Leonardo DRS(DRS) - 2021 Q4 - Annual Report

PART I Business Overview Leonardo DRS is a leading U.S. defense contractor operating in advanced sensing, computing, and mission systems, with 86% of 2021 revenue from the U.S. government and operations governed by a DoD proxy agreement - DRS is a leading provider of defense products and technologies, organized into three operating segments: Advanced Sensor Technologies, Network Computing & Communications, and Integrated Mission Systems[16][22] Key Financial Growth (2017-2021) | Metric | CAGR (2017-2021) | | :--- | :--- | | Company Revenue | 10% | | DoD Budget | 3.8% | | Adjusted EBITDA | 14% | Revenue by Customer (FY 2021) | Customer | Percentage of Total Revenue | | :--- | :--- | | U.S. Government (Direct/Indirect) | 86% | | U.S. Department of Defense (DoD) | 86% | | U.S. Army | 38% | | U.S. Navy | 31% | Revenue by Contract Type (in millions) | Contract Type | 2021 (in millions) | 2020 (in millions) | 2019 (in millions) | | :--- | :--- | :--- | :--- | | Firm fixed price | $2,498 | $2,408 | $2,334 | | Flexibly priced | $381 | $370 | $381 | Backlog (in millions) | Backlog Type | Dec 31, 2021 (in millions) | Dec 31, 2020 (in millions) | Dec 31, 2019 (in millions) | | :--- | :--- | :--- | :--- | | Funded | $2,510 | $2,847 | $2,547 | | Unfunded | $351 | $444 | $297 | | Total Backlog | $2,861 | $3,291 | $2,844 | - The company's workforce consists of approximately 6,575 people, including 1,350 engineers, with employees maintaining over 2,000 security clearances for classified programs[97][98] Risk Factors The company faces significant risks from its 86% dependence on U.S. defense spending, fixed-price contract cost overruns, FOCI compliance, cybersecurity threats, and supply chain disruptions - The vast majority of revenue depends on U.S. defense spending, with U.S. government contracts accounting for approximately 86%, 84%, and 89% of total revenues in 2021, 2020, and 2019, respectively[113][114] - The COVID-19 pandemic continues to pose risks, with $6 million and $12 million in safety expenditures incurred in 2021 and 2020, respectively, and potential impacts from federal vaccine mandates[121][126] - A significant portion of revenue, 87% in 2021, is derived from fixed-price contracts, exposing the company to financial loss from cost overruns or higher inflation[130][132] - As a company under Foreign Ownership, Control, or Influence (FOCI), DRS operates under a proxy agreement with the DoD, with non-compliance risking termination of classified U.S. government contracts[138][139][293] - The company is susceptible to cybersecurity breaches and must comply with evolving DoD requirements, including the Cybersecurity Maturity Model Certification (CMMC), for future contract eligibility[205][209] Unresolved Staff Comments The company reports no unresolved staff comments from the SEC - No unresolved staff comments are reported[319] Properties The company operates a mix of owned and leased properties across 17 U.S. states, D.C., and Canada, including its Arlington, Virginia headquarters, supporting its three segments Selected Significant Facilities | Location | Segment | Approx. Square Footage | Owned/Leased | | :--- | :--- | :--- | :--- | | Milwaukee, WI | Integrated Mission Systems | 610,800 | Leased | | West Plains, MO | Integrated Mission Systems | 447,067 | Owned | | Menomonee Falls, WI | Integrated Mission Systems | 372,856 | Leased | | Melbourne, FL | Network Computer & Communications | 311,287 | Leased | Legal Proceedings The company is involved in ordinary legal proceedings, including a notable CERCLA investigation by the NPS regarding a site operated by an alleged predecessor over 50 years ago - The company is a potentially responsible party in a CERCLA investigation by the National Park Service (NPS) for a site operated by an alleged predecessor over 50 years ago[329][330] Mine Safety Disclosures This section is not applicable to the company - This item is not applicable[331] PART II Market for the Company's Common Equity, Related Stockholder Matters There is no public trading market for the company's common stock, with 100% owned by Leonardo US Holding, Inc., and no anticipated near-term cash dividends - There is no established public trading market for the company's common stock, with US Holding owning 100% of the outstanding shares[333] Selected Historical Consolidated Financial Data This item is reserved in the report - This item is marked as 'RESERVED'[335] Management's Discussion and Analysis of Financial Condition and Results of Operations In 2021, Leonardo DRS achieved revenue growth and significant increases in operating earnings and Adjusted EBITDA, driven by the Integrated Mission Systems segment, and announced the sale of its Global Enterprise Solutions business Consolidated Financial Performance (in millions, except percentages) | Metric | 2021 (in millions) | 