Elbit Systems Ltd. (ESLT) Q2 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems' Second Quarter 2014 Results Conference Call. [Operator Instructions] As a reminder, the conference is being recorded. You should have all received by now the company's press release. If you have not received it, please contact Elbit's Investor Relations team at GK Investor Relations or view it in the News section of the company's website, www.elbitsystems.com. I would now like to hand over the call to Mr. Ehud Helft of GK Investor Relations. Ehud, please go ahead.

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

Thank you, Ehud. Hello, everyone, and thank you for joining us today. Like last quarter, we 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. We are happy with our second quarter 2014 results. Our results indicate a solid business base. Thanks to our ongoing efficiency measures, we were able to keep our operating expenses at similar levels to last year despite a stronger shekel versus the U.S. dollar. Additionally, we demonstrated continued improvement in our backlog, which is a good sign for the future potential growth in revenues. I will now highlight and discuss some of the key figures and trends. Our second quarter 2014 revenues were $702.6 million, at almost the same level as last year. In terms of revenue breakdown across our areas of operations in the quarter, C4ISR systems was 37%; airborne systems was 41%; Armored Vehicle Systems was 9%; electro-optics was 9%; and the rest was 4%. Compared with last year, the makeup of the overall mix was essentially the same, with some growth in airborne systems and some decline in electro-optics. In terms of geographic breakdown in the second quarter: Israel was 24% of our revenues, North America 31%, Europe 14%, Asia-Pacific 17%, Latin America 14% of revenues and the rest of the world was less than 1%. Compared with the second quarter of last year, there were some changes. North America and Israel were slightly higher as an overall percentage of sales. While Latin America increased more significantly, European sales declined. However, we don't see this quarter in Europe as a representative quarter for the long term. We believe that the long-term trend remains for higher potential in the defense markets of Asia-Pacific and Latin America. In line with this, we are very pleased with the increase in our Latin American revenues this quarter. For the second quarter, our gross margin was 28.4%, this was below the gross margin rate of 28.9% reported in the second quarter of last year. The decrease in the gross margin was mainly due to mix of programs sold in the quarter, and the stronger shekel versus the U.S. dollar rate in the second quarter of 2014 compared to last year. Operating income in the second quarter was $62.6 million, with an operating margin of 8.9%. This is compared with an operating income of $66.7 million and operating margin of 9.5% in the second quarter of last year. In the second quarter of last year, we had benefited from a special income of $7.6 million in the G&A expenses, related to a legal settlement with an investment bank. In terms of breakdown of our expenses in the quarter, our net R&D expenses for the second quarter of 2014 were 7.4% of revenues, compared to 7.3% in the second quarter of 2013. Marketing and selling expenses were 7.2% of revenues in the quarter, compared with 8.1% in the second quarter of 2013. The lower level of marketing and sales expenses is not indicative of any trend and is a result of mix of marketing efforts. Our G&A expenses in the second quarter were 4.9% of revenues, compared with 4% of revenues the second quarter of 2013. Excluding the special income last year, G&A expenses were 5% of revenues last year. Financial expenses for the second quarter of 2014 were $8.3 million, compared with financial expenses of $12.7 million in the second quarter of last year. The differences between the financial expenses in each period are primarily due to exchange rate differences in the various currencies in which we operate compared to the U.S. dollar. Taxes in the quarter were $9.9 million, or 18.1% tax rate, versus $5.1 million, or 9.4% of tax rate, in the second quarter of last year. The reason for the relatively higher level of taxes last year was due to the mix of profit generated in the higher tax regions. Consolidated net income for the second quarter of 2014 was $43.9 million, or a net margin of 6.2% of revenues. This is compared with a net income of $49.6 million, or 7.1% of revenues in the second quarter of 2013. Excluding the special income in the second quarter of last year due to the legal settlement, net income was $42 million, or a net margin of 6%. The non-GAAP net income in the second quarter of $52.6 million, net margin of 7.5%, compared with $50.4 million, or a net margin of 7.2% reported in the second quarter of last year. Income per diluted share for the second quarter of 2014 was $1.03. This is compared with $1.17 for the second quarter of last year, or $0.99 excluding the specialty income in that quarter. On a non-GAAP basis, earnings per share this quarter were $1.23, compared with $1.19 in the second quarter of last year. Our backlog of orders at the end of the second quarter was $6.17 billion, which is $370 million or 6% higher than the backlog at the end of the second quarter of last year. We stood at $5.8 billion. Solid growth in our backlog is a positive indication for the potential future growth in revenues providing us with good visibility over the coming years. Approximately 59%, or $3.7 billion, of the current backlog is scheduled to be performed during the second half of this year and 2015. Operating cash flow for the half-year ended June 30 was $15.8 million, as compared to a cash flow of $60.9 million in the first half of last year. The main reason for the lower level of operating cash flow is a delay in payments from the Ministry of Defense in Israel. However, we do not anticipate any risk with regard to these payments. Finally, the Board of Directors declared a dividend of $0.32 per share for the second quarter of 2014. That ends my summary, and I shall now turn over the call to Mr. Machlis. Butzi, please go ahead.

