Earnings Call Transcript - ESLT Q1 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems First Quarter 2022 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 the call to Rami Myerson, Elbit Systems Investor Relations Director. Rami, please go ahead.

Rami Myerson, Investor Relations Director

Thank you, operator. Good day, everyone, and welcome to our first quarter 2022 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 and 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?

Kobi Kagan, CFO

Thank you, Rami. Hello, everyone, and thank you for joining us today. It is both an honor and a privilege to present Elbit Systems' first quarter results to you today. I would like to thank Yossi Gaspar for results in recent months. Yossi has retained responsibility for capital markets and investor relations. I look forward to meeting with Elbit Systems investors and analysts over the coming weeks and months. The first quarter results reflect a healthy market environment for Elbit Systems and sustained demand for our solutions from customers around the world. Revenue growth in the quarter was primarily due to the fulfillment of orders received in previous years and the Sparton acquisition. The Russian invasion of Ukraine last February and proposed budget increases didn't have a material impact on order intake or revenues in the quarter. Profitability in the quarter includes a sharp increase in expenses related to employee stock price-linked compensation plans. These plans help align employee compensation with share price performance, incentivizing our employees to generate long-term value for all of Elbit Systems' stakeholders. Our GAAP and non-GAAP results have always included these expenses. In the first quarter, compensation expenses were significantly larger than normal following the appreciation in the share price after the Russian invasion of Ukraine, reducing profitability in the quarter, as noted in our fourth quarter and full year 2021 results press release published on March 29, 2022. Assuming a decline in share price volatility, we expect that these stock price-linked compensation expenses to return to historic levels. I will now highlight and discuss some of the key figures and trends in our financial results. First quarter revenues were $1.353 billion, an increase of 21% year-over-year. A major part of the growth was organic in addition to the contribution from Sparton, which was acquired in the second quarter of 2021. In terms of revenue breakdown across our areas of operations, airborne systems accounted for 37% of total revenues and increased year-over-year mainly due to airborne precision guided munition sales. Land system sales accounted for 22% of total revenues, a similar level of revenues to 2021. C4ISR makes up 29% of revenues increased year-over-year, primarily due to the acquisition of Sparton and unmanned system sales. Electro-optics accounted for 9% and other sales accounted for 3% of revenues. Our diverse geographic revenue base is important to the long-term sustainability of our business. In the first quarter, North America contributed 27% of our revenues, Asia Pacific 30%, Israel was 21%, and Europe 19%. Asia Pacific revenues increased mainly due to sales of precision guided munitions and UAS. The growth in European revenues was primarily due to the training and simulation phase. The non-GAAP gross margin for the first quarter was 24.6% compared to the first quarter of 2021 at 25.6%. GAAP gross margin in the first quarter was 24.2% of revenues compared to 25.2% in the first quarter of 2021. GAAP and non-GAAP profit in the first quarter include approximately $20 million of expenses related to the stock price-linked compensation plan. The first quarter non-GAAP operating income was $65.8 million or 4.9% of revenue compared with $92.9 million or 8.3% of revenues last year. GAAP operating income for the first quarter was $58.6 million versus $83.8 million in the first quarter of 2021. GAAP and non-GAAP operating profit in the first quarter included expenses of approximately $35 million related to the stock price linked compensation plans. The operating expense breakdown in the first quarter was as follows: net R&D expenses were 7.4% of revenues versus 7.5% in 2021; marketing and selling expenses increased to 6.4% of revenues from 4.6% last year due to the Sparton acquisition and the stock price-linked compensation expense; G&A expenses were 6.2% of revenue compared to 5.5% last year due to stock price-linked compensation expenses; other operating income includes a capital gain of $3.7 million related to the disposal of a non-core business; financial income was $1.1 million in the first quarter compared to financial expenses of $200,000 in 2021. We recorded a tax expense of $8 million in the first quarter compared to $10.8 million in 2021. The effective tax rate in the first quarter was 13.8% compared to 13.4% in 2021. Our non-GAAP diluted EPS was $1.22 in the first quarter compared with $1.72 last year. The GAAP diluted EPS was $1.19 compared with $1.64 last year. The stock price-linked compensation expenses in the quarter were equivalent to approximately $0.72 on an EPS basis. Our backlog of orders as of March 31, 2022, was approximately $13.7 billion, $1.9 billion higher than the backlog at the end of March 2021, and at a similar level to the backlog at the end of 2021. Approximately 55% of the current backlog is scheduled to be performed during 2022 and 2023, and the rest is scheduled for 2024 and beyond. The percentage of shorter backlog declined in recent years following the receipt of more long-term contracts, improving our visibility for future revenues. Operating cash flow for the first quarter was a $36 million inflow compared to a $30 million outflow in the same quarter last year. The Board of Directors declared a dividend of $0.50 per share for the first quarter of 2022. I will now turn the call over to Mr. Machlis, Elbit's CEO. Butzi, please go ahead.

