RADA Electronic Industries Ltd. (DRS) Earnings Call Transcript & Summary

Hello, everyone, and welcome to today's conference call to discuss the merger between Leonardo DRS and RADA Electronic Industries. My name is Kevin, and I'll be your operator today. Before this call, a press release was issued announcing an all-stock merger between Leonardo DRS and RADA Electronic Industries, which is available in the Investors section of both RADA and Leonardo DRS' website. Joining us on the call today are Bill Lynn, Chairman and CEO of Leonardo DRS; Mike Dippold, CFO of Leonardo DRS; and Dov Sella, CEO of RADA Electronic Industries. Following their remarks, we will open the call for questions. Before we begin, Jeff Grampp from Gateway Group will make a brief introductory statement. Mr. Grampp, please proceed.

Thank you for joining us for our Leonardo DRS and RADA merger call. Before management begins their prepared remarks, we would like to remind everyone that this call contains forward-looking statements, including but not limited to, Leonardo DRS' and RADA's expectations or predictions of financial and business performance and industry outlook and the timing and completion of the transaction. Forward-looking statements are inherently subject to risks, uncertainties and assumptions, and they are not guarantees of performance. We encourage you to read the press release issued today, the accompanying presentation, and Leonardo DRS' and RADA's public filings with the SEC for a discussion of the risks that may affect the transaction, Leonardo DRS' and RADA's businesses and the outlook of the combined company. Except to the extent required by law, Leonardo DRS and RADA are under no obligation and expressly disclaim any obligation to update, alter or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise. All forward-looking statements in this presentation are expressly qualified in their entirety by these cautionary statements. This conference call is for informational purposes only and shall not constitute an offer to buy any securities or solicitation of any vote in any jurisdiction pursuant to the proposed business combination or otherwise, nor shall there be any sale of securities in any jurisdiction which the offer, solicitation or sale would be unlawful prior to the registration or qualification under the securities laws of any such jurisdiction. This call is being recorded and will be made available for replay via link in the Investor Relations section of the Leonardo DRS and RADA websites. At the end of this call, we will open the line for questions. With that, I'll turn the call over to the CEO of Leonardo DRS, Bill Lynn.

Thank you, Jeff, and welcome, everyone, to today's call to discuss the merger between Leonardo DRS and RADA. I'm excited to be speaking to you to share this unique opportunity to combine 2 high-quality technology-led defense organizations. Both the Leonardo DRS and RADA teams view this as a true win-win for both sides. We will be referencing a slide presentation for today's call, and I will start my remarks on Slide 3. Let me just begin by introducing myself and the team. My name is Bill Lynn. I've been the CEO of Leonardo DRS for 10 years. Prior to that, I twice served in the Pentagon in senior positions. First as Under Secretary of Defense and CFO from 1997 to 2001, and then as Deputy Secretary of Defense in the Obama administration from 2009 to 2011. In between Pentagon tours, I was a Senior Vice President and led strategy at Raytheon. I'm joined today by Mike Dippold, the CFO of Leonardo DRS and Dubi Sella, the CEO of RADA. I will describe the transaction and the role of Leonardo DRS, Dubi will review RADA's position in the market, and then Mike will lay out the financials for the new combined company. Slide 4 shows an overview of the transaction. Specifically, we are announcing today that Leonardo DRS and RADA Electronic Industries have agreed to join forces through an all-stock merger with Leonardo, our Milan-listed parent owning 80.5% and RADA shareholders owning 19.5% of the combined company. This new combined company had 2021 revenue of $2.7 billion and EBITDA of over $300 million. RADA's unique advanced tactical radar technologies will improve DRS' position as an integrator of air defense, counter-UAS and vehicle protection systems. It will accelerate our transformation into a leading integrator of force protection systems. We also expect the merger to expand DRS sensor capabilities to include radars and to increase RADA's scale, diversity and market access. This merger is expected to be accretive to RADA's earnings per share in year 1. Based on pro forma ownership of 19.5%, the transaction provides a meaningful premium to RADA shareholders. We expect the transaction to close in Q4, subject to approval by RADA shareholders as well as customary regulatory approvals and certain other closing conditions. Let me now pass the call over to Dubi Sella.

