Leonardo DRS, Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023; unaudited. DRS supplies defense electronics, sensing and computing systems, force-protection solutions, and naval power and propulsion systems through Advanced Sensing and Computing (ASC) and Integrated Mission Systems (IMS). The U.S. Department of Defense represented approximately 73% of first-half revenue. Comparisons are affected by the 2022 RADA acquisition and GES divestiture.
Key financial results
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Revenue | $628 million | $627 million | $1,197 million | $1,239 million |
| Gross profit / margin | $145 million / 23.1% | $127 million / 20.3% | $276 million / 23.1% | $261 million / 21.1% |
| Operating earnings | $42 million | $42 million | $67 million | $98 million |
| Net earnings | $35 million | $25 million | $47 million | $61 million |
| Diluted EPS | $0.13 | $0.12 | $0.18 | $0.29 |
| Adjusted EBITDA / margin | $62 million / 9.9% | $67 million / 10.8% | $111 million / 9.3% | $140 million / 11.3% |
Q2 revenue was essentially flat; first-half revenue fell 3.4%. Gross margin improved in both comparisons, but first-half operating earnings declined 31.3%, reflecting lower revenue, increased G&A and research investment, and the prior-year Columbia program contract-modification benefit. Q2 net earnings benefited from a $2 million income-tax benefit, including federal R&D credits; the first-half tax provision was $2 million versus $19 million in 2022.
Cash flow, debt and liquidity
- First-half operating cash use was $346 million, versus $242 million a year earlier; capital expenditures were $27 million. Free cash flow, a non-GAAP measure, was negative $356 million versus negative $254 million.
- Cash declined to $35 million at June 30 from $306 million at year-end 2022. Management attributed increased cash use primarily to working capital, including higher contract assets and inventory, and tax payments associated with R&D capitalization rules.
- Total debt principal was $495 million ($493 million net carrying value): $136 million classified as short-term/current and $357 million long-term. This included $219 million on Term Loan A and $110 million drawn on the $275 million revolving facility. Borrowings are variable-rate; management estimated a 0.5 percentage-point rate change would alter annual interest expense by about $2 million.
- Current assets were $1.697 billion and current liabilities $943 million. Contract assets were $1.018 billion, up from $872 million at year-end; net contract assets were $726 million. These balances and milestone billing timing are relevant to liquidity.
Performance changes, backlog and outlook
- ASC Q2 revenue declined 9% to $404 million and segment Adjusted EBITDA fell 37% to $36 million, reflecting the net GES/RADA comparison, lower tactical computing revenue, and higher R&D and public-company costs. IMS Q2 revenue rose 21% to $226 million and Adjusted EBITDA increased to $26 million, supported by naval power and propulsion and Columbia program improvement. First-half IMS Adjusted EBITDA was down 25% year over year, partly because of a favorable Columbia contract modification in first-half 2022.
- Backlog was $4.357 billion at June 30, up 42.8% from $3.051 billion a year earlier, primarily reflecting a multi-boat Columbia Class electric-propulsion contract. It comprised $3.002 billion funded and $1.355 billion unfunded; DRS expected to recognize about 31% over the following six months. First-half bookings were $1.447 billion, up 1.2%.
- Management described defense market conditions as favorable, citing U.S. defense priorities and continued military support for Ukraine. The filing gives no specific company revenue, earnings, or cash-flow guidance. Management said existing cash, credit access, and expected operating cash generation should meet near- and long-term needs, while cautioning that cash generation and operational improvements are not assured.
Risks, contingencies and unusual items
- Government contract dependence exposes DRS to appropriations delays or cuts, changing priorities, audits, contract termination, and partially funded programs. Fixed-price development contracts require estimates of costs to complete; estimate-at-completion adjustments reduced revenue by $11 million in Q2 and $20 million in the first half.
- Supply-chain constraints and inflation, particularly component lead times, may affect execution and working capital. Other risks include contract performance, cybersecurity, export controls and geopolitical conditions, and rising interest rates on variable-rate debt.
- DRS eliminated its Orphan Mine environmental reserve after concluding liability was no longer probable or estimable, citing the EPA database’s statement that no further federal action would be taken. The National Park Service could still seek damages or remediation costs. The filing says outstanding contract modifications, requests for equitable adjustment, and claims are expected to resolve without material impact, but outcomes remain uncertain.
- Restructuring costs were $8 million in the first half. Non-GAAP Adjusted EBITDA reconciliation included a $9 million Q2 and $8 million first-half benefit among “other one-time non-operational events,” associated in the discussion with reversal of an aged legal-liability reserve. Non-GAAP measures are not substitutes for GAAP results.
Investor verification priorities
- Track whether backlog converts to funded revenue and cash on the stated schedule, particularly the unfunded portion and Columbia Class awards.
- Monitor cash use, contract assets, inventory, receivables factoring, and the availability of revolving credit as working-capital needs evolve.
- Assess whether ASC performance recovers and whether IMS’s Columbia-related improvements persist after the prior-year contract-modification comparison.
- Check the effect of higher R&D, public-company costs, share dilution from the RADA transaction, and restructuring on margins and per-share results.
- Follow developments in the Orphan Mine matter, government contract claims and audits, supply-chain delivery, and variable-rate debt costs.