Leonardo DRS(DRS) - 2023 Q3 - Quarterly Report

PART I. Financial Information Financial Statements (Unaudited) The company's unaudited financial statements for Q3 2023 show total revenues of $1.9 billion, a significant decrease in net earnings to $94 million due to prior-year asset sales, and increased cash used in operations Consolidated Statements of Earnings (Unaudited) | (Dollars in millions) | Nine Months Ended Sep 30, 2023 | Nine Months Ended Sep 30, 2022 | | :--- | :--- | :--- | | Total revenues | $1,900 | $1,873 | | Gross profit | $438 | $391 | | Operating earnings | $126 | $474 | | Net earnings | $94 | $340 | | Diluted earnings per share | $0.36 | $1.62 | Consolidated Balance Sheets Highlights | (Dollars in millions) | Sep 30, 2023 | Dec 31, 2022 | | :--- | :--- | :--- | | Cash and cash equivalents | $47 | $306 | | Total current assets | $1,740 | $1,707 | | Total assets | $3,713 | $3,677 | | Total current liabilities | $951 | $1,042 | | Total long-term debt | $351 | $365 | | Total liabilities | $1,471 | $1,550 | | Total shareholders' equity | $2,242 | $2,127 | Consolidated Statements of Cash Flows (Unaudited) | (Dollars in millions) | Nine Months Ended Sep 30, 2023 | Nine Months Ended Sep 30, 2022 | | :--- | :--- | :--- | | Net cash used in operating activities | ($310) | ($246) | | Net cash (used in) provided by investing activities | ($42) | $448 | | Net cash provided by (used in) financing activities | $93 | ($379) | | Net decrease in cash and cash equivalents | ($259) | ($177) | Note 1: Summary of Significant Accounting Policies Leonardo DRS, Inc. is a defense electronics supplier operating through two segments, with the U.S. DoD as its largest customer - The company operates through two reportable segments: Advanced Sensing and Computing (ASC) and Integrated Mission Systems (IMS)[34] - The U.S. DoD is the largest customer, representing about 80% of total revenues for the nine months ended September 30, 2023[34] Note 2: Business Acquisitions and Dispositions The company completed an all-stock merger with RADA Electronic Industries, Ltd. and divested two major businesses in 2022 - Completed an all-stock merger with RADA Electronic Industries, Ltd. on November 28, 2022, with a total purchase consideration of $511 million[49][50][51] - Sold the Global Enterprise Solutions (GES) business on August 1, 2022, for $450 million, resulting in cash proceeds of $427 million[53] - Divested its share of equity investment in Advanced Acoustic Concepts (AAC) on July 8, 2022, for $56 million[54] Note 3: Revenue from Contracts with Customers The company's revenue is primarily from fixed-price contracts, with total backlog at $4.719 billion, excluding a significant post-quarter Columbia Class submarine contract Total Backlog as of September 30, 2023 | (Dollars in millions) | Amount | | :--- | :--- | | Funded | $3,356 | | Unfunded | $1,363 | | Total Backlog | $4,719 | - Subsequent to Q3, the company agreed to terms for a contract over $3 billion for the electric power and propulsion system on the remaining seven Columbia Class submarines, which is not included in the reported backlog[72] Impact of EAC Adjustments on Revenue | (Dollars in millions) | Nine Months Ended Sep 30, 2023 | Nine Months Ended Sep 30, 2022 | | :--- | :--- | :--- | | Revenue Impact | $(14) | $(22) | Note 11: Debt Total debt principal increased to $485 million as of September 30, 2023, including $217 million on Term Loan A and $110 million drawn on the revolving credit facility Debt Composition as of September 30, 2023 | (Dollars in millions) | Amount | | :--- | :--- | | Term loan A | $217 | | Outstanding revolver | $110 | | Finance lease and other | $157 | | Short-term borrowings | $1 | | Total debt principal | $485 | - The 2022 Credit Agreement provides for a $225 million term loan and a $275 million revolving credit facility[98][101] Note 16: Segment Information For the nine months ended September 30, 2023, ASC generated $1.226 billion in revenue and $121 million in Adjusted EBITDA, while IMS generated $692 million in revenue and $72 million in Adjusted EBITDA Segment Performance (Nine Months Ended Sep 30, 2023) | (Dollars