Leonardo DRS Inc

NASDAQ:DRS

Q2-2025 Earnings Call

[Operator]

Ladies and gentlemen, good day, and welcome to the Leonardo Doctors Second 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, executive]

Thanks for participating on today's quarterly earnings conference call. Joining me today are Bill Lynn, our Chairman and CEO; and Mike Dippold, 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'll 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 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 take 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.

[William Lynn, executive]

Thanks, Steve. Good morning, and welcome, everyone, to the DRS 2 earnings call. Our second quarter results reflect sustained momentum in capturing customer demand, driving revenue growth and expanding both profitability and margin. In the quarter, we secured $853 million of bookings which is a 1.0 book-to-bill ratio for the quarter. We saw a particular strength for our electric power and propulsion, naval network computing, advanced infrared sensing and ground systems technologies all of which contributed meaningfully to Q2 bookings. Our total backlog stood at $6 billion, rising 9% year-over-year. Also noteworthy was that our funded backlog maintained a healthy double-digit growth rate in the quarter.

We continue to expect a book-to-bill ratio greater than 1.0 for the full year, thanks to strong performance in the first half and consistent customer demand across the portfolio. Diving deeper into our quarterly financial performance, we delivered double-digit organic revenue growth squarely in line with the framework shared on the last call. Furthermore, foundation built in the year-to-date is leading us to increase our full year revenue growth expectations to 9% to 11%.

Our profit metrics also showed strong performance. Adjusted EBITDA was up 17%, corresponding margin increased by 70 basis points and adjusted diluted EPS was up 28%. In aggregate, our strong Q2 results position us well to meet our full year outlook. That said, the team and I remain focused on disciplined program execution investing for future growth and navigating a complex operational environment.

We continue to operate in a dynamic macro backlog 1 that remains largely favorable to DRS, but not without its complexities. Let me begin with the positives. Earlier this month, the One Big Beautiful Bill Act was enacted, a sweeping tax reconciliation package that includes $150 billion in defensing with $113 billion front-loaded into FY '26. This legislation represents significant opportunities and tailwinds for DRS. The funding emphasizes the following: shipbuilding and enhancing industrial-based resiliency layered strategic air and missile defense, including initial funding for the Golden Dome initiative, caves and unmanned systems, electronic warfare, missiles and munitions, and more broadly, greater investment in innovation to enhance asymmetric capabilities. Our portfolio is well aligned with these national priorities, and we expect to benefit across the company as this fund thing is obligated over the coming years.

Additionally, the Administration's FY '26 defense budget request calls for $962 billion in total defense spending, including the reconciliation funding, which in total represents a 12% increase year-over-year. Beyond the U.S., global defense spending continues to rise amid ongoing geopolitical tensions. Notably, NATO members are now targeting 5% of GDP for national security with 3.5% dedicated to defense, a sharp increase from the long-standing 2% benchmark. This trend is expected to support incremental international demand, particularly for our ReadyNow differentiated capabilities.

The intensifying global threat landscape is especially acute for our operations and employees in Israel. We are grateful to report that all employees in the region are currently safe. We are closely monitoring the situation and are taking proactive steps to enhance employee safety and operational continuity.

Shifting to supply chain. While our overall supply chain remains relatively healthy, germanium availability and pricing remain a thorny issue. Export restrictions have constrained the available global supply of this raw material. Unfortunately, new mining and refining capacity has also been slower to ramp. We are currently relying on our safety stock, which provides sufficient runway through most of the year. However, in order to sustain timely product deliveries, material flow must improve in the second half. We are actively mitigating the germanium availability challenge through a multipronged approach. We expect these mitigation efforts to offer more meaningful relief in 2026.

On to tariffs. The temporary reprieve granted by the administration is set to expire later this week. As previously discussed, we expect to be largely insulated from direct impacts particularly for inputs where cost increases can be clearly tied to tariffs. However, second order risk persist, including the potential for retaliatory trade restrictions on items such as critical minerals.

Despite the complexities of the macro environment, DRS continues to innovate and deliver cutting-edge technologies to meet the evolving needs of our customers. This quarter, we delivered advanced infrared sensing content for the next-generation short-range interceptor or single replacement as well as other future missile systems. These sensors provide a distinct operational advantage, offering higher resolution, improved countermeasure resilience, lower cost and enhanced overall performance. We're also seeing growing opportunities to integrate our mobile power generation solutions into new missile systems. Overall, I am pleased with our ability to broaden the applicability of our infrared sensing expertise into this logical adjacency.

