Leonardo DRS, Inc. 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 90 Report of Independent Registered Public Accounting Firm To the Shareholder and Board of Directors Leonardo DRS, Inc.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Leonardo DRS, Inc. and subsidiaries (the Company) as of December 31, 2021 and 2020, the related consolidated statements of earnings, comprehensive income (loss), shareholder’s equity, and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Estimation of costs to complete for certain long-term contracts As discussed in Notes 1(D) and 2 to the consolidated financial statements, the Company recognizes revenues for the majority of contracts determined using the ratio of cumulative costs incurred to date to estimated total contract costs at completion. The accounting for long-term contracts involves estimation of the costs to complete a contract in order to accurately recognize the associated revenues. Developing the estimated total contract costs to complete a contract 91 often requires judgment related to the nature and complexity of the work to be performed, subcontractor performance and the risk and impact of delayed performance. We identified the assessment of the estimation of costs to complete for certain long-term contracts in the Integrated Mission Systems segment as a critical audit matter. The evaluation of the costs to complete for certain contracts required a high level of subjective auditor judgment, due to the nature and complexity of the work to be performed for these contracts, subcontractor performance and the risk and impact of delayed performance. Changes to the estimated costs to complete each contract could have a significant impact on the estimated revenues recorded during the period. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design of certain internal controls related to the estimation of costs to complete the selected long-term contracts. For certain contracts, we compared the Company’s historical estimates of costs to actual costs incurred to assess the Company’s ability to estimate accurately. Based on the nature of the individual contract, we evaluated the Company’s estimated costs to complete by: • reading the underlying contract and related amendments to obtain an understanding of the contractual requirements and related performance obligations • assessing costs incurred to-date compared to estimated total contract costs at completion and the relative progress toward satisfying the performance obligation(s) of the contract • assessing, if relevant, the estimated costs to complete on similar or predecessor contracts and programs • inquiring of financial and operational personnel of the Company to identify factors that should be considered within the estimated cost to complete or indications of potential management bias • inspecting correspondence, if any, between the Company and the customer regarding actual to-date and expected performance • analyzing the sufficiency of the Company’s assessment of contract performance risks included within the estimated costs to complete. /s/ KPMG LLP We have served as the Company’s auditor since 2012. McLean, Virginia March 28, 2022 92 LEONARDO DRS, INC. Consolidated Statements of Earnings Year Ended December 31, (Dollars in millions, except per share amounts) 2021 2020 2019 Revenues: Products $ 2,505 $ 2,412 $ 2,220 Services 374 366 494 Total revenues 2,879 2,778 2,714 Cost of revenues: Products ( 2,067 ) ( 2,000 ) ( 1,904 ) Services ( 265 ) ( 284 ) ( 351 ) Total cost of revenues ( 2,332 ) ( 2,284 ) ( 2,255 ) Gross profit 547 494 459 General and administrative expenses ( 293 ) ( 283 ) ( 277 ) Amortization of intangibles ( 9 ) ( 9 ) ( 9 ) Other operating expenses, net ( 9 ) ( 21 ) ( 10 ) Operating earnings 236 181 163 Interest expense ( 35 ) ( 64 ) ( 65 ) Other, net ( 1 ) ( 5 ) ( 3 ) Earnings before taxes 200 112 95 Income tax provision 46 27 20 Net earnings $ 154 $ 85 $ 75 Net earnings per share from common stock: Basic and diluted earnings per share: 1.06 $ 0.59 $ 0.52 See accompanying Notes to Consolidated Financial Statements. 93 LEONARDO DRS, INC. Consolidated Statements of Comprehensive Income Year Ended December 31, (Dollars in millions) 2021 2020 2019 Net earnings $ 154 $ 85 $ 75 Other comprehensive income (loss): Foreign currency translation (loss) gain, net of income taxes 2 1 3 Net unrecognized gain (loss) on postretirement obligations, net of income taxes 10 22 ( 15 ) Other comprehensive income (loss), net of income tax 12 23 ( 12 ) Total comprehensive income $ 166 $ 108 $ 63 See accompanying Notes to Consolidated Financial Statements. 94 LEONARDO DRS, INC. Consolidated Balance Sheets December 31, (Dollars in millions, except per share amounts) 2021 2020 ASSETS Current assets: Cash and cash equivalents $ 240 $ 61 Accounts receivable, net 156 102 Contract assets 743 672 Inventories 205 247 Related party note receivable — 115 Prepaid expenses 23 33 Other current assets 22 33 Total current assets 1,389 1,263 Noncurrent assets: Property plant and equipment, net 364 355 Intangible assets, net 52 60 Goodwill 1,071 1,057 Deferred tax assets 56 87 Other noncurrent assets 137 134 Total noncurrent assets 1,680 1,693 Total assets $ 3,069 $ 2,956 LIABILITIES AND SHAREHOLDER'S EQUITY Current liabilities: Short-term borrowings and current portion of long-term debt $ 41 $ 53 Accounts payable 479 478 Contract liabilities 174 177 Other current liabilities 295 267 Total current liabilities 989 975 Noncurrent liabilities: Long-term debt 352 374 Pension and other postretirement benefit plan liabilities 61 88 Other noncurrent liabilities 74 92 Total noncurrent liabilities $ 487 554 Shareholder's equity: Preferred Stock,$ 0.01 par value: 10,000,000 shares authorized; none issued $ — $ — Common stock, $ 0.01 par value: 300,000,000 shares authorized; 145,000,000 shares issued and outstanding 1 1 Additional paid-in capital 4,633 4,633 Accumulated deficit ( 2,983 ) ( 3,137 ) Accumulated other comprehensive loss ( 58 ) ( 70 ) Total shareholder's equity 1,593 1,427 Total liabilities and shareholder's equity $ 3,069 $ 2,956 See accompanying Notes to Consolidated Financial Statements. 95 LEONARDO DRS, INC. Consolidated Statements of Cash Flows Year Ended December 31, (Dollars in millions) 2021 2020 2019 Operating activities Net earnings $ 154 $ 85 $ 75 Adjustments to reconcile net earnings (loss) to net cash from operating activities: Depreciation and amortization 58 53 51 Deferred income taxes 31 30 12 Other — 3 3 Changes in assets and liabilities: Accounts receivable ( 54 ) ( 35 ) 9 Contract assets ( 71 ) 65 ( 166 ) Inventories 42 ( 38 ) ( 36 ) Prepaid expenses 10 ( 14 ) ( 2 ) Other current assets 12 3 3 Other noncurrent assets 19 22 19 Defined benefit obligations ( 13 ) ( 9 ) ( 1 ) Other current liabilities 28 30 ( 11 ) Other noncurrent liabilities ( 36 ) ( 14 ) ( 16 ) Accounts payable 1 ( 58 ) 156 Contract liabilities ( 3 ) 2 61 Net cash provided by operating activities 178 125 157 Investing activities Capital expenditures ( 60 ) ( 56 ) ( 55 ) Business acquisitions, net of cash acquired ( 14 ) — ( 4 ) Proceeds from sales of assets — 5 8 Net repayments received (advances) on related party note receivable 115 ( 15 ) ( 100 ) Cost method investment ( 2 ) ( 4 ) — Net cash provided by (used in) investing activities 39 ( 70 ) ( 151 ) Financing activities Net (decrease) increase in third party borrowings (maturities of 90 days or less) ( 18 ) ( 11 ) 16 Repayment of related party debt ( 950 ) ( 1,170 ) ( 895 ) Borrowings from related parties 930 1,105 880 Other — ( 4 ) ( 2 ) Net cash used in financing activities ( 38 ) ( 80 ) ( 1 ) Effect of exchange rate changes on cash and cash equivalents — 1 1 Net increase (decrease) in cash and cash equivalents 179 ( 24 ) 6 Cash and cash equivalents at beginning of year 61 85 79 Cash and cash equivalents at end of year $ 240 $ 61 $ 85 Supplemental disclosure of non-cash investing and financing activities Forgiveness of related party debt $ — $ 300 $ — Additions of property plant and equipment and long-term debt for a build-to-suit lease $ — $ 49 $ — See accompanying Notes to Consolidated Financial Statements. 96 LEONARDO DRS, INC. Consolidated Statements of Shareholder’s Equity (Dollars in millions, except per share amounts) Common stock Additional paid- in capital Accumulated other comprehensive loss Accumulated deficit Total Balance as of December 31, 2018 $ 1 $ 4,333 $ ( 81 ) $ ( 3,297 ) $ 956 Total comprehensive income (loss) — — ( 12 ) 75 63 Balance as of December 31, 2019 1 4,333 ( 93 ) ( 3,222 ) 1,019 Forgiveness of related party debt — 300 — — 300 Total comprehensive income — — 23 85 108 Balance as of December 31, 2020 1 4,633 ( 70 ) ( 3,137 ) 1,427 Total comprehensive income — — 12 154 166 Balance as of December 31, 2021 $ 1 $ 4,633 $ ( 58 ) $ ( 2,983 ) $ 1,593 See accompanying Notes to Consolidated Financial Statements. 97 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies A. Organization Leonardo DRS, Inc., together with its wholly owned subsidiaries (hereinafter, “DRS,” “the Company,” “us,” “our,” or “we”) is a supplier of defense electronics products, systems and military support services. The Company is controlled by Leonardo S.p.A (hereinafter, “Leonardo S.p.A.,” “the Parent”), an Italian multi-national aerospace, defense and security company headquartered in Rome, Italy, through its direct sole ownership of Leonardo US Holding, Inc. (“US Holding”). US Holding is the direct and sole shareholder of the Company. DRS is a provider of defense products and technologies that are used across land, air, sea, space and cyber domains. Our diverse array of defense systems and solutions are offered to all branches of the U.S. military, major aerospace and defense prime contractors, government intelligence agencies, international military customers and industrial markets for deployment on a wide range of military platforms. We focus our capabilities in areas of critical importance to the U.S. military, such as sensing, electronic warfare (“EW”), network computing and communications, force protection and electrical power conversion and propulsion. These capabilities directly align with our three reportable segments: Advanced Sensor Technologies, Network Computing & Communications and Integrated Mission Systems. The U.S. Department of Defense (“DoD”) is our largest customer and accounts for approximately 86 % and 84 % of our total revenues as an end-user for the years ended December 31, 2021 and 2020, respectively. Specific international and commercial market opportunities exist within these segments and comprise approximately 14 % and 16 % of our total revenues for the years ended December 31, 2021 and 2020. Our three reportable segments reflect the way performance is assessed and resources are allocated by our Chief Executive Officer, who is our chief operating decision maker (“CODM”). Advanced Sensor Technologies (“AST”) The AST segment provides electro-optical sensor technologies, laser systems, EW systems and intelligence and surveillance solutions to U.S. military and intelligence community customers. Major solutions include ground vehicle targeting and surveillance sensors, including electro-optical and advanced detection systems. Our soldier sensing applications include infrared imaging solutions and precision targeting systems. Our infrared focal plane array foundry produces small sized cryogenically cooled and uncooled infrared sensors. AST also provides aircraft training instrumentation equipment and high-performance radio frequency receivers and transceivers for U.S. and international customers. Our quantum cascade laser technology is being used in military and commercial medical applications. Network Computing & Communication (“NC&C”) The NC&C segment provides defense electronics solutions across all domains of warfare. Our technologies and products can be integrated into legacy and new military platforms, end-to-end network communication systems, satellite services and cyber solutions. We are also a provider of ruggedized computing platforms. For the U.S. Navy and its allies, we provide naval computing infrastructure, network and data distribution, radar and rugged naval control systems, which are present on all U.S. naval surface and subsurface combatant vessels. Our global communications network is a worldwide network of terrestrial and satellite bandwidth that ensures our customers’ data is secure and reliable. Integrated Mission Systems (“IMS”) The IMS segment provides critical force protection, vehicle integration, transportation and logistics, and electrical conversion and ship propulsion systems to the U.S. military. Our force protection systems 98 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) protect service members and military assets from evolving and proliferating threats and include solutions for