RADA Electronic Industries Ltd. (DRS) on Q3 2025 Results - Earnings Call Transcript

Operator: Ladies and gentlemen, good day, and welcome to the Leonardo DRS Third Quarter Fiscal Year 2025 Earnings Conference Call. [Operator Instructions] As a reminder, this event is being recorded. I would now like to turn the conference over to Steve Vather, Senior Vice President of Investor Relations and Corporate Finance. Please go ahead. Stephen Vather: Good morning, and thanks for participating on today's quarterly earnings conference call. Joining me today are Bill Lynn, our Chairman and CEO; John Baylouny, our COO and incoming CEO; and Mike Dippold, our CFO. They will discuss our strategy, operational highlights, financial results and forward outlook. Today's call is being webcast on the Investor Relations portion of the website, where you will also find the earnings release and supplemental presentation. Management may make forward-looking statements during the call regarding future events, anticipated future trends and the anticipated future performance of the company. We caution you that such statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Actual results may differ materially from those projected in the forward-looking statements due to a variety of factors. For a full discussion of these risk factors, please refer to our latest Form 10-K and our other SEC filings. We undertake no obligation to update any of the forward-looking statements made on this call. During this call, management will also discuss non-GAAP financial measures, which we believe provide useful information for investors. These non-GAAP measures should not be evaluated in isolation or as a substitute for GAAP performance measures. You can find a reconciliation of the non-GAAP measures discussed on this call in our earnings release. At this time, I'll turn the call over to Bill. Bill? William Lynn: Thanks, Steve. Good morning, and welcome, everyone, to the DRS Q3 earnings call. We continue to perform well. Our third quarter results demonstrate DRS' close alignment with customer priorities, which was clearly reflected in our strong bookings, revenue and profit growth as well as solid cash flow generation. As I told you last call, we expected second half bookings strength, and that materialized in spades in the third quarter. We secured $1.3 billion of bookings in the quarter, resulting in a 1.4x book-to-bill ratio. Our year-to-date book-to-bill ratio sits at 1.2x, and we continue to see a solid path to remain above 1x for the full year. This quarter, demand was most evident for our counter UAS, advanced infrared sensing, naval network computing and electric power and propulsion technologies. Our exceptional bookings propelled us to another record total backlog, which now sits at $8.9 billion, up 8% year-over-year and also up sequentially. Funded backlog also saw remarkable year-over-year growth of 20% in the quarter. Diving deeper into our quarterly financial performance. Across metrics, we sustained double-digit growth in the year-to-date, including in Q3. This provides greater visibility to close out the year on a strong footing. Furthermore, the foundation built in the year-to-date leads us to increase our full year revenue growth expectations to 10% to 11%. Our profit metrics also showed strong performance. Adjusted EBITDA was up 17%, although margin slightly lagged behind prior year levels as we continue to ramp our investment in internal research and development. Adjusted diluted EPS increased by 21%. Lastly, free cash flow significantly surpassed prior year levels, reflecting improved collection linearity and working capital efficiency. In aggregate, our strong Q3 results place us in a solid position to meet our full year outlook. However, we continue to operate in a dynamic market environment and are focused on smoothly navigating its complexities. The team and I remain focused on execution discipline and maintaining investment to sustain strong organic growth. While DRS continues to perform well, the operating environment offers both opportunities and challenges. Global threats persist, leading to continued growth in U.S. and allied defense investments to expand and enhance capabilities to deter and contest these adversaries. We are thankful that earlier this month, the remaining Israeli hostages were returned and that initial steps toward peace are being made in the Middle East. We are hopeful that the cease fire sustains and brings lasting stability, not only for our employees in the region, but for all situated there. Domestically, the federal government remains shut down, marking the longest full shutdown on record. Unlike the last lengthy government shutdown in late 2018, all agencies, including the Department of Defense are impacted. Thankfully, to date, we have not seen a meaningful impact on our ability to execute our programs or deliver for our customers. However, as the shutdown extends, we are keeping a watchful eye on any impacts. We are hopeful that Congress and the administration negotiate and enact funding to provide clarity and visibility to our national security customers. Zooming out and taking a look at the bigger picture, DRS remains well positioned in areas of customer priority with strong alignment to enduring themes of counter UAS, improving shipbuilding throughput via industrial base expansion, enhancing missile production, and sensing and electronics modernization. There are clear funding tailwinds in the $150 billion for defense embedded in the tax reconciliation passed earlier this year. We are eager to see the enacted funding start to flow to our customers. Shifting to the supply chain. We are executing the strategy laid out last quarter to strengthen our germanium supply chain. We have begun recycling initiatives and are seeing early success in extracting adequate levels of germanium. We are also actively working on strategic agreements with several partners to ensure consistent supply in 2026. Overall, I am pleased with the progress made to date. There's still work to be done before resolving this constraint fully, but I am confident that the initiatives that we have put in place will successfully resolve this challenge in 2026. Let me wrap up my remarks with a few closing thoughts. Our year-to-date results reflect the resilience of our business and the strength of our differentiated technology portfolio. Customer demand is clear for our capabilities, and we remain focused on executing with excellence to support them in their