Amid rising strategic and tactical, there is heightened focused on resilient, multilayered air defense architectures. Golden Dome is a critical part of this effort. Our portfolio, including our over-the-horizon radar and tactical radar technologies as well as counter UAS capabilities as highly relevant and well positioned to support this demand. Additionally, some of our increased internal research and development investment is being directed towards further demonstrated and maturing our sensing capabilities.

We believe we have a highly differentiated offering that can provide customers, added capability and space-based missile tracking and intercept. We are committed to securing competitive successes in this domain. The persistent threat environment is driving escalation of customer interest and an expansion of existing contracts across each of the capability areas I noted earlier. Our tactical radar offering has maintained strong international demand as allied nations look to reinforce their short-range air defense posture. At the same time, were separate expansion and counter UAS opportunities to the company. DRS not only offers industry-leading tactical radars for these missions, but also a comprehensive technology suite including infrared centers, laser and RF systems, along with platform integration expertise to deliver best-of-breed solution.

Customer focus on counter UAS is here to stay and its importance is only growing as evidenced by the recent launch of a joint interagency task force to tackle ongoing threat. Beyond sensing and force -- our network computing business plays an accrual in enabling next-generation shipboard computing, supporting both U.S. and allied naval modern initiatives. Our proprietary ice pierce cooling technology is starting to gain traction, especially as customers seek to increase computing density and system performance and constrained platforms.

Lastly, to round out my optimal updates, I want to briefly touch on our electric power and propulsion business. This part of DRS continues to perform exceptionally well, serving as a consistent financial tailwind propelling both top line growth and margin expansion. We are well positioned to capitalize on medium and term opportunities tied to next-generation platforms and to expand platform in support of the priority to improve shipbuilding throughput.

Our Q2 financial results reflect the strength of our portfolio and growing demand for our differentiated capabilities in a rally evolving threat environment. We have solid momentum in bookings and our remarkable backlog that provides ample runway visibility into enhanced revenue growth. That said, we remain rigorously focused on execution to continue delivering for our customers. Our success to date is a testament to the hard work of our team, and we are committed to building on this foundation in the second half of the year.

Let me now turn the call over to Mike who will review the second quarter and our revised 2020 guidance in greater detail.

[Michael Dippold, executive]

Thanks, Bill. I am pleased with our year-to-date performance. We had a solid quarter, but we are keeping focus on consistent execution to deliver against our full year financial objectives. Let me begin by reviewing Q2 performance. Revenue for the quarter was $829 million, 10% higher year-over-year. The strong continued organic growth is fueling our ability to raise our guidance for the full year, which I will discuss shortly. Both segments had relatively balanced contribution to our increased quarterly revenue. The IMS segment and the company in total benefited from greater revenues from electric power and propulsion programs. Advantor sensing and ground network computing program bolster growth at ASC as well as at DRS at large.

Moving now to adjusted EBITDA. Adjusted EBITDA in the quarter was $96 million, up 17% from last year. Adjusted EBITDA margin in Q2 was 11.6%, representing a 70 basis points of margin expansion compared to last year. The increased margin was from higher volume proved, approved profitability at our Electric Power Propulsion business, most notably on our Columbia Glass program.

Shifting to the segment view. ASC ducted EBITDA increased by 5%, but margin contracted by 50 basis points due to greater internal research and development investment along with less program mix and less efficient program execution caused by rising raw material costs, namely germanium. IMS adjusted EBITDA was up 41% and margin expanded by 290 basis points, thanks to improved profitability on our Columbia class program and across the rest of the electric power and propulsion business.

On to the bottom line metrics. Second quarter net earnings were $54 million and diluted EPS was $0.20 a share, up 42% and 43%, respectively. Our adjusted net earnings of $62 million and adjusted diluted EPS of $0.23 a share were up 32% and 28%, respectively. Solid core operating performance, coupled with interest expense led to favorable year-over-year assets.

