Elbit Systems Ltd (ESLT) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems Second Quarter 2020 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 that is available in the News section of the company's website, www.elbitsystems.com.

I would now like to hand over the call to Rami Myerson, Elbit Systems Investor Relations Director. Rami, please go ahead.

Thank you, Joni. Good day, everyone, and welcome to our second quarter 2020 earnings call. On the call with me today are Butzi Machlis, our President and CEO; and Yossi Gaspar, our Chief Financial Officer.

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. Yossi will begin by providing a discussion of the financial results, followed by Butzi, who will talk about some of the significant events during the quarter and beyond. We will then turn the call over to a question-and-answer session.

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

Thank you, Rami. Hello, everyone, and thank you for joining us today. The results of our second quarter reflects the resilience of Elbit Systems and the actions we are taking to address and mitigate the impact of the COVID-19 pandemic on our activities as we discussed in our earnings call for our first quarter results. Government directed safety measures, supply chain delays and travel restrictions continue to cause some disruptions to our business, including the ability to attend in person, except as inspections.

Our subsidiaries around the world has helped support these inspections where possible. We continue to monitor the situation closely and are adhering to the instructions of the governments of the various countries in which we operate. The extent of the impact of the COVID-19 on the company's performance will depend on future developments, including the duration and the spread of the pandemic, the measures adopted by governments to limit the spread of the pandemic and the resulting actions that may be taken by our customers and our supply chain.

Turning now to our results. As we do every quarter, we will provide you with both our regular GAAP financial data as well as certain supplemental non-GAAP information. We believe that this non-GAAP information provides additional detail to help understand the performance of the ongoing business. You can find all the detailed GAAP financial data as well as the non-GAAP information and the reconciliation in today's press release. Overall, we are satisfied with our performance in a challenging environment.

Revenues and backlog increased year-over-year, and slightly in comparison to the previous quarter. The improvements in profitability and cash flow reflect the increased focus on operations, including the cost control measures that we implemented to mitigate the financial impact of the COVID-19 pandemic.

Our backlog of $10.8 billion provides good visibility and reflects the long-term nature of our business. It generally takes time to finalize contracts in our industry, but once we book, they often provide many years of revenues.

I would like to note 3 events that impacted our results in the quarter. On May 19, we announced a $70 million investment by Charlesbank Capital Partners in Cyberbit, our commercial cyber subsidiary. Elbit Received $48 million for a portion of our shares in Cyberbit and the balance of $22 million was invested in Cyberbit. Following the investment and the sale of our holdings, Elbit Systems is now a minority shareholder. This transaction generated a healthy profit that we reported in other income. I know that we have retained all our military cyber activities within Elbit Systems, and revenues are important under the C4ISR systems line.

In May, we completed the sale and leaseback of 2 of Elbit Systems of America facilities, the profit from these transactions was reported in other operating income line.

During the quarter, we restructured an Israeli joint venture that we had formed with a foreign company and recorded a $4.4 million noncash write-off reported in earnings of affiliated companies and partnership. The remaining assets and employees have been incorporated into albeit, and going forward, will be reported as part of Elbit Systems ongoing activities. The impact of all 3 of these transactions was excluded from our non-GAAP results due to their nonrecurring nature.

I should also note that the acquisition of Elbit Night Vision from L3Harris closed on September 15, 2019, and was, therefore, consolidated into our income statement commencing the date of the acquisition.

I will now highlight and discuss some of the key figures and trends of our financial results.

Our second quarter 2020 revenues were $1.079 billion. In terms of revenue breakdown across our areas of operation, Land Systems sales accounted for 27% of the total sales and increased year-over-year, mainly from the sale of artillery systems and precision munitions to U.S. customers. Electro-optics accounted for 12% of total sales and increased year-over-year mainly due to the acquisition of Elbit Night Vision. Airborne Systems at 36% of sales declined year-over-year primarily due to lower commercial avionics sales in the U.S.