most critical missions. The team has performed remarkably. Their commitment is unwavering and their incredible contributions are foundational to our financial success. Earlier today, I announced that I will be retiring as Chairman and CEO on January 1, and our COO, John Baylouny, has been named the company's new CEO. I've had the distinct privilege of leading DRS as CEO since 2012. The DRS we have today is unmistakably better and stronger than the one I joined 14 years ago. I could not be prouder of what the team and I have accomplished together. We have strategically transformed DRS through a steadfast focus on reshaping the portfolio into enduring areas of demand, driving consistent innovation and executing to provide exceptional capability into the hands of our war fighters. All of these strategic actions have resulted in a consistently growing business with expanding profitability and strong cash generation. I am pleased with where the company is positioned today and the incredible potential ahead of it. This inflection point offers an opportunity for me to hand the reins over to someone who has been my right hand for a near decade. While I'm delighted with what we have achieved, I have high expectations for what this company will achieve under John's leadership as our next CEO. Many of you already know John. He's an outstanding leader and is absolutely the right person to take this on. He has a wealth of knowledge, deep technological expertise and vast experience at DRS spanning over 35 years with significant operational impacts. Equally important, he possesses a profound understanding of our customers and their needs, coupled with an unwavering commitment to driving innovation and delivering solutions that ensure their mission success. Separately, the Board has unanimously elected Fran Townsend, our current Lead Independent Director, to become Chair. She has been a steady hand on our Board dating back to our acquisition by Leonardo. As part of this transition process, John, Mike, Steve and I will have several opportunities to meet with many of you over the coming months. John and I will be sharply focused on ensuring a seamless transition through the end of the year. Congratulations, John. Now let me turn the call over to him so he can review our operational highlights. John Baylouny: Thank you, Bill. First, on behalf of all of our employees, I want to thank you for your extraordinary leadership and the incredible impact you've had on the company. I am honored to be the next CEO of DRS, and I appreciate the trust you and the Board have in me to lead this exceptional organization. I'm very excited about where DRS is today, more importantly, where we can take this company moving forward. The opportunities to create value for both our customers and shareholders are abundant as ever. Let me now turn to discuss key business highlights from the quarter. As Bill mentioned earlier, we continue to see vigorous appetite for our counter UAS solutions. Due to the evolving threats, we are constantly iterating our offerings to stay ahead of the threat. Earlier this month, at the AUSA Annual Meeting, we showcased our leading expertise in counter UAS. We demonstrated our ability to develop and integrate a palletized mission equipment package that is vehicle and platform agnostic and applicable to both manned and unmanned systems. Furthermore, we successfully combined both short-range air defense and counter UAS missions into a significantly smaller and lighter platform to JLTV. In a growing field of counter UAS solutions, DRS stands out due to its reputation for bringing best-of-breed technologies well ahead of others and with proven field-tested results and mission effectiveness. To that end, I would like to commend the team for taking first place at our recent Army counter UAS competition, showcasing our cutting-edge electronic warfare capabilities to disrupt drone threats. Additionally, in Q3, we demonstrated cross-modality success in solving some of the hardest problems facing our armed forces, integrating our sensors to enable threat neutralization through a platform to platform kinetic kill handoff. Our leadership position in counter UAS has translated into demand across our portfolio, including our integrated systems and sensing solutions in tactical radar, electronic warfare and infrared. I want to highlight that in the quarter, we were awarded over $250 million of contracts for our premier ground-based counter UAS and short-range air defense programs. Moving to sensing. We continue to see strong demand building in the missile domain. We are actively engaged in initiatives to expand sensing capacity and bring generational upgrades to sensing content on new platforms. Additionally, unmanned systems present a growing area of opportunity for our multimodal sensing business as we integrate our technologies into both unmanned aerial and surface vessel platforms. Lastly, in our core infrared business, we continue to capture an outsized share of the market to supply our customers with infrared capabilities for dismounted and ground combat vehicle applications. Next, I want to highlight our new software offering, SAGEcore. SAGEcore is an integrated operating system that brings AI, advanced sensor and edge computing together in a single deployable solution for use on tactical platforms across multi-domain environments. SAGEcore is one piece of the innovation we are bringing to the next generation computing and sensor fusion. In the quarter, we also released THOR, a 4 plus 1 multifunction network computing product with the ability to host electronic warfare, onboard crypto and tactical WiFi capabilities. THOR complements the AI processor we developed earlier this year and supports the Army's next-generation C2 initiative with a Zero Trust cost-effective solution for tactical and ruggedized computing at the edge. Additionally, we continue to see steady demand for our next-generation enabled network computing solutions in support of the Navy's network sensor and integrated fire control initiative, Cooperative Engagement Capability, or CEC. Last but certainly not least, I want to commend our electric power and propulsion business for the consistent and remarkable performance. The impact of their strong execution is evident not only at the segment level, but also at the company level. We continue to see this part of our business driving significant growth and margin expansion. We are well positioned to capture incremental scope and remain in