Rada Electronic Industries Ltd (RADA) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the RADA Electronic Industries 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. If you have not received it, please contact RADA's Investor Relations team at GK Investor & Public Relations at 1 (646) 688-3559 or view it in the News section of the company's website, www.rada.com.

I would now like to hand over the call to Mr. Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin?

Thank you, operator. I would like to welcome all of you to this conference call to discuss RADA's second quarter 2020 results. I would also like to thank RADA's management for hosting this call.

With us on the call today are Mr. Dov Sella, Chief Executive Officer; and Mr. Avi Israel, Chief Financial Officer. Dov will summarize the key highlights of the quarter, followed by Avi, who will provide a summary of the financials. We will then open the call for the questions-and-answer session.

Before we start, I'd like to point out that the safe harbor published in today's press release also pertains to the content of this conference call.

And with that, I would now like to introduce RADA's CEO, Mr. Dov Sella. Dov, go ahead, please.

Thank you, Ehud. Good day to all of our call participants. Let's start with the results summary. As you can assume, we are very pleased with our financial results for this second quarter. We demonstrate continuous growth, strong growth both year-over-year and quarter-over-quarter. Growth rates are 75% year-over-year and 16% compared to the previous quarter. We expect the growth to continue for the remainder of this year and also into 2021.

Our gross margins remain stable at about 36%. Our operating expenses are stabilizing, and it means that there is now strong operating leverage in our business. And going forward, we can substantially bring much of the growth down into the bottom line. Our results show that so far, the corona pandemic is having no material financial impact on us -- on RADA. Our strong results speak for themselves.

We have previously discussed the steps that we have taken to protect our workforce, and this has not changed. We have successfully made all the adaptations needed and have overcome all the work challenges that the pandemic has presented on us. And being part of the critical infrastructure industrial base in the U.S. and in Israel, we continue to work at full capacity.

We have also taken steps to protect our ability to deliver our products to customers for our commitments and plans. We have significantly increased our inventory to ensure we have in stock the components we need for manufacturing and to support our strong growth.

We increased our revenue guidance for 2020 from the previous $65 million to the current expectation of over $70 million. The update is based on our current backlog and the orders that we have received in the first half of the year. It represents a growth of over 58% year-over-year.

And as mentioned in the past calls, we continue to expect sequential quarterly revenue growth throughout this year and into 2021. We have a strong balance sheet of $30 million in net cash, which is sufficient for our growth and working capital needs. It allows us to maintain significant inventories to continue to invest in our growth and offer some potential challenges we may face due to the changing economic situation. And obviously, it allows us to continue to invest in our R&D and capitalize on opportunities. We identify that.

Let's talk a bit about our markets. Our radars are enablers in life-saving active protection solutions for military tactical forces and critical infrastructure, which are new and growing segments within the defense systems market.

In our relevant market segments, the interest and need for the solutions in which our radars are key part in, is not just in the U.S., it is global. Being pioneers and leaders in these segments, we are now at the beginning of an anticipated sustained growth period to our opinion. Our strong growth in sales demonstrate the transition of our end markets from the initial stages to the serial production phase.

We estimated our addressable market at about $5 billion in the coming decade. Market is spread even between the U.S. and rest of the relevant world. Today, we are still catching -- scratching the surface of this potential, to our opinion. Competition today is rather limited. We know it will come. It is an attractive market and we have built a very nice lead.

Programs are moving from fulfillment of urgent needs to multiyear acquisition programs, as we just mentioned. We expect that this will enable us to start building backlog into -- in the second half of this year and along 2021, which will establish a long-term growth path in 2021 and hopefully beyond.

About our business development situation. Like everybody else, we are still not traveling out of country to meet face to face with existing and potential customers and partners. We meet virtually by video and phone. Because all are in the same boat, this type of remote business development is currently the industry standout or the new normal or whatever we want to call it. It is less than optimal, though. Integration, testing, demonstration activities continue in our major geographies, which are the U.S. and Israel, and our local presence makes the difference and shows its benefits.

Generally, our sales cycles tend to be long term, about a year, if not more. Hence, we believe that the potential delays in some of our markets due to closures and travel restrictions will recover within a few months. Obviously, if closures and travel avoidance will persist for more than 9 months, to our estimation, it may delay new orders from these restricted geographies along 2021.

In terms of macroeconomics and defense spending, while macroeconomic outlook seems bad, at least for 2020, defense spending is government expense, which is generally less exposed to the macroeconomy. So far, we have not seen any cancellation of existing orders. And in fact, we have continued to get new orders in a good pace, luckily enough.

