Elbit Systems Ltd (ESLT) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Elbit Systems Ltd second quarter 2006 results conference call. All participants are at 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 8, 2006.

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 a copy of today's release and would like to do so, please call Gelbert Kahana, Investor Relations, at 1866 704 6710 or 972 3607 4717. I would now hand over the call to Mr. Ehud Helft of Gelbert Kahana, Investor Relations. Ehud.

Thank you, [Arin]. Good morning and good afternoon to everybody. Thank you for joining us today for the Elbit Systems 2006 second quarter results conference call. Before we begin, I would like to thank Asset Management for hosting this conference call.

With me today on the call are Mr. Joseph Ackerman, President and CEO, Mr. Ilan Pacholder, V.P. Finance and Mr. Joseph Gasper, Chief Financial Officer. Mr. Pacholder will begin with a financial review of the second quarter and then Mr. Ackerman will follow with an overview. We will then open the floor for questions.

Ilan, would you like to begin please.

Thank you, Ehud. Good morning, good afternoon to all of you and thank you for joining us today. I shall firstly review the highlights of our second quarter results and then pass the call to Mr. Ackerman.

Our second quarter 2006 revenues reached $344.8m, a 41.4% increase over the revenues generated in the second quarter of 2005, which were $243.8m. The significant increase is attributed to both the consolidation of Elisra's revenues, which we began December 2005, but also to Elbit's organic growth which continues to -- which continues at a double-digit rate.

Gross profit in the second quarter of 2006 was $89.6m as compared with a gross quarter of $66.1m for the same period last year a 35.5% increase. As expected, our gross margin of 26% was lower than last year as a result of the Elisra consolidation. It is generally in line with our 2006 expected gross margin, as we indicated in previous conference calls.

Our operating expenses were generally in line with our plans and the net R&D cost remains steady at $18.4m or 5.3% of revenues compared to a $17.8m [sic. see press release] in the same quarter 2005. This was actually also reflect the higher level of third party participation in the R&D costs.

The largest operating expenses continues to be sales and marketing which resulted in 7.9% of revenues compared to 7.3% in the same quarter of last year. These expenses are related both to the higher level of revenues and to the ongoing effort to generate new business and, again, is generally in line with our reported expense level.

G&A expenses were kept at 5.5% of revenues, slightly above last year’s second quarter level of 5.2%.

In total, operating expenses were 18.7% of revenues below last year’s second quarter level of 19.8%. And our operating margin was 7.3% of revenues, similar to that of Q2 2005.

In absolute dollars, the operating profit increased by 34% to $64.5m.

Finance expenses saw a large increase year-over-year. In the second quarter of 2006 we had $6.7m in finance costs. The main reasons for the increase in our buoyant level and the general increase in the interest rates.

Elbit's companies and continue to perform according to plan and generated profit of $1.3m in the second quarter of 2006.

As you know, in the second quarter we purchased an additional 4.3% of the outstanding shares of Tadiran and 20% of Sandel Avionics. As a result we had a one-time IPR&D write-off in the amount of $2.2m of which $1m was related to Tadiran and $1.2m was related to Sandel in the second quarter. This [line] also includes the ongoing amortization of intangible asset expenses to Tadiran which at the current ownership level I suppose is about $2.1m to other projects.

Reported net income increased by 38% from $10.9m in Q2 2005 to $15.1m. And reported a diluted EPS in the second quarter of 2006 was $0.36 compared with $0.26 last year. Excluding the one time IPR&D write-off related to the purchase of Tadiran and Sandel shares, net income for the same quarter of 2006 was $17.2m as compared to $14.4m in the second quarter of 2005. And diluted EPS was $0.41 compared to $0.35 last year.

I shall now provide you with the distribution of revenues by areas of operation in the second quarter of 2006 which were as follows.

Airborne Systems revenues increased by 50% to $140.4m and accounted for 40.7% of total revenues.

Land Systems increased by 70% to $57m, or 16.5% of revenues.

C4ISR increased by 55% and reached $68.5m, or 19.9% of total revenues.

Electro-optics decreased from $56.3m to $45.7m due to temporary delay in certain programs and accounted for 13.3% of total revenues.

And other businesses generated revenues of $33.2m, or 9.6% of total revenues.

In general, all business areas, with the exception of Electro-optics showed a significant increase in revenues led by Airborne Systems and C4ISR, as was the case from the first quarter this year.

We expect that Electro-optics revenues will again begin to increase in the coming quarters as revenues are generated under new and existing programs

In terms of geographical contribution, the U.S. and the Israeli market are the two largest markets accounted each for 34.5% of revenues with $119m in each of the markets. In both cases, demonstrating substantial dollar increase over last year's revenues.