active conversations with our customers on industrial base expansion, particularly steam turbine generators. The growth opportunity of proliferating our electric power and propulsion technology into future platforms remains an exciting growth vector. Let me now turn the call over to Mike, who will review our third quarter and our revised 2025 guidance in greater detail. Michael Dippold: Thanks, John, and congratulations. I look forward to working closely with you in your new role to create value for our customers and shareholders. Bill, it's been a heck of a ride, and I'd like to thank you for your outstanding leadership. Overall, I'm pleased with our solid year-to-date performance, particularly amidst a complex and dynamic operating environment. Our third quarter reflects the results of our sustained focus on driving innovation, processing customer demand into revenue growth and maintaining disciplined execution. Let me start by discussing our Q3 performance. Quarterly revenue grew by 18% over the prior year, totaling $960 million. The team did an impressive job converting strong customer demand. We also benefited from favorable timing of material receipts, resulting in revenue above the framework laid out on the Q2 call. From a segment perspective, IMS was our growth engine. IMS quarterly revenue was up 34%, driven by strong contributions from counter UAS and electric power propulsion programs. ASC demonstrated a healthy upper single-digit increase of 9%, thanks to growth from naval network computing, advanced infrared sensing and tactical radar programs. Shifting to adjusted EBITDA. Q3 adjusted EBITDA was $117 million, up 17% from last year. Quarterly adjusted EBITDA margin was 12.2%, reflecting a 10 basis point margin contraction from the prior year. Higher volume and improved electric power and propulsion program profitability were offset by increased research and development investments, less favorable program mix and less efficient program execution, leading to the slight margin decrease in the quarter. Shifting to the segment view. ASC adjusted EBITDA was flat on a dollar basis, but saw a 100 basis point contraction due to greater internal research and development investment, along with less favorable program mix. IMS adjusted EBITDA was up 47%, with margin expanding by 120 basis points, thanks to higher volume and improved profitability on our Columbia Class program. On to the bottom line metrics. Third quarter net earnings were $72 million and diluted EPS was $0.26 a share, up 26% and 24%, respectively. Our adjusted net earnings of $78 million and adjusted diluted EPS of $0.29 a share were up 22% and 21%, respectively. The favorable year-over-year compares were driven primarily by operationally led profit growth, coupled with slightly lower interest expense. Now on to free cash flow. Free cash flow was $77 million for the quarter, up significantly over the prior year despite increased capital expenditure investment, driven by increased net profitability and better working capital efficiency. With 1 quarter remaining, we are revising our full year 2025 guidance to incorporate our strong year-to-date performance, along with factors we expect to influence the business as we close out the year. We now expect revenue in the range of $3.55 billion to $3.6 billion, implying 10% to 11% year-over-year growth. Our backlog position provides clarity into the execution range. The single most important factor driving the output is the variability in the timing and level of material receipts received by year-end. I would resist the urge to fixate on the implied fourth quarter trends. Over the past few years, we have steadily worked to improve quarterly linearity and our year-to-date performance this year is certainly reflective of that initiative. We expect Q4 to reflect comparable patterns as last year, where there is a step down in growth from the first 9 months of the year. Lastly, the nature of our business makes it challenging to run rate quarterly performance into any useful trend. Bottom line, the step-down in implied growth to close the year should not be used as a read-through for next year just as Q4 2024 was not indicative of the growth. We are currently on track to deliver for 2025. Next, we are maintaining the range of adjusted EBITDA. As a reminder, the range is between $437 million and $453 million. As evidenced by our year-to-date results, we continue to expect IMS to be the source of the vast majority of profit and margin expansion for the year. Adjusted EBITDA margin at the company level continues to be constrained by increased R&D investment, less favorable program mix and less efficient program execution, including the impact of germanium. The increased adjusted diluted EPS range incorporates a slightly lower effective tax rate. We now expect adjusted diluted EPS between $1.07 and $1.12 a share. Our revised tax rate assumption for the year is 18%, and our other nonoperational assumptions remain static from our prior guidance. Lastly, with respect to free cash flow conversion, we are still targeting an approximately 80% conversion of adjusted net earnings for the full year. Shifting to 2026. We are in the middle of our normal course budgeting process. It's premature to provide specific guidance for next year, but as a team, we are focused on driving continued organic growth and expanding adjusted EBITDA margin. Consistent with past practice, we plan to provide formal guidance in conjunction with our fourth quarter and fiscal year 2025 call in late February. In conclusion, I want to thank the team for their incredible contributions in bringing innovation to solve complex national security challenges, delivering exceptional technologies to our customers and delivering solid financial results for our investors. We will continue to remain focused on rigorously executing our strategy to create value through durable long-term growth. With that, we are ready to take your questions. Operator: The first question today will be coming from the line of Peter Arment of Baird. Peter Arment: Congrats, Bill and John. Bill, thanks for all the support over the years. Really appreciate it. A question on just IRAD spending. Obviously, you're seeing a lot of opportunities up pretty significantly, 35%, I think, in 2025. How do we expect that trending just because of kind of some of the margin performance we've seen at ASC just because some of that is impacting that? How does that trend as we go forward? Michael Dippold: I would expect to see