Statement of Kevin Stein, Presiden 1, Chief Executive Officer and Director TransDigm Group Incorporated Before the Oversight and Referm' Committee, S. House of Representatives Hearing on Inspector General Report on Excess Pro?ts by TransDigm Group, May 15., 20.19 Chairman Cummings, Ranking Member Jordan and Members of the Commit-tee: Thank you for the opportunity to appear before you todhyand answer your questions about TransDigm Grdu'p Incorporated. .1 11111011111111 by the company?s EXecuti-ve C-h?a?innan and. tounder Nick Howls}r Mr Howley and. I are here this morning to talk with the Committee abdut a recent audit by the Department of Defense .1 Office of? the Inspector Gene-ml (IG) ?of whether the bought certain spare parts from Tr-ansDigm at fair and reasonable prices We understand that the .Con1111ittee' 1s inquiring whether TransDigno has been appropriately earning excess pro?ts with taxpayer funds and whether federal regulations adequately equip contracting of?cers to negotiate fair and reasonable prices for. spare parts. from sole source manufacturers As a threshold. matter we respectfully ask that the Committee take notice of the fact that. the IG did. not. audit or (to use the colloquial term) ?invesngate? TransD1g1n Rather, it audited the procurement practices of the Defense Logistics Agency (DLA) and other govemment buying- agencies- In doing. so the 1G found. that TransDigm. did nothing' .111 contravention. of the federal acquisition laws and regulations with respect to its pricing Introducti-on' Founded 111. 1993 and headquartered 111 Cleveland, Ohio. IransDigm 1s a leading global designer. producer and. supplier of highly engineered aircraft components ransDigm makes a w1de range of prod11ets~from faucets seat belts and wall coverings to parachutes. actuators, valves. and nohes from cargo systems to cockpit-door security systems. TransD1gm has products on nearly all commercial and military aircra??'in service today. However, TranSDigrn- is not a. traditional defense contractorwit 1s: primarily a commercial company When I. say TransDigm 1s primarily a commercial. company, [111111111 that our primary customers are commercial aircraft manufacturers, such as Boei.ng,.AlRBUS.a11d Cessna and the airlines and. other commerolal end users. of those mrplanes Worldwide defense revenues are about one?third of Tranlegm consolidated. Sales. About 5-691 of? our sales are direct to the government. 3 sales are through independent distributors to the government. The rest of our defense sales are to. S. defense contractors IOreign defense contractors and friendly foreign governments TransDigm operates in the commercial marketplace with the soppon: of approximately 21 000 employees worldwide, about 11000 of whom are located 111 the United States Our domestic operations span 20 states including Ohio New York California, Illinois Florida,- Connecticut Arizona, North Carolina. South. Carolina. and Texas - With this workforce TransD1gm operates through 123 subsidiaries that report as 54 operating units. Each operating unit is independently run by its own management team. Page 1 at 8 C11llecti11ely, the operating units. operate. 13-4 manufacturing locations and have over 200,000 product. In general, each operating unit shoulders the research and development costs of the products it makes and sells. I111porta11jtly, the D01) rarely funds the cost of developing the products that TransDigm sells to of TransDigm defense sales are of products developed from 00n1111ere-ielpartaor of a type sold commercially As TransDigm is primarily a commercial Company, its business model is 1111131 different from that of traditional defense contractors receiving- cost-based contracts Howwever its model 18 11111111111111.1'11 the commercial . aerospace, automotive, marine, 1111110111111 industries Briefly, 111 these industries it is common that parts are developed for an original eqmpment111anuifaetursr (OEM), often at the Supplier risk and expense, and sold to the" OEM at cost 01.111111 pro?t margins Alt-er years of selling parts to the DEM for use in their original manufacture of articleswanplanes cars, or supphers are able to realize higher .ntargins and finally achieve an attractive return on their capital investments-11111111 by sell-leg the same parts or subcomponents to end-name as spares at higher prices. This- ?razor/11121111 blade" pricing strategy is 11111111111111.1111 the industry Indeed, 1111 May 18 2017, then-DireetmofDefens'e Pricing Shay Assad. observed how 1111portant.i't is for the government to rely on suppliers using their own capital to do. research and development .111 bring new products to market. and Hcompete 111 place products 1111 new aerospace platfonns; 11121111 are 21315771111011? 