As it did in previous quarter, Europe demonstrated the largest revenue increase. Generated $53.8m, almost three times higher than in the second quarter of 2005, mainly as a result of revenues under the Watchkeeper project.

Other countries increased slightly to $52.7m, or 15.3% of revenues.

Operating cash flow continues to be strong during the first six months, which generated $104.4m, a 21.5% increase over the same period last year.

Last but not least, our backlog of orders continues to grow and reached, at the end of the second quarter, another record of $3.6m, of which over $2m are scheduled to be sold in the next two quarters 2006 and during 2007.

With that I shall now turn the call over to Mr. Ackerman.

Thank you, Ilan.

Our second quarter results, reported today, show the continuation of our top and bottom line growth. The 41% increase over last year in revenues is supported by the additional revenues generated by Elisra on one hand, but no less important is the continued double-digit organic growth in revenues achieved by Elbit Group even without accounting for Elisra revenues.

We achieved this level of organic growth in '05 and now also in the first two quarters of 2006. I believe that these numbers show that our portfolio of products, systems and technologies provide a solution that the market is looking for and we continue to see strong and growing interest in our proven technologies.

One of our greatest assets is our backlog, which continues to increase every quarter. Our current spring backlog provides a high level of top line transparency going forward and the revenue expected to be generated in the next year and a half, based on that backlog, exceeds $2b, or an average of over $330m every quarter.

However, even with such a strong backlog, we continue to invest in our future business in order to ensure our future for profitable growth. These investments are made through our intensive R&D efforts. We are developing marketing activities that are carried out both in existing and new markets for legacy systems and new solutions and also through selective acquisitions.

We have made it clear in the past that selective and accretive acquisitions are an integral part of our strategy and in the second quarter we made two acquisitions. One being a further increase of our position in Tadiran, which now stands at approximately 43%. The second one was the acquisition of 30% in Sandel Avionics, a U.S. company that develops and produces commercial aviation systems.

As you may recall, we indicated in the past that we identified the growing commercial aviation business as a significant potential growth engine for us and we already have several important programs in place including a project with Gulf Stream and another one with [Spirex]. We already have several technologies and systems that are very relevant to the growing needs of this market and we believe that our investment in Sandel will provide us with the leverage required to develop our presence in this important market.

This is a good example of executing our strategy of expanding into new area through selective acquisitions where we identify added value at responsible, at reasonable risk and limited exposure and if our plans materialize we have the option to increase our ownership up to 100% at the same price per share.

We continue to work on implementing the synergy embedded in that provision of Elisra and Tadiran and we see many potential opportunities based on the development of new integrated solutions that would have been difficult to produce otherwise. This process takes time, but this is moving and we are confident that the value of these new solutions will be evident as we progress.

We will continue to execute our strategy and we are committed to our long-term strategic goal of growing Elbit System both organically and through selective acquisition while maintaining our position as one of the leading global defense technology solution providers and improving profitability.

Before I open the floor for question, I would like to make a comment regarding the current events that are taking place in our region as it relates to our operation. Elbit has been operating continuously throughout recent events and we continue to meet our commitment to our international and Israeli customers. Accordingly, our plans for 2006 and beyond remain unchanged. This could not have been achieved without the support and effort of our management team and our employees who have shown tremendous dedication to our Company. We are also supported by our global organization of substantial subsidiaries and facilities throughout Israel, United States and other countries. And I would like to use this opportunity to extend our thanks and appreciation to all of our employees for their tireless efforts.

And now, we will be happy to take your questions. Please.

Thank you very much, Joseph. Ladies and gentlemen, at this time, we will begin the question and answer session. [OPERATOR INSTRUCTIONS]. The first question is from Tsahi Avraham from Clal Finance. Please go ahead then.

Hello everyone. Hello good afternoon. Can you elaborate about the R&D that went down to $18.4m from $21.4m in the first quarter? Is it synergy or?

I think that yes we spend less R&D than in previous quarter due to the fact that although we did not change our R&D plans we could make it more effective due to the fact that we have now many companies like Elisra, Sandel and Tadiran under one umbrella.

And you think it's going to continue on this level until the end of the year?

We won't add more subjects to our R&D plan after these projects.

Okay, maybe another question, you showed an operating margin of 7.3% this quarter. Do you think this margin also represents the future quarters in 2006? You talked about gradually improving.

Tsahi, as you know we do not provide guidance and -- but we did make a point of the gross profit margin that we expect to have this year. As Mr. Ackerman mentioned before, 2006 in terms of [inaudible] and that's why the margin is lower than it would have been otherwise.

