Leonardo DRS - Earnings Call - Q1 2025

Executive Summary

• Q1 2025 revenue was $799M (+16% YoY) and adjusted EBITDA was $82M (+17% YoY), with adjusted diluted EPS of $0.20 (+43% YoY); bookings were $991M (book-to-bill 1.2x) and backlog reached a record $8.6B.
• Results were well ahead of internal expectations, aided by favorable timing of material receipts late in the quarter; management maintained full-year 2025 guidance across all metrics.
• Versus Street: DRS delivered a broad beat—Revenue $799M vs $736.7M consensus*, Adjusted EPS $0.20 vs $0.165*; EBITDA $82M vs $78.1M*; management guided Q2 revenue “around $825M” and margin “mid‑11%,” supporting improved linearity into H2.
• Catalysts: sustained demand in electric power & propulsion (Columbia program), counter‑UAS directed energy demonstrations, AI processor launch, and backlog strength; near-term watch items include ASC margin pressure from germanium costs and tariff-related volatility.

What Went Well and What Went Wrong

What Went Well

• Organic demand and execution: “Our first quarter results meaningfully surpassed our expectations… robust bookings… backlog increased to $8.6 billion”.
• IMS margin expansion: IMS adjusted EBITDA grew 38% with 260 bps margin expansion on favorable contract adjustments and Columbia Class risk retirements.
• Capital return and outlook: Initiated dividend and buybacks; management reaffirmed 2025 guidance and added Q2 color (revenue ~$825M; margin mid‑11%) supporting improved quarterly linearity.

What Went Wrong

• ASC margin pressure: ASC margin fell 130 bps YoY to 8.2% due to a sole‑source optics supplier disruption and higher germanium costs; backlog was reset, with margin “pop back” expected but at a lower baseline.
• Cash usage still negative: Net cash used in operating activities was ($138M) and free cash flow was ($170M), though materially improved YoY due to collections timing and profitability.
• International timing headwind: Management noted a Q1 dip in international revenue due to delivery timing; Q1 growth skewed domestic.

Transcript

Operator (participant)

Ladies and gentlemen, good day and welcome to the Leonardo DRS First Quarter, Fiscal Year 2025, Earnings Conference call. At this time, all participants are in a listen-only mode. Following the company's prepared remarks, there will be an opportunity to ask questions, and instructions will be given at that time. As a reminder, this event is being recorded. I would like to now turn the conference over to Steve Vather, Senior Vice President of Investor Relations and Corporate Finance. Please go ahead.

Steve Vather (SVP of Investor Relations and Corporate Finance)

Good morning and thanks for participating on today's Quarterly Earnings Conference call. Joining me today are Bill Lynn, our Chairman and CEO, and Mike Dippold, our CFO. They'll 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 also make forward-looking statements during the call regarding future events, anticipated future trends, and 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?

Bill Lynn (Chairman and CEO)

Thanks, Steve. Good morning and welcome, everyone, to the DRS Q1 earnings call. Our first quarter results reflect a solid start to the year and meaningfully surpassed our expectations. Strong, steadfast customer demand continued to materialize across our broad and differentiated portfolio. We secured a healthy level of bookings that totaled nearly a billion dollars in the quarter, which translated to a 1.2 book-to-bill ratio. Demand remains well-diversified throughout the business. In Q1, we saw particular order strength for advanced infrared sensing, electric power and propulsion, tactical radars, laser systems, and force protection technologies. It's also worth noting that this marks the 13th consecutive quarter with a book-to-bill above one, a trend that has resulted in our backlog pushing to new company records. As a result, that backlog increased to $8.6 billion, which is up on both a year-over-year basis and a sequential basis.

Furthermore, in Q1, we saw remarkable organic growth of 16%, profit expansion, and improved cash flow. Material receipts pulled into the quarter to drive revenue growth well above our forecast. Overall, we anticipate this will translate into better quarterly linearity for the year on revenue and profit. As you know, we have been focused on driving more balanced quarterly distribution and achieving our full-year financial results. In addition to solid operational performance, we commenced execution of our capital return initiatives with the payment of our first dividend and initial stock repurchases against the authorization announced last quarter. All in all, our strong results in Q1 laid a nice foundation for the year, but we are maintaining a vigilant posture amidst a more dynamic operating environment that has emerged over the past few months. Let me share some more color on our perspectives with respect to the macro conditions.