1.1017111111111211 {11111 11112 do business 1111111 that 111111111 significant 13011111112111.11th 1111111111 1111.111110- recognise: that, We got the 101111 bene?t. 0f1ha research and development and the 111017111111! 11111111111 for .0111 their own 11-ickei-So,-thezefore they 111010111 have 0115,1111 1011112111111: 11111110111211 tin-1a- 111111111 11111-12'111 selling 01111111112111.1102 p1 0111111211: 111? 11.1.1.9 It. 1's also important to note that ransD1gr11 makes apec1ally-de31g11ed parts in very small quantities These parts are made to- order. Usually, we re not pulling them off a shelf in a warehouse At the OEM level, 111111 months or years of development and testing, We might make parts for a few dozen to a few- hundred planes per yea-r. A?er the airplane goes out of production, we have to support the aftennarket for as long as the planes flyeoften decades- For example, the life of the 52 has been extended to. at least. 2050+-98 years 1.10111; 1113 ?rst ?ight and decades a?er production ended That means that we are supplying parts 111111111) 111 order sizes as small as one part and sometimes it is years between orders of apart When an order for an out-o?production part comes in, We may have to order. new- materials (and possibly ?nd 1'1 new supplier), switch machine settings, switch. or redesign. tooling, and. set? -up and calibrate testing equipment Many. times, manufacturing personnel have to re learn how to make the part These contracts may be As described in a January 2017 report on Trans'Dlgm by Bank of America/Merrill s] pricing policies are in line with aerospace industry standards Aerospace suppliers tend to have a razor/razorblade pricing strategy- They tend to make investments 1n product development that are recovered on spare part 1111111, 11111 GEM parts A typical multiple for aftermarket part-s compared to GEM parts In Aerospace is 10X Thus, 115100 GEM part could sell fer $1000 111 the aftermarket Using this modeL when factoring in development costs, very little money is made in the DEM marken but investments are recovered in the aftermarket. This is common across the. aerospace - lndustry, especially for sole source. parts - 2 Remarks, Shay Assad Director, Defense Pricing, Department of Defense, at "The Capitol Forum~?. Defense Procurement in the Trump Adm mistratlon,? Hyatt Regency Washington on Capitol 20.17 Page 2 018- rated orders under the Defense Production Act That: means we must set aside any commercial production that could interfere with meeting the required delivery data These activities require substantial investments oftiine and opportunity costs that. are not captured .111 the ?cost? of the product as reported by the 1.0 Critioally, these production dynamics and the ?razor/razor blade? approach to sales are standard' 1n the aerospace sparewparts industry and describe the market reality that drives TransJDigm a pricing Fade-r11! Acquisition Regzdatimra and I C0 11111111110111! Pricing- 'IP-leaee remember, ITrans'Digm is primarily a. commercial. supp] 1e1-~4not a traditional. defense contractor. As you know the Federal Acquisition Regulations (FAR) require that contracting of?cers buy products and services "at ?fair and reasonable?prices. 3111,113 a general proposition, the- fairness and reasonableness. ofpriees that the DOD pays for commercial Home is determined by market prices generated 1.11 the commercial marketplace Certified supplier cost Information is only required tor procurements in. excess of million. dollars. of non~con1n1erc1al . items that are not bid IG report addresses only one contract Where certi?ed eost data was required and 1.11 that case, it was provided. Where procurements are of. . ournmercia'l. items or are competinve contracting officers c?anwand ?shouldmrely on. other information to establiah price reasonableness. Congress enacted the Federal Acquisition Act and the subsequent Federal Acquisition Reform Act (F ARA) as Well as recent amendments to those laws, to facilitate t'hefederal government a reliance. on the commercial marketplace and emulate commercial-11111.1: buying practices, espeeijally ins-1111111119115 where '3oo.111pet.iftion was-not. fe-'a'a'iblef4 Before these laws were enacted, there was-110' preference or pleat mandate for the. government?s acquisition of comma-dial items "in. '_t'he'open market FASA established a preferenee for commercial. item. purchase by making p'ric'e not cost analysis the norm and. reducing the number of otherwwe onerous. governmentrumque requnements applicable to prooprements 0'1 commermal item's, This was intended to cemmercia'l contractors to enter into government contracts by reducing the infom1-ation burden on. contractors that: are neither equipped nor interested in Supporting coat a11alyaia'I In. fact before this Very Committee, it was noted thatthe commercial?item exception was specifically designed to promote ?the Government?s acquisitionof commercial goods and services by seeking to establish more 3 111111.103 2531994 S. CI A. N. 2561 at 2566 [MI-av 11, .1994) (the purpose at Was "create a new commercial. item exception?, contemplating that ?