Elbit Systems Ltd (ESLT) 2006 Q3 法說會逐字稿

Welcome to the Elbit Systems Limited third-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 November 14, 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 1-866-704-6710 or 972-3607-4717.

I will now hand over the call to Mr. Ehud Helft of Gelbert Kahana Investor Relations. Ehud?

Thank you. Good morning and good afternoon to everybody. Thank you for joining us today for the Elbit Systems' 2006 third-quarter results conference call. Before we begin, I would like to thank Elbit's management for hosting this conference call today.

With me 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 financial review of the third quarter, and then Mr. Ackerman will follow with an overview of the business. We will then open the call for questions. Ilan, would you like to begin, please?

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

Our third-quarter 2006 revenues posted a new record for quarterly revenues at $376.7 million, a 37.7% increase over the $273.6 million generated in the third quarter of 2005. While this increase includes the contribution from Elisra revenues, which we began to consolidate in December 2005, we continue to see double-digit organic growth in Elbit Systems' legacy business.

Our third-quarter gross profit was $96.1 million, a 30.5% increase over last year and representing a gross margin of 25.5%. The gross margin was lower than that of last year due mainly to the results generated by Elisra, where gross profit margin is lower than the other group units. On a nine-month basis, our gross profit margin was 25.9%, which is in line with our annual target of around 26%.

Net R&D expenses, which were $4.1 million above those of the third quarter of 2005, were lower as a percentage of revenues due to the significant year-over-year increase in revenues. On a gross level, before outside participations, we spent in Q3 2006 $4.8 million more than in Q3 2005 and were able to obtain higher third-party participation in the costs.

Overall, we continue to keep our operating expenses at the level of 19% of revenues, below last year's 19.6% level, even after accounting for Elisra's operating expenses which are generally at a higher level than the other group companies.

Financing expenses were $4.4 million, $1.4 million higher than in Q3 2005. The main difference is the higher borrowing level, the increased market rates, and the inclusion of Elisra's borrowing costs. We were also negatively affected by the continual depreciation of the new Israeli shekel against the U.S. dollar since a large portion of our cost is in shekels.

Our effective quarterly tax rate was unusually high at 36%. This is due mainly to provisions required in connection with local tax reporting in Israel, where we are taxed for gains originating [for] depreciation of the Israeli shekel and its effect on dollar-denominated obligations, which are calculated for tax purposes only and do not affect the P&L. We do not expect this to be a representative rate going forward, unless depreciation of the shekel continues.

Our affiliated companies and partnerships continued to perform well and generated income of $4.6 million in the third quarter of 2006, a $3.1 million increase over last year's third quarter. One of the reasons for this large year-over-year increase was the fact that in Q3 2005 we also had a $1.2 million onetime writedown in the expense related to the purchase of additional (indiscernible) shares. This quarter we had no onetime expenses, although this P&L line does include the ongoing amortization of the intangible assets' expense related to the various acquisitions of shares in companies in which we hold 50% and less.

Net income for the quarter increased by 28.7% over the same quarter last year to $18.7 million, as compared to $14.6 million which included, as I mentioned before, a $1.2 million in onetime IPR&D expense last year.

Our EPS for the third-quarter 2006 reached $0.45, $0.10 above our Q3 2005 EPS.

Revenue breakdown in the third quarter of 2006 was comprised of $138.3 million in airborne systems, which increased 20.8% over Q3 2005 and represented 36.7% of our revenues for the quarter.

[Unmanned] systems showed the highest increase and generated $100.9 million in the quarter, 2.5 times the revenues generated in Q3 2005. This increase is due to several programs, led by the Israeli [Bishiv-laly] program and (indiscernible) with the U.S. Marines.

C4ISR revenues increased 49% over Q3 2005 to $66.8 million and accounted for 17.7% of the revenues.

Electro-optics generated less revenues than last year and actually showed a 27.4% decrease to $39.5 million. As we have mentioned last quarter, we believe that this is temporary and we expect that electro-optics revenue will gradually pick up again in future quarters.

Other business sales generated revenues of $31.2 million or 8.3% of total revenues.

In terms of geographical contribution, the U.S. continues to be our largest market, accounting for 45.1% of revenues this quarter; followed by Israel, contributing 26.4% of revenues. Sales in Europe grew by 61.7% year-over-year, but were only 13.3% of our third-quarter revenues due to the large increase in U.S. and Israeli sales. Other countries decreased by 14.4% to $57.1 million in the quarter.

We continue to generate strong cash flow. Operating cash flow in the first nine months was $150.9 million, 56% higher than in the first nine months of 2005.

Our firm backlog continues to grow and set new records. At the end of the third quarter, we had $3.775 billion of backlog, $428 million higher than we had at the beginning of the year. $1.73 billion of that backlog is expected to sell in the fourth quarter of 2006 and during 2007, which means that we already have over $2 billion for revenues for 2008 and beyond.

