Elbit Systems Ltd Q4 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems Fourth Quarter and Full Year 2020 Results Conference Call. All participants are present in listen-only mode. Following management’s formal presentation, instructions will be given for the question-and-answer session. 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 at 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, Operator. Good day, everyone. And welcome to our fourth 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. 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 details of GAAP financial data, as well as the non-GAAP information and the reconciliation in today’s press release. 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 the fourth quarter reflect the resilience of Elbit Systems, our balanced geographical footprint and broad portfolio of advanced technological capabilities and solutions. These have helped us sustain demand for our solutions and services in the period of increased uncertainty caused by the COVID-19 pandemic. The rollout of COVID-19 vaccines is encouraging. We continue to monitor the situation closely while adhering to the instructions of government from the various countries in which we operate. Turning now to our results, we are pleased with them and with the performance of our subsidiaries around the world during a year that was heavily impacted by the pandemic. The subsidiaries have been monitoring and maintaining close contact with our customers worldwide in these challenging periods. Our order backlog and revenues increased year-over-year in comparison with the previous quarter. We maintain profit margins in line with 2019 and improved cash generation due to an increased focus on operations, as well as measures we implemented to mitigate the financial impact of the COVID-19 pandemic. I will now highlight and discuss some of the key figures and trends in our financial results. Fourth quarter revenue of $1,378 million increased 4.3% year-over-year. For 2020 as a whole, our revenues were $4.66 billion versus $4.5 billion last year, representing a growth of 3.4%. In terms of annual revenue breakdown across the areas of operation, airborne systems accounted for 35% of our total annual sales and increased year-over-year mainly due to precision munitions and training and simulation. Electro-optics accounted for 10% of total sales and increased year-over-year mainly due to the acquisition in 2019 of Elbit Night Vision in the U.S. Land system sales accounted for 27% of total annual sales and increased year-over-year mainly as a result of revenues at IMI acquired in 2018. C4ISR accounted for 25% of sales, declining year-over-year primarily due to lower radio sales to Asia-Pacific. Our diverse geographic revenue base is important to the long-term sustainability of our business. In 2020, North America was the largest contributor at 32% of revenues, Israel was 24%, Asia-Pacific 21%, and Europe 18%. The growth in North America was primarily due to increased airborne system sales and the sales of Night Vision systems. The growth in Israel was mainly due to land systems. Compared with the fourth quarter last year, we saw strong growth in North America that more than offset lower sales in certain other markets. This reflects the phasing of programs and payments that fluctuate from quarter to quarter. We believe longer-term trends are more representative of our business. The non-GAAP gross margin for the fourth quarter was 26.3%, compared with the fourth quarter of 2019 of 26.2%. For the full year of 2020, non-GAAP gross margin was 26.7%, compared with 26.9% last year. Non-GAAP gross margin in 2020 reflected an unfavorable program mix and costs incurred due to the COVID-19 pandemic. These were largely offset by the cost control measures we implemented to help limit the financial impact of the pandemic. GAAP gross margin in the fourth quarter of 2020 was 26% of revenues, compared to 21.5% in the fourth quarter of 