Elbit Systems Ltd Q3 FY2023 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems Third Quarter 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. I would now like to hand over the call to Rami Myerson, Elbit Systems' VP, Investor Relations. Rami, please go ahead.

Thank you, Joni. Good day, everyone, and welcome to our third quarter 2023 earnings call. On the call with me today are Butzi Machlis, our President and CEO; Kobi Kagan, our CFO; and 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 content 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 main 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 third quarter of 2023 reflect the sustained demand for our solutions and progress in the implementation of our operational improvement plans. Butzi will discuss the implications of the war in Israel in his remarks. The extent of the impact of the war on our financial results will depend on future developments that are difficult to predict, including the duration and scope of the war. We continue to monitor the situation closely. Turning now to results of the third quarter. Third quarter revenues increased by 11% to $1.52 billion compared to $1.34 billion in the third quarter of 2022. In terms of quarterly revenues by segment, aerospace revenues increased by 24% in the third quarter of 2023 compared to the third quarter of 2022, mainly due to training and simulation sales in Europe and UAS sales in Asia Pacific. C4I and Cyber revenues increased by 9% year-over-year, mainly due to radio system sales in Europe. ISTAR and EW revenues were similar to the revenues in the third quarter of 2022. Land revenues increased by 7%, mainly due to artillery and weapon station sales in Europe. Elbit Systems of America revenues declined 2% in the third quarter due to lower precision guided munition sales. Elbit System's diverse geographic revenue base helps to reduce revenue volatility and support the long-term sustainability of our business. In the third quarter, Europe was our largest market, contributing 33% of group revenues; North America was 24%; Asia Pacific 21%; and Israel contributed 15% of our revenues. European revenues increased due to growth in sales of radio systems, artillery, weapon station and training and simulation solutions. Asia Pacific revenues increased mainly due to growth in UAS sales. Israel revenues declined mainly due to lower ammunition sales in the quarter. The non-GAAP gross margin for the third quarter was 24.9% compared to the third quarter of 2022 at 25%. GAAP gross margin in the third quarter was 24.5% of revenues, compared to 24.2% in the third quarter of 2022. GAAP and non-GAAP gross profit in the third quarter of 2022 included approximately $13 million of expenses related to stock price-linked compensation plans. Third quarter non-GAAP operating income was $117 million or 7.8% of revenues, compared to $84.3 million or 6.3% of revenues last year. GAAP operating income for the third quarter was $106.1 million or 7.1% of revenues versus $73.4 million or 5.4% of revenues in the third quarter of 2022. GAAP and non-GAAP operating profit in the third quarter of 2022 included expenses of approximately $22 million related to the stock price linked compensation plan. The operating expense breakdown in the third quarter was as follows: net R&D expenses were 6.9% of revenues versus 8.4% in 2022. The year-on-year reduction in R&D expenses in the third quarter reflects the phasing of projects. Marketing and selling expenses were 5.7% of revenues versus 5.1% last year. The positive inflection in global defense budget growth has created multiple opportunities. The increase in marketing and sales spend will help to realize the potential created by these opportunities. G&A expenses were 4.8% of revenues compared to 5.9% last year. Other operating income in the third quarter of 2022 of $9.4 million included a capital gain related to the sale of a building in Israel. Financial expenses were $36 million in the third quarter compared to $16 million in 2022. Financial expenses in the third quarter were higher as a result of the significant increase in interest rates and higher debt. We recorded a tax expense of $10 million in the third quarter compared to $8 million in 2022. The effective tax rate in the third quarter was 15% compared to 13% in 2022. Our non-GAAP diluted EPS was $1.65 in the third quarter compared with $1.40 in 2022. GAAP diluted EPS was $1.36 for the third quarter compared with $1.26 in 2022. Our backlog of orders as of September 30, 2023, was $16.6 billion, approximately $1.9 billion higher than the backlog at the end of the third quarter of 2022. Approximately 39% of the current backlog is scheduled to be performed during the remainder of 2023 and 2024, and the rest is scheduled for 2025 and beyond. Operating cash flow in the third quarter was an $11 million inflow compared to $178 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. Elbit CEO. Butzi, please go ahead.

