Elbit Systems Ltd Q1 FY2023 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems' First Quarter 2023 Results Conference Call. 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 first quarter 2023 earnings call. On the call with me today are Butzi Machlis, our President and CEO; Kobi Kagan, our CFO; Yossi Gaspar, Senior EVP, Business Management. 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 detailed GAAP financial data as well as the non-GAAP information and the reconciliation in today's press release. Kobi 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 Kobi. Kobi, please?

Thank you, Rami. Hello, everyone, and thank you for joining us today. The financial results of the first quarter 2023 reflect the sustained demand for our leading technological solutions that supported the growth in the order backlog to $15.8 billion, up 15% relative to the first quarter of 2022. I'm encouraged that our operational activities and the cost base are gradually returning to normal, following the supply chain and labor challenges in 2022. We continue to invest in the operational transformation to realize the potential presented by the large funnel of opportunities around the world, and we are on track to deliver an improved performance. We started to report segment information in five segments from the year ended December 31, 2022. In our press releases for the first, second, and third quarters, we will provide revenues by segment and will report revenues and operating income of each segment in our annual report. Revenues by segment in our press releases for the first, second, and third quarters replace revenues by areas of operation that were previously provided. The five portable segments are Aerospace, C4I and Cyber, ISTAR and EW, Land, and Elbit Systems of America or ESA. I will now discuss some of the key figures and trends in our financial results. I would note that the sale of the Ashot Ashkelon to FIMI Opportunity Funds was completed at the end of the second quarter of 2022, and our results in the first quarter of 2023 do not include a contribution from Ashot Ashkelon. First quarter revenues were $1.393 billion compared to $1.353 billion in the first quarter of 2022. In terms of quarterly revenue by segment, Aerospace revenues decreased by 10% in the first quarter of 2023 compared to the first quarter of 2022, mainly due to lower airborne precision-guided munition sales, partially offset by growth of training and simulation sales. C4I and Cyber revenues increased by 19% year-over-year, mainly due to growth in command and control systems sales. ISTAR and EW revenues increased by 17%, mainly due to Electronic Warfare system sales. Land revenues increased by 8%, mainly due to armored vehicle upgrade sales. Elbit Systems of America's revenues in the first quarter were similar to the first quarter of 2022. Our diverse geographic revenue base is important to the long-term sustainability of our business. In the first quarter, Europe contributed 27%; North America, 24%; Asia Pacific, 24%; and Israel contributed 18% of revenues. European revenues increased mainly due to the growth in UAS, munitions, and training and simulation sales. Asia Pacific revenues declined mainly due to lower precision-guided munition sales. Latin America sales increased due to C4I sales. The non-GAAP gross margin for the first quarter was 26.4% compared to the first quarter of 2022 at 24.6%. GAAP gross margin in the first quarter was 25.9% of revenues compared to 24.2% in the first quarter of 2022. GAAP and non-GAAP gross margin in the first quarter of 2022 included approximately $20 million of expenses related to the stock price-linked compensation plan. First quarter non-GAAP operating income was $105 million or 7.5% of revenues compared with $66 million or 4.9% of revenues last year. GAAP operating income for the first quarter was $94 million or 6.7% of revenues versus $59 million or 4.3% of revenues in the first quarter of 2022. The operating expense breakdown in the first quarter was as follows: Net R&D expenses were 7.9% of revenues versus 7.4% in 2022. Marketing and selling expenses were 5.8% of revenues versus 6.4% last year. G&A expenses were 5.5% of revenues compared to 6.2% last year. GAAP and non-GAAP operating profit in the first quarter of 2022 included expenses of approximately $35 million related to the stock price-linked compensation plan, which, in the first quarter of 2023, were not material. Financial expenses were $24 million in the first quarter compared to financial income of $1 million in 2022. Financial expenses in the first quarter reflect the higher interest rate environment. Financial expenses in the first quarter of 2022 included gains from changes in the fair value of financial assets and exchange rate differences. We recorded a tax expense of $9 million in the first quarter compared to a tax expense of $8 million in 2022. The effective tax rate in the first quarter was 12.8% compared to 13.8% in 2022. Our non-GAAP diluted EPS was $1.70 in the first quarter compared with $1.22 in 2022. GAAP diluted EPS was $1.40 for the first quarter compared with $1.19 in 2022. Our backlog of orders as of March 31, 2023, was $15.8 billion, $2.1 billion higher than the backlog at the end of the first quarter of 2022. Approximately 54% of the current backlog is scheduled to be performed during '23 and '24, and the rest is scheduled for '25 and beyond. Operating cash flow for the first quarter was a $73 million outflow compared to a $35 million inflow in the same quarter last year. The Board of Directors has declared a dividend of $0.50 per share. I will now turn the call over to Mr. Machlis, Elbit's CEO. Butzi, please go ahead.

