Elbit Systems' (ESLT) CEO Bezhalel Machlis on Q1 2016 Results - Earnings Call Transcript

| About: Elbit Systems (ESLT)

Elbit Systems Ltd. (NASDAQ:ESLT)

Q1 2016 Results Earnings Conference Call

May 17, 2016, 09:00 AM ET

Executives

Ehud Helft - GK Investor Relations

Bezhalel Machlis - President, Chief Executive Officer

Joseph Gaspar - Executive Vice President, Chief Financial Officer

Analysts

Gilad Alper - Excellence

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems First Quarter 2016 Results Conference Call. All participants are at 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. 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 turn the call over to Mr. Ehud Helft of GK Investor Relations. Ehud, please begin.

Ehud Helft

Thank you, operator and good day to 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’s President and CEO, and Mr. Joseph Gaspar, Elbit's Chief Financial Officer. Joseph will begin by providing a discussion of the financial results of the first quarter of 2015, followed by Butzi who will talk about some of the significant events during the quarter and beyond. We will 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 contents of this conference call.

With that, I would now like to hand over the call to Joseph. Joseph, please begin.

Joseph Gaspar

Thank you, Ehud. Hello everyone and thank you for joining us today. As we do every quarter, we will provide you with both our regular GAAP financial data, as well as certain supplemental non-GAAP information. You can find all of the detailed GAAP financial data, as well as the non-GAAP information and a reconciliation in today’s press release.

Overall, we are pleased with our performance in the first quarter of 2016, in particular we have continued our growth in backlog and with the continued improvement in our gross margins. I will now highlight and discuss some of the key figures and trends.

Our first quarter 2016 revenues were $721.2 million, an increase of 2.1% compared with the $706.6 million reported in the first quarter of 2015. In terms of revenue breakdown across our areas of operation in the quarter, airborne systems was 39%, C4ISR was 31%, land systems 19%, electro-optics was 7%, and the rest was 4%. Compared with the first quarter of last year, the overall revenue mix from the areas of operation was quite similar.

In terms of geographic breakdown for the quarter, Asia-Pacific was our largest region at 29% of revenues, North America was 25%, Israel was 20%, Europe 16%, Latin America 9%, and the rest of the world was 1%. Compared with the first quarter last year, we primarily saw increased contribution from Asia Pacific, as well as Europe and a lower contribution from the Americas.

For the first quarter, the non-GAAP gross margin was 30.5% versus 29.2% in the first quarter of 2015. Our GAAP gross margin was 29.4% versus 28.5% last year. The improvement in the gross margin was mainly due to the mix of products sold in the quarter and our continued efforts to improve profitability among our various units, while maintaining efficient operation and control over costs.

The first quarter non-GAAP operating income was $66.9 million or 9.3% of revenues compared with $69.5 million or 9.8% of revenues last year. GAAP operating income was $63.3 million or 8.8% of revenues versus $59.8 million or 8.5% of revenues last year.

In terms of our expenses for the quarter, total operating expenses were 20.7% of revenues compared with 20% of revenues in the first quarter of last year. The breakdown was net R&D expenses at 7.8% of revenues versus 7.9% last year, marketing and selling expenses at 8.5% of revenues versus 7.3% last year, and G&A expenses at 5.4% of revenues versus 4.9% last year.

I know that the current increase in marketing and sales expenses was primarily because they were unusually low in the first quarter of last year. The G&A expenses were higher due the increasing value of our share price which caused the value of the Phantom options awarded to employees will increase.

In addition, we had other income of approximately $7 million which we do not include under our non-GAAP results. This is due to the reevaluation of an investment made by an outside investor into a commercial venture subsidiary that was deconsolidated in the quarter. These are subsidiaries that we established with commercial applications for our in-house developed technologies.

As a result of this, we will no longer consolidate the results of this subsidiary. I know that more of our commercial ventures have similarly made progress in recent quarters and are seeing increased interest from our outside investors.

It is our strategy to maintain focus on our core defense business and therefore we bring in partners and investors in our commercial ventures, with a goal of eventually spinning them off and generating cash in-flow to Elbit.

