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Elbit Systems Ltd. (ESLT) Q2 2019 Earnings Call Transcript

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Elbit Systems Ltd. (NASDAQ: ESLT)
Q2 2019 Earnings Call
Aug. 15, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems' second quarter 2019 results conference call. All participants are at present in listen-only mode. 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. Ehud, would you like to begin please?

Ehud Helft -- GK Investor Relations -- Managing Partner

Thank you, operator, and good day, everybody. On behalf of all the investors, I would 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. Yosi Gaspar, Elbit System's Chief Financial Officer. Yosi will begin by providing discussion of the financial results of the second quarter of 2019, followed by Butzi, who will talk about some of the significant event 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 that the Safe Harbor statement in the company's press release issued earlier today also refers to the content of this conference call. With this, I would now like to hand over the call to Yosi. Yosi, please?


Joseph Gaspar -- Chief Financial Officer

Thank you, Ehud. Hello, everyone, and thank you for joining us today. As we do every quarter, we will provide you with both 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 second quarter of 2019 was a solid quarter with strong revenue growth across all our main business regions, as well as continued growth in backlog. Elbit is now a company with revenue run rate of over $4 billion per year, and our backlog is close to $10 billion, giving us good visibility into the next year and beyond.

I will now highlight and discuss some of the key figures and trends in our financial results.

Our second quarter 2019 revenues were $1.064 billion compared with $892 million as reported in the second quarter of 2018, up over 19% year-over-year. In terms of revenue breakdown across our areas of operation in the quarter, airborne systems was 39%, C4I systems 24%, land systems 25%, electro-optics was 9%, and the rest was 3%. Compared with the second quarter of last year, we saw increased land systems revenue, mainly due to our acquisition of IMI, and we had higher land EW sales into Europe. There was a decrease in C4I revenue as we do not consolidate it Cyberbit revenues anymore.

In terms of geographic breakdown for the quarter, we continue to be fairly well diversified between the various regions in which we operate. North America was the largest at 28% of revenues, Asia/Pacific at 25%, Israel at 22%, Europe at 18%, Latin America at 4%, and the rest of the world at 3%. Compared with the second quarter last year, we saw an increase in all our main regions. In North America the growth was primarily due to increased airborne systems sales into the US. The growth in Israel was due to the acquisition of IMI at end of the last year, and Asia/Pacific sales grew due to increased sales of UAS and weapons stations in the region.

For the second quarter the non-GAAP gross margin was 27.7%, compared to the second quarter of last year of 28.6%. The lower gross margin was primarily reflective of the lower gross margin at IMI. The second quarter non-GAAP operating income was $89.6 million or 8.4% of revenues, compared to $73.2 million or 8.2% of revenues last year. I note that despite the low gross margins, we managed to close the entire gap and even increase the operating margin compared with last year. This is a reflection of the hard work we have been doing integrating the IMI operations into our company and extracting some of the synergies already after only two quarters into the merger.

Second quarter GAAP operating income was $83.3 million, versus $111.8 million last year. I note that in the second quarter of 2018 our GAAP operating income included an income of $45.4 million due to an increase in devaluation of shares in two of our subsidiaries as a result of third parties' investment in cyber and bionics.

In terms of our GAAP operating expenses for the quarter, total operating expenses were 19.6% of revenues in the second quarter, compared with 20.6% of revenues, excluding the income from reevaluation of assets last year. The operating expense breakdown in the quarter was as follows: net R&D expenses is 7.3% of revenues versus 8.6% last year, marketing and selling expenses at 6.9% of revenues versus 7.8% last year, and GNA expenses is 5.4% of revenues versus 4.2% last year with the relative increase primarily due to our recent acquisitions.

Financial expenses for the second quarter of 2019 were $20.3 million, compared with financial expenses of $10.7 million the second quarter of last year. The high 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 non-cash accounting expense of $5.2 million, mainly due to the strengthening of the shekel currency.