Moving to free cash flow. Although our quarterly cash usage was higher than this time last year, it was in line with our expectations as we anticipated increased working capital levels to fuel growth in the second half of the year. Despite higher capital expenditure investments in 2025, our first half free cash outflow shows a clear year-over-year improvement that reflects enhanced profitability and a more efficient working capital position. Halfway through the year, we are revising our full year 2025 guidance across our key metrics. We are increasing the range of revenue to $3.525 billion to [ $3.6 billion ], implying a 9% to 11% year-over-year growth. We have solid log visibility for the balance of the year with a modest portion of our revenue coming from book-to-bill programs. timely, 90% of our full year revenue has been reacted or is in backlog.

Given the healthy visibility the timing of material receipts will be the most important factor in determining the level of our revenue output. We are also narrowing the range of adjusted EBITDA. The revised range is expected to be between $437 million and $453 million. At this time, we expect IMS to offer more growth and margin improvement opportunity relative to ASE. The guidance adjustments to revenue and adjusted EBITDA resulted in a reduced implied margin expansion for the year. This is due to 2 factors: One, we are increasing R&D investment well above plan, and two, we are seeing increased raw material input costs, namely related to germanium.

Our revised adjusted diluted EPS range incorporates the tailwinds from increased core profitability lower net interest expense and a reduced diluted share count. We now expect adjusted diluted EPS between $1.06 and $1.11 a share, assumed in these figures is a tax rate of 19% and which is unchanged from our prior guide and a $269 million fully diluted share count, lower than our prior guide as we factor in the impact of stock repurchases. With respect to free cash flow conversion, we still anticipate approximately 80% conversion of our adjusted net earnings for the full year.

The recently enacted tax legislation is expected to offer a limited benefit to our 2025 free cash flow but it will be a modest tailwind in 2026 and beyond. That said, we are still working to quantify the specific impact. Now let me offer up our framework for the third quarter. We expect revenue in the neighborhood of approximately $925 million adjusted EBITDA margin in the mid-12% range and free cash flow generation comparable to Q3 of 2024. Please note the timing of material receipts will weigh heavily on how the second half is allocated on a quarterly basis.

Let me offer some closing thoughts before we take questions. I want to extend my gratitude to the broader DRS team. Our financial success is a direct result of their incredible efforts and unwavering commitment. As we navigate an increasingly complex global environment, we remain consistently focused on delivering exceptional technology to our customers, executing with excellence and driving sustainable long-term growth.

With that, we are ready to take your questions.

[Operator]

[Operator Instructions]. And our first question will come from the line of Peter Arment with Baird.

[Peter Arment, analyst]

Bill, thanks for the color on kind of Golden Dome and how you're positioned. Maybe if I could just ask, when you expect -- I know the architecture hasn't been fully laid out with general -- good line, just getting the assignment. But how do you expect it to kind of roll out in terms of impacting your backlog? When should we start to see kind of some of the programs that you might be well positioned on?

[William Lynn, executive]

Yes. Thanks, Peter. I mean as you said, they're just organizing themselves on the architecture there are industry meetings starting and the department has an internal effort to lay out an architecture. So I think that means you won't see much in the way of bookings or orders this year in calendar '25. But I think given that they're trying to really focus on doing things in this presidential term, you'll start to see orders roll out in the '26 time frame.

[Peter Arment, analyst]

Okay. I appreciate that. And just as my follow-up, just could you talk maybe a little bit on the M&A environment? I know you've had interest there in the past and just are you seeing more deals given where funding is and any update there?

[William Lynn, executive]

Yes. I mean we're -- as you know, we're in the market. We're looking. We're doing diligence. We're seeing a continual flow of things in our -- those 4 core markets where were focused. We have been active. I'd say the only change we're seeing is given the interest in the sector, I think prices are pushing up. So I think that's been a factor here. We're having to assess our financial criteria, which are relatively strict, although we're open to things, the closer they are strategically to our main areas of focus, the more we're willing to extend on financial criteria. And that's the -- what's going on right now is that strategic focus, we are seeing properties that would be interesting there. The prices are relatively high.

[Operator]

[Operator Instructions]. And that will come from the line of Robert Stallard with Vertical Research.

[Robert Stallard, analyst]

First of all, I was wondering if you could dig into this whole germanium and what's going on there? How much of a headwind has it been so far this year? What are you expecting in the second half? And what is this metal used for in terms of your products? And then, see, maybe following up on Peter's question. I was wondering if you could elaborate on this flexibility on looking at M&A? Does this mean you might be open to using equity, for example? Are you looking at a different return metric in terms of when the deal pay off, that would be helpful.

