Earnings Call Transcript - ESLT Q1 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems First Quarter 2021 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.

Rami Myerson, Investor Relations Director

Thank you, operator. Good day, everyone, and welcome to our first quarter 2021 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 the 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 Gaspar, Chief Financial Officer

Thank you Rami. Hello everyone and thank you for joining us today. The results of our first quarter reflect the sustained demand for Elbit Systems solutions and services from our customers around the world as reflected in the growth in revenues and the backlog. The results also reflect the impact of COVID-19 in the quarter that led to lower commercial aerospace sales as well as lower sales and marketing expenses in the quarter. Companies around the world are gradually opening up following the rollout of COVID-19 vaccines. We continue to monitor the situation closely while adhering to the instructions of the governments of the various countries in which we operate. I will now highlight and discuss some of the key figures and trends in our financial results. First quarter revenues of $1,118 million increased 4.4% year-over-year. In terms of annual revenue breakdown across the areas of operation, airborne systems accounted for 30.7% of total annual sales and increased year-over-year mainly due to precision-guided munition sales. Land system sales accounted for 27% of total revenues, a similar level to 2021. C4ISR at 23% of sales, increased year-over-year primarily due to UAS sales to Asia Pacific. Electro-optics accounted for 9% of total sales and declined year-over-year mainly due to the phasing of Elbit Night Vision programs in the U.S. Other sales were 4.5% of revenues and increased significantly year-over-year due to growth at our U.S. medical device subsidiary. Our diverse geographic revenue base is important to the long-term sustainability of our business. In the first quarter, North America was the largest, contributing 31% of our revenues, Israel was 25%, Asia Pacific 21%, and Europe 17%. The growth in Israel was due primarily to UAS security systems, and Asia Pacific sales increased mainly due to sales of UAS and precision-guided munitions. The decline in North America was primarily due to lower commercial aerospace and night vision sales. The non-GAAP gross margin for the first quarter was 25.6% compared to the first quarter of 2020 at 27.6%. GAAP gross margin in the first quarter of 2021 was 25.2% of revenues compared with 27% in the first quarter of 2020. Lower gross margin in the first quarter reflects the impact of a stronger Shekel versus the U.S. dollar relative to the first quarter of 2020 and the less favorable program mix of revenues. We continue with our long-term plan of cost control measures to help mitigate the financial impact of the stronger Shekel. The first quarter non-GAAP operating income was $92.9 million or 8.3% of revenues compared with $90.4 million or 8.4% of revenues last year. GAAP operating income for the first quarter was $83.8 million versus $80.4 million in the first quarter of last year. Operating margins in the quarter were similar to the first quarter of 2020. Marketing and sales expenses helped offset lower gross margins. The operating expenses breakdown in the first quarter was as follows: net R&D expenses were 7.5% of revenues similar to the first quarter of 2020. Marketing and selling expenses declined to 4.6% of revenues versus 6.6% last year due to the reduced level of travel, marketing support, and trade exhibition expenses. G&A expenses were 5.5% of revenues, similar to last year. Financial expenses were $200,000 in the first quarter compared with $4.5 million in 2020. The lower level of financial expenses was mainly a result of the weakening of the Israeli Shekel versus the U.S. dollar between December 2020 and March 2021. The recorded tax expense was $10.8 million in the first quarter compared with $8.8 million in 2020. The effective tax rate in the first quarter was 13.4% compared with 12.6% in 2020. Our non-GAAP diluted earnings per share was $1.72 in the first quarter compared with $1.62 last year. The GAAP diluted EPS was $1.64 compared with $1.44 last year. Our backlog of orders as of March 31, 2021, was approximately $11.8 billion, $1 billion higher than the backlog at the end of March 2020 and $770 million higher than that at the end of 2020. Approximately 59% of the current backlog is scheduled to be performed during 2021 and 2022, and the rest is scheduled for 2023 and beyond. This ratio is similar to that at the first quarter of last year, though the backlog is equivalent to more than two years of revenues and provides good visibility for future revenues. Cash flow from operating activities for the first quarter was a $13 million outflow compared with a $10 million outflow in the same quarter last year. Cash flow from our investing activities included a $61 million deferred payment for the IMI acquired in 2018. The Board of Directors declared a dividend of $0.44 per share for the first quarter of 2021. I will now turn the call over to Mr. Machlis. Butzi, please.

