Leonardo DRS Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 30, 2024

There are 12 speakers on the call.

Operator

Hello. Thank you for standing by. Welcome to Leonardo DRS Second Quarter 2024 Earnings Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer I would now like to hand the call over to Steve Vather.

Operator

Sir, you may begin.

Speaker 1

Good morning, and welcome, everyone. Thanks for participating on today's quarterly earnings conference call. With me today are Bill Lin, our Chairman and CEO and Mike DePold, our 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 will also find the earnings release and supplemental presentation.

Speaker 1

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 ks and our other SEC filings. We undertake no obligation to update any of the forward looking statements made on this call.

Speaker 1

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 the reconciliation of the non GAAP measures discussed on this call in our earnings release. At this time, I will turn the call over to Bill. Bill?

Speaker 2

Thanks, Steve, and thank you all for joining DRS continues to perform well as evidenced by the impressive quarterly results we are releasing this morning. We are experiencing steady customer demand across our diverse portfolio of differentiated technologies. As a result, we posted another consecutive quarter of 1.2 book to bill. In Q2, there was particular strength for our capabilities in advanced infrared sensing, electric power and propulsion, network computing and ground systems integration. Additionally, our total backlog ascended to new company records and now stands over $7,900,000,000 which is up 82% year over year and also up sequentially.

Speaker 2

The robust demand we continue to experience coupled with the easing of supply chain constraints unlocked another quarter of 20% year over year organic revenue growth. We also grew our adjusted EBITDA by 32% and delivered margin expansion of 100 basis points in the quarter. Adjusted net earnings and adjusted diluted EPS increased by 21% 20% compared to last year. Thanks to solid operational execution. I want to take a moment to thank the broader DRS team for driving such marvelous results.

Speaker 2

The team's steadfast focus and our exceptional performance in the first half is prompting us to adjust our outlook for the full year. Mike will walk through the detail of our increased guidance a little bit later on the call. Due to some thoughts on the macro environment, Congress has made preliminary progress on FY 2025 appropriations. However, consistent with prior years, we expect to enter the fiscal year under a continuing resolution. Looking beyond the near term, we believe that the elevated global threat environment will remain as the single most important factor driving defense investment by the U.

Speaker 2

S. And its allies. Technology advancements are changing the nature of warfare and our national security strategy remains consistently focused on deterring and if necessary contesting near peer adversaries. Both of these factors reinforce the imperative to modernize. DRS is well positioned to continue supporting our customers as they enhance their capabilities to address new mission complexities.

Speaker 2

Shifting to supply chain, I made brief mention that improvements on this front are partially responsible for unlocking incremental revenue growth. We have seen a steady and gradual recovery across most, but not all of our supply chain in year to date 2024. Additionally, our steadfast and proactive management of the supply chain coupled with the broader improvement are resulting in better predictability and delivery timelines, increased component material availability as well as improved consistency and quality. Overall, these positive developments are accelerating the pacing of revenue for the year. That said, the revenue step up from the supply chain recovery is expected to be contained to this year with future growth to be more which of course are both significantly higher than pre-twenty 20.

Speaker 2

Which of course are both significantly higher than pre-twenty 20. While inflation has been a lessening factor for us in 2024, there are still some stubborn pockets within our business where we are still absorbing higher input pricing. Shifting to our operations, let me highlight a couple of items this quarter. As I mentioned earlier, we are continuing to see strong demand across our broad and differentiated portfolio. In our sensing business, our technologies continue to be well recognized as the go to standard.

Speaker 2

This is evident in our outstanding quarterly bookings as well as the clear long term opportunity set bolstered by our customers' modernization push for next generation technologies. We are also advancing our leading market positions by partnering with commercial players to jointly develop cutting edge capabilities that meet emerging customer requirements. As an example, we are actively working to integrate edge AI processing into sensors. At the same time, our agility and commitment to excellence makes us a partner of choice across the defense ecosystem. We were recently recognized with a partner to win award from our customer BAE Systems for best in class performance and delivering exceptional capability, quality and on time delivery.

