Executive Summary / Key Takeaways

• Leonardo DRS delivered a strong start to 2025, exceeding expectations with 16.1% organic revenue growth in Q1, driven by robust demand across its Advanced Sensing and Computing (ASC) and Integrated Mission Systems (IMS) segments.
• The company's total backlog reached a record $8.6 billion as of March 31, 2025, providing significant revenue visibility, with approximately 50% tied to long-term U.S. Navy electric power and propulsion programs like the Columbia Class submarine.
• DRS possesses differentiated technology in critical defense areas, including advanced sensing, network computing, force protection, and electric power/propulsion, leveraging capabilities like AI integration, directed energy, and high-efficiency power systems to address evolving threats and modernization priorities.
• Operational execution, particularly on the high-margin Columbia Class program, is driving profitability expansion, contributing to a Q1 2025 operating margin of 7.4% and Adjusted EBITDA margin of 10.3%, with management targeting approximately 14% Adjusted EBITDA margin by 2026.
• The company is maintaining its full-year 2025 guidance, projecting 6% to 9% revenue growth and Adjusted EBITDA between $435 million and $455 million, supported by strong bookings (1.2 book-to-bill in Q1) and improved supply chain predictability, while actively managing risks like supply chain volatility and program execution.

A Defense Technology Powerhouse Aligned with Modern Priorities

Leonardo DRS, Inc. stands as a critical provider of advanced defense technologies, strategically positioned at the intersection of evolving global threats and the urgent need for military modernization. Incorporated in 1968, the company has built decades of expertise, particularly in sensing and naval systems, which form the bedrock of its current focus areas: advanced sensing, network computing, force protection, and electric power and propulsion. This focused strategy aims to create a balanced and diversified portfolio, reducing vulnerability to single program or budgetary shifts, while aligning with the U.S. Department of Defense's (DoD) highest priorities.

The global threat environment remains elevated, marked by conflicts in Ukraine and Israel and increasing competition from near-peer adversaries. This backdrop necessitates higher and prolonged defense investment from the U.S. and its allies, driving demand for next-generation strategic capabilities and the modernization of existing platforms. DRS's platform-agnostic approach and specialized technologies are designed to meet these complex mission needs across land, air, sea, space, and cyber domains.

In the competitive landscape, DRS operates alongside defense giants like Lockheed Martin (LMT), Raytheon Technologies (RTX), Northrop Grumman (NOC), and General Dynamics (GD). While these larger primes often command greater scale, broader market reach, and higher overall profitability margins (e.g., LMT's 2024 gross margin ~18% vs. DRS's TTM gross margin 22.66%, though direct comparison requires segment-level detail), DRS differentiates itself through agility, specialization, and cost efficiency in its core niches. For instance, DRS's focus on cost-effective solutions like uncooled infrared systems or its hybrid electric propulsion systems may offer lower operating costs per unit compared to more complex alternatives from competitors. The company's ability to rapidly develop and field capabilities, such as the directed energy counter-drone system developed in just eight months, highlights an operational tempo that can set it apart. However, DRS faces challenges from the scale and established relationships of larger competitors, as well as potential vulnerabilities in its supply chain compared to the more diversified networks of larger primes.

Technological Edge Addressing Critical Missions

DRS's investment thesis is deeply intertwined with its differentiated technology portfolio. In Advanced Sensing and Computing (ASC), the company develops capabilities spanning the electromagnetic spectrum, from long-range electro-optic/infrared (EOIR) and signals intelligence (SIGINT) to next-generation tactical radars. A key focus is enhancing sensor performance – increasing distance, precision, clarity, and spectral depth – while optimizing size, weight, power, and cost. The acquisition of RADA significantly bolstered its tactical radar offerings, which are now in high demand for counter-UAS and short-range air defense. The company is also pushing into new sensing modalities like over-the-horizon radar and expanding infrared sensing into smaller platforms like tactical drones.

Network computing is another critical ASC area, providing rugged, cyber-resilient systems for battlefield management, command and control, and tactical communications. DRS recently delivered its 100,000th Mounted Family of Computer Systems (MFoCS) to the U.S. Army and is modernizing systems like the Paladin howitzer's weapons control. Innovation here includes integrating edge AI processing into sensors and launching a high-performance AI Processor (AIP) designed for real-time threat detection and situational awareness in military vehicles. This processor is engineered to handle massive battlefield data, enabling AI-aided target recognition. The company is also developing an Open Operating System Architecture software offering for sensing modality fusion and exploring advanced cooling techniques to support increasing shipboard computing density driven by AI and other intensive applications.

In the Integrated Mission Systems (IMS) segment, DRS is a leader in electric power and propulsion for the U.S. Navy, providing systems for top-priority programs like the Columbia Class submarine. This technology offers operational advantages like reduced acoustic signature and lower fuel costs, while also addressing the dramatically increasing power demands of future platforms (e.g., DDG DX requiring 40 MW) driven by advanced sensors and directed energy weapons. The ongoing construction of the 140,000 sq ft Charleston, SC facility, supported by a $45 million Navy investment commitment, is central to expanding capacity and capabilities, particularly for steam turbine systems, to support increased shipbuilding throughput and position DRS for future naval programs. Force protection is another key IMS area, where DRS integrates systems for short-range air defense and counter-UAS. The rapid development of a directed energy counter-drone capability, successfully downing Class 1, 2, and 3 drones at a distance in just eight months, exemplifies DRS's agility and ability to integrate new threat defeat mechanisms.

