Elbit Systems Ltd (ESLT) 2009 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Elbit Systems Ltd. third quarter 2009 results conference call. All participants are at present in listen-only mode. Following management's formal presentation, instructions will be given for the question-and-answer session.

(Operator Instructions)

As a reminder, this conference is being recorded, November 18, 2009. If you have not received a copy of today's press release and would like to do, please call Gelbart Kahana Investor Relations at 1-866-704-6710, or 9723-607-4717. I would now like to hand over the call to Mr. Ehud Helft of GK Investor Relations. Ehud, please go ahead.

Thank you, Operator, and good day, everybody. I would like to thank Elbit management for hosting this call. Joining us today are Mr. Joseph Ackerman, President and CEO, and Mr. Joseph Gaspar, the Chief Financial Officer.

We will begin with a summary of the financial results, followed by a more general discussion of Elbit's overall strategy. We will then turn over the call to the question-and-answer session. Before we begin, I'd like to point out that the Safe Harbor statement in the Company's press release issued earlier today also refers to the content of this conference call, and, with that, I would like now to had over the call to Joseph. Joseph, please.

Thank you, Ehud. Hello, everyone, and thank you for joining us today. Our third quarter of 2009 continues the long trend of progress, with growth, profitability and cash generation. You can find all the detailed figures for the quarter in the press release we issued today, which is also available on our website. Excuse me. I will highlight and discuss some of the key figures and trends.

Our third quarter 2009 revenues were $732.5 million, growing over 9% year-over-year. Our growth was mostly all organic. During the past four quarters, we acquired relatively small companies, with no material revenues. However, we do benefit from their technologies, market access and synergies between them and our other operating entities.

In terms of revenue breakdown, airborne systems was 23%, armored vehicles was 18%, C4ISR was 39%, electro-optics, 16% and the rest was 4%. The growth in the electro-optics area was the result of increased sales of night vision equipment. On a geographic basis, our revenue breakdown for the quarter was as follows. The United States, 29% of revenues, Europe, 27%, Israel, 23%, and the rest of the world was 21%.

To be clear, we do not see the quarterly fluctuations in our revenue breakdown as indicative of any long-term trends. With regard to our gross margin, the third quarter, our gross margin was 29.7%, the same as last year. I'd like to point out that while not fully visible, as margins during the quarter are similar to the last year's level, in the third quarter last year, we had a number of short turnaround and high-margin projects, which we did not have in the third quarter of this year. In addition, the weakness of the dollar actually had a negative impact on our gross margin.

Operating income in the quarter was $65.7 million, and 9% margin, and was affected by the weaker dollar, as well as the increasing marketing, sales and R&D expenses on both an absolute and percentage basis. Operating income in the third quarter of last year was $78.3 million, or 11.7% margin.

In terms of operating expenses, our net R&D expenses for the quarter grew 7.6% of our revenues, compared to 6.7% last year. This increase is a result of increased spending on R&D and projects in order to enhance our competitive position.

Marketing and sales expenses were 9.2% of our revenues in the quarter, compared to 7.5% in the third quarter of last year and was primarily due to our focus on pursuing opportunities in new areas and markets. Our G&A expenses were 3.9% of revenues, same as in the third quarter of last year.

This reflects a continued focus on lean and efficient management operation of the Company. Before continuing, I would like to take a moment to share with you a certain macro trend that is becoming increasingly prevalent in our business environment. While we continue to have many business opportunities, customers now require more seeing and evaluating and essentially a finished product adapted to their specific requirements before they are willing to commit for procurement.

At the same time, while delivery dates stay firm, this requires a shorter production and delivery time. As a result, we are incurring higher marketing and R&D expenses prior to receiving firm orders, which caused our R&D and sales and marketing expenses to increase. However, after receiving the order, we usually enjoy low risk and possibly improved margins. This trend has effects on additional financial parameters, such as lower advances, lower inventory and backlog.

Overall, we have been able to adjust to these trends and we believe that we have strengthened our competitive position by being able to bring to the market more final and field-proven products, as required by our customers. As I said, our operating expenses were also increased due to the weak dollar in the quarter, which increased the dollar cost of our shekel expenses in Israel.