We are in a unique situation as our customers are now operating under a full-year continuing resolution for FY2025. What is different from prior CRs is the DOD's ability to initiate new program starts. Congress also provided greater funding execution flexibility and a higher reprogramming authority threshold. As of now, we have not seen any significant changes to customer procurement behavior, and the leading indicators reinforce the durability of demand. Additionally, we are still targeting a total company book-to-bill above one in 2025. Looking ahead, we are expecting that the FY2026 President's Budget request will likely be released over the next month or so. As I've mentioned on prior calls, historically, the most relevant and predictive variable for future U.S. defense spending growth is the global threat environment. Unfortunately, it remains elevated and largely unchanged, which will maintain pressure on the need for higher investment for the foreseeable future.

We also anticipate that the FY2026 request will provide incremental clarity in the funding allocations for the administration's key priorities. DRS continues to be well-positioned and closely aligned to important national defense initiatives focused on enhancing the lethality, effectiveness, and affordability of critical capabilities. Our customers are expanding their investments in layered air defense and counter-UAS, improving shipbuilding throughput, and more broadly, modernizing technology embedded on combat platforms to deter and contest near peers. We are leveraging our core strengths to actively address each of these secular themes. Next, while the implementation for most of the tariffs announced last month has been temporarily postponed, I still want to discuss the potential implications. Overall, as a pure-play defense technology company, we expect relative insulation from direct impacts related to tariffs. As a reminder, our customer base is largely U.S. defense in nature.

Our geographic footprint is principally in the U.S., with the exception of operations in Canada and Israel. Lastly, our direct supply chain is predominantly comprised of U.S.-based companies. That said, we are keeping a watchful eye on any derivative impacts on the business and are instructing our suppliers to identify any tariff-related costs so that we can pursue remedies from our customers should the need emerge. Secondly, China's increasing restriction on export of rare earth minerals to the U.S. also has limited impact on DRS. For us, the key rare earth reliance is on germanium, as it is an important element in our infrared sensing products. Since the initial restrictions went into effect in mid-2023, we have taken mitigating actions to ensure our raw material suppliers had diverse sources.

However, in the quarter, we discovered that a sole-source optics supplier on an international program was unable to execute on our existing purchase orders. That placed us in an unfavorable position of absorbing increased costs as we rectified the issue with alternative germanium sources. Outside of this discrete supplier issue, there have not been significant challenges with respect to supply to date, but pricing has certainly become more volatile. This supplier challenge that emerged in Q1, combined with the incremental cost escalation of germanium, has been incorporated into our forward estimates and pressured quarterly ASC profitability. We have a steadfast priority on continuously enhancing program execution resilience across the business and are broadening the scope of our focus amidst the more dynamic backdrop. Shifting to operations, we are making steady progress in several key areas. First, improving and expanding shipbuilding is a key national priority.

Our customers' behavior reflects an incredible urgency. We are working to expedite the completion of our Charleston, South Carolina, facility, as well as rapidly deploy the submarine industrial base investment announced last quarter to reinvigorate our steam turbine capability. Additionally, we are in ongoing conversations with customers on how to expand our role in supporting better overall throughput. Separately but related, we are seeing new incremental domestic opportunities emerge for our electric power and propulsion technologies. We won't disclose the specific program names for competitive reasons, but nonetheless, this is an exciting development should these opportunities come to fruition. In the quarter, we also successfully demonstrated our electric propulsion capability on a medium unmanned surface vessel, proving the versatility of our technology as the Navy potentially considers a higher mix of unmanned naval platforms moving forward. Now to counter-UAS.

We are maturing the previously discussed directed energy capability through rigorous customer testing. The multiple rounds of results support the feasibility of near-term operational deployment to augment existing air defense systems. Additionally, we are actively working with partners to explore the integration of our counter-UAS technologies into other domains and platforms, including the maritime arena, to generate incremental growth. Next, in the quarter, in partnership with best-in-class commercial technology partners, we announced the release of our AI processor. This AI processor is designed to quickly deliver real-time threat detection, situational awareness, and advanced mission processing into combat vehicles. This processor integrates with AI algorithms and is engineered to process massive amounts of battlefield data to deliver actionable intelligence and also enable AI-aided target recognition.

We are also investing to advance our own software offering that will serve as an open operating system architecture to enable the management and fusion of multiple sensing modalities. Similarly, we predict that AI and other intensive applications will only drive growth of shipboard processing requirements. As a result, we are seeing customer appetite build for our advanced cooling techniques that enable greater computing density. Last but certainly not least, our infrared sensing remains in high demand across domains, from dismounted to ground combat vehicles to missiles. On the latter, we are being designed into a number of next-generation missile systems to provide our differentiated infrared capability. The diversity and breadth of our technology portfolio is a distinguishing characteristic of DRS and is facilitating multiple avenues for future growth. As I mentioned at the outset, I'm pleased with the nice start to the year.