Thank you, Bill. I'm pleased to be speaking with you all today regarding this transaction between RADA and Leonardo DRS. Before giving a brief overview of RADA, I'd like to convey my enthusiasm for and satisfaction with this transaction. We have closely cooperated with DRS for almost a decade now, and experienced a deep cultural fit between the companies, which are fundamental prerequisites for a successful merger that we believe will be a true win-win for all involved. This merger will enable the RADA segment and the combined company to further drive innovation and competitiveness, increase scale and program diversity, addressable markets, growth and value creation. This is a unique transaction in the Israeli defense market, first of its kind in many aspects, which will strengthen the Israeli defense industry and set trends and directions for the future. Shifting to Slide 6. We are very much focused on tactical radars for the maneuver force as our core business and have become one of the industry leaders in software-defined small form factor tactical radars. Our best value radars have become incumbents in many programs through our go-to-market strategy of addressing all relevant integrators as a merchant supplier that is not providing exclusivity to any one party. This strategy is consistent with Leonardo DRS' own position in the market as a merchant supplier in the U.S. Our business models and customers and programs that we pursue are entirely compatible and synergetic. This is evidenced by our involvement on key programs in the market, including Leonardo DRS on M-SHORAD, Anduril on SOCOM SIP and Elbit on Iron Fist. The strength of our offering and our go-to-market strategy has been highly successful as seen by our historical revenue growth, which has average of over 60% per year between 2018 and 2021. In 2021, we have reached record revenue of $117 million. Out of the $3 billion annual force protection market, we have identified our addressable market of tactical radars and over $6 billion of opportunities over the next decade. Slide #7 highlights our proprietary radars and increased need for our solutions in today's battlefield. Our pulse-Doppler software-defined multi-mission radars are solid state, digital, incorporate active electronically scanned array antenna are compact, mobile and highly reliable while providing hemispherical special coverage and can operate on the move. These software-defined and mobile radars are at the core of modern warfare relating to short-range air defense, counter-UAV, active protection systems for armored vehicles and counter rockets, artillery and mortar solutions. We have invested significantly in this market for over 10 years. So we know it well and have secured a competitive advantage that we believe is durable. These tactical radars are critical enablers of modern force protection solutions. After the Russian invasion of Ukraine in 2014, the U.S. military recognized the need of life-saving counter-UAS, SHORAD and APS solutions that rely on our radars. We believe that the current Russian invasion of Ukraine will highlight the need of these life-saving solutions to the rest of the world, especially NATO and the EU countries and others. We have high hopes that the maturity of our solutions and Leonardo's global reach and European presence will further enhance our customer base in the U.S. and the non-U.S. markets. Now moving to Slide 8 to discuss the attractive force protection market we operate in. Force protection is a sizable $3 billion annual market that is still growing. Specifically, we see a significant market opportunity in the $6 billion mini-tactical radar market over the next decade. Roughly half of this market is attributable to active protection, which is still in its early stage, contributing minimal revenues to RADA. The other half relates to short-range air defense, counter UAV and C-RAM, yet for RADA, we can use the same solution as our radars are multi-mission and software defined. This is also a market where we collaborate with Leonardo DRS. So we see significant opportunities to strengthen our collaboration and together increase our penetration in this market. We are actively executing in these markets and working on new products to address the growing needs within force protection and mini-tactical radars. We believe our placement in multiple flagship programs validates the critical value we provide in force protection. These flagship programs include the M-SHORAD, which is one of the -- of our more important programs where we partner with Leonardo DRS; Iron Fist active protection, APS, where we partner with Elbit and expect to see significant growing revenue starting in 2023; and SOCOM SIP, where we partner with Anduril and see meaningful potential over the coming years given the nearly $1 billion in size of the IDIQ contract. Additionally, we believe that the Iron First solution we are part of is a strong candidate for Stryker vehicles in the U.S. and other programs such as hostile fire detection, APS or vehicle protection system, advanced configuration such as MAPPS and MIPS in the U.K. Now I want to hand the call back over to Bill.

