Leonardo DRS Inc (DRS) 2022 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the RADA Electronic Industries First Quarter '22 Results Conference Call. (Operator Instructions) 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 RADA's Investor Relations team at GK Investor and Public Relations at 1 (212) 378-8040 or view it in the news section of the company's website, www.rada.com.

I would now like to hand over the call to Mr. Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin, please?

Yes. Thank you, operator. I would like to welcome all of you to this conference call to discuss RADA's first quarter 2022 results. I would like to thank RADA's management for hosting this call.

With us on the call today are Mr. Dov Sella, Chief Executive Officer; and Mr. Avi Israel, Chief Financial Officer. Dov will summarize the key highlights of the quarter, followed by Avi, who will provide a summary of the financials. We will then open the call for the questions-and-answer session.

Before we start, I'd like to point out that the safe harbor published in today's press release also pertains to the content of this conference call. And with that, I would now like to introduce RADA's CEO, Mr. Dov Sella. Dubi, go ahead, please.

Thank you, Ehud, and good day to all our call participants. Let's start with an overview of our results this quarter.

We have just reported the results of the first quarter of 2022, with revenues of $22.5 million and adjusted EBITDA of $1.3 million. We see this quarter as a bump in the road and unrelated to the trend of what is going on around us. In this quarter, we actually saw the peak of the impact of our -- on our revenues of the Continuing Resolution in the United States. The passing of the U.S. budget was delayed from September and finally passed on March 11 with all new defense spending effectively on hold for that period. We are very pleased that this is now behind us, and we are already seeing new orders from the U.S. begin again as our recent PR 3 weeks ago of new business mentioned.

We should see the current quarter's results in the framework of the bigger picture, a growing need for Western countries to provide the best and most advanced active defense solutions for their maneuverable military assets and, ultimately, their troops. And the recent war in Ukraine has very unfortunately made this all clear across the world. We are confident that our recovery will be fast.

We keep our revenue guidance of $140 million for the full year, and it should indicate to you that from our perspective here in May, post CR, we expect to receive all the revenues missed in Q1 by year-end. Our strong cash position, along with our confidence that this first quarter is an anomaly, allowed us to continue to produce, invest, acquire inventory and recruit people as per our plans, and we did not pause for a moment given the opportunities ahead of us.

Let's take a look at our end markets. Our software-defined and mobile radars are in the heart of modern warfare needs such as short range air defense, counter-UAV, active protection systems for armored vehicles, counter rocket, artillery and mortar and such. And now even more so evident by the war in Ukraine and the many images of blown out and burnt shells of tanks and military vehicles that we all see on TV.

In the recent years of our growth in the U.S. market, to capitalize on our market position, we decided to produce radar to stock and apply a book and ship commercial approach. We are very fortunate that this unique approach not only made us attractive to our U.S. customers, but because it relied on high levels of inventories and components, it also shielded us from much of the negative impacts and challenges that COVID placed on our -- on us over the past 2 years, including what is now the supply chain constraints that everybody faces.

Our U.S. market is now moving from the Joint Urgent Operational Need statement type of programs, meaning orders on a short and urgent need basis, into programs of record, a trend that will enable us to build many more products over a long period based on an order backlog, generating for us long-term revenue visibility and stable growth. Today, our radars have become the incumbent rather insight solution in quite a few significant platforms, some of which already have converted into programs of record that I just mentioned.

In 2022, we are not reliant on only a few customers and solutions. Furthermore, our book-and-bill strategy enables us to recover very fast from acquisition process delays and bureaucracy as we have experienced until mid-March. We are able to deliver radars from stock sometimes within days to the high satisfaction of our customers, especially during these days of both global supply chain problems and U.S. budget delays and now catch up.

I have only addressed the U.S. market until now, but as I explained in January at our analyst event and webinar, the rest of the world, which I divide into the New East, Europe/NATO countries and the Indian subcontinent, should reach, based on our estimation, revenue levels similar to the USA within 3 to 4 years. And recent events have only made us more confident in this expectation.