[William Lynn, executive]

Yes. Peter, let me -- sorry, Rob, let me -- on germanium and then let Mike expand on germanium it happened is, given the tension with China, the source of most of the germanium supply has reduced to a trickle. We anticipated this to -- in this -- that we built up a safety study, and we're now having to utilize that safety stock that has been effective for us, but it has caused -- to increase. And it's also caused us to seek other sources of germanium outside China. So we're looking other countries and sources of germanium. We're looking at other customers. There is an ability to recycle out of existing products.

And then there are opportunities on some products we could use something other than germanium that requires at least a couple of months' work in terms of redesign, requalifying. It's not overly taxing, but there is a time lag. We're pursuing all of those with a target of 2026 to bring some or all of those online. Let me let Mike answer your question on the fiscal impacts.

[Michael Dippold, executive]

Yes. So Rob, first, you had a question in terms of what product is used for, this is going through our infrared product line. So in our advanced sensing and computing business, but more focused on our infrared sensing capabilities, that's where you see this metal being used.

For the impact, we spoke a little bit about last quarter in terms of the price shock that we saw because of the supply and demand elements that were in play. And we made the comment that absent the germanium impact that the margins of ASC would have been in line in Q1 with expectations. We looked into Q2 here, and the prices remain fairly stable. But what we're seeing is as that availability becomes a concern later in the year, we've had some absorption issues and some overhead rates that have impact a little bit more than we had anticipated in Q1. So that's what we're looking at from an impact perspective, if that's now incorporated into the revised guide that we put forth.

[William Lynn, executive]

Rob, I come back on your M&A question, the financial. We have 3 financial metrics: EPS, ROIC and our overall margin and growth. On EPS, we expect it to be accretive in the first year. There's a little share, but probably not -- without -- we will look ROIC, we're looking at a multiyear return. I think there, we would have flex. I think things that would take maybe a little bit longer to bring a positive contribution to ROIC, we're willing to kind of go belong beyond our notional 3-year window looking 4 years, 5 years. I think that would be well within something we'd find acceptable.

And the other is more general. We have, I think, a very strong right now double-digit growth story. We have a margin enhancement story, I don't think we are now changing our approach there. We don't want to undercut that story with a significant acquisition, and that really hasn't changed. So the change is, I think we'll be more flexible on ROIC.

[Operator]

[Operator Instructions]. And that will come from the line of Michael Ciarmoli with Truist Securities.

[Michael Ciarmoli, analyst]

Bill, maybe just a little bit more application on what Pete was asking about Golden Dome. I mean thinking about timing of order flow, does that kind of stand for already deployed existing systems? Or is this kind of -- are you talking architecture for some of the newer kind of systems and capabilities that might be deployed?

[William Lynn, executive]

Right. It's a little hard to be specific because they don't even have a program yet. But I think directionally, I think the first orders would have to be on existing systems. Just given the timing. And you're going to have to develop -- it will take longer time to -- first the requirements and then the RFP and then the competition for future oriented.

So I think you're -- well, in your question is right. The early orders are likely to come from something that has some maturity, some that's already something that can be produced.

[Michael Ciarmoli, analyst]

Got it. Okay. And then just if I may, just because you used to be in the building. This is obviously a unique and dynamic budget environment. We're getting a big bump up and front-end load here with reconciliation. But we don't have a fight if yet. How are you guys thinking about just budget and trajectory longer term? And maybe kind of, like I said, just drawing on your experience from being in the building.

[William Lynn, executive]

Yes. It's actually not unusual at this point, not to have a fight up, usually, a new administration just puts out a first year budget and is in the middle as they are of their kind of their strategic plan. Obviously, what they have done so far. They really inherited from biding. It takes some months to develop that strategic plan, which they're doing. So I wouldn't expect to see a fight up until the next budget, which is February but that's not unusual.

In terms of what to expect, I mean, there's lots of puts and takes in the reconciliation bill. I think if you look at just general historical trends and tendencies when you move from a Democratic to a Republican administration, normally what you see is a modest, at least bump up in the overall defense spending. Generally politically, a Republican administration sees itself as stronger on defense wants to show that in the budget.

