Elbit Systems Ltd (ESLT) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Elbit Systems LTD fourth-quarter 2006 results conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded March 14, 2007.

I would like to remind everyone that the Safe Harbor language contained in today's press release also pertains to all content of this conference call. If you have not received a copy of today's release and would like to do so, please call Gelbart Kahana Investor Relations at 1-866-704-6710 or 972-3607-4717. I would now like to hand the call over to Mr. Ehud Helft of Gelbart Kahana Investor Relations.

Thank you. Good morning and good afternoon to everybody. Thank you for joining us today for the Elbit Systems 2006 fourth-quarter and full-year 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 of Finance, and Mr. Joseph Gaspar, Chief Financial Officer. Mr. Pacholder will begin with a financial review of the fourth quarter and the full year, and then Mr. Ackerman will follow with an overview. We will then open this 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. I will begin with a financial review of the fourth-quarter and year-end results and then hand over the call to Mr. Ackerman.

Before I begin my review, today is my last day with Elbit Systems. I would like to thank you all for many enjoyable years of working together. It has been very much a pleasure.

Now to the numbers. Our fourth-quarter 2006 revenues were $467.4 million, a 45% increase year-over-year. The fourth-quarter 2006 revenues include a full quarter of Elisra revenues, while last year we had only one month of Elisra sales. In any event we continued to grow organically at a double-digit rate.

Revenues for the full-year 2006 crossed the $1.5 billion mark for the first time, a 42.4% increase over the $1.07 billion in revenues we reported in 2005. And this reconstituted revenues of $220 million in 2006 indicated an unprecedented 23% organic growth rate for the year. Our fourth-quarter 2006 gross profit was $100.2 million, a 28% increase in absolute dollars year-over-year. Our gross profit margin for the quarter, however, was lower than last year's and reached only 21.5%. The main reason for the lower gross margin was due to the negative impact on the gross margin by Elisra mainly due to write-offs related to several projects, and Elisra impacted the fourth-quarter gross profit margin, reducing it by 3.8% points.

The full-year gross profit was affected by Elisra as well, and overall our gross profit increased in absolute dollars by 33.5% over last year to a record $373.5 million. The annual gross profit margin reached 24.5% compared to last year's 26.1%. Again, Elisra's results impacted the full-year gross margin, reducing it by 2 percentage points.

Operating expenses were kept in check, and total operating expenses in the fourth-quarter 2006 reached 16.9% of revenues compared to 20.5% of revenues in the fourth quarter of 2005. For the full year, operating expenses were 18.5% of revenues compared to 19.9% in [all of 95]. We should note that last year the operating expenses, including the onetime IPR&D expense related to the Elisra acquisition, but even excluding that onetime expense we saw a lower level of operating expenses. I remind you that a significant part of the increase in the operating expenses in 2006 comes from the consolidation of Elisra, which last year was consolidated only for a month.

The largest operating expense in 2006 was sales and marketing, which reached $112 million compared to $78.7 million last year, but decreased the percentage of revenues from 7.4% to 7.3%. As you know, marketing the sales projects takes longer and costs more than in the past, but we see the results of these efforts in the continued increase of our backlog.

Another important factor in building up our backlog is R&D, which accounted in 2006 for $115.6 million gross, $92.2 million net compared to $92.4 million gross and $71.9 million net in 2005. However, as a percentage of revenues net R&D expenses actually decreased from 6.7% in 2005 to 6.1% in 2006, mainly thanks to increased efficiencies. G&A expenses were [kept] at 5.1% of revenues similar to the 2005 level.

Our full-year operating income increased by 36.5% to $91.9 million from $67.3 million in 2005, while operating margins were 6% as compared to 6.3% last year. Excluding the 2005 onetime expense related to the Elisra acquisition, our operating profit in 2005 was 78.3% -- sorry, $78.3 million -- and the operating margin was 7.3%. As with the gross margin, 2006 consolidated operating profit and margin were negatively affected by the consolidation of Elisra, which had an operating loss of $22.2 million in 2006, of which $16.8 million was recorded in the fourth quarter.