in millions) | ASC | IMS | Total | | :--- | :--- | :--- | :--- | | Revenues | $1,226 | $692 | $1,900 | | Adjusted EBITDA | $121 | $72 | $193 | - The company uses Adjusted EBITDA, a non-GAAP measure, to manage the business and allocate resources, reconciled to net earnings by excluding items like amortization, depreciation, interest, and gains on business disposals[130][134] Management's Discussion and Analysis of Financial Condition and Results of Operations Revenue for Q3 2023 increased, but net earnings declined significantly due to prior-year asset sales, while Adjusted EBITDA showed mixed results, and total backlog grew substantially to $4.7 billion Q3 2023 vs Q3 2022 Performance | (Dollars in millions) | Q3 2023 | Q3 2022 | % Change | | :--- | :--- | :--- | :--- | | Total revenues | $703 | $634 | 10.9% | | Gross profit | $162 | $130 | 24.6% | | Operating earnings | $59 | $376 | (84.3)% | | Net earnings | $47 | $279 | (83.2)% | YTD 2023 vs YTD 2022 Performance | (Dollars in millions) | YTD 2023 | YTD 2022 | % Change | | :--- | :--- | :--- | :--- | | Total revenues | $1,900 | $1,873 | 1.4% | | Gross profit | $438 | $391 | 12.0% | | Operating earnings | $126 | $474 | (73.4)% | | Net earnings | $94 | $340 | (72.4)% | - The significant decrease in operating and net earnings is primarily due to the prior year's inclusion of a $350 million gain on the sale of the GES business and AAC joint venture[179][180] - Total backlog increased by 50.4% to $4.719 billion, driven by a multi-boat contract for the Columbia Class submarine program[186] Business Overview and Environment DRS is a defense technology provider with the DoD as its largest customer, benefiting from budget growth but facing risks from government shutdowns and global conflicts - The DoD is the largest customer, accounting for approximately 80% of business, with the U.S. Army and U.S. Navy representing 29% and 40% of total revenues, respectively, for the nine months ended September 30, 2023[138] - The President's fiscal year 2024 budget request includes $842 billion for national defense, a 3% increase, which is seen as creating a favorable market environment for DRS[155] - The conflict in Israel poses potential disruptions to the company's RADA operations, which employ approximately 4% of the DRS workforce[152] Key Non-GAAP Operating Measures Adjusted EBITDA for Q3 2023 increased to $82 million, while nine-month Adjusted EBITDA slightly decreased to $193 million, and free cash flow usage increased due to higher working capital needs Key Non-GAAP Measures | (Dollars in millions, except per share) | Q3 2023 | Q3 2022 | YTD 2023 | YTD 2022 | | :--- | :--- | :--- | :--- | :--- | | Adjusted EBITDA | $82 | $58 | $193 | $198 | | Adjusted EBITDA Margin | 11.7% | 9.2% | 10.2% | 10.6% | | Adjusted Diluted EPS | $0.20 | $0.12 | $0.42 | $0.47 | | Free Cash Flow | N/A | N/A | $(335) | $(262) | - Q3 Adjusted EBITDA increased due to improved program performance and operational leverage, offset by higher IR&D investments[198] - YTD Adjusted Diluted EPS decreased due to a higher number of outstanding shares following the RADA merger and increased G&A expenses[203] Review of Operating Segments In Q3 2023, ASC revenue grew 5.6% with Adjusted EBITDA up 33.3%, while IMS revenue surged 21.0% with Adjusted EBITDA jumping 54.5%, both segments showing strong booking increases Segment Performance (Q3 2023 vs Q3 2022) | (Dollars in millions) | ASC | IMS | | :--- | :--- | :--- | | Revenues | $431 (+5.6%) | $277 (+21.0%) | | Adjusted EBITDA | $48 (+33.3%) | $34 (+54.5%) | | Bookings | $820 (+17.1%) | $235 (+35.1%) | - ASC's YTD revenue decreased by 2% due to the 'net divestiture impact,' where the disposed GES business had higher revenue contribution than the acquired RADA business for the period[234] - IMS's YTD Adjusted EBITDA decreased slightly by 1.4% primarily due to a favorable, non-recurring contract modification on the Columbia program in Q1 2022[244] Liquidity and Capital Resources Cash and cash equivalents decreased to $47 million, with net cash used in operating activities increasing to $310 million due to higher working capital needs and tax