And in the U.S., immediate defense spending is even increased to support the economy. We believe the defense spending, especially in the niches that we are focused on, will be resilient to most extent. On the macro level, we assume that huge economic stimulation packages in the U.S., Israel and elsewhere will flow in part of the defense spending. And this has a positive impact on employment and economy activity in general.

Our radars are embedded in life-saving active defense solutions, as we just mentioned. We believe that the programs we are involved with, which are in the heart of the U.S. modernization priorities and emerging needs, will not be those who will suffer from a potential future decrease in defense budgets, if that will happen. We believe that in case general elections in the U.S. may lead to change of government, new markets will continue to grow. And listening to the United States Secretary of Defense a while ago, he mentioned that if there will be budget challenges, it will be an opportunity to reprioritize the modernization priorities over legacy programs of record.

Now while we do sense an atmosphere of budget pressure all around that may accept short-term decisions by our end users, we are still optimistic that our business will continue to grow despite the organic challenges that the pandemic, elections and/or other macro conditions may impose.

A few words about our current progress. I'd like to update you on some of these major programs in which we are involved. The first one is the APS for filing vehicles. We are part of Elbit's Iron Fist solution. Israeli, Eitan AFV development is on schedule. Production will commence in 2022. And the scope is over 1,000 radars along few years.

The U.S. Army Bradley Fighting Vehicle, the testing is ongoing. A bit delayed because of the pandemic because end users cannot be participant in all the tests that are going on. Serial production is expected to commence in 2022 formally. Scope of the first brigade is over 600 radars. We are still optimistic that if the pandemic restrictions will be removed and the tests will be favorable, there are some chances that the schedule of production will come earlier.

In addition to these 2 major programs, there are several additional programs in incubation, requiring potentially thousands of radars with deliveries to start in 2023 and onwards. Generally speaking, the active protection market is not yet affecting our top line. What is affecting our top lines are the ground-based air defense, the short-range air defense programs and specifically also the combo U.S. and the C-RAM portions or subsegments of this market segment.

The U.S. Army, I'm sure, is under testing with some recoverable minor delays, as just mentioned yesterday in open media. Production orders for the first battalion are expected in quarter number 4 of this year. U.S. [MCG] program is en route to become a program of record. While momentum is kept by interim deliveries, and we have delivered over 200 radars to the Marine Corp by now.

We evidenced strong momentum in point defense, following the identified threats of rockets, cruise missiles and drone attacks as evidenced in the near East. Beyond what has been delivered to date, we anticipate significant upside from follow-on orders to the initial orders we have set aside so far and are in production.

Pipeline continues to broaden with promising prospects. Potential orders are especially strong in the U.S., while other international markets are increasingly growing.

To summarize, we are outperforming even our highest expectations. Revenues year-over-year grew 75% to $17.5 million in this quarter, fastest since our acceleration began in 2019, quarter-over-quarter, I mean. And we showed 60% of growth this quarter. Based on strong order flow and current backlog, we have increased our revenue guidance for this year to over $70 million. Given our stable gross margin and stabilizing operating expenses, the growth can substantially flow down to the bottom line. EBITDA of $1.75 million, about 10% of revenues and up 100% compared to the first previous quarter shows that we are now starting to enjoy the fruits of our investments and growth.

From a markets perspective, defense is a critical industry as we mentioned, less exposed to an economic turndown -- downturn, I mean. Furthermore, we see defense budgets generally growing, especially the programs we cater to. The need for our life-saving products is urgent. And for the military forces, and we don't see yet any decrease. And we are in the early stages of enjoying the fruits of our investments over the past few years. We are very well positioned for significant growth, to our opinion. Our current leading and mature radar technology addresses the demanding needs of this growing market for the near term. And through the advanced developments of our next-generation of tactical radars, our R&D is focused on maintaining our leadership in this developing and growing markets for future years. And while reporting our best ever quarterly results, we believe that our next quarters will be even better.

I'd like now to hand over the discussion to Avi Israel, our CFO. Avi, please go ahead.

Thank you, Dov. Good day, everybody. You can find our results on the press release we issued earlier today, and I'll provide a short summary of the second quarter results.

Second quarter revenues were at a record $17.5 million, up 75% year-over-year. Our gross margin in the quarter was at a stable 36% of revenues and has not changed over the past few quarters. This is the level we currently expect and are happy with. As you know, we made significant investments last year, especially in R&D, in sales and marketing as well as our infrastructure in the United States, so our operating expenses grew. However, looking ahead, we don't expect significant changes to the operating expenses going forward.

