Elbit Systems Ltd. (NASDAQ:ESLT) Q3 2023 Earnings Call Transcript

Elbit Systems Ltd. (NASDAQ:ESLT) Q3 2023 Earnings Call Transcript November 28, 2023

Elbit Systems Ltd. misses on earnings expectations. Reported EPS is $1.65 EPS, expectations were $1.7.

Operator: Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems Third Quarter 2020 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, www.elbitsystems.com. I would now like to hand over the call to Rami Myerson, Elbit Systems’ VP, Investor Relations. Rami, please go ahead.

Rami Myerson: Thank you, Joni. Good day, everyone, and welcome to our third quarter 2023 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 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 main 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: Thank you, Rami. Hello, everyone, and thank you for joining us today. The financial results of the third quarter of 2023 reflects the sustained demand for our solutions and progress in the implementation of our operational improvement plans. Butzi will discuss the implications of the war in Israel in his remarks. The extent of the impact of the war on our financial results will depend on future developments that are difficult to predict, including the duration and scope of the war. We continue to monitor the situation closely. Turning now to results of the third quarter. Third quarter revenues increased by 11% to $1.52 billion compared to $1.34 billion in the third quarter of 2022. In terms of quarterly revenues by segment, aerospace revenues increased by 24% in the third quarter of 2023 compared to the third quarter of 2022, mainly due to training and simulation sales in Europe and UAS sales in Asia Pacific.

C4I and Cyber revenues increased by 9% year-over-year, mainly due to radio system sales in Europe. ISTAR and EW revenues were similar to the revenues in the third quarter of 2022. Land revenues increased by 7%, mainly due to artillery and weapon station sales in Europe. Elbit Systems of America revenues declined 2% in the third quarter due to lower precision guided munition sales. Elbit System diverse geographic revenue base helps to reduce revenue volatility and support the long-term sustainability of our business. In the third quarter, Europe was our largest market, contributing 33% of group revenues; North America was 24%; Asia Pacific 21%; and Israel contributed 15% of our revenues. European revenues increased due to growth in sales of radio systems, artillery, weapon station and training and simulation solutions.

Asia Pacific revenues increased mainly due to growth in UAS sales. Israel revenues declined mainly due to lower ammunition sales in the quarter. The non-GAAP gross margin for the third quarter was 24.9% compared to the third quarter of 2022 at 25%. GAAP gross margin in the third quarter was 24.5% of revenues, compared to 24.2% in the third quarter of 2022. GAAP and non-GAAP gross profit in the third quarter of 2022 included approximately $13 million of expenses related to stock price linked compensation plans. Third quarter non-GAAP operating income was $117 million or 7.8% of revenues, compared to $84.3 million or 6.3% of revenues last year. GAAP operating income for the third quarter was $106.1 million or 7.1% of revenues versus $73.4 million or 5.4% of revenues in the third quarter of 2022.

GAAP and non-GAAP operating profit in the third quarter of 2022 included expenses of approximately $22 million related to the stock price linked compensation plan. The operating expense breakdown in the third quarter was as follows: net R&D expenses were 6.9% of revenues versus 8.4% in 2022. The year-on-year reduction in R&D expenses in the third quarter reflects the phasing of projects. Marketing and selling expenses were 5.7% of revenues versus 5.1% last year. The positive inflection in global defense budget growth has created multiple opportunities. The increase in marketing and sales spend will help to realize the potential created by these opportunities. G&A expenses were 4.8% of revenues compared to 5.9% last year. Other operating income in the third quarter of 2022 of $9.4 million included a capital gain related to the sale of a building in Israel.

Financial expenses were $36 million in the third quarter compared to $16 million in 2022. Financial expenses in the third quarter were highly — were higher as a result of the significant increase in interest rates and higher debt. We recorded a tax expense of $10 million in the third quarter compared to $8 million in 2022. The effective tax rate in the third quarter was 15% compared to 13% in 2022. Our non-GAAP diluted EPS was $1.65 in the third quarter compared with $1.40 in 2022. GAAP diluted EPS was $1.36 for the third quarter compared with $1.26 in 2022. Our backlog of orders as of September 30, 2023, was $16.6 billion, approximately $1.9 billion higher than the backlog at the end of the third quarter of 2022. Approximately 39% of the current backlog is scheduled to be performed during the remainder of 2023 and 2024, and the rest is scheduled for 2025 and beyond.

Operating cash flow in the third quarter was an $11 million inflow compared to $178 million inflow in the same quarter last year. The Board of Directors has declared a dividend of $0.50 per share. I will now turn the call over to Mr. Elbit CEO. Butzi, please go ahead.

