Ladies and gentlemen, good day, and welcome to Leonardo DRS First Quarter Fiscal Year 2024 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.

Good morning, and welcome, everyone. Thanks for participating on today's quarterly earnings conference call. With me today are Bill Lynn, our Chairman and CEO; and Mike Dippold, 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. 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 update 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. Bill?

Thanks, Steve, and thank you all for joining us this morning. It was great connecting with many of you at our recent Investor Day in New York. Just as a quick recap, we laid out a compelling investment case for DRS. And as many of you know, we are a unique story amidst a very scarce universe of smid-cap defense technology companies. Our diverse and platform agnostic portfolio is well aligned to customer priorities in areas of healthy demand. This is apparent in the steady pace of bookings, including the $815 million secured this quarter. As a result, our backlog visibility continues to build, and this combined with our multipronged growth strategy is demonstrating a clear path to mid-single-digit organic growth over the next few years. Our Q1 results, 2024 guidance and multiyear targets all reflect the solid confidence we have in our portfolio and competitive positioning. I want to reiterate that foundational to DRS's strong market positioning, our people, innovation and the technology differentiation we have built over 5 decades. We continue to sharpen our investments in R&D and CapEx to increase our distinct edge and that of our customers. We remain focused on executing on our strategy to drive outcomes for our customers and our shareholders. This focus is evident in our exceptional quarterly results. These results were all well ahead of our expectations for the quarter. Our strong Q1 financial performance is a direct outcome of an initiative to drive incrementally better quarterly linearity. I'm pleased with the solid start to the year as it places us on a nice path to deliver on our 2024 commitments. Let me review a couple of specifics. Our revenue growth was entirely organic and accelerated to 21% year-over-year. We continue to convert strong customer demand into bookings and drove a…

Thanks, Bill. I'm excited to discuss our financial results in greater detail. Before I get to that, let me express my heartfelt thanks to the team for helping execute another remarkable quarter. As Bill mentioned, we are working to make progress towards better linearity in our financial performance, and that is certainly evident in our Q1 results. In the quarter, we experienced year-over-year growth of 21%, again, all organic. A significant portion of the growth was driven by our naval power programs, namely Columbia-Class, but momentum for our ground system's integration, advanced sensing and naval network computing efforts were also strong contributors to the performance in the quarter. Moving to the segment view. ASC segment revenues were up 11% due to growth in programs related to advanced infrared sensing, naval and ground network computing as well as tactical radars. Our IMS segment revenues were up an impressive 38% year-over-year, with strong performance apparent across the segment, but growth of our Columbia-Class program was certainly a key driver. Now to adjusted EBITDA. Adjusted EBITDA in the quarter was $70 million, representing significant growth of 43% from last year. As previously discussed, our period expensing of G&A means incremental volume typically drops to the bottom line. And in Q1, this definitely rang true. The increased volume also translated to adjusted EBITDA margin expansion of 160 basis points, taking margin to 10.2% in Q1. On a segment basis, ASC segment adjusted EBITDA increased by 11%, but margin was flat due to less favorable program mix offsetting the higher volume. IMS segment adjusted EBITDA was up 142% and margin was 480 basis points higher than last year due to continued momentum on naval power programs led by the Columbia-Class. Moving to the bottom line metrics. First quarter net earnings were $29 million and diluted…

Thank you. At this time, we will begin the question-and-answer session. [Operator Instructions] Please stand by while we compile the Q&A roster. Our first question comes from the line of Peter Arment with Baird.

Bill, Mike, Steve. Nice results. Hey, Bill, you touched upon force protection and the demand signals there, obviously, are very strong. Can you maybe talk about if you're seeing an increased amount of development opportunities for DRS? And just how do we think about maybe the current pipeline of force protection work? And then, I guess related to that, is maybe you could touch upon just the force structure, the pickup that the Army is doing, a doubling of short-range air defense vehicles and the opportunity for DRS?