Operating income was $634,000 in the quarter compared to operating loss of $843,000 in the second quarter of 2019. Adjusted EBITDA of $1.7 million, which is 10% of the quarter revenues, compared with a negative one of $268,000 in Q2 of last year. Net income attributed to RADA's shareholders in the quarter was $777,000, or $0.02 per share, compared to a net loss of $564,000, or $0.01 per share, in the second quarter of 2019.

I would like to summarize and point out some highlights on our balance sheet as well. As of June 30, 2020, we had $29.9 million in cash net of the small financial debt related to the PPP plan in the U.S.

At quarter end, our shareholders' equity stood at $66.5 million, financing 68% of our balance sheet. Our inventory level increased to $26.5 million from $17.2 million at the end of 2019. This inventory level was strategically increased to support future expected growth and to ensure full availability of components, given the current environment and the need to mitigate against any negative influence of COVID-19 pandemic on our supply chain.

In summary, as Dov mentioned and as the financial results demonstrate, we are very pleased with our progress and look forward to continued growth. That ends my summary.

We should now open the call for questions. Operator, please.

(Operator Instructions) The first question is from Brian Kinstlinger of Alliance Global Partners.

In the past, about 50% of your revenue was coming from the U.S. You mentioned that in 2Q, the primary driver, it sounded like with the U.S., even though I think all markets are growing. So has the mix changed? Is more than 50% coming from the U.S.? And do you expect the U.S. continue to grow faster than the rest of your business?

We do expect that the U.S., as we anticipated early on -- well, first of all, it's basically half of our potential market. In addition, it emerged first, and the rest of the markets are in a trend to follow. So we do expect that it will be over 50% in the near term, especially next year.

Great. And then on the inventory, are you -- given the pandemic is still quite uncertain and demand continues to ramp for RADA, do you expect to continue to add inventory through the remainder of 2020? Or do you expect to work through that inventory and inventory will be coming down over the next 6 months or so?

The pandemic didn't change dramatically our strategy while experiencing new and emerging markets, meaning emergent need. In order to address them, we long ago decided to build to stock. And a lot of our revenues are coming from book and bill sales. The pandemic put another emphasis that, okay, let's try to be as resilient as possible in this emerging market. What will change the inventory levels is mainly the transition to the serial production phase, where you have long-term production plans, you can get advance payments and so on and so forth. So you are going to be more relaxed in the cash needs and working capital. However, since it is, as I said, phasing market, there will be areas that we behave in an urgent need. So it will be a mixture, less pressuring. Hopefully, the mixture will be towards the serial production. And the whole idea is to become cash flow positive soon enough.

Great. And then while demand is ramping, have you seen any changes in the competitive landscape, many competitors improve their capabilities with many tactical radars?

We didn't see any change. It's an ongoing situation or environment. We see the competition, mainly Elta, SRC and maybe 1, 2 more, introducing their developments, testing their equipment, cross our fingers, we are still in the lead.

With that said in the lack of true competitors, although, they're maybe making their way to where you are and the strengthening demand, is there an opportunity for price increases? Or do you think you priced appropriately, given where the market is?

I would not call them untrue competitors. They are fierce competitors, they are world-class radar companies. And I don't think we should remove our foot from this pattern of being very competitive in performance over price.

The next question is from Ken Herbert of Canaccord.

The commentary here in the United States regarding sort of SHORAD and testing on the program seems to be maybe getting a little better from where a few months ago. Can you comment on -- you called out specifically the opportunity for production order in the fourth quarter. Can you comment further on your assumptions for SHORAD at this year and into next year? How we should think about the volume on that particular program potentially ramping and transitioning here?

Yes. The plan is, as I said earlier, in my view, we expect orders of the first battalion, which is 32 vehicles, to be received this year. 32 vehicles is over 120 radars. By mid-next year, we do believe that second and third battalions will be on order. So we believe that next year -- and the orders that we will get this year will be delivered next year.

We do believe that next year, we will be able to deliver 2 battalions, half of the initial program. And the rest will be in 2022.

Okay. That's great. And are you seeing -- how would you characterize or handicap the risk around timing here? Or maybe what are the next major milestones we need to see soon in advance of these first orders?

We are not from here because this is a classified program. We are not being told exactly what's going on, but it is being advertised in the media, as you just read yesterday, and it was mentioned that they are assuming that they will close all the hiccups, as they call them. And the milestone should be, let's say, a note by us or even by our customers' DRS that the production order was placed with them, hopefully, by end of September in this fiscal year, and it will be a bit delayed towards us.