2019. That includes a $55 million charge related to the acquisition of Elbit Night Vision. GAAP gross margin in 2020 was 25%, compared with 25.2% in 2019 for the fourth quarter. GAAP gross profit in 2020 included non-cash expenses of approximately $60 million due to inventory write-offs and asset impairments in our commercial aviation activities resulting from the impact of COVID-19, while in 2019 GAAP gross profit was impacted by ENV reorganization charges as mentioned earlier. The fourth quarter non-GAAP operating income was $113.8 million or 8.3% of revenues, compared with $125.4 million or 9.5% of revenues last year. Margins declined year-over-year due to higher R&D and G&A expenses in the quarter. G&A expenses in the fourth quarter of 2019 benefited from income related to a litigation settlement in the U.S. Non-GAAP operating income in 2020 was $390.1 million or 8.4% of revenues, compared with $379.7 million or 8.4% of revenues last year. GAAP operating income was $325.7 million versus $321.6 million last year. I am pleased that we successfully maintained operating profit margins in 2020 at 2019 levels despite the challenges presented by the COVID-19 pandemic and the additional costs incurred. GAAP operating income for the fourth quarter was $104.6 million versus $63.6 million in the fourth quarter of last year that included the ENV reorganization charges. The operating expense breakdown in 2020 was as follows: Net R&D expenses increased to 7.7% of revenues versus 7.4% in 2019. Our investment in R&D enables us to maintain and build our technological leadership and underpins our long-term prospects. Marketing and selling expenses declined to 6.2% of revenues versus 6.7% last year due to reduced travel and participation in trade exhibitions. G&A expenses were 4.8% of revenues, similar to last year. Financial expenses were $32.5 million in the fourth quarter, compared to $16.4 million in 2019. The increase was mainly due to charges in the shekel-dollar exchange rate in the period. Financial expenses in 2020 were $71.3 million, compared to $69.1 million last year. The effective tax rate for 2020 was 13.9%, compared to 7.9% in 2019. Taxes on income in 2019 were reduced following a settlement with the Israeli Tax Authorities related to adjustments for prior years. We recorded tax expense of $1.9 million in the fourth quarter, compared to tax income of $9.1 million in 2019 due to the adjustments for prior years as mentioned above. During the second quarter of 2019, Elbit Systems raised approximately $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 slight corresponding impact on our earnings per share relative to last year. Our non-GAAP diluted EPS was $2.38 in the fourth quarter and $7.20 for 2020 as a whole. GAAP diluted EPS for the quarter was $1.53 and $5.38 for the full year. Our backlog of orders as of December 31, 2020, was approximately $11 billion, $1 billion higher than the backlog at the end of 2019 and $166 million higher than at the end of the first quarter of 2020. This represents an attractive book-to-bill ratio of 1.21. Approximately 65% of the current backlog is scheduled to be performed during 2021 and 2022, and the rest is scheduled for 2023 and beyond. This breakdown is similar to that of the fourth quarter last year. The order backlog is equivalent to more than two years of revenues and provides good visibility for future revenues. Operating cash flow for the fourth quarter was $172 million inflow, compared with $87 million in the same quarter last year. For 2020 as a whole, we reported $278 million operating cash flow inflow versus $53 million outflow in last year. Operating cash flow benefited from customer advances received in the fourth quarter. The phasing of cash flow remains dependent on timing of payments mainly from the Israeli Ministry of Defense. The Board of Directors declared a dividend of $0.44 per share for the fourth quarter of 2020. I will now turn the call over to Mr. Machlis. Butzi, please?

