Executive Summary / Key Takeaways

• Robust Growth and Record Backlog: Leonardo DRS (DRS) demonstrated strong financial performance in the third quarter of 2025, with double-digit revenue and profit growth, driven by vigorous customer demand and a record total backlog of $8.91 billion. This backlog provides significant revenue visibility, with approximately 50% tied to long-term U.S. Navy electric power and propulsion programs.
• Technological Leadership in Critical Domains: The company is a specialized provider of advanced defense technologies, excelling in areas like counter-UAS, advanced infrared sensing, electric power and propulsion, and network computing. Strategic investments in AI-driven solutions like SAGEcore and advanced cooling technologies for high-density computing underscore its commitment to innovation.
• Strategic Alignment with Defense Priorities: DRS's portfolio is closely aligned with key U.S. and allied defense initiatives, including layered air defense, shipbuilding throughput, missile production, and electronics modernization, benefiting from substantial funding tailwinds such as the "One Big Beautiful Bill Act" and increased NATO defense spending.
• Disciplined Execution Amidst Challenges: Despite macroeconomic complexities, including supply chain constraints (e.g., germanium availability and pricing volatility) and potential impacts from government shutdowns, DRS maintains disciplined program execution and is actively mitigating risks through diversification and contractual adjustments.
• Balanced Capital Allocation: The company has adopted a balanced capital allocation strategy, initiating a cash dividend and a $75 million share repurchase program, while prioritizing value-additive mergers and acquisitions to further expand its capabilities and market reach.

A Specialized Powerhouse in a Dynamic Defense Landscape

Leonardo DRS, Inc., established in 1968, has evolved into a critical supplier of defense electronics products, systems, and military support services for over 55 years. The company's strategic transformation under former CEO Bill Lynn, who led from 2012 until his announced retirement effective December 31, 2025, has reshaped its portfolio to align with enduring areas of demand within the U.S. national security apparatus and its allies. This strategic focus has positioned DRS as a specialized player, concentrating its capabilities in advanced sensing, network computing, force protection, and electric power and propulsion. The U.S. Department of Defense (DoD) remains its largest customer, accounting for approximately 81% of total revenues for the nine months ended September 30, 2025, underscoring its deep integration into national defense priorities.

The global threat environment remains elevated, driving a sustained increase in U.S. and allied defense investments. This backdrop creates significant tailwinds for DRS, particularly with the "One Big Beautiful Bill Act" enacted in July 2025, authorizing an additional $150 billion in mandatory defense-related funding, with approximately $113 billion earmarked for fiscal year 2026. The U.S. House of Representatives further passed the Fiscal Year 2026 Department of Defense Appropriations Act, providing for approximately $832 billion in discretionary defense spending. These legislative measures significantly shape the funding outlook and directly benefit DRS's strategic initiatives.

DRS operates through two primary segments: Advanced Sensing and Computing (ASC) and Integrated Mission Systems (IMS). The ASC segment focuses on real-time situational awareness through advanced sensing and network computing technologies, including electro-optic/infrared (EOIR), signals intelligence (SIGINT), electronic warfare (EW), tactical radars, and space sensing. Its offerings are complemented by rugged, trusted, and cyber-resilient network edge computing products. The IMS segment specializes in power conversion, control, and distribution systems, ship propulsion, force protection, and transportation systems, notably providing next-generation electrical propulsion for the U.S. Navy's Columbia Class submarine program.

Technological Edge: Innovation Driving Competitive Moats

DRS's core investment thesis is deeply rooted in its technological differentiation and relentless innovation, which create significant competitive advantages. In the Advanced Sensing and Computing segment, DRS is advancing sensor distance and enhancing the precision, clarity, definition, spectral depth, and effectiveness of its sensors. This is often achieved in combination with artificial intelligence (AI), enabled by its advanced edge processing solutions.

A key technological differentiator is SAGEcore, an integrated operating system that brings AI, advanced sensor, and edge computing together in a single deployable solution for tactical platforms across multi-domain environments. This platform is designed for real-time battlefield operations, optimized to run AI on ruggedized edge computers, and engineered to rapidly process complex data on-platform, ensuring high-speed threat detection and decision support. Complementing this, the company released THOR, a 4-plus-1 multifunction network computing product with electronic warfare, onboard crypto, and tactical WiFi capabilities, supporting the Army's next-generation C2 initiative with a Zero Trust, cost-effective solution for tactical computing at the edge. These innovations directly address the DoD's need for greater situational understanding and secure data sharing at the tactical edge.