For investors, these technological differentiators represent a significant competitive moat. They align DRS with enduring defense priorities, create opportunities in growing adjacent markets, and provide a basis for securing sole-source or follow-on contracts. While R&D investment (increasing about 20 bps as a percentage of revenue in 2025) impacts short-term margins, it is crucial for maintaining this technological edge and driving long-term growth and profitability.

Performance Reflecting Strategic Alignment

DRS's recent financial performance underscores the effectiveness of its strategy and operational execution. The first quarter of 2025 saw total revenue climb 16.1% year-over-year to $799 million. This growth was broad-based, with ASC revenue increasing 18.0% to $511 million and IMS revenue rising 11.5% to $291 million. This top-line expansion flowed through to profitability, with total operating earnings up 37.2% to $59 million. ASC operating earnings grew 31.6% to $25 million, while IMS operating earnings saw a significant 36.0% increase to $34 million. This resulted in operating margin expansion in both segments, reaching 4.9% for ASC and 11.7% for IMS in Q1 2025.

Profitability in Q1 2025 was also boosted by efficient execution, notably on the Columbia Class program within IMS, which saw favorable contract adjustments related to risk retirement milestones. However, ASC margins faced pressure from increased internal R&D spending and the escalating cost of germanium, exacerbated by a discrete supplier issue on an international program. Management addressed this with a Q1 adjustment and is implementing mitigation strategies like incorporating economic price adjustment clauses in future contracts.

The increase in revenue was primarily fueled by the conversion of the company's growing backlog. Bookings remained strong, totaling $991 million in Q1 2025, resulting in a 1.2 book-to-bill ratio and marking the 13th consecutive quarter above one. This consistent order intake has pushed the total backlog to a record $8.6 billion, providing substantial revenue visibility for years to come, particularly with approximately 50% tied to long-term naval programs.

Liquidity remains solid. While Q1 2025 saw net cash used in operating activities ($138 million), this was a significant improvement from Q1 2024 ($265 million used), driven by better working capital management, including customer advances. The balance sheet is in a net cash position, enabling a more balanced capital allocation strategy. This includes maintaining M&A as the top priority for value creation, supplemented by the initiation of a cash dividend ($0.09 per share declared in Q1 2025) and a modest $75 million share buyback program authorized over two years to mitigate dilution.

Outlook and Forward Momentum

DRS is maintaining its full-year 2025 guidance, projecting revenue between $3.45 billion and $3.525 billion, representing 6% to 9% year-over-year growth. Adjusted EBITDA is expected to be between $435 million and $455 million, with Adjusted Diluted EPS in the range of $1.02 to $1.08. The company targets an 80% free cash flow conversion of adjusted net earnings. This outlook is supported by the robust backlog and management's expectation of continued strong demand and improved supply chain predictability, although the timing of material receipts remains a key variable influencing quarterly revenue linearity.

Management anticipates IMS will contribute more significantly to margin expansion in 2025, primarily driven by the continued progression of the high-margin Columbia Class program. While ASC margins were pressured in Q1, the impact of the germanium issue is expected to be largely contained to that quarter, with prospective mitigation efforts in place. The increased investment in IRAD is expected to continue, aligning with the administration's focus on agility and rapid prototyping.

Looking further ahead, DRS remains committed to its multi-year targets, including achieving mid-single-digit revenue growth annually from a higher base and reaching approximately 14% Adjusted EBITDA margin by 2026. This confidence is rooted in the company's alignment with enduring defense priorities, its differentiated technology roadmap, and the operational leverage expected from increased volume and program execution improvements, particularly on major programs like Columbia Class and the ramp-up of the Charleston facility.

Risks and Considerations

While the outlook is positive, investors should consider potential risks. The dynamic political environment and the operation under a full-year continuing resolution for FY 2025, despite increased flexibility, could still impact program funding, leading to potential delays or cancellations. Supply chain volatility, particularly for critical components like germanium, remains a concern, potentially affecting costs and delivery schedules, although DRS is implementing mitigation strategies. Program execution risk exists, as highlighted by past delays on specific integration programs, which can impact profitability. Furthermore, while international demand is growing, geopolitical factors and export license requirements can introduce uncertainty. Competition from larger, more diversified players could also limit market share gains in certain areas.

Conclusion

Leonardo DRS has established itself as a vital player in the defense technology sector, leveraging its deep expertise and differentiated capabilities in advanced sensing, network computing, force protection, and electric power and propulsion. The company's strategy is clearly aligned with the evolving needs of the U.S. military and its allies, as evidenced by its record backlog and consistent book-to-bill ratio above one. Despite facing challenges related to supply chain volatility and program execution, DRS has demonstrated strong operational performance, driving significant revenue growth and profitability expansion, particularly through the successful execution of the high-priority Columbia Class program. With a clear technological roadmap, strategic investments in key growth areas like AI integration and directed energy, and a commitment to balanced capital allocation, DRS appears well-positioned to continue capitalizing on the robust demand environment. The company's maintained 2025 guidance and long-term margin targets underscore management's confidence in converting its strong market position and technological edge into sustained value for shareholders, making DRS a compelling consideration for investors seeking exposure to the defense modernization theme.