Boeing: We Did Not Overcharge the Pentagon

Screen Shot 2013-10-15 at 11.12.03 AM

At a time when government spending, and particularly defense spending, is at the forefront of the national debate, what the Department of Defense wants to hear least of all is that it has been spending money unnecessarily. But that is exactly what the Pentagon’s inspector general reported. In fact, four times in the past five years, audits have shown that Boeing (NYSE:BA) — the Pentagon’s second largest contractor, after Lockheed Martin (NYSE:LMT) — has collected excessive or unjustified payments on contracts with the U.S. government.

The inspector general’s latest audit, released in July, found that the aerospace manufacturer charged the U.S. Army for new helicopter parts when, in reality, the company installed refurbished components salvaged from old aircraft. For a $4.4 billion contract awarded in 2008, “Boeing significantly overstated estimates” for new parts needed for the twin-rotor CH-47F Chinook helicopters and “primarily installed used parts instead,” according to a report labeled “For Official Use Only,” which was obtained by Bloomberg.

According to the contract, the use of salvaged components was acceptable in some instances, but the report showed that Boeing overcharged the military by as much as $16.6 million by inflating how many new parts were installed on the Army’s fleet of helicopters, which are among its most versatile transporters. The CH-47F Chinook was first used in combat in 1965, during the Vietnam War, and the latest model can fly 196 miles per hour and carry 24,000 pounds.

Boeing’s largest overcharged items were the 142 Chinook engine transmission housings, for which the Pentagon was charged as much as $2.6 million and the inspector general found were not needed. Furthermore, rather than give the Army the unused components, the manufacturer kept the housings for other jobs “even though the Army paid for” the items, the audit discovered. Of course, for Boeing, the $2.6 million or even the $16.6 million that it overcharged the government pales in comparison to the nearly $22 billion in sales its operations generated in the second quarter.

But for the Pentagon, the transmission housings are a perfect example to illustrate the extra costs the Army incurred by Boeing billing for new parts, rather than the salvaged parts that were actually installed. The contract specified that the transmission housings could be salvaged while allowing Boeing to keep 142 new housings to be on hand and use as necessary. “As a result, potential excess costs for the housings were $1.2 million to $2.6 million,” the audit found.

Boeing is not the only party at fault. The report also blamed defense agencies and military services for poor negotiations and lax contract management. However, the inspector general’s audit did recommend that Boeing be required to identify the amount of new parts “contingencies” to be included in contracts.

“The bottom line is that using reworked parts rather than new parts increased Boeing’s profit,” Bridget Serchak, a spokeswoman for the inspector general, told Bloomberg in an emailed statement. The Army paid the company for parts “that were proposed but never installed” and “is paying for additional parts that they do not need and may not use,” she added. In response to the inspector general’s findings, Boeing spokesman Damien Mills told the publication that while the company “recognizes the important work that the Department of Defense inspector general performs,” it disagrees with the audit’s findings.

“We believe we were fully compliant with all government contract policies and guidance applicable to the first CH-47F multiyear contract, and we provided evidence of that to the IG throughout this audit,” Mills said to Bloomberg.

Industry experts support Boeing’s position, noting that fixed-price contracts were carefully negotiated, and had Boeing underestimated the number of new parts required, the company would have had to bear the extra cost.

Serchak did acknowledge to Bloomberg that the CH-47F contract “was not well-written and actually allowed Boeing to determine whether to install a new or reworked part.” The Army will not seek refunds on the 2008 contract because it “did not look at kinds and quantities” of parts in its technical reviews before the contract was signed “and did not define to Boeing what was acceptable and what was unacceptable,” she explained.

As previously noted, this is not the first time the inspector general has called out the company for overcharging the Pentagon. A June audit determined that wasteful spending resulted from personnel at the Pentagon’s purchasing arm, who failed to negotiate “fair and reasonable prices” or to perform sufficient oversight, and from Boeing, which failed to pass on savings it gained from its subcontractors. Still, Boeing was awarded more than $30 billion of prime government contracts in 2012.

Taken together, the past four audits of Boeing contracts show that the Defense Department needs to question the company’s estimates during complex negotiations, Henry Kleinknecht, the former director of pricing and logistics for the inspector general, explained to Bloomberg. “Unfortunately, the Army does not have a cost/price analysis group, much less an experienced one,” Kleinknecht said in an email. The government’s contracting officials do not have “the technical expertise in a lot of these complex areas to go in and figure out what the problems are,” he added.

The revelation did not make huge waves in Washington, but Democratic Sen. Tom Carper of Delaware, who chairs the the Homeland Security and Governmental Affairs Committee, did say in an email to Bloombgerg that he planned to hold a hearing later this year to investigate the Pentagon’s “spare-parts problems” and “other opportunities to curb wasteful spending.”

In total, the 2008 contract and a second contract awarded in June call for the delivery of as many as 430 new or remanufactured helicopters. However, the second five-year agreement, which could have overcharged the Army by as much as $19.1 million, has been revised, and now Boeing must return unused parts to the Army.

Follow Meghan on Twitter @MFoley_WSCS

Don’t Miss: Jim Cramer’s 7 Basic Rules of Investing.