counter-unmanned aerial systems, short-range air defense systems, and active protection systems on ground vehicles. We have military transportation and logistics offerings and ground vehicle integration capabilities to support U.S. forces in a wide range of operational environments. For the U.S. Navy, we provide and support multi-generational power conversion and propulsion systems for our nation’s shipbuilding programs. Other The Company separately presents the unallocable costs associated with corporate functions and certain non-operating subsidiaries of the Company as Corporate & Eliminations. See Note 17 : Segment Information for further information regarding our business segments. B. Basis of presentation The accompanying Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and include the accounts of DRS, its wholly owned subsidiaries and its controlling interests. Interests in joint ventures that are controlled by the Company, or for which the Company is otherwise deemed to be the primary beneficiary, are consolidated. For joint ventures in which the Company does not have a controlling interest, but exerts significant influence, the Company applies the equity method of accounting. All intercompany transactions and balances have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to current year presentation. C. Use of estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant of these estimates and assumptions relate to the recognition of contract revenues and estimated costs to complete contracts in process, recoverability of reported amounts of goodwill, long-lived assets and intangible assets, valuation of pensions and other postretirement benefits, the valuation of deferred tax assets and liabilities and the valuation of unrecognized tax benefits. Actual results could differ from these estimates. D. Revenue Recognition Our revenues consist of sales of products (tangible goods) and sales of services to customers. We recognize the majority of our revenue from contracts with customers using an over time, cost-to-cost method of accounting. On certain other contracts, primarily time and material (“T&M”) and cost-plus contracts, revenue is recognized using the right-to-invoice practical expedient as we are contractually able to bill our customer based on control transferred to the customer. See Note 2 : Revenue from Contracts with Customers for additional information regarding revenue recognition. E. Cost of Revenues Cost of revenues includes materials, labor and overhead costs incurred in the manufacturing, design, and provision of products and services sold in the period as well as warranty costs. Material costs include raw materials, purchased components and sub-assemblies, outside processing and inbound freight costs. Labor and overhead costs consist of direct and indirect manufacturing costs, including wages and fringe benefits, operating supplies, depreciation and amortization, occupancy costs, and purchasing, receiving and inspection costs. 99 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) F. Research and Development Expenses We conduct research and development (“R&D”) activities using our own funds (referred to as company-funded R&D or independent research and development (“IR&D”)) and under contractual arrangements with our customers (referred to as customer-funded R&D) to enhance existing products and services and to develop future technologies. R&D costs include basic research, applied research, concept formulation studies, design, development, and related test activities. IR&D costs are allocated to customer contracts as part of the general and administrative overhead costs and generally recoverable on our customer contracts with the U.S. Government. Customer-funded R&D costs are charged directly to the related customer contract. Substantially all R&D costs are charged to cost of revenues as incurred. Company-funded R&D costs charged to cost of revenues totaled $ 48 million, $ 41 million and $ 31 million in 2021, 2020 and 2019, respectively. G. Foreign Currency Significant transactions in foreign currencies are translated into U.S. dollars at the approximate prevailing rate at the time of the transaction. Foreign exchange transaction gains and losses in 2021, 2020 and 2019 were immaterial to the Company's results of operations. The operations of the Company's foreign subsidiaries are translated from the local (functional) currencies into U.S. dollars using weighted average rates of exchange during each monthly period. The rates of exchange at each balance sheet date are used for translating certain balance sheet accounts and gains or losses resulting from these translation adjustments are included in the accompanying Consolidated Balance Sheet as a component of other comprehensive income. H. Cash and Cash Equivalents Cash and cash equivalents include cash on hand, deposits with banks or other short-term, highly liquid investments with original maturities of three months or less. I. Accounts Receivable Accounts receivable consist of amounts billed and currently due from customers. When events or conditions indicate that amounts outstanding from customers may become uncollectible, an allowance is estimated and recorded. See Note 3 : Accounts Receivable for additional information regarding accounts receivable. J. Inventories Inventories are recorded at the lower of cost (determined by either actual, weighted average or first-in, first-out methods) or net realizable value, and include direct production costs as well as indirect costs, such as factory overhead. The net realizable value is calculated as the expected sales price in the course of normal operations net of estimated costs to finish and sell the goods. See Note 4 : Inventories for additional information regarding inventories. K. Property, Plant and Equipment Property, plant and equipment is carried at cost less accumulated depreciation. Depreciation is calculated on the straight-line method. The estimated useful lives of plant, machinery and equipment and building and building improvements generally range from 3 to 10 years and 15 to 40 years, respectively. Leasehold improvements are amortized over the shorter of the estimated useful life of the improvements or the remaining life of the lease. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the Consolidated Balance Sheet, and the net gain or loss is included in the determination of net earnings. Maintenance and repairs are charged to operations as incurred and renewals and improvements are capitalized. See Note 5 : Property, Plant and Equipment for additional information regarding property, plant and equipment. 100 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) L. Goodwill Goodwill represents the excess purchase price paid to acquire a business over the fair value of net assets acquired. Goodwill is assigned to reporting units and is reviewed for impairment at the reporting unit level on an annual basis, or whenever changes in circumstances indicate that the carrying amount may not be recoverable. A reporting unit is an operating segment, or one level below that operating segment (the component level) if discrete financial information is prepared and regularly reviewed by the segment manager. Two or more components of an operating segment may be aggregated and deemed a single reporting unit if the components have similar economic characteristics. Based upon the aggregation criteria the Company concluded it had seven reporting units at both December 31, 2021 and 2020. The annual impairment test is typically performed after completion of the Company's annual financial operating plan, which occurs as of December 31. The Company uses quantitative assessments and qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If the optional qualitative assessment is performed (Step 0) and the Company concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, an additional quantitative fair value test (Step 1) is performed. When performing the Step 1 goodwill impairment test, we compare the fair values of each of our reporting units to their respective carrying values. In order to compute the fair value of our reporting units, we primarily use the income approach based on the discounted cash flows that each reporting unit expects to generate in the future, consistent with our operating plans. Determining the fair value of our reporting units requires significant judgments, including the timing and amount of future cash flows, long-term growth rates, determination of the weighted-average cost of capital and terminal value assumptions. If, based on the quantitative fair value test, the Company concludes that the carrying value of the reporting unit exceeds its fair value, the Company will recognize a goodwill impairment loss in an amount equal to that excess. The Company completed impairment tests as of December 31, 2021, 2020 and 2019 and no adjustment to the carrying value of goodwill was deemed to be necessary. See Note 7 : Goodwill for additional information regarding goodwill. M. Long-Lived Assets and Acquired Identifiable Intangible Assets Identifiable intangible assets represent assets acquired as part of the Company's business acquisitions and include customer and program/contract-related assets. The values assigned to acquired identifiable intangible assets are determined as of the date of acquisition based on estimates and judgments regarding expectations for the estimated future after-tax cash flows from those assets over their lives, including the probability of expected future contract renewals and revenues, all of which are discounted to present value. The Company assesses the recoverability of the carrying value of its long-lived assets and intangible assets with finite useful lives whenever events or changes in circumstances indicate that the carrying amount of the assets or asset group may not be recoverable. If there are any indicators of impairment present, the Company then evaluates the recoverability of the potentially impaired long-lived assets and acquired identifiable intangible assets based upon expectations of undiscounted net cash flows from such assets. If the sum of the expected future undiscounted net cash flows is less than the carrying amount of the asset or asset group, a loss is recognized for the difference between the estimated fair value and the carrying amount of the assets. Assets to be disposed of, including those of discontinued operations, are reported at the lower of the carrying amount or fair value, less the costs to sell. See Note 5 : Property, Plant and Equipment and Note 8 : Intangible Assets for additional information regarding long-lived assets and intangible assets. N. Derivative Financial Instruments The Company does not use derivative financial instruments for trading purposes. All derivative instruments are carried on the Consolidated Balance Sheet as either assets or liabilities at fair value. The 101 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) classification of gains and losses resulting from changes in the fair values of derivatives depends on the intended use of the derivative and its resultant designation. The Company had no significant derivative or hedging instruments during the years ended December 31, 2021, 2020 or 2019. O. Pension and Other Postretirement Benefits The obligations for the Company's pension plans and postretirement benefit plans and the related annual costs of employee benefits are calculated based on several long-term assumptions, including discount rates for employee benefit liabilities, rates of return on plan assets, expected annual rates of salary increases for employee participants in the case of pension plans and expected annual increases in the costs of medical and other health care benefits in the case of postretirement benefit plans. These long-term assumptions are subject to revision based on changes in interest rates, financial market conditions, expected versus actual returns on plan assets, participant mortality rates and other actuarial assumptions, including future rates of salary increases, benefit formulas and levels, and rates of increase in the costs of benefits. Changes in these assumptions, if significant, can materially affect the amount of annual net periodic benefit costs recognized in the Company's results of operations from one year to the next, the liabilities for the pension plans and postretirement benefit plans and the Company's annual cash requirements to fund these plans. See Note 12. Pension and Other Postretirement Benefits for further information regarding our pension and postretirement plans. P. Income Taxes We and US Holding have entered into a Tax Allocation Agreement (“Tax Allocation Agreement”), dated as of November 16, 2020, with members of an affiliated group, as defined in Section 1504(a) of the U.S. Internal Revenue