Our diverse geographic revenue base is important to the long-term sustainability of our business. In the quarter, North America at 34% of total revenues was the largest geographic area, followed by Israel at 25%, Asia Pacific at 21% and Europe at 15%. Growth in North America was primarily due to Land Systems sales, as mentioned in the acquisition and the acquisition of Night Vision in the U.S.

For the second quarter, the non-GAAP gross margin was 26.5%, down from 27.7% in the second quarter of last year. The decline reflects the business mix as well as additional pandemic-related costs we incurred during the quarter to facilitate the safety of our employees and maintain business continuity.

GAAP gross margin was 26% compared with 27.1% for the second quarter of last year.

Second quarter non-GAAP operating income was $92.7 million or 8.6% of revenues compared with $89.6 million or 8.4% of revenues in the second quarter of last year, as cost control measures helped to offset the impact of the COVID-19 on the gross profit.

GAAP operating income for the quarter was $117.1 million versus $80.3 million in the quarter last year, and includes the profit from the sale and leaseback of Elbit Systems of America facilities as mentioned previously.

The operating expense breakdown in the quarter was as follows: net R&D expenses at 7.3% of revenue were similar to the second quarter last year. Our investment in R&D enables us to maintain and build our technological leadership and underpins our long-term prospects, and therefore, we increased our investment in R&D in absolute terms during the quarter.

Marketing and selling expenses declined to 6.2% of revenues versus 6.9% last year due to reduced travel and participation in trade exhibitions.

G&A expenses were 4.8% of revenues versus 5.4% last year. The lower G&A expenses reflect some of the cost control measures we implemented to mitigate the impact of the COVID-19.

Financial expenses for the second quarter of 2020 were $16.5 million compared with $20.3 million last year.

Other income of $13 million includes the profit generated by the state of Elbit shares in Cyberbit, and equity in net earnings of affiliated companies and partnerships was a loss of $0.4 million following of a $4.4 million investment in an affiliated company in Israel, as mentioned previously.

The effective tax rate in the second quarter of 2020 was 20.8%, higher than the 17.6% tax rate in the second quarter of 2019 due to the higher tax rate on capital gains we booked in the quarter.

During the second quarter of 2019, Elbit Systems raised $185 million through the sale of treasury shares to institutional investors in Israel. This increased our share count by about 3% to 44.2 million shares, having a small corresponding impact on our earnings per share relative to the second quarter of 2019.

Our non-GAAP diluted earnings per share was $1.56 in the second quarter compared with $1.46 in the second quarter of last year. GAAP EPS was $2.02 versus $1.22 last year.

Our backlog of orders as of June 30, 2020, was $10.8 billion, $1 billion higher than the backlog at the end of the second quarter of 2019 and $14 million higher than that the end of the first quarter of 2020. Approximately 55% of the current backlog is scheduled to be performed during the remainder of 2020 and 2021, and the remainder is scheduled for 2020 and beyond. This ratio is broadly similar to that of the second quarter last year.

Operating cash flow for the quarter was a positive of $179 million compared with a negative of $138 million in the same quarter of last year. Our cash flow in the quarter reflects the increased focus on working capital management, including improved collection from our Israeli and international customers as well as more disciplined inventory management. Lower capital expenditure also supported total cash flow in the quarter.

On June 30, we paid the final interest and principal payments for the Series A notes. Elbit System continues to manage its balance sheet conservatively. Besides our cash, we have access to multiple credit lines that can provide us with additional liquidity.

The Board of Directors declared the dividend of $0.44 per share for the second quarter of 2020.

I will now turn the call over to Mr. Machlis. Butzi, please?

Thank you, Yossi. I would like to start by thanking Elbit Systems employees around the world for their continued hard work in the -- in challenging times. We continue to monitor the evolution of the COVID-19 pandemic. Our priorities remain to protect the safety of our employees, maintain business continuity and our supply chain and leverage our abilities to assist and protect our communities. The actions we initiated to address COVID-19 and mitigating the impact are ongoing.

Moving to the business and the quarterly results. The second quarter included a number of strategic milestones and important developments across different areas of our operations. Space is relatively small but strategically important part of our business with large potential. Space-related R&D also contribute to the development of additional capabilities and applications, including airborne laser systems, advanced electro-optic sensors and communication systems.

