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Edited Transcript of ESLT.TA earnings conference call or presentation 26-Nov-19 2:00pm GMT

Q3 2019 Elbit Systems Ltd Earnings Call

Haifa Nov 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Elbit Systems Ltd earnings conference call or presentation Tuesday, November 26, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bezhalel Machlis

Elbit Systems Ltd. - President & CEO

* Joseph Gaspar

Elbit Systems Ltd. - Executive VP & CFO

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Conference Call Participants

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* Ella Fried

Bank Leumi le-Israel B.M., Research Division - Senior Equity Analyst

* Peter John Skibitski

Alembic Global Advisors - Research Analyst

* Ehud Helft

CCG Investor Relations Inc. - Managing Partner - Israel

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to the Elbit Systems Third Quarter 2019 Results Conference Call. (Operator Instructions) Following management's formal presentation, instructions will be given for the question-and-answer session. As a reminder, this conference is being recorded. You should have all received by now the company's press release. If you have not received it, please contact Elbit's Investor Relations team at GK Investor and Public Relations at 1 (646) 688-3559 or view it in the News section of the company's website, www.elbitsystems.com.

I would now like to hand over the call to Mr. Ehud Helft of GK Investor Relations. Mr. Helt, please go ahead.

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Ehud Helft, CCG Investor Relations Inc. - Managing Partner - Israel [2]

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Thank you, and good day to everybody. On behalf of all the investors, I'd like to thank Elbit Systems management for hosting this call. Joining us on the call today are Mr. Butzi Machlis, Elbit's President and CEO; and Mr. Yossi Gaspar, Elbit Systems' Chief Financial Officer. Yossi will begin by providing a discussion of the financial results of the third quarter of 2019, followed by Butzi, who will talk about some of the significant events during the quarter and beyond. We will then turn over the call to the question-and-answer session.

Before we begin, I would like to point out the safe harbor statement in the company's press release issued earlier today, also refers to the content of this conference call.

With that, I would now like to turn the call over to Yossi. Yossi, please.

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Joseph Gaspar, Elbit Systems Ltd. - Executive VP & CFO [3]

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Thank you, Ehud. Hello, everyone, and thank you for joining us today. As we do every quarter, we will provide you with our regular GAAP financial data as well as certain supplemental non-GAAP information. You can find all the detailed GAAP financial data as well as the non-GAAP information and the reconciliation in today's press release.

The results of the third quarter of 2019 showed a good revenue growth, with particularly strong growth in the United States, a strategically important market for us. Elbit has now seen 4 consecutive quarters with revenues at over $1 billion per quarter, and our backlog nearing $10 billion provides good visibility over the coming years.

I should note that the balance sheet and the backlog of Harris Night Vision business has been consolidated as of September 30, 2019. I will now highlight and discuss some of the key figures and trends in our financial results. Our third quarter 2019 revenues were $1.1 billion compared with $895 million in the third quarter of 2018, up 23% year-over-year.

In terms of revenue breakdown across our areas of operation in the quarter, land systems accounted for 27% of total sales and have increased significantly year-over-year, mainly due to our acquisition of IMI completed in the fourth quarter of 2018.

Airborne system sales at 36% of sales increased year-over-year due to avionic sales and the sale of IMI products into the U.S. and Israel.

In terms of geographic breakdown, we continue to be fairly well diversified between the various regions in which we operate. North America was the largest at 30% of our revenues, Asia-Pacific at 23%, Israel at 22%, Europe at 18%. The strong growth in North America was primarily due to increased airborne sales, as I mentioned a few moments ago, and the growth in Israel was due to the acquisition of IMI.

For the third quarter, non-GAAP gross margin was 26.3%, compared to the third quarter of last year of 29.1%. The lower gross margin in the quarter reflects an unfavorable sales mix during the quarter and a lower gross margin of the IMI sales.

Third quarter non-GAAP operating income was $80.7 million or 7.3% of revenues compared with $85.7 million or 9.6% of revenues last year. Third quarter GAAP operating income was $101.7 million versus $79.1 million last year.