Speaker 2

This award among many others received over the years embodies our culture and commitment to ensuring our customers have the very best technology to execute their missions. Our innovation continues to be matched with healthy customer interest, which validates the close alignment of our R and D strategy to future mission needs. You may recall that earlier this year, we unveiled a new family of lasers that cover a wider spectrum of light. These lasers were specifically designed for quantum information science applications. I am pleased to report that we have already secured several orders and continue to gather demand for our state of the art capability in this domain.

Speaker 2

Additionally, we are seeing considerable domestic and international customer appetite for our multi domain force protection solutions. Counter UAS and force protection capabilities remain critical to survivability and operating effectively in today's battlefield. Our tactical radars, advanced sensing and active protection technologies as well as our systems integration expertise continued to be key enablers. I want to briefly mention that in this quarter, we also secured a $417,000,000 contract to provide critical electronic combat control and sonar systems across U. S.

Speaker 2

And Allied Navy submarines. We are pleased that we will be continuing to support the Navy on this important network computing contract for many years to come. This win also provides us with increased visibility into the year as it clears our largest recompete for 2024. Moving to a quick update on our facility expansion efforts in Charleston, South Carolina. We continue to make steady progress as demonstrated by the ramp up of CapEx in the quarter.

Speaker 2

As planned, CapEx will continue to tick up in the second half. Lastly, I want to commend our team in Danbury, Connecticut for their superb commitment to industrial security. This year, DRS was one of 14 recipients of the Cogswell award out of more than 12,500 eligible cleared facilities. This honor now marks our 22nd award, which demonstrates our continued and unwavering company wide commitment to security. Overall, there is a lot to be proud of and I am pleased with our outstanding year to date results.

Speaker 2

That said, I am most proud of the team's continued focus on delivering the very best technology to our war fighters. Our talented people, sound strategy and leading market positions are generating spectacular outcomes for both customers and shareholders. We remain focused on driving sustainable growth, execution consistency and prudent investment, all of which are critical components to our long term value creation formula. Let me now turn the call over to Mike, who will walk you through our Q2 results and revised 2024 guidance in greater detail.

Speaker 3

Thanks, Bill. I'm pleased with our strong continued momentum. I also want to extend my thanks to the team for executing another great quarter. As Bill mentioned earlier, impressive customer demand and a continued supply chain recovery is driving revenue growth well above our prior expectations. Revenue growth in the quarter was 20% and entirely organic.

Speaker 3

A sizable portion of the growth stemmed from increases in our advanced infrared sensing, electric power propulsion as well as our tactical radar programs. Moving to the segment view, ASC segment revenue was up 22% due to growth in programs related to advanced infrared sensing and tactical radars. Our IMS segment revenue was up 18% year over year with solid performance evident across the segment. Now to adjusted EBITDA. Adjusted EBITDA in the quarter was 82,000,000 dollars representing 32% growth from last year.

Speaker 3

Increased volume was the primary catalyst for the 100 basis points of margin expansion in the quarter. At the segment level, quarterly adjusted EBITDA and margin performance continues to be fairly lumpy. The trending is clearer when extrapolated to an annual view. That said, for the quarter, ASC segment adjusted EBITDA increased by 53% with margin up 2 30 basis points due to favorable program mix, higher volume and improved program execution. IMS segment adjusted EBITDA was up 4%, but margin contracted by 130 basis points due to unfavorable program mix and less efficient execution related to a ground surveillance integration program.

Speaker 3

It is important to note that our Columbia class program continues to trend positively with improved year over year profitability. This is evident in 1st half compare where segment adjusted EBITDA is up 47% with 140 basis points of margin expansion over last year. Moving to the bottom line metrics. 2nd quarter net earnings were $38,000,000 and diluted EPS was $0.14 a share, up 9% and 8% respectively. Our adjusted net earnings of $47,000,000 and adjusted diluted EPS of $0.18 a share were up 21% 20% respectively.

