Elbit Systems Ltd (ESLT) 2005 Q2 法說會逐字稿

Welcome to the Elbit Systems LTD second quarter 2005 results conference call. All participants are present in a 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 August 9, 2005.

I would like to remind everyone that the Safe Harbor language contained in today's press release, also pertains to all contents of this conference call. If you have not received copy of today's release and would like to do so, please call Gelbert Kahana Investor Relations at 1-866-704-6710 or 9-723-607-4717.

I would now like to turn the call over to Mr. Ehud Helft of Gelbert Kahana Investor Relations. Please go ahead.

Good morning and good afternoon to everybody, thank you for joining us today for the Elbit Systems 2005 second quarter results conference call. Before we begin, I would like to thank Elbit's management for hosting this conference call. With me today on the call are Mr. Joseph Ackerman, President and CEO, Mr. Ilan Pacholder, VP Finance, and Mr. Joseph Gaspar, Chief Financial Officer. Mr. Pacholder will begin with a brief financial review of the second quarter, and then Mr. Ackerman will follow with an overview. We will then open the call for questions.

Ilan, would you like to begin please

Thank you. Good morning and good afternoon to all of you, and thank you for joining us today. Following the results, the new numbers for the second quarter 2005, for those of you who have not yet seen the full report that was published this morning, and is also available on our website.

Before we proceed with the financial review, I'd like to remind you that as reported earlier in April we completed the first stage of the transaction to purchase Tadiran's shares from Koor Industries, in which we purchased approximately 13.7% of the share [Koors to Tadiran]. Following that transaction we now hold approximately 21% of 31 shares.

From that point on, we have shareholders rights to exercise significant influence over Tadiran, as defined in the equitable accounting standards, we implemented the step-by-step acquisition effort, in our investments in Tadiran, which had previously been accounted for as available for sale securities was accounted for retroactively under the equity method of accounting. This change, which is based on the relevant accounting rules, resulted in a restatement of our results for the last quarter of 2004, and the first quarter of 2005, in which our investment in Tadiran was accounted for as available for sale securities.

As a result our net income for the fourth quarter of 2004, and the first quarter of 2005, were reduced by approximately $1.1 million and $0.5 million respectively, and the net effect on our second quarter 2005 net income was $3.2 million. The excess of the amount paid for Tadiran shares acquired until the end of the second quarter of 2005 over the book value is approximately $62 million. Based on the purchase price and location analogies prepared by independent advisors, the excess was attributed to in-process R&D which is written off immediately, inventory, that is amortized over a quarter, and and various tangible and intangible assets amortized over a period of between 2 and 15 years. The balance of $19 million was attributed to goodwill in accordance with U.S. GAAP is not amortized pending any repayments and permanent effects.

Our net income for the second quarter 2005 was affected by a $5.6 million expense, which included three items, $3.5 million in IPR&D, which is one-time write-off, $1.1 million in inventory and motivation, and $1 million in tangible and intangible asset amortization, which is ongoing. The $5.6 million expense was partially offset by our $2.4 million share in Tadiran profit for the quarter, providing a net negative effect of $3.2 million on second quarter net income.

All of these numbers are included in the earnings for affiliated companies in our P&L report. As we reported we can expect further effects on our financial results, giving the example if we purchase additional Tadiran shares from Koor in compliance with the amendments to the agreement with Koor announced July 6, 2005 as well as the purchase of Koor's shares in Elisra. We report the effects on the completion of the respective purchases.

In order to provide our ongoing results for the quarter, I'll also provide you as we go with the numbers excluding the one-time R&D expense, as I mentioned before, when I get to the meaning of significant income and its estimation. Our second quarter 2005 revenues reached $243.8 million, a 5.2% increase over the second quarter of 2004 revenues of $231.6 million. The largest contributor of revenues was the Airborne systems business at $93.4 million or 38.3% of total revenues, followed by Electro-optics with $56.3 million or 23.1% of revenues, C4 ISR with $44.1 million or 18.1%, and Land systems at $33.2 million or 13.6% of revenues, and the balance of $16.8 million or 6.9% of revenues was produced by other businesses. While the C4ISR and the Electro-optics businesses considered continued the revenue growth, Land systems decreased compared to the second quarter of last year. We expect this decrease to be temporary and for Land systems revenues to pick up again.