However, we do hedge our exposure and thus recorded much lower than usual financial expenses due to an income primarily due to our US-dollar shekel hedge. Subsequently, during the quarter we had a financial expense of $0.6 million, compared to a financial expense of $16.1 million in the third quarter of last year, which included the impact of writeoffs related to auction rate securities last year in the amount of $6 million. The affiliates, which we do not consolidate, performed well, contributing $6.2 million to the net income in the quarter. This is compared to $2.1 million last year.

Starting from the first quarter of 2009, we implemented the SFAS 160. Thus, consolidated net income is reported, before eliminating net income or loss attributable to the non-controlling interest. Consolidated net income for the quarter grew 24.3%, reaching $59.6 million, or 8.1% of revenues, compared to $48 million, or 7.1% of revenues. We had a $1.4 million minority share in the profit of subsidiaries in the quarter, compared to $12.4 million last year. It's important to note that at the beginning of the second quarter of this year, we purchased the remaining 49% shares of Kinetics to complete 100% ownership of this company.

As a result, we now fully consolidate Kinetics' results and therefore we have seen a material year-over-year reduction in the minority line. Net income in the third quarter of 2009 attributable to the Company's shareholders increased by 63.7% to $58.3 million, or 8% of revenues. This is compared to $35.6 million, or 5.3% of revenues, last year.

Diluted net earnings per share for the third quarter of 2009 attributable to the holders of the Company's ordinary shares was $1.35, compared to $0.83 last year. Backlog as of September 30, 2009, was $5 billion, with 57% of the backlog scheduled to be performed during the remainder of 2009 and 2010.

Operating cash flow during the quarter was $127 million, compared to $112.9 million in the third quarter of 2008. Finally, the Board of Directors declared the dividend of $0.36 per share for the third quarter of 2009. That ends my summary, and I shall now turn over the call to Mr. Joseph Ackerman.

Thank you, Joseph, and hello to everybody. I would like to apologize and ask Joseph to talk on my behalf this time, as I have lost my voice, as you can hear. I am here on the call, and if required I will be available to answer any questions that will be addressed to me at the end. So back to you, Joseph.

Thank you, Joseph. As you can see, our third quarter of 2009 was yet another strong quarter and we are well on the way to another year of record profit and growth. We are also particularly pleased with our proven ability to quickly adapt to changes in the market. I discussed a few minutes ago how we have been able to adjust to the evolving trends in the defense industry without needing to compromise our overall profitability and continue to improve our market position.

Over the past few years, our efforts and investments were based on our analysis of the direction of the global defense industry. In particular, we foresaw a move to digitization of battlefields and we developed, built and integrated world's leading C4ISR systems.

In October, and as widely reported in the Israeli news, the IDF operated its fully operational pilot run of their DAP system supplied by us with stunning results. The DAP, the Digital Army Program, links all echelons of the army, from small infantry squads up to the division level into a unified and secure network.

All land forces operations, including command, control and communications, are highly integrated and interface down to the single soldier level, operating new and advanced applications. In the recent pilot run, as the touch of a handheld screen, commanders down to individual soldiers were able to view the exact location of all army assets, as well as enemy locations and movements, based on data collected from UAVs and other intel sources.

As new scenarios occurred, data was distributed widely to commanders, were fully coordinated and able to make immediate adjustments and decisions, as necessary. The pilot proved that the DAP substantially enhances the ongoing operations of the army and was a resounding success. The target is that the DAP will be deployed throughout the IDF by 2011.

The adoption of the DAP by the IDF brought a lot of interest by other potential customers and we are currently in discussions with a number of them around the world that are keen to deploy our solution and we believe that this has a great potential to generate more business for Elbit in the future.

Acquisitions remain another important element of our growth strategy. In July, we signed an agreement for the purchase of all of BVR Systems' assets for $34 million. BVR is engaged in the area of training, simulation and building systems for air, sea and ground forces. Closing is expected shortly.

In September, we converted an $18 million loan to Mikal to a 19% equity stake with an option to purchase the remainder by 2011. Mikal has three main subsidiaries, an artillery developer, Soltam Systems, an armored vehicle firm, Symar, and an electro-optics company, ITL Optronics.