Thank you, Kobi. I'm encouraged by the financial results in the first quarter, the strong demand, and the large funnel of opportunities and a series of significant contracts booked since the end of the first quarter. Over the last three years, we have experienced the challenges of COVID-19, supply chain disruptions, and changes in the labor market. Elbit Systems has demonstrated its resilience through this period and the remarkable ability of our employees to deliver and support our customers during a very volatile period. There is still work to do to complete the operational transformation we presented at our Investor Day in March. I believe the first quarter results provide confidence that we are on track to deliver the transformation. Elbit Systems is benefiting from the healthy demand for artillery solutions from countries and militaries around the world that have started to implement the lessons learned from the Russia-Ukraine conflict, including the critical importance of effective indirect fire. We also continue to receive orders from legacy customers. Elbit Systems has developed a comprehensive portfolio of systems and solutions for artillery forces. The portfolio includes howitzers, mortars and rocket launchers, munitions, flight control and command control systems, target designators, UAVs, and range systems. We provide this to our customers as tailored solutions or as standalone systems. A few weeks ago, on May 18, we announced a $305 million five-year contract to supply 20 Precise & Universal Launching System or PULS rocket artillery systems, as well as rockets and missiles of various ranges to the Royal Netherlands Army. The PULS system can launch both fully flying rockets and precision guidance mortars and missiles with ranges of up to 300 kilometers. The PULS launchers can be mounted on a broad range of wheeled and trucked platforms, providing a significant reduction in maintenance and planning costs. The Dutch contract follows rocket artillery contracts from two European countries we received during the first quarter. In 2022, German defense company KMW signed a cooperation agreement with Elbit Systems Land and Elbit Systems Deutschland to develop the Euro-PULS next generation of European long-range rocket artillery. This agreement will enable both companies to address the growing potential in the European market for this solution. In April, we were awarded a $102 million eight-year contract to supply a battalion of ATMOS 155 millimeter truck-mounted howitzers to an international customer. The ATMOS is a combat-proven wheeled howitzer designed for artillery deployment and operations, enabling the provision of fire support for a broad range of missions. In May, the Rheinmetall and Elbit team conducted a live-fire demonstration of an automated 155-millimeter wheeled howitzer in Southern Israel. This demonstration was part of the cooperation agreement we signed with Rheinmetall in 2022 to develop, market, and manufacture European automated wheeled self-propelled howitzers. The solution combines and leverages the technological capabilities of both companies and will provide a mature and relevant solution for NATO armies that are planning to recapitalize and expand their artillery force. Elbit Systems provides a broad portfolio of market-leading solutions for warfighters in all domains, in the air, underground, and at sea, from a single soldier to large formations and headquarters. Our simulation solutions provide more realistic training that better prepares soldiers for a wide range of scenarios at lower cost. In May, our British subsidiary, Elbit Systems UK, was awarded a $71 million contract by the UK MOD to provide, maintain, and operate the Ground Manoeuvre Synthetic Trainer systems or GMST for the British Army's Boxer armed vehicle and Challenger 3 tanks. The contract will be delivered over three years with an additional nine-year period of operation and maintenance service at UK facilities. A few weeks ago, we marked a significant milestone for our Hellenic International Flight Training Center contract with the arrival of the first two M-346 aircraft at the International Pilot Training Center in Kalamata. The M-346 aircraft are equipped with Elbit Systems' integrated virtual avionics that simulate combat and flight scenarios to enhance the pilots' training experience. The Hellenic Flight School contract is on track and delivering as planned. At our recent Investor Day, we discussed the investments we are making to upgrade and expand our contractual footprint as part of the transformation of our company to enable our internal target of revenue between $6.5 billion and $7 billion and operating margins around 10% in the future. In May, we opened our new manufacturing facility in North Charleston, South Carolina. The new facilities will employ hundreds of people and assemble large vehicle systems for the United States Military and Allied Nations, including the mission command platforms for the U.S. Army's CPI2 program and the Sigma howitzer system for the Israeli Defense Forces. Construction of our new ammunition production site in Ramat Beka is on track, and it should be up and running by 2024. The new state-of-the-art facility will benefit from the growing demand for munitions. Last week, thousands of Israeli employees volunteered during Elbit Talk, which means they are doing good at Elbit to contribute and give back to the local communities. During this year, during Elbit's Talk Week, our employees contributed more than 3,000 hours volunteering in dozens of projects around the country, with Holocaust survivors, the elderly, as well as youngsters who need a helping hand. I'm proud to see the enrollment of thousands of Elbit Systems' employees around the world that volunteer to participate in activities that benefit our community. And with that, I will be happy to take your questions.