Butzi Machlis: Thank you, Kobi. I would like to begin by thanking all Elbit employees and their families around the world for their hard work and dedication in these challenging times. Since 7th of October, as related Elbit operation around Israel and our employees deployed in the field supporting the ideas. I’m proud of their commitment to all our customers around the world and their dedication provides me with confidence that Elbit Systems will be able to overcome the challenges we face today and may face in the future. I also want to send my sincere condolences to the families of our employees that have lost their loved ones during this conflict. The financial results in the third quarter include double-digit revenue growth, a record backlog of $16.6 billion and improved profitability.

Combined with a significant contract for customers around the world, we received in recent months reflects the strong demand for our solutions. They also – they also increased confidence in our ability to overcome the short-term challenges and deliver on our potential in the longer-term. I would like to discuss the impact of the war so far in Israel that presents both challenges and opportunities. Elbit Systems is Israel’s largest defense company, and we supply a range of solutions to the Israeli Defense Force. These includes the Digital Army Program or DAP 750 Command and Control solutions, Electronic Warfare Systems, UAVs, Artillery and Mortar Systems for Main Battle Tanks and armored vehicles, night vision systems as well as a range of training and simulation solutions for the single Soldier to the Squadron and Battalion across all domains and more Our solutions are currently being used extensively by the IDF.

We have also accelerated the development of some of our solutions that we are still in development and we’re scheduled to be feed it in the medium or longer-term. They have already been sent to the fleet in days of weeks. We did this, thanks to the dedication of our employees and our culture of innovation and creativity. We have ramped up production to support the IDF and maintain deliveries to our international customers at the same time. We have increased production capacity at our factories by adding shifts and we have properly recruited several hundred additional temporary employees to support the search. We have implemented all of this at the same time as approximately 15% of our Israeli workforce of 14,000 employees has been called up to serve as reserves in the IDF.

We pray for a safe and speedy return of all the hostages and soldiers to their homes and families. I would like to share some of my initial observations in different land from the regular meeting we conduct with the end users in the IDFs and discuss some of the relevant contracts received in recent months that demonstrate that our international businesses remain solid and continue to grow. The conflict has highlighted the importance of multi-domain warfare that connects all process operating in the Air, on the Ground and the Space enables the transfer of information between them to close a sense of the future cycle rapidly and effectively. Elbit Systems’ Italy is a market-leading supplier of a range of solutions across the sense of the future cycle that is made up of three major elements.

The Sensor that collect information, the infrastructure that enables the transfer of information and the sectors that engaged with based on the information guidance. Some examples of our capabilities include, our ISTAR Division provides a range of advanced sensors that operate across The Electromagnetic Spectrum. This sensor collects the valuable and actionable mission-critical intelligence and can identify exploit and gain LME activity and capabilities. The division also provides The Advanced Targeting — Target Acquisition and Laser Targeting Solutions. In August, we were awarded a $55 million contract to supply a multi-layered ReDrone Counter Unmanned Air Systems for the Netherlands. The ReDrone System is comprised of advanced radar system sensors and Electro-optical sensor with the capabilities and the Command and Control Systems to protect against the growing drone risk.

We continue to see healthy demand for our Night Vision Solutions from customers around the world, including yesterday’s announcement from the US DoD for a large Night Vision global contract for ESAs Night Vision business. The information collected by these sensors that are installed on a range of man and unmanned platform is distributed around the battle field by Elbit Systems C4I and Cyber Advanced Communications and Command & Control Solutions that create a real-time, multi-domain network warfare environment from headquarters to the front-end. The current generation of the Digital Army Program that we supply to the IDF, The Torch-X 750 enables Advanced Digital Capabilities in the battlefield from the IDF operating on thousands of our Advanced Software-Defined Radios that enable the flow of data.

Torch-X 750 connects the forces across multi-domains, enabling the rapid and effective transfer of information, including Voice, Video and Text around the battlefield to be used by decision-makers at all levels of the command-chain. In October, Elbit Systems Sweden was awarded a $170 million continued contract to become the integration partner for the Swedish Army Digitization Program, LSS Mark. This contract is an important validation of our Command & Control and Military Digitization capabilities. Elbit Systems Land provides a range of factors to the IDF, including Precision-Guided Munition launch or relate from platforms on the ground, in the Air and the Space. We also supply a range of Artillery Tank on ammunition. These systems enable engagement of the threats identified by the sensor.

In October, we received a $135 million contract, two-year contract from an international customer to establish an artillery ammunition factory. The contract reflects the strong demand for ammunition from countries around the world and the decade of Elbit experience producing a range of artillery, mortars and tank munitions. In September, we were awarded two contracts from the European country, worth approximately $200 million to supply a C4I solution to artillery battalions and Hostile Fire Counter Attack solution. This solution provides a good example of Elbit comprehensive center to shooter capabilities that help accelerate the cycle to identify and engage the enemy quickly and effectively with limited collateral damage. We initiated and we are implementing our operational improvement plan to support our transformation into a larger, more profitable company.