And then second, they have more initiatives, multiple questioners have mentioned Golden Dome but there's force protection, there's shipbuilding, there are programmatic reasons to increase the budget. So I think at the end of the day, when the smoke clears, you'll see a Trump budget that over time is moderately higher than its Biden predecessor.

[Operator]

[Operator Instructions]. And that will come from the line of Seth Seifman with JPMorgan.

[Seth Seifman, analyst]

Wanted to ask the -- you talked about performance, good performance in electric power and propulsion and about the opportunities there maybe to capitalize on what's coming into the resources coming into the industrial base. I wonder if you could be more specific around kind of where you see opportunities do those opportunities come out of the new facility in Charleston primarily? And what the time line for capitalizing on some of those opportunities might be?

[William Lynn, executive]

Sure, Seth. And I'll start and then let Mike add some more color. I mean first of all, the core program, of course, in our naval power is Colombia which is secured through the middle of the next decade and is on a steady increase. And we are using that South Carolina facility to execute that program with greater and greater efficiency, which should be a tailwind on margins. beyond that, which is really what I think you're asking is we see that facility and our overall capabilities generally is well positioned to help the Navy surge content into the industrial base with the goal of particularly increasing the throughput of submarines where we have important content beyond just -- in particular, I would say the first of those opportunities is in the area of steam turbine generators. The Navy has now given us $50 million of that industrial base money to build a test capacity in South Carolina for that. What should follow on is another contract to design a new steam turbine generator with production to follow.

The problem that's addressing is that there's only 1 producer of steam turbine generators, which makes it something of a choke point in submarine production. And the Navy is interested in the second source to address that choke point. So I think we're a principal part of the avenue to address that challenge.

And beyond that, I think there's a more general view, and we're talking to the navy in the future about can we use our capacity as a supplier to take on more work and allow the yards to dedicate their resources to producing submarines faster. That's still sort of an early stage discussion, but I think there's real potential personal content to move to suppliers such as DRS with, again, the goal of increasing that submarine throughput.

[Michael Dippold, executive]

Yes. The only thing I'll add, Seth, is from a timing perspective, we do have the Columbia portion of the building to begin to come on in 2026 and late-2026 and actually begin to pull the work in that Columbia piece of the investment will not only cover Colombia, but also if we have some successes in new platforms that will help a capacity perspective and ability to execute.

What Bill was mentioning in terms of the steam turbine efforts, that funding is now flowing, and we're starting those exercise. That will come on from a timing perspective a little later outside of 2026 as we create that test capabilities and start to move forward on the steam initiatives. From there, you can start to see your tool that we're putting in a toolbox from a steam turbine generator perspective start to be an impact of a new outside of that 2027 time frame as we seek to execute development work with the anticipation of hopefully having production there.

[Seth Seifman, analyst]

Great. And maybe just as a quick follow-up, do you expect -- how do you look at the bookings environment I can have? Do you expect to exit the year with the backlog higher than it was at June 30?

[William Lynn, executive]

Yes, we do. But let me let Mike address.

[Michael Dippold, executive]

Yes. I would -- the bookings for the quarter of the kind of 1:1 ratio. I wouldn't put too much stock into that. We're continuing to see strong demand across all elements of the business. for the sixth period, we're still sitting above the 1:1 ratio, and we expect that to continue throughout the second half of the year. So still a lot of confidence, the tailwinds in the threat environment is there, the budget alignment is there, and we feel good about our ability to continue to see strong bookings throughout the remainder of the year.

[Operator]

[Operator Instructions]. And that will come the line of Andre Madrid with BTIG.

[Andre Madrid, analyst]

You previously disclosed intentional sales would outpace the broader sales growth for this year. With the new NATO commitments, again, that's not instantaneous. It's over a decade, but could we see upside to what you initially thought international would be through the out years?

[William Lynn, executive]

Yes. I think a couple of things are happening in the international space right now. First off, will draw a little bit of the international is what happens with Ukraine. So I think first and foremost, that's going to be an indicator of where our international sales go. So far, that demand has continued.

From a NATO perspective, we are seeing consistent demand signals across some of the Eastern European members of NATO and are focused on being able to execute there. The question in the long term will be what does that mean from a European industrial base investment is buying American. We continue to see the elements moving towards the ReadyNow capabilities are still important. So we see that as a tailwind to kind of U.S. domestic opportunities to sell abroad. I expect to see that trend continuing, and we still view the international market as the growth engine because of NATO, but also just because of the other macro trends and the hot global conflicts that are emerging.

