Elbit Systems Ltd (ESLT) 2018 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems Second Quarter 2018 Results Conference Call. (Operator Instructions)

As a reminder, this conference is being recorded. You should have all received by now the company's press release. If you have not received it, please contact Elbit's Investor Relations team at GK Investor and Public Relations at 1 (646) 688-3559, or view it in the News section of the company's website, www.elbitsystems.com.

I would now like to hand over the call to Mr. Kenny Green of GK Investor Relations. Kenny, please go ahead.

Thank you very much. Thank you, and good day to everyone. On behalf of all the investors, I would like to thank Elbit Systems' management for hosting this call. Joining us on the call today are Mr. Bezhalel Butzi Machlis, Elbit's President and CEO; and Mr. Yossi Gaspar, Elbit Systems' Chief Financial Officer. Yossi will begin by providing a discussion of the financial results for the second quarter of 2018, followed by Butzi, who will talk about some of the significant events during the quarter and beyond. We will then turn over the call to the question-and-answer session.

Before we begin, I would like to point out the safe harbor statement in the company's press release issued earlier today also refers to the contents of this conference call. And with that, I would now like to hand the call over to Yossi. Yossi, please go ahead.

Thank you, Kenny. Hello, everyone, and thank you for joining us today. As we do every quarter, we will provide you with both our regular GAAP financial data as well as certain supplemental non-GAAP information. You can find all the detailed GAAP financial data as well as the non-GAAP information and the reconciliation in today's press release.

This quarter, we saw solid year-over-year revenue growth as well as good generation of cash. There are a number of onetime aspects which affected our results this quarter, which I will walk through in my summary.

I will now highlight and discuss some of the key figures and trends in our financial results. Our second quarter 2018 revenues were $892 million compared with $818 million reported in the second quarter of 2017, up 9% year-over-year. The growth was driven by sales from our growing backlog as well as the addition of revenues from our acquisition of Universal Avionics Systems in the United States on April 11, which we consolidated for the first time in the second quarter.

In terms of revenue breakdown across our areas of operation in the quarter, airborne systems was 41%, C4ISR was 32%, land systems was 16%, electro-optics was 8%, and the rest was 3%.

Compared with the second quarter of last year, airborne systems made up a larger portion of our sales, due to increased sales of these systems in the U.S. and Europe, while there were lower sales of electro-optics systems and a slight decrease in C4ISR sales.

In terms of geographic breakdown for the quarter, North America was 28% of our revenues; Europe at 18%; Israel, 19%; Asia Pacific, 21%; Latin America, 6%; and the rest of the world was 8%. North America increased partially due to the acquisition of Universal. APAC also increased, while there was slight decrease in Europe.

For the second quarter, the non-GAAP gross margin was 28.6% versus 30.4% last year. Our GAAP gross margin was 28% in the quarter versus 29.6% last year. Our gross margin was affected by mix of projects sold in the quarter as well as by a less favorable exchange rate environment. The second quarter non-GAAP operating income declined to $73.1 million, or 8.2% of revenues compared with $82.7 million, or 10.1% of revenues last year.

GAAP operating income in the quarter increased to $111.8 million or 12.5% of revenues compared with $75.3 million or 9.2% of revenues last year. In terms of our GAAP operating expenses for the quarter, total operating expenses were 15.5% of revenues compared with 20.4% of revenues in the second quarter of last year. The GAAP operating expenses included other income of approximately $45.4 million, which we do not include in our non-GAAP results. This was due to 2 capital gains from the reevaluation of investments made by outside investors in 2 of our commercial venture subsidiaries, Cyberbit and Beyeonics. The primary contribution was the capital gain at Cyberbit, following a $30 million investment from Claridge Israel.

The operating expense breakdown in the quarter was as follows: net R&D expenses were 8.6% of revenues versus 8.2% last year. The increase partially due to lower participation of externally funded R&D; marketing and selling expenses were 7.8% of revenues versus 8.1% last year; and G&A expenses were 4.2% of revenues versus 4.1% last year. I note the operating expenses also fully consolidate those of Universal Avionics for the first time.

Financial expenses for the second quarter of 2018 were $10.7 million compared with financial expenses of $6.8 million in second quarter of last year. The increase was mainly due to higher debt level and increased interest rates. Other income includes a $5.1 million adjustment to the fair value of our investment in one of our Israeli subsidiaries.

Taxes in the second quarter were $7.3 million or 7.6% of pretax income versus $10.3 million or 15.1% of pretax income in the second quarter of last year. For the second quarter, non-GAAP net income was $57.5 million or a net margin of 6.5% versus $68.8 million or a net margin of 8.4% last year. Non-GAAP diluted net earnings per share were $1.35 compared with $1.61 last year.

On a GAAP basis, second quarter consolidated net income was $91.9 million or a net margin of 10.3% versus $63 million or a net margin of 7.6% last year. GAAP diluted earnings per share were $2.12 compared with $1.46 last year.