Yes. Thanks, Peter. On the last point, we were pleased to see that as the Army did its biannual review of its force structure even though the overall force structure contracted, the end strength went down. They more than doubled the commitment to force protection, particularly short-range air defense. So we think that reflects, I think, the immediate lessons of Ukraine, but the longer-term trends that have been going on in the last few years that led them to contract with us to do with the M-SHORAD to begin with. As you indicated, there are still development opportunities for newer versions and different types of systems. The one that we're working most actively now is called M-LIDS, which is the counter UAS system. It's a little bit -- a more targeted version of a short-range air defense system. We're in the -- we put the first version out and the Army is buying it. The second version, which will take 2 vehicle -- a 2-vehicle solution and combine it into a single vehicle solution is, we're just finishing the development of that now and the Army is going to -- they like that enough that they're going to cut over their existing buy into that. And so we think that this is going to continue to progress down the line. And we think DRS with its portfolio of Force Protection Solutions is very well positioned to ride this trend.

Yes. And can you talk, I guess, a little bit about the RADA business? I mean, tactical radars, obviously, are probably -- the demand is insatiable, I'm sure, off the charts. Can you maybe just talk about how that business is doing just given the conflict of Israel?

Yes. We don't give guidance at the business level, but you're right that we are running that business 24/7 at this point. Given the demand, not only in Israel and Ukraine, but what that's triggered in militaries around the world as it's exposed force protection, vulnerability to organic units. You've reached a point now where you can't just protect forces at the edge of the battlefield. It kind of a perimeter defense. You have to have defense that's organic to units. I think that's what Ukraine in particular has shown. And a key element of that force protection is tactical radars and RADA has a leading, if not the leading, solution, and we are seeing increasing demand. So we're pleased with the acquisition we made 18 months ago.

And just, lastly, a quick one for Mike. Just could you maybe talk a little bit about working capital trends for the rest of the year? I know as Columbia 3 ramps up and just kind of the cadence of the year, which is obviously seasonal and picks up into the back half of the year?

Yes. I don't think you're going to see too much dissimilarity to what you've seen in the prior years. I think the trend is going to be pretty much the same. Obviously, we've got out to a little better start here in Q1, but I'll remind you that that's going to be a little bit offset as we progress the year because of the capital outlays for the South Carolina facility. So I would still expect a lot of the cash generation to occur in the fourth quarter, albeit hopefully at a little better linearity than we've seen in the past.

One moment for our next question. Our next question comes from the line of Robert Stallard with Vertical Research.

Bill, maybe I'll start with you. A couple of questions. First of all, on the DoD budget outlook in FY '25, where you start to see the military doing some trimming of perhaps what you might say, lower priority areas. Is there any risk of a knock-on impact on DRS from any of these changes?

Yes. Rob, I think the budget has come out about where we expected. It took a long time in multiple CRs, but the '24 budget finally emerged, and it emerged at the level that President Biden and then speaker McCarthy agreed to last summer. And on top of that, the supplemental was passed at the expected level, the requested level, and then the '25 budget came out, again at the expected and the agreed-upon level. So the expectations we had in building our plan, I think, were fulfilled to your kind of broader point. Is that forcing trade-offs? Yes, it clearly is. And I think it's gone down the path that we've predicted, which is those trade-offs start with platforms, whether it's the Virginia-Class submarine or the cancellation of the FARA helicopter. That's where the services have gone and that kind of confirms our philosophy of being platform agnostic so that when platforms are delayed or canceled and upgrades replace them, we're positioned to move on those upgrades just as easily as we were positioned to put our electronics and sensing and other equipment on new platforms. So we think that dexterity, the agility to move between upgrades and platforms has been confirmed by the recent budget decisions.

And just a follow-up. I mean has there been any changes on the M&A pipeline at this stage?

Nothing that I can report in terms of specifics. We have a robust pipeline. We're actively engaged in reviewing those -- those opportunities. Our criteria remain the same. We want -- and we think we are seeing opportunities that are a strategic fit to our core market. They need, financially, to be EPS accretive. They need to have returns above our weighted average cost of capital, at least over 3 or 4 years, and they need to support our strategic growth and margin expansion path. So we're continuing to review against those criteria. We are finding opportunities, but we don't have anything that we have gotten to the decision stage and are ready to announce yet.