Speaker 3

Strong operational execution outweighed the headwind from increased taxes and a higher relative tax rate in the year over year compare. Moving to free cash flow. Cash collections were slightly better than last year with a small free cash generation in the quarter, a great outcome driven by higher net profitability and better working capital efficiency, which more than offset the increased year over year CapEx investment. Let me shift to a discussion on our updated guidance. Based on the remarkable first half performance, we are increasing our guidance across all key metrics.

Speaker 3

We are now expecting a higher revenue range between $3,075,000,000 $3,175,000,000 which represents a 9% to 12% year over year growth, all of which is still organic. We have solid visibility for the year as we recently secured recompetes and continue to execute from our sizable backlog position. However, our revenue output will largely depend on the timing of material receipts, progress of labor input as well as the level and pacing of customer orders. For adjusted EBITDA, the range has also increased and is now between $375,000,000 $395,000,000 We are still expecting healthy margin improvement year over year, primarily from the Columbia class transition to production as well as some operational leveraging from higher volume. The implied margin improvement is a little lower than our prior guide due to less favorable program composition from the increased revenue output, some discrete less efficient program execution as well as the lingering impact of inflation in pockets of the business.

Speaker 3

Overall, we expect both our ASC and IMS segments to contribute to our revenue growth and annual margin improvement. The adjusted diluted EPS range was increased to between $0.82 $0.88 a share. Embedded in this range are lower expected tax rate of 20.5%, but our fully diluted share count remains consistent with our prior guide at 268,000,000 shares. Lastly, we are still targeting 80% free cash flow conversion of adjusted net earnings for the year. When we think about the likely cadence of the second half consistent with prior years, it is our expectation that the Q4 will contribute strongly to the financial performance of the year.

Speaker 3

Obviously, a significant portion of the guidance increase is coming from the outperformance in the Q2. The balance of the increase will manifest primarily in the Q4. As a result, we are anticipating a small step up in Q3 from Q2 translating to revenue around $775,000,000 with adjusted EBITDA margin in the lowtomid11 percent range. Our revised 2024 guidance does not change our 3 year financial targets. We remain committed to driving mid single digit revenue growth annually, albeit from higher revenue base, while driving approximately 14% adjusted EBITDA margin by 2026.

Speaker 3

Let me wrap up with a few quick closing thoughts. We are pleased with our performance to date and applaud the broader team in achieving these results. That said, we are maintaining a steadfast focus on driving execution to meet our commitments to our customers and shareholders. With that, we are ready to take your questions.

Operator

Thank Our first question comes from the line of Robert Stallard with Vertical Research. Your line is open.

Speaker 4

Thanks so much. Good morning.

Speaker 5

Good morning, Rob.

Speaker 4

And I've got a couple for you. First of all, I was wondering if you could elaborate on these, what I think you call the efficiency issues in the IMS division in the quarter and whether you're expecting them to continue going forward?

Speaker 2

Mike, why don't you go ahead?

Speaker 3

Sure. Yes. So Rob, this is a program, it's a land integration program that we have within the IMS segment. It's a program that's a handful of years old and we had to anticipate kind of closing it out this year. We've had some delays that we've had in the program testing and completion of the program, which has extended it out a bit.

Speaker 3

And that's really what the headwind is. We believe that this is at the 10 yard line, we can see the light at the end of the tunnel here. It's just taken us a little longer and a little bit more cost to complete than we had previously anticipated. So I believe it's contained to 24. I don't think it will impact anything in the long term, but it is a headwind we're dealing with for the current year.

Speaker 4

Okay. That is a follow-up. It sounds like the overall supply chain situation is getting better, but I was wondering if you could sort of contrast where it's got better than most perhaps and where there is still some work to do?