Our Q1 financial performance provides us confidence in executing on our 2025 outlook. Clearly, the operating environment is significantly more dynamic compared to last year, and this has required us to leverage our agility to navigate through new complexities. That said, DRS remains well-positioned to enduring defense priorities. We are maintaining a sharp focus on delivering critical innovation at speed, efficiently, and in an affordable manner. With that, let me turn the call over to Mike, who will walk you through our financials in further detail.

Mike Dippold (CFO)

Thanks, Bill. I would echo that we are off to a solid start to the year across our key financial metrics. Overall, the quarter was well ahead of our expectations. In Q1, revenue growth was 16% and ended up being meaningfully above the framework we laid out on the last call. This was mostly due to the favorable timing of material receipts. Late in the quarter, we saw some supplier deliveries pull left by just a few days, which materialized as a sizable tailwind to Q1. Let me reiterate, this will mostly help drive improved quarterly linearity in 2025. Taking a closer look at the quarter, the most notable drivers of growth were programs related to ground and naval network computing, as well as offerings in tactical radars and electric power and propulsion.

From a segment perspective, the programmatic increases to network computing and tactical radars spurred quarterly ASC revenue growth of 18%. IMS revenue was also up nicely at 11%, with growth evident across the segment. Strong contribution from both electric power and propulsion, as well as force protection programs, were visible in the quarterly IMS revenue output. Now to adjusted EBITDA. Adjusted EBITDA in the quarter was $82 million, representing 17% growth from the last year. Adjusted EBITDA margin in Q1 was 10.3%, which represents 10 basis points of year-over-year margin expansion. The slight margin expansion was primarily as a result of favorable net contract adjustments and higher volume. Shifting to the segment view, ASC adjusted EBITDA increased by 2%, but margin declined by 130 basis points, primarily due to negative contract adjustments in the segment.

As Bill mentioned earlier, the discreet cost growth from the sole-source supplier on the infrared sensing program, as well as the broader impact of greater germanium costs on our remaining backlog, hampered profitability in the quarter. IMS adjusted EBITDA was up 38%, and margin expanded by 260 basis points, which was well beyond what we anticipated. Embedded in our baseline plan for the segment was the continued progression of Columbia Class and some operational benefit from increased volume, which both occurred in the quarter. However, incremental to our expectations was the recognition of favorable contract adjustments as a result of risk retirement milestones reached on Columbia Class. Onto the bottom-line metrics. First quarter net earnings were $50 million, and diluted EPS was $0.19 a share, up 72% and 73% respectively.

Our adjusted net earnings of $54 million and adjusted diluted EPS of $0.20 a share were up 42% and 43% respectively. Strong organic operational performance combined with a reduced effective tax rate and a lower interest burden drove the favorable year-over-year compare. While the Q1 tax rate was lower due to excess tax benefits on equity compensation, we still anticipate a normalized full-year tax rate of 19%. Moving to free cash flow, our cash usage in the quarter was significantly lower than this time last year, thanks to increased net profitability and enhanced working capital efficiency, partly aided by favorable timing and quarterly cash collections from customers. Our capital expenditures in the quarter were approximately 4% of revenue, in line with our expectations discussed on the last call. Overall, the year-over-year free cash flow improvement in Q1 supports better line of sight into achieving our full-year outlook.

With only one quarter behind us, we are maintaining our 2025 guidance across our metrics. We delivered a solid Q1, but the more dynamic operating backdrop offers both puts and takes that we are still evaluating. As a quick refresher, we expect the following for the full year: revenue in the range of $3.425 billion-$3.525 billion, implying a 6%-9% year-over-year growth. Material receipts will continue to be the biggest factor influencing revenue output. We are operating with significant backlog visibility, but a small portion of book-to-bill revenue still remains. Our adjusted EBITDA range is expected to be between $435 million-$455 million. At this time, we expect IMS to offer more growth and margin improvement opportunity relative to ASC. Adjusted diluted EPS remains in the $1.02-$1.08 per share range.

The underlying assumptions on tax rate and fully diluted share count remain consistent at 19% and 270 million shares respectively. Also, we are still targeting 80% free cash flow conversion of adjusted net earnings for the year. Lastly, let me frame up what we are seeing for the second quarter. At this time, we are expecting revenue to trend around $825 million, with adjusted EBITDA margin likely in the mid-11% range. I'll wrap up with some quick thoughts. We have an exceptional team. Our strategy is sound, and we are well-positioned for long-term success. We are focused on capturing and converting significant demand into strong, continued organic growth. Additionally, we are keeping a steadfast focus on program execution to deliver value for customers and our commitments to shareholders. With that, we are ready to take your questions.