Okay. That’s very helpful. And you -- obviously, active protection is not very meaningful yet from a revenue standpoint. Can you talk about how that could impact 2021 and 2022 as we continue to see, specifically on the Bradley, things gradually move forward?

In 2022, we will start deliveries of the Israeli Eitan program and hopefully the Bradley. So a few tens of millions of dollars may happen in 2022. And again, the massive will be in 2023 and onwards.

Okay. That's helpful. And just one follow-up. As you look at the -- you highlighted the competitive landscape, is it fair to assume that R&D spending within your broader comments around OpEx, R&D spending holds relatively flat at these levels? Or do you envision having to increase R&D spending here in the next few quarters or into 2021?

I believe that here in Israel, where the majority of the R&D is executed, we are almost stabilizing. I mean we had our ambitious plans, but it took us some time to build up the -- and train the people to build up the talented engineering force and train them. And now we are almost there, and we are working full scale.

I mean we are developing 3 radars in parallel. And all 3 of them will start testing next year. In the U.S., we still expect some recruitments of engineering force to happen. But on the total picture, we are almost stabilizing.

Okay. And just finally, on the U.S. operations, are you fairly -- you just talked about the R&D or the engineering side, fairly well staffed up there and operating, where are you on the ramp of that facility? And when do you get to sort of the full capacity?

Capacity-wise, the production capability is there. It is up and running, and we have enough technicians to support the production at this level. Capacity is ramping up. And if we need, we can top-up up to 3 shifts and produce up to $100 million worth of radars. We are not there yet. We do believe that by the end of this year, we will deliver 250 radars to the U.S. market from our U.S. plant, and we have already delivered a few dozens of radars from there.

The next question is from Will Manuel of Edison Group.

Yes. Congratulations on a great quarter. Just would like maybe a little bit more color on the rest-of-the-world opportunities. If you could sort of maybe drive down a bit into sort of countries and time lines.

It's too early to tell about time lines because the rest of the world is in an urgent need phase. I mean initial orders, very promising though, but still some of the geographies are affected by the coronavirus. And the things are a bit delayed. So I cannot tell you exactly when, but the potential is there, and I cannot comment about specific countries, I'm sorry.

Okay. And in terms of sort of product development, sort of next-generation products of yours, can you give us some sort of idea on that?

Yes. We are developing our next generation of active protection radars of counter-UAV and short-range air defense radars and also next-generation of C-RAM radar. All types of our radars are being now -- all the lessons that we've learned are being introduced into the next generation, which will start to be tested, as I mentioned, less than a year from now.

And how -- I mean with those products, what's the sort of change in -- or would there be any sort of change in gross margins? Is there more of the sort of software element, does that change anything in the sort of medium term?

Could you please repeat that, sorry?

Is there any sort of change in the sort of gross margins from those next-generation products?

No, we keep -- as I mentioned earlier, we keep the same go-to-market strategy of customers, products, price plans and so on. We -- our desire is to stay highly competitive.

The next question is from Jeff Bernstein of Cowen.

Congratulations on a good quarter. A couple of questions for you. The incremental EBITDA margin just quarter-to-quarter here, looks like it was about 5%. So you're getting a lot of fall-through to the bottom line. Just interested if there was any sort of one-timers there and how we should think about EBITDA margins going forward. I know for prime contractors, there gets to be a level that you don't want to flaunt in front of the government. But can you guys make 15% operating margin? Or what sort of a level beyond which you're not going to go?

So first of all, answering your first question, there was no onetime event in the quarter or previous quarter and so on. Everything is business as usual, nothing special. You estimated correctly that by growing the top line and maintaining the gross profit, the numbers will fall all the way down to the operating income as well as to the EBITDA. The gap between the operating expenses and adjusted EBITDA is currently something like $1 million per quarter. So you can do the mathematics yourself, assuming that we maintain our growth, assuming that we maintain our gross profit, the gap between operating profit and the EBITDA per quarter is around $1 million. Nothing special.

Just to add a few words to that, Jeff. We believe that the production facility is around radars, especially in the U.S., naturally, also in Israel are relatively new. And with some more experience in the automation, we can improve our efficiency, but it is not to the level of 50%. It's one tool, that's the most -- let's not forget that we are in a competitive environment. It's not that we can raise prices. We are not there.

Okay. And I'm just wondering, being an optimist, you talked about the headwinds from not being able to go see customers, et cetera, for business development, but it would seem like at this point in time, that would be a relative advantage for you over competitors.

