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Boeing Discloses KC-46 Design Flaw as Companies Report Mixed Earnings

Jul. 26, 2014 - 03:45AM   |  
By MARCUS WEISGERBER   |   Comments
Under Development: Boeing officials have long said they do not expect to profit on the KC-46A tanker before it enters production.
Under Development: Boeing officials have long said they do not expect to profit on the KC-46A tanker before it enters production. (boeing)
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WASHINGTON — Boeing said it would eat $272 million in the development of the new KC-46A aerial refueling tanker after discovering wiring issues in test aircraft.

The “after-tax charge” was disclosed by James McNerney, the US aerospace giant’s chairman and CEO, during an earnings call last week. The issue was one of the few standouts during a week in which US defense firms reported mixed earnings in the second quarter.

“I think people expected a KC-46A charge, but I think the magnitude of it was a bit surprising,” said Byron Callan, an analyst with Capital Alpha Partners.

Boeing officials have long said they do not intend to profit on the development of the Air Force tanker, instead planning profits when it enters production. The 179-aircraft program could expand to as many as 400, valued at $80 billion, McNerney said during the July 23 earnings call.

“The increased spending is primarily related to additional engineering and systems installation rework required mainly to meet wiring specifications,” McNerney said. “The issues at hand are well-defined and understood, which in no way mitigates our disappointment in having to take this charge.

“[I]t remains a franchise program for Boeing and we expect to realize strong returns over decades of production and in-service support,” he added.

Still, the charge shows the complexities and risk associated with fixed-price development contracts, Callan said.

“When companies have fixed-price contracts, there’s not a lot of margin for error there,” he said.

Aside from the tanker, companies continue to look overseas to offset a decrease in Pentagon spending. But those Defense Department spending cuts, which are set to return in 2016, were an afterthought to firms touting international export goals.

“It was surprising ... how little discussion there was about the broader US defense environment,” Callan said. Stocks have been mixed, he noted.

For many companies that for years have been downsizing and cutting overhead, “there’s probably not a whole lot more they could really do to significantly boost margins from here,” he said.

Raytheon and Lockheed Martin implied they would take up sales goals for international markets, Callan said.

“Demand for Raytheon’s innovative and affordable solutions from our global customers was strong in the quarter, and international opportunities in the second half of the year are significant,” Raytheon CEO Thomas Kennedy said in a statement.

Northrop Grumman said foreign sales are expected to grow 25 percent, from 10 percent of the company’s business in 2013 to 13 percent in 2014, according to a Cowen note to investors. The growth partially offsets a 25 percent drop in “in-theater revenues” and an estimated 6 percent decline in other DoD work.

“International isn’t exactly risk-free either,” Callan said. “There is development work involved and there could be issues that crop up on this stuff.”■

Email: mweisgerber@defensenews.com.

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