Boeing [BA] on Wednesday posted lower net income in its first quarter due to another charge on the Air Force tanker refueling aircraft program, and the company said the added development monies keep the program on schedule to deliver the first 18 aircraft by August 2017.

Boeing has all four KC-46 flight-test tankers flying with more than 500 flying hours to date and has met a number or requirements on the path to a Milestone C production decision that is expected from the Air Force around the end of the second quarter, Dennis Muilenburg, the company’s chairman, president and CEO, said on an investor call. He added that flight-testing for Milestone C is about 80 percent completed.

Boeing Chairman, President and CEO Dennis Muilenburg. Photo: Boeing
Boeing Chairman, President and CEO Dennis Muilenburg. Photo: Boeing

The ongoing flight-test program has raised some concerns of late, including higher than expected loads on the boom during refueling. Boeing took a $156 million, 24 cents earnings per share (EPS) after-tax charge on the program to resolve issues uncovered during testing and incorporate the fixes into aircraft built and in production, have the changes certified, maintain the schedule, and accelerate the entry into production, Muilenburg said.

There are no new technical issues being discovered, Muilenburg said.

To keep to the schedule, Muilenburg said, “We are concurrently building production aircraft while we move through the remaining testing.” There are currently seven aircraft in production and the supply chain is delivering on the 15th aircraft, so there are “concurrency costs” to maintain schedule. He added that there is more focus across Boeing on the KC-46.

“Ultimately we see this in the long run as a franchise program, a market of around 400 aircraft, and one that will produce profitable growth for decades to come, both in terms of production and support for our customers,” Muilenburg said. “And without question this is an investment worth making.”

Net income in quarter slipped 9 percent to $1.2 billion ($1.83 EPS) from $1.3 billion ($1.87 EPS) a year ago. Excluding certain pension adjustments, core earnings fell 21 percent to $1.7 billion ($1.74 EPS), a dime below consensus estimates for earnings per share.

Sales in the quarter rose 2 percent to $22.6 billion from $22.1 billion a year ago.

The higher sales were driven by the Defense, Space & Security segment, which posted a handsome 19 percent revenue increase to $8 billion, led by higher deliveries of F-15 fighters and C-17 transport aircraft, and increased volume in aircraft modernization and sustainment, and training systems. International business was 37 percent of sales.

Operating earnings in the defense business also bloomed, up 11 percent to $822 million, although margin fell 80 basis points to 10.3 percent due largely to the KC-46 expenses.

Commercial Airplanes, Boeing’s largest segment, saw sales fall 6 percent to $14.4 billion on eight fewer aircraft deliveries—176 in the quarter—while operating earnings tumbled 36 percent to $1 billion, reflecting both the KC-46 charge and a $70 million pre-tax charge on the 747 aircraft program. Commercial operating margin fell more than 3 percent to 7.2 percent.

The company expects Commercial Airplanes to return to double-digit margins in 2017 and continues to plan for rates in the mid-teens over the next several years, Muilenburg said.

Boeing left its financial guidance for the year intact despite the charges. Muilenburg said this is because of solid performance across organization in the quarter, plans for the rest of the year, and various initiatives to improve efficiencies and productivity.

Muilenburg said the company recognizes it “cannot stand still” in the face of “intense competition,” adding that it has to continue to improve its cost performance. “We intend to play offense and accelerate our efforts to drive quality, safety, productivity, and organizational improvements throughout the entire ‘One Boeing’ enterprise and in our supply chain, enhancing affordability and our competitive position in the market, creating capacity to invest, increasing operating margins, and driving shareholder value,” he said.

Muilenburg also said that Boeing plans to continue building out its services business in both the commercial and defense segments, saying this market presents growth rates of 5 to 10 percent annually.

Free cash flow in the quarter was $483 million and the company spent $3.5 billion on stock buy backs, which lowered the share count and helped elevate earnings, and $700 million on dividends. The backlog at the commercial business stood at $424 billion at the end of the quarter compared to $431.4 billion at the end of 2015.

Total contracted backlog at the defense segment stood at $47.2 billion, with international orders accounting for 37 percent—compared to $45.2 billion at the end of 2015.