Butzi Machlis, President and CEO

Thank you, Yossi. Before I review the results, I want to acknowledge the hard work of the thousands of Elbit Systems employees and our suppliers in Israel who have supported our customers during this challenging time. Regarding the first quarter, I am pleased to see growth in our order backlog, which includes many contracts we discussed previously. Revenue and backlog growth this quarter indicate strong demand from our global customers. Increased geopolitical tensions in Europe and Asia Pacific have influenced this demand, as many governments are raising defense spending in response to the COVID-19 pandemic and are opting to invest these budgets domestically. Elbit Systems is well-placed to take advantage of this trend through our multi-domestic strategy and numerous subsidiaries. In April, we secured a $1.65 billion U.S. contract from the Hellenic Ministry of National Defense to establish and operate the International Flight Training Center for the Hellenic Air Force, following our selection in January after an international competitive tender. This contract aligns with an agreement between the defense ministries of Israel and Greece. We will supply new Leonardo M-346 aircraft and maintain the training fleet, which includes M-346 and T-6 aircraft. Additionally, we will provide Embedded Virtual Avionics on the training aircraft, networked flight simulators, and Ground Based Training Stations, along with a command and control system for effective management of flight training operations. We believe that militaries worldwide are eager to enhance their simulator and training capabilities to offer more realistic training at a lower cost. Elbit Systems has developed a strong portfolio of leading training and simulation solutions and has been awarded training contracts in Israel, the UK, and Asia-Pacific over the past year. In April, Elbit Night Vision in the U.S. received a $41 million contract from the U.S. Marine Corps for Squad Binocular Night Vision Goggle systems, part of a $249 million IDIQ contract from September 2019. Elbit Night Vision, which we acquired in 2019, is the sole supplier of these systems to the U.S. Marine Corps. In March, Elbit Systems Deutschland was chosen to provide XACT nv33 Night Vision Goggles for the Special Forces and Special Operation Units of the German Federal Police, which are already used by the German Armed Forces. I am optimistic about generating synergies between our thermal imaging night vision portfolio and the image intensifier night vision business in the coming years. This approach represents the future of advanced systems for night operations, and Elbit Systems is positioned to meet the demand for integrated night vision systems. In April, we completed two acquisitions: Sparton Corporation and Rokar. Our U.S. subsidiary acquired Sparton for $380 million from Cerberus Capital Management. Sparton has developed electronic sensors supporting U.S. Navy and Allied Military Forces undersea warfare. As one of the two suppliers for the U.S. Navy, Sparton will enhance our portfolio of maritime capabilities and integrated solutions, including maritime unmanned systems and electronic warfare solutions. We also acquired Rokar International from BAE Systems for $31 million, a company based in Jerusalem that specializes in high-end GPS receivers and guidance systems for advanced defense applications. I welcome the hundreds of Sparton and Rokar employees to Elbit Systems and look forward to their contributions to our long-term success. In summary, our backlog gives us good visibility, and we see significant growth potential for our high technology solutions globally. I will now be happy to take your questions.

Operator, Operator

Thank you. The first question is from Ellen Page of Jefferies. Please go ahead.

Ellen Page, Analyst

Good morning, thanks for the question. Just wanted to ask about the organic decline in electro-optics. It was weak in H2 2020 as well, and I just wanted to get a sense of when growth might return to that business and how to think about the conversion of the recent $41 million Night Vision contract with the U.S. Marine Corps?

Yossi Gaspar, Chief Financial Officer

Well, we have seen a temporary delay in some of the development processes at Elbit Night Vision. This has been already solved, and so we expect to see the results of that in the revenues of the second quarter. So that is regarding your first question. The second question is just an ongoing multi-year program with over $250 million potential, and we are getting sequential purchase orders. We record in our backlog only the firm funded purchase orders, although in the IDIQ program we are quite certain that all of that will come through during the future.

Ellen Page, Analyst

Okay, thank you. That's it for me.