this internal research and development investment kind of stay at this percentage of revenues. I think we're in a more dynamic operating environment where the procurement processes has changed from the department. And I think that we're going to continue these investment levels to provide that agility in order to maintain this growth. Peter Arment: Okay. So that was roughly like mid-3% or so roughly or right around there? Michael Dippold: Yes. I think around there. Yes. Peter Arment: Okay. Helpful. And then just, I guess, any updates on just kind of foreign military sales activity. Obviously, there's a lot of demand signals from Europe. You guys are well positioned. What are you seeing there, Bill? And any opportunities for DRS? William Lynn: Yes. Thanks, Peter. We do think we're going to see a ramp-up in foreign military sales opportunity. We're just at the -- I think, at the start for the force protection, the counter UAS. I think that has a real opportunity. We continue to see demand for our sensors, the EO/IR sensors and for our network computing. And I think given the threat environment, we expect those to continue. And then we are working to develop markets for our naval power and propulsion system, particularly in Asia. Peter Arment: Just last one for me, just on Mike, on the germanium pricing, has things stabilized there? Have you gotten more suppliers or supply lined up for next year? Michael Dippold: Yes, I'll take that out to start and then maybe hand it over to Bill. But first, on the pricing side, as we talked about in our last call, I think we've got 2025 kind of lined out, and there were no real surprises or anything from our last call on the germanium front. We are making some progress in terms of solidifying supply into '26. And I'll hand it over to you, Bill, there. William Lynn: Yes. As Mike said, we're trying to build a structure that supports our revenue flow for optics going forward. And so that involves in the near term, recycling existing germanium from older optics. Over the midterm, we've moved to diversify our supply base with agreements with different suppliers and processors. And basically, we need to move it away from reliance on China. We're seeing success in both those near-term and midterm initiatives, and we think that will put us in a strong position in 2026. Operator: And our next question will be coming from the line of Robert Stallard of Vertical Research. Robert Stallard: Best of luck, Bill, and congratulations, John. First to kick things off, very good quarter for bookings. And I was wondering if there was any unusually large orders that were placed this quarter. And in relation to that, how do you expect these bookings to flow through to revenues? Michael Dippold: Yes. I would say there was an increase in demand that we saw on the counter UAS and short-range air defense programs. So those came in heavy for the quarter, which accelerated some of the bookings results, primarily in the IMS segment. So that was a little bit of a pop there. And then we did see some acceleration just across the board as just the typical flow you see at the government fiscal year-end as September wrapped out. So a little bit plused up. That said, as I look out for the year, I expect to be comfortably ahead of that 1:1 target that we've put out there. We've got a good foundation for that. So we expect the demand to continue and feel good about our bookings number for the year. In terms of the revenue turn, obviously, for us, it's about our funded backlog and how that pulls over into revenue. Bill mentioned in the prepared remarks here that the funded backlog was up 20% year-over-year. And if you look at it sequentially, it's up 7%. So we're feeling good about the foundation we have for 2026, Rob. Robert Stallard: Okay. And then as a follow-up for Bill, you highlighted the extended U.S. government shutdown. If this carries on, what sort of potential risk do you see for DRS from this situation? William Lynn: Yes, Rob, it depends for how long, of course. We're anticipating at least going well into November. And as I said in the prepared remarks, the impact of that length is moderate. As it starts to go longer than that, it's -- the people who pay us and give us the awards aren't there. And so you'll start to see delays in awards and delay in pay. But it would really have to keep going for a longer period, where we're already basically longer than we've ever seen, but it would have to be a historic length before we'd see an impact. Robert Stallard: Okay. And then just one final one for Mike. You said there were some, I think, operating efficiency issues on programs in the quarter. You highlighted germanium. But is there anything else we should be aware of? Michael Dippold: It's primarily germanium. Obviously, with our development programs, we always have a little lower margin when we have that mix. But in terms of the context of the comment, it centers around germanium. Operator: And our next question will be coming from the line of Michael Ciarmoli of Truist Securities. Michael Ciarmoli: Bill, John, congrats. And Bill, thanks for everything over the years. Maybe just back to Peter's question on the margins. I mean you guys had '26 targets out there. You've obviously got this elevated R&D. How do we think about the payback and measuring the return on this R&D? Do we -- should we expect? Do we see new programs, maybe an acceleration of revenue growth off of what you've done this year? Just trying to get a sense of really measuring the payback on the R&D investments. Michael Dippold: Yes. I think the payback on the R&D investments are going to put us in position to attack a lot of those adjacent markets and growth opportunities that we've had. So I think as you think about the kind of new way of procurement and coming to the table with solutions that are already at a higher kind of technical maturity, that's what we're really doing here. And I think it is giving us some good opportunities in the counter UAS domain. I think it's giving us some opportunities here as we look to kind of unmanned surface vessels. So all of these are giving us some additional opportunities to continue the growth that we've seen, and that's really what we're expecting from the IRAD investments at these levels, Mike. Michael Ciarmoli: Okay. Okay. Is that -- you just mentioned counter UAS, and we've heard it a couple of times. Is there any way to sort of quantify or size your exposure at this point to counter UAS programs and maybe size the pipeline