WASHINGTON — Boeing promises it is still on track to meet a key August 2017 deadline on its KC-46A Pegasus tanker, which will provide the backbone of America's future air refueling efforts for decades to come.
But with the revelation of its latest design challenge, the world's largest aerospace company is running thin on margin left to hit that milestone.
As part of its second quarter earnings report, Boeing confirmed that it had encountered an issue with the integrated fuel system on the tanker, a militarized version of its 767 commercial flight.
Because the Air Force's liability for the EMD engineering and manufacturing development phase of the tanker program is capped at $4.9 billion, anything over that is paid for directly by Boeing. The work to fix the fuel system issue came with a pre-tax charge of $835 million. When combined with a $425 million pre-tax charge from last summer's wiring issue, the company has now racked up $1.2 billion in pre-tax overages on the program.
That's not ideal for the company, but Boeing always expected to take a hit in the short term to tap into the long-term fighter market, said Richard Aboulafia of the Teal Group.
"It isn't that bad in the broader scheme of things. Everyone knows it was an aggressive bid to keep Airbus out of the market, and they'll make it good in the long run," he said. "They'll get to build all the tankers, keep the franchise, do the support and keep the enemy out of your market. That's worth a billion dollars".
Adds Rebecca Grant of IRIS Research, "financially, I don't think it's a big concern for the company. I think you see the nonreaction in the stock price bearing that out. We've known for a long time that Boeing is willing to absorb costs to get this right. I don't think they need to worry, but I think they need to stay very focused on the delivery date."
That last point is key, as a series of delays has pushed back the first test flight of an "all-up" KC-46 several times. Initially scheduled for 2014, the flight then targeted April before being pushed back farther.
Throughout the delays, executives for Boeing have emphasized that its focus is on a contractual obligation to provide 18 ready-to-go tankers — known as a required assets available deadline — on the ramp by August 2017, and noted that first flight dates are targets, not obligations.
But both the Air Force and Boeing admit there is not much margin left in the program to meet that deadline, forcing a revised schedule. That now puts a target deadline for first flight of the KC-46 in September, with a Milestone C decision between about January and April 2016 timeframe.
Brig. Gen. Duke Richardson, the USAF tanker program head, said in a statement that he remains "optimistic" Boeing will meet that August 2017 deadline. "While we have more heavy lifting coming up, we believe it is achievable and do not see any technical showstoppers," he said.
But as an Air Force spokesperson noted, "all previous schedule margin is gone."
That lack of margin is driving Boeing to throw significant assets at the program, something Grant said the company likely will likely be successful at doing.
"I think they will bend over backwards to keep that delivery date, and I give them a good chance of doing so," Grant said. "They will put the resource into the problem to eliminate any risk they have open. They will get the right people and do what they need to do to get it done both in time and effort."
To help keep themselves on track, Boeing has begun production on the first two low-rate initial production aircraft before the test models have gone through their checkups.
That in and of itself is not unusual in the aerospace world, but given that the first full-up tanker model has yet to take to the air, the decision comes with risks. If problems are discovered during tests, they will have to be retrofitted into production models — the dreaded concurrency.
Concurrency always carries with it risks, Aboulafia said. He points to programs such as the F-35 joint strike fighter, B-1 bomber and C-5 transport as examples of how concurrency can threaten to derail programs. So while he agrees Boeing can meet the deadline, he says it is not without additional costs.
"The question is if Boeing wants to meet the deadline and take the lumps in higher production costs from concurrency — building and modifying and modifying some more — or if they [decide to] miss the deadline and take their lumps in penalties," he said.
One factor working in Boeing's favor is a July 21 order from FedEx for 46 767s, the base plane for the tanker program. That keeps the line hot and drives down overhead, Aboulafia said.
"It's economically problematic to keep a line going at 14 planes a year," he said. "By having FedEx buy these planes it really helps the program's critical mass."
Making his first quarterly report since ascending to Boeing's top spot, President and CEO Dennis Muilenburg insisted the company remains bullish on the tanker despite the issue.
"We do have a lot more work to do as we progress through the remaining ground and flight test phases, but we are on the right path," Muilenburg said, according to a transcript of the second quarter earnings call. "We also remain confident in the long-term financial value of the tanker program for our company."
There is reason for his optimism. The Air Force is locked in for 179 tanker aircraft under its KC-X recapitalization program, and could decide to purchase further KC-46 models under its future KC-Y and KC-Z programs. Boeing sees a potential market of up to 400 aircraft, worth around $80 billion, Muilenburg added.
However, the KC-46A has yet to win a competition outside the US, most recently losing a $1.33 billion competition in South Korea to the Airbus A330 MRRT design. And while Boeing is hopeful about a Japanese tanker requirement, Aboulafia believes the company would be best served to keep its focus on the US.
"They should curb their enthusiasm for the international market, which is larger than it was but nothing like the size of the US market," he said. Boeing "missed an opportunity to get in the international market. They lost it. But it looks like they can keep the US market, which is stronger."