Leonardo DRS Third Quarter 2026 Earnings Call - LEONARDO DRS INC

Explicit Guidance:

• Full-Year 2026 Revenue: Raised and narrowed to $3.95 billion – $3.985 billion, implying 8%–9% organic growth year-over-year.
• Full-Year 2026 Adjusted EBITDA: Raised to $545 million – $555 million (previously $425M–$540M).
• Full-Year 2026 Adjusted Diluted EPS: Raised to $1.50 – $1.53.
• Full-Year 2026 Tax Rate: Updated assumption to 13% (implied Q4 effective rate of ~19%).
• Full-Year 2026 Capital Expenditures (CapEx): Expected to approximate 4% of revenue, remaining elevated in Q4.
• Full-Year 2026 Free Cash Flow (FCF): Targeting 75% conversion of adjusted net earnings; Q4 expected to remain the strongest FCF quarter.
• Full-Year 2026 Share Count: Unchanged at 269 million shares.
• Acquisition Impact: The pending acquisition of RAFT (expected Q4 close) is excluded from 2026 results; expected to be accretive to adjusted diluted EPS in the first full year of ownership.
• 2027 Outlook: Formal guidance to be released in February 2027; company targets a low double-digit growth profile for 2027 (including RAFT), with a "muted" margin expansion rate compared to 2026's performance.

Business-Segment Outlook:

• Integrated Mission Solutions (IMS): Expected to maintain mid-to-high teens margins (approx. 16%) as a run rate; driven by strong execution in naval power, counter-UAS, and operational leverage.
• Advanced Systems & Components (ASC): Expected to deliver accelerated margin expansion in Q4 and 2027; growth driven by favorable mix from tactical radars and counter-UAS programs.
• Tactical Radars: Identified as a primary growth engine expected to outpace the overall framework in 2027, driven by a $500 million contract (JIAIDA-401) and global demand for distributed sensing.
• Electric Power Propulsion: Anticipated demand growth from the Navy and allies as ships shift to integrated electric architectures; KDDX win serves as a proof point for future U.S. Navy adoption (new classes, unmanned surface vessels).
• Space: Projected 100% budget growth (FY27 request); focus on sensing, missile warning (TRON 3), and software-defined communications; executing on multiple payloads and OTAs.
• Commercial Nuclear: Pipeline existing for instrumentation and controls on both large-scale and small modular reactors (SMRs); viewed as a potential growth area for future instrumentation and safety controls.

Market and Competitive Outlook:

• Counter-UAS/Drone Ecosystem: Market shifting from "exquisite" centralized systems to distributed, low-cost tactical radars; demand seen across Middle East, Eastern Europe, and Indo-Pacific.
• Threat Landscape: Proliferation of low-cost drones driving a need for high-volume, low-cost interceptors and sensors; "one-way" vectors blending with missile threats.
• Naval/Indo-Pacific: Growing demand for deeper missile magazines and onboard power to support directed energy and electronic warfare at range; expectation that future ship classes will adopt full-electric architectures.
• International Expansion: Accelerating demand for sovereign capability; establishment of DRS-UK to serve European markets and facilitate local content/production; seeing licensing interest in Europe.
• Competition: Acknowledges competition exists but notes high demand signals and market share gains; views RAFT acquisition as a key differentiator to integrate AI/software with fielded hardware.

Macro / Industry Outlook:

• Defense Budget: Confident in sustained and growing demand despite current Continuing Resolution (CR) uncertainty; views the FY27 budget request as highlighting bipartisan priorities in drones, space, and shipbuilding.
• Geopolitics: Global security complexity (Ukraine, Indo-Pacific, Middle East) viewed as persistent, driving continued investment in security solutions.
• Supply Chain: Implementing AI-driven supply chain visibility; utilizing strong balance sheet to procure materials in advance of contracts to mitigate shortages (referencing lessons from "Germanium" shortage); building in-house capacity.
• Regulatory/Political: Confident that defense investment priorities will remain bipartisan regardless of election outcomes or CR extensions.

Strategic Initiatives:

• RAFT Acquisition: Pending acquisition of RAFT expected to close in Q4 2026; aims to add AI-focused mission software, data fusion, and command & control capabilities; expected to be margin- and revenue-accretive.
• Capacity Expansion:
  • DRS-UK: Established to serve European customers and enable local production for tactical radars.
  • Charleston Facility: Expanding capacity to support electric power and propulsion for surface combatants.
  • Dallas Assembly/Foundry: Expanding uncooled infrared and thermal imager production to serve low-cost drone manufacturers (e.g., Tandem Orbit Thermocore order for >50k units).
• Product Launches:
  • Thor: AI-enabled rugged embedded computing system launched to deliver sensor fusion and command/control at the tactical edge.
  • Vehicle-Agnostic Counter-UAS: New pallet-based system integrating modular sensors and effectors (kinetic and directed energy).
  • Electrified Propulsion: Permanent magnet system for KDDX destroyer; steam turbine generator capability development.
• M&A/Partnerships: Strategic partnership with Doosan for KDDX in-country integration; licensing interest in Europe; acquiring RAFT for software integration.

Risks and Headwinds to Outlook:

• Continuing Resolution (CR): Current CR (through Dec 11) not expected to have a meaningful impact; management confident even in prolonged scenarios due to bipartisan defense priorities.
• Acquisition Execution: Risks include timing of regulatory approvals, satisfaction of closing conditions, and successful integration of RAFT.
• Supply Chain: Potential for material sourcing issues, though mitigated by pre-buy strategies and AI forecasting; specific historical reference to "Germanium" shortage.
• Budget Appropriations: While the budget request shows high growth, actual appropriated amounts may vary; however, priorities in drones/space/shipbuilding are viewed as non-partisan.
• Competition: Acknowledges competition in counter-UAS and shipbuilding markets (e.g., Anduril's entry into submarine components), though management views such industry growth as positive for the industrial base.

Management Tone on the Future:

• Confidence Level: High; expressed confidence in "sustained and durable growth" and "exceptional execution."
• Guidance Changes: Raised and tightened ranges for full-year 2026 revenue and EBITDA; noted that third-quarter results drove this confidence.
• Strategic Narrative: Emphasizes a shift from "exquisite" to "distributed" capabilities; views the current environment as structurally favorable for DRS's portfolio of radars, sensors, and electric propulsion.
• Hedges: Standard caution regarding forward-looking statements and risks affecting actual results; no specific downside hedges in guidance numbers themselves, though "muted" 2027 margin expansion is noted relative to 2026's outperformance.

Miscellaneous:

• Backlog: Record-funded backlog of $5.6 billion provides strong visibility.
• Third Quarter Bookings: Exceeded $1.6 billion (book-to-bill 1.5x); strongest since becoming a public company four years ago.
• Specific Wins: $500M JIAIDA-401 contract; Extended Mass Surveillance System (EMSS) fielded within one week; KDDX destroyer program win; $40M JTTX award; $96M Mark 41 VLS award.
• Tax Rate Context: FY2026 full-year tax rate of 13% includes a lower rate; Q4 normalized to ~19%.
• Share Count: 269 million shares assumed for EPS calculations.