In July, Israel launched into orbit the Ofeq 16 electro-optical reconnaissance satellite. The advanced camera on the satellite the satellite was developed and manufactured by Elbit Systems.

Elbit is a world leader in developing high-performing space cameras that are smaller and lighter than our competitors. We have sold our advanced base cameras to governments and commercial customers around the world.

At the end of 2019, Elbit's first nanosatellite, NANOVA, was successfully launched into orbit, with a commercial communications payloads. The nanosatellite built on our experience in developing, manufacturing and deploying space electro-optic payloads and satellite communications.

Maritime is an additional area where Elbit Systems has a broad portfolio of capabilities. In July, we received a $53 million contract from a Navy in Southeast Asia to equip their ships with an integrated intelligence suite of capabilities that enables them to perform complex reconnaissance missions, generating an operational picture for the earth surface and under-water domain.

Under this program, Elbit Systems will supply an array of systems, including electronic intelligence systems, naval tactical communication intelligence systems and jamming capabilities, electro-optical payloads, hull mounted and towed active/passive sonars, underwater communication systems and combat management systems. This contract provides a good indication of the breadth of Elbit portfolio of maritime capabilities that are based on decades of operational experience with the Israeli Navy. This includes the Seagull, an operational unmanned surface vessel, that recently participated in trials conducted for the U.K. MOD to examine the possible use of unmanned surface vessel for antisubmarine warfare activities as well as advanced sonars and underwater acoustic communication system from our Canadian subsidiary, GeoSpectrum Technologies. The contract also highlights the growing demand for our naval and other defense capabilities from customers in Asia Pacific due to elevated geographical tension in the area.

The U.S. is our largest market. And in 2019, we reported more than $1.2 billion of sales in the U.S. In the recent months, we have seen sustained momentum across the portfolio. We supply advanced avionics and helmet mounted displays for most of the U.S. airborne platforms, including the F-35, F-16, F-15 and F-15 fighter, C-17 and C-130 transport aircraft as well as Blackhawk, Chinook and Apache helicopter. The large orders announced by the U.S. DOD in recent months for a number of these programs should provide Elbit with multiyear revenue streams that are not currently included in our backlog.

We continued to upgrade our systems on these platforms with new technologies. The next-generation of JHMCS II, helmet mounted display system for the F-16V and F-16 block 70 and 72 is currently undergoing flight tests following selection by a number of international customers.

We continue to provide a range of advanced border protection solution for the U.S. Department of Homeland Security. Our autonomous solution includes stationary relocatable and mobile surveillance tower systems and ground detection systems. These systems that are fielded along with the sovereign U.S. border include command and control, electro-optic and IR sensors and cameras, radars and communication systems and provide autonomous artificial intelligence and machine learning technologies.

In our U.S. medical equipment subsidiary, KMC, develops and manufactures advanced medical instruments in collaboration with many of the leading medical device and life science companies. KMC partners with its customers to develop and manufacture innovative medical devices, leveraging a multi-disciplined engineering team with a broad experience -- expertise in areas, including hardware and software design, robotics, optics, fluidics and chemistry integration under contract manufacturing and developing labeling equipment. The COVID-19 pandemic has increased demand for KMC's automated diagnostic products and its engineering capabilities as the medical equipment companies mobilize to fight the pandemic.

We supply a broad range of training equipment and services to customers around the world. Elbit is a leading supplier of training simulators for air, naval and ground platforms to the Israel defense forces.

In June, we received a $38 million contract from the Israeli Ministry of Defense to provide operations, maintenance and logistics services for the Israeli Air Force Flight Academy, Textron T-6 trainer aircraft fleet. This contract follows a decade during which Elbit Systems provided these services to the Israeli Air Force.

Elbit Systems provide a range of training and logistics services for the Israeli Air Force Flight Academy. These include an interconnected multi-cockpit mission training center for cadets, flying the M-346 trainer jet that provides realistic simulated battlefield training as well as emergency training on the ground.