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

Thank you, Ilan. We reported today the highest quarterly revenues, EPS, and backlog in our history. The revenue increase was achieved by a double-digit organic top-line growth rate in our legacy businesses, which started in 2005 and continued throughout this year, and the consolidation of Elisra which started in December 2005.

In terms of top-line transparency we continue to show a very strong backlog of [new] orders that have continually increased every quarter. This backlog indicates close to $1.5 billion in orders received in the first nine months of this year, of which over $550 million were received in the first quarter alone.

The orders which we gained since our last conference call include a diversity of orders received by many of our group companies in a variety of businesses and include, among others, two contracts that were signed in Germany, one by Elisra who won an $[8] million contract to supply personal survival radios to the German Air Force. The other contract, awarded to Elop, was with German Armed Forces to supply $5 million worth of portable, lightweight designators.

While these contracts are of relatively small amounts, their importance is that they are for supply of advanced systems to a major NATO member. We believe that if they will be satisfied with our systems, other major countries may follow.

During the quarter, both Elop and Elisra announced other contracts for larger amounts as well, with Elisra reporting a $65 million contract for electric warfare system, while Elop announced a contract to supply a land system valued at approximately $130 million.

At the same time another subsidiary, Cyclone, was awarded an $18 million contract by Boeing for structural components for the F-15 aircraft. Recently, we also announced two very important wins, one in the area of Homeland Security and the other in the area of [sim] aviation, neither of which is reflected in our end of Q3 backlog but are both strategically important.

Recognition of our technologies came also from a different direction, when the [autumn] Popular Science magazine announced last week that our Skylark II UAV received a 2006 Best of What's New award in the aviation and space category. This prestigious award [is] recognition of the system's superior technological capabilities. Our Skylark I system has been flying successfully in many countries and has proven to be an important operational asset for the forces using it.

I think that the main point that needs to be addressed when we look at our results, in addition to the ongoing efforts to improve performance steadily across the board, is the performance of Elisra, whose margins have been traditionally lower than the average of our group. As you know, we have begun to take steps in order to improve this, including restructuring of the company.

We believe that Elisra is a very capable company, with outstanding technological assets and potential, and can be a profitable and strong company for the benefit of its employees, customers, and shareholders. We are continuously reviewing the options that we have in order to put the company on a successful growth and profit improvement path.

While we work on increasing the synergies between the companies, we continue to invest in research and development and marketing, and to execute our long-term strategy of growing our businesses both organically and through selective acquisitions of synergistic businesses, with the aim of maintaining the steady growth in our top and bottom line. With that, I will be happy to take your questions now.

(OPERATOR INSTRUCTIONS) Joseph Wolf of UBS.

A question about margins on a couple of levels. If I look at what is going on, I guess overall in the Company, and maybe if you can isolate Elisra, can we talk about how the core Company is (technical difficulty) the margin side perhaps year on year, and even versus the second quarter? And then how Elisra is impacting that.

What is the time frame? I know there has been a restructuring plan you have talked about putting into plan for Elisra. What kind of time frame are we thinking about in terms of a gain in margins, and how much can be achieved there?

Joseph, I would like maybe to start by giving what we usually do not do, giving some information about Elisra, which I think may help clear up some issues.

Elisra's contribution on the top line was approximately $50 million in the quarter, while the gross profit margin is below 20%. I think that that information can give you an idea of the contribution that they had during the quarter. And can also demonstrate that, on the other hand, what we call the legacy Elbit businesses have performed at least as good as they did last year.

With regards to the restructuring plans?

Yes, you know we have now a new management in Elisra, and we are now considering several alternatives as how to restructure Elisra to enable them to demonstrate margin at least close to the average of our group. We are now pursuing [some] alternatives. My plan is that within several quarters, we are going to see the results.

Just in terms of business, just a follow-up, I mean, it seems like on the -- [more] contract wins that the product and the Company are moving forward on this front. Where do you see the operational issues within Elisra? Is it an overfocus on R&D? Or is it in other organizational issues that will naturally move out as you integrate?

Yes, as you can see, they got several very important wins recently. We see their backlog growing. Their problem is in processes, in culture, in level of management, which we already reduced. We need to put some more robust system processes in place and mainly to adopt what we do in Elbit. By doing that, it has to do also with all kinds of reorganization of the company, and consolidating all kinds of small groups within the company.

We have [put a] plan in place. Together with the employees, with the management, we are going to implement it. As I said before, in a few quarters, we're going to see the results in the bottom-line numbers.

Just one final question. How much of your -- is there any part of your ability that is cut off by the fact that 30% is still owned by IAI?

No, no, in terms of what we can do with Elisra, I think we do it jointly with IAI. We are sharing the same interests.