The Europe/NATO countries are typically following the doctrine and solutions of the U.S. military and the need for short range air defense and point defense is becoming widely recognized. When we spoke with you in January, we said the market is in its incubation phase, but I believe we have advanced since then. We have already seen engagement and already been engaged with quite a few prominent European weapon system providers and our radars are being integrated and continuously tested as part of their solutions.

To date, mobile short range air defense and counter-UAS programs were sporadic and in low volumes to European customers. However, we believe the current event will lead to an uptick in 2023. We also evidenced of growing interest in the U.S. in the integrated and proven systems we are already part of, as part of an immediate military support of Ukraine and neighboring countries.

The New East and India markets are both waking up around the need to mitigate the UAS and cruise missile threats in view of recent attacks, which demonstrated significant damages. We expect growing sales of counter drone solutions to both markets during the current and especially next year. We also remind you that we recently announced plans to set up an Indian joint venture company with a local partner by the end of 2022.

Let's review our financial expectations ahead. I want to give you a little more perspective on our forward-looking financial expectations. We are confident that our recovery from current Q1 revenue level will be fast as evidenced by Q1 new business that we have announced just 3 weeks ago when we declared $29 million in new business, which is up 22% compared to previous year. Our 2022 guidance of $140 million, which we reiterated this morning, implies 20% revenue growth. We expect that our shares will convert into revenues along Q2 and the second half of the year.

In terms of geographic breakout expectations of our full year revenues, to remind you what we discussed in January, we expect the U.S. market to be about $90 million in revenues, while about 90% of our guidance are already incorporated in the defense budget line items and some already in our backlog. The urgent nature of some of our anticipated revenues this year, also around Ukraine, which is not considered in our forecast, represents further upside to our U.S. revenue expectations. For the non-U.S. market, we forecast about $40 million of radar revenues during '22. And finally, we expect around $9 million coming from our legacy avionics business.

We believe that our overall margins will not be affected by the CR delay in Q1, and revenues of the produced items will convert into profit and cash per our regular margins. And if we were to add $9 million or so, based on our estimation for the first quarter and actually The Street consensus, which estimated $31 million, gross margins and cash generation would have been in line with our expectations. So it's all about the top line -- the missing top line here.

On the OpEx side, as I said earlier, we did not delay any of our investments and continued to move forward at full throttle. We topped up our manpower as per our plans, which is now stabilizing at around 250 people in Israel and towards 90 people in the USA. Salaries increased somewhat due to manpower pressure by around 4% to 5% on the average. We had some onetime expenses of about $650,000 this quarter, which most of it will be absent in the coming 3 quarters when considering the OpEx. And lastly, in view of the increased cost of labor and supplies, we have also recently adjusted our selling prices accordingly.

Before we summarize, let's have a short look at our new products launch. Our new developments, namely the nMHR, the xMHR and the iCHR, all are addressing the new and evolving needs of our defense markets and introduce increased ranges, higher accuracies and additional very sophisticated and advanced features in these radars. These radars are starting field testing very soon, and we already have initial orders for them. We believe these products have a bright future and present strong further growth potential, keeping us in the lead and widening our opportunities pipelines.

So let's summarize. While Q1 revenue levels are below expectations, they are only a bump on the road and do not change the broader picture. Like all in our industry, we are pleased with the CR being completed and behind us. The U.S. revenues, which shifted away from Q1, will be delivered along the remainder of the year, and there is no adjustment to our gross margin expectations or associated cash flow. Most importantly, there is no change to our full year guidance of $140 million, which is up 20% compared to 2021. We continue as planned without posing because the opportunity, which is now right in front of us, is big and very clear.

Beyond what I discussed with you only 4 months ago, the rest of the world has just had a strong waking up call with the unexpected war in Ukraine, and we believe this will translate to upside in the orders over the coming years, similar to the strong growth we experienced in the U.S. in recent years. Therefore, I'm very optimistic and very much look forward to our follow-on discussion in the next quarter.

I'd like now to hand over the discussion to Avi Israel, our CFO. Avi?