In the air, the cadets train with Elbit's Embedded Virtual Avionics or EVA. The EVA enables advanced mission operation training on a trainer aircraft by generating a simulation suite that provides virtual avionics, weapons and sensors and a synthetic environment to increase training effectiveness and also significantly reduce costs. Elbit Systems provide comprehensive training solutions, systems and logistics services to customers around the world.

Our Affinity joint venture with KBR in the U.K. provides procurement, operations and maintenance services for 3 aircraft fleets of the U.K. Royal Air Force Flight Academy as part of their military flight training system. Affinity supports a training pipeline that is more effective and efficient in U.K. military Air group that are better prepared for their duties.

Elbit's selections by Boeing to provide avionic and training capabilities for the U.S. Air Force T-7 trainer was an important validation of our training and simulation capabilities. We believe that militaries around the world are keen to expand their simulator and training capabilities to provide more realistic training that better prepares the soldiers for a wide range of scenarios at a lower cost.

In summary, Elbit Systems have continued to work in recent months to maintain deliveries to our customers and protect our employees. Our backlog continues to provide us with significant visibility, and we continue to see significant potential around the world for our leading high-technology solutions as we work to generate value for all of our stakeholders, our employees, our customers, our suppliers and, of course, for you, our shareholders.

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

(Operator Instructions) The first question is from Sheila Kahyaoglu of Jefferies.

This is actually Ellen on for Sheila. You raised the dividend back to $0.44 in the quarter after lowering that last quarter. So how do you think about free cash flow in the second half? How comfortable are you with it? And how much of the -- about $150 million generated in the quarter was from Israeli government payments versus core operations?

Well, actually, as you have seen, we have quite a lot of -- we have experienced quite a lot of fluctuations in our cash flow during the past quarters. Some of that related with the payment from the Ministry of Defense here in Israel. Fortunately, we were successful to get the payments in the second quarter. And we're looking forward to generate cash flow in the second half of the year as well.

Having said all of that, we all are aware about the pandemic around the world and about the fact that here in Israel, the budget for 2020 is not yet finalized, but we are optimistic that we'll be able to handle that.

The next question is from Pete Skibitski of Alembic Global.

One question I had -- I had a question on the revenue by regions. I just noticed the Asia Pacific revenue down kind of sharply this quarter, which I thought was a little surprising because you've won a lot of fairly sizable contracts in the Asia-Pacific region. So I was just wondering, is this maybe a timing case where the new contracts haven't ramped up yet, but the old ones have ramped down? Or is there some impact of COVID, in particular, in the Asia-Pacific region? I guess I was just wondering if you could clarify that.

Yes. I would say the following: first of all, yes, we did suffer, to some extent, not materially from disruptions in this area, acceptance testing by customer of our equipment and so on, but this was not a material impact.

Regarding the major contract that we got in the first quarter, it does take some ramp-up to prepare for production, and we will start delivering that part in the -- towards the end of this year and during the next year and the following year. So this is something that takes time until we see the transformation from new business to revenues.

The third element is that one -- actually 1 or 2 programs that we had last year, we -- quite often, we finished delivery during the first quarter. So we did not have their impact during the second quarter of this year. I should, in general, recommend to look at our multi-quarter performance and 1 quarter shouldn't be very characteristic about how we operate.

Okay. That's very helpful. I appreciate that, Yossi. And then separately, revenue-wise, on commercial avionics, obviously, we've seen Boeing and Airbus take rates down going forward and COVID has impacted, to a lesser degree, but saw that in your business and general aviation as well. I'm just wondering if you can quantify for us the decline you saw in the quarter from commercial avionics versus business in general avionics?

Well, I would say the following: I mean the defense avionics did perform well and in line with the general trend of the business of the company. The commercial part is not a huge part of our business yet. We did -- during this quarter, some of the revenues that we performed compared with the previous quarter were lower in the commercial avionics deliveries. We did see in the beginning of the third quarter, some upside coming back. But again, this is very fluid. And I would not dare to do some expectations on this part.