of opportunities? You mentioned AUSA. There's certainly a lot of competing companies from new entrants to large-scale primes guys like yourselves, everybody is thrown around new offerings. I mean, can you give us any sense of where your revenues are today or what you think your growth rate is or sort of adoption penetration there? Michael Dippold: Yes. And I think this is one of DRS' nice differentiators is when we talk about counter UAS, that is largely all of our force protection type of revenue that we have there. So we talk about and disclose force protection being about 20% of our revenues. That's largely dominated by the short-range air defense and counter UAS programs. So we have real penetration, which we believe gives us an advantage as we look to the future here. So that's -- think about that kind of in that 18% to 20% range of revenue is all tied to those efforts. John Baylouny: Let me add to that quickly and just say that we're the current provider, the approved provider for counter UAS for the U.S. Army. Our solutions are battlefield tested. We know that our solutions work, and we're always adapting our solutions to the evolving threat. We did see a lot of counter UAS solutions on the AUSA floor, but we distinguish ourselves by having a battle-proven capability. And we're very close to our customer. We understand what they need. We understand where they're thinking. We do expect that counter UAS to kind of expand and proliferate to all echelons of the forces and really all domains. And so we see a real opportunity in the future here is driving innovation and pushing this out new technology. Michael Ciarmoli: Okay. Would you say you're kind of equally exposed to both kinetic and kind of non-kinetic solutions for counter UAS? John Baylouny: Yes. I would say this, Michael. I think that you're going to see both capabilities on the battlefield. It's going to depend on where you are in the Echelon. If you're up in the front -- next to the front, you're going to see some capabilities back in the back at higher echelons, you're going to see other capabilities. DE is going to end up probably at both echelons, but those capabilities are going to be different. So you're going to start seeing the counter UAS market kind of proliferate across all echelons, all different capabilities, and we provide all of that. Michael Ciarmoli: Okay. Okay. Last quick one for me, Mike. Just should we expect the same margin profile in '26 with kind of IMS being the lead engine and some more of that IRAD dampening down the ASC margins? Michael Dippold: Yes, I wouldn't expect the trends to continue. We're not going to go deep into '26 here. But in terms of just the allocation of profit, the investment is going to stay heavy at ASC, and we still feel pretty good about the tailwind that is Colombia as we look into the future. Operator: And our next question will be coming from the line of Kristine Liwag of Morgan Stanley. Kristine Liwag: Bill, congratulations on your retirement. It's been a pleasure to see how you've transformed DRS over the years. And John, congrats on your new role. I guess following up on the supply chain, you guys have called out germanium a few times. So I just wanted to dive a little bit deeper into this. Can you talk a little bit more about your sourcing strategy for this? Like how much inventory do you have? It sounds like you got a little bit better access, but it would be really helpful to understand regarding some sort of time line or some sort of quantity. William Lynn: Yes. Thanks, Kristine. I don't think I can give you precise numbers, but let me give you kind of the approach. We had before anticipating these kinds of issues, bought a buffer stock, which is we are using to transition '25 and support our '25 flow-through. At the same time, we're now actively involved in recycling from older optics and pulling the extracting the germanium and constructing new optics from that. And that's -- now we've seen success in that process, and that will bridge us into '26 and get us partway through '26. And then at the same time, we're involved in developing partnerships with companies in both the mining and the processing area outside of China, so that we have a long-term supply, and that's what gives us confidence that we're going to have a robust '26, and we're going to be able to support our germanium needs with these both midterm and short-term initiatives. Kristine Liwag: Great. And maybe pivoting to a different topic. I mean, in the quarter, you guys made a $15 million investment in Hoverfly. I wanted -- I think you're now at 25% of your equity stake here. I wanted to better understand what's your strategy regarding these unmanned capabilities? Where does this fit into your broader portfolio and strategic vision? Michael Dippold: Yes. I would say the investment with Hoverfly is really kind of key to some of the strategy that we have in terms of making sure we're bringing the best-in-breed technologies to different solutions. We think this tethered capability is going to allow for -- obviously, for elevated sensing, for targeting, potentially for counter UAS. So there's some good applications here for this capability, and that's what fostered the investment. Kristine Liwag: Got you. Great. If I could do a follow-up question. IMS growth was up 34% year-over-year, 32% up sequentially. Can you provide any color on how much of this was driven by the Columbia Class? And were there any other transitions in shipsets that drove this step up? Michael Dippold: I didn't catch what -- the first part of that question, Kristine, I'm sorry. Kristine Liwag: Sorry, on IMS growth, IMS was up 34% year-over-year, up 32% sequentially. Just trying to understand how much of this step-up was driven by Columbia Class or if there were other transitions in shipsets that drove this increase? Michael Dippold: Yes. So a good question. The increase in the revenue -- actually, Columbia has been pretty stable from its revenue output in a quarterly cadence throughout the course of the year. The increase in revenue is really coming from a lot of the short-range air defense and counter UAS programs for the quarter. So that's where the big pop was this quarter. Operator: [Operator Instructions] The next question will be coming from the line of Anthony Valentini of Goldman Sachs. Anthony Valentini: Bill, congrats on a great run. I'm just trying to get a sense for the longer-term growth prospects here. Are there opportunities to take what you guys are doing in