DRS Q2 Deep Dive: Margin Expansion Meets Supply Chain Headwinds and Elevated R&D Investment

Aerospace and defense company Leonardo DRS (NASDAQ:DRS) met Wall Street’s revenue expectations in Q2 CY2025, with sales up 10.1% year on year to $829 million. The company’s full-year revenue guidance of $3.56 billion at the midpoint came in 1.2% above analysts’ estimates. Its non-GAAP profit of $0.23 per share was 7.4% above analysts’ consensus estimates.

Is now the time to buy DRS? Find out in our full research report (it’s free).

StockStory’s Take

Leonardo DRS met Wall Street’s revenue expectations for the second quarter, but the market responded negatively due to concerns around margin pressure and operational challenges. Management cited strong demand across electric power and propulsion, naval computing, and advanced infrared sensing as primary growth drivers. CEO Bill Lynn pointed to “a complex operational environment,” noting that germanium supply chain disruptions and rising raw material costs affected profitability, particularly in the advanced sensing segment. Increased internal research and development spending also weighed on margins, as leadership acknowledged these investments were necessary to keep pace with evolving defense requirements.

Looking ahead, management’s updated full-year guidance reflects confidence in revenue growth driven by robust backlog and continued demand for differentiated defense technologies. However, the company highlighted ongoing risk from germanium supply constraints, which could persist into next year. CFO Mike Dippold stated that “timing of material receipts will be the most important factor in determining the level of our revenue output,” and emphasized that higher research and development spending will remain a margin headwind in the near term. Leadership also pointed to international opportunities as NATO defense budgets rise and to the potential for expanded roles in naval industrial base initiatives.

Key Insights from Management’s Remarks

Management attributed Q2 performance to strong execution in core defense segments but cited higher input costs and R&D investments as headwinds to profitability.

• Electric power and propulsion outperformance: The electric power and propulsion segment delivered significant revenue and margin gains, with the Columbia Class submarine program highlighted for its efficiency and consistent growth. Management expects this business to benefit further from U.S. Navy industrial base investments and future shipbuilding programs.

• Infrared sensing supply chain challenges: Advanced infrared sensing programs, a key driver of bookings, faced margin pressure due to rising germanium costs and supply shortages. CEO Bill Lynn explained the company is “actively mitigating the germanium availability challenge through a multipronged approach,” including alternative sourcing and recycling, but full relief is not expected until 2026.

• Increased R&D investment: Internal research and development spending has been elevated to accelerate product readiness and maintain competitiveness in areas like counter-unmanned aerial systems (UAS) and space-based missile tracking. CFO Mike Dippold noted this investment is currently a “sizable headwind from a margin perspective.”

• NATO and international demand: Management pointed to rising global defense budgets, particularly among NATO countries targeting 3.5% of GDP for defense, as an emerging tailwind. Leonardo DRS’s “ReadyNow” capabilities are positioned to benefit from this trend, especially in Eastern Europe and Israel.

• Bookings and backlog visibility: The company ended the quarter with a strong backlog, up nearly 9% year over year, and expects a book-to-bill ratio above 1.0 for the full year, providing solid visibility for future revenue. However, the timing of material receipts and contract negotiations may affect quarterly performance.

Drivers of Future Performance

Management expects revenue growth to remain robust, but future performance will depend on supply chain stability, sustained R&D spending, and execution on key defense programs.

• Germanium supply chain risks: The company is actively managing risks related to germanium, a critical input for infrared sensors. Management expects mitigation efforts like alternative sourcing and recycling to ease constraints by 2026, but ongoing volatility could create operating margin headwinds in the near term.

• Elevated R&D spending: Leadership forecasts continued high internal research and development investment to address customer needs in counter-drone, missile defense, and space sensing technologies. This spending is a deliberate choice to ensure product relevance but will likely restrain near-term margin expansion.

• Naval and international program execution: The company is positioned to capitalize on U.S. Navy industrial base initiatives, including new steam turbine generator contracts and expanded roles in submarine and shipbuilding programs. International growth, especially in NATO markets, is also expected to contribute meaningfully to future revenue, contingent on successful partnerships and evolving geopolitical dynamics.

Catalysts in Upcoming Quarters

In the coming quarters, the StockStory team will focus on (1) progress in securing germanium supply and margin stabilization in the advanced sensing business, (2) contract wins and execution milestones in naval power and shipbuilding programs—especially the Columbia Class and steam turbine generator initiatives, and (3) international sales momentum stemming from rising NATO defense budgets and new partnerships. Developments in U.S. defense funding and industrial base investments will also be key signposts.

Leonardo DRS currently trades at $42.30, down from $48.22 just before the earnings. Is the company at an inflection point that warrants a buy or sell? Find out in our full research report (it’s free).

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