In terms of geographical distribution, we generated 36.1% of our revenues in the U.S., 31.9% in Israel, 7.5% in Europe, and 24.5% in other countries. All of our markets with the exception of Europe showed increased revenues, with Israel leading the growth this quarter. As with the Land systems, we expect revenues in Europe to increase in the future as revenues in several programs are expected to be recognized.

Gross profit for the second quarter of 2005 was $66.1 million as compared with gross profit of $59.9 million last year. The gross profit margin improved from 25.9% in the second quarter of last year to 27.1% in the second quarter of 2005, thanks to the mix of programs that were sold this quarter, which had relatively higher gross margins.

Operating profit in the second quarter 2005 was $17.6 million or 7.2% of revenues compared with $16.3 million or 7% of revenues in the second quarter of 2004. During the second quarter we continued on the trend that we initiated in the last quarter of 2004, and invested in the development of new technologies and products at a higher rate than our historical average. As a result our gross investment in R&D during the second quarter of 2005 reached 9.1% of revenues compared with 7% in Q2 of 2004.

However, we have been able to secure higher third-party participation in our R&D efforts, and as a result our net R&D expense was 7.3% of revenues, as compared with 5.9% in the second quarter of 2004. As we invest those funds with authorizations for future business opportunities the rate of expenditures may vary as we progress.

As I mentioned earlier, the full effect of the Tadiran purchase is reflected on the equity in earnings of the series of companies, which in the second quarter 2005 showed a loss of $1.2 million compared with income of $1.6 million in the second quarter of 2004. These results as I said include the effect of the $5.6 million expense related to the Tadiran share purchase, and only 1 million of that is related to tangible and intangible asset amortization, that is actually long-term on-going amortization expense.

Our reported net income for the second quarter of 2005 was $10.9 million or diluted EPS of $0.26 per share, compared to $13.3 million or diluted EPS of $0.33 per share in the second quarter of 2004. Excluding the Tadiran-related one time IPR&D write-off, our net income in EPS for the second quarter of 2005 was $14.4 million and the EPS was $0.35 respectively. Cash generation continued to be strong, and in the first six months of this year we generated $86.1 million in operating cash flow.

In the second quarter cash flow from operations was $36.8 million. Although we made no large project announcements in the second quarter, our backlog continued to increase and at the end of the quarter reached a new record of $2.4 billion. 65% of the backlog relates to orders out of Israel, and approximately 60% or 1.44 billion of our backlog against the quarter, is scheduled to be sold in the two quarters of 2005 and during 2006.

With that, I should now hand it over to Mr. Ackerman.

Thank you, Ilan. In our last conference call I you talked about the result as being the continuation of the performance we have shown in year 2004. With the release of our second quarter numbers, I am pleased to tell you that a trend of increased revenues, profitability, and backlog continues.

The major contributor to our profitability this quarter was the higher profit margin which was achieved thanks to the mix of contracts sold in this quarter, with a relatively high gross profit margins, we continue to make the necessary efforts to increase our margins in the long run . Although the process is a complicated one, we are confident in our ability to achieve modest improvement over time.

Having said all that with the long-term view that we always take, we continue to invest in developing new technologies, and have spent a relatively high amount of R&D. We anticipate that over time these investments in technology, which are expensed in the present, will contribute to our continued growth and profitability going forward.

On the specific M&A front, since our last call we have accomplished an important step in the effort to consolidate the leading private defense and electronic companies in Israel. With the signing of the amended agreement with Koor Industries to purchase their 70% holding in Elisra Electronics in consideration for $70 million in cash. Under the amended agreement signed on July 6th, we accelerate that agreement with Koor of an additional 5% of Tadiran shares, out of the total of 18.2% of Tadiran shares that we agreed to acquire, as part of the second stage of that agreement.

