Leonardo DRS, Inc. — Q3 2021 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2021. Unless noted, financial amounts are in millions of dollars. DRS supplies defense electronics, systems and support services through Advanced Sensor Technologies (AST), Network Computing & Communications (NC&C), and Integrated Mission Systems (IMS). The U.S. Department of Defense represented approximately 84% of Q3 revenue and 85% of nine-month revenue.
Financial results and liquidity
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Revenue | $720 | $719 | $2,059 | $1,952 |
| Gross profit / margin | $131 / 18.2% | $122 / 16.9% | $394 / 19.1% | $337 / 17.3% |
| Operating earnings | $53 | $37 | $155 | $102 |
| Net earnings | $35 | $15 | $96 | $38 |
| GAAP diluted EPS | $0.24 | $0.10 | $0.66 | $0.26 |
| Adjusted EBITDA / margin | $71 / 9.8% | $61 / 8.5% | $210 / 10.2% | $156 / 8.0% |
| Adjusted EPS | $0.25 | $0.17 | $0.73 | $0.34 |
| Bookings | $484 | $950 | $1,919 | $2,542 |
Cash flow: Q3 operating cash flow was $138 and free cash flow was $109. For the nine months, operating cash flow was negative $111 and free cash flow was negative $153, improving from negative $230 and negative $267, respectively, in 2020. Nine-month capital expenditures were $42. Cash was $78 at September 30, versus $61 at year-end 2020.
Debt and liquidity: Total debt was $496, including $124 classified as short-term/current and $372 long-term. Debt included a $139 related-party term loan at 7.5% due November 2022, a $98 related-party loan at 5.0% due October 2024, and $75 drawn on a $450 revolving facility. Current assets were $1,225 and current liabilities $832. DRS reported access to credit facilities and expected operating cash generation to meet liquidity needs, while noting that future cash generation and operational improvements are not assured.
Changes versus the prior comparable period
- Q3 revenue was nearly flat, while nine-month revenue rose 5.5%. Nine-month growth was led by AST (+11.3%) and IMS (+5.6%); NC&C revenue was approximately flat. Q3 NC&C revenue declined 10.5%.
- Nine-month gross margin increased 1.8 percentage points (19.1% versus 17.3%), and net earnings more than doubled. Management attributed stronger profitability to improved contract performance, development programs moving into production, APEX efficiency efforts, and lower interest expense.
- Interest expense fell to $27 for the nine months from $49, primarily following the parent’s $300 debt forgiveness in December 2020 and lower borrowing costs/levels.
- Backlog was $3,152, down 8.8% from $3,454 a year earlier; nine-month bookings decreased 24.5%. Management linked the declines mainly to large awards received in 2020 that were subsequently entering production. DRS expected to recognize about 28% of September 30 backlog as revenue over the next three months.
- Contract assets rose to $788 from $672 at year-end 2020, while contract liabilities declined to $160 from $177. Management cited timing differences between revenue recognition, billing and customer payments.
Outlook, commentary, risks and unusual items
- Guidance: The filing provides no specific company revenue or earnings guidance. Management said FY2022 U.S. defense budget proposals and committee recommendations appeared aligned with DRS’s focus areas, but the budget process was still pending.
- Contract estimates: Estimate-at-completion adjustments reduced revenue by $11 in Q3 and $20 for the nine months, primarily on firm-fixed-price development programs, including submarine electric propulsion work. The comparable reductions were $30 and $63 in 2020. Contract estimates and costs to complete remain judgmental and could change.
- COVID-19 and workforce: DRS reported $6 of COVID-related expenditures in the first nine months of 2021. Federal contractor vaccination requirements, potential employee or supplier attrition, and broader pandemic effects could disrupt operations; the company said impacts were uncertain.
- Acquisition: DRS acquired substantially all assets of Ascendant Engineering Solutions, a gimbal producer, on July 28, 2021 for $11, with up to $5 of contingent consideration. The acquisition was assigned to AST.
- Customer and execution risks: The business is heavily dependent on U.S. government funding and contracts, many of which are fixed-price, partially funded or terminable. Risks include appropriations delays, cost overruns, supplier shortages and longer lead times, audits and contract disputes, cybersecurity threats, and changes in government priorities.
- Contingencies: The company described an unresolved CERCLA matter involving a site with alleged historical radioactive contamination. It has recorded its best estimate of its liability, but the ultimate scope and cost are uncertain. DRS also faces routine contract audits, claims and legal proceedings; management said amounts above recorded accruals were not expected to materially affect financial condition or liquidity, though a particular period’s results or cash flows could be affected.
- Other items: Nine-month results included $4 of costs related to an anticipated securities offering and $6 of COVID response costs. Adjusted EBITDA and adjusted EPS are non-GAAP measures and exclude specified items; they should be considered alongside, not as substitutes for, GAAP results.
Important facts for investors to verify
- Whether backlog converts to funded orders and revenue as expected, given lower bookings and the sizable year-over-year backlog decline.
- Whether contract asset growth and milestone billing patterns affect working capital and cash conversion; nine-month operating cash flow and free cash flow remained negative.
- Whether margin gains persist as development programs transition to production, and whether additional fixed-price contract estimate adjustments arise.
- Debt repayment and refinancing plans, particularly the $139 related-party loan due in November 2022, and the company’s dependence on parent-related financing arrangements.
- The operational and financial effects of federal contractor vaccination requirements, supply-chain constraints, and U.S. defense appropriations.
- Developments in the CERCLA matter and any other government contract audits, claims or legal contingencies.