Rami Myerson, Investor Relations Director

Thanks, Ellen.

Operator, Operator

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

Pete Skibitski, Analyst

Yes, hello Butzi and Yossi and Rami, and good afternoon. I hope everyone's doing well. Butzi, it sounds like the global demand environment is very strong right now. You mentioned Europe and Asia Pacific, was just wondering if COVID is still sort of slowing things down and all. Particularly with India being sort of a COVID hotspot, are you seeing any problems closing deals because of COVID still?

Butzi Machlis, President and CEO

We see an improvement in the overall situation, which is related to COVID all around the world. We are starting to travel and to meet customers. However, in some countries like India and Brazil, for example, it is still difficult to meet customers. Because of that, there are still some delays in delivering programs and concluding contracts. However, I believe that the situation is improving, and in the coming quarters, we will continue to do business as we used to do in the past. I believe that the situation in these countries will improve as well. So it is impacting us, but we certainly see an improvement, and I hope that it will improve in the coming quarters.

Pete Skibitski, Analyst

Okay, understood. And then any color on what drove the sequential improvement in backlog? It looked to be up nicely. I wasn't sure if the Greek deal got booked in the first quarter or if that will get booked into the second quarter?

Butzi Machlis, President and CEO

The $1.6 billion contract we received from the Greek Ministry of Defense is not included in the backlog for the first quarter because we only received it in April. Therefore, it will be reflected in the results for the second quarter. This applies similarly to the two acquisitions we made, Sparton and Rokar, whose results will also be part of the second quarter outcomes and are not included in the first quarter results.

Pete Skibitski, Analyst

Okay, so first quarter was just pure organic backlog growth?

Butzi Machlis, President and CEO

Right.

Pete Skibitski, Analyst

Okay. And then, on the headwinds to gross margin from the Shekel strength, should we expect maybe another one or two quarters of headwind there before things kind of level out? What's the right way to think about that?

Yossi Gaspar, Chief Financial Officer

Hi Pete. We expect this over the year, over the rest of the year to improve our gross margins gradually. We expect to have an improved number in the second quarter. As you know, we do not give guidance, so we'll not say anything about the specific number, but the improvement will come.

Pete Skibitski, Analyst

Okay, got it. I guess Yossi, just a couple more for you. The decline in marketing expenses this quarter was fairly substantial for that particular line. Was that just kind of a one-off spending save there or do you expect that spend to return to kind of that $70 million or so per quarter level or is that more of a permanent kind of a step down in expense for the marketing line?

Yossi Gaspar, Chief Financial Officer

No, this quarter, it was an extraordinarily low number, low travel, low marketing expenses, essentially no meetings face-to-face and no shows, and so on and so forth. So, looking forward, we see that we will catch up on this in the second, third, and fourth quarter, gradually grow over the year. And essentially, I would not be surprised if we come back to the average levels of the 2019 numbers that we have seen in marketing and sales.

Pete Skibitski, Analyst

Okay, okay. Got it. And then just last one from me on the IMI payment that you mentioned in the quarter, is that the last payment for IMI? I had actually modeled a payment in 2022, so I wasn't sure if you had one more left or not?

Yossi Gaspar, Chief Financial Officer

Yes. This payment that you see that we did it in January, initially it was planned to be paid in December. So, it moved a couple of days into this year and the next payment will be towards the end of 2022. It may move also into 2023, but right now it's planned for the end of 2022.

Pete Skibitski, Analyst

Okay, and that's the last one.

Yossi Gaspar, Chief Financial Officer

And that is, yes, it is the last one. There is one item there in our agreement with them that if we have an extraordinary business performance by IMI due until the period of 2026, we might need to do another small payment to the government. Right now, we hope we'll be doing it in the future, but right now it is in the out years.

Pete Skibitski, Analyst

Okay. Understood. Thanks so much for the help guys.

Yossi Gaspar, Chief Financial Officer

Thank you.

Operator, Operator

The next question is from Dina Korshunov of Leader Capital Markets. Please go ahead.

Dina Korshunov, Analyst

Hey guys. Good afternoon. How are you?

Yossi Gaspar, Chief Financial Officer

Good afternoon, Dina.