(this approach Shall be used where competition is nctfeeslble and adequate. intermatlpn on commercial prices available to determine price reasonableness. (emphasis added) See also at new 'exeeptloh shall be used where competition is notpractt'cpbleu (emphasis - -added). I '4The legislative hi i5tory underlying FASA and PARA provides explicit sta1111111111115~ supporting this p'd?rpcse ?Title. includes provisions that would reduce impediments to the purchase of commercial 'IllItems by exempting surh purchasesfrem a series of statutes theta-re Unique to government purchases, and that have no counterpart in the "com'merciial-I-sector" (emphasis. added). 5. Rep. 103-w258', 1994 236.1 31256.6 (May 11, 19.94). "The Would amend the Truth in Negotiations Act for DOD and Civilian agencies to create a new cemmerclal item This approach would relieve commercial contractors. pm What they consider their number one disincentive to participating 1'11 government procurementsm w7.1115: burden of collecting cost data for the government? {emph'aslaaddedl '5 Rep. .103 253, 1994. S. -.C CA. N. 2551 31.25.66 (May 1994}. Page 3 013 commercialelike prosednres which will free businesses from. remaining Government data and audit re uirements sitn: 11. the sale of co mereial ite 1s and remote the Government?s use of . commercial sources.? - The Inspector General 15- Atrdit Report For parts that Qualify: as commercial items, the FAR requires contracting officers to Lisa price analysis to detennine whether the price being offered bythe contractor is fair and Contracting. O'f?oers are directed to use price comparisons with historical prices from previous purchases; current price lists, catalogs or advertisements-Ian independent government estimate: or prices identi?ed through market research for the same (it-similar items, as Well as analysis to identify-pricing inconsistencies." Only as a last resort should contractors request cost. Cit-1111.3 In. TransDigm?s case, of the 47 parts audited, 43 of the? parts "are in fact commereial items In all of the con-tracts reviewed by the IS the Contracting of? cers "found. TransDigm 3 prices fair- and. reasonable. In auditing. those pttrehaSes however the IG ignored the PAR provisions regarding item contracting; ignored that many of the parts were not soleusouree and had. adequate competition; and failed. to take into account how TransDigm and companies "like TransDi-g111-a actually do business 111 the. aftem1a?1ket Using an arbitrary profit. percentage and cost analysis inconsotent with the FAR and Congressional intent, the ..1G determined that TransDigm a calculated pro?t from those sales was excessive But the also found that the contracting of?cers who reviewed the spare parts that the bought from TransDignt followed all applicable laws rules, and regulatronswand importantly, that Tranlepm did nothing illegal in its pricing. Keeping 1.11 mind the fundamental differences between how- the commercial suppliers and traditional. defense contractors do business with the government and the laws that exist today, we suggest the followmp As to commercial companies like TransDigna, and commercial 11111115 and items for which there"; are competltwe Sources the relevant inquiry as to pro?t should not be whether the prices that the paid for 5 products are reasonable as compared to some arbitrarily established percentage mark-?op over cost. If this approach Were adopted some government suppliers may exit the market leaving holes in. the DoD?s supply chain Instead we should maintain. the approaeh Congress intended. that is, detennining whether those prices are . reasonable as compared to the same or similar items that have been bought and. sold 111 the commercial market Under that Standard the answer in case is, ?yes As I- described- a moment ago high pro?t margins are prevalent throughout the aftermarket for spare parts and the proF that TransDigm earn-s on its parts lie within industry norms Moreover T'ransDigr?n earns comparable pro?t from the sale of a Commercial part and. the sale of the commerctally comparable part to a commercial customer Further, .111 total. TransDig-m defense aftermarket margins are lower than its commercial. aftennarket margins by a full 1.0 percentage points 5 1570 The Federal Acquisition Reform 'Actof 1995 Joint Heating ?Before the Committee on Government Reform and Oversight and the Committee on National Security House of Representatives at. 2 (may 25 1995) (emphasis added) 61-1111 15.4113 31.2111) 71-1111 15,404,11111. 