Upon completion of this step, Elbit Systems and Koor will have equal representation on Tadiran's Board of Directors, I shall be appointed as Chairman of the Tadiran Board for a period of two years, and the provisions of shareholders agreement relating to joint controlling of Tadiran will enter into effect. This first stage is subject to the approval of Elbit Systems shareholders at our general shareholders meeting which has been scheduled for 23rd of August. Upon completion of that stage, Elbit Systems will hold a total of approximately 26% of Tadiran shares. We have found strong support from our shareholders for this transaction, and assuming we receive our shareholders consent in the meeting, we should expect to close this stage before the end of this month.

Upon depletion of the second stage of Elisra's transaction, which is subject also to the receipt of government authorities including the Israel Antitrust Authority, we shall complete the purchase of Koor remaining 13% of Tadiran, and will own at that point approximately 39% of Tadiran shares, based on our current shareholdings, and 70% of Elisra shares.

Last Thursday we announced the signing of the WATCHKEEPER programme contract between Thales U.K. and the U.K. Ministry of Defense. Following that signature, we expect that the contract value at approximately 30 million pounds will be signed this year between Thales and the Leicester-based JV, as it's being covered by Elbit Systems and Thales. The WATCHKEEPER is one of the largest UAV programs in the world today, and we expect that this will solidify our position in this growing field of business, where we have been a leading participant for years.

And now I would like to open the conference call for questions. Operator, please.

Thank you, sir. Ladies and gentlemen, at this time we'll open the question and answer session. [OPERATOR INSTRUCTIONS] Our first comes from George Shapiro from Citigroup. Please go ahead, sir.

Just a couple of things. What drove the strength in the C4 ISR systems?

As you know, we have been awarded for a large program in Israel, DAP, Digital Army Program. And these numbers are reflected by that.

Okay. The same question not quite as strong but electro-optics had a pretty big increase year-over-year too.

Yes. This has to with some concepts we got on observation systems and electro-optics devices worldwide. Some of this is part of our defense activity, and some is part of our Homeland Security business.

Okay. And anything in particular that drove the higher R&D in the quarter, and what should we expect for the rest of the year?

Yes, I think that we found that there are many areas that we believe that if we invest this R&D, we will get results in the short future, in the near future. So, yes, we did approve some R&D spending mainly in electro-optics, in lasers, Airborne. Again, both for defense applications and Homeland Security applications.

What was the total debt at the end of the quarter? I didn't see that in the release?

George, total debt was $137 million. Of that 128 million was long-term debt, and net debt excluding the cash was $83 million.

Okay. Thanks.

You're welcome.

Thank you. Our next comes comes from Greg Agnew, Friedman, Billings and Ramsey. Please go ahead. One moment, please.

What's the problem?

Excuse me for the slight delay. We will return to the question immediately. I will repeat, our next question comes from Greg Agnew, Friedman, Billings and Ramsey. Please go ahead.

Can everyone hear me now?

Yes, we can hear you.

Okay. Great. Just a point of clarification. Did you say there was going to be a $30 million contract signed by the end of the year between Thales and the Leicester joint venture with respect to the WATCHKEEPER program?

We said that before the end of the year, 300 million pounds.

Okay, I thought that sounded low. Just assuming that material revenue begins to hit for WATCHKEEPER in the '06 timeframe, can you give us a sense as to how you see those funds falling out, you know, with initial development, and then obviously ramping up in the out years? What should we look for, as far as revenue contribution from that program next year?

We expect the program to continue for about 6 or 7 years, and as large programs normally behave, normally it's a bell shape -- the exact shape we cannot tell you yet. We're still working on the contract.

Okay. Great. Thank you very much.

Thank you. Our next question is Joseph Wolf, UBS, please go ahead.

Hi. I'm sorry. I got on the call a little bit late, so if you addressed this issue, I apologize. It's a very technical question. I'm looking at the income statement, and I wanted to get a better sense just for the under the line items, the minority interest, and the share in partnership loss. How we should think about this going forward, and how they are connected to the transaction with Elisra and Tadiran?