Thank you, Dubi. I'll continue on Slide 9 with a high-level overview of Leonardo DRS. We are a pure-play defense technology leader. Our solutions are present on nearly all U.S. Army vehicles and nearly all U.S. Navy vessels. Additionally, as a mid-tier player, we are uniquely agile and our offerings are platform independent. The combination of proprietary technology and mid-tier agility has positioned us as a top competitor in our 4 core markets: force protection, advanced sensing, network computing, and electrical power and propulsion. These markets are aligned to top DoD priorities and, therefore, grow faster than the overall budget. The strength of our business model is evidenced by our track record of market-leading revenue and adjusted EBITDA growth. Moving now to Slide 10 on our diversified and substantial installed base across multiple domains. One of the pillars of our strategy has been to leverage that installed base in both the Army and the Navy. In the Navy, our computers, displays and power propulsion and distribution systems are on nearly every surface combatant in the fleet. In the Army, our cooled and uncooled infrared sensors and mission computing systems are on nearly every Army combat vehicle. Our track record of success across diverse platforms, domains and primes allows us to pursue next-generation programs from a position of incumbency and technological strength. It also makes us impervious to platform and DoD budget choices. We are equally comfortable providing our technology to the next generation of vehicles and vessels or if budget challenges require upgrading existing platforms. Slide 11 highlights our 4 core markets. Each of these multibillion-dollar markets is growing faster than the overall DoD budget. Within these markets, we have a track record of success and are embedded on leading programs. In advanced sensing, we are 1 of only 3 companies developing third-generation infrared sensing for Army vehicles. We are 1 of only 2 companies producing soldier weapon sights, and we are the sole provider of the dismounted targeting system. In network computing, we are the sole provider of the mounted family of computer systems, the battle management system that connects our soldiers to each other and their commanders. In force protection, DRS is the integrator on the Army's mobile counter-UAS system and the mission equipment provider on the Army short-range air defense system where we have successfully partnered with RADA. The urgent need for these systems has been demonstrated in Ukraine. We already had a strong presence in force protection, but expect the combination with RADA to make us an even more significant leader in this growing market. In electric power and propulsion, we provide the propulsion system for the Navy's flagship program, the new Columbia-class ballistic missile submarine. That program is just beginning production and provides a $300 million annual revenue opportunity for more than a decade. Now moving to Slide 12 to discuss next-generation systems that will shape the battlefield of the future. We are uniquely positioned to allow our forces to see further with better sensors, act faster with better data, protect assets against the next generation of threats and operate with increased stealth through electric power. As a result, we see many avenues to drive above-market growth. In integrated sensing, autonomy requirements and sensing capability needs are growing in all branches of U.S. armed forces. The integration of our existing sensor capabilities and network computing solutions will provide decision quality data to commanders at all levels on the battlefield. As a result, we are confident in our ability to capture future integrated sensing opportunities. In space sensing, the continual evolution of threats, such as hypersonics, are driving new requirements and more frequent sensor upgrades to low Earth orbit