Code of 1986, as amended (the “Tax Code”), members of one or more consolidated, combined, unitary or similar state tax groups and additional parties who are part of an “expanded affiliated group” for certain tax purposes. The agreement provides for the method of computing and allocating the consolidated U.S. federal tax liability of the affiliated group among its members and of allocating any state group tax liabilities among the state members for the taxable year ending December 31, 2021 and each subsequent year in which the parties are members of a group (whether federal or state). The agreement also provides for reimbursement of US Holding and/or DRS for payment of such tax liabilities, for compensation of any member for use of its “net operating loss” or “tax credits” in arriving at such tax liabilities and the allocation and payment of any refund arising from a carryback of net operating losses or tax credits from subsequent taxable years. Under the agreement, the parties have agreed to calculate and allocate their respective tax liabilities and other tax attributes for taxable years beginning with the first consolidated taxable year that included DRS (i.e., the taxable year ended December 31, 2008) as if the agreement was then in effect. The provision for income taxes is determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. Income taxes as presented attribute deferred income taxes of US Holding to DRS in a manner that is systematic, rational and consistent with the asset and liability method and the governing Tax Allocation Agreement which allocates the tax liability amongst the entities, including DRS. The provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from differences between the financial and tax basis of DRS’ assets and liabilities and are adjusted for changes in tax rates and tax laws when such changes are enacted. In general, the taxable income of DRS is included in the consolidated U.S. federal and state tax returns of US Holding. Where applicable, US Holding’s current portion of U.S. federal income taxes payable were offset against DRS’ net operating loss carryforwards in the period the related tax expense was recorded. Consequently, our net operating loss carryforwards are deemed to have been settled with 102 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) US Holding in each year in an amount commensurate with the carrying value of the tax effected net operating loss utilized. If management determines that some portion or all of a deferred tax asset is not “more likely than not” to be realized, a valuation allowance is recorded as a component of the income tax provision to reduce the deferred tax asset to the amounts expected to be realized. In determining whether the Company’s deferred tax assets are realizable, management considers all evidence, both positive and negative, including the history of financial reporting earnings, existing taxable temporary differences and their projected reversals, as well as projected future income and tax planning strategies. We believe it is more likely than not that we will generate sufficient taxable income in future periods to realize our deferred tax assets, subject to the valuation allowances recognized. The Company assesses its tax positions for all periods open to examination by tax authorities based on the latest available information. Those positions are evaluated to determine whether they will more likely than not be sustained upon examination by the relevant taxing authorities. Liabilities for unrecognized tax benefits are measured based on the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. These unrecognized tax benefits are recorded as a component of income tax expense. Interest and penalties related to unrecognized tax benefits are not material. See Note 10 : Income Taxes for additional information regarding income taxes. Q. Earnings Per Share Basic earnings per share (“EPS”) is computed by dividing net earnings by the weighted average number of shares of common stock outstanding during each period. The computation of diluted EPS includes the dilutive effect of outstanding stock-based compensation awards, only in periods in which such effect would have been dilutive for the period. In February 2021, the Company completed a forward stock split of 1-for- 1,450,000 shares of common stock. The consolidated financial statements have been retroactively adjusted as necessary to reflect the forward stock split for all periods presented. There were 100 shares and 145.00 million basic and diluted common shares outstanding before and after the forward stock split, respectively, for all periods presented. R. Fair Value Measurements Fair value is the price the Company would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant on the measurement date. We are required to maximize the use of observable inputs and minimize the use of unobservable inputs in measuring fair value, and to utilize a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The three hierarchical levels used to measure fair value are as follows: Level 1 — Quoted prices in active markets for identical assets or liabilities. Level 2 — Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and inputs other than quoted prices that are directly or indirectly observable. Level 3 — Significant inputs to the valuation model are unobservable. In certain instances, fair value is determined through information obtained from third parties using the latest available market data. In obtaining such data from third parties, we have evaluated the methodologies used to develop the estimate of fair value in order to assess whether such valuations are representative of fair value. The Company categorizes plan assets for disclosure purposes in accordance with this fair value hierarchy. Certain plan investments are measured at fair value using the net asset value (“NAV”) per share (or its equivalent) practical expedient and are therefore not categorized as Level 1, 2, or 3. NAV is defined as the total value of the fund divided by the number of the fund’s shares 103 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) outstanding. See Note 12: Pension and Other Postretirement Benefits for further information regarding our pension and postretirement plans. S. Financial Instruments Our financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses and other current liabilities. Financial instruments are reported in the Consolidated Balance Sheet at carrying value, which other than the 7.5 % Term loan due November 30, 2023, approximate fair value. See Note 11: Debt for further information regarding our debt. T. Acquisitions, Investments, Variable Interest Entities and Divestitures Acquisitions Our consolidated financial statements include the operations of acquired businesses from the date of acquisition. We account for acquired businesses using the acquisition method of accounting, which requires that any assets acquired and liabilities assumed be measured at their respective fair values on the acquisition date. The accounting for business combinations requires the Company to make significant judgments and estimates. Any excess of the fair value of consideration transferred over the assigned values of the net assets acquired is recognized as goodwill. During the third quarter of 2021 the Company acquired substantially all the assets of Ascendant Engineering Solutions (AES), an advanced gimbal producer located in Austin, TX. The purchase closed on July 28, 2021 for a purchase price of $ 11 million with an additional $ 5 million payable upon the achievement of certain financial and operational targets. AES designs, develops and manufactures high-performance, stabilized, multi-sensor gimbal systems for the growing market of Group 1, 2 and 3 unmanned aerial systems (UAS) serving several branches of the DoD. The company is focused on gimbal payload opportunities in strategic U.S. government programs including those intended to counter current and next-generation anti-access and area-denial systems. We believe this acquisition enables the integration of our own Electro-Optical and Infrared systems with the gimbals of AES and is a strategic investment, offering an integrated solution for our customers in the market for lightweight military platforms including small unmanned aerial systems. The acquisition has been accounted for as a business combination and has been integrated into our Advanced Sensor Technologies segment. Investments Investments where we have the ability to exercise significant influence, but do not control, are accounted for under the equity method of accounting and are included in other noncurrent assets on our Consolidated Balance Sheet. Significant influence typically exists if we have a 20% to 50% ownership interest in the investee. Under this method of accounting, our share of the net earnings or losses of the investee is included in operating profit in other income, net on our Consolidated Statements of Earnings (Loss) since the activities of the investee are closely aligned with the operations of the business segment holding the investment. We evaluate our equity method investments for impairment whenever events or changes in circumstances indicate that the carrying amounts of such investments may be impaired. If a decline in the value of an equity method investment is determined to be other than temporary, a loss is therefore recorded during the current period. See Note 13: Equity Method Investments for further information regarding our equity method investments. The Company’s cost method investment consists of an investment in a private company in which we do not have the ability to exercise significant influence over its operating and financial activities. Management evaluates this investment for possible impairment quarterly. 104 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Variable Interest Entities The Company occasionally forms joint ventures and/or enters into arrangements with special purpose limited liability companies for the purpose of bidding and executing on specific projects. The Company analyzes each such arrangement to determine whether it represents a variable interest entity (“VIE”). If the arrangement is determined to be a VIE, the Company assesses whether it is the primary beneficiary of the VIE and if it is, consequently required to consolidate the VIE. The Company did not have any investment in VIEs as of December 31, 2021 or 2020. U. New Accounting Pronouncements Recently Adopted Accounting Pronouncements Changes to Disclosure Requirements for Defined Benefit Plans In August 2018, the FASB issued ASU 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans . Specifically, the amendment removes disclosure requirements for amounts classified in accumulated other comprehensive income expected to be recognized over the next year and the effects of a one-percentage-point change in the assumed health care cost trend rate on service cost, interest cost and the benefit obligation for postretirement benefits. The amendment also requires additional disclosure around weighted-average interest crediting rates for cash balance plans, a narrative description of the reasons for significant gains and losses, and an explanation of any other significant changes in the benefit obligation or plan assets. The adoption of the standard as of January 1, 2021 did not have a material impact on our consolidated financial statements. Simplifying the Accounting for Income Taxes In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes which removes certain exceptions to the general principles in Topic 740 for: recognizing deferred taxes for investments, performing intra-period allocations and calculating taxes in interim periods. The amendments also improve consistent application of and simplify U.S. GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The standard is effective for fiscal years beginning after December 15, 2020. The adoption of the standard as of January 1, 2021 did not have a material impact on our consolidated financial statements. Accounting Guidance Issued but Not Yet Adopted as of December 31, 2021: Government Assistance In November 2021, the FASB issued ASU 2021-10, Government Assistance (Topic 832): Disclosure by Business Entities about Government Assistance which requires certain disclosures to be included with respect to the types of assistance, the accounting for the assistance as well as the effect on the financial statements of the assistance. The purposes of the ASU is to increase transparency and eliminate disparity of accounting for and reporting of the receipt of government assistance. The standard is effective for fiscal periods beginning after December 15, 2021. The Company does not expect the adoption to have a material impact on our disclosures. Note 2. Revenue from Contracts with Customers The Company recognizes revenue for each separately identifiable performance obligation in a contract representing an obligation to transfer a distinct good or service to a customer. In most cases, goods and services provided under the Company’s contracts are accounted for as single performance obligations due to the complex and integrated nature of our products and services. These contracts generally require significant integration of a group of goods and/or services to deliver a combined output. 