Thank you, Yossi. I am very pleased with the significant volume and value of contracts we announced in supporting our third quarter results overall. These contracts provide an encouraging indication of sustaining demand from our customers. Many of these are strategic and will provide Elbit with strong market positions and multiyear value instruments. Our software-defined tactical radios, tactical acquisition systems, and tablet computers are important building blocks for the command and control solutions we provide militaries around the world that enable them to conduct multi-domain operations. The multi-domain operation requires the ability to connect different capabilities, sensors, and weapons, so an integrated and resilient network of Elbit Systems provides numerous customers around the world. In December, we signed a $338 million contract with the Swiss Department of Defense to provide the Swiss Armed Forces with an army-wide tactical mobile software-defined radio network solution. The contract followed the election at the end of 2019 after a rigorous evaluation which found that our systems provide a better price-performance ratio over the competition. In November we received a contract from the Spanish Army to supply E-Lynx software-defined radios for the combat battalion of the Spanish MOD. The new radio network for the battalion level is a first step in the Spanish combat radio network modernization program. Elbit will supply hundreds of radios for both dismounted soldiers and combat vehicles. The selection of the E-Lynx static radio followed competitive technical and field evaluation by the Spanish MOD. Elbit Systems UK, our British subsidiary was awarded a $137 million contract from the UK MOD in January to provide the British Armed Forces with a future target acquisition solution for joint terminal attack controllers and fire supporting under the dismounting joint fires integration of the DJ Fire program. Elbit Systems UK’s DJ Fire Solution is a network target acquisition solution that acquires and communicates target information to artillery and close air support for effective engagement of precision and non-precision fires. The solution is employed by AI and will interface with the radio systems of the British Army, Royal Air Force, and Royal Navy. In December 2020 and January 2021, we received three contracts from the Dutch MOD with a cumulative value of $89 million to supply all the Royal Netherlands Army with software-defined radios, command and control systems, night vision systems, and tactical computers. We believe that militaries around the world are keen to expand their cumulative and training capabilities to provide more realistic training that better prepares personnel for a wide range of scenarios at lower costs. In January, we were selected by the Hellenic Ministry of National Defense to establish and operate the International Flight Training Center of the Hellenic Air Force. It’s part of an agreement between the defense ministries of Israel and Greece following an international competitive tender. The contract award is contingent on completion of negotiation with the Hellenic Ministry of National Defense. In January, Elbit Systems UK was awarded a $166 million contract - a 12-year contract for the UK MOD for the Royal Navy Future Naval Training Program as part of the Fisher consortium led by Capita. Elbit Systems UK is a provider and integrator of training solutions for the consortium and will develop a new combat system operator training program in the future submarine school and modernize and manage legacy synthetic training systems across the Royal Navy. In November, we were awarded a $96 million contract to supply a European country with a Rotary-Wing Mission Training Center and support services to train its Air Force, Army, and Navy helicopter pilots and crews. Elbit Systems was a pioneer in the unmanned aircraft market and we supply about 80% of the Israeli Defense Forces unmanned aircraft systems or UAS. Elbit Systems US has accumulated decades of service and has been selected by more than 30 different customers across five continents. As this technology has matured we have upgraded our offering and now supply integrated fleets of UAS and platforms like the Helmet Mounted StarLiner that will be certified to operate in civilian aerospace. In December, the Canadian Government selected the StarLiner to support maritime environmental protection missions in the Arctic and along the Canadian Eastern and Western Coast. In March, we were awarded a $300 million five-year contract to provide Hermes 900 Unmanned Aircraft Systems, subsystems, as well as maintenance and support services to a country in Asia. We are also transitioning our autonomous system technology and experience to the land and naval domains. Our civil unmanned surface vessel or USV is operational with the Israeli Navy, and generally we received a contract to supply civil USVs to the navy of a country in Asia-Pacific. Under the contract, Elbit Systems will provide civil USVs that are specifically configured to perform mine countermeasures missions, while facilitating the option to integrate antisubmarine warfare technology models. Elbit Systems has a large portfolio of solutions for armored vehicles and tanks including manned and unmanned turrets, active protection, target acquisition, fire control, and communication systems. Our combat technology demonstrator integrates the latest generation of legacy capabilities and new technologies for combat vehicles. These include our Iron Fist with Active Protection Systems in the RNLA division that provides the crew with a 260-degree vision from inside the vehicle. Generally, we announced a $172 million contract to supply Sabrah Light Tanks to the army of a country in Asia-Pacific. As a prime contractor, Elbit Systems will supply Sabrah Tanks based on general dynamics tank ASCOD platform and/or the wheeled Pandur 8x8 platform manufactured by Excalibur Army from the Czech Republic. Both platforms will be equipped with 105 millimeter targeting ranges of Elbit subsystems including electro-optical sights, fire control systems, TORCH-X battle management systems, and E-LynX software-defined radio systems. The 30-ton Sabrah Light Tank provides a unique combination of powerful fire capacity and high maneuverability. In February, we received a $46 million contract to supply 6X6 Armored Personnel Carriers or APCs to the army of a country in Asia-Pacific. The 6X6 wheeled vehicles were developed by Iveco Defence Vehicles in cooperation with the Brazilian Army. As a prime contractor, Elbit Systems will equip the APCs with turrets and various subsystems from the company. We were contracted by BAE Systems Hägglunds in February to supply Iron Fist active protection systems and electro-optical commander sights for the Royal Netherlands Army's CV90 armored combat vehicles modernization program in a contract worth $82 million. After a long period of investment building our portfolio and expanding our global presence in the naval arena, Elbit Systems is well-positioned to capitalize on the growing demand in an increasingly contested maritime domain. On 23rd December, our U.S. subsidiary, Elbit Systems of America, signed a definitive agreement with Cerberus Capital Management to acquire Sparton Corporation. Sparton develops and supplies electronic sensors that support undersea warfare for the U.S. Navy and Allied Military Forces. The transaction is conditioned on various clauses including receipt of U.S. regulatory approvals. I would like to take this opportunity to invite all of the participants on the call and our shareholders to our Investor Conference on April 6th. The conference will be virtual due to the COVID-19 pandemic. The conference will focus on the long-term trends of the business, including a discussion on growth engines and innovation. In summary, our backlog continues to provide us with good visibility and we continue to see significant potential around the world for our leading high-tech technology solutions. And with that, I will be happy to take your questions. Operator?