constellations. We believe we have strong intellectual property from internal and NASA investments and can provide novel, low-cost solutions that address these needs. In short-range air defense, we are seeing an increased focus given the proliferation of weaponized drones, rockets, artillery and mortars, as evidenced recently in Ukraine. We are differentiated in this market through our platform-agnostic solutions and our agility to meet market demands in truncated time lines. In electrification, threats from Russia and China are driving the need for increased power flexibility and better acoustic performance. We will seek to extend our success on the Columbia-class subsystem to the new U.S. destroyer and new attack submarines. Now moving to the next section, where we will provide a summary of why this merger is a great opportunity for both companies and their respective shareholders. Slide 14 gives us combination highlights. In summary, we believe this combination increases RADA's scale, competitiveness, program diversity and addressable market. It creates a leader in the rapidly growing force protection market. It expands international opportunities for both companies. It maintains balance sheet flexibility and ultimately, it will unlock value for our shareholders. Let me unpack each of these points on the next few slides. Slide 15 gives a snapshot of the combined company. As a result of this transaction, RADA shareholders will become owners of a defense technology leader with balanced exposure across high-growth markets, program diversity and market-leading positions in force protection and advanced sensing. Slide 16 highlights some of the exciting synergy opportunities for the combined Leonardo DRS and RADA entity. The merger brings together 2 of the strongest players in the force protection market. DRS is a force protection integrator for short-range air defense, vehicle protection and infrared systems, while RADA offers tactical radars that have unique size, weight and power advantages. Going forward, we see significant opportunities to more closely collaborate and deliver highly competitive solutions that increase our market share in the force protection market. Slide 17 displays some of the macro factors propelling increased demand for our solutions. The vulnerability of Russian forces in Ukraine to drone attacks has highlighted the need for modern, capable force protection systems. Not only is this accelerating U.S. purchases of these systems, but it is likely to move European countries, which are considerably behind in this area to move toward acquiring these critical force protection assets. As a result, we see international expansion opportunities through our combined global footprint. In particular, the combined company can leverage the experience and relationships of Leonardo in its 4 domestic markets: Italy, the U.K., United States and Poland as well as across its worldwide presence. Moving to Slide 18 to discuss the balance sheet flexibility for the pro forma company. As of Q1, the combined company last 12 months net leverage is less than 1x, and it's anticipated to improve to below 0.5x by close. Both of these metrics are below peer averages. This provides flexibility for targeted acquisitions as well as dividend distributions. Supplementing strong organic growth with acquisitions is expected to be a central part of our strategy going forward. Finally, Slide 19 lays out why we think this is a compelling investment opportunity. Given the profit growth that significantly outpaces peers, we believe there is a strong case to be made for a multiple in-line with our peers. Multiple expansion to peer multiples or even to historical average pure multiples would unlock significant value for shareholders. I'll now turn the call over to our CFO, Mike Dippold, to cover the financial background of Leonardo DRS and some of the transaction details.