Operator (participant)

Thank you. At this time, we will begin the question-and-answer session. As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. One moment for questions. Our first question comes from Michael Ciarmoli with Truist Securities. You may proceed.

Michael Ciarmoli (Senior Research Analyst)

Hey, good morning, guys. Thanks for taking the call. Our questions, nice results. Hey, Mike or Bill, I guess you talked about material receipts and pulling some work left. Can you maybe talk specifically to what programs? Was that more on the shipbuilding, the propulsion side, and then any color you can give on international growth in the quarter? Was that a contributor?

Mike Dippold (CFO)

I'll take that one, Mike, and appreciate the question. The material acceleration and the impact of the revenue was really more holistic across the board. We've seen some good supplier deliveries. Our on-time deliveries have been improving. We saw some acceleration. Again, not a lot. It pulled forward a week or so, and that really impacted the revenue for the quarter. A good result there, good confidence in the supply chain right now. That's what drove the overperformance on that side. The increase from the year-over-year revenue has really been actually on the domestic side. The international, as you'll see when the Q is released, is actually a little dip for the quarter just from some of the timing from certain deliveries to actually to support Ukraine. The international was a little headwind for the quarter.

I don't anticipate that perspectively, but for Q1, it was a domestic growth story.

Michael Ciarmoli (Senior Research Analyst)

Okay, got it. Just piecing this together quickly here on the fly, I think you just said $825 million revenue to Q. I mean, the low end of the guidance, that would imply second half maybe flat, almost down, I think, year-over-year. I mean, is that just, is there anything, you talked about supply chain? We've got the good kind of demand backdrop looking to above one. Anything we should read into, just kind of leaving the door open for maybe the unknowns on tariff trade, if at all, anything materializes there?

Mike Dippold (CFO)

I think you should think about it a little differently. I would say that we're continuing to push and improve linearity across the business, and I think you're seeing that materialize. Even if you kind of throw the Q1 results in the Q2 framework, our H2 guide would then say we're going to be somewhere between flat to up 6% on the top line and still showing a margin expansion in the 50 to 80 basis point range. If you look back into 2024, it's relatively consistent with what we started to see in Q4 of 2024, right? You saw the acceleration of revenue growth pull in as we improved our linearity. On the back end, you started to see the quarters not have the same robust growth. I think you're going to see that trend materialize here in 2025 as well.

Michael Ciarmoli (Senior Research Analyst)

Okay, perfect. Last one for me. Just any concern going forward on that ASC margin? Should we expect a snapback, or is that program now going to be running at a lower margin given the measures you had to take with that challenge supplier?

Mike Dippold (CFO)

Yeah, no, good question. Yeah, what we did here is we took the adjustment in Q1 to kind of reset the backlog for the remainder of the program. The lion's share, the impact is going to be in Q1, and then you'll have obviously a lower gross margin perspectively, but that will be mitigated, and you'll see a popback.

Michael Ciarmoli (Senior Research Analyst)

Okay, perfect. I'll jump back in the queue. Thanks, guys.

Operator (participant)

Thank you. Our next question comes from Seth Seifman with J.P. Morgan. You may proceed.

Alex Bilichenko (Managing Director of Mergers & Acquisitions)

Yeah, hey, guys. Thanks for the question. This is Alex on for Seth. Maybe I wanted to kind of ask at a higher level in terms of the margin expectations for this year. Obviously, Q1 came in a little bit lower at 10.3% versus the full-year guide implies a 12.8% margin. I understand last year we kind of saw a similar dynamic where the margin started lower before kind of increasing as the year went on. Curious kind of if you guys could help us walk through the puts and takes here. I imagine Columbia is a pretty big driver of the expected margin expansion. Maybe if you could kind of put a finer point on it and help us understand that bridge a little bit better.

Mike Dippold (CFO)

Yeah, Alex, the bridge is going to be a little more simple than that. What you're going to see, because we period expense our G&A, the volume matters in terms of the drop-through on the EBITDA margin percentage. As our revenue increases quarter-over-quarter, you'll start to see the margin have that impact of that additional operational leverage. That is what's really going to drive it in terms of if you're looking at the sequential quarter projections.