Financial expenses in the first quarter of 2016 were $1.7 million compared with financial expenses of $5.7 million in the first quarter of last year. The lower financial expenses in the quarter were mainly due to currency exchange differences. We had a one-time income from a capital gain of $3.9 million due to the sale of land that we owned.

For the first quarter of 2016, non-GAAP net income was $51.2 million or a net margin of 7.1% versus $52.6 million or a net margin of 7.4% last year. Non-GAAP diluted earnings per share were $1.02 compared with $1.23 last year.

On a GAAP basis, first quarter net income grew 17% to $52.3million and a net margin of 7.3% versus $44.6 million and net margin of 6.3% last year. GAAP net income per diluted share was $1.22, as compared with $1.04 last year.

Our backlog of orders at quarter end was $6.775 billion, $505 million or 8.1% higher than the backlog at the end of the first quarter of 2015. Approximately 63% of the current backlog is scheduled to be performed during 2016 and 2017.

Operating cash flow for the quarter was $24.5 million compared with $82.9 million in the same quarter last year. The cash flow this quarter was lower due to the fact that the cash flow in the first quarter of last year was particularly strong.

The Board of Directors declared a dividend of $0.40 per share for the first quarter of 2016.

That ends my summary, and I shall now turn the call over to Mr. Machlis. Butzi, please.

Bezhalel Machlis

Thank you, Joseph. We are pleased with our first quarter financial results, especially our solid growth of over 8% in backlog which provide us with strong revenue visibility over the long-term. This comes on top of good level of revenues in the past few quarters.

Another important aspect of our result is a gradual trend over the past few years of improving gross margins. This is a effort of the ongoing backlog we have taken to operate efficiently, improve in term of processes, while harvesting synergies across our large businesses – business units.

I would like to mention that the environment for defense spending has become increasingly positive and we see many opportunities in the market. We are investing more in sales and marketing in order to build and positive growth opportunities and as our recent growth in backlog showed we are being successful which should benefit us for the years to come.

We are seeing strength in many of our target markets, particularly Asia Pacific and the resumption or world in defense spending in New York, the order we have won in the past few month’s highlights the diversification in our business and how our target markets are growing across many regions.

In the United States which have always been one of our major regions, with over a quarter of revenues, a few weeks ago we received a US Navy contract to perform to modification perform modifications to Naval Test Pilot School's C-26 aircraft. The Naval Test Pilot School trained experienced pilot, naval flight officers and engineers to become qualified test pilots, test flight officer and flight test engineers that support test and evaluation programs.

At the end of March, we announced that our Integrated Fixed Towers, IFT border surveillance system that we are building in Arizona were certified by the Chief of the U.S. Border Patrol to Congress as meeting its operational requirements. The IFT provides Border Patrol Agents long-range, 360-degree, all-weather, persistent surveillance capability, certification of the first IFT deployment was a major milestone in the program towards the next stage. Now that we have proved this milestone, the door is open for further deployment.

In Europe, following the decline that affected defense budget for a over decade and more sharply since 2010, defense budget finally started to grow in 2016, empowered due to various geopolitical events affecting the regions. For us Europe continues to perform well.

To highlight a recent order in Western Europe, we won a $20 million of contract for the supply of tactical mobile radios, known E-LynX over a three-year. The E-LynX radio solution offers reliable voice, data and video services simultaneously, along with integrated blue force tracking capabilities, and is designed to serve as the mobile networking backbone for modern Battle Management Systems and soldier systems.

Asia Pacific has also become a major market for us and in the first quarter was a largest contributor to our revenues. In this region defense budget had been growing over the past few years before the trend we fulfilled early and back into and we are now enjoying its role. We recently were awarded a $30 million two year contract in Australia for the supply of thermal weapon sight.

The growing working product is recognized as the category leader for its very small size, light weight and its high performance during day, night operations. Australia is a really important market for the system and we are already the prime system integrator for current defense offers Battle Management System.