Butzi Machlis, CEO

Thank you, Kobi, and good luck. Growth in the first quarter reflects the strong demand for our solutions from customers around the world. As Kobi mentioned, growth in the quarter does not include the impact of the Russian invasion of Ukraine or the proposed increase in defense spending by NATO countries. In recent months, we have witnessed a noticeable increase in our peers and incoming inquiries as militaries look to equip themselves with a range of Elbit's capabilities. We believe many of these will convert to orders and revenues over time. I expect elevated geopolitical tensions and growing defense budgets will support the improved momentum in the businesses over the coming years. I would like to share my perspective on the profitability and compensation expenses in the quarter. Elbit Systems' 19,000 employees are one of the company's most important assets. We continue to invest in recruiting, retaining, and motivating a high-quality workforce to realize the long-term potential of Elbit Systems. I believe it is important to align employee compensation and incentives to the share price to encourage long-term value creation for all stakeholders. We continue to work on a range of efficiency plans as we have discussed with you in the past as part of our effort to improve profitability and cash generation. Turning to recent geopolitical developments, the Russian invasion of Ukraine was the wake-up call for many countries. I expect it to be a turning point for European and global defense spending. Elbit Systems has invested in a broad portfolio and global footprint and is well positioned to benefit from the faster defense budget growth proposed by governments in Europe and in other parts of the world. Elbit Systems has a global footprint of multiple operational subsidiaries that are an integral part of the domestic defense ecosystem in the home countries. They employ hundreds of local employees and support domestic supply chains. I expect that our subsidiaries will benefit from the increase in defense budgets in the home countries as governments look to invest the increased funding in supporting the domestic defense industry. Our investment in R&D as a percentage of sales is higher than many of our peers to ensure we can provide a portfolio of technologically advanced cost-effective solutions to our customers. Elbit Systems has demonstrated that it can leverage the significant operational experience of our engineers, most of them veterans with significant military experience, many of them continue to serve and they’re often using Elbit's products and systems. This provides a valuable short feedback loop between the field and lab. The current conflict has highlighted the relevance of our portfolio. I would like to provide a few examples. Elbit Systems provides a broad range of systems that protect aerial, naval, and ground platforms from a range of threats. We provide electronic warfare systems for air platforms like the missile warning system for the US Air Force Air National Guard systems. In May, we were selected by Airbus to supply J-MUSIC DIRCM systems for the A330 MRTT aircraft of the European Air Force. Our DIRCM system defends military and commercial aircraft from ground-to-air missiles. We also supply chaffs and flares for a range of aircraft. The Iron Fist Active Protection System has been selected by Israel, the Netherlands, Australia, and the US to protect armed vehicles from a range of incoming strikes. Last year, the UK MoD Navy selected Elbit Systems UK to provide electronic warfare systems that will help protect all navy ships. We expect an increase in demand for unmanned systems as a result of the conflict. Elbit Systems has a broad portfolio of unmanned aircraft. The IDF recently unveiled its new explore and attack companies that will incorporate Elbit Systems drones to identify and designate targets at the final level. A few months ago, with the Hermes Starliner, we became the first unmanned aircraft certified for commercial airspace. The conflict highlighted the need for advanced command and control systems that enable combined forces operations by connecting intelligence, maneuvering forces, and logistics across multiple domains. Our C2 system incorporates intelligence gathered by a range of sensors, utilizes AI to identify targets, and connects to the relevant defector, shortening the sensor-to-shooter loop and helping our customers to engage targets quickly and efficiently. Our command and control systems are in service with customers, including Israel, Sweden, the Netherlands, the UK, and the US. These are just a few examples, and I believe there are many other products and systems in Elbit Systems' portfolio that will benefit from increased demand as militaries around the world apply the lessons learned from the conflict in Ukraine. I would like to reiterate Elbit Systems' commitment to environmental, social, and governance best practices. At our recent Investor Day, we highlighted the investments we are making to reduce our environmental footprint. We are also introducing electric vehicles for our employees after a very successful rollout of hybrid vehicles a few years ago. We are rolling out a solar field at our new facility in the south of Israel and PV panels on the roofs of buildings around the world. We are also connecting sites to natural gas to reduce emissions. We are investing in R&D to develop solutions that will help reduce fuel consumption and emissions. One example of this R&D is our training and simulation systems that help reduce the flying hours required to train a pilot. I am proud to see the involvement of thousands of Elbit Systems employees around the world in activities that benefit their communities. Last week, more than 70 Elbit employees organized, hosted, and monitored a Hackathon to develop tools that protect children from violence on social media. I visited the Hackathon, and was impressed to see how our employees leveraged Elbit's innovative and interconnected culture to develop tools to protect our children online. And with that, I will be happy to take your questions.