Alex Bilichenko (Managing Director of Mergers & Acquisitions)

Got it. Okay, that's helpful. Maybe as a second question, kind of a bigger picture question. I know you guys talked about expediting the investments in the Charleston facility. Another thing we kind of saw related to shipbuilding earlier this week is these plans for this reconciliation bill. I think there's expected to be $34 billion of funding for shipbuilding. Kind of just thinking about, is there any opportunity, at least with the Charleston facility, to maybe get DRS more involved on kind of the current classes of ships, given all this kind of funding going into them, going into shipbuilding right now? Just kind of curious about maybe how DRS could be involved in that as well.

Bill Lynn (Chairman and CEO)

Yeah, I'll take that, Alex. We do see opportunity there. I mean, you should look at this as a step. We've got the Columbia Class program, which is the original justification for Charleston, and that continues to increase both in terms of volume and margin. We also now have an investment from the Navy to expand our content, in particular to become a second source on the steam turbine generators. We're just in the process now of developing the design for that, and that will phase in over the next several years. Beyond that, we're in discussion with the Navy about further investments they might make and further support we might give to the expanded throughput, particularly of Virginia Class submarines, which is a lot of the focus of that reconciliation bill that you mentioned, as well as the administration's priorities.

We think we're in negotiation to have a participation in that through a Navy investment. Much of that would come through Charleston.

Alex Bilichenko (Managing Director of Mergers & Acquisitions)

Got it. That's super helpful. Thank you, guys.

Operator (participant)

Thank you. Our next question comes from Jon Tanwanteng with CJS Securities. You may proceed.

Jon Tanwanteng (Managing Director)

Hi, good morning. Thank you for taking my questions. A really nice quarter. I was wondering if you could just talk a little bit about the guidance. You obviously did much better in Q1. Some of that was pulled in, obviously, but the full year was unchanged. I was wondering, does that give you more cushion for the year, or is that really an offset from higher inputs and tariffs and things like that?

Mike Dippold (CFO)

No, Jon, I think of it as our continued thrust on that improved linearity. I think that's what we're doing. We're pulling some things left here. Still have that, as I mentioned earlier, still have the kind of 0%-6% growth on the second half and still have the lion's share of the margin expansion on the back end. I would say it's less conservatism and more our continued thrust to have more linear operations quarter-over-quarter.

Jon Tanwanteng (Managing Director)

Got it. Understood. As we hear rumors of potentially up to or approaching a $1 trillion defense budget, how do you expect your share of that to evolve? I know you've previously said that you expect to grow ahead of the defense budget. I'm wondering if that still holds true in the current environment and given what priorities are at the DOD today.

Bill Lynn (Chairman and CEO)

Yeah, I mean, Jon, obviously, we don't have a budget yet, but I think the trends are good. As you say, they're talking about a trillion dollars. I assume that means 050, in other words, beyond defense. That would still mean a meaningful increase in the defense budget year-over-year and over the original Biden program. That's reinforced by the talk about an up to $150 billion front-loaded add in the reconciliation bill. I think the general trends are up. We think the priorities of the new administration, as they've been demonstrated in that reconciliation bill, that was a congressional, and then in the Hegseth Memo and other comments that are coming from the new administration, I think they overlap strongly with our core markets in shipbuilding and force protection, the nuclear triad represented by Columbia.

We feel like we are well-positioned for this growth and to take our share of it.

Jon Tanwanteng (Managing Director)

Okay, great. Last one. I just wanted to focus on a comment you mentioned about being integrated into next-generation missile systems. Is that a market that you've traditionally had a lot of exposure to? Can you just size the opportunity that's ahead of you?

Bill Lynn (Chairman and CEO)

For us, that's a little bit more of an adjacent market. We have a core capability in sensors. We're world-class in terms of sensors. Moving that capability into missiles is something that we're in the midst of doing, and we see it as sort of a new opportunity, a greenfield for us. As the sensing capabilities of missiles, the accuracy of missiles continues to increase, we think that we can provide the technology to do that.

Jon Tanwanteng (Managing Director)

Okay. Just to be clear, this is more of a greenfield opportunity for you, and you do have design wins in this arena.

Bill Lynn (Chairman and CEO)

Yes, exactly right.

Jon Tanwanteng (Managing Director)

Okay, great. Thank you.

Operator (participant)

Thank you. Our next question comes from Ron Epstein with Bank of America. You may proceed.

Good morning, everyone. This is [Marianne Allen] for Ron today.

Michael Ciarmoli (Senior Research Analyst)

How are you doing?

Bill Lynn (Chairman and CEO)

Good morning, Marianne.

