Elbit Systems Ltd (ESLT) 2019 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems Second Quarter 2019 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. Ehud Helft of GK Investor Relations. Ehud, would you like to begin, please?

Thank you, operator, and good day, everybody. 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. 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 of the second quarter of 2019, 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 that the safe harbor statement in the company's press release issued earlier today also refers to the contents of this conference call.

With that, I would now like to hand over the call to Yossi. Yossi, please.

Thank you, Ehud. 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.

The second quarter of 2019 was a solid quarter with strong revenue growth across all our main business regions as well as continued growth in backlog. Elbit is now a company with revenue run rate of over $4 billion per year, and our backlog is close to $10 billion, giving us good visibility into the next year and beyond.

I will now highlight and discuss some of the key figures and trends in our financial results. Our second quarter 2019 revenues were $1.064 billion compared with $892 million as reported in the second quarter of 2018, up over 19% year-over-year. In terms of revenue breakdown across our areas of operation in the quarter, airborne systems was 39%; C4I systems, 24%; land systems, 25%; electro-optics was 9%; and the rest was 3%.

Compared with the second quarter of last year, we saw increased land systems revenue mainly due to our acquisition of IMI, and we had higher land and EW sales into Europe. There was a decrease in C4I revenue as we do not consolidate Cyberbit commercial revenues anymore.

In terms of geographic breakdown for the quarter, we continue to be fairly well diversified between the various regions in which we operate. North America was the largest at 28% of revenues, Asia Pacific at 25%, Israel at 22%, Europe at 18%, Latin America at 4% and the rest of the world at 3%.

Compared with the second quarter last year, we saw an increase in all our main regions. In North America, the growth was primarily due to increased airborne systems sales into the U.S. The growth in Israel was due to the acquisition of IMI at end of the last year. And Asia Pacific sales grew due to increased sales of UAS and weapon stations in the region.

For the second quarter, the non-GAAP gross margin was 27.7% compared to the second quarter of last year of 28.6%. The lower gross margin was primarily reflective of the lower gross margin at IMI. The second quarter non-GAAP operating income was $89.6 million or 8.4% of revenues compared with $73.2 million or 8.2% of revenues last year. I note that despite the lower gross margins, we managed to close the entire gap and even increased the operating margin compared with last year. This is a reflection of the hard work we had been doing integrating the IMI operations into our company and extracting some of the synergies already after only 2 quarters into the merger.

Second quarter GAAP operating income was $80.3 million versus $111.8 million last year. I note that in the second quarter 2018, our GAAP operating income included an income of $45.4 million due to an increase in the valuation of shares in 2 of our subsidiaries as a result of third parties' investments in Cyberbit and Beyeonics.

In terms of our GAAP operating expenses for the quarter, total operating expenses were 19.6% of revenues in the second quarter compared with 20.6% of revenues excluding the income from revaluation of assets last year. The operating expense breakdown in the quarter was as follows: net R&D expenses at 7.3% of revenues versus 8.6% last year; marketing and selling expenses at 6.9% of revenues versus 7.8% last year; and G&A expenses at 5.4% of revenues versus 4.2% last year, with the relative increase primarily due to our recent acquisitions.

Financial expenses for the second quarter of 2019 were $20.3 million compared with financial expenses of $10.7 million in the second quarter of last year. The higher level of financial expenses this quarter was due to the implementation of accounting standard ASC 842 relating to operating leases. In the quarter, this generated a noncash accounting expense of $5.2 million mainly due to the strengthening of the shekel currency.

In our GAAP result, we had other income of $1.6 million. This was due to a capital gain at our subsidiary BrightWay Vision, which amounted to $4.5 million, which amount was balanced by the adoption of the accounting standard ASU 2017-07 relating to nonservice cost component of pension plans.

For the second quarter, non-GAAP net income was $64.3 million or a net margin of 6% versus $61 million or a net margin of 6.8% for the second quarter last year. On a GAAP basis, second quarter net income was $53.8 million versus $91.9 million in the corresponding quarter last year.

Number of shares. I note that during the second quarter, Elbit Systems raised $185 million through the sale of treasury stocks to institutional investors in Israel, which increased our share count by about 3% to approximately 44 million shares. This had a slight corresponding impact on our earnings per share. Our non-GAAP diluted earnings per share were $1.46 compared with $1.43 in the second quarter last year. GAAP diluted earnings per share were $1.22 compared with $2.15 in the second quarter last year.