Our nonconsolidated subsidiaries have done very well and contributed significantly to our profit this year, generating net income of $14.7 million compared with a loss of $1.6 million in 2005. The main contributors were Tadiran, VSI, (indiscernible), all of which had a very good 2006. I remind you that in 2005 we also were affected by a onetime IPR&D expense related to the acquisition of the (indiscernible) shares.

The result of all of that was a net profit of $23.9 million or 5.1% of revenues for the fourth quarter and $72.2 million or 4.7% of revenues for the year, setting new records for both quarterly and annual net profit. Our EPS for the fourth quarter and the full year were $0.57 and $1.72 respectively. Excluding onetime IPR&D expense related to Tadiran shares acquired in 2006, our net profit and EPS in 2006 were $74.4 million and $1.78 respectively.

In comparison, excluding the onetime charges related to the Elisra and Tadiran acquisitions, we had $7.6 million net income in the fourth quarter of 2005 and $51.1 million net income for the full-year 2005. Accordingly, our net income, excluding onetime expenses in both years, increased by 45.6% year-over-year, while our fourth-quarter net profit was three times our [EBIT] in 2005.

Looking at the revenues, distribution by lines -- in 2006 were as follows. Elbit Systems continued to be the largest division and generated revenues of $547.8 million or 35.3% of revenues, increasing by 30.2% year-over-year. ELINT Systems was the second largest, generating revenues of $317.7 million, accounting for 20.9% of total revenues. You may recall that a year ago when ELINT Systems sales were slightly down, we expected an increase in 2006, and indeed, the division increased revenues 2.7 times year-over-year.

C4ISR revenues increased by 44.2% to $313.5 million or 20.6% of revenues, while Electro-Optics were 8% lower than in 2005, generating revenues of $223.3 million or 14.7% of our total revenues. It is important to bear in mind that many of the systems sold by the other group divisions include advanced Electro-Optics that do not count for the direct Electro-Optics revenues. So the actual value of Electro-Optics systems in the group is higher. Other business has accounted for $120.9 million or 7.9% of revenues.

All geographical divisions have demonstrated strong growth, led by the U.S. with $609.5 million accounting for 40% of the revenues and representing a 53.3% year-over-year increase. (indiscernible) Israel with $407.1 million or 27% of revenues and a 29% year-over-year increase. Other countries accounted for $272.9 million or 17.9% of revenues and an 8% year-over-year increase as predicted in the past.

As was predicted in the past, revenues in Europe more than doubled year-over-year and reached $233.7 million, accounting for 15.3% of revenues in line with expectations. Our backlog of orders continues to increase, and the [fee] range reached $3.79 billion, a $439 million increase over the beginning of the year. 68% of the backlog is for sales outside Israel, and approximately 70% of the backlog is scheduled to be performed during 2007 and 2008. The majority of the 30% balance is scheduled to be performed in 2009 and 2010. Last but not least, operating cash flow in 2006 was very strong as well, setting a new record at $201 million compared with $187.6 million last year.

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

Thank you. 2006 was, indeed, another record year across all parameters. We continued our strong top-line growth and achieved a [23%] organic growth rate. We did this while maintaining strong profits, record net profit and EPS, record backlog and operating cash flow. In fact, these results were achieved despite the negative impact that Elisra had on our consolidated results. I think this is a demonstration of the Elbit Systems group strengths and capabilities.

We have already taken several steps in order to turn around Elisra, including backlog during 2006, reducing the number of employees, streamlining the operations of the three companies in the Elisra organization while reducing overhead and increasing the efficiency of its operations. Yes, our work is not yet complete, and we expect that additional steps will be made, including a further reduction in the number of employees and consolidation of several facilities. Having said all that, I believe that Elisra is an important asset for the Elbit System group, (indiscernible) our portfolio and a strong fit with our strategy and growth engines, and we see significant forces working together in all of our business areas.