105 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In some contracts, the Company provides multiple distinct goods or services to a customer. In those cases, the Company accounts for the distinct contract deliverables as separate performance obligations and allocates the transaction price to each performance obligation based on its relative standalone selling price, which is generally estimated using cost plus a reasonable margin. We classify revenues as products or services on our Consolidated Statements of Earnings based on the predominant attributes of the performance obligations. While the Company provides warranties on certain contracts, we typically do not provide for services beyond standard assurances and therefore do not consider warranties to be separate performance obligations. Typically we enter into three types of contracts: fixed-price contracts, cost-plus contracts and T&M contracts (cost-plus contracts and T&M contracts are aggregated below as flexibly priced contracts). The majority of our total revenues are derived from fixed-price contracts; refer to the revenue disaggregation disclosures that follow. For fixed-price contracts, customers agree to pay a fixed amount, negotiated in advanced for a specified scope of work. For cost-plus contracts typically we are reimbursed for allowable or otherwise defined total costs (defined as cost of revenues plus allowable general and administrative expenses) incurred, plus a fee. The contracts may also include incentives for various performance criteria, including quality, timeliness and cost-effectiveness. In addition, costs are generally subject to review by clients and regulatory audit agencies, and such reviews could result in costs being disputed as non-reimbursable under the terms of the contract. T&M contracts provide for reimbursement of labor hours expended at a contractual fixed labor rate per hour, plus the actual costs of material and other direct non-labor costs. The fixed labor rates on T&M contracts include amounts for the cost of direct labor, indirect contract costs and profit. Estimating the transaction price for an arrangement requires judgment and is based on expected results which are determined using the Company’s historical data. We estimate that the revenue that we expect to be entitled to receive from a customer to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur. Revenue from contracts with customers is recognized when the performance obligations are satisfied through the transfer of control over the good or service to the customer, which may occur either over time or at a point in time. Revenues for the majority of our contracts are measured as determined by the ratio of cumulative costs incurred to date to estimated total contract costs at completion (the "cost-to-cost method"). We believe this is an appropriate measure of progress toward satisfaction of performance obligations as this measure most accurately depicts the progress of our work and transfer of control to our customers. Due to the long-term nature of many of our contracts, developing the estimated total cost at completion and total transaction price often requires judgment. Factors that must be considered in estimating the cost of the work to be completed include the nature and complexity of the work to be performed, subcontractor performance and the risk and impact of delayed performance. After establishing the estimated total cost at completion, we follow a standard Estimate at Completion (“EAC”) process in which we review the progress and performance on our ongoing contracts at least quarterly. Adjustments to original estimates for a contract's revenue, estimated costs at completion and estimated profit or loss often are required as work progresses under a contract, as experience is gained and as more information is obtained, even though the scope of work required under the contract may not change and are also required if contract modifications occur. When adjustments in estimated total costs at completion or in estimated total transaction price are determined, the related impact on revenue and operating income are recognized using the cumulative catch-up method, which recognizes in the current period the cumulative effect of such adjustments for all prior periods. Any anticipated losses on these contracts are fully recognized in the period in which the losses become evident. 106 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) EAC adjustments had the following impacts to revenue for the periods presented: Year Ended December 31, (Dollars in millions) 2021 2020 2019 Revenue $ ( 34 ) $ ( 77 ) $ ( 55 ) Total % of Revenue 1 % 3 % 2 % The impacts noted above are attributed primarily to changes in our firm-fixed-price development type programs. As changes happen in the design required to achieve contractual specifications, those changes often result in the programs’ estimate and related profitability. The reductions to revenue for the years ended December 31, 2021, 2020 and 2019 were related to certain masted surveillance and submarine electric propulsion programs within our IMS segment, solider sensing programs within our AST segment and adjustments to the measurement of variable consideration related to certain requests for equitable adjustment with the U.S. Navy within our NC&C segment. Conversely, if the requirements for the recognition of contracts over time are not met, revenue is recognized at a point in time when control transfers to the customer, which is generally upon transfer of title. In such cases, the production that is in progress and costs that will be recognized at a future point in time are reported within "inventories". Costs to obtain a contract are incremental direct costs incurred to obtain a contract with a customer, including sales commissions and dealer fees, and are capitalized if material. Costs to fulfill a contract include costs directly related to a contract or specific anticipated contract (e.g., certain design costs) that generate or enhance our ability to satisfy our performance obligations under these contracts. These costs are capitalized to the extent they are expected to be recovered from the associated contract. Contract Assets and Liabilities The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets), and customer advances and deposits (contract liabilities) on the Consolidated Balance Sheet. Amounts are billed as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals (e.g., biweekly or monthly) or upon achievement of contractual milestones. Generally, billing occurs subsequent to revenue recognition, resulting in contract assets. However, we sometimes receive advances or deposits from our customers before revenue is recognized, resulting in contract liabilities. Year Ended December 31, (Dollars in millions) 2021 2020 Contract assets $ 743 $ 672 Contract liabilities 174 177 Net contract assets $ 569 $ 495 Revenue recognized in 2021 and 2020 that was included in the contract liability balance at the beginning of each year was $ 108 million and $ 104 million, respectively. The change in the balances of the Company’s contract assets and liabilities primarily results from timing differences between revenue recognition and customer billings and/or payments. Contract assets related to amounts withheld by customers until contract completion are not considered a significant financing component of our contracts because the intent is to protect the customers from our failure to satisfactorily complete our performance obligations. Payments received from customers in advance of revenue recognition (contract liabilities) are not considered a significant financing component of our contracts because they are utilized to pay for contract costs within a one-year period or are requested by us to ensure the customers meet their payment obligations. 107 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Value of Remaining Performance Obligations The value of remaining performance obligations, which we also refer to as total backlog, includes the following components: • Funded - Funded backlog represents the revenue value of orders for services under existing contracts for which funding is appropriated or otherwise authorized less revenue previously recognized on these contracts. • Unfunded - Unfunded backlog represents the revenue value of firm orders for products and services under existing contracts for which funding has not yet been appropriated less funding previously recognized on these contracts. The following table summarizes the value of our backlog at December 31, 2021 and 2020: Backlog: Year Ended December 31, (Dollars in millions) 2021 2020 Funded $ 2,510 $ 2,847 Unfunded 351 444 Total Backlog $ 2,861 $ 3,291 We expect to recognize approximately 62.5 % of our December 31, 2021 backlog as revenue over the next 12 months, with the remainder to be recognized thereafter. Disaggregation of Revenue AST : AST revenue is primarily derived from U.S. government development and production contracts and is generally recognized over time using the cost-to-cost method. We disaggregate AST revenue by geographical region, customer relationship and contract type. We believe these categories best depict how the nature, amount, timing and uncertainty of AST revenue and cash flows are affected by economic factors: Year Ended December 31, (Dollars in millions) 2021 2020 2019 Revenue by Geographical Region United States $ 880 $ 821 $ 711 International 76 107 58 Intersegment Sales 14 12 12 Total $ 970 $ 940 $ 781 Revenue by Customer Relationship Prime contractor $ 505 $ 443 $ 372 Subcontractor 451 485 397 Intersegment Sales 14 12 12 Total $ 970 $ 940 $ 781 Revenue by Contract Type Firm Fixed Price $ 822 $ 813 $ 614 Flexibly Priced (1) 134 115 155 Intersegment Sales 14 12 12 Total $ 970 $ 940 $ 781 ________________ (1) Includes revenue derived from time-and-materials contracts. 108 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NC&C: NC&C revenue is primarily derived from U.S. government development and production contracts and is generally recognized over time using the cost-to-cost method. We disaggregate NC&C revenue by geographical region, customer relationship and contract type. We believe these categories best depict how the nature, amount, timing and uncertainty of NC&C revenue and cash flows are affected by economic factors: Year Ended December 31, (Dollars in millions) 2021 2020 2019 Revenue by Geographical Region United States $ 928 $ 942 $ 988 International 37 75 41 Intersegment Sales 7 9 24 Total $ 972 $ 1,026 $ 1,053 Revenue by Customer Relationship Prime contractor $ 704 $ 620 $ 655 Subcontractor 261 397 374 Intersegment Sales 7 9 24 Total $ 972 $ 1,026 $ 1,053 Revenue by Contract Type Firm Fixed Price $ 845 $ 903 $ 956 Flexibly Priced (1) 120 114 73 Intersegment Sales 7 9 24 Total $ 972 $ 1,026 $ 1,053 ________________ (1) Includes revenue derived from time-and-materials contracts. IMS : IMS revenue is primarily derived from U.S. government development and production contracts and is generally recognized over time using the cost-to-cost method. We disaggregate IMS revenue by geographical region, customer relationship and contract type. We believe these categories best depict 109 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) how the nature, amount, timing and uncertainty of IMS revenue and cash flows are affected by economic factors: Year Ended December 31, (Dollars in millions) 2021 2020 2019 Revenue by Geographical Region United States $ 913 $ 792 $ 895 International 45 41 21 Intersegment Sales 1 1 1 Total $ 959 $ 834 $ 917 Revenue by Customer Relationship Prime contractor $ 174 $ 283 $ 442 Subcontractor 784 550 474 Intersegment Sales 1 1 1 Total $ 959 $ 834 $ 917 Revenue by Contract Type Firm Fixed Price $ 831 $ 692 $ 763 Flexibly Priced (1) 127 141 153 Intersegment Sales 1 1 1 Total $ 959 $ 834 $ 917 ________________ (1) Includes revenue derived from time-and-materials contracts. Note 3. Accounts Receivable Accounts receivable represent amounts billed and currently due from customers. Payment is typically received from our customers either at periodic intervals (e.g., biweekly, or monthly) or upon achievement of contractual milestones. Accounts receivable consist of the following: December 31, (Dollars in millions) 2021 2020 Accounts receivable $ 157 $ 104 Less allowance for doubtful accounts ( 1 ) ( 2 ) Accounts receivable, net $ 156 $ 102 The Company maintains certain agreements with financial institutions to sell certain trade receivables. Receivables are derecognized in their entirety when sold, and the Company’s continuing involvement in the sold receivables is limited to their servicing, for which the Company receives a fee commensurate with the service provided. Pursuant to the servicing agreements, the Company collected approximately $ 15 million and $ 27 million at December 31, 2021 and 2020, respectively, of these sold receivables that had not yet been remitted to the financial institutions. These unremitted amounts collected on behalf of the financial institutions are included within short-term borrowings and current portion of long-term debt in the Consolidated Balance Sheet. 