My question is going to be the first one on Europe. As these European countries build up their own defenses and they try to do their own domestic systems, how exposed are you and how big is the opportunity for you as a subsystem provider?

I think there's a substantial near-term opportunity, Marianne. I think in certain systems like counter-drone force protection, some of our advanced sensing programs, we're pretty far ahead, particularly when you're talking about production. I think that as they want to increase their capabilities and their capacities in those areas, they're going to turn to companies like ours. Over time, I think that may evolve into a competition as they use some of their new resources to develop organic capabilities. I think that's down the road.

Thank you. A follow-up on the Navy opportunity. As you become a clear competitor or a clear alternative to actually increase the throughput with more outsourcing, with dual-source alternatives, even with opportunities for higher volumes with commercial opportunities in some cases, how fast you could see those opportunities play out? What is your sense of the Navy actually or that money actually spreading down the supply chain? How much ahead or how much involvement you should have as this administration asks for some skin in the game or commercial terms? Are you thinking about internal R&D to actually support and go forward and try to capture these opportunities?

That's a complex question. Marianne, on the last part there, we're already 85% fixed price. We're, I think, already much closer to the commercial model that they're talking about. We know how to operate in that environment. We have been increasing our IR&D, our organic investment, and we've been pushing it more towards things like developing prototypes of different capabilities. I think we are already positioned in, we're already doing what they're talking about doing. We're less of a cost-plus shop and less of a response, just a pure response to requirements. With things like the directed energy capability for counter-UAS, we try and be proactive and get ahead of customer needs and demonstrate them.

On the first part of your question in terms of the competition in the naval area, if you're implying that that's going to be a threat to the shipyards and the Navy, I don't think that's right. I think this is an enabler for the shipyards. Their overwhelming desire, and it's what their customer wants, is to increase that throughput. To do that, they're going to have to diversify the work and push more into the suppliers like ourselves so that they can produce more submarines faster rather than more content on each submarine. Things like us doing integration and testing more of it before we ship to the yards, I think are the kinds of initiatives that the Navy is looking for, and I think the yard very much supports. I think this is a collaborative enterprise.

It's not something where we're trying to take share from the yards.

Great. Just a quick follow-up on that one. In the investor day, you guys shared that you have exposure and you work with the Korean Navy. Through these alternative, I don't know, shipyards or help too for the Navy to have not only more throughput but improve the maintenance of current ships and stuff, do you have any exposure through those alternative channels?

We're engaged right now in supporting a new ship class for the Korean Navy, and we're competing to put our electric power on the next frigate class. We don't have yet to have a response to our proposal on that. Yes, we're engaged with the international customers, particularly in Korea. I don't know how this debate's going to go in shipbuilding, but I think we do have that kind of knowledge and exposure of the international customer.

Thank you so much.

Operator (participant)

Thank you. Our next question comes from Andre Madrid with BTIG. You may proceed.

Andre Madrid (VP and Aerospace and Defense Analyst)

Hey, good morning, everyone.

Bill Lynn (Chairman and CEO)

Morning.

Mike Dippold (CFO)

Morning.

Andre Madrid (VP and Aerospace and Defense Analyst)

I want to ask, I understand that you guys are kind of staying on with the dividend and the buybacks as you had kind of signaled last quarter, but I want to revisit the M&A environment, see what you guys are seeing there, and get your sense if that's still on the table from a cap deployment perspective.

Bill Lynn (Chairman and CEO)

Yeah. No, Andre, we did initiate the dividend and the buyback, and we'll continue through on that. The priority still for the balance sheet strength that we have is M&A. Despite the kind of a little bit of disruption in the market, we are still seeing a robust pipeline. We're seeing opportunities that are strategically attractive, and we're in the process of doing diligence on those without anything at this point to announce. We're actively engaged in the process side and the diligence side, and it remains the top priority we have for capital allocation.

Andre Madrid (VP and Aerospace and Defense Analyst)

Got it. Got it. I guess pivoting back now to tag on another question here, but I can't help but ask, given the adjustment you took this quarter to reset for the germanium impact on the sole source contract, is there a point in time where this problem might creep up again? How much leeway does this provide us, I think? It seems like we're set for through the balance of the year, but is there the possibility that this might resurface beyond? I know you have several years' worth of supply of germanium in inventory, but still.

Mike Dippold (CFO)

Yeah. The way I think I would look at this is what we did in Q1 was adjust for the new pricing mechanisms and getting the advanced germanium to this supplier and took that for our backlog. I think the important thing to note is perspectively, what we have been doing is including economic price adjustment clauses in our future contracts in order to kind of mitigate the risk here of price volatility. The customer has been willing to have those conversations. We're putting those clauses in place. I think it becomes about backlog, and I think we largely have it contained here because we have pricing commitments now on those backlogs. We have schedule commitments and supply commitments for that.