In our GAAP result, we had other income of $1.6 million. This was due to a capital gain at our subsidiary Brightway Vision, which amounted to $4.5 million, which amount was balanced by the adoption of the accounting standard ASU 2017-07 relating to non-service cost component of pension plans.

For the second quarter, non-GAAP net income was $64.3 million or a net margin of 6% versus $61 million or a net margin of 6.8% for the second quarter last year. On a GAAP basis, second quarter net income was $53.8 million versus $91.9 million in the corresponding quarter last year.

Number of shares. I note that during the second quarter, Elbit System raised $185 million through the sale of treasury stocks to institutional investors in Israel, which increased our share count by about 3% to approximately 44 million shares. This had a slight corresponding impact on our earnings per share. Our non-GAAP diluted earnings per share were $1.46, compared with $1.43 in the second quarter last year. GAAP diluted earnings per share were $1.22 compared with $2.15 in the second quarter last year.

Our backlog of orders as of June 30, 2019, was $9.8 billion, $1.73 billion higher than the backlog at the end of the second quarter of 2018 and $397 million higher than that of the end of 2018. This represents over 21% increase in backlog year-over-year. Approximately 56% of the current backlog is scheduled to be performed during 2019 and 2020, and the remainder is scheduled for 2021 and beyond. The ratio is similar to that of the second quarter last year.

Operating cash flow for the quarter was a negative $138 million, compared with a positive cash flow of $147 million in the same quarter last year. I know that Elbit Systems also received cash from two sources this quarter, which is not part of the operating cash flow. One, which I mentioned earlier, was the $185 million due to the sale of shares in dilution of investors. The second was a proceed from factoring of $345 million of the premises evacuation asset as part of the agreement for the acquisition of IMI.

So overall we were able to reduce our debt significantly. The board of directors declared the dividend of $0.44 per share for the second quarter of 2019. That ends my summary and shall now turn over the call to Mr. Machlis, Elbit's CEO. Butzi, please.

Bezhalel Machlis -- President and Chief Executive Officer

Thank you, Yosi. We are very pleased with our second quarter results. We have good progress across [audio cut] revenue over 19% higher than in the second quarter last year, and Elbit is now a company generating more than $1 billion in sales every quarter. Furthermore, our backlog continues its trend of growth, which is a good sign for our long-term future.

As you know, in the first year, we completed two key acquisitions, and we are in the process of integrating the new businesses in depth. In particular, while it will take time to bring the margins of IMI up to where Elbit margin currently stand, we are already working on making improvements and looking to extract the significant synergies within our new land division. However, we are pleased that despite the lower growth margins we have been able to maintain our operating margins at similar levels to those of last year.

Elbit also has decades of experience in successfully assimilating acquisitions and taking advantage of the synergies. We hope that in the coming months we will complete the acquisition of Harris night vision businesses that we announced a few months ago. We believe it will be significant to our long term growth strategy.

Turning to our ongoing businesses, Elbit continues to perform well, and we have won new businesses across all our main targets. Just to highlight some of our recent wins, in North America we won a $50 million six-years contract for the supply of structural parts for an aircraft for composite materials. We also won a further $26 million contract from the United States Custom and Border Protection Agency to install our Integrated Fixed Tower system on another segment of the US Arizona/Mexico border. Today we have one contract covering a total of approximately 200 miles of the border.

In Europe, to receive a 4-year $73 million contract to provide J-MUSIC directed infrared countermeasure system for the German Air Force Airbus A400M aircraft, and in Asia/Pacific we were awarded a $80 million contract to upgrade tents and supply radio systems for South Asian Arms. Overall we see ongoing demand for our solutions, which are strong indications of the operational importance of advanced and common capabilities that we have in all domains of operational engagement, whether maritime, land, and air.

In summary, looking at Elbit, as we advance through 2019, we are not only the leading high technology defense company but we are becoming a company of more significant scale and with many more growth opportunities ahead of us. And with that, I will be happy to take your questions.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, at this time we will begin the question and answer session. If you have a question, please press *1. If you wish to cancel your request, please press *2. If you are using speaker equipment, kindly list the handset before pressing the numbers. Your questions will be pulled in the order they are received. Please stand by while we pull for your questions.