And then just finally, one for Mike. The $4 million of restructuring in the quarter, I don't know if you could elaborate on what's behind that?

Yes. This is actually just a continuation, Rob, of what we announced last year with the Canadian facility reorganization. It's really just the accounting treatment and that you kind of have that accrue for the severance when the commitment date for the employees was reached. So we're kind of accruing it over time. But this is that effort that we put forth last year where we detailed the savings associated with this facility consolidation, and this is just the kind of tail end of that.

One moment for next question. Our next question comes from the line of Seth Seifman with JPMorgan.

Thanks very much, good morning, everyone. Wanted to -- just to dig in on the sales outlook for the rest of the year. It seems that if Q2 kind of looks like Q1, then the implication is really not very much growth at all in the back half of the year. And I know that the comps get tougher, so that makes sense on some level, but also we see the growth in the backlog, and we see the demand environment. And so, I mean it would seem after this performance at the first -- in the first quarter that the balance of risk in the sales outlook is pretty clearly to the upside?

Yes. I would take that to say that I think a lot of the performance and overperformance was a little bit of a pull forward as we improved the linearity. I think that's a piece of it. And we still want to see how the cadence of the orders play out for the rest of the year. Certainly pleased about where we are in Q1, certainly think that we are positioned to execute within the guide range that we put forth, and that's kind of where we are today, Seth.

Okay. Okay. And I know that you don't -- you guys don't have segment guidance, but maybe at a qualitative level, if we think about Q2 sales and EBITDA kind of looking like Q1, is that -- is that similar in the segments? Or were there certain pieces of goodness on Colombia, for example, in the first quarter that helped out there that aren't necessarily recurring? And then maybe there's some opportunity for kind of gradual improvement through the year in advanced sensing and computing?

Yes, good question. And you've got it pretty much nailed. So what we saw in the ASC segment in Q1 was a little bit of more revenue contribution from the development type programs. And what we expect to see is that to move more towards production as the year progresses. So you'll see a little pickup in the advanced sensing segment in terms of a profitability perspective. On the IMS side, they were the ones that benefited from some of the pull forward, if you will, from later quarters in 2024(sic) [ 2023 ] -- so that absorption of the fixed cost really helped that segment margin. So I would think as you look to Q2 and beyond, you'll start to see kind of a pullback, if you will, a little bit on IMS and an acceleration of ASC. And at the end of the day, I do believe both segments will contribute fairly equally to the revenue growth for the year as well as the margin expansion.

One moment for next question. Our next question comes from the line of Mariana Perez Mora with Bank of America.

So first one in the South Carolina facility. Could you please like give us some color on how the development is going? What should we expect in the near term? Or what kind of milestones we could be looking at?

Is that South Carolina?

Yes, South Carolina Yes. We're -- we've signed a lease now. We're just starting the work, as Mike indicated, that the CapEx will start to increase now as the work starts. This is a 2- to 3-year development. The -- as we've said, the focus of this phase is on Colombia and improving the profitability and the efficiency of the Columbia work. And we're in discussions now with the Navy and the shipyards about how we could use is an expansion of this facility to pull more work towards -- in our direction in a way that would allow them to increase the submarine production rate as is the national goal, particularly on the Virginia-Class, but overall, increase the submarine industrial base by redistributing the work between yards and suppliers. This facility could play a key role in that, that submarine industrial based funding that was passed in the supplemental could be a part of that equation as well.

Yes. And that was where my question was finded next. Like considering that the shipyards or ships such a long cycle development effort, how soon could we see some like firm commitment from these parties for this facility to play a role on accelerating and making a more robust shipholding production in the U.S. or even supporting [ OCIS ]?

Yes, some -- was a multistage answer, I guess, is -- I mean, right now, we're building the facility. So that will take 18 months, 2 years. The negotiations with the Navy are ongoing in terms of support for an expansion, I think you could see some results in a matter of months or a year or so, but then you would have to then turn that funding into an expansion of the facility, which would come at the end of the initial build that we're doing. So it's a multiyear midterm prospect in terms of expanding that revenue base that's the overall goal.