110 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 4. Inventories Inventories consists of the following: December 31, (Dollars in millions) 2021 2020 Raw materials $ 43 $ 52 Work in progress 161 193 Finished goods 1 2 Total $ 205 $ 247 Note 5. Property, Plant and Equipment Property, plant and equipment by major asset class consists of the following: December 31, (Dollars in millions) 2021 2020 Land, buildings and improvements $ 312 $ 294 Plant and machinery 191 186 Equipment and other 298 276 Total property, plant and equipment, at cost 801 756 Less accumulated depreciation ( 437 ) ( 401 ) Total property, plant and equipment, net $ 364 $ 355 Depreciation expense related to property, plant and equipment was $ 49 million, $ 44 million and $ 42 million for the years ended December 31, 2021, 2020 and 2019, respectively. Land, buildings and improvements include assets under finance leases in the amount of $ 104 million and $ 108 million as of December 31, 2021 and 2020, respectively. See Note 9: Leases for additional information. As of December 31, 2021, the Company accounted for our manufacturing facility in Menomonee Falls, WI as a build-to-suit lease with a failed sale-leaseback and is included in the Land, building, and improvements in the above table. See Note 11: Debt for additional information. 111 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 6. Other Liabilities A summary of significant other liabilities by balance sheet caption follows: December 31, (Dollars in millions) 2021 2020 Salaries, wages and accrued bonuses $ 70 $ 61 Fringe benefits 74 71 Litigation 10 10 Restructuring costs 4 1 Provision for contract losses 48 44 Operating lease liabilities 24 22 Other (1) 65 58 Total other current liabilities $ 295 $ 267 Retirement benefits $ — $ — Operating lease liabilities $ 73 $ 81 Other (2) 1 11 Total other noncurrent liabilities $ 74 $ 92 ________________ (1) Consists primarily of taxes payable, environmental remediation reserves and warranty reserves. See Note 15: Commitments and Contingencies for more information regarding the warranty provision. (2) Consists primarily of workers’ compensation liabilities and certain payroll taxes deferred under the CARES Act. Note 7. Goodwill Changes in the carrying amount of goodwill by reportable segment are as follows: (Dollars in millions) AST NC&C IMS Total Balance at January 1, 2020 (1) $ 363 $ 275 $ 419 $ 1,057 Acquisitions — — — — Balance at December 31, 2020 363 275 419 1,057 Acquisitions 14 — — 14 Balance at December 31, 2021 $ 377 $ 275 $ 419 $ 1,071 ________________ (1) Goodwill is reported net of $ 1,313 million, $ 1,049 million and $ 606 million of accumulated impairments as of January 2020 for the AST, NC&C and IMS segments, respectively. Note 8. Intangible Assets Other intangible assets mainly refer to the fair value of existing customer contractual relationships attributable to the acquired business and patents which are being amortized over their respective lives. The fair value of intangible assets typically is determined, as of the date of acquisition, based on estimates and judgments regarding expectations for the estimated future after-tax earnings and cash flows (including cash flows for working capital) arising from backlog and follow-on sales to the customer over their estimated lives, including the probability of expected future contract renewals and sales, less a contributory assets charge, all of which is discounted to present value. The following disclosure presents certain information regarding the Company's intangible assets as of December 31, 2021 and 2020. All intangible assets are being amortized over their estimated useful lives, as indicated below, with no estimated residual values. 112 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 2021 December 31, 2020 (Dollars in millions) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Customer relationships $ 957 $ ( 908 ) $ 49 $ 957 $ ( 899 ) $ 58 Patents and licenses 9 ( 6 ) 3 7 ( 5 ) 2 Total intangible assets $ 966 $ ( 914 ) $ 52 $ 964 $ ( 904 ) $ 60 Amortization expense related to intangible assets was $ 9 million, $ 9 million, and $ 9 million respectively, for the years ended December 31, 2021, 2020 and 2019. Customer relationships are amortized on a straight-line basis over their estimated useful lives of 10 to 15 years. Patents and licenses are amortized on a straight-line basis over their estimated useful lives of 5 to 10 years. The estimated annual amortization expense related to intangible assets for the subsequent five years is as follows: (in millions) Year Ending December 31, Estimated Annual Amortization 2022 $ 9 2023 9 2024 9 2025 9 2026 9 Note 9. Leases The Company leases various real estate for manufacturing facilities, administrative offices and warehouses under both finance leases and operating leases. In addition, the Company leases vehicles, machinery and office equipment under operating leases. We determine whether our contracts are or contain a lease at the inception of such arrangements. A contract is or contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. ROU assets and lease liabilities are recorded on the Consolidated Balance Sheet as of the lease commencement based on the present value of the future lease payments over the lease term. As our leases do not generally explicitly state the discount rate implicit in the lease, we use our incremental borrowing rate, which is determined based on the rate of interest that the Company would have to pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term as of the lease commencement date. In addition to the present value of the future lease payments, the calculation of the ROU asset also includes lease payments made at or before the commencement date of the lease, less any lease incentives received. The remaining lease cost is amortized over the remaining life of the lease on a straight-line basis. We evaluate ROU assets for impairment consistent with the treatment of other long-lived assets. Some of our leases include options to extend the lease terms or to terminate the lease early. We include the impact of the option in the determination of the ROU assets and liabilities when it is reasonably certain that we will exercise the option. Our lease payments are largely fixed, but may include variable payments that do not depend on an index or rate, such as usage-based amounts, and are recorded as a lease expense in the period incurred. The Company’s lease agreements do not contain any material residual value guarantees or restrictive covenants. 113 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In 2019, we have entered into a sale-leaseback transaction related to a facility in Milwaukee, WI. We have analyzed the transaction and determined the criteria to recognize a sale has been met and we have derecognized the related assets. The arrangement does not contain a repurchase option or other substantive obligations related to the property. Further, we have determined that the underlying lease meets the criteria to be classified as an operating lease. As a result, we have recognized an immaterial loss related to the transaction. As of December 31, 2021, the Company has not entered into any significant leases that have not yet commenced. We elected not to recognize a ROU asset and lease liability for leases with an initial term of 12 months or less. These leases are expensed on a straight-line basis over the lease term. The Company elected the practical expedient to not separate lease and non-lease components and to instead account for them as a single component. We have elected this practical expedient for all classes of assets. Lease Cost The Company’s total lease cost consists of the following: Year Ended December 31, (Dollars in millions) 2021 2020 Operating lease cost (1) $ 26 $ 24 Finance lease cost (2) : Amortization of right-of-use assets 8 7 Interest on lease liabilities 5 5 Total lease cost $ 39 $ 36 ________________ (1) Operating lease expense is included within cost of products, cost of services or general and administrative expenses, dependent upon the nature and use of the ROU asset, in the Company’s Consolidated Statements of Earnings Operating lease cost includes short-term leases of approximately $ 3 million and $ 5 million and an insignificant amount of variable lease cost for both 2021 and 2020 . (2) Finance lease expense is recorded as depreciation and amortization expense within cost of products, cost of services or general and administrative expenses, dependent upon the nature and use of the ROU asset and interest expense, net in the Company’s Consolidated Statements of Earnings. Supplemental Balance Sheet Information Supplemental balance sheet information related to leases is as follows: December 31, (Dollars in millions) 2021 2020 ROU assets Operating leases (1) $ 84 $ 88 Finance leases (2) 104 108 Total leased assets $ 188 $ 196 Liabilities Current lease liabilities: Operating (1) $ 24 $ 22 Finance (2) 6 5 Noncurrent lease liabilities: Operating (1) 73 81 Finance (2) 107 109 Total lease liabilities $ 210 $ 217 114 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) ________________ (1) Operating lease assets are included within other noncurrent assets and operating lease liabilities are included within other current liabilities (current portion) and other noncurrent liabilities (noncurrent portion) in the Company’s Consolidated Balance Sheet. (2) Finance lease assets are included within property, plant and equipment, net and finance lease liabilities are included within short-term borrowings and current portion of long-term debt (current portion) and long-term debt (noncurrent portion) in the Company’s Consolidated Balance Sheet. Supplemental Cash Flow Information Supplemental cash flow information related to leases is as follows: Year Ended December 31, (Dollars in millions) 2021 2020 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 27 $ 27 Operating cash flows from finance leases 5 5 Financing cash flows from finance leases 5 4 Right-of-use assets obtained in exchange for new lease liabilities: Operating leases 18 16 Finance leases 4 46 Weighted Average Lease Term and Discount Rate Lease terms and discount rates related to leases are as follows: December 31, 2021 2020 Weighted-average remaining lease term: Operating leases 5 years 5 years Finance leases 15 years 16 years Weighted-average discount rate: Operating leases 4.3 % 4.4 % Finance leases 4.6 % 4.5 % 115 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Maturity of Lease Liabilities: As of December 31, 2021, future minimum rental payments on leases with initial non-cancellable lease terms in excess of one year were due as follows: (Dollars in millions) Operating Leases Finance Leases Year Ending December 31, 2022 $ 27 $ 11 2023 25 11 2024 19 11 2025 12 10 2026 9 10 Thereafter 14 104 Total lease payments 106 157 Less: imputed interest 9 44 Present value of lease liabilities 97 113 Less: current maturities 24 6 Long-term lease obligations $ 73 $ 107 Note 10. Income Taxes Earnings (loss) before taxes consists of the following: Year Ended December 31, (Dollars in millions) 2021 2020 2019 Earnings before taxes Domestic $ 203 $ 112 $ 89 Foreign ( 3 ) — 6 Total $ 200 $ 112 $ 95 Income tax provision (benefit) consists of the following: Year Ended December 31, (Dollars in millions) 2021 2020 2019 Current: Federal $ ( 1 ) $ — $ — State — 3 2 Foreign 1 2 1 — 5 3 Deferred: Federal 43 24 17 State 5 — — Foreign ( 2 ) ( 2 ) — 46 22 17 Total $ 46 $ 27 $ 20 116 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The reconciliation from the statutory federal income tax rate to our effective income tax rate follows: Year Ended December 31, 2021 2020 2019 Statutory federal rate 21.0 % 21.0 % 21.0 % State rate, net of federal benefit 3.6 % 2.3 % 0.5 % Foreign rate differential ( 0.2 ) % 0.5 % 0.5 % Research & development credit, net of reserves ( 0.2 ) % ( 0.7 ) % ( 2.3 ) % Nondeductible expenses 0.9 % 0.4 % 0.7 % Global intangible low taxed