Speaker 2

Yes. As I said in the opening comments, Rob, we are seeing a better environment both in terms of the supply chain, the market itself, lead times have come down, Availabilities are up. We are not though back to or anywhere close really particularly in things like electronic components to the pre-twenty 20 pre COVID timeframe. The other factor in this is we are much more heavily managing the supply chain than we did in the past. Obviously, like everyone else, we've moved away from just in time delivery and are looking at resilience in the supply chain.

Speaker 2

And I think part of the improvement we saw this year was that proactive management.

Speaker 4

Okay. And then just a final one for me, one for Bill probably. Looking on the sort of funding outlook for the DoD and obviously the political uncertainty we have later on this year, I was wondering what sort of risk DRS might have if the Ukrainian supplemental were to be zeroed And what sort of offset perhaps there could be from European demand? Thank you.

Speaker 2

Yes. I mean, I think, Rob, overall, I think the change in administration, either to Harris or Trump led is going to have a modest impact on the defense budget because the threat they're dealing with is the same. The pacing threat is still China and the Pacific. The immediate threat still Putin in Ukraine. I do think you highlight the biggest difference between a Democratic and Republican White House would be how they've talked about Ukraine.

Speaker 2

I wouldn't I'd be a little surprised if you saw an abrupt ending of Ukraine spending. Most of its backfill for U. S. Equipment at this point rather than direct transfers to Ukraine. So I think you probably see less of that under a Republican White House than you would under a Democratic, but I think it would be a gradual change.

Speaker 4

That's great. Thanks so much.

Operator

Thank you. Please stand by for our next question. Our next question comes from the line of Seth Seifman with JPMorgan. Your line is open.

Speaker 6

Hi, yes. Good morning, Bill, Mike and Steve. This is actually Alex Ladd on for Seth today. First, kind of wanted to dig more into the change in outlook that we saw for adjusted EBITDA margins. I think if you take the midpoint of the sales and adjusted EBITDA guides, it implies a step down to 12.3 margins for the year.

Speaker 6

And certainly, got that there's a stronger sales outlook, but it seems like the release in kind of your prepared remarks earlier imply that there's a bit of less drop through and less favorable mix and some program execution headwinds are kind of driving this. So I was wondering if you could kind of provide more color on this. I'd assume given the margin improvement that you're expecting from Colombia in the second half, It's not related to that, but maybe if you could kind of highlight more specifically what types of programs we should be driving this?

Speaker 2

Yes. Let me open and then turn to Mike for some more detail. You're right. We're now projecting about an 80 basis point improvement year over year from 2023 to 24. That's still substantial improvement.

Speaker 2

It is strongly driven by the Columbia program and that contract transition is each year we get a better contract mix and with better profit margins and that continues to happen. The headwinds that we identified are the program the surveillance program that we're closing out this year, more slowly than we had expected. In addition, the revenue increase, the mix of the revenue increase is towards the lower end of our margin portfolio. So there's a mix issue. And then we are still seeing some pockets of inflation.

Speaker 2

Still about a third of our contracts are priced under older inflation assumptions. And so we're still carrying some of that. We expect that to this to be the last year of that. Mike, why don't you add?

Speaker 3

I think you covered it pretty well. I'll just answer the latter part of your question, which was on the kind of H2 outlook. So we do expect to see a little tick up in the profitability in the second half to drive us to the guide range that we just put out and that's going to be driven by the Columbia. And as Bill mentioned, as we start to execute on the later shipsets, they will come with a higher margin and you're going to see even in year shift as we execute that program in the second half of the year.

Speaker 6

Great. Thanks. That's helpful. And then maybe as a follow-up, obviously sales growth was pretty strong in the first half at about 20%. Appreciate the sales guide being up more towards the double digits.

Speaker 6

But I think and I think you also pointed to Q3 being up a little bit year over year. So that kind of implies a pretty decent decline in the Q4. Just thinking about the demand environment. It seems like there could be some opportunity for upside. So curious if you kind of level set us on this and how we should think about that progression maybe Q4 a little bit more too?