Okay, thanks.

Our next question is from [Shaul Eyal] of CIBC. Please go ahead then.

Hello and congratulations first of all on a strong quarter. We've been hearing a lot of reports about drones actually being used in Lebanon. I imagine there'll be a lot of equipment that is from Elbit which is being used. I imagine that your ability to comment is limited, but you give us any color on feedback your getting from the field? I imagine this is probably the first time some of your equipment is being used in the way that it's being used right now.

You know that Elbit is one of the largest defense industry in Israel and certainly our technologies, our systems are taking part in the battle in Lebanon. But I can tell you that our solutions are relevant to this event and we are trying to support our soldiers as much as best we can. Well I can tell you that these technologies are very successful. But we will wait a few more days until all our soldiers will come back home safely and then we'll discuss the future business related to them.

Fair enough. I have a slightly easier question. Backlog has been growing now consistently for quite a few quarters in a row. Should we expect backlog to continue edging up for the rest of the year based on the visibility you have into your pipeline?

Yes. Absolutely. The backlog, at the end of '06 will be higher than $3.6b.

Thank you very much and good luck going forwards.

Thanks.

Thank you very much. Our next question is from [Emir Oveer] of Poalim Shaar. Please go ahead then.

Hello and congratulations for the good report. I'm sorry for my rusty English but I have two questions. The first one is about the application of the situation in Lebanon on your backlog on your current, your future agreement with -- on the project -- what I mean is the project that you're working on right now, is it going to be -- is it going to be any problems because of the current situation in Lebanon? Is the first one. And about the Israeli military, what I'd like to ask is if the short-term, not in the long run, if the military budget is going to -- part of it is going to go for simple products and because of that it's going to hurt the more special projects like you have. I hope you understand this because I am not too good in English.

Yes, that's okay. First, Elbit is well prepared for this unexpected event. And I can tell you that the majority of our workforce showed up every day since this war started, so I don't see any impact on our ability to meet our commitment to our customers. We have been talking to every single customer showing them details what we are doing for them, taking advantage of the fact that Elbit has the facility, not only in the North part of Israel but also in the Center and South. We have also facilities in Europe and United States and everybody's very, very helpful. So we don't see any impact of our ability to continue in our ongoing business as usual.

I'm not talking about your ability. I'm talking about the customer about like political reason like we saw in another company in the [Tadiran Sandel]. Maybe because of political reasons that part of your projects will be -- will maybe -- we've talked about your customers or there will be delays or whatever?

Having said all that, and as I mentioned we talked to every single customer. We do not experience any single event when -- where Elbit is affected by this event.

What happened in the [inaudible] in Turkey? Can this scenario can happen also to you?

I'm talking about Elbit now. Talking about Elbit.

I know, but.

Elbit. [inaudible] other companies I don't know but, generally speaking, I don't see any -- as of now -- any negative impact on our Company.

Okay.

And your second question, certainly after the war, we will see some synergy costs within our IDS. I cannot tell you whether Elbit will be create an official. Certainly not of this event, that's for sure. So we'll wait and see. But, to say the least, I don't see Elbit being negatively affected by this war even if you will see some changes in the defense budget.

Right. Thank you very much and, again, congratulations for the very good report.

You're welcome.

Thank you. Our next question is from [Neil Amicom] of Bank Hapoalim. Please go ahead.

Thank you. Most of my questions were answered already just a few clarifications. The inventory I thought was pretty high and was high in the first quarter also can you really expect this level to continue looking forward?

Firstly, sure the inventory is high but this is according to our plans because we expect a higher revenue in the coming quarter so this is according to our plan. Just to make sure that we don't have any finished goods in our warehouses. But it's all work in progress, raw materials which is prepared for our coming quarters.

So you're saying that the inventory days are not -- will change too much?

Change -- it changes slightly due to the plan that we have to be prepared for our -- you can see that the sales for our coming quarter are higher than in the past and the nature of the projects ask for higher inventory. This is according to our plans and for us this is a positive sign in this case.

Okay. And about your gross margin, before Elisra we talked about improvement in gross margins. Can you tell us if you can say at least that going on in Elbit before Elisra?

Yes, I think that we say that we expect to see an improvement in gross profits without Elisra. The number you see, 26%, is with Elisra. It is well know that Elisra is representing a lower GP than the average of our Group and together with Elisra now we saw 20% which demonstrates what Elbit can do separately. But what I can tell you that starting '07 we will see an improvement in performance also in Elisra. So we expect a better yearly profitability for all Elbit Group in '07.

Okay, great. Thank you.