[Andre Madrid, analyst]

Got it. Got it. Maybe a follow-up to that. I mean, so long as they fit into the criteria that you've outlined already. Would you be especially interested in acquiring anything over in Europe? And I guess, following on to that, given that valuations have been a little high right now, a little rich, what's your added towards forging partnerships with defense tech names? I mean, this seems to be -- become more prevalent in the current threat and demand environment. So curious to hear your thoughts there.

[William Lynn, executive]

We have a global focus on our M&A obviously, we demonstrated that when we acquired [ Arada ] and the triangular merger that brought us public, Arada Israelian we have looked in Europe and Asia as well. So we're -- we have an international focus. We're not limited just to the U.S.

In terms of partnerships, that, too, is on the table. We have had discussions with different companies about we might make that will increase our mutual competitiveness. And so that's -- that would be on the table as well.

[Operator]

[Operator Instructions]. And that will come from the line of Kristine Liwag with Morgan Stanley.

[Kristine Liwag, analyst]

Bill, you've kind of talked a lot about the germanium as here. I was wondering, are there other rare earth metals that you're watching? And it sounds like 2026, you'll see some improvement. But if -- if you have -- I guess, what were the industry is everybody else also trying to figure out supply. If things don't necessarily pan out as you expect for 2026. How could this shortage of germanium or higher cost affect operating performance?

[William Lynn, executive]

Thanks, Kristine. We do look at other -- I would say the biggest other material we think about is permanent magnets because that's a part of the electric drive system in Colombia, and the other. We are pretty well protected right now and that we have the supply for all of our existing programs. So as we look at it, it's more protecting against future programs, and we're looking at what steps would we need to do that. But in terms of germanium on '26, as I said, we have multiple paths in terms of recycling other sources, other materials. We think that through the course of '25, those are going to come online and allow us to start begin back up the ramp again in terms of germanium and protect the '26 program.

[Kristine Liwag, analyst]

I see. That's really helpful. And following up on the opportunity in European NATO even though NATO in Europe wants to spend more money on defense, there's also a concerted effort to focus more on indigenous capabilities. So I mean, you guys are largely an American company. but your ownership is also with a European parent. So do you have any indication in terms of how these governments view you? Do they view you as an American company? Or do they view you as a hybrid because of your European parent ownership. How does that work? And does that change the opportunity for Europe for you regarding the higher spend?

[William Lynn, executive]

I think we're in a proxy, we're most definitely a U.S. company, and I think that's how we're viewed both in the U.S. and Europe. I think though the angle towards which you're headed is, right, is where we have opportunity, which is maybe unique given our ownership structure is we have the opportunity to team with and collaborate with Leonardo because of our closeness and that allows us then to go into Europe as a home team and to use the good offices and the teaming arrangements with Leonardo. And we're seeing opportunities in the U.K. and elsewhere where we can execute on that partnership. It's that partnership rather than just being seen as a it's not how we're seeing as our country origin. It's how we partner with our share -- 70% shareholder.

[Operator]

[Operator Instructions]. And that will come from the line of Austin Moeller with Canaccord Genuity.

[Unknown Analyst]

Just my first question here. If we look at the House Appropriation Committee's draft of the defense bill, there's a 57% plus up to about $5.2 million for the Columbia class program and I was wondering if you could just comment on that and the reported 12- to 16-month delay in boat construction for Columbia class and how that is the 1 versus 2 production rate for Colombia and Virginia class and how we should think about that?

[William Lynn, executive]

Yes. On Colombia, the navy working with the yards has intentionally put us in a relatively segregated position so that we have, as I said, the contracts on Colombia for the ship sets all the way through shipset 12, which takes you into the mid-2030s. The purpose of that was to insulate this critical component from the ups and downs of the progress itself. And the reason to do that is you don't want to lose -- this is a complex program. You don't want to lose the learning. You don't want to lose the expertise of the workforce by having gaps and having down cycles and then for the retrain. That will cause schedule and budget, issues in the Navy and nor are we looking for that.

So we're not really affected by that budget increase. You talked about we have our budget set by contract all the way through the 2030s. And the intent of setting that contract out was not changed the motor schedule, the drive schedule based on relatively modest changes in the ship delivery schedule, the submarine delivery schedule.