In 2006 we continued to execute a strategy that enabled us to grow from a $590 million revenue company in the year 2000 to a $1.5 billion company today. This year many parts of our strategy came together, and we began to see the fruits of the efforts we have made to expand our businesses. In particular, we launched several important programs that assure the continued growth of our businesses. These include among others two electronic [welfare] projects, aggregating to $135 million won by Elisra; unmanned [pilot] project in Belgium and Portugal for armed vehicles; several projects in the Homeland Security business area won by Ortek and Kollsman, including cost of security system and a selection of Kollsman as part of the Boeing team for the SDI network in the United States and the inauguration of the Israeli Border Police IT system with (indiscernible).

In Elbit Systems we won several important programs for Helmet Mounted Systems in the United States and were selected to provide displays and tracking system for Bell Helicopter for the U.S. Army. We also were awarded a long-term contract to provide civil avionics systems in Europe.

In addition, we began to see new commercial aviation aerostructure businesses generated by our Cyclone subsidiary, and this has developed very nicely over the recent period. Elop won several important contracts as well, including payload program for air and naval applications, a 130 million ground system program, as well as many, many others. This year we will seize several important orders directly to the (multiple speakers) in the United States, some of which have already been delivered, while others will continue other IDIQ contracts, and they aggregate to 100s of millions of dollars.

The progress we won with the US Marine Corp includes Laser Target Designators, various Electro-Optics systems and others. The projects I have just described are only a sample of this business that has been won by the group, and they will present the wide range of technologies and the synergies that have been developed among the group companies as we aim to come to the market and with the best available integrated solutions.

In addition to the US, Europe is an increasingly important market to us. I'm happy to report that as expected our European business more than doubled since last year, reaching in excess of [15%] of our total revenue. 2006 was our 11th consecutive year in which we achieved increased revenue and growth in backlog of orders year-over-year. Without 23% of (indiscernible), a significant net profit increase in 2006, our backlog was continuously through our future growth supported by our (indiscernible) in the R&D and marketing.

We feel highly confident in our continued and strong growth into the future. However, we always strive to improve our efficiency, and we see room for improvement particularly in our gross margins, following our integration with Elisra (technical difficulty) Elisra into the Elbit Systems family. I strongly believe that we are taking the right steps and will see improvement in the near future.

And while we do that, we plan to continue to carry out the strategic plan that has proven itself in positioning Elbit Systems as a global player in the growing defense electronic business. This strategy includes the development of leading-edge technologies that give us an advantage over our competition in the major programs, concentrating on developing new growth engines such as land systems, armed land vehicles of all types, ISR technologies, Homeland Security systems and airborne systems both military and commercial. These, together with our M&A activity which focused on some objectives (indiscernible), we ensure the continuation of our profitable growth.

Finally, and just before opening up the floor to Q&A, I would like to thank Mr. Ilan Pacholder very much for his hard work and significant contribution over the years to Elbit Systems. Ilan still remains within our group as he takes the position of CFO of Tadiran Communications. I will wish him the best of success with his next challenges.

And with that, I would like now to open the call for questions and answers. Operator, please.

(OPERATOR INSTRUCTIONS). Joseph Wolf, UBS.

A couple of questions and, of course, congratulations to Ilan. We will miss you at Elbit. Regarding the gross margin, I guess my question is, it has a couple of sides to it, but the first way I wanted to tackle it is, was the decline in the fourth quarter attributed to Elisra of the same magnitude as it was all year-round, meaning if it was just typical seasonality plus Elisra in all of the quarters for the year? And if that is the case, as we think about 2007, how should we be modeling gross margin? Back to the 2006 levels on a quarterly basis, or is there something we should be thinking about because there has been a pretty wide swing this year?

The second question I have is regarding just the Tadiran Communications contribution. It looks like there was a big onetime gain in the fourth quarter. I'm wondering if I'm just looking at that properly as I look at the fourth-quarter results.

This is Joseph Gaspar answering here. Regarding your first question or regarding the GP percentage, if we exclude the impact of the Elisra performance, especially in the fourth quarter, we see kind of a very small swing from previous years in the GP for this year. We expect that this impact that we had in the fourth quarter with the performance of Elisra, we expect it not to repeat itself, definitely not at that magnitude in the future, and hopefully the Company as we expect would improve its performance and be reflected in the overall GP of the group.