Speaker 2

Yes. I think the one factor you missed there Alex is the improved linearity that we're experiencing this year. This has been a drive we've had. So when you're looking at year over year comps, the easier ones are in the front end of the year and the tougher ones are in the back end because of the math of the increased linearity of 2024 versus 23. It is still driving to that 9% to 12% year over year increase, which we do think is a strong year.

Speaker 6

Okay. Thank you. That's very helpful. That's all from me.

Operator

Thank you. Please stand by for our next question. Our next question comes from the line of Andre Madrid with BTIG. Your line is open.

Speaker 7

Bill, Mike, Steve, good morning. Thanks for the question. I wanted to start off talking a bit more about the South Carolina facility. I mean, have you guys already started thinking, I mean, when

Speaker 2

you look more broadly just

Speaker 7

at the naval supply chain, skilled labor has been really hard to come by. You see this across some of your SMITCAP peers as well. I mean, have you guys started to consider what recruiting will look like for this eventual facility once it's actually rolled out?

Speaker 2

Yes, we have. And in fact, the placement in South Carolina was intentional in that we think we have a strong pool of potential employees there. And importantly, it's out of the catchment area of the 2 big yards, the 2 nuclear yards, Newport News and Electric Boat. In terms of broadening the submarine industrial base, that is one of the things we wanted to do. The Navy is supportive of this is to broaden the geography of that submarine industrial base.

Speaker 2

So we think we have a strong pool of employees and we are starting where we've obviously broken ground and we're about I think about a quarter of the way through the build cycle for Charleston. And as we ramp up we'll and we get closer we'll start even stronger recruiting efforts to bring in a talented workforce.

Speaker 7

Understood. Understood. Thank you. And if I could follow that up still on the naval front. I mean, we look at Columbia Class, the ramp there is pretty well underway.

Speaker 7

I mean, what other opportunities for power and propulsion do you think are available moving forward? I know DDG X was supposed to see supplier down selection earlier this year, but I think that got pushed out. Is there any other color there? Yes. I mean,

Speaker 2

I think the Andre, you ought to think of over kind of mid to long term think of 3 buckets of opportunities for DRS in the propulsion area. One is DDG X you mentioned, but even more broadly other classes of ships DDG X, SSN X are the 2 most prominent. We do think there's a very strong case to put the electric power technology on those new classes of ships both because operationally it's quieter, which is important in a war fighting sense. It is cheaper in terms of the operating cost because of the lower fuel costs. And probably most importantly, the power demands of ships going forward are going to increase by several multiples.

Speaker 2

And it will be very difficult and that's driven by not just the propulsion system, but by the sensor suites, which are taking increasing amounts of power. And ultimately, when you're looking at 30 to 50 year lives for these ships, you're looking at directed energy being part of the equation and the power requirements for directed energy are substantial. All of that drives you towards electric power as the choice here on power propulsion. So we think that there's a strong case in the mid to long term for those. The second basket is international The second basket is international opportunities.

Speaker 2

We've talked about the Korean one. No, we don't have a decision on that yet. But we do think that that's just a leading edge of international opportunities. International Navy is just like the U. S.

Speaker 2

Navy is looking strongly towards electric power. And then the 3rd basket of opportunities is for us to get increased content on existing programs as we look at expanding the submarine industrial base and realigning the work between the yards who will be dedicated to producing more submarines faster and the supplier base which will be looking to do more of the content on each submarine to allow that in increased throughput. So we think there's strong potential in this market area coming from those 3 baskets.

Speaker 7

That's very helpful color. If I could squeeze in one more, what would some of that increased content look like? I mean, are you able to break that down or is that a little too granular?

Speaker 2

It's probably a little too granular at this point because we're under negotiation. We've talked about the way we've set the Charleston facility up is that it's the initial phase is the business case is justified just based on the contracts we now have for Columbia go all the way through the 2030s. That visibility gave us the business case to invest in greater efficiency and capacity to execute that work in a better way. But there's a second phase that we could bring work in a number of types into that facility with investment from the Navy in this case to expand that submarine industrial base. But I can't really give you much specifics in terms of the exact content of that expansion.

