Elbit Systems Ltd. (ESLT) Q3 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Elbit Systems limited Third Quarter 2013 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, November 14, 2013. I would like to remind everyone that the Safe Harbor language contained in today's press release also pertains to all contents of this conference call. If you have not received a copy of today's release and would like to do so, please call CCG Investor Relations at 1 (646) 201-9246. I would like to hand the call over to Mr. Ehud Helft of CCG Investor Relations. Mr. Helft, please go ahead.

Thank you and good day, everybody. On behalf of all the investors, I would like to thank Elbit Systems management for hosting this call. Joining us on the call today are Mr. Butzi Machlis, Elbit Systems President and CEO; and Mr. Yossi Gaspar, Elbit Systems Chief Financial Officer. Yossi would begin by providing a discussion of his financial results of the quarter, followed by Butzi, who would talk about some of it's significant events during the quarter and beyond. We'll then turnover the call to a question-and-answer session. With that, I would like to now turn over the call to Yossi. Yossi please?

Thank you, Ehud. Hello, everyone, and thank you for joining us today. As usual, I will provide you with both our regular GAAP financial data, as well as certain supplemental non-GAAP information. You can find all the detailed GAAP financial data, as well as the non-GAAP information in today's press release. Our results of the third quarter show growth in both revenue, operating and net income, as well as improvements in margin across the board. I will now highlight and discuss some of the key figures and trends. Revenues in the third quarter of 2013 were $730.6 million, as compared to $677.5 million in the third quarter of 2012, drawing close by growth of 8% year-over-year. In terms of revenue breakdown across our areas of operation, Airborne Systems was 39%, land-based assistance was 11%, C4ISR systems was 37%, Electro-Optics systems 9% and the rest was 4%. Compared with last year, we saw a growth in the C4I and airborne systems revenues, while land vehicle systems declined. On a geographic basis, North America remained our largest region at 30% of revenues, Israel was 25%, Europe was 17%, Asia-Pacific 13%, Latin America 11%, and the rest of the world was 4%. Compared to its last year revenues from Israel grew strongly as a portion of the overall mix, Latin America grew as well, while we saw a comparative reduction in revenues from North America and Asia-Pacific. I know that we do not see the quarterly fluctuations in our revenue breakdown as indicative of any long-term trends, and we believe the long-term trend has the potential of a higher level of growth in the emerging defense markets of Latin America and Asia-Pacific. Gross margins. For the third quarter, our gross margin was 28.4%, slightly higher than the gross margin of 28.3% reported in the third quarter of last year. The non-GAAP gross margin in the third quarter of 2013 was 29.1% compared to its 29% in the third quarter of last year. Operating income in the third quarter was $61.1 million or an 8.4% margin. This represents a year-over-year growth of 25% in operating income compared with the $49 million or 7.2% margin as reported in the third quarter of last year. The strong 25% growth in operating income versus the 8% growth in revenue demonstrates the leverage of various operations in our business, as well as the major efforts we placed for maximizing our use of business like synergies, as well as maintaining an efficient cost structure. The non-GAAP operating income in the third quarter of 2013 was $72.3 million or 9.9% of revenues as compared with $61 million or 9% of revenues in the third quarter of last year. Our net R&D expenses for the quarter was 7.4% of revenues compared with 7.5% last year. Marketing and selling expenses were 8.5% of revenues in the quarter compared with 8.7% last year. On an absolute basis, our net R&D expenses and marketing and sales expenses were slightly higher than those of the third quarter last year, in order to capitalize on opportunities we're seeing in our end market. G&A expenses were reduced to 4.2% of revenues in the quarter compared to 4.8% in the third quarter of last year. On an absolute basis, the G&A expenses were also reduced to $30.5 million in the quarter versus $32.7 million in the third quarter of last year. The overall trend of lower G&A expenses is due to generally improved efficiencies in the operation of our business over time, as well as synergies realized from the improved integration of our businesses. Financial expenses in the third quarter of 2013 were $6.6 million compared with $5.5 million last year. Taxes. We reported a tax expense of $7.5 million, which is an effective tax rate of 13.6% in the third quarter of 2013, compared to a tax expense of $4.9 million or an effective tax rate of 11.2% in the third quarter of 2012. The affiliates, which we do not consolidate, contributed $3.4 million to the net income in the quarter. This is compared with $1 million last year. Consolidated net income attributable to Elbit Systems shareholders for the third quarter grew to $49.6 million or a net margin of 6.8%. This is compared with net income of $39.5 million or a net margin of 5.8% in the third quarter of 2012. Diluted net earnings per share for the third quarter were $1.17 compared with $0.95 for the third quarter of 2012. Our non-GAAP net income was $55.8 million or 7.7% of revenues compared with $49.4 million or 7.3% of revenues in the third quarter of 2012. Non-GAAP EPS for the quarter was $1.32 compared with $1.18 for the third quarter of last year. Operating cash flow for the third quarter of 2013 was a negative of $37 million, primarily because of the late approval of Israeli defense purchase by the government, which has led to delay in payments from the Israeli Ministry of Defense to its supply. We expect this to be resolved in the near term. Our backlog of orders as of September 30, 2013, stood at $5.7 billion. This was a slight decline from the backlog at the end of the prior quarter, which stood at $5.8 billion. Approximately 49% of the backlog is scheduled to be performed during the rest of this year and 2014. The majority of the balance is scheduled to be performed during 2015 and 2016. Finally, the board declared a dividend of $0.30 per share for the third quarter of 2013. That ends my summary. And I'll turn over the call to Butzi Machlis. Butzi?

