier TransDigm Group.
Nicholas Howley, the company’s cofounder, board chair and former CEO, didn’t have a lot of answers.
One question: Did your company refuse to give pricing data to the military?
“I don’t know,” Howley replied.
Was Howley aware that his compensation as CEO was more than the CEOs of Raytheon, Boeing and Lockheed Martin combined?
“I don’t know.”
Seventeen times Howley ended up answering, “I don’t know.” Which infuriated Rep. Katie Porter (D-Calif.). “For $68 million a year,” she told Howley, referring to his 2020 compensation, “you need to know what’s going on in your company.”
What Porter and everybody else didn’t know: Howley has made out much better than that.
Since TransDigm went public in 2006, Forbes estimates that Howley has amassed a fortune of $1.1 billion. That’s based on his disclosures of TransDigm stock sales and publicly reported CEO compensation before he stepped down to become board chair in 2018.
To critics, TransDigm is a symbol of corporate greed. Its playbook: buy companies that are the only ones that make particular aircraft parts and jack up prices for customers who don’t have alternatives. Reviews by the Pentagon’s inspector general in 2019 and 2021 found that immediately after acquiring a company, TransDigm raised prices on 44 of 46 items, and reaped profit margins as high as 4,436% over the 15% that investigators deemed reasonable. It was all legal. Still, a former employee described TransDigm as a “cancer.” Another told Forbes that the company is the “Satan of aircraft parts.”
To investors, however, TransDigm’s business model has proven ingenious. The Cleveland-based company has rung up a total return (stock-price appreciation plus dividends) of 29% annually since its IPO, according to FactSet data, with revenue growing over tenfold to $5.6 billion in fiscal 2022. That total return is No. 1 by a wide margin among U.S.-listed aerospace and defense companies over that span, roughly a third better than the next closest, rival parts-maker HEICO.
To taxpayers, TransDigm is a boondoggle. With $816 billion in funding, the Pentagon is the fifth-largest line item in the U.S. government’s $5.8 trillion budget for fiscal 2023. Overcharging for spare parts alone may have inflated defense spending by billions over the past two decades, according to Pentagon audits that looked at a universe of companies beyond just TransDigm. A review of a 2018 contract with a TransDigm unit found that the military would pay $119.3 million over 10 years for 100 parts that should have cost $28.3 million — $9 million a year up in smoke. Air travelers, too, pay higher fares due to what the House Oversight committee has called TransDigm’s “abusive pricing practices.” Airlines are the company’s biggest customers.
In a statement, the company said, “The Department of Defense audits of select contracts consistently concluded that TransDigm businesses followed all laws and regulations.” It also said, “The DoD typically receives a substantial discount to commercial market prices where available.”
Howley, 71, has generally avoided talking to the media. He didn’t respond to requests to speak to Forbes.
Howley isn’t the only TransDigm executive who’s gotten rich. The company awards big stock-option packages to executives, including the managers of its subsidiaries, contingent on meeting ambitious financial goals.
“It’s made many people quite wealthy,” Bob Henderson, who retired at the end of 2021 as vice chairman, told Forbes.
The company’s zeal for inflating prices is well documented. The Defense Department has conducted at least four investigations going back to 2006. All of them concluded that TransDigm has reaped excessive profits. In May, CBS’ 60 Minutes produced a segment on price-gouging that called out the company along with some of the biggest Pentagon contractors.
Less well-known is the relentless pressure to improve financial returns, and qualify executives for stock awards, that four former employees told Forbes has led managers to boost revenue with aggressive accounting maneuvers that could amount to fraud. And Forbes is reporting the billion-dollar wealth of the man behind the sprawling operation for the first time.
Birth Of TransDigm
Howley grew up in Havertown, a Philadelphia suburb, the son of the president of Lansdowne Steel & Iron, which made munitions for the U.S. military. (Like father, like son: a 1971 GAO report faulted the company for overstating costs to inflate pricing.) Howley worked there during high school and while studying mechanical engineering at Drexel University, he said last year on a podcast hosted by a business partner, private-equity investor Will Thorndike. “That was likely the best on-the-ground practical business experience I received in my life,” Howley said of Lansdowne, where he operated machine tools and got his first taste of management and finance.
After earning an MBA from Harvard in 1979, Howley landed at IMO Industries, an industrial conglomerate, where he was eventually tasked with setting up four underperforming aerospace parts units for sale. On the podcast, Howley described, at times gleefully, how he and his boss, Doug Peacock, maneuvered behind the scenes to buy the businesses themselves, negotiating a joint bid with the private-equity firm Kelso. When management realized what Peacock was up to, they fired him, but given Howley’s key role in the sale process they couldn’t easily jettison him, he said, despite suspicions he was in on it, too. There were other bidders, but “they weren’t going to get much help from me,” Howley said with a laugh.
Thus was born TransDigm in 1993. Howley and Peacock quickly arrived at a formula to grow industrial companies. “You can get the price up, you can get the cost down and you can generate new business,” Howley said on the podcast. “Almost anything else, tertiary at best.”