propulsion on Columbia to other types of ships and programs? And the primes are talking about significant growth in missiles, which I think are highly dependent on the sensors. You guys have expertise there. So I'm wondering how large the missile business is today for DRS and where that can go over time? Any color really on the large growth vectors would be great. William Lynn: Thanks, Anthony. This is John. Let me start with the ship and the propulsion systems. And absolutely, we are looking and bidding other ship classes, and we have some real progress in that regard, shaping. We believe that we have an advantage in providing energy flexibility on board a ship. It's not obvious, but the more energy, more power a ship has, the further away can fight longer range of radars, longer-range electronic warfare, a longer-range directed energy. And our solutions allow for that capability to be able to direct that energy to different places on the ship. So yes, for sure, we believe that there's opportunity long-term growth for us there. Turning to missiles. DRS has always been a supplier of the best infrared sensing in the industry and other sensors as well. We're really at the top of the food chain. When it comes to missiles, those missiles have to be smarter. They have to have longer range. They have to have greater capability. So we're seeing an increased pull for those higher-performing sensors into that space. And so we're playing at all different levels from the very low-cost, high-volume missiles and effectors all the way to the very high-end missiles and effectors. Operator: And the next question will be coming from the line of Seth Seifman of JPMorgan. Seth Seifman: Congratulations to Bill and to John as well. I wanted to ask, John, you mentioned at the outset the SAGEcore. I wonder if you could talk a little bit about how that fits into the Army's NGC2 plans and the extent to which that can be a growth driver. It seems there's a good amount of funding headed in that direction. William Lynn: Thanks, Seth. Let me step back and talk about the fact that when we see platforms, all platforms are going to end up having to think for themselves. They're going to have to sense for themselves and think for themselves. At the end of the day, those platforms that are at the edge of the battle space, whether it's land, sea or air, are going to have disrupted communications in battle. So those -- the computing resources for those platforms to think about what's happening on the battle space has to be on the platform, has to be at the edge. And so this is where we're putting our energy. This is where we're putting a lot of our money is to build out that capability. The connectivity from the platform up to the enterprise we'll be there at certain times and some of the enterprise capabilities will play there. But those platforms have to think. So this is part of NGC2, next-generation C2 program with the Army is being able to build out a capability on the platform, not just to communicate but also to think. And so we're adding the AI capability. And now with the SAGEcore, it's really the DRS' operating system, which we're going to place on to those computing resources at the edge that allow those platforms to think for themselves, to fuse the sensing information to have AI to understand what's going on in the edge and to be able to make sense and act on the information. So that's where SAGEcore fits into the program, not just for the Army's platforms, but we're also using it in the sea for USVs. We're also putting in other air platforms and in space as well. Seth Seifman: Excellent. Excellent. And as a follow-up, if we could just talk about IMS and on the Colombia, kind of what shipset you're up to? Or maybe a different way of saying it is, how far up the curve are we in terms of when you've got kind of to a place where pricing has kind of stabilized? Michael Dippold: Yes. And we've talked about Colombia in the past that we're always kind of working on 3 different shipsets simultaneously in terms of our revenue base. What happened in 2025 is we will start to pretty much retire the second chipset, which was bid at a lower price point. So subsequent to 2025, we'll be at a cadence where all of the new ship and revenue base associated with the different ship classes will be negotiated after the design was materially complete after the inflation impacts to labor and materials. So we should see more consistent margin output from Colombia starting in 2026 with one more year of margin expansion. And then the little asterisk I'd put on that is before we see the margin benefit from the South Carolina facility and think about that impact starting in 2027. Operator: Our next question will be coming from the line of Andre Madrid of BTIG. Andre Madrid: Congrats to Bill and John. I wanted to talk again about Hoverfly. Great to see the up investment there. Is this something that fits into your previously outlined M&A criteria? Michael Dippold: Yes. I would say that when we're talking about M&A, we're looking at different aspects of that, whether they're joint ventures, partnerships, minority investments. And certainly, with this capability having the ability to assist us in elevated sensing to bring our sensors through from a network perspective, I think that this kind of checks the boxes that we were looking at from an M&A perspective, and it's certainly strategic to where DRS is headed. Andre Madrid: Got it. Got it. That's helpful. And then I wanted to follow up on the C-UAS work that you guys are doing. Could you maybe talk a bit more about the margin profile of that work and if it's generally accretive or dilutive to IMS? Michael Dippold: Yes. We don't get into the marginality of this particular programs, but it's the same customer set. It's in line with the rest of our portfolio. There's no anomalies here from a drag or from a tailwind perspective. Operator: And our next question will be coming from the line of Ronald Epstein of Bank of America. Alexander Christian Preston: This is Alex Preston on for Ron today. First of all, I just wanted to echo the congratulations to both Bill and John. I wanted to circle back on the government shutdown. Obviously, 3Q bookings are really strong. You guys mentioned there's not a ton of material impact at this point. But I'm wondering if you're seeing any slowness in the contracting environment? And if so, where? I think, for instance, we might have expected Golden Dome awards to be maybe a little more firmed up by now given