3 FAR reheat?.111) and Page 4 :11 a Finally, we believe ransDigm 5 defense aftermarket profits are generally consistent with those of its peers. .Rcaponacr 1'0. False Pubiic Claims With. the foregoing in mind I would like to address squarely allegations that have been. - publicly made against TransDigm and explain why each .13 1101111113. First, Tmn9Digm [1119 been price gouging "its products with" mark-ups aver cost/?r0111 1 7?11 to 4 451% The 1G audit. reviewed 48 parts purchased through I '13 contracts bctWeen January 2.015 and January 201-7 with-a total. value of $29.7 million. The IG omitted one of those transactions because "certi?ed cost data was provided. Of the 47 remaining parts and-,itcd .43 are in fact commercial itememfor which .the FAR does not require even cost data to establish price. reasonableness The conclusion that TransDigm earned excess pro?t 017.3161] million on 460171111: 47 parts _pordhaeed is based on cost data that cXcludcs many actual costs of doing business, The informal cost. data. provided by TrausD-igm is understated (and the pro?t is overstated) because Transi-Digm provided estimated standard costs, which. excludes costs previously mentioned like scoop times and. switching "costsweunique to but no.1 unusual in the. Iurt'hermorc, many general and administrative costs such as taxes, interest capense litigation c0515, acqu1s1t1on patent. costewall cl Which are normally recognized under generally accepted accounting 1101plcs-mare excluded from the federal government?s cost calculation and therefore. do not re?ect the actual full costs incurred by TransDigni necessary to conduct- the business and provide parts to customeraw-?-commercial and government. Fatally, it 1111151 be understood that What IS ?fair and reasonable under government procurement guidelines 18 gene-rally ?exible The ?nal determlnatton 15 left to the discretion. of contracting officers who in this case originally found that prices paid. were fair and reasonable. The prices paid by the were comparable to the prices paid by a commercial customer To be clear, the law does not provide for any maximum allowable margin on the ?xed~price-type contracts that constitute the bulk of TransDigm' a businessWith. thegovemment. Indeed despite the fact that the IG arbitrarily determined that a. n1ark~up o'Ver cost of 15%. was reasonable for purposes of this. audit it is not. unusual for the to accept as reasonable price increases of up to 25% Without Justifcanon and. the FAR anticipates that scenario 9 Iwi115a1 it again: in. all of the contracts reviewed by the 1G, the. contracting of? cers found. Transtigm 5 prices fair and - reasonable and the it?: found. that the contracting oftteelra and Tran'aDigni folloWed applicable laWs; - Second, TransDigm Irasfniled to relocate its cost information to procurement of?cerst Of the '47 parts audited 43 were commercial item's; Farther 10 had adequate sources of or not the award. was pursuant to a competitive bid. The could have used full-?and open competition to acquire those parts, which would. hare mooted the need for data but it chose to use a sole (source acquisition strategy In addition 33 were at or below the- simpli?ed acquisition threshold, which was than 3150, 0'00 In. all these cases the applicable regulations do not require certi?ed cost and pricing data to establish. price reasonableness and contracting of?cers are directed by the FAR to establish 9's-ee DFAR 217.75115. Pages of 8 fair and reasonable pricing using price analysis Cost analysis is to be used only as a last resort In fact, the IG states that there was ?no Speci?c requirement in the FAR or DFARS that required or compelled contractors to p1 owdc uncertifled cost data when requested Further he concurs that contracting offloers are supposed to use a hierarchy of price analysis and regulatory requirements discourage contracting officers from askingfor cost data. when determining whether a price is fair and rfeasoliable;H In all cases, TransDigm complied with. the