Thank you, Kobi. I would like to begin by thanking all Elbit employees and their families around the world for their hard work and dedication in these challenging times. Since October 7th, we have been actively supporting Elbit operations around Israel and our employees deployed in the field. I'm proud of their commitment to all our customers worldwide, and their dedication gives me confidence that Elbit Systems will be able to overcome the challenges we face today and may face in the future. I also want to extend my sincere condolences to the families of our employees who have lost their loved ones during this conflict. The financial results in the third quarter include double-digit revenue growth, a record backlog of $16.6 billion, and improved profitability. Combined with a significant contract for customers worldwide that we've received in recent months reflects the strong demand for our solutions. They also increase confidence in our ability to overcome short-term challenges and deliver on our potential in the longer term. I would like to discuss the impact of the war in Israel, which presents both challenges and opportunities. Elbit Systems is Israel's largest defense company, and we supply a range of solutions to the Israeli Defense Force. These include the Digital Army Program or DAP 750 Command and Control solutions, Electronic Warfare Systems, UAVs, Artillery and Mortar Systems for Main Battle Tanks and armored vehicles, night vision systems, as well as a range of training and simulation solutions for individual soldiers to squadrons and battalions across all domains and more. Our solutions are currently being extensively used by the IDF. We have also accelerated the development of some of our solutions that were still in development and were scheduled to be delivered in the medium or longer term; they have already been sent to the field within days or weeks. We achieved this thanks to the dedication of our employees and our culture of innovation and creativity. We have ramped up production to support the IDF and maintain deliveries to our international customers at the same time. We have increased production capacity at our factories by adding shifts and have properly recruited several hundred additional temporary employees to support the effort. We have implemented all of this at the same time as approximately 15% of our Israeli workforce of 14,000 employees has been called up to serve as reserves in the IDF. We pray for a safe and speedy return of all the hostages and soldiers to their homes and families. I would like to share some of my initial observations from different lands from the regular meetings we conduct with the end users in the IDFs and discuss some of the relevant contracts received in recent months that demonstrate that our international businesses remain solid and continue to grow. The conflict has highlighted the importance of multi-domain warfare that connects processes operating in the air, on the ground, and in space, enabling the transfer of information between them to close the sense of the future cycle rapidly and effectively. Elbit Systems is a market-leading supplier of a range of solutions across the sense of the future cycle that is made up of three major elements. The sensors that collect information, the infrastructure that enables the transfer of information, and the sectors that engage based on the information guidance. Some examples of our capabilities include our ISTAR Division, which provides a range of advanced sensors that operate across the Electromagnetic Spectrum. This sensor collects valuable and actionable mission-critical intelligence and can identify, exploit, and gain intelligence on enemy activity and capabilities. The division also provides advanced targeting and laser targeting solutions. In August, we were awarded a $55 million contract to supply a multi-layered ReDrone Counter Unmanned Air Systems for the Netherlands. The ReDrone System comprises advanced radar system sensors and electro-optical sensor capabilities and Command and Control Systems to protect against the growing drone risk. We continue to see healthy demand for our Night Vision Solutions from customers worldwide, including an announcement from the US Department of Defense for a large Night Vision global contract for ESA's Night Vision business. The information collected by these sensors, which are installed on various manned and unmanned platforms, is distributed around the battlefield by Elbit Systems' C4I and Cyber Advanced Communications and Command & Control Solutions, which create a real-time, multi-domain network warfare environment from headquarters to the front lines. The current generation of the Digital Army Program that we supply to the IDF, the Torch-X 750, enables advanced digital capabilities in the battlefield, with the IDF operating on thousands of our Advanced Software-Defined Radios, allowing for the flow of data. Torch-X 750 connects the forces across multiple domains, enabling the rapid and effective transfer of information, including voice, video, and text around the battlefield for use by decision-makers at all levels of the command chain. In October, Elbit Systems Sweden was awarded a $170 million continued contract to become the integration partner for the Swedish Army Digitization Program, LSS Mark. This contract serves as an important validation of our Command & Control and Military Digitization capabilities. Elbit Systems Land provides a range of solutions to the IDF, including Precision-Guided Munition launched from platforms on the ground, in the air, and in the space. We also supply a range of artillery and tank ammunition. These systems enable the engagement of threats identified by the sensor. In October, we received a $135 million two-year contract from an international customer to establish an artillery ammunition factory. This contract reflects the strong demand for ammunition from countries worldwide and decades of Elbit experience producing a range of artillery, mortars, and tank munitions. In September, we were awarded two contracts from a European country, worth approximately $200 million, to supply a C4I solution to artillery battalions and a Hostile Fire Counter-Attack solution. This solution provides a good example of Elbit's comprehensive center-to-shooter capabilities that help to accelerate the cycle to identify and engage the enemy quickly and effectively with limited collateral damage. We initiated and are implementing our operational improvement plan to support our transformation into a larger, more profitable company. The war in Israel has not changed our long-term plans but has increased our focus on the portfolio and should help us identify capability or technology gaps, as well as those businesses that are less relevant to our strategy. In summary, I am encouraged by the progress in the third quarter as well as the resilience we have demonstrated in overcoming multiple challenges in recent years. I am confident in our ability to overcome the current challenges and deliver on our potential to all our stakeholders: our customers, our employees, and, of course, to you, our shareholders. Before I conclude, I would like to thank our customers and partners from around the world for the numerous expressions of support over the last two months. And with that, I will be happy to take your questions.