[Unknown Analyst]

Okay. And if we think about the force protection counter UAS side of the equation, if we do see the Ukraine war continue, I think you talked about this a little bit already, but presumably, that's incrementally positive for sales into U.S. NATO allies, et cetera?

[William Lynn, executive]

I think more generally, the threat that put and posted through by attacking Ukraine is what's driving Europe to hire defense budgets, and they're seeing that concrete threat that Putin has prepared to cross borders in a way that we haven't seen in 80 or 90 years. That is then driving programmatic implications prominent among them is force protection. The advent of drones, the importance of having not just kind of perimeter protection around your formations, but really organic protection inside those formations, so programs like RLDs, that counter UAS system become critical. And what we're seeing is a growing international demand for that kind of system, partly driven by Ukraine but more generally driven by the trends in warfare that you're seeing in Ukraine, you're seeing in Israel and how do you bring on systems that counter that and with some urgency given what Putin is doing in Ukraine and the future implications of that.

[Operator]

[Operator Instructions]. And that will come from the line of Jon Tanwanteng with CJS Securities.

[Jonathan Tanwanteng, analyst]

I was wondering if you could break down the new guidance range and just the components of it, especially the revenue line. What's driving that? Is it stronger demand or contract modifications, maybe just more confidence in the ability to work down improved supplier execution? Is there something else that's going on? Just any help there would be helpful.

[Operator]

Yes. From the guidance on the revenue side here, the uplift is certainly driven just by the continued demand that we're seeing. We got out of the gate really hot from a bookings perspective in Q1. And that confidence, coupled with the consistency of the supply base and the material receipts germanium with the astric there continues to perform well, and that gave us the confidence to increase the guide for the full year. At the half from a revenue perspective, we're up 13% year-over-year. So the bookings demand, where we are with the backlog year-over-year, what we've executed to date through the 6 months and the stability of the supply base gave us the confidence to increase the revenue guide, Jon.

[Jonathan Tanwanteng, analyst]

Okay. Great. And how should we think about the R&D intensity going forward over the next 3 to 5 years and how that affects the operating leverage, especially if you chase these new programs in the new DoD budgets and increasing of spending?

[William Lynn, executive]

I'm sorry, I didn't catch the end of that. Can you repeat that question again?

[Jonathan Tanwanteng, analyst]

Yes. How should we think about R&D intensity and the operating leverage that you have, especially with the new DoD budgets and with the higher NATO commitments.

[William Lynn, executive]

Yes. So from an R&D budget perspective, I'm assuming you're talking about the internal R&D spend, correct?

[Jonathan Tanwanteng, analyst]

Yes.

[William Lynn, executive]

But ultimately, what we wanted to do and what we've made a priority of is there's certainly an emphasis within the administration to get products to the more fighter quicker. And therefore, they're trying to accelerate procurements and we wanted to ensure that we have ReadyNow solutions and ReadyNow capabilities and are investing in increased IRAD in order to make that a reality.

So we've taken up our IRAD from about 2.8% in 2024 to an area where we're sitting at the mid-3s here at the half year point. So that's a sizable headwind from a margin perspective, but we do believe we're investing in areas that are getting a lot of enthusiasm around it. And when you talk about the counter drone capabilities when you talk about space, missile seekers, as Bill mentioned in the prepared remarks, these are the areas we're investing in. The markets are growing, and we thought it would be prudent to continue to invest heavily in there to facilitate our continued growth.

[Jonathan Tanwanteng, analyst]

Okay. Great. If I could sneak 1 more in there. Just when do you think you can get margins on products containing germanium or alternatives back to the normalized range, whether that's through pricing or group supply or going to some of these alternatives, I guess, technology to do so.

[William Lynn, executive]

Yes. I think the first challenge we have is to execute against the backlog. Right now, we're in a position where we're a predominantly fixed-price shop. So the pricing fluctuations are being in our results, and that's what's realized in our guide prospectively. We don't add contract modifications that allow some flexibility in terms of the recovery when you have the volatility in germanium like we've seen, which is largely due to some of the trade wars and other elements that are going on at our kind of outside of our control. We've seen mixed results from a customer receptive perspective on that, and we're continuing to push hard on that to make sure that we're derisked from the price volatility.