2020 (in millions) | % Change | | :--- | :--- | :--- | :--- | | Total Revenues | $2,879 | $2,778 | 3.6% | | Gross Profit | $547 | $494 | 10.7% | | Operating Earnings | $236 | $181 | 30.4% | | Net Earnings | $154 | $85 | 81.2% | | Adjusted EBITDA | $310 | $268 | 15.7% | | Adjusted EBITDA Margin | 10.8% | 9.6% | +1.2% | Key Operating Metrics (in millions) | Metric | 2021 (in millions) | 2020 (in millions) | | :--- | :--- | :--- | | Bookings | $2,595 | $3,055 | | Backlog | $2,861 | $3,291 | | Free Cash Flow | $118 | $74 | Segment Revenue Performance (in millions) | Segment | 2021 Revenue (in millions) | 2020 Revenue (in millions) | % Change | | :--- | :--- | :--- | :--- | | Advanced Sensor Technologies (AST) | $970 | $940 | 3.2% | | Network Computing & Communications (NC&C) | $972 | $1,026 | (5.3)% | | Integrated Mission Systems (IMS) | $959 | $834 | 15.1% | Segment Adjusted EBITDA Performance (in millions) | Segment | 2021 Adj. EBITDA (in millions) | 2020 Adj. EBITDA (in millions) | % Change | | :--- | :--- | :--- | :--- | | Advanced Sensor Technologies (AST) | $125 | $123 | 1.7% | | Network Computing & Communications (NC&C) | $95 | $90 | 5.9% | | Integrated Mission Systems (IMS) | $90 | $55 | 62.7% | - The company agreed on March 21, 2022, to sell its Global Enterprise Solutions (GES) business to SES Government Solutions, Inc. for $450 million in cash[395] Consolidated Cash Flow Summary (in millions) | Cash Flow Activity | 2021 (in millions) | 2020 (in millions) | 2019 (in millions) | | :--- | :--- | :--- | :--- | | Net cash provided by operating activities | $178 | $125 | $157 | | Net cash provided by (used in) investing activities | $39 | $(70) | $(151) | | Net cash used in financing activities | $(38) | $(80) | $(1) | Quantitative and Qualitative Disclosure of Market Risks The company's primary market risks include interest rate fluctuations, limited foreign currency exposure to the Canadian dollar, and inflation risk, particularly from supply chain cost pressures - The company is exposed to interest rate risk on variable-rate borrowings under its revolving credit facilities, with no outstanding amounts as of December 31, 2021[530] - Foreign currency risk is limited, primarily to the Canadian dollar, with $54 million in receivables as of December 31, 2021[531] - The company has experienced inflationary pressures on supply chain costs for micro-electronics and commodities, which could negatively affect future financial results if not mitigated[532] Financial Statements and Supplementary Data This section presents the company's audited consolidated financial statements for 2019-2021, with an unqualified opinion from KPMG LLP, highlighting long-term contract cost estimation as a critical audit matter - KPMG LLP issued an unqualified opinion on the consolidated financial statements, identifying the estimation of costs to complete certain long-term contracts as a critical audit matter[536][539][543] Consolidated Statement of Earnings (in millions) | Line Item | 2021 (in millions) | 2020 (in millions) | 2019 (in millions) | | :--- | :--- | :--- | :--- | | Total Revenues | $2,879 | $2,778 | $2,714 | | Gross Profit | $547 | $494 | $459 | | Operating Earnings | $236 | $181 | $163 | | Net Earnings | $154 | $85 | $75 | | Basic and Diluted EPS | $1.06 | $0.59 | $0.52 | Consolidated Balance Sheet Summary (in millions) | Line Item | Dec 31, 2021 (in millions) | Dec 31, 2020 (in millions) | | :--- | :--- | :--- | | Assets | | | | Total Current Assets | $1,389 | $1,263 | | Total Noncurrent Assets | $1,680 | $1,693 | | Total Assets | $3,069 | $2,956 | | Liabilities & Equity | | | | Total Current Liabilities | $989 | $975 | | Total Noncurrent Liabilities | $487 | $554 | | Total Shareholder's Equity | $1,593 | $1,427 | | Total Liabilities & Equity | $3,069 | $2,956 | - Company-funded R&D costs charged to cost of revenues totaled $48 million, $41 million, and $31 million in 2021, 2020, and 2019, respectively[581] - In March 2022, the company agreed to sell its Global Enterprise Solutions (GES) business for $450 million in cash[799] Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants on accounting and financial disclosure - No changes in or disagreements with accountants are reported[801] Controls and Procedures Management concluded the company's disclosure controls and procedures were effective as of December 31, 2021, with no material changes to internal control over financial reporting during Q4 2021 - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of the end of the reporting period[802] - The Annual Report omits a management report on internal control over financial reporting due to a transition period for newly public companies under SEC rules[806] Other Information The company reports no other information for this item - No other information is reported for this item[807] Disclosure Regarding Foreign Jurisdictions