In the quarter, we exercised a purchase option that we had on one of our buildings and sold it, generating a capital gain and income of $28 million, which reduced our operating expenses. The operating expenses breakdown in the quarter was as follows: net R&D expense at 7.2% of revenues versus 7.8% last year; net R&D spend was 7.9 -- $79.5 million in the quarter compared with $69.6 million last year; marketing and selling expenses at 6.9% of revenues versus 7.8% last year; G&A expenses at 5.2% of revenue versus 4.2% last year, with the relative increase primarily due to our recent acquisitions.

Financial expenses for the third quarter of 2019 were $18.5 million compared with financial expenses of $8.1 million in the third quarter of last year. The higher level of financial expenses this quarter was due to the implementation of accounting standard ASC 842 relating to operating leases. In the quarter, this generated a noncash accounting expense of $6.6 million, mainly due to the strengthening of the shekel versus the U.S. dollar.

We had another expense of $2.8 million. This was due to non-service cost component of pension plans following the adoption of accounting standard ASU 2017-07.

For the third quarter, non-GAAP net income was $58.7 million or a net margin of 5.3% versus $67.3 million or a net margin of 7.5% in the third quarter of last year. On GAAP basis, third quarter net income was $72.1 million versus $64.1 million in the corresponding quarter last year. I know that during the second quarter, Elbit Systems raised $185 million through the sale of treasury shares to institutional investors in Israel. This increased our share count by about 3% to 44 million shares, having a slight corresponding impact on our earnings per share relative to last year.

Our non-GAAP diluted earnings per share were $1.32 compared with $1.57 in the third quarter of last year. GAAP diluted earnings per share were $1.63 compared with $1.50 in the third quarter of last year.

Our backlog of orders as of September 30, 2019, was $9.8 billion, $1.7 billion higher than the backlog at the end of the third quarter of 2018 and $396 million higher than that at the end of 2018. This represents over 21% increase in backlog year-over-year. Approximately 46% of the current backlog is scheduled to be performed during the remainder of 2019 and 2020, and the remainder is scheduled for 2021 and beyond. The ratio is broadly similar to that of the third quarter of last year, where it was 45%.

Operating cash flow for the quarter was $48.8 million outflow compared with $19 million outflow in the same quarter last year. We have increased our focus on the cash generation and expect to see gradual improvement over the coming quarters.

The Board of Directors declared a dividend of $0.44 per share for the third quarter of 2019.

That's my summary, and I shall now turn over the call to Mr. Machlis, Elbit's CEO. Butzi, please go ahead.

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Bezhalel Machlis, Elbit Systems Ltd. - President & CEO [4]

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Thank you, Yossi. Elbit Systems has evolved significantly in the past year, and it's of much greater scale than only a year ago. This is especially true in our key strategic region, United States. Over the past year, we completed 2 large acquisitions. In September, we completed the acquisition of the Night Vision business from L3Harris Technologies for $350 million. The Night Vision business has strong market positions in the U.S. and adds advanced technologies to Elbit Systems portfolio, with significant potential for delivering -- for revenue synergies. This acquisition further enhanced our position in the U.S., a strategic market for us.

I would like to take this opportunity to welcome the Night Vision employees into the Elbit Systems family.

At the end of last year, we completed the acquisition of IMI Systems. The combination of Elbit and IMI capabilities together with Elbit Systems broad market presence enabled us to offer an enhanced product portfolio and realize the potential of IMI's technologies in Israel, and more importantly, in the international arena. The integration of IMI is progressing in line with our expectations, and we continue to explore further opportunities to extract revenue and cost synergies.

Our gross margin in the third quarter was impacted by the sales mix and IMI. Land systems management is working hard to raise IMI margins up to Elbit's. Progress is encouraging, but the improvement will be gradual. Elbit has decades of experience in successfully integrating acquisitions and extracting synergies often significantly ahead of plan.

Taking a closer look at the performance of Elbit Systems during the quarter, as Yossi mentioned, our revenue grew by 23% year-over-year, a mixture of organic growth and IMI. Our businesses continues to perform well, and we have won new businesses across all our main target regions.

I would like to highlight some of our recent wins. In Europe, we were pleased to have been selected to provide the Swiss Armed Forces with an army-wide tactical Software Defined Radio solution, a key capability for the Swiss Armed Forces. This selection followed a rigorous evaluation procedure, which ultimately found our system, providing a better price performance ratio over the competition. The contract award is subject to approval by the Swiss Parliament. A few weeks ago, we announced a 5-year, $50 million contract to supply the Portuguese Air Force with a complete Electronic Warfare suite and Customer Logistics Support for the new KC-390 multi-mission aircraft.