These acquisitions, following two acquisitions in the second quarter of this year, remain a critical part of our longer-term strategy of complementary growth through M&A of companies which can add significant value through harvesting of synergies over the above sum of its parts. We are currently evaluating a number of small and medium-size acquisition opportunities and we see hope to be able to conclude in the coming months the closing of these acquisitions.

Our aim through these acquisitions is to unlock additional value and further strengthen our position as a global leader by enhancing our product portfolio and customer base. Time and again over past years, we have proven that we can very successfully integrate new companies into the Elbit family.

In summary, this was a good quarter and a good year so far, despite the challenging macroeconomic environment we all witnessed in the world. Thanks to our investments for securing our continued growth, we believe that 2010 will even be a better year for Elbit. With that, I would like to now open the call for questions and answers. Operator?

(Operator Instructions).

The first question is from Tom Erlich of RBC Capital Markets. Please go ahead.

Hi, guys. Thanks for taking my questions here. I have a few of them. The first one regards your prepared remarks. You're saying that the next year could be even a better year for Elbit. I was wondering what sort of growth rates should we expect.

When you look at other companies that are bigger than you and not as focused on the growing parts like electronics, you get to see something around mid single digits. Is it reasonable to say Elbit can outpace the big guys next year?

Well, as you know, and I apologize for that, we don't give guidance, but we are pretty sure, based on our backlog and based on what we see for the future that we continue to grow our company also in 2010, but we cannot indicate the right figure.

Okay. Thanks. And maybe another question regarding your competitive position, as the dynamics of the order cycle change and you guys obviously have a lot of flexibility, how is the better competitive positioning demonstrated? Has your win rate gone up? Do you think your win rate is going up? How should we think of that?

Well, exactly this kind of flexibility allows me to tell you that I am pretty confident that we continue to grow the Company. As you say, we do know our competitors and I believe that this change in the marketplace gives us an advantage.

Okay, very well. And maybe a last one before I hop into the queue. Could you quantify for us perhaps the impact of foreign exchange on your operating and gross margins, so we can have a better view of the normalized operating margin for Elbit, absent of foreign exchange impact?

Well, as you know, our cost basis is strongly affected by the shekel on one hand. On the other hand, material cost is usually US dollars. We are hedging our exposure for the shekel versus the dollar. We of course prefer a stronger US dollar versus the shekel, but I think that so far the Company was successful in mitigating the changes in the foreign exchange to keep the bottom line at the right numbers.

Okay, guys. Thanks a lot, good luck going forward, and Joseph I hope you feel better. Thanks.

Thank you.

The next question is from Roni Biron of UBS. Please go ahead.

Hi, guys. Could you please repeat the revenue mix by product and then, regarding your profitability, do you see a further room for margin expansion and, if so, where should it come from?

The revenues by product lines were airborne systems, 23% of revenues, armored vehicles, 18%, C4ISR, 39%, electro-optics, 16%, and the rest, 4%. What was the second part of the question?

On further room -- if you see any further room for margin expansion from these levels and if so, if you can try to pinpoint where exactly should it come from?

I think what we have seen during the recent several years, our gross margin moved from the 26%, 27% range and we just reported this quarter 29.7% gross profit. I think that was due to significant and successful improvement in our operations -- in the successful integration of the various acquisitions that we had over the years and building the synergy in the Company. As you know, we never say that's enough. We definitely are looking for improvement in the future, operational and otherwise, but at this point in time, as we don't give guidance, I'm sorry to just stay with that.

Okay, thank you very much.

The next question is from [Meir Payd] of [Nye Systems]. Please go ahead.

Hey, guys. I would like to know what is the revenue recognition policy in regarding to buyback or offset obligation in contracts? Do you recognize 100% or you do some other revenue recognition issue?

Well the commitments that we have in our contracts for offset are part of -- are reflected, like any other commitments that we have versus our competitors, and we definitely take that into consideration when we recognize revenue, and definitely when we recognize other commitments, which are not only revenue, in the contracts, working with the customers.