In electric power and propulsion, the IMS segment is a leading provider of next-generation electrical propulsion systems for the U.S. Navy, particularly for the Columbia Class ballistic missile submarine. DRS's high-efficiency, power-dense permanent magnet motors, energy storage systems, and associated efficient, rugged, and compact power conversion and electrical actuation systems are critical. These technologies are designed to meet the needs of an increasingly electrified fleet, offering significant operational advantages such as energy flexibility, longer combat ranges for radars and electronic warfare, and the ability to support directed energy weapons. The company's proprietary Ice Piercer cooling technology is also gaining traction, enabling greater computing density in constrained platforms, which is crucial as AI and other intensive applications drive increased shipboard processing requirements.

DRS's commitment to R&D is evident in its increased internal research and development expenditures, which contributed to higher general and administrative expenses in the nine months ended September 30, 2025. These investments are directed towards maturing capabilities like directed energy counter-UAS systems, demonstrating space sensing capabilities, and integrating its technologies into unmanned aerial and surface vessels. The company's infrared sensing products, critical for dismounted and ground combat vehicle applications, are also being designed into next-generation missile systems, representing a new, greenfield opportunity for DRS to leverage its world-class sensor expertise.

Financial Performance and Operational Momentum

Leonardo DRS delivered strong financial results for the third quarter and nine months ended September 30, 2025, reflecting robust demand and disciplined execution. For the three months ended September 30, 2025, revenues increased by 18.2% year-over-year to $960 million, while for the nine months, revenues grew by 14.9% to $2.588 billion. This growth was primarily fueled by continued backlog expansion across both operating segments, particularly in force protection, electric power and propulsion, and advanced sensing activities. Gross profit saw a significant increase, rising by 24% to $222 million for the three months and by 19.8% to $600 million for the nine months ended September 30, 2025. This led to an expansion in gross margin by 110 basis points and 100 basis points, respectively, driven by favorable revenue mix and efficient execution on Columbia Class programs. Operating earnings also demonstrated strong growth, increasing by 24% to $93 million in Q3 2025 and by 28.3% to $222 million for the nine-month period. Net earnings followed suit, growing by 26.3% to $72 million in Q3 2025 and by 41.9% to $176 million for the nine months. Diluted EPS reached $0.26 for Q3 2025 and $0.65 for the nine months, up 23.8% and 41.3% respectively.

The IMS segment emerged as a significant growth engine, with quarterly revenue up 34.4% to $383 million and operating earnings increasing by 54.8% to $48 million in Q3 2025. Its operating margin expanded by 120 basis points to 12.50%, largely due to operational leverage from higher revenue and continued program improvement on the Columbia Class submarine program. The ASC segment also posted healthy revenue growth of 8.8% to $580 million in Q3 2025, though its operating margin saw a slight contraction due to increased internal R&D investments and general and administrative expenditures, as well as the impact of higher germanium costs.

Bookings remained robust, totaling $1.307 billion in Q3 2025, resulting in a strong 1.4x book-to-bill ratio for the quarter. Year-to-date bookings reached $3.151 billion, with a book-to-bill ratio of 1.2x. This exceptional bookings performance propelled the total backlog to a record $8.909 billion as of September 30, 2025, an 8% increase year-over-year. Funded backlog also saw remarkable growth of 20% year-over-year. Approximately 50% of the total backlog is attributed to long-term electric power and propulsion programs with the U.S. Navy, providing substantial revenue visibility for up to 15 years.

From a liquidity perspective, DRS generated $77 million in free cash flow for Q3 2025, a significant increase over the prior year, driven by improved net profitability and better working capital efficiency. Net cash used in operating activities decreased by $113 million to $59 million for the nine months ended September 30, 2025, primarily due to lower cash used to fund working capital. The company's balance sheet is in a net cash position, enabling a balanced capital allocation strategy that includes a recently initiated cash dividend of $0.09 per share and a $75 million share repurchase program over two years, alongside its primary focus on value-additive M&A.