Thank you, Yossi. I'm pleased with our results of the quarter reflecting the year-over-year trend of improvement in revenues and profitability. We continued to find many areas where we can provide increased value for the entire organization and over the past few years, we have worked hard at improving those efficiencies across all our divisions. As Yossi already mentioned, in the quarter we were able to increase our revenues by growth to 8% over the last year, operating a business with bigger footprint result a corresponding increase in our operating expenses. Our operating income in the quarter grew by 25%. I would like to point out that while we focus on keeping a tight rein over expenses, at the same time, we see many opportunities in our end markets, which we continue to pursue vigorously. We consider both the Latin America and Asia-Pacific as potential growth markets for us with significant long-term opportunities. In fact, during the quarter, we received a number of orders from the Asia-Pacific region, including a $33 million follow-on contract to supply our Digital CoMPASS electro-optical Payload System to an Asia-Pacific airport to be installed on board helicopter. Our Digital CoMPASS system is a highly stabilized multi-sensor electro-optical payload system for urban platform with cutting-edge day and night surveillance by that acquisition and reconnaissance capabilities. In addition, in South Korea, an important and growing defense market, we received a follow-on contract to supply advanced Helmet Mounted Display systems for the [ph] helicopter. This contract award follow an initial contract that was signed in 2009 as part of the Korean helicopter program. Recently, we established a jointly owned company in Korea with a Korean company Sharp Aviation K. Our joint company known as Sharp Elbit Systems Aerospace or SESA offers a great [ph] solution, such as the Korean Light Attack Helicopter and the Korean Future Fighter Development project. We consider Korea as well as the entire Asia-Pacific region to be a very important market for us. Although the North America market faces ongoing budget challenges, we continue to achieve success in that market and we are particularly pleased with the recent decision to proceed with the joint Elbit occurred helmet mounted solution as a sole helmet mounted system for the S35. 2013 is shaping up to be a good year for Elbit Systems, and I believe we still maintain significant and depth future potential, which we intend to unleash over the coming years. With that, I would like now to open the call for questions and answers. Operator?

[Operator Instructions] The first question is from Ella Fried of Leumi.

My first question refers to the Asian market. Can we assume that there is an additions to the backlog, will it set next year this turned off decrease in the first 9 months that we see in the results?

Our geographical growth engines have not changed and we see Asia-Pacific as a potential growth market with significant long-term opportunities. We cannot judge on a quarterly basis and we expect to see the growth coming back to its course in the future.

Yes. It's not 1 quarter, 3 quarters?

Yes, but still I believe that there are significant opportunities for Elbit in this region. Therefore, I'm optimistic that this market will continue to grow for us.

Okay. And another question concerning the possibilities in Elbit's space program towards some publications that Israel is improving the prefers with European Union on different space programs. Are you seeing any positive influence in this aspect?

We have programs with the European Union, with European funds that are developing technologies and products in conjunction with the space programs with our subsidiary, our electro-optics and our subsidiaries in Europe. So we're definitely a part of that and definitely a very advanced technology.

The next question is from Athan Axioni of Halman-Aldubi.

My question is with regard to the backlog. How should we interpret the quarterly decline. Is this just noise in upward trend or should we interpret it as a change of trend?

I don't think that this is change of trend. There are many opportunities in front of us in many places. I already mentioned, Asia-Pacific, but not only in Asia-Pacific, South America, they are also very important regions to us, so I believe that the growth will continue.

So you expect the backlog to resume growth in the future quarters?

Yes. I expect the backlog to continue to grow. I just want to mention that due to a long process of approval here in Israel, the approval of the Israeli Defense budget. There were many delays in Israel and many areas of new business, but not only and I'm sure that right now, after the budget was approved, these delays will not be relevant anymore and we'll continue to get orders from [indiscernible] So I'm optimistic that the growth in backlog will continue in the future.

The next question is from Yet You Dvori of Takle Discount.

Regarding to the last 3 quarters, we can see a decline in most of the areas, except Israel and Latin America. Can you give us some more colors about the competitive environment at Europe and the U.S. and what are you looking forward for the next year?

As you know, we have many technologies in Elbit. Actually there are very few companies who have such a variety of technologies under one roof. And I believe that there are many opportunities for us all over the world and I believe that the synergy in Elbit will help us to continue to promote new solutions and new ideas which are innovative, and which can bring a lot of benefit to the end-user. Therefore I see, as I already said there are too many opportunities for us in the future. And it's true that the outcome budget -- some budget limitations in some areas. But I believe it's also good for us because there are many opportunities for Elbit can be more or less based on the technology which we have. You also need to remember that you cannot judge the way the backlog is flipped based on 1 quarter results. And I see many opportunities for us all over the world.

