Leonardo DRS, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; comparisons are to Q1 2022 unless stated otherwise. 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 accounted for approximately 80% of revenue. DRS completed its all-stock RADA acquisition in November 2022.
Financial performance and liquidity
| Metric | Q1 2023 | Q1 2022 / comparison |
|---|---|---|
| Revenue | $569 million | $612 million; down 7% |
| Gross profit / margin | $131 million / 23.0% | $134 million / 21.9% |
| Operating earnings | $25 million | $56 million; down 55% |
| Net earnings / diluted EPS | $12 million / $0.05 | $36 million / $0.17 |
| Adjusted EBITDA / margin (non-GAAP) | $49 million / 8.6% | $73 million / 11.9% |
| Adjusted diluted EPS (non-GAAP) | $0.07 | $0.19 |
| Cash from operations / free cash flow (non-GAAP) | $(334) million / $(346) million | $(255) million / $(266) million |
Cash and cash equivalents were $174 million at March 31, 2023, versus $306 million at year-end 2022. Total debt principal was $612 million ($610 million net of issuance costs), including $215 million drawn on the revolving facility; $250 million was classified as short-term borrowings and current debt. Current assets were $1.712 billion and current liabilities $1.019 billion.
Operating cash outflow reflected working-capital use, including lower accounts payable and increased contract assets and inventory; management also cited incremental tax payments related to R&D capitalization rules and inventory investment to address supply-chain lead times. Financing provided $216 million, primarily from debt borrowings. Capital expenditures were $15 million.
Material changes and business drivers
- Revenue fell $43 million. The decline reflected the net effect of the GES divestiture and RADA acquisition in ASC, and the absence of a favorable $25 million Columbia submarine contract modification recognized in Q1 2022 in IMS.
- ASC revenue was $391 million, down 1%, while Adjusted EBITDA rose to $37 million from $32 million. IMS revenue was $189 million, down 13%, and Adjusted EBITDA declined to $12 million from $41 million, primarily due to the prior-year Columbia modification.
- General and administrative expenses increased $24 million to $100 million, attributed to greater independent R&D investment, RADA’s commercial business model and public-company costs. Intangible amortization rose to $6 million from $2 million following the RADA acquisition.
- Backlog increased 43% year over year to $4.272 billion, including $2.947 billion funded and $1.325 billion unfunded. The increase was driven largely by a $996 million unfunded multi-boat Columbia-class propulsion award. DRS expects to recognize about 39% of March 31 backlog over the next nine months. Q1 bookings were $749 million, broadly flat with $747 million.
- Contract-estimate changes reduced Q1 revenue by $9 million, versus a $1 million reduction a year earlier, primarily on firm-fixed-price development programs.
Outlook, risks and contingencies
- No company-specific revenue or earnings guidance is provided in the filing. Management describes the defense market as favorable, citing the U.S. FY2024 national defense budget request of $842 billion and priorities including advanced capabilities and support related to Ukraine. It expects international sales to remain a similar share of revenue, about 20%.
- Management says cash, credit access and expected operating cash generation should meet near- and long-term liquidity needs, while cautioning that cash generation and operational improvements are not assured.
- Key exposures include U.S. government budget and appropriation delays, customer concentration, contract termination rights, fixed-price cost overruns and estimate uncertainty, supply-chain constraints, inflation, cybersecurity and compliance requirements, and variable-rate debt. A 0.5 percentage-point change in rates on variable debt outstanding was estimated to change annual interest expense by approximately $2 million.
- Legal and environmental matters include a CERCLA-related site investigation with potential remediation liability; the timing and amount remain uncertain. Management believes amounts beyond recorded accruals should not materially affect financial condition or liquidity, but a resolution could materially affect results or operating cash flows in a particular period. The filing also discusses routine government contract audits, claims and adjustments.
- Product warranty accruals were $23 million at quarter-end, after an $8 million provision and $3 million of reversals and utilization. Management reported disclosure controls were effective and no material change in internal control; it reported no material changes to the risk factors in its 2022 Form 10-K.
Most important facts for investors to verify
- Whether operating cash flow and free cash flow recover as working-capital investment and payment timing normalize, and how factoring activity affects reported cash flows.
- Execution, funding and conversion to revenue of the Columbia-class award and the $1.325 billion of unfunded backlog.
- Whether ASC’s margin improvement persists and IMS recovers after the prior-year Columbia modification benefit rolled off.
- Progress on RADA integration, the acquired business’s contribution and the continuing increase in public-company and R&D costs.
- Debt maturities, revolver usage, variable-rate exposure, and the resolution or changing estimates of contract, environmental and government-audit contingencies.