Operator, Operator

The first question is from Scott Forbes of Jefferies.

Scott Forbes, Analyst

How are you kind of seeing demand signals come through as we think about the opportunities stemming from what's happening in Eastern Europe, particularly as we start to get some clarity on NATO budgets? I mean, what do you see as really the largest areas of opportunity, whether that really be from a product perspective or more geographical?

Butzi Machlis, CEO

It's a combination. And I would say that we see, in Europe, growing demand for solutions to protect platforms and to protect sites, which includes the electronic warfare solution, DIRCM system, active protection system, chaffs and flares, and more. We also see growing demand for our UAVs, for command and control systems, for intelligence solutions, for cyber protection systems, and also for guided munitions, with a growing demand for guided munitions in order to rebuild stocks again in Europe. But this is not just in Europe. We see growing demand also in the US, also in the Far East, to support forces in protecting themselves against China. And actually, we see growing demand here in Israel. We have a budget, we have a five-year planning, and we are also obtaining new programs and contracts in our country. So altogether, we see growing demand for most of our portfolio, and we also see growing budgets and interest almost all over the world. The fact that we have such a wide portfolio and so many subsidiaries in the US, of course, also in Canada, in the UK, in Germany, in Austria, in Romania, in India, in Australia, and many others, helps us to be part of the local supply chain in all of these countries. So the combination of our wide portfolio and large footprint is a strong strategy of the company for many years, and we are taking advantage of it now. We expect to see many more contracts for the company and to continue the momentum we are seeing also in the coming quarters.

Scott Forbes, Analyst

And then just on the US specifically. I mean you've had a chance to take a more detailed look at the FY '23 budget. What were your initial takeaways, and how do you feel your product portfolio aligns with those priorities being shown in that budget?