income — % 0.2 % 1.0 % Change in valuation allowance ( 1.4 ) % ( 2.5 ) % 0.2 % Change in tax reserves ( 0.4 ) % 2.2 % 0.2 % Other ( 0.3 ) % 0.7 % ( 0.7 ) % Effective tax rate 23.0 % 24.1 % 21.1 % The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2021 and 2020 is as follows: December 31, (Dollars in millions) 2021 2020 Deferred tax assets: Federal net operating losses $ 5 $ 18 State net operating losses 16 21 Tax credit carryforwards 21 23 Accrued compensation and benefits 23 26 Contract liabilities 21 20 Accrued expenses 5 5 Pension and post-retirement plans 18 24 Inventory capitalization 5 8 Other 5 8 Disallowed interest 1 1 Total gross deferred tax assets 120 154 Less valuation allowance 10 11 Deferred tax assets 110 143 Deferred tax liabilities: Intangible assets ( 41 ) ( 44 ) Fixed assets ( 12 ) ( 11 ) Other ( 1 ) ( 1 ) Deferred tax liabilities ( 54 ) ( 56 ) Net deferred tax asset $ 56 $ 87 Our deferred tax balance associated with our retirement benefit plans includes a deferred tax asset of $ 11 million and $ 14 million as of December 31, 2021 and 2020 respectively, that are recorded in accumulated other comprehensive earnings to recognize the funded status of our retirement plans. See ‘ Note 12: Pension and Other Postretirement Benefits for additional details. As of December 31, 2021 and 2020 the Company had U.S. federal net operating loss carryforwards of $ 28 million and $ 131 million, respectively, which we anticipate we will be able to apply prior to their expiration which commences in 2025. The annual utilization of approximately $ 28 million of certain our Federal net operating losses is subject to limitations under section 382 of the Internal Revenue Code. As of December 31, 2021 and 117 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2020 we had apportioned state net operating loss carryforwards of $ 239 million and $ 327 million, respectively, which are associated with jurisdictions in which we currently file and the Company expects to utilize prior to expiration except for those for which we have recorded a valuation allowance. We have federal tax credit carryforwards that commence expiring in 2032, which we anticipate being able to utilize prior to their expiration. Tax Uncertainties The Company maintains reserves for uncertain tax positions related to unrecognized income tax benefits. These reserves involve considerable judgment and estimation and are evaluated by management at least quarterly based on the best information available. The Company’s total liability for unrecognized tax benefits as of December 31, 2021, 2020 and 2019 was approximately $ 22 million, $ 25 million and $ 18 million, respectively; all of which will impact the effective tax rate when recognized. Approximately $ 15 million, $ 22 million and $ 16 million as of December 31, 2021, 2020 and 2019, respectively, have been recorded within (and as an offset to) deferred tax assets. In addition, the Company does not believe there are any tax positions for which it is reasonably possible that the unrecognized tax benefits will vary significantly over the next 12 months. The table below summarizes the activity associated with our unrecognized tax benefits: (Dollars in millions) 2021 2020 2019 Balance at January 1, $ 25 $ 18 $ 14 Increase related to prior year tax positions — 3 3 Increase related to current year tax positions 1 4 1 Decreases related to prior year tax positions ( 4 ) — — Lapse of statute of limitations — — — Settlements with taxing authorities — — — Balance at December 31, $ 22 $ 25 $ 18 The Company is subject to U.S. federal income tax as well as income tax of multiple state and foreign jurisdictions. The Company has substantially concluded all U.S. federal income tax matters for years through the tax year ended December 31, 2016 except as it relates to the net operating loss carryforward and tax credit carryforwards. Substantially all material state and local matters have been concluded for years through the tax year ended December 31, 2015. The Company has substantially concluded all material tax matters in foreign jurisdictions for years through the tax years ending during 2016. As of December 31, 2021, the Company has accumulated undistributed earnings generated by our foreign subsidiaries and most have been taxed in the U.S. as a result of the Tax Cuts and Jobs Act of 2017 (the “TCJA”). The TCJA allows for a dividend received deduction for repatriation of foreign earnings. We intend to indefinitely reinvest these earnings. Should the Company’s undistributed earnings from its investment in non‐U.S. subsidiaries be distributed in the future in the form of dividends or otherwise, the Company may be subject to foreign and domestic income taxes and withholding taxes. 118 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 11. Debt The Company’s debt consists of the following: December 31, (Dollars in millions) 2021 2020 7.5 % Term loan due November 30, 2023 (1) 139 139 5.0 % Daylight term loan due October 15, 2024 (1) 78 98 Finance lease and other 161 163 Short-term borrowings 15 27 Total debt principal 393 427 Less unamortized debt issuance costs and discounts — — Total debt, net 393 427 Less short-term borrowings and current portion of long-term debt ( 41 ) ( 53 ) Total long-term debt $ 352 374 ________________ (1) The Company’s debt with related parties consists of two term loans and a working capital credit facility with US Holding, as described below. Term Loans In January 2009, the Company entered into a credit agreement with its ultimate parent company, Finmeccanica S.p.A. (presently Leonardo S.p.A.) in the amount of $ 2 billion (the “2009 Credit Agreement”). The 2009 Credit Agreement was subsequently assigned to US Holding and has a maturity of November 30, 2023. The 2009 Credit Agreement provides for a term loan bearing interest at a rate of 7.5 %, with interest payments due semi-annually on June 20 and December 20 in each year (the “ 7.5 % Term loan”). The outstanding balance of the 7.5 % Term loan at December 31, 2021 and 2020 was $ 139 million and $ 139 million, respectively. The fair value of this term loan at December 31, 2021 and 2020 was $ 182 million and $ 182 million, respectively; however the Company has the ability to prepay the outstanding principal balance at the carrying amount without penalty. During 2020, US Holding forgave $ 300 million of related party debt. This was treated as a capital transaction and the amount was recorded in additional paid-in capital, as US Holding is a related party. In June 2017, the Company entered into an unsecured term loan with US Holding in the principal amount of $ 137.5 million, the proceeds of which were used to finance the acquisition of Daylight Solutions, Inc. (the “Daylight Term Loan”). The Daylight Term Loan had an outstanding balance of $ 78 million and $ 98 million at December 31, 2021 and 2020, respectively, which approximates its fair value. The Daylight Term Loan matures on October 15, 2024. The Daylight Term Loan has an interest rate of 5.0 %, with interest payments due semi-annually on April 15 and October 15. During April 2018, the Company was advanced an additional $ 50 million by US Holding under a term loan. This term loan bears interest at 4.0 % and had an initial maturity date of December 31, 2018, which was extended until December 31, 2021. This term loan was repaid in full, with no prepayment penalty, on December 19, 2020. Credit Facilities The 2009 Credit Agreement provides for a revolving credit facility available for working capital needs of the Company (the “Revolving Credit Facility”). As of December 31, 2021 and 2020, the Revolving Credit Facility had a credit limit of $ 450 million and $ 450 million, respectively, and an interest rate of LIBOR plus 3.5 %. There is a commitment fee of 0.25 % applied to the unused balance of the Revolving Credit Facility and there are no compensating balance requirements. There was no balance on the Revolving Credit Facility as of December 31, 2021 and 2020. 119 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company also maintains uncommitted working capital credit facilities with certain financial institutions in the aggregate of $ 65 million and $ 60 million at December 31, 2021 and 2020, respectively (the “Financial Institution Credit Facilities”). The Financial Institution Credit Facilities are guaranteed by Leonardo S.p.A. The primary purpose of the Financial Institution Credit Facilities is to support standby letter of credit issuances on contracts with customers and also includes a revolving facility with a maximum borrowing limit of $ 15 million, which bears interest at LIBOR plus 0.5 %. At December 31, 2021 and 2020, there was no balance outstanding on the revolving facility. The Company had letters of credit outstanding of approximately $ 35 million and $ 31 million as of December 31, 2021 and 2020, respectively, which reduces the available capacity of the Financial Institution Credit Facilities by an equal amount. Finance Lease and Other As of December 31, 2021, finance lease and other of $ 161 million includes approximately $ 113 million related to finance lease liabilities and $ 48 million related to our Menomonee Falls, WI manufacturing facility, which has been accounted for as a build-to-suit lease with a failed sale leaseback. Approximately $ 6 million has been recognized as the current portion of long-term debt for the finance lease liabilities and financing liability related to the build-to-suit arrangement. Short-term Borrowings As of December 31, 2021 and 2020, the Company recognized $ 15 million and $ 27 million, respectively, collected on behalf of the buyers of our trade receivables pursuant to our factoring arrangements as short-term borrowings and current portion of long-term debt in the Consolidated Balance Sheet, which approximates its fair value. Refer to Note 3: Accounts Receivable for more information. Interest Paid Total interest paid associated with our debt was $ 35 million, $ 64 million and $ 65 million in 2021, 2020 and 2019, respectively. Maturities of long-term debt as of December 31, 2021 are as follows: (Dollars in millions) Year Ending December 31, 2022 $ 41 2023 171 2024 40 2025 7 2026 7 Thereafter 127 Total principal payments $ 393 ‘ Note 12. Pension and Other Postretirement Benefits Retirement Plan Summary Information The Company maintains multiple pension plans, both contributory and non-contributory, covering employees at certain locations. Eligibility requirements for participation in the plans vary, and benefits generally are based on the participant's compensation and years of service, as defined in the respective plan. The Company's funding policy generally is to contribute in accordance with cost accounting standards that affect government contractors, subject to the Tax Code and regulations thereunder. Plan 120 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) assets are invested primarily in equities, bonds (both corporate and U.S. government), U.S. government-sponsored entity instruments, cash and cash equivalents and real estate. The Company also provides postretirement medical benefits for certain retired employees and dependents at certain locations. Participants are eligible for these benefits when they retire from active service and meet the eligibility requirements for the Company's postretirement benefit plans. The Company's contractual arrangements with the U.S. government provide for the recovery of contributions to a Voluntary Employees' Beneficiary Association (“VEBA”) trust and, for non-funded plans, recovery of claims on a pay-as-you-go basis, subject to the Tax Code and regulations thereunder, with the retiree generally paying a portion of the costs through contributions, deductibles and coinsurance provisions. The Company also maintains certain non-contributory and unfunded supplemental retirement plans. Eligibility for participation in the supplemental retirement plans is limited, and benefits generally are based on the participant's compensation and/or years of service. 