applicable laws, rules, and. regulations governing the pricing of its centracts. Third I1 as created afalse network of subsidiaries disguised as campetitdrs, 111111 monapolizlng the 111111141111 This statement which was not addressed by the 16 Report but has been repeated publicly, at best re?ects a fundamental nusunderstandmg of how Tranlegm is structured and why it is structured this way First I note that: very few TransDigm operating units provide products that are capable of competing against each other and. to the extent they do so, it is almost always at the OEM development stage-moot in the aftermarket I am not aware of. any situatidn where two- .TransDignt operating units provide competing products directly to DOD. Second, 'Tran'sDig-m . does not own any distributors contrary to public assertions. In. short, this-accusation is simply false. Fourth, TrausDign?r operates as a monopolist and 11023 11011111111111: 1111 products itself but rather gnome-1111111111 proprrefmy parts businesses and raises prices: By way of background, producing and selling a sole source part is not synonymous with having a monopoly A sole course precinct IS the only one quali?ed for a speci?c application But, at the initial development of the product there was likely robust coppetltlon for the original development; and OEM production award 1111111111?. second source cattweand often does-ulster develop a competing product for sale to the OEM and/or the aftennarket In fact, three of the .47 parts that were subject to the audit hare been second-sourced? 1n the last few years This ts beyond the 0 parts already mentioned that had competitive sources of supply In addition, several DOD branches, such as the Strategic Alternate Souircing.P.rogran1 Of?ce of the A11 Force 'S-ustainment Center, are actively pronmting' their alternate sourcin-g programs to. develop alternate sources of sopply?, create new repair protocols and capabilities, promote reverse. - engineering of parts, and promote the utilizatiOn of used and overhauled parts At any time, on any one of our hundreds of thousands of products, a second source can be introduced if a competitor makes the decision to invest in developing and qualifying the product With regard to acqutsntons and product development while it is true that TransDi?grn has grown its business through the acquisition of companies with existmg products and existing costumers in the commercial and defense markets, TrandDigrn undertakes signi?cant engineering projects resulting In "new innovative products improved. existing products, and better manufacturing methods With approximately 3,000 engineers worldwide and electing to spend almost $3.00 million to over the last flue ?scal years, TransDigm was recently recognized "by Forbes as among the world?s most innovative companies. For example, prior to 9f11'TransDign'1 S. Adams Rite subsidiary manufactured the cockpit door locking system on the Airbus utilizing basic technology to address rapid decompression and a basic door handle look But, after 9311, the industry needed a more. robust. door locking system, while balancing- the need to handl lo a rapid decompression event Airbus contracted with. Adams Rite in 21002 to develop such. a system, and in eight months, Adams Rite had developed and tested the system Today that system ?les on over 1 ,000 aircraft Soon thereafter, Airbus asked Adam's Rite to develop an entire cockpit door Page 13 of 8 module For the A380, consisting of.? the door panel, looking System, _,keypad camera, and decompression scenario??something Adams Rite had never done hetero" At the time Airbus was haying industrialization problems and its current door was overweight and expensive Today, Adams Rite cockpit door module 15 the most. reliable and .Iadvanoed door to the market, balancing three key risks of intrusion, ballistics, and. rapid decompression. The system responds to a Ideohmpie'seion event 1n less than ?ve only door' 1n the world to do So in addition on the .A380 Adams Rite achieved a 20% weight rednetion and 10% cost reduction over Airhus' original de31gn Today our cockpit door. module is [Lilying on over 465 A380 and . A350 aircraft On the tWo projeots combined we spent almost $11 million of our own R6221) funds and. invested. 3 million 1'11 capital equipment 011 the military Side, Whippany Actuation Systems designed and. manufactures a. nontrol. '.actuation system that enables the conversion of""dnn1b? unguided. 