I think we largely have it if you couple in the fact that we're going to be including these clauses prospectively to give us some reopener relief in case there continues to be volatility in pricing.

Andre Madrid (VP and Aerospace and Defense Analyst)

That's good to hear. That's good to hear. How frequently are those repriced or, I guess, renegotiated?

Mike Dippold (CFO)

What we're looking at right now is to start to include that in all of the programs that are beyond our funded backlog. We're having conversations in real time to modify existing options, modify existing IBIQ placements that are coming perspectively. We're really taking an aggressive stance here to make sure we get that reopener ability in as quickly as possible.

Andre Madrid (VP and Aerospace and Defense Analyst)

Got it. Got it. Mike Dippold, appreciate it as always. Thanks.

Bill Lynn (Chairman and CEO)

Thanks, guys.

Mike Dippold (CFO)

Thanks.

Operator (participant)

Thank you. Our next question comes from Karl Oehlschlaeger with Vertical Research Partners. You may proceed.

Karl Oehlschlaeger (VP of Global Aerospace and Defense)

Thanks, guys. Maybe this one's for Mike. On ASC, you had this charge of the raw materials, I guess, and you think you've worked through it, but has that, sort of excluding that charge, is there a new kind of lower baseline expectation of margin there versus what you kind of thought going into the year?

Mike Dippold (CFO)

I think if you're looking at our overall margin expansion for the year, we've always thought it was going to be skewed towards the IMS segment because of the strength of Columbia. I think that that remains. I think you're going to see the overwhelming majority of the margin expansion coming out of the IMS segment. The ASC segment, obviously, this will be a headwind to the overall margin for the year. If you think about where we were in our last call, we were talking about incremental investment on the IRAD front. The overwhelming increase in the IRAD is also coming from ASC. When you think about the kind of segment-over-segment outlook for 2025, I think that the IMS segment's going to be the driver in terms of the margin expansion while ASC kind of hangs more in line with where they were last year.

Karl Oehlschlaeger (VP of Global Aerospace and Defense)

Okay. And then just kind of follow up on cash, I guess, for revenues, and you did a good job of kind of improving the linearity. And cash too was as bad as it had been because of the outflows you've had in the past in Q1. Is Q2 and Q3 going to be kind of similar to what you've had in the past, though, or it's sort of more of a break-even and then a pretty big Q4?

Mike Dippold (CFO)

Yeah. I think, yes, the trend line's going to be similar. We accelerated some cash into Q1. I think some of that Q1 overperformance was some accelerated payments we received from certain customers. I think when you're looking at Q2's cash, we probably won't get to that same break-even level that we were in last year. We probably have a little bit still on the negative side, just giving back a little bit of the overperformance we had in Q1. Trend line's the same, just making our incremental benefits in the overall linearity, and I think you saw that in Q1.

Karl Oehlschlaeger (VP of Global Aerospace and Defense)

Okay. And then maybe this one's for Bill. This $150 billion that's getting talked about, the shipbuilding angle was discussed a bit, but maybe give a little bit more color on other opportunities within that, like this Golden Dome's a big portion. When you think about that $150 billion, do you think you have a bigger share of that $150 billion than you do of the overall budget? Is it just kind of skewed better towards DRS than kind of the overall budget that the U.S. has?

Bill Lynn (Chairman and CEO)

Hard to say because we haven't seen a new budget from the administration, but I think I said at the outset, we do think the broad priorities that are reflected in that reconciliation bill towards shipbuilding you mentioned, towards force protection, counter-UAS, the support for the Golden Dome where we think we have multiple options at the lower end in counter-UAS and the sensing end with things like over-the-horizon radar. In the space, we're competing. I think that the Tranche 3 is going to be part of Golden Dome. It looks that way anyway. We're competing in that area with our space sensing capabilities. We think we align with multiple dimensions of this reconciliation bill.

Karl Oehlschlaeger (VP of Global Aerospace and Defense)

Okay. Thanks, guys.

Operator (participant)

Thank you. Our next question comes from Kristine Liwag with Morgan Stanley. You may proceed.

Yeah. Hey, this is Justin on for Kristine this morning. Thanks for taking the questions. Bill, one for you. It looks like the Secretary of Defense is pushing for a pretty big transformation of the army with new details trickling out this week. Just wanted to ask to what extent you see any risks or opportunities here for some of the changes announced, given the service accounts for about a third of your revenue base.