The first question is from Sheila Kahyaoglu of Jefferies.

Just wanted to ask a little bit deeper into the segments, if you don't mind, the Aerospace sales to start with, maybe were down 10% year-over-year, I believe. Is this the precision guided munition headwind related to a single program? And how do we think about sort of that return to growth there?

The answer to the question is a reduction in airborne precision-guided munition sales that we had in the first quarter of 2022. Due to program mix, we didn't have that substantial amount of airborne precision-guided munition sales in the first quarter of 2023. This is the main explanation for this decline.

Sheila, I want to add that, if you remember, last time we discussed the different segments, we also highlighted the importance of looking at the entire corporation due to the many synergies between the divisions. One quarter, one division may perform better than others, and various projects can also influence the results. I want to emphasize this point again to ensure you recognize the overall integrated future. I believe this leads to better performance for the corporation.

Okay. Now, that's helpful color. And then maybe if you could just go to Land for a second. Your partners with BAE on OMSE. That program. Maybe if you could just provide us an update on the planning of that program and how you're thinking about the opportunity and next steps in this sort of armored vehicle upgrade?

This opportunity is a tender, and we are participating in it as we modernize with our solution. We are currently waiting for all the decisions. We expect decisions on the GSU regarding the first phase of the project. That is the current status.

The next question is from Atinc Ozkan of Wood & Company.

I have a couple of questions. The first one is, in your previous call, you mentioned that following this transformation over the last couple of years, you are now in a position with infrastructure to support annual revenues of $6 billion to $7 billion with improved profitability. You also mentioned that you believe you will reach 10% operating margin targets soon. Can you elaborate or provide more specifics about when you expect to achieve these levels for both the top line and operating margins? Is this midterm guidance, or do you believe it will be attainable in 2023 or 2024? That's my first question. My second question is, since you will be completing most of your CapEx upcycle with the new ammunition plant in Negev operational next year, and with the South Carolina plant already completed and the ERP investment finished, how do you view your CapEx budget and annual CapEx or revenue trends moving forward?

This is Yossi. In response to your first question, I believe the most telling metric is our backlog of orders, which is nearing $16 billion and growing at a robust double-digit rate year-over-year. Our revenues have increased at a mid-single-digit rate year-over-year thus far. As mentioned previously, we are actively working to narrow the gap between our backlog growth and revenue growth by boosting revenues. According to our press release today, approximately 54% of the $15.8 billion backlog is expected to convert into revenues over the next seven quarters, covering this year and next. With a straightforward calculation, we anticipate revenues in the range of over $6 billion next year, potentially reaching closer to $7 billion within one to two years. This projection is based solely on the straightforward transformation of our backlog. Additionally, as highlighted in our investor meeting, we are taking all necessary steps to enhance our operational capabilities for manufacturing and delivering products to our customers across various global facilities, with some already completed and others slated for completion in 2023 and 2024. This progress will enable us to achieve our goals. By focusing on revenue growth while managing overhead and general administrative expenses, we expect to return to the operating profit levels we experienced several years ago. This addresses your first question. For your second question, I will pass it over to Kobi for a response.

Thank you, Yossi, and hello, Atinç. As Yossi mentioned, we are in the process of building our infrastructure to turn our backlog into revenue, which requires capital expenditures. Specifically, the South Carolina facility is nearly finished, and we have begun operations there with most of the investment completed. The ERP investment is also nearing completion, and we anticipate that the last major division will go live on July 1st of this year. We are continuing our capital expenditures on the ammunition plant in the Ramat Beka-Negev Desert in southern Israel to facilitate the relocation of facilities from the Ramat HaSharon site to the Negev site. Consequently, we expect a modest decrease in capital expenditures as we finalize the ERP system, but we are continuing to invest heavily in our production capacity to convert the backlog into revenue.

Okay. Crystal clear. And I may follow up just with a very short question regarding the Aerospace segment. I do remember that you guys have now additional capacity put into operation in your production line for drones in Israel. Is it possible to basically tell us what the waiting line is if a client comes and orders you? I don't know, does no drones right now. Just to give you an example from your unlisted peer in Turkey, Baykar has now a three-year waiting line for drones. I'm just trying to have an idea whether you have the same kind of bottleneck.