So they are usually defined as specific contracts, and the revenue recognition takes that into account, like any other thing. Specifics, if you would like to have, I would be happy to sit with you and explain you how we do that.

Okay, thanks.

(Operator Instructions)

The next question is from Avshalom Shimei of HSBC. Please go ahead.

Thank you. I just wanted to know if we can get a little bit more color on the fact that you've been saying for the past two or three quarters that clients have been taking more time now to take decisions regarding their, of course, buying decisions and choosing the right platforms for them as a deployment, et cetera. I'm just wondering, can you a little bit elaborate if that change is something that you see going forward to sustain, or you think it's just a matter of the budget changes that we've been seeing in the last year. What do you think about that?

I think this is basically going to stay for a while, and we are well prepared for that. It gives us the time to take advantage of the vast portfolio that we have and come up the customer with already developed solutions.

This is what we'll continue to do. In order to do that, we allocated more money for research and development and ready to be produced as we get the order. And, as I mentioned before, we see this as an advantage for a company like us.

Okay, thanks.

The next question is from [Richard Gessau] of Deutsche Bank. Please go ahead.

Yes. Hi, gentlemen. I just wanted to check and you had given some guidance of double-digit revenue growth for 2009. I wanted to see if you still stand by that, and the second question has to do with the geopolitical issues that have been making the news lately, specifically regarding Turkey, what kind of impact do you see from that, if any?

Yes, we did plan for a two-digit growth for this year. I'm still holding this as our plan, and if for whatever reason we won't meet it, we'll be close to that. As for your second question, yes, there is some issues within the diplomacy between our two countries, but business-wise, still Turkey is an important customer for us, and although the size of the business that we had in the last year is not significant for our company, the customer is important and we haven't seen any impact whatsoever on our ability to perform business in this area.

Okay, thank you very much.

The next question is from [Etan Etz] of [Halman Aldubi].

Good afternoon. I am looking at your backlog. I see that it's actually down from the end of '08, so that seems inconsistent with your expectation of 2010 being higher than 2009. Can you please explain?

What we said is that 2010 will be a better year, many parameters, and we still believe that that is the case. Regarding the backlog, as said, the environment, the business environment, I believe we explain the dynamics of it and in our case there are many opportunities which are significant in volume and, as we have seen last year, in the third quarter, just by moving one contract by two weeks, it did fall in one quarter versus the other question. Last year, we had a contract of close to $200 million from Brazil as the (inaudible - background noise) and therefore small changes in the timing of the order arrival, while we closed on a fixed base the backlog numbers, this can have fluctuations.

We still believe that the business is there, the opportunities are there, there is a lot of demand for our products and systems, and from point of view of volume of opportunities and point of view of number of leads, we feel the strong request for our products.

So you're saying you had some contracts closed just after the September 30th, so that's one of the reasons for the decline?

No, I said that that is the case last year, and it always happens from time to time.

I'm still unclear how you can expect a better year with a lower backlog.

I'm not sure. Could you clarify your question, please?

Well, if you have a lower backlog, that means you have less orders to perform next year, right? Obviously it also goes into further years, but if you have a lower backlog, you have less expected revenue, right? So how is that consistent with your expectation that you will have higher revenue in 2010.

The revenues of a specific year, like next year, are comprised of orders that you have in the backlog and orders that you are going to receive and still be able to transform them in revenues during that year. As we have explained earlier, there's quite a lot of dynamics in the backlog, and if the cycle, the repeat cycle, is quicker, then you have a better chance of achieving those improved revenues.

Thank you very much.

All right.

There are no further questions at this time. Before I'd ask Mr. Ackerman to go ahead with his closing statement, I'd like to remind participants that a replay of this call will be available two hours after the conference ends. In the US, please call 1-888-326-9310. In Israel, please call 03-925-5900 and internationally please call 9723-925-5900. Mr. Ackerman, would you like to make a concluding statement?

Yes, I would like to thank all of you for joining us today, and I'm looking forward to speaking with you in our next quarter conference. Have a good day, and goodbye.

Thank you. This concludes the Elbit Systems Ltd. third quarter 2009 results conference call. Thank you for your participation. You may go ahead and disconnect.