that Prevent Inspections This section is not applicable to the company - This item is not applicable[809] PART III Directors, Executive Officers and Corporate Governance This section outlines the company's nine-member board of directors and executive officers, whose structure and committee functions are influenced by a DoD proxy agreement requiring independent proxy holders Board of Directors and Executive Officers (as of Dec 31, 2021) | Name | Age | Title | | :--- | :--- | :--- | | William J. Lynn III | 68 | Chief Executive Officer and Chairman | | David W. Carey | 77 | Lead Independent Director | | John A. Baylouny | 60 | Executive Vice President, Chief Operating Officer | | Michael D. Dippold | 41 | Executive Vice President, Chief Financial Officer | - The board comprises nine directors, with its composition governed by a proxy agreement with the DoD requiring five independent proxy holders to mitigate Foreign Ownership, Control, or Influence (FOCI)[848][849] - The board maintains four committees: Audit, Compensation, Nominating and Corporate Governance, and a Government Security Committee, with the latter required by the proxy agreement for classified information safeguarding[851][859] Executive Compensation The company's executive compensation program is performance-based, with a significant portion 'at risk', comprising base salary, annual cash incentives (ICP), and a cash-based long-term incentive plan (LTIP) with performance and retention components - The executive compensation philosophy emphasizes pay-for-performance, with 81% of CEO target compensation and 69% for other NEOs being 'at risk'[869][877] 2021 Summary Compensation Table (Select NEOs) | Name and Principal Position | Fiscal Year | Salary ($) | Non-Equity Incentive Plan Compensation ($) | All Other Compensation ($) | Total ($) | | :--- | :--- | :--- | :--- | :--- | :--- | | William Lynn, CEO | 2021 | 1,156,439 | 5,067,533 | 99,632 | 6,323,603 | | John Baylouny, COO | 2021 | 515,584 | 1,441,400 | 52,865 | 2,009,849 | | Michael Dippold, CFO | 2021 | 468,341 | 1,198,567 | 51,904 | 1,718,811 | - The 2021 Annual Incentive Compensation (ICP) was based 75% on financial metrics and 25% on individual strategic, operational, and ESG goals[902][905] - The Long-Term Incentive Plan (LTIP) is a cash-based plan, with 50% as a performance component over a three-year cycle and 50% as a time-based retention component for 2021 and future awards[934][936] - The company's Executive Severance Plan provides benefits for termination without cause, with change in control benefits requiring a 'double trigger'[963][965] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters As of March 28, 2022, 100% of the company's common stock is owned by Leonardo US Holding, Inc., a subsidiary of Leonardo S.p.A., with no beneficial ownership by directors or executive officers Security Ownership | Name | Number of Shares Owned | Percent of Class (%) | | :--- | :--- | :--- | | Leonardo S.p.A. | 145,000,000 | 100.0 | | All directors and executive officers as a group (13 persons) | — | — | Certain Relationships and Related Party Transactions, and Director Independence The company's relationship with its parent, Leonardo S.p.A., is governed by a DoD Proxy Agreement to mitigate FOCI, alongside other agreements like a Tax Allocation Agreement and financing arrangements with US Holding - The company operates under a Proxy Agreement with the DoD to mitigate FOCI, granting five independent, security-cleared proxy holders voting rights over shares owned by its parent, US Holding[1031][1032][1036] - The Proxy Agreement restricts the ability of Leonardo S.p.A. and US Holding to control operations, share facilities and personnel, and regulates communications between the entities[1034][1035] - The company has a Tax Allocation Agreement with US Holding and affiliates to allocate consolidated U.S. federal and state tax liabilities[1059] - Financing from US Holding includes a 7.5% Term Loan ($139M outstanding) and a 5.0% Daylight Term Loan ($78M outstanding) as of year-end 2021, following $300 million of debt forgiveness in 2020[1074][1075] Principal Accountant Fees and Services KPMG LLP serves as the company's independent auditor, with total fees of approximately $4.7 million in 2021, a decrease from $7.9 million in 2020 due to lower audit-related fees Fees Paid to KPMG LLP (in thousands) | Fee Category | 2021 (in thousands) | 2020 (in thousands) | | :--- | :--- | :--- | | Audit Fees | $3,870,549 | $5,554,293 | | Audit-related services | $65,000 | $2,351,440 | | Tax Services | $— | $— | | All Other Services | $811,097 | $— | | Total Fees | $4,746,646 | $7,905,733 | Exhibits and Financial Statement Schedules This section lists all financial statements and exhibits filed with the Form 10-K, including key documents like the Amended and Restated Proxy Agreement and the Tax Allocation Agreement