Dina Korshunov, Analyst

I have two questions. My first question is, if you can tell us a bit about the civil aviation regarding the COVID-19, do you see any recovery in this field?

Yossi Gaspar, Chief Financial Officer

Yeah, well the worldwide expectations and plan right now is that the recovery will be gradual and will come back to the levels of 2019, somewhere in 2024. And that is the overall opinion of most of the analysts in that business area. In our operation in the U.S., we do see some recovery. It is not yet at the rate that shows us significant growth. However, we do see positive numbers compared with what happened during 2020. But we are still planning, our multi-year plan is to be like what the overall expectations are to come back or maybe even grow more than 2019 levels by 2023 or 2024.

Dina Korshunov, Analyst

That makes sense. Thank you. And then the second question can you tell a bit about IMI implementation, what about it, where does it stand?

Butzi Machlis, President and CEO

Hi Dina, we have merged IMI with the land division in Elbit. In this division, we are producing platforms and upgrading tanks while also developing and delivering guided munitions. Recently, we announced a reorganization in Elbit, combining all our guidance capabilities under this new land division. I am confident that this division will become a world leader in providing solutions and platform upgrades for numerous customers worldwide. When we acquired IMI, most of their activities were based in Israel, and I am pleased to report that over 50% of our new business last year came from the international market, thanks to Elbit's marketing capabilities and our subsidiaries. Additionally, we have secured a significant contract for active protection systems both in Israel and the Netherlands. We are also making strides in the U.S. and Australian markets with this system. There is an increasing demand for our new portfolio, and we are working diligently to enhance IMI's margins, making good progress ahead of our acquisition plan. We are also developing new facilities for IMI in the southern part of the country and plan to relocate a large portion of IMI to these facilities around 2024.

Dina Korshunov, Analyst

Alright, I understand. Thank you very much, guys.

Yossi Gaspar, Chief Financial Officer

Thank you, Dina.

Operator, Operator

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

Ella Fried, Analyst

Hey, good afternoon. I have also a couple of questions. The first is what immediate or long-term impact, if any, from the recent operation in Gaza and the results on the local scene and maybe results concerning potential exports, and will it affect in some way to think when bookings from local and foreign customers?

Butzi Machlis, President and CEO

As you know, Israeli customers' needs are a very important customer segment for Elbit, and we have been working with these needs to develop and deliver new systems for many years. And of course, we supported our troops during the operation in Gaza, and I'm happy to say that the solution that we provided was relevant and effective. We continue to develop new technologies and new systems for the Israeli customers and based on the experience we gathered here to deliver these solutions also to other customers. If I touch on one area, which is very relevant and even more relevant than ever, is the high-power laser that we are developing for the Israeli Ministry of Defense. High-power laser technology has seen a breakthrough. We believe that we can provide a solution to protect Israel as well as our other customers against missiles and rockets via high-power laser. The Israeli Ministry of Defense has chosen us to develop this system, and we are working hard to do so. I believe it will change the way Israel defends itself and can also be relevant for other customers as well. But this is only one example.

Ella Fried, Analyst

I have a question if you don’t mind. I know that the army is very much waiting for this high-power laser. When do you think, I mean, roughly it will become operational? Is it about two years, three years, or is there any deadline?

Butzi Machlis, President and CEO

No, this is more or less the timeline. We are actually waiting for the defense budget, for the Israel defense budget, to continue the development and production. I hope that this budget will be formed soon. I believe that everyone is convinced right now that there is a need to find a way to finance this program and to bring this to the field as soon as possible. To answer your question, it will take a few years until the development will be completed.

Ella Fried, Analyst

In a few years you mean more than two. But there is no besides the deadline. Okay. And then I have another question, actually more on the price earnings, and I really would like to learn from your experience, because as we all know here locally in Israel, the Israeli Shekel strength is hurting most exporters in Israel. And not only in Israel, the weakening of the dollar is actually affecting many other exporters in dollars. So from your experience, and also there's some inflation expected in the next two years, quite prominent inflation whereas what we had in the U.S. in your experience, can the prices in such surroundings be adjusted for all these currency exchange influences or do you think that they very much remain steady dollar dominated? Because I think it's very important for forecasting many companies who are not operating in the U.S.?