Speaker 2

That's what we're discussing now with both the shipyards and the Navy.

Speaker 7

Very helpful. I'll jump back into the queue. Thanks.

Operator

Thank you.

Speaker 2

Thanks, Bill.

Operator

Please stand by for our next question. Our next question comes from the line of Mariana Perez Moura with Bank of America. Your line is open.

Speaker 8

Thank you. Good morning, everyone.

Speaker 3

Good morning. Good morning.

Speaker 8

So you mentioned in the prepared remarks a lot of developments to actually implement AI, quantum and cybersecurity to the edge. Could you please describe how your investments there, how much of those are, call it like customer R and D versus your own R and D? And which specific arenas you're seeing the opportunities for this? Is it like the traditional Navy and Army? Or you actually have a way to get into unmanned air or space?

Speaker 2

There's a lot there, Mariana. On the AI front, the focus of the investment is how do you bring better processing to the edge and then basically improve the capability of our sensors. And by sensors here I mean both our ground based vehicle sensors as well as our space based sensors. We use AI processing and you push it to the edge and that we think will improve performance. And the investment there is a mix of us.

Speaker 2

It's teaming with some commercial companies. As you know, a lot of the AI expertise lies on the commercial side of the industrial base and we found some partners there. With Quantum, our entry point into Quantum is really through lasers. You need a photonics engine to be able to do quantum computing and sensing. And we have some of the best laser capability in the world at daylight solution.

Speaker 2

And so we've been doing some IRAD to develop that capability. And now we're getting some co investment from customers and we're getting some initial orders and contracts that are starting to help finance. We're still in the early state well, we're in the early stages of Quantum, but we're also in the early stages of our participation in Quantum. But we think that Photonics engine has enormous potential.

Speaker 8

Thank you. And the other one is about Colombia. In their earnings call, General Dynamics mentioned that they are seeing some progress in the shipyards. I'm curious if you're seeing something of that progress to spill over your work or and then what are the key milestones that we should be looking at as outsiders to see if the progress towards production?

Speaker 3

Yes. I think the important thing for us to realize with DRS is that we did get the entirety of the contract let to us last year for all 12 shipsets to maintain the continuous production. So we're a little disconnected from any comments that GD makes there because we are executing on the existing standalone contract. We continue to progress well there. And I think maybe because of my financial seat, I think the indicator is going to be the continued margin expansion as you see that we're continuing to hit those milestones and execute effectively.

Speaker 8

Thank you very much.

Operator

Thank you.

Speaker 2

Thanks, Bart.

Operator

Please standby for our next question. Our next question comes from the line of Sam Strelzikar with Drew Securities. Your line is open.

Speaker 9

Hi, good morning. Can you guys hear me all right?

Speaker 4

Yes, Jim.

Speaker 9

On for Mike Schmoyer this morning. Thanks for taking the question. I was wondering if you guys could maybe give a little bit more detail on the upper revision for revenue. Could you potentially break that out kind of maybe if the drivers where the drivers are between the 2 segments IMS and ACS? And then in addition to that, looking at the mild margin pressure for the year, how should we think about kind of the trajectory of margins in the second half?

Speaker 2

I'd go ahead and take that.

Speaker 3

Yes. So let me start with the first half on the revenue side and on the top line side. We are seeing a pretty holistic demand push across both segments. So we're feeling good about our backlog position and therefore our ability to deliver revenue growth out of both segments. And I think you're going to see a similar trend as we end up that both segments will contribute fairly equally to the revenue growth for DRS for the year.

Speaker 3

On the margin side, I would also say that both segments are executing in a similar fashion in which they will both contribute to our margin expansion year over year. And that's kind of the expectation we walked into the year with and it's still kind of what we're holding even with the higher revenue output.