Thanks, Bill. I appreciate the opportunity to discuss the financial merits of this transaction. When evaluating this merger, the financial merits are apparent, as shown on Slide 21. As we have mentioned, the merger is connecting 2 companies that are in a unique position to capitalize on a market that is poised for growth given the geopolitical events occurring along the Eastern European border and in the South China Sea. The financial position and outlook is ultimately underpinned by 4 key investment highlights that we expect to enable robust shareholder return. From a top line growth perspective, DRS has 2 major assets providing confidence in our ability to maintain our market positions and continue our revenue growth. First and foremost is our technological capabilities that are aligned with some of the fastest-growing and most prominent areas of the defense budget. Over 80% of our revenue base is correlated to the advanced sensing, network computing, force protection and electric power and propulsion markets where we have secured foundational programs and are market leaders. Also, the merger with RADA will enhance our position in the advanced sensing and force protection markets given their embedded status on some of the most prominent air defense program in the United States. In addition to the market alignment, our revenue is quite diverse with no single contract representing more than 10% of our revenue. This insulates us from any single budgetary decision. This is further enhanced by our platform-agnostic market approach where we sell our defense electronics products on all platforms, allowing for revenue expansion irrespective of large platform decisions. These attributes have led to successful capture of foundational programs in all of our market segments, resulting in pro forma annual organic revenue growth of 9% from 2018 through 2021. We also expect the combined company to have highly profitable growth with substantial margin expansion. Recent foundational programs in force protection and next-generation programs such as the Columbia-class submarine and our next-generation weapon sights are transitioning from development to production. This transition has driven a 300 basis point increase in margin since 2018, facilitating an EBITDA CAGR of 22%. We expect this dynamic to continue and enable 150 to 200 basis points of margin expansion through 2023, driving a low double-digit EBITDA CAGR. Over the longer term, we are targeting mid-teens margins and low double-digit earnings growth. Now moving to Slide 22. I'll unpack the combined company financials in a bit more detail. The pro forma combined company financial statements demonstrate an attractive top line growth, coupled with impressive margin expansion, driving increased profit levels and cash generation. Pro forma revenue has grown 9% annually from 2018 to 2021 despite battling global pandemics and a shock to the global supply chain. This includes 5% growth in 2021, outpacing much of our pure-play defense peers. The revenue expansion is derived from an 8% revenue CAGR contribution from DRS and an impressive 61% growth from the expansion of RADA and the proliferation of their tactical radars for counter-UAS and air defense. The revenue growth is largely attributed to our ability to secure foundational program in some of the most pressing need areas of the defense budget, which have not only propelled our historic growth, but also give us confidence in continued revenue growth that is well supported by the President's 2023 budget request. A couple of foundational programs to highlight include our integrated propulsion system on the Columbia-class submarine fleet, which is expected to contribute over $3 billion of revenue over the remainder of the program. There are also multiple programs in force protection that combine our market-leading advanced sensing capabilities with our system integration pedigree, enabling programs such as the previously mentioned M-SHORAD as well as multiple infrared countermeasure programs protecting aircraft in the skies. In our advanced sensing market, we have been awarded next-generation weapon sights that are sold domestically and to allies abroad. This program is highlighted by the recently announced $590 million contract award for our FWS-I program and the receipt of international awards realized for our exportable weapon sights, which have been accelerated due to Eastern European demand stemming from the Russian invasion of Ukraine. Lastly, in our network computing market segment, our flagship ruggedized computing solution, the MFoCS Block II, is operating under an $800 million IDIQ contract to provide mission command computing for the U.S. Army through 2026. The strong top line growth we have been able to achieve is noteworthy, but our margin expansion and our EBITDA growth story is even more impressive. EBITDA of the combined entity has grown at an impressive 22% since 2018, over double the revenue growth, driving a 300 basis point margin expansion. The EBITDA expansion is driven in large part by the transition of many next-generation fixed-price development programs that have moved into a robust production base, driving higher profit margins. We anticipate continued margin expansion, allowing EBITDA to grow to continue to outpace revenue and driving margins into the mid-teens. Lastly, I want to cover the combined company outlook on Slide 23. We continue to be aligned with the key focus areas of the Department of Defense and the needs of our global allies. Additionally, global power competitions, coupled with the conflicts along the Russia-Eastern European borders have provided political support for robust defense spending domestically and internationally. Our market positioning and capabilities, along with these macro tailwinds support our outlook for mid-single-digit revenue growth from 2021 through 2023 with EBITDA and net income growth that is anticipated to be more than double that rate, driving increased profit generation and an additional 150 to 200 basis points of EBITDA margin expansion. In terms of cash generation, we expect the combined business to convert net income into free cash flow at or above a 90% rate. This is consistent with our historical results, excluding the 2021 results which were impacted by the company's decision to invest in inventory to mitigate potential impact of extending lead times across the supply chain. In the longer term, we anticipate mid- to high single-digit organic revenue growth with the balance sheet flexibility to supplement that growth inorganically with an even stronger EBITDA and net income expansion until our EBITDA margins settle into the mid-teens, allowing for EBITDA and free cash flow generation in excess of many of our industry peers. We believe our unique combination of revenue confidence, margin expansion and market alignment underpinning sustained growth potential makes the combined company a compelling investment opportunity. I will now hand the call back to Bill for some closing remarks.