In the U.K., we were awarded a $38 million contract to supply comprehensive Joint Fires Synthetic Training system to the British Army. The system will be supplied over 2 years, and the contract includes 4 years of maintenance, technical support and on-site training.

In Southeast Asia, we announced $150 million contract for a multi-layer array of unmanned aircraft systems, or UAS. Under the contract, we will supply a network multilayer UAS solution, including more than 1,000 THOR multi-role vertical take-off and landing mini-UAS, scores of Skylark LEX, Skylark 3 and Hermes 450 tactical UAS as well as universal ground control stations.

In the U.S., we recently announced a $23 million win by our newly acquired Night Vision's businesses for the supply of systems and various spare components to the United States Marine Corps. The order is part of the $249 million 5-year squad binocular night vision goggles system ID/IQ contract awarded several days before the finalization of the acquisition of the Night Vision businesses by our U.S. facility.

In September, we announced our selection by Boeing to supply cockpit displays, data links and embedded training capabilities for the U.S. Air Force T-X advanced pilot training aircrafts.

We continue to see demand across the globe for our solutions from our legacy and recently acquired businesses, highlighting the value provided by our broadband product suite. In summary, as Elbit moves into 2020, we are not only a leading high-tech defense electronic company, we are also a company of significant scale, a bigger player in the large U.S. market with multiple growth opportunities ahead of us.

And with that, I will be happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

The first question is from Pete Skibitski of Alembic Global.

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [2]

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My main question is on gross margin. I know you guys talked about mix, and I want to make sure I understand exactly what you mean by that. Was the mix related to your within IMI? And in other words, IMI gross margin was down versus the first half of the year. Or was it related to some other item?

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Joseph Gaspar, Elbit Systems Ltd. - Executive VP & CFO [3]

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It's a combination of both. IMI's gross margin historically used to be in the teens, as you know, and we are working hard to improve that. And actually, they were able to improve slightly in the last 3 quarters. And we see the gradual improvement for the future. However, they start for a relatively low number. While we are in the high 20s, they are in the high teens. So that is one aspect.

The other, the mix element is that given the rest of the business, from time to time, we have a mix of products and mix of programs sold in the quarter, sometimes with higher profitability, sometimes with lower profitability. And that's what we mean by a mix in the quarter.

In general speaking, I would look at the longer-term gross profit performance of the company. And the value of the specific quarter gross profit, I would say, is a little bit limited.

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [4]

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Okay, okay. So you're expecting an improvement sequentially in the fourth quarter, Joseph?

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Joseph Gaspar, Elbit Systems Ltd. - Executive VP & CFO [5]

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Well, we're working hard to improve it. We don't provide guidance, as you know. Usually, the fourth quarter is a strong quarter, definitely in the revenue line. We'll see how it goes.

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [6]

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Okay, okay. And let me ask on working capital. You made some comments in your prepared remarks. How are you thinking about the fourth quarter? Do you think working capital will be a tailwind for you? And is there maybe a free cash flow to net income conversion ratio for the full year that you think you can hit?

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Joseph Gaspar, Elbit Systems Ltd. - Executive VP & CFO [7]

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I expect to improve the situation in the fourth quarter. However, I do not expect total turnaround. We're working hard to collect from our customers the money. Here in Israel, we have a little bit difficult situation with the Ministry of Defense and in general, actually, with the whole budgetary situation of the whole country due to the political situation. However, we expect to collect that in the coming quarters in one way or another. Other customers, we're working hard to get the money in. The other element of the working capital, we have a slightly higher than usual level of inventory. Part of that will be reduced we expect during the fourth quarter, but part of that will continue with us in view of the fact that we have to provide for the growth of the revenue line in the future quarters.

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [8]

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Okay. Understood. I guess, I'll ask one last one. I appreciate all the color. On active protection systems, it seems like you've had some breakthroughs recently. I think you guys announced in August, you won the Israeli Eitan APS competition on Rafael? And I understand that Eitan will go into production in 2021. And so I'm trying to maybe think about a revenue profile there like maybe a similar U.S. program could be. I'm guessing maybe you have a limited number of development revenue you'll book before the Eitan gets introduced around 2021, but then thereafter I imagine maybe it ramps as the vehicle goes into production. Is that the right way to think about it?