The war in Israel has not changed our long-term plans. It also increases the focus on the portfolio and should help us identify capability or technology gaps, as well as those businesses that are less relevant to our strategy. In summary, I’m encouraged by the progress in the third quarter as well as resilience we have demonstrated overcoming multiple challenges in recent years. I’m confident in our ability to overcome the current challenges and deliver on our potential to all our stakeholders, our customers, our employees and, of course, to you, our shareholders. Before I conclude, I would like to thank our customers and partners from around the world for the numerous expressions of support over the last two months. And with that, I will be happy to take your questions.

Operator: Thank you. Ladies and gentlemen, at this time, we will begin the question-and-answer session. [Operator Instructions] The first question is from Pete Skibitski of Alembic Global. Please go ahead.

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Q&A Session

Pete Skibitski : Yes. Thank you. Gentlemen, good afternoon and I hope you and your families are safe and you’re all doing reasonably well during what I’m sure is a very difficult time to start out.

Butzi Machlis: Thank you, Pete. Thank you.

Pete Skibitski : Yes. Maybe to start with Kobi. Kobi, can you talk more about the third quarter gross margin in particular? I know last year, you had the stock comp expense that impacted gross margin. This year, I think you expected second half margins to be better. So maybe you could just walk us through what impacted the third quarter gross margin and if you expect fourth quarter to see a higher gross margin?

Kobi Kagan : Yes. Thank you, Pete. I’ll talk about — I think there are four layers to the answer. The first one is that we are still in the implementation phase of our operational improvement, a plan to support our transformation. And that plan includes the ERP effort and multiple investments that are still going on, and we will see the continuation of the improvement of our profitability had GP and OP level. The second part is, of course, project mix that you have each quarter. The third issue is that it’s more — we think that it’s more relevant to look at three quarters and not just on one specific quarter. I mean, if you look at the third — at the three quarters from the beginning of 2023, you see that if we deduct the stock price linked compensation plans, we keep the same GP level and even a bit better.

And the last issue is that when we are discussing prices of products and systems, of course there are variety. We are a very diverse company with a lot of projects and systems and products and that creates of course different environment of prices that we can get from the market. So we think that we are on plan. We see the — with the GP, we see an improvement, significant improvement on the operational expenses level. So we keep the trend of improved profitability altogether.

Pete Skibitski: Okay. And just to follow-up financially. Do you expect to be free cash flow positive in the fourth quarter?

Kobi Kagan: As Butzi discussed previously, and as we disclosed, we are expecting the government of Israel, the Ministry of Defense to pay fully their due payments in all of our receivables in the fourth quarter. So certainly, we are expecting a positive Q4 cash flow wise, and we are sure expecting to be fully paid from the government of Israel.

Pete Skibitski: Okay. Okay. And then maybe one last one for me, and I’ll get back in queue for Butzi. Butzi, I don’t know if you have a chance to examine this potential supplemental funding request for Israel that’s passed through the US House of Representatives. It’s about $14.5 billion. And I don’t know a lot of the line items, but I have heard there’s funding for iron beam, for instance, in there, amongst other items. So I’m just wondering, I guess, have you had a chance to gain some view of what’s in there, and would you expect that to be meaningful to Elbit, if that passes?

Butzi Machlis: Yes, we have an intimate dialogue with our government, with IMOD, on our show, in this package, and certainly, I will not go into all the details right now, but I can tell you that we expect to get part of it. As you know, we have Elbit System of America, which produce different systems and products with IDF using SMS funds. So it’s a big opportunity for us and we expect to enjoy from this package as well.

Pete Skibitski: Okay. Yeah, I mean your backlog, I guess, year-to-date backlog is up 9.5%. And that is really before, of course, this potential supplemental impact and any increased Israel, you know, IMOD funding. So it sounds like maybe all the extra capacity that you’ve been building is — it was good foresight, I guess, is the way to say it, to build all that extra capacity. So thanks guys. I’ll get back in queue.

Butzi Machlis: Thank you very much. Thank you.

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

Ella Fried: Good afternoon. Thank you for taking the questions. First, I would like to congratulate you on the growth, on the revenue in this quarter. And mostly, on the way the company is functioning at this time and I think as citizens, we are all very impressed by it. And it was good to hear and how you cope with the reality creatively and efficiently. I have a few questions. The first question is about the focus that you mentioned on the portfolio that you are evaluating maybe from the M&A perspective, potential either buying or selling of capabilities, which makes a lot of sense when the company is growing at this pace. Could you give us some more details about this process?