DRS Q3 Deep Dive: Leadership Transition and Margin Pressures Offset Strong Defense Demand

Aerospace and defense company Leonardo DRS (NASDAQ:DRS) reported Q3 CY2025 results beating Wall Street’s revenue expectations, with sales up 18.2% year on year to $960 million. The company expects the full year’s revenue to be around $3.58 billion, close to analysts’ estimates. Its non-GAAP profit of $0.29 per share was 3.8% above analysts’ consensus estimates.

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StockStory’s Take

Leonardo DRS’s third quarter saw strong underlying demand, particularly in counter-unmanned aerial systems (UAS), advanced sensing, and naval propulsion technologies, but the market responded negatively to the results. Management pointed to elevated internal research and development (R&D) spending and germanium supply chain constraints as contributing to operating margin pressures. CEO William Lynn highlighted that “demand was most evident for our counter UAS, advanced infrared sensing, naval network computing and electric power and propulsion technologies,” while also noting increased internal investment and supply chain initiatives intended to address these operational challenges.

Looking ahead, management’s updated guidance is driven by expectations for sustained growth in core defense markets and ongoing investment in R&D to maintain technological leadership. The company is focused on resolving germanium supply issues and scaling new software and hardware platforms such as SAGEcore and THOR. Outgoing CEO William Lynn emphasized, “We are actively working on strategic agreements with several partners to ensure consistent [germanium] supply in 2026,” while incoming CEO John Baylouny stated that DRS is “well positioned to capture incremental scope” in naval and sensing solutions, supported by a robust backlog.

Key Insights from Management’s Remarks

Management attributed the quarter’s performance to robust bookings in key defense segments and ongoing investment in next-generation technologies, while also acknowledging supply chain and margin headwinds.

• Counter UAS momentum: Demand for DRS’s counter UAS offerings surged, highlighted by over $250 million in contracts and new integrations like a mission equipment package designed for flexible deployment across platforms. Management credited battlefield-proven effectiveness as a differentiator, positioning DRS as the current approved provider for the U.S. Army and driving further adoption across domestic and international customers.
• R&D investment impact: Elevated internal R&D spending, now around 3% of revenue, weighed on margins but is seen as critical for accessing adjacent markets and accelerating technical maturity. CFO Michael Dippold explained, “We’re going to continue these investment levels to provide that agility in order to maintain this growth.”
• Germanium supply chain initiatives: The company began recycling initiatives and diversified supplier agreements to address constrained access to germanium, a key material for infrared optics. Management expects these actions to resolve supply risks by 2026, with near-term reliance on buffer stock and mid-term partnerships to reduce dependence on China.
• Naval and propulsion platform growth: Electric power and propulsion businesses delivered consistent performance, with DRS seeking to expand its technology into additional ship classes. The company’s energy flexibility solutions are seen as supporting future platform growth, especially as ship power requirements increase for advanced systems.
• Product innovation and integration: New software and hardware launches, such as SAGEcore (integrated AI, sensing, and edge computing) and THOR (multifunction network computing), are aimed at enabling next-generation command and control across domains. These offerings support integration with Army and Navy modernization efforts and are expected to drive future adoption.

Drivers of Future Performance

Management’s outlook remains focused on sustained defense demand, backlog execution, and mitigating supply and margin headwinds through ongoing R&D and supply chain initiatives.

• Backlog-driven visibility: A growing backlog, now at $8.9 billion, provides a solid foundation for 2026 revenue, with management emphasizing robust funded orders in counter UAS, naval, and sensing programs. The team expects bookings to remain above a 1:1 book-to-bill ratio, supporting steady top-line growth.
• Margin pressures from cost structure: Persistent R&D investment and less favorable program mix are expected to weigh on adjusted EBITDA margin. Germanium supply costs, while being addressed, will continue to pressure margins, particularly in the ASC segment, until alternative sourcing and recycling initiatives fully take effect.
• Execution amid uncertainty: Management cited risks from the prolonged U.S. government shutdown, which could delay contract awards and payments if extended further, as well as the need to execute on both new product rollouts and supply chain stabilization to meet full-year targets.

Catalysts in Upcoming Quarters

Looking forward, the StockStory team will be watching (1) the pace at which germanium supply chain initiatives reduce margin pressure, (2) the successful rollout and adoption of new platforms like SAGEcore and THOR in Army and Navy programs, and (3) whether DRS can sustain above-1x book-to-bill performance amid government funding uncertainty. Execution in international markets and foreign military sales will also be key signposts for continued growth.

Leonardo DRS currently trades at $38.65, down from $40.18 just before the earnings. Is there an opportunity in the stock?Find out in our full research report (it’s free for active Edge members).

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