reconciliation funding is to be spent. There's contract vehicles in place. Curious if you have any commentary on that. William Lynn: Yes. As I said, it would take a while before this would catch up to influencing things like that. It would through -- think of things like testing to prove systems out, but those schedules are generally pretty far out. And so we haven't really seen much more than modest impact yet. And it would have to go much closer to the end of the year before we'd see that. Alexander Christian Preston: Okay. And then just as a quick follow-up, we've noted -- a bunch of us have noted the strength in counter UAS bookings and revenue this quarter. Just curious if you could characterize more on where the demand is coming from. I know you mentioned there's particular strength in the U.S. Army, there's foreign military sales involvement. Just curious if you could provide any color on the split there. John Baylouny: Yes. I think that's where the demand is coming from for sure. We are seeing demand coming from really all over. We're seeing demand coming from the Army for sure, and that's evident in the bookings. We're seeing demand coming from Navy, Marines as well in the U.S. Air Force has also plagued with this problem. We're seeing progress there in demand building and some bookings there as well. And of course, direct commercial and international FMS sales as well. There's demand coming from all avenues, as you might imagine, due to the changing nature of warfare. Operator: And our next question will be coming from the line of Jon Tanwanteng of CJS. Jonathan Tanwanteng: Bill, congratulations on your retirement, and John and Fran on their appointments. My first question is, if you could drill just a little bit more into the germanium supply, that would be helpful. You mentioned bridging into the future with the recycling and then the alternative supply. But do you expect to be constrained in the coming quarters as your stockpile falls off and then maybe catch up later in the year? Or how do you expect that to shape up? Does -- do the programs that you have in line fill 100% of the supply right out of the gate or does it take time to get there? William Lynn: We think we have a plan, Jon, that does bridge from the '25, where I think we've taken account of the supply restrictions and price increases. And we have it planned into '26 with the different initiatives that I mentioned. So we're feeling comfortable as to where we are. Jonathan Tanwanteng: Okay. Great. That's helpful. And then second, is the price on these alternative supplies significantly higher than what you're seeing in the market? And does that further impact the ASC margin as we go forward? How should we think about the profitability there as you ramp these alternative sources? Michael Dippold: Yes. I would say that, as you know, we're largely a fixed price shop. So the higher pricing is certainly going to be inherent in those programs as we look into 2026. Jonathan Tanwanteng: Okay. Got it. One last one, if I could. Just any changes to thoughts on capital allocation? You obviously did the Hoverfly investment, you did some share repurchases, but any thoughts on capital allocation and use of cash going forward? William Lynn: Yes. I mean, as we've said that we want to have a balanced capital allocation strategy. So we've instituted a dividend this year. We have a moderate buyback, but our priority continues to be seeking out M&A opportunities that meet both our strategic and financial criteria. In that, we've exercised patience. We've looked at a lot of things. We are doing the Hoverfly this quarter, as we mentioned. We're looking at larger investments as well. But you should expect going forward to see more M&A, but a balanced strategy as well. Operator: And our next question will be coming from the line of Austin Moeller of Canaccord. Austin Moeller: Just my first question here. You've talked about recycling germanium from older optics. It sounds like you're going to get additional legs on your supply beyond Q1 '26, which is I think what you discussed last time for your visibility. Have you looked into alternative like glass-based solutions like BlackDiamond glass potentially to replace the germanium just given it has less temperature sensitivity and better supply? William Lynn: We -- you're correct. We are looking at alternative materials. It's particularly relevant for smaller optics where you can replace germanium with other. And that is part of the portfolio of solutions we're pursuing. And that one is in the early stages, but we are seeing success there as well. Austin Moeller: Okay. And just a follow-up. If we -- I know we're in a shutdown here, but if we think about the opportunity for Golden Dome and when do we start to get RFPs and contracts for that, do you have any sense of the timing next year? And there's also like your partner, AeroVironment has been testing per UAS solutions at Grand Forks in North Dakota. John Baylouny: Let me take the Golden Dome part of that. For sure, we're seeing a lot of activity on Golden Dome. While the architecture is not yet public, we certainly see movement. You're probably aware of the SHIELD RFI -- RFP that I think 1,500 companies bid, including DRS. We do expect that to move forward very quickly. I think that we see opportunity here, not just in the space sensing, but also in the underlayer and also in the over-the-horizon radar area. So we believe that, that's going to move forward and general [ recruit ] lines moving forward very quickly. On the counter UAS front, we see a lot of activity in counter UAS, including Leonardo's activity. And I think that just to go back to the points about the fact that we are the ones that are solving this problem for the Army. We have battle-proven technology. We've proven our capability, and we're following the threat, making sure that we're ahead of the threat and very close to our customer. Operator: Thank you. I would now like to turn the call over to management for closing remarks. Please go ahead. Stephen Vather: Thank you, Lisa, and thank you all for your time this morning and your interest in DRS. As usual, if you have any follow-up questions, please call or e-mail me. We look forward to speaking with all of you again soon. Enjoy the rest of your day. Operator: This does conclude today's program. Thank you all for participating. You may now disconnect.
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Bank of America Downgrades Leonardo DRS to Neutral, Shares Drop 5%