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Bezhalel Machlis, Elbit Systems Ltd. - President & CEO [9]

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Yes, you're right. We almost completed the development of the system, and we're waiting for an order from the Israeli Ministry of Defense. As we all know, this Eitan is very important platform here in Israel, and I'm sure it will go into production with big numbers. And we are very proud by the fact that we have been selected by the Israeli MOD. We don't yet have an order. Therefore, we didn't talk about that, but we expect to have this order soon, and it will go into production, as you said, probably in the year -- in about a year time from now. We see a lot of interest for the system in many other places. As you all know, we are discussing this system also with the U.S. forces for the Bradley A3 in the U.S. And there is also a lot of interest in Europe as well as in Asia-Pacific, and we expect this product or system to be a growth engine for our land division as well as for the entire corporation. And we expect it to go into production, as I said, in about a year from now for Israel as well as, hopefully, for other customers as well.

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Operator [10]

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(Operator Instructions) The next question is from Ella Fried of Bank Leumi.

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Ella Fried, Bank Leumi le-Israel B.M., Research Division - Senior Equity Analyst [11]

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First, regarding the appreciation of shekel and the current hedge situation. As we know, the third quarter was partially hedged. And if I remember correct, the fourth quarter was almost with no hedge at all. And how are you coping with the present rates and the shekel appreciation in general?

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Joseph Gaspar, Elbit Systems Ltd. - Executive VP & CFO [12]

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Well, we are experiencing a strong shekel. And actually in the third quarter, this suffered to some extent from the strong shekel as well. We -- the fourth quarter will be affected as well. I'm not sure what will be the average rate on that fourth quarter shekel. However, we are now in the $3.48 per dollar or $3.46 per dollar range. We're working hard to reduce, as you know, our cost basis and to be minimally affected by that. We did not hedge anything for the fourth quarter. We'll have some impact. I don't think that will be something extremely drastic.

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Ella Fried, Bank Leumi le-Israel B.M., Research Division - Senior Equity Analyst [13]

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And another impact or not, the labor cuts, the letting go of part of IMI and all this procedure. Will we see the impact of it on the results of the fourth quarter? And how much of it did we see in the third quarter?

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Joseph Gaspar, Elbit Systems Ltd. - Executive VP & CFO [14]

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Well, actually, the impact of that, you see it, first of all, in the cash flow. We did pay whatever needed to be paid according to the agreements that we had with the unions and the employees and the government when we bought IMI. So that is one impact. The other impact, we started seeing gradual initial reduction in the headcount. And according to that, a reduction in the cost basis of the operation of IMI. And therefore, we actually were able to bring them at breakeven plus, I would say, the operating profit level. Some of the reasons of that are in that element that we just discussed right now. Looking into the future, we expect to get the benefit, the full benefit in the following year and by reduction of cost -- cost basis. In parallel, we, of course, have gone through restructuring of the business and focusing in the business elements, better coordinating at IMI in line with what we do in the rest of the company.

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Ella Fried, Bank Leumi le-Israel B.M., Research Division - Senior Equity Analyst [15]

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For how long do you think -- is your estimated that this process -- I mean, the bulk of this process will last 2 quarters, almost 3 quarters from now?

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Joseph Gaspar, Elbit Systems Ltd. - Executive VP & CFO [16]

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Yes, I think we'll be done with most of it somewhere during 2020.

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Operator [17]

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There are no further questions at this time. Before I ask Mr. Machlis to go ahead with his closing statements, I would like to remind participants that a replay of this call will be available 2 hours after the conference ends. In the U.S., please call 1 (888) 326-9310. In Israel, please call 03-925-5921. And internationally, please call 972-3-925-5921. A replay of this call will also be available at the company's website, www.elbitsystems.com.

Mr. Machlis, would you like to make your concluding statement?

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Bezhalel Machlis, Elbit Systems Ltd. - President & CEO [18]

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I would like to thank all our employees for their continued hard work. To everyone on the call, thank you for joining us today and for your continued support and interest in our company. Have a good day, and goodbye.

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Operator [19]

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Thank you. This concludes the Elbit Systems Ltd., Third Quarter 2019 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.