We are -- our commercial avionics is mainly focused on the business jet, so -- and not that much on the wide-body airplanes. So we are affected, but not at the level that the general industry is affected.

Okay. Very helpful. I'll ask one more and then I'll get back in queue. I'm not sure if there's others in queue. But I guess I want to think about the timing of margins in the back half of the year. If we look at the second half of 2019, you had a decline in margin rate in the third quarter and then a sharp ramp-up in the fourth quarter. I'm just wondering if you're expecting that similar kind of dynamic in the back half of 2020?

Well, as you know, we do not give guidance. However, I think that we do expect to have some recovery on the gross profit level. For the second half. I think that the performance on the operating profit this quarter, and in general, for the first half, was quite good. And we do not expect any significant change on that part.

The next question is from Dina Korshunov of Leader Capital Markets.

My question is, do you feel in generally, that the risks in the defense market is rising in the last quarter or the last couple of months due to the pandemic, the economic risks?

It depends. In Israel, as you probably know, there is no defense budget. There is no budget. So here are some delays in new orders. However, in the U.S. as well as in the U.K., in West Europe as well as in Australia, we see growing demand and we receive more contracts, and this is mainly to support the local economy to create more jobs. And just to remind all of us, we have dozens of subsidiaries all over the globe, and it helps us right now to communicate with our customers, but also helps the local government to create more jobs and to support the local economies.

In some areas, we see some cuts because of budget priorities. But it's relatively not in many places. And with also a growing tension, security tension in several places around the globe, which generate more demand for our products.

Altogether, we have a wide portfolio and -- with many technologies and many solutions. And we are spread in many countries with dozens of subsidiaries. Altogether, it creates stability. And we have also a strong backlog, almost USD 11 billion, which help us to take the right measure and to adapt ourselves to the changing -- to the changes in the market.

The next question is from Ella Fried of Bank Leumi.

The question is actually about the next backlog cycle mix. I think we know from experience that post crisis, the mix is more driven or sometimes often driven by upgrades and budget shrink and the airborne systems upgrades and maybe some land upgrades. Are you actually preparing for this trend? Do you think it's going to happen? And if you do, what kind of steps it needs -- you need to be taking because that was less the focus of the recent years?

Ella, as you know, our portfolio can support new platforms as well as upgrading existing platforms. We are -- we continue to provide the new avionics for new fighters in the U.S. as well as in other countries, and we continue to upgrade existing platforms all over the world. The same is true also for land application. We continue to provide new electronics and new systems to new ground platforms, and we also -- we are also actively upgrading existing platforms in the market. So we are ready -- our portfolio supports both and we are ready for any decision that our customers will take.

I also want to mention that our portfolio can help customers to save cost. And I'll give you 2 examples. First, the command and control application and autonomous systems are doing more -- bringing more operational value with less people, and they are doing it much more efficiently. That's one example. And another example is simulators in training system. Here instead of using real flights and real tank hours in the field, we are providing simulators and building flight schools to replace active hours in the air and on the ground. And once again, it helps our customers to prepare themselves with less cost associated. So we are -- we have a wide portfolio. We can support most of the demand in the market. We are following the demand and the request of our customers closely, and we are adapting ourselves to the changing requirements in the market.

I've noticed that the simulators are doing great. And I think they will be even -- doing even better as time goes on. The question actually is if we will see some shrinkage of the budget, which for a while, is almost inevitable, at least in some of the countries, do you think the targets that you marked for IMI growth have to be maybe reconsidered and kept to be softened a bit? Or you still think that it will be the same 2020 -- and 2022, beginning 2023, that was the general position.

On the contrary, Ella, we see growing demand for our land portfolio. Just to remind all of us, we combine capabilities from IMI with Elbit capabilities. And by combining these capabilities together, we are able to provide guided munition to our customers, for different air forces as well as for land forces and for navies around the globe. There is a growing demand for that. And we have really state-of-art solutions. And this -- and I see a lot of potential there. And that's one area.

And talking about upgrading existing platforms, that's an area where IMI portfolio is very relevant, active protection system as well as armor and additional stuff are very relevant for upgrade programs as well.