Leonardo DRS (NASDAQ:DRS) shares fell more than 5% intra-day today after Bank of America downgraded the company to Neutral, citing that the stock's current valuation already reflects much of its potential upside.

While DRS has delivered strong performance, including an 82% year-over-year growth in backlog and securing its largest recompete contract, BofA believes there are better near-term opportunities in the market, particularly in companies with a stronger focus on capitalizing on increased global defense spending and Navy-centric initiatives.

BofA acknowledged that DRS’ new South Carolina facility, which will support the Columbia-class submarine program, is expected to enhance profitability and efficiency, but the benefits are unlikely to be realized until operations begin in 2026.

Until significant progress is made in the Columbia-class program or growth materializes from other defense contracts, BofA sees limited room for further stock appreciation at the current valuation.

The analysts highlighted the AUKUS submarine partnership between Australia, the US, and the UK as a long-term growth opportunity for DRS, but BofA believes the current stock price already factors in much of this potential.

Bank of America Downgrades Leonardo DRS to Neutral, Shares Drop 5%

Leonardo DRS (NASDAQ:DRS) shares fell more than 5% intra-day today after Bank of America downgraded the company to Neutral, citing that the stock's current valuation already reflects much of its potential upside.

While DRS has delivered strong performance, including an 82% year-over-year growth in backlog and securing its largest recompete contract, BofA believes there are better near-term opportunities in the market, particularly in companies with a stronger focus on capitalizing on increased global defense spending and Navy-centric initiatives.

BofA acknowledged that DRS’ new South Carolina facility, which will support the Columbia-class submarine program, is expected to enhance profitability and efficiency, but the benefits are unlikely to be realized until operations begin in 2026.

Until significant progress is made in the Columbia-class program or growth materializes from other defense contracts, BofA sees limited room for further stock appreciation at the current valuation.

The analysts highlighted the AUKUS submarine partnership between Australia, the US, and the UK as a long-term growth opportunity for DRS, but BofA believes the current stock price already factors in much of this potential.

Leonardo DRS, Inc. Showcases Strong Q1 2024 Financial Performance

Leonardo DRS, Inc. Kicks Off 2024 with Strong Financial Performance

Leonardo DRS, Inc. (NASDAQ:DRS) kicked off the first quarter of 2024 on a high note, as detailed in their recent earnings conference call. The company, under the leadership of Chairman & CEO Bill Lynn and CFO Mike Dippold, reported a remarkable 21% year-over-year revenue growth, which was entirely organic. This growth is a testament to the company's strong market positioning and its ability to meet the evolving needs of its customers. The financial metrics shared, including a 1.2 book-to-bill ratio and bookings worth $815 million, underscore the company's robust performance and the high demand for its offerings. Furthermore, the record backlog of $7.8 billion, an 84% increase from the previous year, along with a 43% increase in adjusted EBITDA, highlights the company's solid foundation for sustained growth.

On the strategic front, Leonardo DRS's commitment to innovation and technology differentiation is evident in its significant investments in research and development (R&D) and capital expenditures (CapEx). These investments are crucial for maintaining the company's competitive edge in the defense technology sector. The company's diverse and platform-agnostic portfolio, which aligns well with customer priorities, has played a pivotal role in achieving these impressive results. This strategic focus not only enhances Leonardo DRS's market positioning but also contributes to its strong financial performance.

Operationally, Leonardo DRS reported strong demand across its portfolio, especially in areas such as advanced infrared sensing, tactical radars, and air defense systems, with notable interest from international customers. The domestic market also showed robust demand, particularly for naval network computing and electric power and propulsion technologies. These operational highlights reflect the company's ability to cater to a wide range of defense technology needs, further solidifying its market position and growth prospects.

Despite the company's strong performance and optimistic future outlook, DRS's stock price experienced a decrease of approximately 4.65%, trading at $20.52. This decline might seem counterintuitive given the company's strong Q1 achievements and strategic advancements. However, stock prices can be influenced by a variety of factors beyond a company's immediate performance, including market sentiment and broader economic conditions. The trading session saw fluctuations between $19.88 and $21.225, indicating some volatility in the stock's price. Over the past year, DRS's stock has seen highs and lows, ranging from $24 to $14.12, with a current market capitalization of around $5.39 billion. This volatility in stock price, despite the company's solid performance, highlights the complex nature of stock markets and the importance of long-term investment perspectives.

In conclusion, Leonardo DRS, Inc. has demonstrated a strong start to 2024, with significant financial achievements and strategic advancements that position it well for continued growth in the defense technology sector. The company's focus on innovation, technology differentiation, and aligning with customer priorities are key drivers of its success. Despite the recent dip in stock price, the company's solid fundamentals and optimistic future outlook suggest a promising path ahead.