Yossi Gaspar, Chief Financial Officer

Hi, Ella this is Yossi.

Ella Fried, Analyst

Hi Yossi, good to hear you.

Yossi Gaspar, Chief Financial Officer

Yeah. I would give you two aspects of that answer. One is on contracts that we have. In quite a lot of them we have elements of indexing so that they do protect us, maybe not a 100% but quite significantly material protection against inflation.

Ella Fried, Analyst

Relating to dollar index or specific inflation?

Yossi Gaspar, Chief Financial Officer

It depends on the customer and on the currency. So it varies, of course. So that is regarding what we call the backlog of orders. Regarding future contracts, we do take into consideration when we price our proposals. We do take into consideration expected inflation rates and expected internal labor rates which are dependent on the expected local currency versus the dollar value. So to some extent we do mitigate through that future, medium and longer-term impact. In parallel with that, of course, we do every effort possible in order to reduce our cost base and improve our competitiveness on one hand and our profitability on the other hand. These processes take some time. I did mention in the past the implementation of the one ERP system that we do implement worldwide in our subsidiaries. We look at additional aspects that we have initiated in order to move some of the production activities and even some of the engineering activities to low-cost countries. So in that way, we do mitigate our costs and the increase in the cost basis of the company. So all this is going on, these are multi-year plans, the company executes them, and we are optimistic that we will be able to mitigate the impact of the currency exchange rate.

Ella Fried, Analyst

Well, first it's good to hear that many aspects are protected because the exchange rate changes were quite dramatic as we know here. And on the other hand, do we think we'll see also a time where you're collecting payments from your customers becoming shorter? Or because you are mentioned as far as one of the companies with the longer collecting time, so, we will still use it as a marketing tool?

Yossi Gaspar, Chief Financial Officer

No, I think we did complete that strategic cycle that you referred to about using the payment terms as a marketing tool. We stopped that actually or significantly reduced that last year already.

Ella Fried, Analyst

And then came corona.

Yossi Gaspar, Chief Financial Officer

And then came corona, that's right. But, one of our major customers, the Ministry of Defense here in Israel, did pay nicely towards the end of last year. They continue to pay, although there is still a material debt that they have not completed yet the payment of. Looking for the upcoming budget that is going to be approved somewhere this year, hopefully, and then this will be resolved as well. In other places worldwide, we are in a process of reducing, as we just said, the terms of what we give our customers of payment. And actually, if you have looked at our recent two or three quarters, and you look at the number of customer advances in our contracts, you can see a constant increase in the advances. And that is part as a result of the change of policy that we have here and putting more emphasis on cash flow and getting more initial down payments and progress payments from our customers. This is an ongoing process which focuses on cash flow.

Ella Fried, Analyst

Okay. Thank you very much for taking my questions. It was nice to talk to you.

Rami Myerson, Investor Relations Director

Thank you, Ella.

Operator, Operator

There are no further questions at this time. Before I ask Mr. Machlis to give his closing statement, I want 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 please call 03-925-5900, and internationally please call 9-723-925-5900. A replay of this call will also be available on the company's website at www.elbitsystems.com. I'd now like to let Ella ask another question, please go ahead.

Ella Fried, Analyst

Oh, okay. Thank you. It's not that important. I just was late in reacting to the call. So, I would like to ask you about factoring as we spoke about cash flow actually, how are you still using it, and is it still a high rate now than you used to use it, or is it the same level more or less?

Yossi Gaspar, Chief Financial Officer

Occasionally we use it. In the first quarter we had a relatively low level of factoring. And if you look at the trend, compared to last year, we have a lower level in overall, and we plan to have a lower level during the year as well. In assessing, our assessment is that the payments from the customer will come in time and will not need that element or reduce it significantly.

Ella Fried, Analyst

Okay. Thank you again.

Operator, Operator

Mr. Machlis, would you like to make your concluding statement?

Butzi Machlis, President and CEO

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. Have a good day and goodbye.

Operator, Operator

Thank you. This concludes the Elbit Systems Limited first quarter 2021 results conference call. Thank you for your participation. You may go ahead and disconnect.