Kobi just alluded. We are expanding our production facility, our production capabilities for UAVs. We are building a new facility right now in the City of Modi'in, which is not far away from Jordan and Israel. This is on top of the facilities we already have. This facility should go live by the end of this year, which will enable us to meet the growing demand for UAVs that we are seeing all around the globe, and to enable us also to deliver to our customers in a relatively short period of time.

The next question is from Ella Fried of Bank Leumi.

I have actually a few. And the first question is, what was the reason for inventories going up? I mean, it could be future growth, rising prices of materials, fly delays? Or it means investment in long-term projects?

This is Yossi. As we mentioned during our investor event, we are planning for this year, 2023, to design each quarter to convert our backlog into revenue by increasing sales quarter-over-quarter. To meet the backlog for 2023, we needed to purchase raw materials and invest more in our operations, which we began doing in the first quarter. This aligns with our strategy to have those inventories ready to generate revenue in 2023 and into 2024. This approach will help us build the additional revenue we are anticipating in the upcoming quarters.

We should view this as a positive sign. I have a few more questions. In about two and a half weeks, you're heading to the Paris Le Bourget Air Show, and you're likely to come back with even more orders and a significantly larger backlog. Following up on the previous questions, how do you intend to manage this growing backlog in the short and medium term? It seems you'll be receiving numerous orders and attempts to place orders. Will you be accepting more of these orders like leading American companies, or are you considering any other strategies? Do you have the capacity for increased outsourcing?

Thank you, Ella. Butzi. You are right. We see a growing demand for our products and systems and we see a very big funnel ahead of us. And that's exactly why we took the decision to invest to enhance our facilities in Israel at Tel-Aviv port. Just to remind all of us, we are expanding our new land facility here in the north part of Israel to port more Land Systems revenues. We expanded our radio facility in the north part of the country in order to support growth and revenues of the C4I and Communication Equipment division. The same we did also at Rehovot in order to support more revenues coming from our ISTAR division. We mentioned already the new UAV facility we are building these days, and we are going to unveil it by the end of this year. And that's on top of the much better investments, which we started to build three years back and will go live next year. That's only in Israel, a broad new facility in the UK, in South Carolina, a new facility in Bristol, UK, which we are going to know of very soon. A new facility, which was another Elbit already in Germany to deliver more equipment to our European customers. So we took into account the growing demand. And we have mature products. We are local in our markets via the dozens of subsidiaries we have all over Europe and more around the globe. And we will be able to take more orders from the growing demand that we see, and to convert it in a relatively short period of time to revenues and to profit. And because of that, we feel confident to mention the $6.5 billion to $7 billion revenues that we will be able to achieve. This is a level of 10% operating margin.

Well, it sounds like lots of work. And I have another follow-up question. Does it mean that we should be looking again at your pipeline? I mean, this also calls for some kind of, I don't know, M&A or any kind of new acquisitions pipeline that will help all these workloads?

Yes, the answer is yes. This is not just about the main reasons; there are two key reasons for pursuing mergers and acquisitions. One is to enhance our market position. For example, we decided to acquire a company in the U.S. to strengthen our presence with the U.S. Navy. Similarly, we opted to acquire a vision-related company in the U.S. to bolster our position with the U.S. Army. These are just two examples. One reason is to seek new markets and positions, primarily in the U.S. and Europe. The other type of M&A we are pursuing involves acquiring new technologies. A case in point is our acquisition of Rokar a few years ago in Jerusalem, which introduced new technology to our company. We have demonstrated our ability to execute M&A effectively in the past. We know how to create synergies between the new companies we incorporate into Elbit's existing portfolio and manage them well. Therefore, we are actively looking for more opportunities to expand the company in these two areas. At the same time, we continually review our portfolio to ensure that it aligns with the company's current strategy. For instance, a year ago, we decided to divest Ashot Ashkelon, which was a great company, not because it wasn't a good business, but because it didn't integrate well with our portfolio. We were pleased that FIMI chose to acquire it from us, resulting in a favorable deal for both parties. This process of evaluating our portfolio continues alongside our search for new M&A opportunities to ensure our current holdings match our strategic objectives.

So can you shed a bit more light in both directions or do we have to wait?

I have nothing special to report right now. But I can tell you that we are both working in both directions.

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 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 972-3-925-5900. A replay of this call will also be available on the company's website, www.elbitsystems.com. Mr. Machlis, would you like to make a concluding statement?

Thank you. I would like to thank all our employees for their continued hard work and contribution to Elbit Systems' success. For everyone on the call, thank you for joining us today and for your continued support and interest in our company. Have a good day, and goodbye.

Thank you. This concludes the Elbit Systems Ltd. First Quarter 2023 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.