The first question is from Pete Skibitski of Alembic Global. Pete, please go ahead.

Pete Skibitski -- Alembic Global -- Analyst

Hello, Butzi and Yosi. Congratulations on the first half adjusted margins. I'm sure that was a lot of hard work. Let me start. First question on the cash flow. It was nice, I think, to get that premises evacuation money in early, and of course you got the cash from the share sale like you mentioned. So the balance sheet looks like it will be in great shape heading into 2020, especially if cash collections improve in the second half, and so that's my first question is it looks like you had a receivables build in the second quarter. I'm guessing maybe on some overseas customers. So I'm just wondering if you expect to collect a substantial portion of that receivable in the second half of the year and just was wondering if you have a sense of where your free cash flow and that income conversion might end up on a full year basis.

Joseph Gaspar -- Chief Financial Officer

Hey. We expect to collect most of that cash in the remaining of the year. If you look back on our performance, two, three, or maybe more years, there were fluctuations in the cash receipts, and then toward the end of the year we were able to catch up most of the cash, the remaining cash. So we expect that to happen this year as well, and with that to keep a strong balance sheet.

Pete Skibitski -- Alembic Global -- Analyst

All right, guys. Very good. And a few small questions on revenue. I guess the first one, Yosi, your comments on Cyberbit Commercial not being consolidated anymore. Was that consolidated in the second quarter of 18? I'm just wondering if we should adjust last year's revenue to account for this or --

Joseph Gaspar -- Chief Financial Officer

Yes. Cyberbit Commercial got a significant investment from third-party shareholders during the second quarter of last year, and then that means that we consolidated only part of Cyberbit Commercial last year in the second quarter. And part was already not consolidated. This second quarter this year, the whole second quarter did not include anything from Cyberbit Commercial.

Pete Skibitski -- Alembic Global -- Analyst

Okay, OK. So you had a bit of a topline headwind from that it sounds like, and then was FX any meaningful headwind to revenue in the second quarter?

Joseph Gaspar -- Chief Financial Officer

Excuse me? I didn't get you.

Pete Skibitski -- Alembic Global -- Analyst

I'm sorry. Was the impact from the shekel, did that have any meaningful impact to your revenue? Was that a revenue headwind for you in the second quarter?

Joseph Gaspar -- Chief Financial Officer

It did have some impact, but not very much. We have seen the impact mainly in the lease agreements, which most of them are in shekels, while we show them on our PNL and balance sheet, we show them in US dollars, so they increased. The difference moved to a non-cash item into our PNL finance expenses, but most of that was the impact. Other than that not very much.

Pete Skibitski -- Alembic Global -- Analyst

Okay, OK. And then I'll ask one more and then I'll get back in queue. Again, the excellent first half adjusted margins, how are you guys thinking about adjusted margins into the second half of the year? Because you did have margin expansion last year in the second half, and so I'm just wondering how you think things will shake out in the second half this year, understanding some of the moving pieces.

Joseph Gaspar -- Chief Financial Officer

I'm sorry, Pete, but, you know, we do not give guidance. However, said that, we continue to work very hard to provide our cost base, and we have seen that during the last several quarters getting better and better. Of course, if the local currency has also impact on that on our overall performance, we are looking optimistic to the future, but things are still a long way to go.

Pete Skibitski -- Alembic Global -- Analyst

Understood. Thanks so much, guys.

Bezhalel Machlis -- President and Chief Executive Officer

Thank you.

Operator

If there are any additional questions, please press *1. If you wish to cancel your request, please press *2. Please stand by while we pull for more questions.

The next question is a follow up question from Pete Skibitski from Alembic Global. Pete, please go ahead.

Pete Skibitski -- Alembic Global -- Analyst

Okay, I'm back. Guys, there was a lot of concern in US markets yesterday about the global macroeconomic backdrop in global growth. The market sold off quite a bit. I was just wondering, you guys are so geographically dispersed in terms of your revenue, so I was just wondering over the last few months, have you seen anything to indicate a deterioration in some of your customers from a geographic perspective? Do you see incremental weakness out there geographically, or do things roughly seem the same now as they did call it six months ago?