121 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The following tables provide certain information regarding the Company's pension, postretirement and supplemental retirement plans as of December 31, 2021 and 2020: Defined Benefit Pension Plans Postretirement Benefit Plans Supplemental Retirement Plans (Dollars in millions) 2021 2020 2021 2020 2021 2020 Change in benefit obligation: Benefit obligation at beginning of year $ 226 $ 261 $ 2 $ 3 $ 23 $ 24 Service cost — — — — — — Interest cost 5 7 — — 1 1 Plan participants' contributions — — — — — — Actuarial (gain) loss ( 3 ) ( 10 ) — ( 1 ) ( 1 ) ( 1 ) Benefits paid ( 13 ) ( 10 ) — — ( 1 ) ( 1 ) (Gain) loss due to settlement — ( 21 ) — — — — Plan amendments — — — — — — Exchange rate differences and other — ( 1 ) — — — — Benefit obligation at end of year $ 215 $ 226 $ 2 $ 2 $ 22 $ 23 Change in plan assets: Fair value of plan assets at beginning of year $ 151 $ 158 $ 1 $ 1 $ 11 $ 10 Actual return on plan assets 15 19 — — 1 1 Plan participants' contributions — — — — — — Employer contributions 13 6 — — 1 1 Benefits paid ( 13 ) ( 10 ) — — ( 1 ) ( 1 ) (Loss) gain due to settlement — ( 21 ) — — — — Exchange rate differences and other — ( 1 ) — — — — Fair value of plan assets at end of year 166 151 1 1 12 11 Contributions between measurement date and year end — — — — — — Funded status of the plans at year end $ ( 49 ) $ ( 75 ) $ ( 1 ) $ ( 1 ) $ ( 10 ) $ ( 12 ) The amounts recognized in the Consolidated Balance Sheet, as of December 31, 2021 and 2020 consist of: Defined Benefit Pension Plans Postretirement Benefit Plans Supplemental Retirement Plans (Dollars in millions) 2021 2020 2021 2020 2021 2020 Noncurrent assets $ — $ — $ 1 $ 1 $ — $ — Current liabilities — — — — — — Noncurrent liabilities ( 49 ) ( 75 ) ( 2 ) ( 2 ) ( 10 ) ( 11 ) Net liability recognized $ ( 49 ) $ ( 75 ) $ ( 1 ) $ ( 1 ) $ ( 10 ) $ ( 11 ) 122 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Amounts recognized in accumulated other comprehensive income (before taxes) at December 31, 2021 and 2020 consist of: Defined Benefit Pension Plans Postretirement Benefit Plans Supplemental Retirement Plans (Dollars in millions) 2021 2020 2021 2020 2021 2020 Prior service cost $ — $ — $ — $ — $ — $ — Net actuarial loss (gain) 40 52 ( 1 ) ( 2 ) 6 7 Total amount recognized in accumulated other comprehensive losses (earnings) $ 40 $ 52 $ ( 1 ) $ ( 2 ) $ 6 $ 7 The aggregate accumulated benefit obligation (“ABO”) for the Company's defined benefit pension plans combined was $ 237 million and $ 249 million at December 31, 2021 and 2020, respectively. The ABO represents benefits accrued without assuming future compensation increases to plan participants and is approximately equal to our projected benefit obligation (“PBO”). The table below presents information for the pension plans with an ABO and PBO in excess of the fair value of plan assets at December 31, 2021 and 2020. (Dollars in millions) December 31, 2021 December 31, 2020 Projected benefit obligation $ 237 $ 249 Accumulated benefit obligation 237 249 Fair value of plan assets 178 162 The following table summarizes the weighted average actuarial assumptions used to determine our benefit obligations at December 31, 2021 and 2020: Defined Benefit Pension Plans Postretirement Benefit Plans Supplemental Retirement Plans 2021 2020 2021 2020 2021 2020 Rate assumptions Discount rate 2.8 % 2.4 % 2.6 % 4.3 % 2.8 % 2.5 % Increase in future compensation levels N/A N/A N/A N/A N/A N/A Expected long-term return on plan assets 5.9 % 6.4 % 5.9 % 6.4 % N/A N/A Health care trend rate assumed for next year N/A N/A 4.6 % 5.4 % N/A N/A Ultimate health care trend rate N/A N/A 4.3 % 4.3 % N/A N/A Year rate reaches ultimate trend rate N/A N/A 2031 2031 N/A N/A 123 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The following table summarizes the components of net periodic benefit cost for the Company's pension, postretirement and supplemental retirement plans for the years ended December 31, 2021 and 2020 and 2019: Defined Benefit Pension Plans Postretirement Benefit Plans Supplemental Retirement Plans (Dollars in millions) 2021 2020 2019 2021 2020 2019 2021 2020 2019 Service cost $ — $ — $ — $ — $ — $ — $ — $ — $ — Interest cost $ 5 $ 7 $ 7 $ — $ — $ — $ 1 $ 1 $ 1 Expected return on plan assets $ ( 7 ) $ ( 8 ) $ ( 7 ) $ — $ — $ — $ — $ — $ — Amortization of net actuarial loss (gain) $ 2 $ 3 $ 2 $ ( 1 ) $ ( 1 ) $ — $ — $ — $ — Amortization of prior service cost $ — $ — $ — $ — $ — $ — $ — $ — $ — Settlement expense (income) $ — $ 3 $ — $ — $ — $ — $ — $ — Net periodic benefit cost $ — $ 5 $ 2 $ ( 1 ) $ ( 1 ) $ — $ 1 $ 1 $ 1 The following table summarizes the other changes in plan assets and benefit obligations recognized in other comprehensive earnings for the Company's pension, postretirement and supplemental retirement benefit plans for the years ended December 31, 2021 and 2020 and 2019: Defined Benefit Pension Plans Postretirement Benefit Plans Supplemental Retirement Plans (Dollars in millions) 2021 2020 2019 2021 2020 2019 2021 2020 2019 Net actuarial (gain) loss $ ( 11 ) $ ( 21 ) $ 19 $ — $ ( 1 ) $ ( 1 ) $ ( 1 ) $ ( 1 ) $ 4 Prior service cost — — — — — — — — — Amortization of net actuarial (loss) gain from prior years ( 2 ) ( 6 ) ( 2 ) 1 1 — — — — Amortization of prior service cost — — — — — — — — — Other (1) — — — — — — — — — Total recognized in other comprehensive income $ ( 13 ) $ ( 27 ) $ 17 $ 1 $ — $ ( 1 ) $ ( 1 ) $ ( 1 ) $ 4 ________________ (1) Includes foreign exchange translation. 124 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The following table summarizes the weighted average actuarial assumptions used to determine our net periodic cost of the plans for the years ended December 31, 2021, 2020 and 2019: Defined Benefit Pension Plans Postretirement Benefit Plans Supplemental Retirement Plans 2021 2020 2019 2021 2020 2019 2021 2020 2019 Rate assumptions Discount rate 2.8 % 2.7 % 3.6 % 2.1 % 2.8 % 3.3 % 2.4 % 2.4 % 3.5 % Expected long - term return on plan assets 6.4 % 6.3 % 6.9 % 6.4 % 5.8 % 5.7 % N/A N/A N/A Increase in future compensation levels N/A N/A N/A N/A N/A N/A N/A N/A N/A Health care trend rate assumed for next year N/A N/A N/A 5.8 % 6.0 % 6.5 % N/A N/A N/A Ultimate health care trend rate N/A N/A N/A 4.5 % 4.5 % 4.5 % N/A N/A N/A Year rate reaches ultimate trend rate N/A N/A N/A 2030 2029 2027 N/A N/A N/A The expected long-term return on plan assets assumption represents the average rate that the Company expects to earn over the long-term on the assets of the Company's benefit plans, including those from dividends, interest income and capital appreciation. The assumption has been determined based on expectations regarding future rates of return for the plans' investment portfolio, with consideration given to the allocation of investments by asset class and historical rates of return for each individual asset class. A one percentage increase or decrease in healthcare trend rates in the table above would have an insignificant impact to our service and interest cost and the postretirement medical obligations. Plan Assets The Company is responsible for formulating the investment policies and strategies for each plan's assets. Presently all of the plans are governed by a single investment policy and are uniformly invested. As part of the policy statement the Company has implemented a glide path which adjusts the percentage of assets invested in return seeking assets based upon the attainment of specific funding percentages. The non-return seeking assets are invested primarily in bonds with maturities closely matching the anticipated payment of benefits. The table below represents all of the Company's funded pension plans' and postretirement benefit plans' weighted-average asset allocation at December 31, 2021 and 2020 by asset category: Asset Allocation 2021 2020 Asset Category Equity securities 41 % 55 % Debt securities 47 % 33 % Real estate 6 % 6 % Other, primarily cash and cash equivalents, and hedge funds 6 % 6 % 125 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The table below presents the target allocation ranges for each major asset category for the Company's benefit plans for the years ended December 31, 2021 and 2020. Target Asset Allocation Range 2021 2020 Asset Category Equity securities 40 % - 60 % 40 % - 60 % Debt securities 30 % - 50 % 40 % - 50 % Real estate 5 % - 10 % 5 % - 10 % Other, primarily cash and cash equivalents and hedge funds 5 % - 10 % 5 % - 10 % The following tables provides the fair value of plan assets held by our defined benefit plan by asset category and by fair value hierarchy level. Certain investments are measured at their NAV per share and do not have readily determined fair values. As such, these investments are not subject to leveling in the fair value hierarchy. December 31, 2021 (Dollars in millions) Level 1 Level 2 Level 3 Total Asset category Investments measured at fair value: $ — $ — $ — $ — Cash and cash equivalents $ 11 $ — $ — $ 11 Equity securities 6 — — 6 Debt securities — — — — Total $ 17 $ — $ — $ 17 Investments measured at NAV: Collective trust funds — — — 162 Equity and fixed income funds — — — — Total $ 17 $ — $ — $ 179 December 31, 2020 (Dollars in millions) Level 1 Level 2 Level 3 Total Asset category Investments measured at fair value: Cash and cash equivalents $ 9 $ — $ — $ 9 Equity securities 6 — — 6 Debt securities — — — — Total $ 15 $ — $ — $ 15 Investments measured at NAV: Collective trust funds — — — 148 Equity and fixed income funds — — — — Total $ 15 $ — $ — $ 163 For the year ended December 31, 2022, the Company expects to contribute $ 5 million to its pension plans and an inconsequential amount to its postretirement plans. During 2020 the Company deferred approximately $ 7 million in pension contributions until 2021 under the CARES Act and IRS Notice 2020-82, which was included in the total pension contributions for 2021 of $ 13 million. 126 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The following table presents expected pension and postretirement benefit payments over the next 10 years: (Dollars in millions) Defined Benefit Pension Plans Postretirement Benefit Plans Supplemental Retirement Plans Year Ending December 31, 2022 $ 12 $ — $ 1 2023 12 — 1 2024 13 — 1 2025 13 — 1 2026 13 — 1 2027-2031 63 — 6 Defined Contribution Plans The Company maintains defined contribution plans covering substantially all domestic full-time eligible employees. The Company's contributions to these plans for the years ended December 31, 2021, 2020 and 2019 amounted to $ 22 million, $ 21 million and $ 19 million, respectively. Note 13. Equity Method Investments Our share of net earnings related to our equity method investments was $ 2 million, $ 3 million and $ 2 million for the years ended December 31, 2021, 2020 and 2019, respectively, which was included in our Network Computing & Communications business segment operating profit. Below is a list of the entities accounted for under the equity method and recorded in other noncurrent assets on our Consolidated Balance Sheet: % of Ownership Carrying Value (Dollars in millions) 2021 2020 2021 2020 Advanced Acoustics Concepts, LLC 51 % 51 % $ 27 $ 25 Note 14. Share-based compensation plans The Company does not have any share-based compensation plans. See Note 6 : Other Liabilities , for information regarding cash compensation. Note 15. Commitments and Contingencies Commitments The Company’s commitments are primarily related to our lease and credit agreements. See Note 9 : Leases and Note 11 : Debt for additional information on our leases and credit agreements. Contingencies From time to time we are subject to certain legal proceedings and claims in the ordinary course of business. These matters are subject to many uncertainties and it is possible that some of these matters ultimately could be decided, resolved or settled in a manner adverse to us. Although the precise amount of liability that may result from these matters is not ascertainable, the Company believes that any amounts exceeding the Company's recorded accruals should not materially adversely affect the Company's financial condition or liquidity. It is possible, however, that the ultimate resolution of those matters could result in a material adverse effect on the Company's results of operations and/or cash flows from operating activities for a particular reporting period. We establish reserves for specific legal matters 127 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) when we determine that the likelihood of an unfavorable outcome is probable and the loss is reasonably estimable. Some environmental laws, such as the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (also known as “CERCLA” or the “Superfund law”) and similar state statutes, can impose liability upon former owners or operators for the entire cost of investigating and remediating contaminated sites regardless of the lawfulness of the original activities that led to the contamination. In July 2000, an entity which later became a subsidiary of the Company received a Section 104(e) Request for Information (“RFI”) from the National Park Service (“NPS”), pursuant to CERCLA, regarding the presence of radioactive material at a site within a national park, which site was operated by an alleged predecessor to our subsidiary over 50 years ago. Following the subsidiary’s response to the RFI, the NPS directed it and another alleged former operator to perform an Engineering Evaluation and Cost Analysis (“EE/CA”) of a portion of the site. The Company’s subsidiary made a good faith offer to conduct an alternative EE/CA work plan, but the NPS rejected this offer