Leonardo DRS, Inc. — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three months ended March 31, 2021, filed May 17, 2021. Leonardo DRS supplies defense electronics, systems and military support services across land, air, sea, space and cyber domains through Advanced Sensor Technologies, Network Computing & Communications, and Integrated Mission Systems.
The U.S. Department of Defense was the end customer for approximately 86% of revenue, compared with 83% in the prior-year quarter. The U.S. Army and Navy represented approximately 44% and 29% of total revenue, respectively. Leonardo S.p.A. remains the ultimate parent through Leonardo US Holding, Inc.
Key financial metrics
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Revenue | $681 million | $583 million | +16.8% |
| Gross profit | $136 million | $106 million | +28.3% |
| Gross margin | 20.0% | 18.2% | +1.8 percentage points |
| Operating earnings | $51 million | $35 million | +45.7% |
| Net earnings | $29 million | $10 million | +190.0% |
| Basic and diluted EPS | $0.20 | $0.07 | +$0.13 |
| Adjusted EBITDA | $71 million | $50 million | +42.0% |
| Adjusted EBITDA margin | 10.4% | 8.6% | +1.8 percentage points |
| Bookings | $715 million | $678 million | +5.5% |
| Free cash flow | $(262) million | $(309) million | Improved by $47 million |
Product revenue was $570 million and service revenue was $111 million. Approximately 88% of revenue came from firm-fixed-price contracts and 12% from flexibly priced contracts. Segment revenue was $219 million for AST, $264 million for NC&C and $201 million for IMS, with growth in all three segments.
Cash flow, debt and liquidity
- Cash and cash equivalents declined to $30 million at March 31, 2021, from $61 million at December 31, 2020.
- Operating cash flow was $(249) million, compared with $(296) million in the prior-year quarter. Working-capital use included a $126 million increase in contract assets, a $135 million decrease in accounts payable and a $28 million decrease in contract liabilities.
- Investing cash flow was $102 million, including $115 million of repayments on the related-party note receivable and $13 million of capital expenditures.
- Financing cash flow was $116 million, including $375 million of related-party borrowings and $250 million of repayment of related-party debt.
- Total debt principal increased to $544 million from $427 million at year-end 2020, primarily due to a $125 million borrowing under the revolving credit facility. Long-term debt was $373 million, and current debt and short-term borrowings were $171 million.
- The revolving credit facility had a $450 million limit and $125 million outstanding. Financial institution facilities totaled $60 million, with approximately $31 million of letters of credit outstanding.
- Management stated that cash, available credit facilities and expected operating cash generation should satisfy short- and long-term liquidity needs, while cautioning that future cash generation and operational improvements are not assured.
Material changes versus the prior comparable period
- Revenue growth reflected higher deliveries in ground vehicle sensing, next-generation weapon sights, naval shipboard launch systems, common display systems, ruggedized computing and counter-drone programs.
- Improved contract execution and the transition of certain development programs to production increased profitability across all segments.
- Interest expense declined by $6 million, primarily following the $300 million forgiveness of related-party term-loan principal in December 2020.
- Other expense declined by $6 million, principally because the prior-year period included a $5 million foreign-exchange loss related to Canadian-dollar receivables.
- General and administrative expense increased by $11 million, including higher independent research and development, bid and proposal spending, and $4 million of transaction costs related to an anticipated securities offering.
- COVID-19 response costs were $3 million in the quarter; the company reported $12 million of such costs during 2020.
- Backlog increased from $2.945 billion at March 31, 2020 to approximately $3.326 billion at March 31, 2021, with management expecting approximately 52% of the March 31, 2021 backlog to convert to revenue over the following nine months.
Guidance, outlook, commentary and risks
The filing does not provide formal quantitative full-year revenue or earnings guidance. Management expects international revenue to remain approximately 14% of total revenue and believes the company’s focus on priority Department of Defense programs supports continued demand. The filing discusses a proposed U.S. fiscal 2022 defense budget of $715 billion, while noting uncertainty regarding future priorities, appropriations and funding timing.
Key risks include dependence on U.S. government spending and partially funded or terminable contracts; budget reductions, delays or cancellations; fixed-price contract cost overruns and estimate changes; dependence on major customers and suppliers; cybersecurity and physical-security threats; export controls and foreign ownership requirements; litigation, environmental matters, government audits and contract claims; pension and tax assumptions; COVID-19 effects; labor and supply-chain disruptions; and risks associated with acquisitions, intellectual property and key-person retention.
The company reported $1 million of unfavorable revenue impact from estimate-at-completion adjustments in Q1 2021, primarily related to submarine electronic propulsion programs. It also maintains reserves for contract losses, warranties, litigation and environmental matters. Management believes existing accruals are adequate and that outstanding contract claims and requests for equitable adjustment will not materially affect results, although adverse resolutions could affect a particular reporting period.
Disclosure controls and procedures were evaluated as effective, and no material change in internal control over financial reporting was reported. The filing states that there were no material changes to the risk factors in the company’s Form S-1.
Investor verification points
- Reconcile the filing’s inconsistent backlog references: the financial-statement note reports $3.326 billion at March 31, 2021, while one MD&A comparison table displays $3.291 billion.
- Assess the sustainability of the significant margin improvement and the effect of transitioning development programs to production.
- Monitor negative operating cash flow, substantial contract-asset growth and the timing of customer billings and collections.
- Review the increase in revolving-credit borrowings and the company’s related-party financing arrangements with US Holding.
- Evaluate concentration in the U.S. Department of Defense, particularly the Army and Navy, and the impact of future appropriations and program priorities.
- Review fixed-price program estimates, contract-loss reserves, environmental exposure, government audits and outstanding claims.
- Distinguish GAAP results from Adjusted EBITDA, Adjusted EPS and free cash flow, which are non-GAAP measures and exclude specified items.