Okay, thank you very much.

Yair Reiner of CIBC.

Congrats, first, on the strong quarter. Just a couple of questions for me. First of all, a very strong uptick there in research and development costs. Can you give us an idea of what is behind that? Were there any onetime items in there? How should we expect to see that line going forward?

As you know, we have a long-term plan for research and development. Certainly, we did not shut down any, any activity in R&D. The reason why we were successful to do what we planned with a low number is, by looking across the organization, we managed to avoid some duplication. So we did the same with a low number just by eliminating, to [minimize] the duplication within the group.

But research and development was up strongly during the quarter, was it not? I mean it was $25 million compared to $18 million last quarter.

Yes, but what Mr. Ackerman referred to was the year-over-year. It is higher than it was last year, and I think that this quarter is more of the level of the R&D. This quarter is.

Fair enough, so we should look at that as the right number going forward?

(indiscernible)

Okay, second question is about the Homeland Security announcement that you made. You mentioned that it had important strategic value for the Company. Can you give us kind of more of a sense, more color, how you see this opportunity moving forward? When do you expect it to begin kind of ripening for you?

As we announced, this program is important. It is big. I'm sure that once we start implementing this program, we will see more customers showing interest in that technology. This is a good example of how we can look for good potential partners. I'm pretty sure that by doing that successfully we will see this line of business, of Homeland Security, growing in our portfolio.

Very good. Final question for me. There seems to be a lot of momentum in the business right now. From where you sit at this moment, would you expect backlog to continue moving upward next quarter?

Yes.

Thank you.

[Amir Avisi] of Poalim Sahar.

I would like to congratulate you for the good financial. My English is not so good. I'll try to ask anyhow. First of all, I would like to know about the land systems. Can you put some more light on why it has become such a high level? Is it going to continue to be 20% of the Company, or it's just for this quarter or this period?

Second question is about the electro-optics. (indiscernible) project of Elop, the $130 million, (indiscernible) will bring the [improvement] to this section.

The third question is about Europe. Can I say that the Watchkeeper was the cause to the increase in the revenue from this area?

Last question, and I promise you it will be the last, do you see -- do you start to get any indication from the Israeli Ministry of Defense due to the war in Lebanon?

Okay, one by one. What we all see in the world, the trend is that more and more orders are going to come for land applications. We see that not only in Israel, but we see that in Europe, the United States, and the rest of the world.

Yes, we do foresee the land business [inevitably] growing due to the fact that we adopted the strategy about eight years ago to strengthen ourselves in the land business. Just to mention the digital arms program that we announced a year ago, and many other programs we have both in Israel, Europe, and the United States. Land is going to be a very important line of business for us.

Coming to Elop, Elop's business is divided into two segments. Two segments. One is Elop programs; but the other is Elop being part of the land businesses. So we record sometimes the sales under land, but Elop is doing their part under that. So this is why although you see a decrease in sales, but part of it goes under the land businesses.

So the $130 million contract is for the land business, or for (multiple speakers)?

No, the $130 million is Elop, it is solely Elop. But Elop has (indiscernible) electro-optics; but they have some other activities which goes under land and you don't see these -- it is not reflected into their numbers.

Okay, so can the land business [then] go to the (indiscernible) mostly from the Marines contract?

No, no. It is Marines in the U.S., it is the land business in Europe, it is the digital arms program in Israel, and many other places. They have programs all over the world.

Okay, [firstly] about Europe, we say that a few years ago we are going to see the business in Europe growing, not only due to the Watchkeeper, but also some other programs that we had announced recently in Europe. In Portugal, in Belgium, in Turkey, and others. But even this number is going to grow next year. So Europe is going to be a very successful segment for us.

You questioned about the war here. Our systems in that war were very successful. We are going to see in the near future more orders coming to Elbit as the result of this war.

Okay, thank you very much.

Nir Amikam of Bank Hapoalim.

All of the questions were answered, but I wanted to clarify a few. You said $50 million for Elisra this quarter?

Yes, five-zero. Approximately $50 million, five-zero, in the third quarter.

Which means that I can see organic growth at about 19 or 18%?

Your calculation is correct, yes.

Okay. Can you give us a little bit of a breakdown in the inventory, or at least the customer advances?

I can tell you that we had -- at the end of the quarter, we had advances of about, on the short-term we had $295 million. Okay? That is on the short-term; and we had $130 million long-term.

Okay. Is that including the ones in the inventory, right?

Right.

Okay. Another thing about the -- you talked before about the Homeland Security project, which is -- I'm guessing you are talking about the Boeing one. The border project. Can you tell us the extent of the project? Maybe the potential there today? Because from what I understand, it is in a test session or something like that. How much is [Colman's] contribution to the project?