Bathroom Faucets
In 2022, TransDigm said about 90% of its sales were from proprietary products. Many of them might not seem special — things like valves, door latches and bathroom faucets. But the company takes advantage of peculiarities in the highly regulated nature of the aviation industry. Every part on a commercial aircraft, and the methods for manufacturing it, must be certified as safe and reliable by the Federal Aviation Administration. It’s a time-consuming and expensive process, and even with huge price hikes, most of TransDigm’s products remain a small part of the overall cost of an aircraft, mitigating the incentive for customers to seek out less expensive alternatives.
When an aircraft is under development, parts makers compete to win a place on it. That holds down prices. Companies may lose money or scratch out thin profits selling components to Boeing and Airbus during the initial production runs. But they have a freer hand in selling replacement parts to airlines and other operators — the so-called aftermarket. Planes can keep flying for decades after they’re no longer produced.
True to that formula, the aftermarket accounted for 55% of TransDigm’s sales last year, but roughly three-quarters of a measure of profit called Ebitda (earnings before interest, taxes, deductions and amortization).
One example is the case of a quick-disconnect coupling half, a small part that allows for the rapid connection and disconnection of fluid lines without tools. TransDigm sold it to the Pentagon in 2017 at a price that amounted to a 219% a year increase from 1991. On a subsequent purchase for the same price in 2018, the inspector general determined TransDigm booked an excess profit margin of 1,698%.
Prices and manufacturing costs have been redacted in reports the Defense Department releases to the public, but for a 2019 congressional hearing, House Democrats revealed that the inspector general found it cost TransDigm $173 to make a quick-disconnect coupling that it sold it to the Pentagon for $6,986.
While the Pentagon has not accused TransDigm of breaking any laws, something is definitely broken, starting with the rules governing defense acquisitions. A big reason the Pentagon hasn’t negotiated better deals is that TransDigm has been able to refuse its requests for cost information to gauge the fairness of its pricing. By law, military contractors don’t have to produce cost data on transactions below $2 million. Congress raised the limit in 2018 from $750,000, saying it wanted to cut red tape.
Voluntary Refund
Former TransDigm employees told House Oversight Committee staff that the company structured contracts to avoid hitting the thresholds that would trigger cost-reporting requirements. From 2017 through June 2019, 95% of TransDigm’s contracts fell below that level.
After getting pummeled in the 2019 hearing over the Pentagon inspector general’s findings, the company complied with a request to refund $16.1 million in overcharges. TransDigm has so far stiff-armed the Defense Department on another request — to return $20.8 million in excess profit found in a 2021 follow-up review. TransDigm claims that the 15% profit limit the inspector general’s report set is arbitrary and the review’s methodology was flawed because it excluded legitimate costs.
STICKER SHOCK
Here are five types of spare parts TransDigm sold to the Defense Department with profit margins as high as 4,436% over what the Pentagon inspector general deemed a fair level (15%), according to a 2019 report.
There’s one area where TransDigm may have broken rules. The Pentagon’s inspector general said in 2019 it had asked the Defense Criminal Investigative Service to look into allegations, first raised by the Washington business publication Capitol Forum, that the company failed to disclose in the federal contracting system that it was the owner of 12 subsidiaries that bid for Pentagon business. That would make it harder for the military to track TransDigm’s pattern of price hikes.
A spokesperson for the inspector general’s office told Forbes she could neither confirm nor deny that an investigation was underway. TransDigm didn’t respond to Forbes’ request to comment on the matter.
For all the attention directed at its relationship with the Pentagon, TransDigm’s direct sales to the military account for less than 10% of its revenue, according to Howley’s congressional testimony. More quietly, the company’s aggressive price increases have also ruffled feathers with airlines.
“They hate [TransDigm] with a passion, but they have no choice,” a former employee at subsidiary AvtechTyee told Forbes. “You don’t like it, your plane doesn’t fly.”
Plane makers can be caught in the middle. “The airline customers complain to Boeing that TransDigm prices are high, and that’s making it hard to manage cost,” Abdol Moabery, CEO of GA Telesis, a company that repairs planes and distributes parts, told Forbes. “Boeing didn’t contract TransDigm to make these parts. Boeing contracted a company that TransDigm bought.” Boeing declined to comment.
TransDigm’s counterargument is that the expense and effort it puts in to deliver reliable parts quickly, so planes don’t languish idle on the ground, is worth the sting of higher prices. “Customers should not have to worry about our product and if they’re going to get it when they need it,” said Henderson, the retired TransDigm executive. “That comes with price.”
Shipping Parts Prematurely
At TransDigm subsidiary AvtechTyee, which makes structural components and audio and flight-deck systems, pressure to perform led managers to commit fraud, said Phyllis Santistevan-Sullivan, who was AvtechTyee’s finance chief and worked there from 2018 until she was fired in May 2021.
In a lawsuit filed in February, Santistevan-Sullivan claimed the company improperly sped up booking revenue to meet aggressive quarterly financial targets and pushed favorable numbers into the future when they weren’t needed for the current period. Santistevan-Sullivan says she was fired in retaliation for pushing back at the practices. She told Forbes she presumes similar things happen at other TransDigm units. “You could see presidents that weren’t meeting their goals would be let go,” she said. “If you can’t meet your budget, you’re not going to be around very long.”