Our backlog of orders as of June 30, 2018, was $8,065,000,000, $736 million higher than the backlog at the end of the second quarter of 2017, representing an increase of 10%. Approximately, 55% of the current backlog is scheduled to be performed during 2018 and 2019, and 45% of the current backlog is scheduled to be performed for 2020 and beyond. The ratio is similar to that at the same time last year. Operating cash flow for the quarter was a positive of $146.7 million compared with a positive cash flow of $54 million at the same quarter last year.

In the first 6 months of 2018, the cash flow was just below breakeven. The Board of Directors declared the dividend of $0.44 per share for the second quarter of 2018.

That ends my summary, and I shall now turn over the call to Mr. Machlis, Elbit's CEO. Butzi, please.

Thank you, Yossi. Elbit Systems again demonstrated another quarter of profitable growth, while continuing to increase the backlog. I would like to take a few minutes to look at an element of our broader strategy.

Our long-term growth and development has always been built on both investing in our businesses and growing it on an organic basis, while at the same time acquiring and adding synergetic businesses to our organization. As you know, at the start of the second quarter in April, we completed the acquisition of Universal Avionics in the U.S. for approximately $120 million. Universal develops commercial avionics systems for the retrofit and forward-fit market, including flight management systems, displays, communication systems, complete cockpit solutions and additional advanced commercial avionics systems. We see these products as complementary to our existing commercial avionics systems, our Enhanced Flight Vision System and our commercial Head-up Display product line.

We believe that the newly combined portfolio creates synergies that would strengthen our competitive position in the commercial avionics market. I also want to highlight that while Elbit is primarily an electronic defense company, mainly -- many of our technologies have significant commercial potential beyond the purely military. It has been our strategy for many years to look at relevant technologies for the commercial realm, and we open partner with strategic investors to aid in the development of our commercial businesses.

This quarter, as Yossi mentioned, we saw 2 capital gains amounting to $44 million from follow-on external investment rounds in some of our commercial ventures. The largest portion of which was from our holding in Cyberbit in the commercial cybersecurity space.

We have been very much encouraged by the technological and business achievement of Cyberbit in recent years, and the company has made much progress. In June, Claridge Israel partnered with us by investing $30 million in Cyberbit, which will provide the company with increased funding and know-how to expand sales and marketing, primarily in North America, boost product development and enhance its customer and partner support. This is in line with our strategy to bring outside strategic partners whenever we see opportunities in developing commercial applications.

We are optimistic that Cyberbit will further develop its commercial businesses for years to come and creates further value for Elbit Systems' shareholders. Also, a few days later, Beyeonics, our subsidiary that develops innovative surgeon-centered visualization technologies, raised $11.5 million from other outside investors. Both these successful investment rounds increased shareholder value at the subsidiaries and ultimately to Elbit Systems shareholders, attesting to the commercial potential of our technologies and the success of this strategy.

Finally, as you know, also in the M&A realm, we are looking to close the acquisition of Israeli Military Industries (sic) [Israel Military Industries] in the coming months, and we are working hard towards this goal. As I already mentioned last quarter, we believe there are many potential synergies between IMI and Elbit, and IMI will bring us access to new market and product, and we can leverage our existing business platform. We hope to bring you an update on this in the coming months.

On an organic basis, our core business continues to perform well. We recently announced 2 electronic warfare system orders. The most recent one was an $85 million award to supply the Israeli Navy with EW suites after successfully completing intensive sea trials. We were also awarded a $17 million contract from a European country to supply a range of advanced ground-based electronic warfare and signal intelligence systems.

The increasing demand for our solutions are clear indications of the growing operational importance of advanced and combat-proven capabilities that Elbit has in all domains of operation and engagement, maritime and in air. Over many years, Elbit has proven over and again that we can build our business successfully on both an organic basis as well as acquiring and assimilating new organizations and technologies successfully into the Elbit family. We'll continue to do so over the coming quarters and years.

I will now be happy to take your questions. Operator, please.

(Operator Instructions) The first question is from Yoav Burgan of Poalim Sahar.

Couple of questions for me. The first one, looking at your top line, so obviously, you are unwilling to quantify the different contributors to this quarter's abnormal growth. But still, if I'm trying to fully understand, on the one hand, we have the adoption of the ASC 606 standard, and on the other hand, we have the first time that Universal Avionics is consolidated. And I think there was also -- I assumed at least, there was also a bit of strengthening of the U.S. dollar. So Yossi, could you provide some color, I mean, on the magnitude of the impact of these -- of what's been going on?

Well, I'd say the following. The addition of Universal revenues to our results was definitely positive, but it is relatively minor. So it did contribute several tens of millions, but in the very low tens of millions, what -- this is Universal. The 606, I would say, the more we are getting away from the beginning of the year, we see less and less of contribution related directly to that element. And somewhere towards the end of the year and maybe in the first half of next year, it will diminish in total. So we do not quantify that, but it was less of, percentage-wise, an addition compared to the first quarter. All the rest, I would say, was definitely organic growth, pure organic growth, even compared to previous years and based on the backlog. I would say, the change in the currency does affect to some extent, but it is not material element.