Speaker 9

Okay, that's great. And then, so I guess it's just that one program really that you guys are seeing kind of some pressure on. Is there any where else that you're seeing any issues or is that really just kind of isolated to that one program?

Speaker 3

Yes. We're 85% firm fixed price. So there's always some opportunities that there may be some risk. I think what we've done well as a management team is to make sure that we're identifying risks early, understanding the mitigation of those risks and maybe equally as important identifying opportunities. So as we look forward, yes, we have some fixed price development efforts, but we also have an incredible balance between our risks and our opportunities.

Speaker 3

And that's really what underpins our confidence that we're going to be able to execute effectively and then deliver on our EBITDA margin commitments all the way through 2026.

Speaker 9

Okay, great. And then just one final follow-up, if I could. On the CapEx the South Carolina facility, should we expect a pretty steady increase or ramp on that? Or is there kind of a peak and then ramp back down with that trajectory that we could think about?

Speaker 3

For the remainder of the year, I would expect to see kind of CapEx commitments looking pretty similar to Q2 with a slight ramp up as we get into latter Q3 and into Q4. So I think you'd see a gradual step up and that's the expectation that we have in terms of the cadence of the execution of the South Carolina facility for the remainder of the year.

Speaker 9

Great. Thank you very much guys.

Operator

Thanks. Thanks. Please standby for our next question. Our next question comes from the line of John Tanwanteng with CJS Securities. Your line is open.

Speaker 10

Hi, good morning. Thanks for the questions and great quarter and outlook.

Speaker 3

I was wondering if you

Speaker 10

could talk a little bit more about the long term expectations for defense spending, maybe split between domestic and international and kind of ex the Ukraine supplementals. It seems like there's been a push to grow defense spending at the DoD at a higher percentage than it's been in the past? Broadly, you're seeing that among allied nations as well. How does that factor into your long term growth expectations if it's any different from what you've presented at the Investor Day or before?

Speaker 2

Thanks, John. I don't think it's different than what we presented the Investor Day, but there we did talk about that at this point the international environment broadly speaking is growing faster than the U. S. Defense budget and we are seeing that in our revenue mix. We've doubled to about 10% our international revenue over the last 3 or 4 years and we're still on that trajectory of increase.

Speaker 2

We do think we'll see an increase this year in our international and projecting forward. So we think that environment that you talked about where Europe is increasing and going for that too and now U. K. Is talking about 2.5% of GDP. And similarly in Asia, you're seeing strong increases in Australia and Japan.

Speaker 2

And we're that gives us I think opportunity to further increase the international content of our revenue base.

Speaker 10

Okay, great. Thank you. Any updates on capital allocation and specifically M and A? We've seen some really attractive assets go for reasonable to high multiples. And I'm wondering if that if you're getting a look at those deals or if you're seeing more opportunities?

Speaker 2

We have been seeing more opportunities. We've been quite active in diligence over the past 6 months. We don't have anything to announce, but we're we continue to see opportunities in the four core markets that our strategic framework and where we would want to do any kind of M and A. We continue to have the strict financial criteria and we evaluate them against this. But as I said, we are seeing opportunities.

Speaker 2

We're prudent, but we do think we will be able to execute on an M and A strategy over the near to midterm.

Speaker 10

Okay. And if I could squeeze one more in, any update on just what your parent LDO, Leonardo is doing? They've been active in M and A markets as well.

Speaker 2

We can on our M and A, we have a shareholder agreement where we consult closely with them and we're aligned in that there are 70% shareholders, so any increase in value drops directly into their share price. So we're aligned on what we're looking for and we participate with them.

Speaker 10

Okay. Thank you.

Operator

Thank you. Please standby for our next question. Our next question comes from the line of Jan Franz Engelbrecht with Baird. Your line is open.