Competitive Positioning and Strategic Responses

DRS operates in a highly competitive defense sector, contending with larger, more diversified prime contractors such as Lockheed Martin Corporation (LMT), RTX Corporation (RTX), Northrop Grumman Corporation (NOC), and General Dynamics Corporation (GD). While these competitors boast greater scale, broader portfolios, and often faster innovation cycles due to larger R&D budgets, DRS carves out a specialized and critical niche through its focused technological expertise and operational agility.

DRS differentiates itself through its emphasis on tailored electronic warfare solutions, advanced sensing, and power systems. For instance, its integrated mission systems for ground, air, and sea applications offer specialized capabilities, particularly in hybrid electric propulsion for submarines, which can provide more efficient power distribution and reliable performance in prolonged missions compared to traditional solutions. DRS's leadership in counter-UAS solutions is a prime example, where its battlefield-tested and constantly iterated offerings, including cutting-edge electronic warfare systems, have earned it first place in DoD competitions. This contrasts with the broader, often platform-centric approaches of larger primes.

The company's high proportion of fixed-price contracts, representing 88% of its revenue for the nine months ended September 30, 2025, is a significant competitive advantage. This aligns well with the new administration's focus on speed, innovation, efficiency, and best-in-class technology, often favoring fixed-price models. DRS's rigorous understanding of risk management and ability to deliver innovative capabilities affordably positions it favorably against competitors who may be less accustomed to such contract structures.

DRS is also strategically addressing vulnerabilities. The challenge of germanium availability and pricing, a critical raw material for its infrared sensing products, is being mitigated through a multi-pronged approach including utilizing safety stock, recycling initiatives, diversifying its supply base outside of China, and incorporating economic price adjustment clauses into future contracts. This proactive stance aims to de-risk future programs from price volatility and secure a robust supply chain by 2026. Furthermore, the Navy's interest in DRS becoming a second source for steam turbine generators, addressing a critical choke point in submarine production, highlights DRS's growing strategic importance within the industrial base.

Outlook and Key Risks

Leonardo DRS has revised its full-year 2025 guidance upwards, reflecting strong year-to-date performance and continued customer demand. The company now expects revenue in the range of $3.55 billion to $3.6 billion, implying 10% to 11% year-over-year growth. Adjusted EBITDA is maintained in the range of $437 million to $453 million, with the IMS segment expected to drive the vast majority of profit and margin expansion. Adjusted diluted EPS is projected between $1.07 and $1.12 per share, based on a revised effective tax rate of 18%. The company remains committed to an approximately 80% free cash flow conversion of adjusted net earnings for the full year.

The outlook is underpinned by several key assumptions: the passage of FY 2025 appropriations, a stable supply chain, and the continued strong demand for DRS's differentiated technologies. The variability in the timing and level of material receipts by year-end is identified as the single most important factor influencing revenue output. Management anticipates that the improved quarterly linearity observed in 2025 will continue, meaning a step-down in growth in Q4 compared to the first nine months, which should not be interpreted as a read-through for 2026.

Despite the positive outlook, several risks warrant investor attention. The ongoing U.S. government shutdown, if protracted, could lead to delays in contract awards and payments, impacting operations and financial position. Geopolitical conflicts, particularly in Israel and the broader Middle East, pose potential disruptions to DRS's Israeli operations, though no material impact has been observed to date. Inflationary pressures on supply chain costs, especially for micro-electronics and commodities, continue to be a concern, potentially affecting profitability if not fully mitigated through contractual adjustments. While germanium supply is being actively managed, its volatility remains a risk.

Conclusion

Leonardo DRS stands as a compelling investment opportunity within the defense sector, distinguished by its deep technological expertise, strategic alignment with critical national security priorities, and a proven track record of disciplined execution. The company's robust financial performance in 2025, marked by double-digit growth and a record backlog, underscores the strength of its core investment thesis. With a leadership transition underway, incoming CEO John Baylouny is poised to continue the strategic trajectory, leveraging DRS's innovative capabilities in advanced sensing, electric power and propulsion, and counter-UAS to address evolving global threats.

The company's commitment to R&D, coupled with its balanced capital allocation strategy, positions it for sustained long-term growth and enhanced shareholder value. While macroeconomic and supply chain challenges persist, DRS's proactive risk mitigation strategies and strong competitive positioning, particularly its fixed-price contract expertise, provide resilience. Investors should recognize DRS as a specialized defense powerhouse, strategically positioned to capitalize on the increasing demand for advanced defense technologies and to deliver consistent performance in a dynamic global environment.