[OPERATOR INSTRUCTIONS]. We have a follow-up question from [Emir Oveer] of Poalim Shaar. Please go ahead.

Hello, I want to ask a general question about the U.S. military budget or the Federal budget, if you'll excuse me again for my English. But there are certain changes in the big project like in the planned F-22 and F-35 and the new marine ship, I've forgot the name but you know what I mean. This kind of project where there was a problem and now I understand that the problem where the problem become smaller. So is it going to affect you all these changes in?

Thank you for the question. No, Elbit is capturing indirect Phase I houses of the U.S. defense budget. And we see this market as a great potential for us and, as you could see, our business in U.S. is growing despite some changes, plus and minuses in United States. And we see great potential in United States and you'll see that also in '07 we will grow our business there.

Yes, but are you taking a part in this huge project?

We are not part of that. We are part of the JSF. We are part of the F-22. And these two programs, after the changes, [project represent] for the year around $1m for Elbit.

Sorry, but your last sentence again, I haven't heard you.

I'm saying that the U.S. market is so big even after the changes being planned for the JSF, for the F-22 and for the ship that we didn't mention the name. Also even after the changes that these three projects represent to Elbit $1b of business.

Okay, thank you very much.

You're welcome.

Next question is from [Marina Last] of [Moulup]. Please go ahead.

Hello, I just wanted to ask can you repeat the reason, please, for the increase in financial expenses in the second quarter if we compare it to the previous quarter?

The main ingredient in the financial expenses are the increased level of quarries that we had significantly higher than last years, coupled with the general increase in interest rates in the market. This includes of course all the other bank-related expenses etc. that go into that P&L line, but the more significant ingredient is the borrowing cost.

The borrowing cost?

Yes, the increased level of borrowing.

I see. It's not something with the CPI Index, the Index for?

It includes also expenses related to the exchange rates. But, as I said, the one significant -- the most significant item is the borrowing. As I said, it's influencing many other items.

But that's if you compare it to the previous quarter or to the second quarter of 2005?

We're not comparing it. If you look at the expense line, what it includes this was the answer that I gave you.

I see, so just the interest rate in the borrowing.

Again, it includes many items. The most significant is the borrowing cost, the banking costs etc. It also includes additional expenses related to exchange rates and that's all.

And this implicates in the next quarters it will be the same level or something like?

That depends on the borrowing level on the [inaudible]. Again, the level of borrowing that will be in the coming quarter, exchange rates and all the other things that have caused all the change this quarter.

Okay, thank you.

You're welcome.

Our next question is from Greg Agnew from Friedman Billings Ramsey. Please go ahead.

Good afternoon. Thanks for taking my call. With respect to the events that are going on over there, I was wondering if you have undertaken any initiatives for [ESL] defense or if you are basically undertaking any new projects to address the threat?

You know Elbit being one of the largest defense companies, I don't see a way that if this problem won't be resolved that Elbit won't take part in that, but I cannot be more specific than that.

Okay. And then just a follow-on the previous question, Ilan, can you tell us what your current weighted average cost per debt is?

Most of our borrowings are in U.S. dollar and are linked to the -- present U.S. dollar is linked to the Libor rates and that is spread about that. This ranges with different companies but we normally do not go into that type of information. But it is based on U.S. Libor rates mostly.

Okay, great. Thank you very much.

You're welcome.

Thank you. Next question is from Gilad Ben-Avi from Bank Hapoalim Research Department. Please go ahead.

First, congratulations on a strong report. I want to ask about the percentage of sales from Israel which are higher than the last quarter from the quarter last year. What are the reasons of the increase in the percentage of the sales in Israel?

Yes, we have several programs for the IDS. These are the [defense] quarters that we have announced a few years ago and now time comes for delivering these goods including digital army program, many others. But you can see that's not only Israel sales go up, but also United States.

Another question if I may about engine growth in the areas of electro objects. What is your estimation about the revenues next two quarters for Elisra Optics? Do you think it would be the same as the first quarter of 2005 or the same level?

We have experienced a decrease in sales for Elisra Optics in this quarter but this is why Elbit is having a wide portfolio to compensate that. I hope and believe that it will be improved in the coming quarter.

Okay, thank you very much.

Thank you very much. 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 1888 269 0005, in the U.K. please call 0800 169 8104, in Israel please call 039 255 925, internationally call 972 3925 5925. Mr. Ackerman, would you like to make your concluding statement.

Thank you. I would like to thank all of you for joining us today and I'm looking forward to seeing you again in our third quarter conference call.

Thank you very much. This concludes Elbit Systems Ltd second quarter 2006 results conference call. Thank you for your participation, you may go ahead and disconnect.