Speaker 5

Good morning, Bill, Mike and Steve. I just had a question on force protection. It's clearly seeing significant demand tailwinds, I would imagine in the Middle East. I was wondering if you could just highlight the 2024 growth outlook for that specific end market? And if there's any milestones or programs that we should look out for later in 2024 heading into 2025 in force protection specifically?

Speaker 2

Yes. No, I mean, I think you've got the underlying market dynamics right. The conflicts in Ukraine and Israel have highlighted the importance of organic force protection that we've returned to a world where there are air threats and that those air threats have been exacerbated by the advent of drone technology, which extends even to the lower end of military capabilities. They're still able to put drone threats in the air. That all has made our decision to invest in the Army Short Range Air Defense, the counter UAS, the active protection, we're seeing growth in all of those.

Speaker 2

I think we mentioned it on an earlier call, but the Army has doubled the force structure that they've this year that they dedicate to short range air defense. They got went from 4 to 9 battalions that's even as they shrunk the force structure. So they have fewer assets, but they're devoting a higher proportion to the mission of short range air defense. And we are also starting to see international demand. We were able I think to enable help that demand by developing a single vehicle solution for the counter UAS, which makes it more operationally efficient and lowers the price point, make it more competitive in the international markets.

Speaker 2

So I mean overall, I think in this area the trends are very positive.

Speaker 5

Thanks, Bill. That's really helpful. And just a quick follow-up, I guess also sort of high level, but we've seen this growing trend or call, I guess, from the industry for the need for interoperability between the U. S, NATO, Allied Nations in terms of weapon platforms. Is there any opportunity that you guys are targeting?

Speaker 5

I know it's early days, but maybe I would think top of mind would be sensors or anything like that. Anything that you can comment maybe on the longer term there?

Speaker 2

Yes. I mean, frankly, that's always been there. I mean, obviously, NATO alliances, what just celebrated 75th anniversary. So the and then we have close alliances in Asia as well. So that's always been there.

Speaker 2

I think you're right. It's been reemphasized with some of the conflicts we face and with the threat of China. Where we see it? Yes, sensing is one area where we see people. I would say even more you see it on computing and communications.

Speaker 2

And we do the battlefield computing for the U. S. Military and we do see international opportunities for that. We already sell it to the U. K.

Speaker 2

It is part of some of the foreign military sales of vehicles to Eastern Europe. So there's a dynamic there that basically if you're particularly if you're buying U. S. Sourced vehicles, there's certainly an incentive to put the same network computing, 1, because it's integral to the vehicle, but 2, that does give you that interoperability that you suggested.

Speaker 5

Great. Thanks, Bill. Congrats on a good quarter. I'll jump back in the queue. Thanks.

Operator

Thank you. Please standby for our next question. Our next question comes from the line of Christine LeWagg with Morgan Stanley. Your line is open.

Speaker 11

Hi, this is Justin on for Christine. Thanks for taking the question.

Speaker 3

Hey, Justin.

Speaker 11

I think lots have been covered already, but maybe just a quick one on ASC. I think last quarter you mentioned mix was shifting from development to production over the course of the year. I guess how much of that shift manifested here in 2Q results? And is it still fair expectations for further tilt towards production type work in the back half for the segment? Thanks.

Speaker 3

Yes, I think you're spot on with your assessment. We are starting to see some of those development programs moving to production and the production efficiencies improving on those programs, which has certainly helped in both the revenue growth as well as the margin. So I would expect to see that trend continue into the second half of the year. Okay.

Speaker 11

I'll stick the one. Thanks.

Speaker 5

Thank you.

Operator

Thank you. Ladies and gentlemen, I'm showing no further questions in the queue. I would now like to turn the call back over to Steve for closing remarks.

Speaker 1

Thank you all for your time this morning and your interest in the company. Of course, if you have follow-up questions, please don't hesitate to call or email me. We look forward to speaking with all of you again soon. Enjoy the rest of your day.

Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now

Powered by Quartr
Earnings Conference Call
Leonardo DRS Q2 2024
00:00 / 00:00