Thanks, Mike. The merger of DRS and RADA benefits all stakeholders. Creating a global company with access to best-of-breed U.S., European and Israeli technologies will ensure U.S. and allied military partners have the solutions needed for the future of battlefield. It will also generate significant value for our shareholders. We are excited to announce this merger today and look forward to sharing updates with you throughout the process. That completes our prepared remarks, and we're now ready to take your questions.

[Operator Instructions] Our first question comes from Greg Konrad with Jefferies.

Just 2 quick ones for me. I mean any background on how the ownership structure came about? And you mentioned premium for RADA. Can you just maybe walk through the math and kind of how that's calculated given DRS largely being private or part of Leonardo?

Sure. Thanks, Jeff (sic) [ Greg ]. We worked with RADA for multiple years, most -- in particular, on the successful M-SHORAD program. So we've known them well. They decided over the last 12, 18 months that they were going to explore their strategic options, and we began a discussion with them. And we came to the conclusion that we're demonstrating today that this was a great strategic fit for both companies, gives RADA scale and diversity and a base that they don't have as a small company. For us, it gives us the one sensor we don't have, radar, in our portfolio which we see over the midterm future. This integrated sensing world where you're going to put more and more functionality into sensors and fuse the data and use our network computing capabilities to present decision quality data to commanders at all levels on the battlefield. We think that potential on top of the combination we already have in force protection was a strategic home run for us. And then, of course, we have been interested in going public. By doing the reverse merger, the way we've done it, we're able to gain the NASDAQ listing and get in an expeditious fashion with far less risk than an IPO, we're able to get the public listing. So this was strategically a terrific opportunity for us. Financially, it's accretive and it accelerates our growth. And then, of course, it gives us the public listing. All of those led us to seek the ownership structure we're describing. In terms of the premium, you're right, DRS is privately held inside Leonardo. We've been conservative, I think, in terms of the multiples that we're using. We've used a discount from our peers. We think that even with that, it provides RADA some -- RADA shareholders some premium against their current share price. And we think over the longer haul, for investors, the expansion of multiples of the combined entity towards peer multiples as we drive that double-digit EBITDA growth and get our margins into the mid-teens provides a significant opportunity.

And then just one quick follow-up. I mean you mentioned potential synergies, but any way to kind of size or frame that opportunity? And just given development cycles, I mean, how do you think about timing versus the organic growth targets that you laid out through 2023 and longer term?

Yes. No, it's a great point. I mean you probably have to look at synergies in 3 buckets. There will be some cost synergies. RADA is a public company now and has costs associated with that, that they will no longer have. But more importantly, I think, is the synergies we get in the immediate term, you're talking about the time frame, in the next 2 or 3 years in the force protection arena where we think that market is growing. The U.S. is already moving to increase their buys, and this is going to make us an even stronger player in that market. And then Europe, which has really been behind in force protection, particularly air defense. The Ukraine conflict has highlighted that gap. And we're seeing movement there in Europe, and we think the combination of RADA and DRS is extremely well positioned to take advantage of that expansion in Europe. And then over the midterm future over the next several years, we think several areas are ripe for this combination. One is going to be a next generation of counter-UAS and short-range air defense systems, particularly as they go, not just with kinetic kill capabilities but expand non-kinetic capabilities. We're positioned well on that. Electronic warfare is a growing area and again, combining RADA's radar with our other sensing capabilities puts us in a great position there. And then finally, as I said before in the answer to your last question, we see integrated sensing as the future of the military, where you take all of the sensor data coming into a vehicle or into a unit and fuse it and provide decision quality data to commanders. We think that's the future. And the combination of RADA and DRS is well positioned to take advantage of that future.

Our next question comes from Austin Moeller with Canaccord Genuity.

So just my question here, do you guys feel that $179 million in cash is enough to serve the combined company's capital needs in the near term? Or do you think that an additional capital raise might be required?

I'm going to let Mike Dippold, our CFO, go to that one.

Sure. So we have a capital structure in place that also, in addition to the cash on hand, provides us liquidity to kind of navigate our working capital needs. That said, as Bill alluded to in the presentation, our balance sheet will be very attractive even with that capital structure in place. So we will have a flexible balance sheet that allows us to operate within our organic means, but also gives us some opportunity to deploy a capital allocation strategy that should be advantageous to the company.

Okay. Great. And then just a follow-up. Do you feel that this merger improves the capability of getting RADA's radars and Iron Fists installed on the directed energy variants of the SHORAD?

I think in all the various opportunities that are going to happen with short-range air defense, the combination of Leonardo with its integration capabilities and RADA with its terrific tactical radar capabilities is going to make us stronger. So yes, I think that particular opportunity will be stronger, but I would say it's really across the board. Integration plus the radar is going to be a winning combination.

And I'm not showing any further questions at this time. I'd like to turn the call back to Bill Lynn for any remarks.

Well, thanks, everyone, for getting up a little bit early this morning. This is an exciting day for both Leonardo DRS and RADA. We think the future is very bright for this new combined company, and we're excited to share it with you. Thank you again, everyone.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.