Regarding the second question, Tadiran, in the aggregated net earnings for the period, we have several components. One of them is the Tadiran Communications performance, of course. In addition to that, we have other subsidiaries as well included there. As we said in the past, we have a subsidiary, we have a partnership in the US by the name of VSI, a strong partnership working in [airborne] systems, which has performed well. We have a partnership in Israel by the name of SCD working in (indiscernible) components has performed well, and then another one in Israel, which has performed well as well.

So this [composed] number that ended for the full $14.7 million that shows up there. The comparative number for last year, this includes, as Ilan said before, the onetime write-offs for the acquisitions of the Tadiran in last year. So it should not be a comparative number to the 14 [months].

Okay. But just -- I hate to press you on the gross margin. It's just it seems to me that looking forward, and this will be a very big swing factor in profitability next year. First quarter of 2006 you had Elisra; gross margin was 26.2. Fourth quarter you had Elisra; the gross margin was 21.4. I know that there's some seasonality in the profitability of the business and in the mix of business, but I'm wondering if the 24.5% margin average for the year is something we should think about for all of '07, or is there something else we should be thinking about?

I think that a more right approach would be to neutralize the fourth quarter Elisra impact and look at the numbers as an outcome (indiscernible) [neutral assets].

[Sackay Averham], [Karl Finance].

You show that you have very high revenues in the fourth quarter combined with a low gross margin. Was there any onetime item in the fourth quarter that pushed you towards these results?

In point of view of the revenues, our normal revenues, they did grow. I agree the organic growth was strong, and it does reflect our strong backlog that we had, that the Company had.

From the point of view of the gross profit margin, as mentioned earlier, it was significantly affected by some of the write-offs that caused the very poor performance of Elisra in the [first] quarter, and we look at that as a transitional period, which essentially should not be repeated definitely not at that strength in the future.

Okay. But if you look at the Elbit results reached during the fourth quarter, the gross margin was only 25.2%, also lower than the last quarter.

If you analyze year-over-year the fluctuations in the gross margin quarter-over-quarter of Elbit performance, you would realize that we usually have a higher gross margin in the first three quarters and then in the [fourth] quarter sometimes slightly lower. I would recommend to look at our performance on a yearly basis and not necessarily on a quarterly basis from that point of view.

Okay. Thank you. The last question, could you give us Elisra's operating loss in 2006?

Yes, Elisra's operating loss was $26 million -- not operating loss, the net profit (multiple speakers) $26 million, and of course, our share was 70% of that, which is $18 million.

[Arvind Rhamannagi], CIBC.

Congratulations on a great quarter. I just had a question related to some M&A activity. Are you planning on any M&A activity for 2007?

M&A is an [initial] part of our strategy both in Israel and outside of Israel, and we're looking for two types of acquisitions. One, which brings us additional technologies or a company which will give us access to new markets. Certainly we're looking for acquisitions, mainly in Israel and the United States or maybe some more in Europe. But we don't have anything in particular that we can announce.

That is great. I also wanted to clarify some of the numbers you provided for the geographic breakdown. I missed a couple of numbers. Could you just (technical difficulty)--

Which numbers? Could you repeat, please?

You gave a breakdown of the geographic numbers, right?

Yes. Okay. From the point of view of revenues, for 2006 total revenues were as you see $1.5 billion, out of which 40% amounting to $[609] million were for the US; our second biggest market, Israel, 27% which is $407 million; Europe for $234 million, 15%, and the rest of the world $273 million, 18%.

Okay. Great. And as far as the breakdown of your products, I got $547.8 million for Elbit.

Care point systems? The breakdown of the different areas of operation, that is the one that you're looking for?

Yes.

Okay. Just a minute, please. The airborne systems amounted for $547.8 million, which is 35.9% of the revenues; land systems $317.7 million, 20.9%; (indiscernible) star systems, $313.5 million, 20.6%; Electro-Optics business, $223.3 million, 14.7%, and the other products and systems, which are mainly non-defense, $120.9 million, which is 7.9%, altogether was $1.523 billion.

[Amir Avivi], Poalim Sahar.