Our backlog of orders as of June 30, 2019, was $9.8 billion, $1.73 billion higher than the backlog at the end of the second quarter of 2018 and $397 million higher than that of the end of 2018. This represents over 21% increase in backlog year-over-year. Approximately 56% of the current backlog is scheduled to be performed during 2019 and 2020, and the remainder is scheduled for 2021 and beyond. The ratio is similar to that of the second quarter last year.

Operating cash flow for the quarter was a negative of $138 million compared with a positive cash flow of $147 million in the same quarter last year. I note that Elbit Systems also received cash from 2 sources this quarter, which is not part of the operating cash flow. One, which I mentioned earlier, was the $185 million due to the sale of shares to institutional investors. The second was a proceed from factoring of $345 million of the premises evacuation asset as part of the agreement for the acquisition of IMI. So overall, we were able to reduce our debt significantly. The Board of Directors declared a dividend of $0.44 per share for the second quarter of 2019.

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

Thank you, Yossi. We are very pleased with our second quarter results. We have good progress across

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Revenue was over 19% higher than in the second quarter last year, and Elbit is now a company generating more than $1 billion in sales every quarter. Furthermore, our backlog continues its trend of growth, which is a good sign for our long-term future.

As you know, in the past year, we completed 2 key acquisitions, and we are in the process of integrating the new businesses into Elbit. In particular, while it will take time to bring the margins of IMI up to where Elbit margin currently stand, we are already working on making improvements and looking to extract significant synergies within our new land division. However, we are pleased that despite the lower gross margins, we have been able to maintain our operating margins at a similar level to those of last year. Elbit also has decades of experience in successfully assimilating acquisitions and taking advantage over the synergies. We hope that in the coming months, we will complete the acquisition of Harris Night Vision businesses that we announced a few months ago. We believe it will be significant to our long-term growth strategy.

Turning to our ongoing businesses. Elbit continues to perform well, and we have won new businesses across all our main target regions. Just to highlight some of our recent wins, in North America, we won a $50 million 6-year contract for the supply of structural parts for an aircraft from composite materials. We also won a further $26 million contract from the United States Customs and Border Protection agency to install our Integrated Fixed Towers system on another segment of the U.S. Arizona-Mexico border. To date, we have won contracts covering a total of approximately 200 miles of the border.

In Europe, we received a 4-year $73 million contract to provide J-MUSIC Directed Infrared Counter Measure system for the German Air Forces' Airbus A400M aircraft. And in Asia Pacific, we were awarded a 3-year $80 million contract to upgrade tanks and supply radio systems for a South Asian army. Overall, we see ongoing demand for our solutions, which are a strong indication of the operational importance of advanced and combat-proven capabilities that we have in all domains of operational engagement, whether maritime, land and air.

In summary, looking at Elbit, as we advance through 2019, we are not only a leading high-technologically defense company, but we are becoming a company of more significant scale and more -- with many more -- and with many more growth opportunities ahead of us.

And with that, I would be happy to take your questions.

(Operator Instructions) The first question is from Pete Skibitski of Alembic Global.

Butzi and Yossi, congratulations on the first half adjusted margins. I'm sure that was a lot of hard work.

Thank you.

Thank you.

Let me start. First question, on the cash flow. And it was nice, I think, to get that premises evacuation money in early, and of course, you got the cash from the share sale like you mentioned. So the balance sheet looks like it'll be in great shape heading into 2020 especially if cash collections improve in the second half. And so that's my first question, is it looks like you had a receivables build in the second quarter, I'm guessing, maybe on some overseas customers. So I'm just wondering if you expect to collect a substantial portion of that receivable in the second half of the year. And just was wondering if you have a sense of where your free cash flow-to-net income conversion might end up on a full year basis.

Yes. We expect to collect most of that cash in the remaining of the year. If you look back on our performance 2, 3 or maybe more years, there were fluctuations in the cash receipts, and then towards the end of the year, we were able to catch up most of the cash, the remaining cash. So we expect that to happen this year as well and with that to keep a strong balance sheet.

Very good, very good. And a few -- 2 small questions on revenue. I guess the first one, your -- Yossi, your comments on Cyberbit Commercial not being consolidated anymore, was it consolidated in the second quarter of '18? I'm just wondering if we should adjust last year's revenue to account for this or I lost track.