Thank you. The first question is from Greg Konrad of Jefferies. Please go ahead.

Good morning. Just to start, I mean, if you could talk a little bit about 2021, I mean, you had a very strong booking year. When you think about the mid single-digit growth target long-term, what type of book-to-bill is required to support it and has there been any change in either duration or makeup of orders that change that dynamic when we think about backlog conversion in 2021?

I would say the following. We do not provide guidance, but the growth in our backlog of more than 10% this year suggests what might happen in the next year and a half to two years. This backlog will be converted into revenues, no doubt about that. In the past, we discussed mid single-digit growth, but the significant growth in the backlog may influence that. However, I cannot specify to what level as we are not in a position to provide guidance on that.

That’s helpful. And then, I mean, you called out the strength in airborne on precision munitions and training and simulation, and kind of the growth in inflected up in Q4, and I know there’s been a little bit of headwinds on the aero structure side. I mean has that business reset higher, were there kind of one-time items or how do you kind of think about the momentum as we look at Q4 growth rate for airborne systems?

We feel very confident about the growth in airborne systems for military platforms, which is reflected in the increasing backlog. There is a small segment of airborne systems related to commercial avionics that did not experience growth in 2020. We reassessed our business lines in this area due to the pandemic, but this segment accounts for less than 5% of our revenues in airborne systems. The military segment is experiencing strong growth.

Okay. And then just last one for me, I mean, in your comments you talked about the phasing of cash flow largely dependent on Israel and you had a very strong Q4, but for the year the receivables were quite a headwind. I mean, is there any way to at least bracket kind of what you are thinking for this year or maybe some of the ranges based on how working capital trends?

Well, as you probably know and we have still spoken about that in the past, cash flow item is a high priority in our management focus. We put a lot of emphasis on creating free cash, and yes, the Ministry of Defense here in Israel is lagging behind to some extent. However, we believe that in the future once things start stabilizing in Israel, the part will also come through. All the other aspects, cash management is a very important part of our focus in the business management.

Thank you.

The next question is from Pete Skibitski of Alembic Global. Please go ahead.

Hey, Rami, and good afternoon.

Good afternoon, Pete.

Given the recent election, it's still early to determine the direction of a governing coalition. Do you have any initial insights into how Israeli defense spending might change today compared to yesterday? Additionally, regarding cash flow, does this provide you with more clarity on MOD payments?

Yes, Pete, as you pointed out, we are still awaiting the final results. Due to the political situation in Israel, there hasn't been an active five-year planning for the IDF for over a year, which has resulted in them owing us some money. However, I am quite confident that they will fulfill their financial obligations, as Yossi mentioned earlier. I believe that once the yield planning program for the IDF is activated, we will begin to see new contracts emerge here in Israel. I am not worried at all about the development of new programs in Israel. We are well positioned to secure new contracts in the near future, and I perceive no risk associated with the outstanding payments; I am completely confident that they will pay us soon.

Okay. That’s very helpful. Thank you for that. And then, just another thing I wanted to get clarity on top level is, we talked the last couple of quarters just about the impact of COVID in terms of slowing travel, slowing business development, signing of contracts, and deliveries. Can you compare the progress you are seeing or not in terms of the ability just to conduct business in a COVID environment and from fourth quarter to maybe extrapolating forward to the first quarter and second quarter? I know it seems like Israel is doing really well with the vaccination. So I am sure that’s helping. But globally there seems to be some issues out there still. So I was just wondering if you could just characterize the ability to conduct business now versus maybe last quarter?

Yeah. Pete, I must say that we do not see any significant impact from COVID on our business. On the contrary, the fact that we have dozens of subsidiaries around the globe is a huge strength to the company. Because one of the reasons to make acquisition programs is, of course, military needs, but there is also another important reason which is to support local economies and create jobs in countries around the globe to deal with the economic crisis and its unemployment levels. The fact that we have dozens of contracts around the globe helps us to continue dialogue with our customers continuously and also to obtain new contracts to support their local defense needs as well as their local economic requirements. So we see a lot of potential. We don’t see any issues with the supply chain. We had some issues in the second quarter last year when it just started, but we overcame them quite quickly, and the funnel of new business for the company is very big, actually it’s the largest we've ever had. So I am quite optimistic about the future.

That’s great. That’s great. Okay. Appreciate the color. Let me just ask one last question and I will get back in queue on Hermes, which seems to be doing very well. You had the big $300 million contract earlier this year? And then also I wanted to just understand, the deal with Canada for the Hermes, is that a lease deal? And then also can you just talk about this arrangement with Korea, KAI? I don’t know if that means the potential for kind of current Hermes sales or development of a new unmanned system, so I just was wondering if you could provide any color there?

Yeah. With Korea and KAI, it's cooperation in the market of UAVs in the country and around, and we are discussing promoting our current portfolio as well as adaptation for local needs. As for the Canadian program of StarLiner, it’s a combination of lease and sale of services.

Okay. Okay. That’s great.

Maybe I will let Yossi elaborate a bit more about that.

It’s a deal that’s combining some elements of lease and sale of services.