I would like to ask a few questions about, the first one is about Tadiran Communications. When I look at the backlog, I see that you wrote only $4 million of the equity net earnings and Tadiran earned 10 times more than these numbers. Could you explain to me why you hold 43%, so it is possibly higher I think or I'm missing something here.

The second is the effect of the dollar on the GP; was there any effect? And the third question is about the backlog. The SBI project is fully included in the backlog?

And about the land system [subfill], such a huge growth if I compare it to last year, or is it only onetime efforts, or is it something you would (indiscernible) we are supposed to see during the next year because of a plan or something? And can you give some more color for (inaudible) growth in this sector? And that will be all for the time. Thank you.

Okay. First question. The Tadiran portion in the equity net earnings, you are correct of calculating the $4 million. However, this number is a result of a calculation which starts with our share in the Tadiran Communications profit from which we deduct or from which we deduct numbers that represented in our disclosure when we bought the shares that's the difference that we are actually over the years deducting from the net profit. So you cannot just take the 42% ownership times the profit, you will have --- it's a most complicated calculation resulting from the initial calculation of the acquisition of the shares.

Regarding the --

So I guess this is standard depreciation or something like that?

That is correct. (multiple speakers) the difference from the value, the equity of when we bought it and the price for which we bought it.

The second question was the influence of the shekel/dollar ratio on our performance. Yes, we were affected because some of our expenses, actually a significant part of our expenses, our man power had performed and paid in shekels in Israel. But all of that is included in our numbers. So --

Can you describe how many percentage from the GP affects -- the dollars/shekel ratio affects the overall GP?

I would not offer a number, but I would not say it has been significant.

Not significant?

No. Not significant in relation with numbers of the whole corporation. SBI project is included to the extent that the contract that we had received, which has at this point in time are not material in the context of our backlog. But we expect them to grow significantly in the future.

Okay.

Let me refer to what you asked about the land business. You're absolutely right, we're going to see a growing demand for land systems and products both in Israel and outside of Israel. So yes, we do anticipate to see these high numbers also in the futures.

Okay. Thank you. And about Electro-Optics, it still looks not so good if I compare it to the rest of the sector or the segments.

I would like to explain here something regarding the Electro-Optics. The Electro-Optics numbers here that are presented, for example, the $223 million for 2006, they include direct and adoptive sales to customers. However, I would like to give some clarification there, in some of the other areas of operation like, especially in the land systems but to some extent also the airborne systems, they include Electro-Optics products and subsystems that are sold by the airborne systems and categorized as airborne systems, of course, or land systems. So the accepted volume of our Electro-Optics business in the group is higher than the 223, and it is not diminishing. It is actually steady and growing.

Okay. Thank you very much. Another question about can you -- about Ilan Pacholder that is moving to Tadiran Communications to replace Nehemia Shiff. Is this the beginning of a new era at Tadiran Communications? Do you expect that because of this replacement, the bond between -- the connection between Elbit Systems and Tadiran Communications will be more tight?

What I can say -- I am the Chairman of Tadiran Communications -- and I can say that the relationships now between Tadiran and Elbit are relatively good. For us it was very important to look for a good, strong CFO for this Company. I am happy that committee we assigned on the (indiscernible) Board to look for a CFO to replace Nehemia Shiff, they found Ilan as the best CFO they could find in Israel.

So we, I would say, are not happy to let him go from Elbit, but we are very happy that he is staying within the group, and he will contribute also in addition to all the channels that he has in Tadiran also to include directly between the two companies, I would be very happy to see that. But this is not his major goal. His major goal is to enhance the portfolio of the Company, but yes, by knowing both Tadiran and Elbit, it will be very helpful.

(OPERATOR INSTRUCTIONS). [Renard Manor], [Yahad Bank].

Thank you. I would like to know about digital land army projects to the IDF. If you can give us some indication about the scale of this project and how much of it appears already in your backlog and some if you can relate to its profitability and maybe to the extent of exporting this technology to your export markets?