Thank you, Dubi. Good day, everybody. Thank you for joining. You can find our results on the press release we issued earlier today, and I will provide a short summary of the first quarter results.

First quarter revenues were $22.5 million versus $25.2 million in the first quarter of last year. As Dubi noted, a large portion of our U.S. revenues were delayed due to the CR in the U.S., which should be delivered in the coming 3 quarters.

Our gross margins in the quarter were 33%. I note that our gross margins have a level of fixed cost within them, so they were impacted by the delay in revenues. I will also add that given our expectations for orders for the short-term deliveries, we have already made the preparation and build products for our inventories that will need to be delivered in the coming quarters. We believe that our full year gross margin will be at around similar levels at what we have delivered in the recent quarters.

First quarter operating expenses were $8.2 million compared to $6.4 million in the first quarter of last year. We believe this will be the peak for the year and should reduce slightly in the coming 3 quarters as the quarter had a number of onetime factors of about $650,000.

Operating loss was $0.9 million versus $4.5 million of operating income in the first quarter of 2021. Net loss was $0.7 million versus $3.8 million of net income in the first quarter of last year.

We reported an adjusted EBITDA for the first quarter of $1.3 million, which is 6% of revenues, versus adjusted EBITDA of $4.8 million, or 19% of revenues, in the first quarter of last year. I would like to further add that as an additional $9 million of revenues per The Street consensus that were shifted to the coming quarters, as explained by Dubi, had actually been delivered in the quarter, our gross margin, operating income and adjusted EBITDA would have been pretty similar to our Q4 numbers.

I would also like to summarize and point out some highlights from our balance sheet. As of March 31, 2022, we had almost $66 million in net cash and no financial debt at all. I note that as of Q1 end, all our needed cash investments in working capital and inventories have been made and are behind us. We expect the cash level to increase strongly as revenue ramp up again towards the second part of the year. As of quarter end, our shareholders' equity stood at a record $156.2 million, financing 75% of our balance sheet.

In summary, as Dov indicated, looking ahead, the second quarter is expected to show significant jump in the record results, which we continue to improve throughout the rest of the year.

That ends my summary. We shall now open the call for questions. Operator, please. Operator?

(Operator Instructions) The first question is from Peter Arment of Blair.

Maybe you could just describe a little bit about the revenue shortfall here and just how we should think about how that kind of layers in, I guess, the rest of the year? Do you start to see some immediate recovery...

Peter, you are not heard clearly here. Can you come closer to the mic?

Is it any better, Avi?

Not really.

Okay. All right. Maybe just go on to the next one, and I'll come back.

The next question is from Scott Forbes of Jefferies.

Now that we kind of have a finalized U.S. budget, when you look at that -- is there anything that really stood out in terms of program funding? And as you kind of look through the fiscal year '23 budget request, is there anything that kind of stood out there? What's your initial take on that?

We are not surprised, not with this year budget and not for me next year, it's all based on our plans. We have 4 anchor programs of record or similar like the IM-SHORAD of the Army, the GBAD of the Marine Corps, now the ABAD of the U.S. Air Force and also SOCOM [SEAL] and quite a few additional opportunities around them in smaller scale. So it continues to evolve and grow based on our expectations and plans.

And then just on kind of inventory. I mean it's still built by like $10 million in this quarter. I know you've talked about that being related to kind of the supply chain impact. I guess how do you see the supply chain as it stands today? How has that changed versus last quarter? And then how do you think about maybe that wind down of inventory to more normalized levels?

Okay. Normalized, it's probably a relative term. We decided early on, as I mentioned in our review, to adopt a commercial book-and-bill approach because it was a new and emerging market, and we know and saw the need for urgent deliveries. So we topped up our inventories to enable us a stable production plan a year ahead based on our pipeline and destination of conversion of pipeline into orders.

So we maintain that. It protected us for all the products that we are currently selling. It protected us from any supply chain issues when this havoc started. Now when product programs are transferring to programs of record and we have visibility, we can relax. But I don't believe we will go below 6 months ahead of inventories that will enable us 6 months of deliveries based on our plans.