70~111111 rockets. to. Smart "laser- guided missiles, giving war?ghters a low-cost, highly accurate strike capabil.ity._ The advanced precision. kill. w'eapnn. system laser-guided rocket is available to all that military branches and is able-to launch from rotary and ?xed. tying aircraft. Whizppany [has hired 170 additional. enipldyees i111 obnneotion with its r'arnp up in manufacturing. volume from ],400 parts in 2015 to over 12, 000 parts in 2018 to support full rate production and. surge capacity requtrements while maintaining a quality rating of over 99 85% and on?tirrie delivery of Over 98% 'Tra'nsDigt'n encourages {its independent operating units- to prioritize high quality and on?: time delivery With this' 111 n1i.,nd the Company 5 AyteehTyee wae I-just last. month named a recipient of Sikorsky Program Supplier. of the Year SikOrsky hoted, ?AyteotTyee was a Vital supplier on Sikorsky 5 future vertical lift platforms, 97 Raider and SB 1 Def ant Their innovatiye centribu?ohs were highlighted by the first use of composite pitch control rods on a Sikorsky program AnteohTyee successfully designed a unique carbon ?ber- rod under the "strict time constraints of Sikorsky a rapid prototype ensho11n1e.nt.-A1deo11Tyee showed a great deal of agility 1n. balancing priorities to ensure both programs critical milestones were met. In addition, last month the Company 5 Date Device Corporation subsidiary was named General A'tozrnics' Aeronauttcal Systems, Inc Supplier of the Year for the third year in a row for having a 100%. quality rating and 100% on.~time delivery .rating,-plaoi11g BBC in the top of Genera-l .AtoImIIios supply base We. make with the intention of holding them lon-g~tern1. The focus after we buy a business ineludes: - II Streamlining the business into a fooused structure with simple lines. of authority andantonomons decisionvmaking ?1 "Improving reliability, quality, and delivery. This is the real. value to our customers . and the he's-t. way 'to sustain market position. I11 Improving ef?ciency We invest capital as necessary and e?ffeetiev 1- Focusing and re?ning the new business generation process We have distinguished ourselves in getting new or improved. products Selected on meet ..new' airplane development pro grams u? When contract, or market Conditions permit, we initially look to price? the products to re ?eet our View of the market and Value. We invest significantly to own and provide high quality engineered products and work hard to deliver I them on time This has significant value to our customers Yes pricing. is one of a number of? elements that We review when we analyte and acquire but it is. one of many factors. Page 7 of a For exeniple, Transi)igni1 acquired its Kirkhill business in March 2.018. Since the acquisition, Kirkhill has added almost 100 employees and introduced entry?level wage increases: to stay ahead of the new Los Angeles County minimums and attract new employees The Company will invest close to $9 million 111 infrastructure and productivity capital projects this year Consequently; employee turnover has decreased and delivery and quality has improved - since the acquisition although there 15 still more improvement to be dono. Fi??h, TronsDigm is?trthe'r monopolizing the market by raring to acquire Esterline. TransDigm appreciates the DoD?e continuing. interest inthe'integrity of'the- defense industrial hose and its coneems about excess-We o-OnSolidatiOn. that oan'erode that indtistriol base. For this reesom 11111131115111 provided extensive and detailed infommtion responsive to Del) 5 data. requests regarding its acquieiti'on ofEs-tjerline There 13 very little overlap in competitive capabilities between the legacy TraneDigt-n and the leg-acy- Ester-line businesses and little to no eompetition at a D01) procurement level. Notably,. the as well as the Department of Justice and the Federal. Trade Commission; made no obj eetions, in whole or in part, to the acquisition, which. was consummated in March 2-019. . Con 12! 1111' on explanations will help dispel confusion. about TransDigrn and how TrensD-ifgm does business, particularly business in cenneetion with the Department of Defense While TransDig'm .s deFe?nee hale-5' are a distinct minority of its overall 'businesS, We are enormously proud of the opportunity that our employees have 11-1 contributing to the defenee of the Nation We are extremely pr'Oud of the inn0vati0n we help. bring to the Department?s ability to defend the Country and its interests in an increasingly dangerous world Thank. you for the opportunity to appear before you tedey and introduce Tran-sDigm and discuss Out business model and the aviation spares eftemterket. We look forWard to answering your questions-1.. - .PageaofB