Thank you, Yossi. I am pleased with the results and particularly the solid growth in our backlog. This is a good indication to our potential to grow while providing us with visibility into the coming years. During the quarter, we also saw a general resurgence of activity in certain geographical regions, such as Latin America and Asia Pacific. While we see much long-term growth potential in the defense area, I am particularly pleased with the return to growth in Latin America, an area of focus for us. We also received some recent orders in these regions which have added to our backlog over the past few months. In May, we were very pleased to have won a 1-year $133 million Homeland Security order for Latin American customer to be performance over the next year. This award allows the -- followed the $100 million award that we received in April in the region for a new innovative intelligence-gathering system, also to be performed over the coming years. This second award is an important milestone for us in the Homeland Security field, in which, we are witnessing a growing demand worldwide. The systems are based on highly advanced and unique technologies, which benefit from synergies across our divisions. These include Command and Control and intelligence capabilities to be operated via dedicated control centers intended to play a major role in fighting crime, preventing violence and improving citizen's safety and security. Our technological edge and vast operational experience in command and control missions or defense applications have positioned us as market leaders for Homeland Security projects, especially in emerging defense regions. In the Philippines, in June, we were awarded a $20 million contract for the supply of upgraded Armored Personnel Carriers to the Philippine Armed Forces. The contract marks a significant breakthrough for us, and details the first won award to us in the Philippines, an important customer in the Asia Pacific region. This award is a further demonstration of our leadership position in the field of ground vehicle upgrades, and follows an order received earlier this year for $219 million for a tank upgrade program for a customer in the Asia Pacific region. While [indiscernible] revenues was weaker this quarter as Yossi mentioned, we don't see this as indicative of a trend, and we have continued to win important businesses in the region. A few weeks ago, we were informed by the Swiss Federal Department of Defense, Civil Protection and Support that we were selected as a preferred supplier for UAS 15 new reconnaissance drone program. In such, they have selected our Hermes 900 heavy-fuel engine. While it is still early, and the selection has not yet led to orders, the decision to use our system after extensive competitive price is an important mark of the success and superior capabilities of our unmanned reconnaissance systems. In summary, our businesses is performing well. We are winning new businesses in all our regions, including key contract wins in target growth markets. While the current results are very similar to those of last year, the fact that our backlog is $370 million ahead of where it was the same time last year bodes very well for the future. Elbit Systems remains very well-positioned, both physically and financially, and I look forward to the opportunities ahead. With that, I will be happy to take your questions. Operator?

[Operator Instructions] The first question is from Gilad Alper of Excellence.

I have a question on the implications from the war in Gaza. So firstly, do you see any risk of contracts being canceled because of the war? And secondly, exactly the opposite, do you see any upside for new contracts based on the way your commitments performed during the war?

Our systems are being used by the Israeli Armed Forces, and it's once again a strong evidence for us that we are very relevant. We are -- these technologies that we have in the -- we are supplying defense and warning systems, is very well appreciated all over the world by different customers, and I don't see major risks for us in the future. And we've got the local support from different customers all over the world during the activity in Gaza. I just want to remind all of us that we are also supplying many jobs in -- all over the world via subsidiaries and via joint ventures that we have. So I don't see -- and based on the previous experience we have in the past, I don't see any major changes in the potential that we are heading -- that we have ahead of us.

Okay. Just a very quick follow-up. Assuming that you do get some new contracts because of the war, what's the timeframe at booking basically like? Is it like the new next quarter or the next 2 quarters, the next 2 years?

It's a bit early to judge, and of course, the IAS and other customers have to take their decisions. It's a little bit too early for me to answer this, to give you a clear answer about this.

The next question is from of Katya Schneiderman [ph] of Citibank.

I have a few questions, please. First of all, your sales were flat in this quarter, but the backlog keeps growing. So I wanted to ask should we expect revenues to jump in the second half of this year or it will be posting to 2015?

I wouldn't it use the word jump, but we definitely are optimistic about growth in revenues in the second half compared to the first half. And of course, 2015 will also reflect the growth in the revenues moving in -- the growth in the backlog moving into revenues.

Okay. So just a follow-up. So can we expect this level of backlog growth of 5% or 6% year-on-year, is it sustainable?

There are many opportunities ahead of us. This is hard to predict. But I can tell you that we -- the portfolio that Elbit has is very relevant, and we offer more for less and with -- there is a lot of demand for high [ph] stock capabilities, for Homeland Security capabilities, for different UAVs and other type of systems. And I'm very optimistic about the future because, as I already said, I see a lot of potential for the company in the future.

[Operator Instructions] A follow-up question from Gilad Alper.

Just if we look at the geographies, Latin America and the Far East, I think, for the first time equaled in terms of size to revenues coming from the U.S. or from North America. Should we expect that in the near future or maybe in the longer-term, the Far East and Latin America are going to become the most important geographies for Elbit?

From what we see in our backlog, we have -- we are optimistic about growth of revenues in these emerging markets. However, I would say that the U.S. market is also a very solid one, and presently the biggest one. We are encouraging the race between these 2.

The next question is from Ella Fried of Bank Leumi.

My question relates to the current level of operating profit and gross profit. Can we look at these levels as representative of the next few quarters, or do you think we'll have to see a further erosions in these levels?

Well, as you know, we do not give any forecast...

Yes, well, more the feel and the current level -- of course, if the current level of shekel remains, there is no further appreciation?

We have intensive activities of improving yield and reducing the cost base of the company. So, hopefully, they will continue to support our business. And will able to support these levels of operating profits. But I would not guess anything for the future because we have seen what happens with the dollar-shekel and other impacts to our business.

The next question is from Ethan Etzione [ph] of Etzione Portfolio Management [ph].

I wanted to ask about the tax rate. I see this quarter your tax rate was higher than as far back that I can see. You did mention that it depends on the different countries where you operate, but can you give us some sense of where we should see the tax rate going forward?

I think the tax rate that we see in this quarter is not representative for the long term. It is a specific quarter with income coming from higher taxable regions. I think if you look at what we were -- have experienced in the last 4, 5, 6 quarters, that's more representative for the future.

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) 326-9310. In Israel, please call (03) 925-5901, and internationally, please call 972-3-925-5901. A replay of the call will also be available at the company's website, www.elbitsystems.com. Mr. Machlis, would you like to make a concluding statement?

Yes. I would like to thank all our employees for their continued hard work. 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. Second Quarter 2014 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.