Howley acknowledged on the podcast that the company is quick to replace underperforming executives.
In a court filing, TransDigm’s lawyers denied the allegations in Santistevan-Sullivan’s lawsuit and said she was fired for poor performance. The company declined a request from Forbes to comment further. A trial is scheduled for December 2024.
Santistevan-Sullivan said she discovered that $400,000 of revenue was improperly booked on a new project for Boeing, though no product was shipped, nor was Boeing invoiced.
She said the company also sent a prototype part to defense giant Lockheed Martin in 2019, almost a year before it was ready, so that hundreds of thousands of dollars in revenue could be recorded that quarter. Lockheed sent it back.
The former AvtechTyee employee who spoke anonymously corroborated Santistevan-Sullivan’s account of the Lockheed Martin incident, but said she was wrong in one respect — the part had actually been shipped to Lockheed prematurely twice to book milestone payments. “By the second time they were no longer really enjoying us very much,” he said.
Lockheed declined to comment.
Santistevan-Sullivan and the former employee said the part was shipped to Lockheed over the objections of engineers on the orders of Kevin Hanson, AvtechTyee’s vice president of sales and marketing. An idiosyncrasy of TransDigm is that sales and marketing chiefs are the No. 2 executives behind the subsidiary presidents, former employees told Forbes.
The former employee said the revenue booked from shipping the unfinished part was crucial to hitting quarterly targets, which were key to executive promotions. Missing the quarter’s revenue target “would have derailed [Hanson’s] ascendancy,” he told Forbes.
Hanson was promoted to president of the TransDigm subsidiary Korry Electronics in October 2021. He didn’t respond to a request for comment.
Improper revenue recognition is one of the most common types of financial fraud, accounting for 40% of fraud enforcement actions by the Securities and Exchange Commission between 2014 and 2019, according to a study by the Anti-Fraud Collaboration. The SEC didn’t respond to Forbes’ questions about TransDigm.
Acing The Audits
Two former finance employees at another subsidiary told Forbes that when TransDigm buys a company, it’s aggressive about setting up the so-called opening balance sheet — the basis against which future revenue and profit growth will be measured. The company books unusually high reserves for inventory losses and marginally profitable part-supply agreements that can be used as a “kitty” to boost revenue in the first few years after an acquisition, they said.
Creating high reserves reduces the book value of the acquired company, which requires TransDigm to record high amounts of what bookkeepers call goodwill to account for the difference between the company’s value and the purchase price. Goodwill essentially is a statement of confidence by TransDigm that it will make up the difference in value by improving the business.
TransDigm reported goodwill in 2022 that’s 48% of its total assets — an unusually high share, said Francine McKenna, an accounting expert and former Wharton lecturer who publishes a newsletter called The Dig. The company has only booked a hit to goodwill in its earnings once, in 2017. Both are “massive” red flags that TransDigm may be overpaying for its acquisitions and not acknowledging cases in which it hasn’t reaped the returns it expected, McKenna said.
TransDigm didn’t respond to questions about its accounting practices, but said in its statement that the company “undergoes thorough internal and external audits.”
Clear Skies
After years of government reports documenting TransDigm’s aggressive pricing, some things may be starting to change.
Rule-writing is under way on a measure passed by Congress last year that will give the Defense Logistics Agency, which handles purchasing for the Pentagon, the ability to compel companies to provide more information to back up claims that an item they’re selling to the military is identical to ones they sell to civilian customers. Companies have taken advantage of loose definitions of what counts as commercial products under regulations that absolve them of the responsibility to release cost data to determine if prices are reasonable on the presumption that those prices are governed by market forces and should be spared government red tape.
DLA has made slow progress on a program to reverse-engineer parts made by TransDigm to spark competition, which would, theoretically at least, lead to lower prices. It completed the process with 13 parts and said it received competitive bids for an unspecified number. That’s out of a universe of 986 parts DLA sourced from TransDigm that it identified as initial candidates.
Analyst Ken Herbert of RBC Capital Markets said he doubts there will be much interest from industry given the small quantities that the Pentagon orders of many of the parts. “I’m skeptical DLA can get enough companies fired up to take on the risk and make the investments,” he said.
Meanwhile, it’s clear skies for TransDigm’s commercial business. Air travel has rebounded from pandemic lows and airlines are clamoring for more planes while Boeing and Airbus are struggling to meet demand. The result is airlines holding onto older planes longer, and continuing to take jets out of storage that were parked in 2020. That means they’re spending more on maintenance and aftermarket parts — TransDigm’s sweet spot. Because of supply chain disruptions, airlines are also building higher inventories of parts. Even after TransDigm stock reached an all-time high last week, it remains a top pick for a number of Wall Street analysts.
TransDigm has had leverage to carry out some of its highest price increases ever, said Herbert. Airlines, rather than fighting it, are passing on the costs in higher airfares. “It’s sort of a perfect storm in a positive way for a company like TransDigm,” he said.
With assistance from Robert LaFranco.
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