Thank you. Ladies and gentlemen, we will now start the question-and-answer session. The first question is from Pete Skibitski of Alembic Global. Please go ahead.

Yes. Thank you. Gentlemen, good afternoon, and I hope you and your families are safe and doing reasonably well during what I'm sure is a very difficult time to start out.

Thank you, Pete. Thank you.

Yes. Maybe to start with Kobi. Kobi, can you talk more about the third quarter gross margin in particular? I know last year you had the stock compensation expense that impacted gross margin. This year, I think you expected second half margins to be better. So maybe you could just walk us through what impacted the third quarter gross margin, and if you expect fourth quarter to see a higher gross margin?

Yes. Thank you, Pete. I will talk about – I think there are four layers to the answer. The first one is that we are still in the implementation phase of our operational improvement plan to support our transformation. And that plan includes the ERP effort and multiple investments that are still going on, and we will see the continuation of the improvement of our profitability at the GP and OP levels. The second part is, of course, project mix that you have each quarter. The third issue is that we think it’s more relevant to look at three quarters and not just one specific quarter. I mean, if you look at the three quarters from the beginning of 2023, you see that if we deduct the stock price-linked compensation plans, we keep the same GP level and even a bit better. And the last issue is that when we are discussing prices of products and systems, of course, there are a variety. We are a very diverse company with a lot of projects, systems, and products, and that creates, of course, a different environment of prices that we can get from the market. So we think that we are on plan. With the GP, we see significant improvement at the operational expenses level and therefore, we keep the trend of improved profitability altogether.

Okay. And just to follow-up financially. Do you expect to be free cash flow positive in the fourth quarter?

As Butzi discussed previously, and as we disclosed, we are expecting the government of Israel, the Ministry of Defense to pay fully their due payments in all of our receivables in the fourth quarter. So certainly, we are expecting a positive Q4 cash flow-wise, and we are sure expecting to be fully paid by the government of Israel.

Okay. And then maybe one last one for me, and I'll get back in queue for Butzi. Butzi, I don't know if you have a chance to examine this potential supplemental funding request for Israel that has passed through the US House of Representatives. It's about $14.5 billion. I don't know a lot of the line items, but I have heard there's funding for iron beam, for instance, in there, amongst other items. So I'm just wondering, I guess, have you had a chance to gain some view of what's in there, and would you expect that to be meaningful to Elbit, if that passes?

Yes, we have an intimate dialogue with our government, with the Ministry of Defense, regarding this package, and certainly, I will not go into all the details right now, but I can tell you that we expect to get a part of it. As you know, we have Elbit Systems of America, which produces different systems and products that the IDF uses with SMS funds. So it's a big opportunity for us, and we expect to benefit from this package as well.

Okay. Yeah, I mean your backlog, I guess, year-to-date backlog is up 9.5%. And that is really before, of course, this potential supplemental impact and any increased Israeli, you know, Ministry of Defense funding. So it sounds like maybe all the extra capacity that you've been building is – it was good foresight, I guess, is the way to say it. So thanks guys. I'll get back in queue.

Thank you very much. Thank you.

The next question is from Ella Fried of Bank Leumi. Please go ahead.

Good afternoon. Thank you for taking the questions. First, I would like to congratulate you on the growth of revenue in this quarter, mainly on the way the company is functioning at this time. I think as citizens, we are all very impressed by it. It was good to hear how you are coping with the reality creatively and efficiently. I have a few questions. The first question is about the focus that you mentioned on the portfolio that you are evaluating, maybe from the M&A perspective, potential either buying or selling of capabilities, which makes a lot of sense when the company is growing at this pace. Could you give us some more details about this process?