And last one from me on M&A. You mentioned you are looking at some companies -- like I'm curious like if you could give us some color on how robust is that pipeline? Is just like couple companies, a handful of companies or doses(sic) [ dozens ] of them? And then when you analyze those companies to your criteria, how many of those deals actually like just like expire or die when you do your due diligence?

It's hard to give you precise numbers. I would say, over the course of the year, we look at -- carefully at dozens of companies and then a modest number of those we go into diligence. And if -- and then if that works out, you would only end up with one or two where you get into the offer stage over the course of the year.

One moment for next question. Our next question comes from the line of Sam Struhsaker with Truist Securities.

On for Mike Ciarmoli. Congrats on a pretty nice quarter here. Kind of just building off of the prior line of questioning a little bit. Regarding these kind of delays in the submarine pipeline, do you guys see any maybe more near-term opportunities kind of before that South Carolina facility is done where you guys might be able to take on a little bit more work? In addition to what's already -- what's already kind of happened that might kind of see some more near-term opportunities there? Or would you really just kind of be looking for what you guys just discussed on a slightly longer-term basis?

In terms of the larger opportunities, which would be new classes of ships, DDGX and SSNX. Those are several years away in terms of real revenue, the international opportunities are a little bit closer in. And the real revenue increase in the immediate term for us is the growth in the Columbia-Class submarine as we move up the curve shift set by ship set.

Right. I guess, while I was kind of getting at more so is, do you guys see any opportunity where kind of some more work might be able to be passed on to you guys within the existing programs which you're on? To kind of try to help aid with these issues getting up to rate by the broader industry?

Yes. That's what I was talking about with the South Carolina facility is that if you redistribute the work or you moved some of the work that's done now at the yards into our South Carolina facility to allow a higher through at the yards, that would be certainly an expansion of our revenue base.

Got it. And then one more here kind of on the fiscal year '25 budget. Do you guys have any kind of opinion there on how that's looking for you guys, push and takes?

Yes. The '25 budget that dropped. Again, I think as Bill kind of alluded to earlier is that it wasn't really a surprise. And as we look through the funding line items, we feel our programs were pretty well fed. I think that goes to the platform-agnostic approach that we've had and where we align with the modernization priorities, both with the Navy and the Army and the Greater Defense Department as a whole. So we feel pretty good about where we landed in our first [ technical inset ] at the '25 budget.

One moment for next question. [Operator Instructions] our next question comes from the line of Jonathan Tanwanteng with CJS Securities.

I just wanted to push the guidance from a different angle. Last quarter, I think you mentioned that the lower end of the range was predicated on maybe more extended spending and budgetary issues given that we've seen both the passage of the spending bill on the Ukraine. Bill, would you expect to be more at the midpoint or the upper half of the range now? Just how are you thinking about that, just given the updates to how topo spending is going to play out this year?

Yes. I think the budget passage and the supplementals are certainly a nice occurrence to happen as early as they did. We're going to see how those outlays flow in terms of when you're going to start to see the order flow because of those passages. And if the trends continue in a positive way, that could be a nice tailwind. But right now, we're still targeting towards the midpoint of the guide and are going to see how this plays out for the next quarter or 2.

Okay. Fair enough. And then just regarding the pushouts of these more -- the newer platforms and the Navy ships, maybe beyond the end a decade. Can you just tell us maybe what the net change in your opportunity set is? Through the latter half of the decade, you've obviously seen more demand flow in to enforce protection and other things that are going on. Maybe the Navy starts to spend more, as you've indicated, on production of what they have in hand. Is that a net decreasing opportunity through 2030, or that is pretty much static just given the puts and takes?

The DDGX and SSNX were always at the end of the planning period. So that hasn't really changed our opportunity set. The more immediate opportunities are the growth in Colombia, the opportunities provided by the submarine industrial base and the international opportunities. Those are the things that are in the next 3-4 years, those are what's going to drive growth.

Okay. And so, basically, the overall opportunity set hasn't changed even with the pushouts in some places?

Exactly.

This concludes the question-and-answer session. At this time, I will turn the floor back to Steve Vather for closing remarks.

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

This concludes today's conference. You may now disconnect. Thank you for your participation.