This is for the products that we are currently selling. For the new products, we have our challenges around the delivery of components as everybody else. But we took a close look at it quite a while ago, anticipating this issue, and we feel that also for the new products, we are not going to be affected dramatically from the supply chain delivery times. We do see price changes here and there. And unfortunately, we need to adapt our prices accordingly, and we are doing that.

The next question is from Peter Arment of Baird.

Dubi, Avi, can you hear me?

Yes.

Sorry about that earlier. Could you maybe just give us a little color on the recovery of the revenue shortfall in Q1? Is that -- does it all come through in the second quarter? Or does it -- do you start to anticipate that moving into the second half of the year?

Until you get all the orders in your hand, you are not entirely sure. But we do anticipate that a significant part will convert already in this quarter. But to be realistic, we say that it will convert for sure until the end of the year. I hope it will be in the next 2 quarters, meaning this one and the second one -- and the next one.

Okay. And then just the continuing resolution, once that was signed for the fiscal '22 budget in March, so did you see an immediate pickup in orders? Is that what you're kind of alluding to with the $29 million in order activity that you see?

Yes. If you take a look at the $29 million composure, a lot of it came from the U.S. And in the 5 months before that, we had minimal new orders coming from the U.S. due to the CR. It's all about that. So the flow started and we are optimistic.

Okay. And then just related to CRs, there are some concerns that because of the congressional elections this fall, that we'll have another CR. Just what are your thoughts on that impacting your 2022 outlook?

It's a bit far away from us to understand the total U.S. politics. But my estimation is that even if we will have a CR end of this year, it will be shorter. I think a lot of the current CR was around bipartisan issues and miss of consensus about the defense budget and the new administration. I believe a lot of that will be behind us. I think also the Ukrainian war is making things more clear and urgent or decisive for the lawmakers in Washington. So CR is bad for business -- for defense business. Let's hope it has a minimal effect, if at all.

The next question is from Austin Moeller of Canaccord.

So my first question here, is there any update from you on testing of the Iron Fist APS for the M2 Bradley?

Yes. Testing is on schedule, results are good. I cannot say beyond that.

Okay. That's helpful. Do you guys have any update on the India JV and how we might expect revenues to ramp from that over the next year or 2? I know you've said that it can take a long time to ramp up in India, but things that are sort of going better than expected so far.

Yes. India is always an enigma around the schedule and when things happen. We are believers. We have our internal goal to establish the JV by the end of this year, definitive agreement and so on, allocation of facilities and starting to invest. I believe that when the market opens up at the beginning, it will open up in an urgency. At the beginning, we will supply from here. And probably by next year's end, we will have production capability in country.

And also, I hope that the business will support it. It is similar to what we did in the U.S. We started setting up our facility there when we saw that there is business and it's happening. We started selling in 2017, and we set up our facility during 2018. We would like to adopt the same approach here.

Okay. Excellent. And then in the plan for the fiscal year '23 budget and beyond, have you heard anything about the latest news on the Army's thinking about how many total battalions of SHORAD they may ultimately purchase?

The original quantity is 144, that's firm, and it is moving even faster than original plans, basically also in view of what's happening now. We do see increasing quantities. I believe that the full structure -- original full structure that they've been talking about the Army is something like 10 to 12 battalions. It will be a mixture of the directed energy and the kinetic. We are currently part of the kinetic. We have good momentum also around the directed energy. So I do hope that we will stay on board for the whole quantity.

The next question is from Brian Kinstlinger of Alliance Global Partners.

To follow-up just on CRs, in general, is what different for RADA today as opposed to past years, I've covered the stock and the impact of the CR that you have programs of record. And if that's the case, we've seen CRs almost every year for the past 15 to 20 years. So is there a risk of something like this happening in the December or the March quarter ongoing now with CRs every year almost? Why or why not?

I think that my experience with CR is relatively limited, I must tell. But from my understanding a judgment, we were a bit unlucky in the fact that 2 programs of records of ours, the ABAD and SOCOM [SEALs] were new. So the CR kind of heard them directly. However, once you are already a part of an established program of recording, it is not categorized as new. Maybe it is not as quick as moving -- quick moving as you know, without CR, but it is not heard as we were heard. So these 2 big programs that we were relying on actually caused a lot of the miss in Q4 and Q1.