[Jonathan Tanwanteng, analyst]

Okay. Any sense of timing of when that normalizes overall? It's going to be a program-by-program negotiation to be fair. So it will be on a contract-by-contract basis.

[Operator]

[Operator Instructions]. Our next question will come from the line of Ronald Epstein with Bank of America.

[Ronald Epstein, analyst]

Yes. So germanium has been a bit of an issue for you guys. It really doesn't seem like it's been for anybody else. I'm curious why that may be the case? And then two, are there any other rare earth that we should start worrying about for you or others, given what's going on broadly with trade, particularly with China?

[William Lynn, executive]

Ron, I think, obviously, we're a sensor house and it's an important piece of our product base. So germanium, I think, stands out for us. I don't know what's going on with others. But I'm sure they're not getting germanium.

The other one, and I mentioned it on an earlier question, I'd say the principal other one we focus on is in the electric power area is permanent magnets. And there, I think currently, we're in a strong position with holding what we need for -- to execute our current programs, but we are trying to anticipate future disruptions and trying to think about how do we -- we're hopeful, of course, of winning future electric drive program. So we need to think about how we protect future sources of supply it's a high-class problem, but we're anticipating winning other programs, and we're taking steps now to protect against that future potential.

[Ronald Epstein, analyst]

And then if you could feel back Daniel a little bit on with the big investments that are being made into the naval industrial base shipbuilding industrial base. What other opportunities are out there for you all? I mean, I would imagine there's got to be a whole bunch of them, if you could maybe mention a few.

[William Lynn, executive]

Are you talking shipbuilding? Or are you looking beyond shipbuilding?

[Ronald Epstein, analyst]

Shipbuilding.

[William Lynn, executive]

Well, in shipbuilding, I think, as we said, we have the current Columbia program, the biggest near-term opportunity is the steam turbine generator that I talked about coming after that, I think, is just the general enhancement of Virginia class and other industrial base program, the realignment of the workload between yards and suppliers. And then the one I didn't mention, but -- well, I didn't mention, beyond that, a little bit longer term out is future ship classes, we think will look to electric drive as the propulsion system because of the operational advantages in terms of cost, in terms of quietness and in terms of the power density, when you start to look at it directed energy weapons, mechanical systems just cannot meet the needs. And even as you increase sensor demand, which is inevitable, mechanical systems won't meet the needs.

So we think the next-generation destroyer DGX is a good candidate. The next-generation submarine, the SSNX is probably an even better candidate -- and then internationally, international navies are looking at electric drive as well. So we think over the next 5 to 10 years, there's going to be a shift into electric drive, and we think we stand to benefit from that.

[Ronald Epstein, analyst]

Got it. Got it. And then if I can ask you just 1 more sort of more macro question. given your experience kind of on the hill and the building. How would you expect fiscal '27 to play out, right? I mean in terms of the budget process this year was sort of bizarright? Do we get another reconciliation? I mean, how is it all going to go? I mean it seems kind of likely that there's going to be another continuing resolution. I don't know. I mean if you were to look in your crystal ball and take a ride at it, how would you go as fiscal set that '27 plays out?

[William Lynn, executive]

I think -- as I said, at the end of the day, it's hard, as you said, this has been a very unusual year with a very large increase in the reconciliation, Bill. And there's still -- they allocated a lot of that to '26, but not all of it. So there's still some reconciliation money out there that needs to be allocated. They have to make it as soon on what is the '27 base bill -- as I said in answer to an earlier question I have a hard time believing a Republican President wants to be lower than its democratic predecessor. So I think that's going to drive some increase -- so I mean I think what you want to see is maybe is -- what you'd like to see is sustained and predictable increases in the defense budget will let us meet the growing threats from China and Russia. That's the policy goal I do think it's going to be -- it's the policy goal of this administration. So I think they're going to have to find a way through reconciliation, maybe a second reconciliation bill, I don't know. And the core budget builds to execute on that sustained predictable growth. That should be their goal, and I think it is their goal.

[Operator]

I'm showing no further questions in the queue at this time. I would now like to turn the call over to Steve Vather for any closing remarks.

[Stephen Vather, executive]

Thanks for your time this morning and for your interest in DRS. As usual, if you have any follow-up questions, please call or e-mail. We look forward to speaking with you all again soon. Enjoy the rest of your day.

[Operator]

This concludes today's program. Thank you for participating. You may now disconnect.