Your next question is from Dov Rosenberg of Clover Finance.

First of all, just a quick technical question. I was wondering where does Australia fall under? Is it under other countries or APAC?

APAC.

APAC? And other countries went much higher this quarter, I think it was 29 versus jumping up quarter by quarter. Can you specify what country was that, that sort of push forward there?

We don't be that detail in very minute, small numbers. So...

Okay. What was it, One country, is there any trend there, or we're pushing at nothing?

Nothing material to be reported about.

Okay. Now you guys mention in the past, you talked about Cyber, I was wondering if there is sort of any change, you see that breaking out. Is there -- I mean obviously a revenue opportunity, but you're positioning there. Is there any change in that market and where you stand?

No. We have may technologies in this area and there are many opportunities for us in Israel as well as in other places. It will follow the [indiscernible] capabilities and this market is growing and our position in this market is going to work.

Okay. Is that a substantial part of C4 or it still crumbs?

It's an important part of our portfolio. We usually are not giving details about this segment separately.

Okay. Israel is 25% this quarter, I think it was even higher in the bookings. I was wondering going forward, where a normalized rate would be and then if you'd expect before we get there on a quarterly basis it will stay high?

First of all, just to correct, it was not higher in the bookings. Mr. Machlis explained earlier that we had in this quarter some delays in receiving orders from the Minister of Defense in Israel because there budget was not yet in place and finalized. So you shouldn't assume that it's higher in the backlog. It's the other way around.

Okay. And so it should have returned to a normalized, say, 2021, already next quarter or further on?

We believe that the [indiscernible]

The next question is from Yoav Bergen of Poalim Sahar.

A few questions for me. The first one regarding your revenue breakdown by yours areas of operation. Is this the right system segment was very strong on this quarter. What could we -- could we get some more color on the significant growth please?

Before I practically reflect all the technology we have -- before I include UAVs and here I would like to mention that the helmet, new UAV which was launched 1.5 years ago. It was already delivered to many customers and I believe that's the most advanced UAV when we started which will available today in the market. On top of that, under C4I we have communication systems, we have electro-optical payload. We have EW systems, we have command control and many other technologies. And this synergy between all this technologies enables us to promote and to provide very unique technical solution and advanced solutions for our customers. So that's really a reflection of the strategy of combining different technologies in the company, which enable us to promote unique solution for our customers.

Okay. And are you reasonably comfortable or confident that we can expect obviously not this growth rate, but a substantial growth rate in the C4Is going forward, I mean in the future as well?

I believe that we are the world leader in this market. And I see a lot of potential for us in the future in this area.

Okay. Regarding your geographic breakdown of revenues, it seems it's concerning, I think, you've talked about it in the previous question obvious as well. It seems a bit concerning that Israel has become again like something like a quarter of your total revenues, given all the noise regarding the Israeli -- The Minister of Defense budget and everything that's going on within the local defense industries, which seems a bit pessimistic. Could you address these concerns?

This is Yossi. As you probably know, revenues that you see today are usually contracts that we got 2012 to -- 15 months ago. So it takes that time until -- from the time the contract is signed, until you start seeing that in the revenue line. So you shouldn't couple the things that happened in the last several months with the Israeli budget, with the revenues in Israel that you see in this quarter. The revenues in Israel are a reflection of contract that was signed 1, 2 or 3 years ago.

Okay. So we should feel comfortable going forward that Israel will not be such a substantial contribution to total revenues. Is that a good assumption?

Yes. I think, as it was mentioned with the previous question, we will continue to see Israel with a portion of about 20%, probably 22%, which is the normal average for the long-term volume of the business.

Okay, great. And maybe 1 last question, if I may. Regarding the backlog, obviously the backlog is currency stuck and I would assume, it wasn't pursuing growth and maybe even in the beginning of next year. When -- could you provide some kind of prudent assumption when could we actually assume or when could we actually anticipate some kind of returning to the gross pattern?

As I already mentioned. There are many opportunities for us all over the world and I believe that we are well-positioned in many of them. So I believe that in the future, even as in the near future, we will continue the growth in our backlog.

Okay. So when you say near future, somewhere towards the mid- or the second half of next year, is that a fair assumption?

Yoav, you know that we don't give guidance. And with backlog and order, that is something that we definitely -- our level of understanding, when expect that order would be signed is not there. So the volume of the business opportunity that Mr. Machlis has referred to, and the number of business opportunities definitely give us the comfort that by the end of the day the backlog will resume to grow.

Within the near future?

Yes.

[Operator Instructions] There are no further questions at this time. Before I ask Mr. Machlis to go ahead 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 039255921. And internationally, please call 9 (723) 925-5921. A replay of the call will also be available on the company's website, www.elbitsystems.com. Mr. Machlis, would you like to make your concluding statements?

I would like to thank management and all our employees for their continued hard work. To everyone on the call, thank you for joining us today and for continued support and interest in our company. Have a good day and goodbye.

Thank you. This concludes the Elbit Systems Limited Third Quarter 2013 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.