Okay. So if -- and this leads to my second question. Looking at your profit margin, looking at your non-GAAP gross margin and your non-GAAP operating margin, it seems they have come out a bit low this quarter and actually in the previous quarter. And I was actually expecting them to be a bit stronger, mainly due to the strengthening of the dollar. So Yossi, could you provide color on this as well?

Yes, I would say -- regarding the currency, I would say the following: first of all, the dollar really strengthened more significantly in the first quarter. Second quarter was still not that material, the change, so that is one thing. Regarding the overall margin, I'd say that we have a mix of programs sold in this quarter and last quarter, actually, which are, I would say, at a lower profitability. As you might know, programs requiring higher engineering content are sometimes lower in margins than programs -- pure production programs. So it's a mix of things that on average, over the years, over the quarters, in the year, will probably come out more or less as we have seen in the past, but it is very dependent on the actual revenues recognized in the specific quarter.

Okay. But on a longer-term perspective, you are still confident that you can still reach or stay at your objectives of around plus, minus 30% non-GAAP gross margin and 10% non-GAAP operating margin, correct?

These are definitely the goals. As to the timescale at which we will reach that, I am a little bit hesitant now to give you more detail.

But if I can add, I would like to say that there are many activities we do in the company to make sure that we'll achieve these goals. We are combining business units together. And we just recently centralized the entire acquisition infrastructure of the company we are acquiring right now as one group. We are investing in new ERP system, which should come -- which should go live mid next year. These activities together with other, of course, the main rationale behind them is to support achieving the goals, which were mentioned by you.

The next question is from Michael Klahr of Citibank.

Just related to the legal costs related to the U.S. investigation, actually in the first half, there's a big pickup on what was the -- in the full year 2017. Do you expect the current rate of expense continue during the rest of the year or at least until there's some conclusion to that? Can you comment on those expenses?

You were referring, Michael, to what? To the G&A expenses? Michael? Hello?

Michael, we didn't hear you. Could you repeat?

Ladies and gentlemen, it seems the questioner has disconnected. (Operator Instructions) The next question is from Ella Fried of Bank Leumi.

I have 2 questions. Regarding the prospect in terms of geographies and development, of course, we all expect the merger, but even before, you mentioned that U.K. appears to be prospect, and you identify that is a very prospective market. And I saw that the Asia Pacific grew -- region grew in the recent quarter. So could you give us some color on this trend in terms of geographies and product mix, if possible, and especially U.K.?

We -- as you all know, the increase in defense spending in Europe, the demand to reach a spend of 2% of GDP, and we see growing demand all over the continent. We have subsidiaries in Europe as we have in the U.S. By the way, we see the same trend in the U.S. as well. We see increasing defense spending in the U.S. as well, and we see many more opportunities in the U.S. as well as in Europe in all different types of solutions, which include entire portfolio of the company. You mentioned U.K., U.K., certainly, we see a lot of potential in the U.K. We have hundreds of people in our subsidiaries in the U.K. We recently established Elbit Systems U.K., which includes -- which is [great] to the customer, which -- and we are combining all the activities we have under Elbit Systems U.K. And we see a lot of potential in the airborne domain, in the EW domain, in the C4I domain as well as in the land domain. So there are many opportunities for us in the U.K. But not only -- we see also a lot of interest in other countries as well, in Germany and in other places in Europe as well. So altogether, defense spending is growing, and we see opportunities for us in the U.S. We see opportunities for us in Europe, and also Far East, Asia Pacific is an important market for us. Just to remember, we have several contracts in Australia. We have a strong subsidiary in Australia. And not just Australia, also other countries in this region are showing more and more interest in our portfolio. So altogether, Asia Pacific, U.S. and Europe are spending more. We are well positioned there, and I'm optimistic that we'll be able to grow our backlog in the future.

Okay. And I would like to follow up on Yoav's question. Do you expect the profitability in the second half to be higher knowing the impact of the product mix that is expected in the second half?

Ella, as you know, we do not provide guidance but we are working hard to improve the present situation.

(Operator Instructions) There is a follow-up from Ella Fried of Bank Leumi.

May I -- another question. When do you expect the announcement of completing the acquisition of Israeli Military Industries (sic) [Israel Military Industries]? Is it -- we expected actually in the end of September the last time we heard your update, I think.

Ella, as you know, we completed our part, and right now, we are waiting for final approvals from the government. I believe that it's soon. And it's difficult for me to say a date, but I believe it's quite soon. I believe it will happen -- I believe that there are good chances it will happen soon, and for sure, this year.

(Operator Instructions) There are no further questions at this time. Before I ask Mr. Machlis to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available 2 hours after the conference ends. In the U.S., please call 1 (888) 782-4291. In Israel, please call 039-25-5929. And internationally, please call 9723-925-5929. A replay of the call will also be available on the company's website, www.elbitsystems.com. Mr. Machlis, would you like to make your concluding statement?

Well, I'd like to thank all our employees for their continued hard work. To everyone on the call, thank you for joining us today and for your continued support and interest in our company. Have a good day, and goodbye.

Thank you. This concludes the Elbit Systems Ltd. Second Quarter 2018 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.