As we announced, it is going to be material, but we will give you more details after we get the order.

Okay, so you did not get the order yet?

No, [at least] it is not in our backlog.

Okay. But you can't -- because there were a lot of numbers said, like $2.5 billion for the whole project. Can you give us some kind of color today what we are talking about, just temporarily?

As I mentioned, it is going to be material to Elbit. Very important strategically, but also size-wise. Again, more details, I can give you more accurate ones as we get the order, after we put it in our books.

Okay. Another question about the depreciation of the shekel. How can we look at it looking forward. How much is there an effect? Because this quarter it really surprised me in the taxes. Is it something that you're protecting against, doing anything to maintain something more normal in the taxes?

To answer your first question, how much will it be in the future, if you know it share it with me.

Not the shekels movement, but what you're doing to prevent it.

In terms of shekel-dollar exposure, we manage it continuously. But we do have some exposures, as we always say. [I know] exposures are things that we monitor.

In terms of tax rate, that is -- it is a P&L item, but as you know, it may turn around depending on the direction of the currency.

Okay, so can't really protect it, some way to do some kind of [leverage] there?

As I said, we protect it partially when we think it is appropriate. As you know, we do cover all the positions that we have that are not U.S. dollar or shekels. That we do.

Okay. Last question (indiscernible) because we see, we talked before about the customer advances. What kind of leverage should we expect looking forward? Because I'm guessing looking forward we would see more leverage, more financial leverage?

I think that financial leverage -- with the caveat that unless something significant happens -- should not -- there is no reason for that to change dramatically, at least in the near future.

Okay, thank you.

[Laura Herzon] of Ion Asset Management.

I have a question about the equity affiliate number for this quarter. At 4.6 million, it was high. Were there any oneoffs this quarter, or can we expect this kind of number going forward?

There were no oneoffs this time. Actually when you compare it to last year, you have to remember that we had less the $1.2 million onetime IPR&D expense that presents a larger gap between the numbers year-over-year. So you have to take that into account.

That number includes basically [31] that have done well this quarter. All the companies in which we own 50% and less, including VSI, SCD, and some others, they have been doing well.

Okay. So this is the approximate level we should expect going forward?

This is what we had this quarter. If we continue to do well, we will see in the future.

Okay, thank you.

[Shai Taki] of [Matak].

A couple of questions about Elisra. Could you give us some details about Elisra's operating performance? Looking at my notes (indiscernible) it seems that the loss there was quite substantial. So if you could give us some color there?

Were there any onetime items or (indiscernible) onetime items relating to the reorganization plan you announced in this quarter? Afterwards, I have a couple of other questions on different subjects.

Okay. With your permission, I would like to stick to the information I gave before. I can tell you that Elisra's operating expenses are a lot lower than Elbit's, as a percentage of revenues. You can take it from there.

In terms of onetime, we did have some -- I would not call it onetime. We did have some expenses related to the processes that we started in Elisra this quarter. That is included in the numbers.

Okay, thank you. So regarding the Homeland Security project with Boeing, could you give us some color about where it is in terms of the -- let me rephrase. How will the change in the political climate in the U.S. can affect this program? Could you give us your opinion about it?

I think all I can do is to repeat what I said. I think that this team was selected recently. This program is important both for Boeing and for ourselves. Shortly, we are going to get the formal contract [ask]. I don't see any risk about that.

As we get the order, we will give you more details later about the content of that. Again, I repeat again, this is a very important one, size-wise and strategic-wise for us.

So you don't see it -- the Democrats taking the House and the Senate does not jeopardize this project?

No, I don't think so.

Okay, thank you. One last question. Given the size of your backlog, do you think you can continue with the double-digit growth in '07?

I think so, yes.

Thank you.

(OPERATOR INSTRUCTIONS) 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 2 hours after the conference. In the U.S., please call 1-877-332-1104. In the UK, please call 0-800-169-8104. In Israel, please call 0395-5925. Internationally, call 972-3925-5925. We have a follow-up question from Amir Avisi from Poalim Sahar.

Just one other question about the (indiscernible) rate. [If] the shekel (indiscernible) do you have an estimation about the tax rate for the whole year?

The normal tax rate has been in the 26% range, plus or minus; and we may be around that. Maybe slightly higher.

Have you adjusted for the (indiscernible) next quarter?

I don't think it is correct to measure it on a quarterly basis. I think that for the near future, I see it -- leaving the shekel issue aside -- a little, probably slightly above the 26% level I said.

For the whole year? For the whole 2006?

2006 is almost over, so I guess the answer is (indiscernible). It will be [above] 26, but not clear where it is going to be [for that].

Okay, thank you.

Mr. Ackerman, would you like to make your concluding statements?

I would like to thank everybody for joining us today. I am looking forward to see you again in our next conference call. Thank you.

Thank you.