Yes. The -- Cyberbit Commercial got a significant investment from third-party shareholders in the -- during the second quarter of last year. And then that means that we consolidated only part of Cyberbit Commercial last year in the second quarter, and part was already not consolidated. This second quarter this year or the whole second quarter did not include anything from Cyberbit Commercial.

Okay. Okay. So you had a bit of a top line headwind from that, it sounds like. And then was FX -- any meaningful headwind to revenue in the second quarter?

Excuse me? I didn't get you.

I'm sorry. Was the impact from the shekel -- did that have any meaningful impact to your revenue? Was that a revenue headwind for you in the second quarter?

It did have some impact but not very much. We have seen the impact mainly in the lease agreements, which most of them are in shekels. While we showed them on our P&L and balance sheet, we showed them in U.S. dollars. So they increased. The difference moved to a noncash item into our P&L finance expenses, but most of that was the impact. Other than that, not very much.

Okay. Okay. And then I'll ask one more, and then I'll get back in queue. Again, the excellent first half adjusted margins, how are you guys thinking about adjusted margins into the second half of the year? Because you did have margin expansion last year in the second half, and so I'm just wondering how you think things will shake out in the second half this year understanding some of the moving pieces.

I'm sorry, Pete, but we do not give guidance. However, said that, we continue to work very hard to improve our cost base, and we have seen that during the last several quarters getting better and better. Of course, if the local currency has also impact on that, on our overall performance, we are looking optimistic to the future, but things are still a long way to go.

(Operator Instructions) The next question is a follow-up question from Pete Skibitski from Alembic Global.

Okay. I'm back. Guys, there was a lot of concern in U.S. markets yesterday about the global macroeconomic backdrop and global growth. The market sold off quite a bit. I was just wondering, you guys are so geographically dispersed in terms of your revenue. So I'm just wondering, over the last few months, have you seen anything to indicate a deterioration in some of your customers from a geographic perspective? Do you see any incremental weakness out there geographically? Or do things roughly seem the same now as they did, call it, 6 months ago?

On the contrary, we see more demand for defense equipment and for defense electronics. We see more opportunities for us in the U.S. market, and we see a growing demand in Europe. Just to remind all of us that there is demand from NATO to spend 2% of GDP on defense, and many countries are still far away from doing it. And we have very good positions. We have several very good positions in Europe, in the U.K., in Germany, in the Netherlands, in other countries of the world, and with subsidiaries and with long good history. We see growing demand in all of these places. And the same is also happening in Australia and in Asia Pacific.

So altogether, we see growing demand, more opportunities. And I'm happy that we are able to capture part of it. And that's the reason for the growth in the backlog. I expect it to continue.

That's great, that's great. And the fact that they weren't able to form a government in Israel, and you've got the new elections in September, did that slow anything down in the second quarter in terms of order flow from the IMOD or revenue recognition? I'm just wondering if that had any impact at all on the second quarter or if you expect it to in the third quarter.

In Israel, we are working from the long term, very long-term program. So the -- some delays in a quarter will not really -- does not really change the picture. So of course, Israel is a very important customer for us, and we are waiting for after the new government will be established. And probably a different budget will be concluded here, and then a procurement plan will happen. And there are many good opportunities for us in the coming future.

That's great, that's great. I -- yes, I did want to ask about a couple of programs in particular. You guys got a lot of press this quarter about this -- I think it's pronounced the CARMEL, the CARMEL Future Armored Vehicle. And it looks like you have a lot of systems on the vehicle. I couldn't tell if you built the entire vehicle or more so the advanced systems on the vehicle. So I'm wondering if you could clarify that and then your sense of, do you expect to actually go into production on that in the near term or the midterm and if you think there's going to be export opportunities for that.

The CARMEL demonstrates our warfare systems, not for a vehicle. It's not for a new platform. We are not the platform manufacturer. We are -- our expertise is in systems and sensors and integration solutions into the AFV. As you know, we are a leading company in Israel as well as abroad, providing very advanced systems and solutions for the AFV market, and we are quite famous with our solutions. I'm quite proud of the good positions we have in many countries in new AFVs and new tanks as well as in upgrading existing platforms, Western and Eastern platforms. We're investing quite a lot bringing new innovation and new technology into our systems for the future.