To be clear, once those are more established programs, CR, which keeps funding the same as last year, you'll be able to maintain those levels in years 4 when they are more mature programs. Is that what you're saying?

That's what I'm saying. And also, I'm saying that we are very agile in delivery. So once it recovers and they need more, we are adapting ourselves very quickly.

The next question is from Arnold Ursaner.

Can you comment on the margin differential between the products you sell to the U.S. government and the just-in-time more rapid products you're supplying to other nation states?

When we sell from Israel, we sell at the same prices to everybody. In the U.S., at the beginning, we sold not directly, but through other companies, so they topped it up accordingly. But basically, we sell at the same prices.

Okay. And your balance sheet is, obviously, quite strong and the market is not reacting well to your release this morning. Can you remind us if you have a share repurchase authorization in place and, in a broader sense, highlight your priorities for your growing balance sheet and free cash flow?

We don't have any current -- although we have an outstanding year 3 like we always do in the last 4 -- some 4.5 years, we do not intend to use it now. Our cash flow situation, our cash balance situation is pretty strong. We don't believe that currently we have any need for additional cash. And we believe that as revenue will grow, as we expected in the third quarter of 2022, the cash generation will be delivered.

So again, I'm a little unclear if you have excess cash and strong free cash flow? You've funded growth in the business, you've funded inventories. I'm wondering why your Board doesn't think share repurchase as a higher priority at the moment given where your stock price is.

You are wondering what, please? We are not understanding you here.

You have a Board of Directors, I can't understand why share repurchase isn't a higher priority given your strong balance sheet, your free cash flow generation. You'll be working down the inventories as you sell finished goods, which will enhance free cash flow. I guess I don't understand your Board's thinking why a share repurchase isn't a much higher priority in the short run given where your stock is trending.

Okay. So our priority is to grow our business. We believe that we have a very wealthy business -- very healthy business, sorry. And we raised money in the past from the market in order to grow the business and to make this company a great success. That's our current strategy and our current strategy is not calling for a buyback of RADA's shares.

Operator, do we have any more questions?

(Operator Instructions) Our next question is from [Ron Oh] of (inaudible).

First of all, it's [Ron Oh]. My question is regarding the guidance. As you mentioned, 90% of the guidance is already marked in the U.S. budget or in specific lines in the budget. Can you maybe refer, apart from India, what are the major upsides that you see for the guidance for this year?

You're talking about the Indian market?

No, apart from India, other upsides that may occur and are not currently in the guidance.

It's too early to say.

Like don't you see the European market started to wake up from what's happening?

We do see it. But remember, we are radars that are embedded in recon systems. It's not immediate. We are not selling bullets and ammunition. It has its lead time. It took us 3 years in the U.S. since Ukraine take one 2014 until we started to see revenues in '17. I hope that in Europe, it will be much less, but it will be 1 year, 1.5 years at least. Directly to Europe, I mean.

However, we do see -- and this is maybe a potential upside. We do see momentum around the systems that we are already embedded in, in the U.S., being relevant to Europe and Ukraine and adjacent countries. But it's a hope and we need to wait a while until it materializes.

My second question is regarding your foreign exchange policy over hedging. We see the U.S. dollars now getting much [upper] against the Israeli shekel and the euro. Do you have any like hedging policy?

Absolutely. We have hedging policy. We are protecting our exchange -- our budget exchange rates. Strong dollar for exporters, as we are, is good news.

Probably, we should expect, in the second quarter, like additional gains from foreign exchange differences?

Yes, it's throughout our income statement.

There are no further questions at this time. Mr. Sella, would you like to make your concluding statement?

Yes. Thank you, operator. On behalf of the management, I would like to thank all of our investors for your continuing interest in our business and support. We look forward to speaking to you again soon. Stay well and healthy and good day to all.

Thank you. This concludes the RADA Electronic Industries' First Quarter 2022 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.