We were also awarded a $22 million contract to supply intelligence and cyber analysis and research systems for Asia-Pacific country over a two year period. The system to this supply consist of CYBERBIT, weak system. a highly advanced end to end intelligence and investigator solution that support every stage of the intelligence process, including the collection of the data for multiple sources, data basis and samples, processing of the information, supporting research analysis and evaluation of the information with advanced analysis tool and disseminating the intelligence to the intended recipient.

In summary, our business has continued to perform well. I believe we are well positioned in the right technological areas and geographical markets over defense industry that are viewed for growth in the coming years.

The ongoing growth in the backlog coupled with an improving environment for defense spending throughout the world positioned us well to continue our long-term growth for this – for favorable future.

With that, I will be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] The first question is from Gilad Alper of Excellence. Please go ahead.

Gilad Alper

Hi. Thanks for taking my call. My question is on the continued disconnect between the rise or the growth in backlog and the somewhat disappointing growth in revenues, I think we've been seeing that for three quarters now and I think its coming to a peak where revenues are basically stagnating and backlog is growing, I think 8% from last year, so can you just talk about why we are seeing this continued disconnect? Thanks.

Joseph Gaspar

Our backlog has grown, as you have mentioned 8% in the last quarter year-over-year I am talking about, and distribution of the backlog varies over the years, the distribution over the future years. Some of the backlog is in more longer term than used to be in the past. So therefore we see that coming through a little bit slower than what we have seen in the past.

However, we do seen the need and near term future, the growth - the absolute growth in the backlog maybe not at 8%, but maybe at a lower percentage number that will drive the growth in revenue this year and next year.

Gilad Alper

That - I mean, is there any way to make the approximate and say that you know, if backlog is growing by 8% than revenues on a year and year out basis should grow by 4% or there are about or maybe there is no way to actually make such an exact connection?

Joseph Gaspar

We are releasing in our press release the number that describes the percentage of the backlog to be sold in the coming quarters, in the next seven quarters, that means three quarters of this year and 2017. Probably to take the approximation of that, maybe the most - the best way to make an estimate.

Gilad Alper

Okay. Okay, thanks.

Operator

The next question from [indiscernible] Please go ahead.

Q – Unidentified Analyst

Hi. I wanted to ask whether the backlog includes the contract with KBR and if so at a 100% or at 50%?

Joseph Gaspar

The backlog does not include the contract that we have with KBR, the MFTS contract at all, same way the revenues in the future will not include these revenues. However, the profit generated by these revenues in the future we will count for 50% of that in our equity line.

So the growth of the backlog of over $500 million in the last year does not include the over $700 million of this contract which is above it.

Q – Unidentified Analyst

So you are not going to consolidate this operation?

Joseph Gaspar

No.

Q – Unidentified Analyst

So second question please, what is the total inventory of your Phantom options?

Joseph Gaspar

Sorry, I didn’t get that.

Q – Unidentified Analyst

What is the total amount of the Phantom options outstanding?

Joseph Gaspar

I think, I am not sure that I have the exact number, but if you were looking, our 20-F – in our 20-F release of the end of 2015 we have all the details over there. So - and if you don’t find there give me a call, send me an email and I will inform you.

Q – Unidentified Analyst

Thank you.

Operator

[Operator Instructions] The next is a follow up from Gilad Alper [Excellence] Please go ahead.

Gilad Alper

Thanks again. Just another question on the Cyber division of NICE Systems, along both of your quarters ago, if you can just say a few words about development of that business in terms of breakeven, in terms of do they generate revenues as much as you had expected when you bought the company? Thanks.

Bezhalel Machlis

We are happy where this acquisition remained and business is growing for us, the business is profitable and it meets our expectations and beyond.

Gilad Alper

Okay. Thanks.

Operator

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 two hours after the conference ends. In the U.S., please call 1-888-326-9310; in Israel, please call 03-925-5900, and internationally please call 972-3-925-5900. A replay of this call will also be available at the company’s website, www.elbitsystems.com.

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

Bezhalel Machlis

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 good bye.

Operator

Thank you. This concludes the Elbit Systems Limited first quarter 2016 results conference call. Thank you for your participation. You may go ahead and disconnect.

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