You know, it's an ongoing process that we have in the company to explore the portfolio we have to ensure that we have the right portfolio to add more capabilities based on M&A opportunities and to divest from some businesses that are less relevant. We see many opportunities for the company in the near and medium future, not just in Israel but also in many other locations. We have a process in place, and this process is ongoing. We made very good acquisitions in the US a few years back, and I was very happy to hear yesterday, as I mentioned earlier, that Night Vision received unit contracts in the US to provide night vision equipment to the quarter. That's a very good example of an acquisition we made, so we continue to look for opportunities to make additional acquisitions and potentially exit some of the businesses we have that are less relevant. IMI is another good example. As you all remember, we acquired IMI in 2018, and today it is a completely different company. We have combined many elements from Elbit into the Land division. IMI is just one of them. We combined our technologies and guidance capabilities, which came from another part of the organization. So together, we have a very strong vertical organization providing a variety of guided munitions, not just to Israel but to many other customers, and we see huge potential for that. So that's another example of a good acquisition we made in the past. We continue to explore the portfolio, look for opportunities, and adjust the company accordingly.

Okay. Are you mainly looking outside Israel, or do you seem to have interest in everything that is appealing locally?

We are talking about acquisitions. When we are discussing acquisitions, we usually look for two elements. One is new technologies that we still require, Rokar, which we acquired from BAE, is a good example of that. It was a relatively small acquisition, but it brought us technology we didn't have, specifically related to immune GPS technology. This is one type of acquisition. We are looking for another. New market provisions in new markets like the acquisition we made of Night Vision in the US, which brought us into new technology as well as new markets that we didn't occupy before. Maintaining a strong portfolio within the company is critical since it has grown considerably, and we need to ensure that we have the right capabilities for current and potential M&A opportunities.

Okay. Well, I have another question that is more related to Kobi. Is the high percentage of mobilization among the workforce going to have a positive impact on the profitability of the quarter from your perspective?

First, Ella. Hi, Ella. Thank you for your kind words since the beginning. We really appreciate your compliments. Regarding the mobilization, we have currently 15% of our workforce in Israel, which is approximately 2,000 employees. We are very proud of them serving our country during these difficult times. And of course, that level creates some disruption, which I addressed in my previous remarks, as we are hiring temporary employees, and some retired employees have happily come back to support the effort. So, we don't think this will contribute financially. We didn’t select the 2,000 employees that were mobilized, so part of those are from the production, while part are from engineering, etc. Overall, it does not provide a financial contribution.

Okay. Thank you very much for answering my questions.

Thank you, Ella.

The next question is from Shahar Cohen of Yosi Capital. Please go ahead.

Hi, guys. Did you get any more clarity about the long-term projects within Israel? Additionally, are sales going to the Israeli Defense Forces registered within the Israeli segment, or do they go through the American facility that goes to the US in your report? Lastly, if you could speak about the potential of Sayyad in other markets given the successful implementation and proven battlefield results we see with, that would be great.

Hey, Shahar, it's Butzi. Of course, the IDF is a very important customer for us, and we heavily support their forces. We expect general orders to come from the MOD within 12 weeks, and certainly, we anticipate getting additional notices. Regarding Sayyad, I will just say that we already have several international customers for derivative systems being used in Europe and North America. To the best of my knowledge, we have the most comprehensive solution currently available in the market, and we see lots of potential for that. This system includes radios, networks, applications, training packages, hardware, and much more.

Regarding geographical distribution, when we have FMS sales, they are recorded under Israel.

Got you. One follow-up question. Have you noticed anything practical yet exciting regarding the interest in orders from non-Israeli customers for platform solutions currently being deployed in Israel? Have you observed any significant shift in demand for some of the solutions? If so, which of your solutions has seen a rise in demand outside of Israel due to the conflict?

I think it's too early to speak about the results of the war and better management afterward. We are still very much involved in supporting the process. Of course, when this war is over, we'll be in a better position to learn and understand more. Our solutions and systems are heavily used by the forces. To the best of my knowledge, the operators recognize the importance of the solutions we provide. After the war, we will be able to sit down with our customers and analyze what else needs to be done, and we will share this data with them.

Got you. And one last, if I may squeeze, the margin of your rush orders you are currently receiving from Israel, are they below 1.5 or above your usual margins? I'm talking about gross margin.

We don't see any different level of margins in the rush orders, so we don't see any difference there.

All right. Thanks.

Thank you, Shahar.

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 concludes. In the US, please call 1888-782-4291. In Israel, please call 03-925-5900. For international calls, please dial 9723-925-5900. A replay of the call will also be accessible on the company's website. Mr. Machlis, would you like to make your concluding statement?

I would like to thank our employees again for their hard work and dedication. 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. third quarter 2023 results conference call. Thank you for your participation. You may go ahead and disconnect.