Okay. Okay. Understood. Understood. Okay. Last one for me actually and I won’t get back on. But, Yossi, while we have you, I thought you guys did a great job maintaining margin rate in 2020. It seems like in 2021, we will have some additional volume. I don’t know how mix will trend in 2021, but do you have any sense or any color as to how we should be expecting margin rate to trend in 2021? Maybe give us a sense of performance and mix and volume and how that all kind of shakes out?

We do not provide guidance, but there are three factors to consider that could influence that metric. The first is negative; the strong shekel compared to the U.S. dollar affects our labor costs. On the positive side, there are two factors. One is the continuous improvements in operations, including the ERP system, which enhances yields and production costs. The other positive factor is the company's growth, which does not necessarily lead to a proportional increase in overhead costs. When considering all these factors, we would be disappointed if we did not see a positive outcome, but we cannot provide guidance on this matter.

No. I appreciate the color very much. Thanks very much, guys.

Thank you, Pete. I just want to add that we announced the organization of the company a few months ago to increase efficiency, reduce general and administrative costs, and achieve more synergy between the different activities of the company. I am sure it will also help improve the bottom line.

Right. Great. Thank you, guys.

The next question is from David Winters and Liz Cohernour, of Wintergreen Advisers. Please go ahead.

Hi. This is Liz Cohernour. And we have been shareholders for approximately five years and have long admired the company’s management, business models, and disclosures, your sense of responsibility and corporate growth through acquisition, which we know takes some time to integrate everything into what’s going on and I noticed that Elbit is part of two indexes in Israel. A question I have has to do with the difference between that experience and a company in the U.S. that could have far lesser quality management, business, finances, and operations, and just for being part of an index, they seem to have the stock price bounce along and grow upward. Could you comment for me on the difference between the impact of the index or what distinguishes you as I believe a finer company for many others?

Thank you for the question, Liz. It's important to consider the technical aspects of being listed on various indexes across different regions and the eligibility of individual companies. Currently, we are listed on the indexes of the Tel Aviv Stock Exchange, while in the U.S., we are on pure indexes because we do not meet the eligibility criteria for others at this time. However, we remain focused on our business operations to ensure we are a strong company, regardless of our inclusion in a specific index.

Thank you. I was just curious. The index seems to be a big driver. But my personal preference is certainly for quality businesses at a good price. So I thank you for your work and for your response.

Thank you very much, Liz.

Thank you.

We have received a question offline from Dina Korshunov from Leader and she would like to know what the status of the integration of IMIs?

The integration is progressing well. I want to remind everyone that the Active Protection Systems, specifically the Iron Fist Active Protection Systems for IMI, have been very successful under Elbit. We are incorporating it into a comprehensive suite of solutions for land forces. In Israel, we secured the competition to provide an active protection system for the IDF's 8x8 vehicle APC, and we've also won contracts in The Netherlands alongside Elbit. This is just one example. We are combining IMI's munition activities with our guidance capabilities from Elbit to deliver guided munitions solutions to our clients. We've achieved significant success in multiple countries, including several in Europe, in providing new guided munitions. Additionally, we are diligently working to consolidate various IT systems into a new ERP system as previously mentioned by Yossi. We are also collaborating with the ministry to relocate part of IMI's production from the central region to the South, where we are establishing new facilities. We recently began construction and aim to move production activities to the South by around 2024. This shift will enhance our profitability and operational efficiency, especially as we invest in new production lines and technologies. Previously, IMI relied heavily on the Israeli market, generating about 80% of its business domestically and 20% from exports. However, after integrating IMI's portfolio and leveraging our global subsidiaries and Elbit's marketing efforts, I'm pleased to report that over 50% of our new business now comes from international markets, including contributions from the U.S. and European countries. I am confident that we will soon reach 80% of exports, in line with the rest of the organization. We continue to enhance the company’s profits and are currently surpassing our initial plans. I believe we will soon integrate IMI's bottom line with that of the company. Overall, I am very satisfied with the integration process.

Thanks. Operator?

There are no further questions at this time. Before I ask Mr. Machlis to proceed with his closing statement, I would like to remind participants that a replay of this call will be available two hours after the conference ends. In the U.S., please call 1-888-782-4291, in Israel call 03-925-5900, and internationally call 9723-925-5900. A replay will also be available on the company’s website at www.elbitsystems.com. Mr. Machlis, would you like to make your concluding statement?

I would like to thank all 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. Yossi and I look forward to speaking to you at our Investor Conference on April 6th. Have a good day and good-bye.

Thank you. This concludes the Elbit Systems Limited fourth quarter and full year 2020 results conference call. Thank you for your participation. You may go ahead and disconnect.