I think we are lucky in the fact that our primary market is in the U.S. And in the U.S., we have already established our local presence and production. So in the U.S., we kind of are immune. And the rest of the emerging markets are suffering from delays, but everybody is suffering from delays. So I think we are here on par with our competition.

Okay. And then you mentioned the Marine Corps program, was that GBAD that's going to become program of record?

Yes.

The next question is from [Isaac Pedometski].

In April, after such a good report we say (foreign language). And now to my first question, it is regarding your R&D. In the past, you said that your R&D department is working on development of 4 new radars. Out of the 4 radars, you introduced 2 new radars. When do you plan to introduce the other 2? And also in the recent interview conducted by Jefferies, you mentioned that RADA is developing bigger radars. Is this a change of direction? Because up to now, you concentrated on small radars.

And my second question is regarding the Indian market, if you were there...

To your questions, let me answer one by one.

First of all, we are developing 3 new radars now. We have developed -- fourth one is already introduced. And the rest of the 3 -- the rest 3 will be introduced, as I mentioned, less than a year from now.

Bigger radars are relative. We have a small -- smaller -- smallest and we are going to do something a bit bigger than our small, but it is all tactical. The concept is radars that are installed on vehicles, working with the maneuver force and so on.

So the new radar we are talking about compared to the bigger radar that we have now, it's a round shaped with the diameter of 80 centimeters, we are talking about a rate of 120 by 90 centimeters. So this is bigger. The antenna is bigger. Ranges are doubled, but it is still compact and maneuverable.

So let's put it in proportion. What is your next question, please?

My second question is regarding the Indian market. In view of the latest tension between India and China, how do you foresee RADA involvement in the Indian market?

We have stated quite a few times that India is one of our strategic market -- target markets. We have already initial sales of radars there. Indian market is behaving slowly by nature, by definition, let's say, even. You need a very long-term thinking and air in your lungs, as we say. We have dedicated specific Vice President of Business Development to address the Indian market. We have the patience and we know that one time, it will pay back. But stay tuned.

(Operator Instructions) The next question is from Austin Moeller of Canaccord.

I just had one question. Can you guys provide any additional commentary around the C-RAM opportunity that you're working on at the moment or not yet?

Not yet, not yet. We are working on C-RAM in the U.S., it's being under our initial testing. We cannot talk too much about it. Mainly, our C-RAM sales are non-U.S. sales, naturally, in Israel around Gaza and not only in Africa for UN forces, not directly and so on. But it is too early to say.

And the C-RAM opportunity that's currently in Israel, that's not related to Iron Dome that specifically the red color stock? Or is that also other stuff...

So our C-RAM -- C-RAM is a wide myriad of solutions. It can be also addressing artillery from being shot at you from 30-and-over kilometers away. Is not -- these are not the ranges that our radars are compact, and tactical radars are reaching. We are talking about the tactical ranges of about 10 kilometers and less both are the short-range rockets, that kind of stuff.

And also, cruise missiles to a certain extent, with cruise missiles, you need the longer ranges. So we are developing a bit of a bigger radar, as we mentioned, doubling the ranges. But again, we stay at the tactical level. It's not Iron Dome. Iron Dome is addressing the long range, the longer range, it is called medium, okay? But tens of kilometers of rockets, maybe even more than 100 rocket missiles that are being fired at stationary bases and villages and houses. We are not there. We are in the tactical layer.

The next question is from [Ron Dwarf].

First of all, congratulations for the results. And my question is, given the fact that as of 17th of July, we disclosed that you have orders in almost $50 million in revenue, or most of it will be recognized this year, and given the fact that the fourth quarter is usually a strong one in the industry from budget needs to be dispensed, don't you think that the new guidance is too conservative?

There are uncertainties, and we do believe that it is realistic and not too conservative. And if we are lucky, we will give a new guidance, if not, it will be realistic, but it is -- the market is -- not all the orders are delivered this year. Not all of them. So it's not plain and simple mathematics. We do stand behind our new guidance, and we believe this is firm and realistic.

There are no further questions at this time. Mr. Sella, would you like to make your concluding statement?

Yes. Thank you, operator. On behalf of the management, I would like to thank you all for your continued interest in our business. We will be presenting at the Canaccord conference today and on Thursday. If you would like to speak with us, please be in touch with our IR team or with the Canaccord relevant representative. We still have open slots for tomorrow and Thursday. Otherwise, we look forward to speaking with you and updating you again in our third quarter results release in approximately 3 months from now. We wish you all to stay well, and have a good day. Thank you very much.

Thank you. This concludes the RADA Electronic Industries Second Quarter 2020 Results Conference Call. Thank you for your participation.