Bill Lynn (Chairman and CEO)

Yeah. No, I mean, we feel that where we're headed with the army is going to, they're going to have to look at longer-range sensors given the threat, given what you've seen in Ukraine. As you look at Indo-Pac, you're looking at longer ranges. We think our core sensing capability is going to be even more valuable. We think as they make adjustments, we feel good about the platform-agnostic position we have. If they make adjustments that pull back on certain new platforms, they're still going to have to have improved sensing and computing. That means legacy upgrades. It means putting them in autonomous vehicles. It's easy for us to pivot to those new platforms and support putting the modern capabilities in those. We think we're well-positioned against those army priorities.

Obviously, even as they reduced the force structure in the last administration, they increased the part of the force structure that was dedicated to air defense and counter-UAS systems. It's that kind of alignment we think is going to continue in this administration. That kind of priority is going to pass through as we see the new budget.

Got it. Super helpful. Maybe just another quick one. A couple of peers have called out marginally slower contracting activity in recent weeks. Are you seeing any evidence of this? The press release called out sort of no change to customer behavior, and bookings were quite healthy. Just trying to square some of the commentary we're seeing across the space. Thanks.

Mike Dippold (CFO)

Yeah. I really can't comment on other companies. We obviously exceeded our expectations on bookings. We did not see customer demand. We saw it not only did we not see it flagged this quarter, we saw it increased. We had nearly $1 billion in bookings, which was higher than we had in our plan.

Great. I'll leave it there. Thanks.

Bill Lynn (Chairman and CEO)

Thank you.

Operator (participant)

Thank you. As a reminder, to ask a question, please press star one one on your telephone. Our next question comes from Jan Engelbrecht with Baird. You may proceed.

Jan Engelbrecht (Senior Research Analyst)

Good morning, Bill, Mike, and Steve. Congrats on another good quarter. A lot has been talked, obviously, about the supplementals, the funding, and the strong expected 2026 budget requests. Would you say that there's any increased confidence from your side to pursue high-growth opportunities and perhaps self-fund product development, just given the signals that you've seen by the new administration in terms of hardware support and just the areas that you play in?

Mike Dippold (CFO)

I think what we see is we want to continue the path that we were on. We've been increasing our CapEx. We talked about on an earlier question the support that gives the submarine and the Navy, a shipbuilding industrial base. We want to increase our IRAD, and we try and translate that into proactive moves with the customers, supporting, for example, the directed energy capability on counter-UAS. We're already heavily fixed price. We're, I think, in the kind of commercial terms that the new administration has talked about. We've been moving in that direction for a couple of years. I think what we want to do is continue steps down that same path. I'll just add on to what Bill's saying here is for the quarter, we increased our IRAD by about 40% compared to the prior year.

We are making the investments in areas, as we discussed on last call, to get our mission equipment package on unmanned surface vessels, getting it on robotic combat vehicles. We do think we're going to have to be agile in terms of to fulfill the procurement desires of getting things in the hands of the war fighters faster, getting innovative tech quicker. We're making the investments to make that a reality. You started to see that immediately here in the Q1 numbers with that uptick in our IRAD spend.

Jan Engelbrecht (Senior Research Analyst)

Great. Thanks, Thanks, Mike. Mike, just a quick follow-up, perhaps an easy one. Just on interest expense, just the cadence for the year, we obviously saw it looks like $1 million for this quarter, much lower than prior quarters. Just how should we think about that for the rest of 2025?

Mike Dippold (CFO)

Yeah. There is likely going to be a tailwind from lower interest expense that carries into the full year. We wanted to see another quarter or so play out before we took that to the bench. We do believe, given our cash position, what we've seen from an improved cash linearity perspective, that even with the capital allocation we implemented, we probably will see a lower interest burden than we did in the prior year.

Jan Engelbrecht (Senior Research Analyst)

Good. Thanks, Mike. I'll jump back in with you. Appreciate it.

Mike Dippold (CFO)

Thanks.

Bill Lynn (Chairman and CEO)

Thank you.

Operator (participant)

Thank you. At this time, I will turn the floor back to Steve Vather for any closing remarks.

Steve Vather (SVP of Investor Relations and Corporate Finance)

Thank you all for your time this morning and your interest in DRS. Of course, if you have any follow-up questions, please do not hesitate to contact me. We look forward to speaking to you all again soon. Enjoy the rest of your day.

Operator (participant)

Thank you. This concludes today's conference. You may disconnect now. Thank you for your participation.