Bezhalel Machlis -- President and Chief Executive Officer

On the contrary, we see more demand for defense equipment and for defense electronics, and we see more opportunities for us in the US market. And we see a growing demand in Europe. Just to remind all of us that there is demand for NATO to spend 2% of GDP on defense, and many countries are far away from doing it. And we have very good positions. We have several very good positions in Europe, in the UK, in Germany, the Netherlands, and other countries of the world, and we subside rate it. We have a long, good history, and this is one demand in all spaces. The same is also happening in Australia and Asia/Pacific.

So altogether we see one demand, more opportunities, and I am happy that we are able to capture part of it. That's the reason for the growth, and I expect it to continue.

Pete Skibitski -- Alembic Global -- Analyst

That's great. That's great. And the fact that they weren't able to form a government in Israel, you've got the new elections in September, did that slow anything down in the second quarter in terms of order flow from the IMOD or revenue recognition. I'm just wondering if that had any impact at all on the second quarter or if you expect it to in the third quarter.

Bezhalel Machlis -- President and Chief Executive Officer

In Israel, we are working from the long term, very long term program, so some delays there in a quarter have not really changed the picture. So, of course, Israel is a very important customer of ours, and we are waiting for after the new government will be established. Probably a defense budget will be concluded here, and then a procurement plan will happen. And there are many good opportunities for us in the coming session.

Pete Skibitski -- Alembic Global -- Analyst

That's great. That's great. Yeah, I did wanna ask about a couple programs in particular. You guys got a lot of press this quarter about this -- I think it's pronounced Carmel future armored vehicle, and it looks like you have a lot of systems on the vehicle. I couldn't tell if you built the entire vehicle or more so the advanced systems on the vehicle so I'm wondering if you can clarify that, and then, you know, your sense of do you expect to actually go into production on that in the near term or the midterm and if you think there's gonna be export opportunities for that?

Bezhalel Machlis -- President and Chief Executive Officer

The Carmel, the [inaudible] was for systems, not for a vehicle. It's not for a new platform. We are not a platform manufacturer. Our facility is in systems and sensors and integration solutions into the AFV. As you know, we are a leading company in Israel as well as abroad providing really advanced systems and solutions for the Israeli market, and we are quite famous with our solutions and quite proud of it. Good provisions we have in many countries.

In new AFVs and new things as well as in upgrading existing platforms, Westernizing platforms, we're investing quite a lot, bringing new innovation and new technologies into existence for the future, and what we have presented here is new technologies for the AFV markets, which includes autonomy and AI and drones and operated form and the ASV, unique sensors which are part of the AV, different type of technologies coming from all of the group. And also a new process tool for operating glowing hedges.

We needed a new helmet, which enabled the operator to work undercover, to see 360 degrees by a helmet which is delivered to you for our Elbit helmet, and to operate all the sensors and the weapons via the helmet. Many customers saw it. There's a lot of interest for the concept and for the system, and I'm proud to say that we have already found orders for part of the systems which we have presented. We continue to invest in this domain. We are well positioned in this domain, and IMI acquisition helps us here because it brings active protection systems to our [inaudible], the [inaudible] system, which that's an important area where we progress quite a lot of work. So altogether I'm very proud of this common demonstration, and it will get available to [inaudible] from different customers all over the world for the technologies.

Pete Skibitski -- Alembic Global -- Analyst

That's great. It was very impressive, very impressive. So thanks for the color. One last question for me programmatically. Can you give us some more color on I would call it a new business model, I would say, for the Hermes 900 in which you have this contract, I think, with a Portuguese entity sort of via the EU Maritime Safety Agency, and I think ultimately Iceland has been the first end user from it looks like essentially a leasing program of the Hermes 900 for maritime patrol to Iceland. And so I'm just wondering if you could give us a sense of how big this opportunity is. Do you expect to grow it and add more customers in this sort of different business model? It looks like maybe it's a different model for maybe customers that can't afford the cost of actually owning UAV. I was wondering if you could describe kind of what's going on there.