And what we have presented here is new technologies for the AFV market, which includes autonomously -- autonomy; AI; drones, which are operated from the AFV; unique sensors, which are part of the AFV; different type of technologies coming from all over the groups -- from all of the group; and also a new concept to operating closed hatches with a new helmet, which enables the operator to work undercover, to see 360 degrees via a helmet which is delivered to you through our [airborne] helmet, and to operate all the sensors and the weapons via the helmet. We -- there is -- when many customers saw it, there was a lot of interest for the concepts and for the systems. And I'm proud to say that we have already some orders for part of the systems which we have presented. We continue to invest in this domain. It's a -- we are well positioned in this domain. And the IMI acquisition helps us here because it brings active protection systems to our new -- to our unmanned turrets, the IRON-FIST system, which -- that's an important area where we progress quite a lot as well.

So altogether, I am very proud of this CARMEL demonstration. And we get very good interest from different customers all over the world for the technologies.

That's great. That was very impressive. Very impressive. One last question for me programmatically. Could you give us some more color on -- I want to call it a new business model, I would say, for the Hermes 900, in which you had this contract, I think, with a Portuguese entity sort of via the EU Maritime Safety Agency. And I think ultimately, Iceland has been the first end user. From a -- it looks like essentially a leasing program over the Hermes 900 for maritime patrol to Iceland. And so I'm just wondering if you could give us a sense of how big this opportunity is. Do you expect to grow it and add more customers in this sort of different business model? It looks like maybe it's a different model for maybe customers that can't afford the cost of actually owning UAV. But I was wondering if you can describe kind of what's going on there.

It's not a new model for us. We are implementing the leasing model in different business segments in the company. One of them is simulators, for example, though we implement the PFI model here in Israel. And this concept of leasing UAVs is also new -- not new for us. Our subsidiary in the U.K., which won the Watchkeeper program in the U.K. together with Thales, leased already UAVs to the British forces in Afghanistan. So we continue with this model for other markets as well. You are right, we won a contract for the European agency. We did something similar with the UN forces in Africa as well.

So as you know, we have a very vertical portfolio in the area of UAV. We control the UAV turret, the communication, the command control, the electro-optics, all other sensors. So we are open to selling leases, and we are also open to lease and to operate -- to lease new UAVs to different customers all over the world. And this is, by the way, not relevant just for UAVs. It's also relevant for other type of groups for some business. So from additional businesses as well, I mentioned the simulators. We do something similar in the area of simulators here in Israel.

The next question is from David Fingold of Dynamic Funds.

Look, I'm happy to see that the L3-Harris merger provided you with an acquisition opportunity. And what I was going to ask was, there's other announced M&A in the defense space. And I wondered if you had any color on whether or not that could present other opportunities to buy businesses that might need to be disposed of for regulatory purposes or to improve the balance sheet of the companies that are merging.

I would say that our strategy includes acquisitions as well. We are well-known for good acquisitions we made in the past. Just to remind all of us, we acquired some companies here in Israel which were not in good shape, like Elisra and Soltam. And we assimilated them into Elbit in a very good way, and they are very profitable and successful today.

We believe in acquisitions as well as in organic growth, and we have a strong balance sheet to support it. And there are 3 main reasons for acquisitions. And so just to remind all of us, this year, it's going to be -- in the past 12 months, going to be the third acquisition we are doing, the Harris Night Vision. We acquired IMI, but not to forget that we acquired Universal Avionics solutions in the U.S. as well. There are 3 main reasons for acquisition for us. The first one is to enhance our portfolio. That was the main reason for the acquisition of IMI.

The second reason is to gain additional positions in strategic markets. And the third reason is it's the kind of R&D. It's to replace -- although we invest quite a lot in R&D, between 8% to 9% each -- in each quarter from our revenues, there are still a lot of innovation outside. And in some cases, we see fit to acquire small companies which have unique technologies, which are complementary to ours. So these 3 acquisition are -- these 3 reasons are still very relevant, and they are part of our strategy. As I mentioned earlier, we have a strong balance sheet. We can support the strategy for the future growth.

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) 326-9310. In Israel, please call 03-925-5925. And internationally, please call 972-3-925-5925. A replay of the call will also be available at the company's website, www.elbitsystems.com.

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

I would like to thank all our employees for their continued hard work. For 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 2019 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.