Butzi Machlis, CEO

I would say that we see a growing demand for naval activity, and the fact we have started right now as part of the Elbit family helps us a lot to participate in this effort. Talking about airborne activities, just to remind everyone that we have systems like helmets and parts of the avionics on each and every certified F-15, F-18, V-22, and F-16, of course, and each Apache. We have a major part on the T-X, the T-7 of Boeing. So we have a strong position on many airborne platforms in the US. We also have many systems to support the ground forces, including laser designators, night vision equipment for soldiers, target acquisition solutions, guided munitions, and active protection systems, all of which are required to support the troops in Europe. So altogether, I believe that we are well positioned to take advantage of the growing need in the U.S. market based on our strong position we have in the U.S. under Elbit Systems of America, which has more than 3,000 employees.

Operator, Operator

The next question is from Ella Fried of Bank Leumi.

Ella Fried, Analyst

When I was offline, I congratulated you on the growth in this quarter, even though it is not necessarily representative of the year. But I hope that it indicates a lot. I would like to ask you about the timeline that you spoke of regarding these opportunities. The things in the defense industry usually move slowly, but there is a feeling that this time, some countries are very keen to get their orders as fast as possible. How much of it do you expect, or expect is a stronger word, how much do you think that will be translated into orders that we will see before the end of this year? Because obviously, next year we'll see a lot of it. But presently, it feels like a lot is going on, but how much of it actually translates into reality that is visible in the near quarters?

Butzi Machlis, CEO

First, I want to remind everyone that you can see in the numbers an impressive growth in revenue, which is prior to the invasion of Ukraine that took place at the end of February this year. What you can actually see in the numbers is a 21% year-over-year increase in revenue. And if you take out the one-time expense we had for the Phantom auction, you can also see growth in the gross profit from approximately $281 million to $347 million and operating profit from $84 million to $94 million. So we see significant growth in revenues and also growth in profit before the invasion of Ukraine. Regarding your question, we see a lot of inquiries and a growing demand for our systems and products. I can tell you that we also see some urgent requirements, which I believe will yield programs and contracts in a relatively short period of time, hopefully, this year. Of course, we also see budgets that will yield results next year as well, but we see that the funnel of opportunities is growing. I believe that part of it will be seen in our numbers in the coming quarters this year.

Ella Fried, Analyst

And I have also a financial question. The gross margins were a bit more solid in this quarter. We know that there are lots of pressures related to currency rates and the supply chains, and a lot of inflation for many other reasons. But can we hope to see this level of above 26% throughout the year, or is it still a hesitant situation? I know that you are doing your best to achieve it, but is it something that we can expect, or do we have to be cautious?

Yossi Gaspar, Senior EVP, Business Management

You know from previous discussions that we are not providing guidance. However, we have improved from previous quarters to this quarter by 0.4% our gross profit, and we have significantly improved our operating profit as well. But one thing I wanted to point out is that in view of what Butzi just mentioned earlier about the increase in the funnel of marketing opportunities, if you look at our results, you will see an increase in marketing expenses. This is not just about spending money. These are two things that are related to one another. When we have marketing opportunities growing, then definitely, the company is spending marketing efforts to catch this new business. So there is a correlation, and these extraordinary expenses in marketing have affected our operating profit to some extent. We want to capture the business. We want to do everything possible to benefit from the positive business environment we are experiencing now. So maybe we have a little bit of a drag on our operating profit because of this element, but no doubt that increasing our backlog and growing the top line will show up in the operating profit and bottom line as well in the future.

Butzi Machlis, CEO

And I also want to add two topics that I believe are important. We continue to work on efficiencies to invest in new facilities. We are building a new facility in the south for Mi. We continue to deploy the new ERP system in the company, which I’m sure will benefit us in the near future as well. And of course, the currency level as it is now is more favorable than it was in the first quarter, which I hope will help us to create more profit in the future.

Operator, 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 US, please call 1 (888) 782-4291. In Israel, please call 039-25-5900. 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 your concluding statement?

Butzi Machlis, CEO

Thank you. I would like to thank all our employees for their continued hard work and contribution to Elbit's success. 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.

Operator, Operator

Thank you. This concludes the Elbit Systems Ltd. First Quarter 2022 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.