payments Cash Flow Summary (Nine Months Ended Sep 30) | (Dollars in millions) | 2023 | 2022 | | :--- | :--- | :--- | | Net cash used in operating activities | $(310) | $(246) | | Net cash (used in) provided by investing activities | $(42) | $448 | | Net cash provided by (used in) financing activities | $93 | $(379) | | Net decrease in cash and cash equivalents | $(259) | $(177) | - The increase in cash used for operations was primarily due to funding working capital, including incremental tax payments for R&D capitalization and inventory investments to combat supply chain lead-times[248] Quantitative and Qualitative Disclosures about Market Risk The company faces market risks primarily from interest rates on variable debt, limited foreign currency exposure mainly to the Canadian dollar, and manages inflation through contract pricing - The company is exposed to interest rate risk on $327 million of variable-rate debt ($217M Term Loan A and $110M revolver); a 0.5% change in the weighted average interest rate would result in an approximate $2 million change in annual interest expense[253] - Foreign currency exposure is limited, with the primary risk related to receivables in Canadian dollars totaling $39 million as of September 30, 2023[254] - Inflation risk is managed by including cost escalation assumptions in bids for longer-term firm fixed-price contracts[255] Controls and Procedures Management concluded that the company's disclosure controls and procedures were effective as of September 30, 2023, with no material changes to internal control over financial reporting during the quarter - Based on an evaluation as of September 30, 2023, the principal executive officer and principal financial officer concluded that the company's disclosure controls and procedures were effective[256] - No material changes to the internal control over financial reporting occurred during the third quarter of 2023[258] PART II. Other Information Legal Proceedings The company is subject to various legal proceedings, notably eliminating its reserve for the 'Orphan Mine' Superfund site after EPA's no-further-action determination, though the National Park Service may still seek damages - The company eliminated its reserve for the 'Orphan Mine' Superfund site after the EPA determined in June 2023 that no further federal action would be taken; however, the National Park Service (NPS) may still seek to recover damages[120][121] Risk Factors The company faces updated risks including cybersecurity threats through its supply chain, geopolitical instability impacting international operations, and potential disruptions from foreign export controls on key materials - The company is at risk of cybersecurity incidents through its third-party suppliers and is currently responding to a cyber-attack that impacted one of its suppliers[263] - International business exposes the company to geopolitical risks, including the war between Israel and Hamas, which could disrupt its Israeli operations through workforce calls for duty, logistical impacts, and reduced customer confidence[272] - The company is subject to risks from dynamic geopolitical climates, including recently enacted export controls by foreign governments on rare elements which could materially impact the business[267] Unregistered Sales of Equity Securities and Issuer Purchases The company reported no unregistered sales of equity securities, use of proceeds, or issuer purchases of equity securities during the period - None[274] Other Information No director or officer of the company adopted or terminated a Rule 10b5-1 trading arrangement or a non-Rule 10b5-1 trading arrangement during the third quarter of 2023 - No director or officer adopted or terminated a Rule 10b5-1 trading arrangement during the three months ended September 30, 2023[276] Exhibits The report lists several exhibits filed with the Form 10-Q, including the company's Incentive-Based Compensation Recoupment Policy and certifications by the CEO and CFO - Exhibits filed include CEO and CFO certifications (31.1, 31.2, 32.1, 32.2) and the company's new Incentive-Based Compensation Recoupment Policy (99.1)[278]