Bezhalel Machlis -- President and Chief Executive Officer

It's nothing new for us. We are implementing a little model and [inaudible] business segment in the company. One of them is simulators, for example, though we implement the [inaudible] model here in Israel, and this concept of leasing UAVs is also not new for us. Our subsidiary in the UK, which runs the [inaudible] programs the UK [inaudible], leased already UAVs to the British forces in Afghanistan. So we continue with the smaller other markets, as well. You're right. We want a contract for the European agency. We did somewhat similar with the UN forces in Africa, as well. So, as you know, we have a very vertical controlling of UAV. We control the UAV itself, the communications, the command control, the optics or other sensors. So we are open to sell UAVs, and we're also open to lease and to operate, to lease UAVs to different customers all over the world.

And this is, by the way, not relevant just for UAVs. It's also relevant for other type of groups for some business, some additional business, as well. I mentioned the simulators. We do something similar in the area of simulators here in Israel.

Pete Skibitski -- Alembic Global -- Analyst

Great. That's great. Thank you so much for the color. Thanks both to Butzi and Yosi.

Bezhalel Machlis -- President and Chief Executive Officer

Thank you.

Operator

The next question is from David Fingold of Dynamic Funds. David, please go ahead.

David Fingold -- Dynamic Funds -- Vice President and Senior Portfolio Manager

Thank you. Look, I'm happy to see that the L3 Harris merger provided you with an acquisition opportunity, and what I was gonna ask was there's another announced MNA in the defense space. And I wondered if you had any color on whether or not that could present other opportunities to buy businesses that might need to be disposed of for regulatory purposes or to improve the balance sheet of the companies that are merging?

Bezhalel Machlis -- President and Chief Executive Officer

I would say that our strategy includes acquisitions as well. We are well-known for good acquisition profit, for good acquisitions to be made in the past. Just to remind all of us, we acquired some companies here in Israel which were not in good shape like Elisra and Fulton, and we assimilated them into Elbit in a very good way. And they are profitable and successful today. We believe in acquisition as well as in organic growth, and we have a strong balance sheet to support it. And there are three main reasons for acquisition. Just to remind all of us this year it's going to be the third acquisition we're doing, Harris Night Vision. We acquired IMI, but not to forget we acquired Universal Avionics Solutions in the US, as well.

[Inaudible] acquisition for us, the first one to enhance our portfolio. That was the main reason for the acquisition of IMI. The second reason is to gain additional position in strategic markets, and the third reason is a kind of R&D. We always invest quite a lot in R&D, between 8-9% in each quarter from our revenues. We see a lot of innovation outside, and in some cases we prefer to acquire smart companies which have unique technologies which are complementary to ours.

So these three reasons are still very relevant, and they're a part of our strategy. As I mentioned earlier we have a strong balance sheet which can support this strategy for the future as well.

David Fingold -- Dynamic Funds -- Vice President and Senior Portfolio Manager

Thank you.

Operator

There are no further questions at this time. Before I ask Mr. Machlis to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available two hours after the conference ends. In the US, please call 1-888-326-9310. In Israel, please call 03-925-5925, and internationally please call 972-3-925-5925. A replay of the call will also be available at the company's website, www.elbitsystems.com. Mr. Machlis, would you like to make your concluding statement?

Bezhalel Machlis -- President and Chief Executive Officer

I would like to thank all of our employees for their continued hard work. For 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.

Operator

Thank you. This concluded the Elbit Systems Ltd second quarter 2019 results conference call. Thank you for your participation. You may go ahead and disconnect.

Duration: 35 minutes

Call participants:

Ehud Helft -- GK Investor Relations -- Managing Partner

Joseph Gaspar -- Chief Financial Officer

Bezhalel Machlis -- President and Chief Executive Officer

Pete Skibitski -- Alembic Global -- Analyst

David Fingold -- Dynamic Funds -- Vice President and Senior Portfolio Manager

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