Yes, the digital army program is one of the biggest programs we ever had -- account for multi hundred million dollars. In the backlog we have quoted only slightly higher than $100 million, so still we have less forward-looking. We cannot tell the exact profit of this program, but this program is profitable. But the big advantage we have is the lessons learned using this program already in the idea that we see many requirements worldwide utilizing -- it is not the whole program but many derivatives of that, and we have already [seen a constant] using that technology outside of Israel. So we see this line of business very, very promising for our future.

Thank you and congratulations for your strong numbers.

Amir Avivi, Poalim Sahar.

The last question is about when do you expect that Elisra will be operating balanced? Can you give us the target or when do you think it will happen?

As you are probably aware and as we have said in the past after we bought the 70% equity in Elisra, we worked with management and employees and with our partners there to streamline the operations, and right now we have an operation working as a one company, one CFO, one CEO and one COO. A strong business, strong new business [we'll receive] during this year and during 2006, and we have worked with the Company to improve its efficiencies and profitability.

By the end of 2006, we still have in front of us some challenges. In the numbers by the end of 2006, you will see that. 2007 will be a year with some additional significant efforts to work with the Company and the management particularly to co-locate operations, and we're looking forward so that by the end of 2007 and hopefully by the beginning of 2008 we are going to bring this good technological company to a level close to the performance of the whole group.

At the end of 2007 and at the beginning of 2008, you expect it to be balanced. Is that what you are saying?

Balanced or more.

Or more? Okay. 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 US please call 1-888-254-7270. In the UK please call 0-800-917-4256. In Israel please call 03-925-5942. Internationally call 972-3-92-55-942.

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

Yes, I would like to thank all of our employees for their hard work this past year and you, our shareholders, for your continued support. Thank you for joining us today, and I hope to see all of you in our first-quarter 2007 conference call.

Mr. Ackerman, excuse me, we have an additional question. Would you like to take it?

Yes.

[Ella Freed], [Friznole].

I would like to congratulate you on the impressive growth. The two questions are, as we talk, I see a headline saying that Elbit intends to participate in privatization of the Israeli military industry. We know that Elbit enjoys very strong growth and very strong cash flow, but the profit margin is relatively low. Don't you think this kind of acquisition might create further pressure on the improvement of the profit margin for another two or three years?

Let me start with referring to Elbit's long-term strategy. We always say, when the Israeli government will take the state-owned industry private, Elbit will take a role in this exercise. It did not happen yet, but when this will happen, certainly we will be part of that. But we will make sure that this acquisition will be accretive in the first year.

So we have not even started to look into the numbers, but totally agree to what is reflected in your question. We will have to make sure that this acquisition will be accretive in the full-time, and I expect this is going to happen when the Israeli government will sell their companies. So this is part of our strategy, but I don't see this happening in the full future unfortunately.

I have another -- one more question, if I may. Regarding the backlog, the backlog refers to the end of 2006, and we're now two and a half months later. Did it improve significantly during the period or regarding this year, or it was more or less the same page that we saw at the end of -- because we had selling some of the orders were finalized, actually the closure was after the end of 2006. So does it fully reflect the growth of the backlog for the current year?

Let me try to give you the answer in that way. I don't expect the backlog of 2007. Secondly, I don't expect that to be lower than the current backlog that you saw in our books.

Okay. But can it be better?

Sure. There are many opportunities that we are currently pursuing. What I can say that I don't expect this to be lower than. Certainly we are working very hard --- it will be higher then.

But by saying that, also to add one more point. Especially in the United States, we are recording our backlog [on these] projects which are fully funded, which is in most cases is one year time period. In addition, we have what we call soft backlog, which accounts for more than $1 billion additional backlog to the numbers that you see in our books.

In Tadiran's cash flow, we learned that it is becoming more common kind of short cycle orders in the military industry. Do you feel this as well at Elbit?

Yes, we are. Yes, we are. This trend we see especially when our system is required in the (indiscernible).

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

Yes, we want to thank all of you for joining us today, and I hope to see you all in our first-quarter 2007 conference call. Thank you and good-bye.

Thank you. This concludes the Elbit Systems LTD fourth-quarter 2006 results conference call. Thank you for your participation. You may go ahead and disconnect.