As I mentioned earlier, --, I guess, you were not there -- during this quarter we had the relatively large expense related to the Tadiran share purchase. The total expense this quarter was about $5.6 million. Off that about $3.5 million of that is the one-time write-off of IPR&D, $1.1 million approximately is amortization of inventory, which is not technically a one-time item, but is amortized over about one quarter. The rest, which is about $1 million, is the other tangible and intangible assets amortized over periods based on their expected life, which goes between 2 and 15 years.

On the other hand, we had about -- we had income of about $2.4 million left on our share in Tadiran, which offset part of that expense. The rest of that line is comprised of our holdings in companies such as DSI, Elisra, et cetera, which over the years have contributed to our bottom line.

Okay. Great. I'm sorry for having you repeat that.

That's okay.

And then I guess someone tried to ask this question before, and you talked about appropriate spending on certain products, and projects that will bear fruit right away. I'm wondering how we should think about your view on R&D spending. Is there a range you're looking to spend for the year, or is it a product by product that we'll have a hard time modeling going forward, as you look out into the second half of 2005?

Yes. The average out years of R&D spending is between 7.5 and 8% of revenues. We did have some outstanding expenses, which we approved. On a yearly basis we want to see growth in the R&D spending.

When you say you want to see growth, you mean as a percentage of sales, or in dollars versus last year?

That's percentage out of sales.

Okay. Thank you.

Thank you. Our next questions is [Manish Haramajani] of CIBC. Go ahead.

One quick question on gross margins. Your gross margins picked up about 40 basis points quarter over quarter. Where do you see gross margins going in the second half of '05 and '06? You see 27% upside, or do you see it going down from these levels?

You know, we always have to apologize. We don't give exact guidance, but what I can say is that '05 in all parameters, including gross margins will be better than '04, and we are looking to continue that trend in '06.

Okay. Thank you

Thank you. [OPERATOR INSTRUCTIONS] We have a follow-up question from George Shapiro, Citigroup. Please go ahead.

I was just wondering, Joseph, at this point what do you see left to consolidate in the Israeli market, or in terms of what you ultimately think -- where you ultimately think we are in that whole process?

As you know, after the consolidation of Tadiran and Elisra, Elbit is becoming approximately the only known government-owned defense industry in Israel. The rest are IRI, IMI and Rafael, which represent about 50% of the Israel defense industry.

The government of Israel already announced many times that they are willing to privatize the defense industry. Started that with IMI, and shortly after that with some other companies. When this happened, and we already talked to our government, certainly Elbit being an Israeli company, is a good candidate to take part in this exercise. If you are asking about any ending timeframe, they seem to be very serious.

But if you're going to be half the market, is there going to be restrictions on allowing you to be much bigger than that?

I think that -- well, you know, after talking to the Minister of Defense, the customer is pushing for the end game will be in Israel, you will see two major industries, major companies, major defense companies. So one of those will be Elbit after this consolidation, with part of the government-owned industries.

Okay. Thanks.

You're welcome.

Thank you. Next question Yoav Burgan from Poalim Shaar.

The soft backlog figure you referred to on your previous conference calls, has that remained stable, or is this increasing or declining?

This soft backlog stayed the same as last time, but I would like to take this opportunity to emphasize the fact that the WATCHKEEPER contract is not yet in this backlog.

Okay. Great. Thank you

Thank you. There are no further questions at this time. Before I ask Mr. Ackerman to go ahead with his closing statement, I would like to remind participants, that a replay of this call is scheduled to begin two hours after the conference. In the U.S. please call 1-888-269-0005. In Israel please call 03-9255-945, internationally please call 9-723-9255-945.

Mr. Ackerman, would you like to make a concluding statement?

Yes. I would like to thank all of you for attending the Elbit Systems conference call, and I'm looking forward to seeing you all in our next call. Thank you.

Thank you. This concludes Elbit Systems' second quarter 2005 results conference call. Thank you for your participation. You may go ahead and disconnect.