We see a growing demand for our IMI -- for the IMI activity, just to share with you -- I don't know if you remember, but when we acquired IMI less than 2 years ago, IMI is, if I'm not mistaken, about 15% in the international market, something like that. Today they are doing more than 40% already abroad. And we are working also on efficiency. So we bring more business to IMI. We combine capabilities between Elbit, the old Elbit and IMI. And we do more export, and we are improving profitability in IMI, and we are very happy with this acquisition.

Okay. That's great to hear. And one more question…

And talking about the active system -- just Active Protection Systems, just to remind all of us, we won the active protection competition here in Israel for the 8x8 armored vehicles of the IDF Eitan We will provide the Active Protection System for this platform. We were chosen by the U.S. Army to provide the Active Protection System for the Bradley, the same is true in Australia and also in the Netherlands.

And we -- and there is a lot of synergy between Elbit for control capabilities, battle management capabilities, site capabilities and the IMI Active Protection Capabilities as well, which supports new platforms as well as upgrade activities as well.

Well, that's great to hear. Another question, I think that refers to both of you. It's -- you raised quite a lot of cash in this quarter. And is it just being prudent and conservative facing COVID and these times? Or do you have some kind of acquisition targets or just the will to be prepared if something occurs because there might be -- you maybe find something more interesting for acquisition in the next year, couple of years?

Cash is very important target for us. Reducing working capital, increasing cash balance and improving our cash position. This is very important during all times, specifically during the times that now we are living in the COVID-19 environment. We want to make sure that we have enough cash, enough liquidity to run our business. And that is what we do. We had several quarters in the past. That were quite low in our cash performance. I think we did catch up very nicely this quarter. And we continue to emphasize and put a lot of emphasis on the cash performance of the organization.

In general, I would also answer the second part. As you probably know, our strategy for many years does include acquisitions. We did quite a lot of them. And of course, most of -- essentially all of them, we did with cash. So to say if we have some specific target for the next months, I would say no. But we definitely -- that is part of our all-time strategy to acquire and grow the business through M&A.

So basically, you are being prudent, but also ready for anything interesting comes across to sum up?

That's correct.

The next question is a follow-up question from Pete Skibitski of Alembic Global.

Just one sort of 2-part follow-up on cash flow. Advances -- it looked like there were advances that were really strong this quarter and for the whole first half. That was great to see. I don't know if that was related to a couple of programs, in particular, maybe the Asia Pacific that we talked about earlier? But I was wondering if you could give us any color on the strong advances. And then the second part is just it looks like receivables continue to build. Any expectation for the second half of the year on receivables declining?

Okay. Regarding the cash, I think during previous calls, we did explain that we moved for a situation that we saw increased working capital in the company. And we did change some of our policies to improve the cash generation. This change in policy has resulted in working with our customers for improved payment terms, improved for us, payment terms, which include advances, down payments for the various contracts that we are awarded. I think that we do see now the actual result of this strategy. And -- which did come through to significant growth in the advances of the new contracts that we have received.

So -- and going forward, we continue to put emphasis on this element, on the cash settlement. And hopefully, that will continue for the future as well. It, of course, depends on the business environment and the capabilities of the customers and their budgets to provide us with these advances. I think this quarter was a very good one from that aspect.

The receivables are -- have grown, and that is related with the progress in the various programs and the various contracts that we have. I'd like to remind you that some of these receivables are what we call unbilled receivables because according to the new accounting rules, we recognize revenues on the input method, on the cost input method. And therefore, as we progress on the program, we recognize the revenues. And then we'll -- they will be transformed, of course, in cash in due time according to the payment milestones of the various contracts with our customers.

(Operator Instructions)

There are no further questions at this time. Before I ask Mr. Machlis to go ahead with his concluding 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 03-925-5900. And internationally, please call 9 (723) 925-5900. A replay of this call will also be available at the company's website, www.elbitsystems.com.

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

Thank you. I would like to thank all of our employees again for their continued hard work, particularly in these challenging times. 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 2020 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.