Leonardo DRS, Inc. quarterly report, Q3 FY2023

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Leonardo DRS, Inc. — Q3 2023 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2023; comparisons are with the corresponding 2022 periods. The unaudited filing was signed November 2, 2023. DRS supplies defense electronics, sensing, computing, force-protection, and naval power and propulsion systems through its Advanced Sensing and Computing (ASC) and Integrated Mission Systems (IMS) segments. The U.S. Department of Defense was the end customer for approximately 80% of nine-month revenue.

Financial performance and liquidity

  • Revenue: Q3 revenue was $703 million, up 10.9%; nine-month revenue was $1.900 billion, up 1.4%. Q3 growth was driven mainly by naval electric power and propulsion programs; nine-month growth also reflected those programs, partly offset by the net effect of the GES divestiture and RADA acquisition.
  • Profit and margins: Q3 gross profit was $162 million and gross margin 23.0%, versus $130 million and 20.5%. Nine-month gross profit was $438 million and gross margin 23.1%, versus $391 million and 20.9%. GAAP net earnings were $47 million for Q3 and $94 million for nine months, versus $279 million and $340 million, respectively. Diluted EPS was $0.18 and $0.36, compared with $1.33 and $1.62.
  • Prior-period comparison: 2022 results included approximately $350 million of operating income from the GES and AAC dispositions. This materially inflated prior-year GAAP operating earnings and net earnings. Excluding items under the company’s non-GAAP measure, Adjusted EBITDA was $82 million for Q3 (up from $58 million) and $193 million for nine months (down from $198 million). Adjusted EBITDA margin was 11.7% and 10.2%, versus 9.2% and 10.6%. Adjusted diluted EPS was $0.20 and $0.42, versus $0.12 and $0.47.
  • Cash flow: Nine-month operating cash flow was negative $310 million, versus negative $246 million. Capital expenditures were $42 million; reported free cash flow, a non-GAAP measure, was negative $335 million versus negative $262 million. Management attributed cash use primarily to working-capital investment, including contract assets, inventory, and tax payments related to R&D capitalization requirements.
  • Balance sheet and debt: Cash was $47 million at September 30, down from $306 million at year-end 2022. Debt was $483 million net of issuance costs, including $217 million on Term Loan A and $110 million drawn on the $275 million revolver; $132 million was classified as current debt and short-term borrowings. Variable-rate debt exposes the company to rate changes; a 0.5 percentage-point change was estimated to affect annual interest expense by about $2 million.
  • Working capital and orders: Contract assets rose to $1.061 billion from $872 million and inventory to $383 million from $319 million. Backlog was $4.719 billion, including $3.356 billion funded, up 50.4% from the prior-year comparison; bookings were $2.502 billion for nine months, up 8.6%.

Material changes and segment performance

  • Q3 ASC revenue increased 5.6% to $431 million; nine-month revenue declined 1.8% to $1.226 billion, partly because prior-year GES revenue exceeded the contribution from RADA. ASC Q3 Adjusted EBITDA rose to $48 million from $36 million; nine-month Adjusted EBITDA was $121 million versus $125 million.
  • Q3 IMS revenue increased 21.0% to $277 million; nine-month revenue increased 9.1% to $692 million, primarily reflecting naval power and propulsion activity. IMS Q3 Adjusted EBITDA rose to $34 million from $22 million; nine-month Adjusted EBITDA was $72 million versus $73 million.
  • Subsequent to quarter-end, DRS agreed to terms and pricing totaling more than $3 billion for most of its electric power and propulsion system work on the remaining seven Columbia-class submarines. This award was not included in September 30 backlog.

Outlook, commentary, and risks

  • The filing provides no specific company revenue or earnings guidance. Management said existing cash, credit facilities, and expected operating cash generation are expected to meet short- and long-term liquidity needs, while noting there is no assurance cash generation or expected operational improvements will continue.
  • Management described defense demand as supported by U.S. strategic priorities and rising defense budgets, but identified uncertainty from appropriations delays, continuing resolutions, or a government shutdown. The fiscal 2024 continuing resolution was due to expire November 17, 2023.
  • Key exposures include dependence on U.S. government contracting; partially funded or terminable contracts; fixed-price execution and cost-estimate risk; supplier delays and component shortages; inflation; and customer audits and contract adjustments. Most revenue is from fixed-price contracts, and the majority of long-term contracts use cost-to-cost revenue estimates that require judgment.
  • The Israel-Hamas conflict could disrupt Israeli operations, including through workforce, transport, and logistics impacts; approximately 4% of DRS’s workforce resided in Israel at quarter-end. A cyberattack at a supplier was being addressed and had not materially affected DRS at the filing date.
  • DRS eliminated its Orphan Mine environmental reserve after the EPA database indicated no further federal action, but the filing says the National Park Service could still seek damages. Management believes outstanding contract modifications and claims are expected to be resolved without material impact; outcomes remain uncertain.
  • Disclosure controls were concluded to be effective, with no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  • Whether working-capital investment—particularly contract assets and inventory—converts into customer billings and operating cash flow.
  • Funding, schedule, and execution terms for the post-quarter Columbia-class award, and how it affects backlog and future margins.
  • Whether recent gross-margin improvement and Q3 Adjusted EBITDA growth persist, given weaker nine-month Adjusted EBITDA and the prior-year one-time Columbia program benefit.
  • Liquidity and interest costs as cash remains low and variable-rate borrowings are outstanding; also review the effect of receivables factoring on cash flows.
  • Potential effects of U.S. appropriations uncertainty, supply-chain constraints, and the Israel conflict on programs, staffing, and delivery schedules.
  • Compare GAAP results with the company’s non-GAAP measures, including their exclusions and the effect of the higher share count following the RADA merger.