Leonardo DRS, Inc. — Q3 2022 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2022. Leonardo DRS supplies defense electronics, systems and support services through Advanced Sensing and Computing (ASC) and Integrated Mission Systems (IMS). The U.S. Department of Defense represented 83% of Q3 and 82% of nine-month revenue. The company was controlled by Leonardo S.p.A. through its wholly owned U.S. holding company.
Key financial metrics
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $634 million | $720 million | $1,873 million | $2,059 million |
| Gross profit / margin | $130 million / 20.5% | $131 million / 18.2% | $391 million / 20.9% | $394 million / 19.1% |
| GAAP net earnings | $279 million | $35 million | $340 million | $96 million |
| GAAP diluted EPS | $1.92 | $0.24 | $2.34 | $0.66 |
| Adjusted EBITDA / margin | $58 million / 9.2% | $70 million / 9.8% | $198 million / 10.6% | $210 million / 10.2% |
| Adjusted EPS | $0.17 | $0.25 | $0.66 | $0.73 |
| Bookings | $874 million | $484 million | $2,304 million | $1,919 million |
Cash flow and liquidity. Nine-month operating cash flow was negative $246 million, compared with negative $111 million a year earlier; free cash flow, a non-GAAP measure, was negative $262 million versus negative $149 million. Cash declined to $63 million at September 30 from $240 million at year-end 2021. Total debt was $417 million, including $35 million outstanding under a $450 million related-party revolving facility; long-term debt was $350 million. Current assets were $1.431 billion and current liabilities $912 million. Contract assets rose to $913 million from $743 million at year-end, while inventory increased to $246 million from $205 million.
Management said available cash, credit facilities and expected operating cash generation should meet short- and long-term liquidity needs, while cautioning that future cash generation is not assured. The cash flow statement reports nine-month operating cash use of $246 million; MD&A reports Q3 operating cash use of $4 million.
Material changes versus the prior comparable period
- Revenue fell 12% in Q3 and 9% year to date. ASC revenue declined 21% in Q3 and 16% year to date, reflecting the GES sale, component shortages and slower U.S. Army installation activity. IMS revenue rose 10% in Q3 and 9% year to date, supported by force-protection and Navy submarine programs.
- Reported earnings were substantially lifted by divestiture gains. The GES and Advanced Acoustic Concepts (AAC) transactions generated an aggregate $350 million pretax gain included in other operating income. Excluding specified unusual items, Q3 adjusted EPS was $0.17, down from $0.25; nine-month adjusted EPS was $0.66, down from $0.73.
- Adjusted EBITDA declined 17% in Q3 and 6% year to date. The nine-month margin nevertheless increased to 10.6% from 10.2%, primarily due to improved IMS program performance and development programs transitioning to production.
- Nine-month bookings increased 20%. Backlog was $3.138 billion versus $3.152 billion a year earlier; management said backlog was up approximately 4% excluding GES. The company expected to recognize about 21% of September 30 backlog as revenue over the following three months.
- Operating cash use widened as the company built inventory and contract assets to address longer supply-chain lead times, and vendor payments reduced accounts payable. The company paid a $396 million dividend to its sole shareholder in August, using proceeds from the GES and AAC divestitures.
Outlook, management commentary, risks and unusual items
- No numerical full-year financial guidance is stated in the provided filing text. Management cited stronger bookings and anticipated that international sales would remain a similar share of revenue; it also noted expected continued supply-chain effects into 2023.
- The RADA Electronic Industries merger had received RADA shareholder approval and CFIUS approval after quarter-end. The company anticipated closing in late November or early December 2022; the transaction would issue DRS shares to RADA holders and change the ownership mix.
- A continuing resolution funding the U.S. government was enacted through December 16, 2022, leaving FY2023 appropriations unresolved. Management highlighted possible delays or reductions in government funding and changing defense priorities.
- Supply shortages, longer lead times, inflation and fixed-price contract exposure remain key execution risks. Management reported moderate supplier pricing pressure on certain naval programs and stated that higher-than-expected labor or supply inflation could hurt margins. EAC adjustments reduced revenue by $11 million in Q3 and $22 million year to date in 2022.
- Other disclosed risks include dependence on U.S. government customers, contract cost-estimation uncertainty, audits and procurement compliance, cybersecurity, and geopolitical and export-control requirements. The filing reported no material changes to previously disclosed risk factors.
- Legal and environmental matters include ordinary-course claims and a longstanding CERCLA-related site matter involving alleged historical radioactive contamination. Management believes recorded provisions are adequate, but notes that outcomes could adversely affect results or cash flows in a particular period. It considers outstanding contract modifications and claims unlikely to have a material impact.
- After quarter-end, US Holding converted to an LLC and is expected to be taxed as a partnership; DRS said it would prospectively file its own consolidated tax return. The filing reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- How much of reported earnings and EPS reflects the $350 million pretax divestiture gain, and how do recurring results compare using GAAP and the company’s non-GAAP measures?
- Whether component availability, COVID-related installation delays and inflation improve, and whether ASC revenue and margins recover as management anticipates.
- Whether bookings convert into funded backlog, revenue and cash, and whether the $913 million contract-asset balance and elevated inventory are collected or deployed as planned.
- Whether negative operating and free cash flow persist, and how the dividend, working-capital needs and related-party debt affect liquidity.
- The timing, share issuance, ownership consequences and integration risks of the RADA merger, along with the impact of the changed tax-filing structure.
- Developments in FY2023 government appropriations, the CERCLA matter and other government-contract, cybersecurity and supply-chain risks.