and opted to perform the EE/CA itself. The NPS previously posted its intention to open a formal public comment period regarding the EE/CA at the end of 2019. To the Company’s knowledge, the EE/CA has not been released and a public comment period has yet to be opened. Following completion of the EE/CA, the NPS may seek reimbursement for its investigative and remedial efforts to date, or direct one or more of the potentially responsible parties to perform any remediation that may be required by CERCLA or may enter an alternative dispute resolution proceeding to attempt to resolve each party’s share. In addition, the NPS may seek to recover damages for loss of use of certain natural resources. The Company believes that it has legitimate defenses to its subsidiary’s potential liability and that there are other potentially responsible parties for the environmental conditions at the site, including the U.S. government as owner, operator and arranger at the site. The potential liability associated with this matter could change substantially due to such factors as additional information on the nature or extent of contamination, methods of remediation that might be recommended or required, changes in the apportionment of costs among the responsible parties, whether the NPS seeks to recover additional damages, whether the NPS’s plans to investigate additional areas to identify a need for further remedial action for which the Company may be identified as a potentially responsible party and other actions by governmental agencies or private parties. The Company has recorded its best estimate of damages and its share of remediation costs related to the site to reflect what we and our advisors reasonably believe we would be liable for based on the current information and circumstances of the claim, exclusive of other potential liabilities that may be asserted in the future. In the performance of our contracts we routinely request contract modifications that require additional funding from the customer. Most often, these requests are due to customer-directed changes in the scope of work. While we are entitled to recovery of these costs under our contracts, the administrative process with our customer may be protracted. Based on the circumstances, we periodically file requests for equitable adjustment (“REAs”) that are sometimes converted into claims. In some cases, these requests are disputed by our customer. We believe our outstanding modifications, REAs and other claims will be resolved without material impact to our results of operations, financial condition or cash flows. As a government contractor, with customers including the U.S. government as well as various state and local government entities, the Company may be subject to audits, investigations and claims with respect to its contract performance, pricing, costs, cost allocations and procurement practices. Additionally, amounts billed under such contracts, including direct and indirect costs, are subject to potential adjustments before final settlement. Management believes that adequate provisions for such potential audits, investigations, claims and contract adjustments, if any, have been made in the Consolidated Financial Statements. 128 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Restructuring costs We engage in targeted restructuring initiatives in order to rationalize headcount and align our operations in a more strategic and cost-efficient structure. In connection with these restructuring initiatives we recorded charges totaling $ 5 million, $ 12 million and $ 20 million for the years ended December 31, 2021, 2020 and 2019, respectively. Costs incurred were related to employee termination and severance costs, as well as costs related to discontinuing product lines or closing down of locations. Charges were recorded within other operating expenses, net, with the exception of costs incurred related to the write-down of inventory, which were recorded in cost of products. See the table below for a breakout of restructuring costs incurred by segment and by nature of cost incurred: Year Ended December 31, (Dollars in millions) 2021 2020 2019 AST Severance $ 3 $ — $ — Facility abandonment — — 3 Inventory — — — Total AST 3 — 3 NC&C Severance 2 6 1 Facility abandonment — — — Inventory — — 2 Total NC&C 2 6 3 IMS Severance — — 2 Facility abandonment — 6 6 Inventory — — 5 Total IMS — 6 13 Corporate Severance — — — Facility abandonment — — 1 Inventory — — — Total Corporate — — 1 Total $ 5 $ 12 $ 20 The following is a summary of changes in the restructuring provision balance during the years ended December 31, 2020 and 2021: (Dollars in millions) Balance at January 1, 2020 $ 4 Additional provision 12 Reversal and utilization ( 15 ) Balance at December 31, 2020 1 Additional provision 5 Reversal and utilization ( 2 ) Balance at December 31, 2021 $ 4 129 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Product Warranties Product warranty costs generally are accrued in proportion to product revenue realized in conjunction with our over-time revenue recognition policy. Product warranty expense is recognized based on the term of the product warranty, generally one year to three years , and the related estimated costs, considering historical claims expense. Accrued warranty costs are reduced as these costs are incurred and as the warranty period expires, and otherwise may be modified as specific product performance issues are identified and resolved. The following is a summary of changes in the product warranty balances during the years ended December 31, 2020 and 2021: (Dollars in millions) Balance at January 1, 2020 $ 13 Additional provision 16 Reversal and utilization ( 12 ) Balance at December 31, 2020 17 Additional provision 17 Reversal and utilization ( 15 ) Balance at December 31, 2021 $ 19 Note 16. Related Party Transactions Under our current proxy agreement, DRS remains largely independent from the Parent. Additionally, the Company provides services related to the US interface for the Parent and its other affiliates. These services include financial, tax, trade compliance, marketing and communications and legal. The Company also has related-party sales with the Parent and its other affiliates that occur in the regular course of business. Related-party sales for these transactions are included in revenues and were $ 11 million, $ 26 million and $ 16 million for the years ended December 31, 2021,2020 and 2019, respectively. The receivables related to these transactions with the Parent and its other affiliates of $ 2 million and $ 5 million, respectively, and payables of $ 1 million and $ 8 million, respectively, are included in accounts receivable and accounts payable in our Consolidated Balance Sheet as of December 31, 2021 and 2020. The Company entered into a Surplus Treasury Agreement with US Holding (the “Surplus Agreement”) in December 2019. The Surplus Agreement allows the Company to advance excess funds to US Holding when funds are available. The advances bear interest at LIBOR plus between 5 and 20 basis points depending on the tenor of the advance. As of December 31, 2021 and 2020, the Company had advanced $ 0 million and $ 115 million to US Holding, which is presented on the balance sheet as a related party note receivable. During 2020, US Holding forgave $ 300 million of related party debt. This was treated as a capital transaction and the amount was recorded in additional paid-in capital, as US Holding is a related party. The Company entered into Tax Allocation Agreement with US Holding, dated as of November 16, 2020. Refer to Note 1: Summary of Significant Accounting Policies for more information. Note 17. Segment Information Operating segments represent components of an enterprise for which separate financial information is available that is regularly reviewed by the CODM in determining how to allocate resources and assess performance. Our Chief Executive Officer is our CODM and he uses a variety of measures to assess the performance of the Company as a whole, depending on the nature of the activity. The Company’s operating and reportable segments consist of AST, NC&C and IMS. All other operations, which consists primarily of DRS Corporate Headquarters and certain non-operating subsidiaries of the Company, are grouped in Corporate & Eliminations. 130 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) We primarily use Adjusted EBITDA to manage the Company and allocate resources. Adjusted EBITDA of our business segments includes our net earnings before income taxes, amortization of acquired intangible assets, depreciation, restructuring costs, interest, deal related transaction costs , acquisition and divestiture related expenses, foreign exchange, COVID-19 response costs, non-service pension expenditures and other one-time non-operational events. Adjusted EBITDA is used to facilitate a comparison of the ordinary, ongoing and customary course of our operations on a consistent basis from period to period and provide an additional understanding of factors and trends affecting our business segments. This measure assists the CODM in assessing segment operating performance consistently over time without the impact of our capital structure, asset base and items outside the control of the management team and expenses that do not relate to our core operations. Certain information related to our segments for the years ended December 31, 2021, 2020 and 2019, is presented in the following tables. Consistent accounting policies have been applied by all segments within the Company, within all reporting periods. A description of our reportable segments as of December 31, 2021 and 2020 has been included in Note 1: Summary of Significant Accounting Policies . Transactions between segments generally are negotiated and accounted for under terms and conditions that are similar to other government and commercial contracts; however, these intercompany transactions are eliminated in consolidation. Total revenues and intersegment revenues by segment for the years ended December 31, 2021, 2020 and 2019 consists of the following: (Dollars in millions) 2021 2020 2019 AST $ 970 $ 940 $ 781 NC&C 972 1,026 1,053 IMS 959 834 917 Corporate & Eliminations ( 22 ) ( 22 ) ( 37 ) Total revenue $ 2,879 $ 2,778 $ 2,714 (Dollars in millions) 2021 2020 2019 AST $ 14 $ 12 $ 12 NC&C 7 9 24 IMS 1 1 1 Total intersegment revenue $ 22 $ 22 $ 37 Depreciation by segment as of December 31, 2021, 2020 and 2019 consists of the following: (Dollars in millions) 2021 2020 2019 AST $ 20 $ 19 $ 19 NC&C 13 11 10 IMS 16 14 13 Total depreciation $ 49 $ 44 $ 42 Total assets by segment as of December 31, 2021 and 2020 consist of the following: (Dollars in millions) 2021 2020 (1) AST $ 929 $ 864 NC&C 616 699 IMS 1,145 1,018 Corporate & Eliminations 379 375 Total assets $ 3,069 $ 2,956 (1) The 2020 amounts have been adjusted to reflect the correction of the allocation of certain assets within each segment. 131 LEONARDO DRS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Reconciliation of reportable segment Adjusted EBITDA to Net Earnings (loss) consists of the following: (Dollars in millions) 2021 2020 2019 Adjusted EBITDA AST $ 125 $ 123 $ 94 NC&C 95 90 75 IMS 90 55 63 Corporate & Eliminations — — 2 Total Adjusted EBITDA $ 310 $ 268 $ 234 Amortization of intangibles ( 9 ) ( 9 ) ( 9 ) Depreciation ( 49 ) ( 44 ) ( 42 ) Restructuring costs ( 5 ) ( 12 ) ( 20 ) Interest expense ( 35 ) ( 64 ) ( 65 ) Deal related transaction costs ( 5 ) ( 9 ) — Acquisition and divestiture related expenses — — — Foreign exchange ( 1 ) ( 1 ) — COVID-19 response costs ( 6 ) ( 12 ) — Non-service pension expense — ( 5 ) ( 3 ) Other one-time non-operational events — — — Income tax provision ( 46 ) ( 27 ) ( 20 ) Net earnings $ 154 $ 85 $ 75 Note 18. Subsequent Events The Company has evaluated subsequent events through March 28, 2022, which represents the date on which the Consolidated Financial Statements were issued. On March 21, 2022, the Company entered into a definitive agreement to sell its Global Enterprise Solutions (GES) business to SES Government Solutions, Inc., a wholly-owned subsidiary of SES S.A., for $ 450 million in cash. GES, which is part of the NC&C segment, provides commercial satellite communications to the U.S. Government and delivers satellite communications and security solutions to customers worldwide. SES S.A. has guaranteed the payment of the purchase price and performance of all other obligations of SES Government Solutions, Inc. under the agreement. The transaction is subject to customary closing conditions, including approvals under the Hart-Scott-Rodino Antitrust Improvements Act (HSR) and by The Committee on Foreign Investment in the United States (CFIUS) and The Federal Communications Commission (FCC). 132 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.