Elbit Systems Ltd.

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems' third quarter 2020 results conference call. All participants are present in a 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 Meyerson, Elbit System Investor Relations Director. Rami, please go ahead.

Thank you, Ilana. Good day, everyone, and welcome to our third quarter 2020 earnings call. On the call with me today are Butsi Mahlis, 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. Yossi will begin by providing discussion of the financial results, followed by Bussi, 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, please. Thank you, Rami.

Hello, everyone, and thank you for joining us today. The results of our third quarter reflect the resilience of Elbit Systems the sustained demand for our products and services, and the operational improvement that is a result of the initiatives we have discussed with you in the past. As you are all familiar with COVID-19 has resulted in a significant slowdown in commercial air traffic and industry experts forecast that the commercial air traffic recovery to the 2019 level will likely take a number of years. Elbit Systems' commercial aviation exposure is relatively small as a percentage of revenues, but we are not immune to the slowdown in the market. Our third quarter results include a $60 million non-cash expense for the impairment of commercial aerospace assets and inventory write-offs as a result of the impact of the COVID-19 on demand for products and services that Elbit Systems supplies to the commercial aviation market. These expenses have been recorded mainly in the cost of revenues line item in the P&L and have been excluded from our non-GAAP results as we believe these expenses are not representative of LBIT's regular ongoing business. The recent news on COVID-19 vaccine are encouraging and we continue to monitor the situation closely while adhering to the instructions of the governments of the various countries in which we operate. Turning now to our results. 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. The non-GAAP information is particularly relevant this quarter as the third quarter results in 2019 included a one-off capital gain from a sale and leaseback transaction in Israel, and the third quarter results of this year include the interventory write-offs and impairment as mentioned above. Overall, we are satisfied with the improved performance in a challenging environment. Our order backlog and revenues increased year over year, And in comparison to the previous quarter, the improvements in profitability reflect the increased focus on operations, as well as the measures we have implemented to mitigate the financial impact of the COVID-19 pandemic. Our backlog of orders as of September 30, 2020, was $10.9 billion. more than one billion higher than the backlog at the end of the third quarter of 2019, and 55 million higher than that at the end of the second quarter of 2020. The order backlog is equivalent to more than two years of revenues and provides good visibility into the future. I should also note that the acquisition of Elbit Night Vision from L3 Harris closed on September 15, 2019, and was therefore consolidated into our financial statement commencing the date of the acquisition. I will now highlight and discuss some of the key figures and trends of our financial results. Our third quarter 2020 revenues were $1 billion and $134 million. In terms of revenue breakdown across the areas of operation, Land system sales accounted for 29% of total sales and increased year-over-year mainly due to precision-guided munition sales to customers in North America and Asia Pacific. Electro-optics accounted for 10% of total sales and increased year-over-year mainly due to the acquisition of Elbit Night Vision. C4ISR at 25% of sales declined year-over-year primarily due to lower radio sales to Latin America. Our diverse geographic revenue base is important to the long-term sustainability of our business. In the quarter, North America was 30% of total revenues, was the largest geographic area, followed by Israel at 25%, Asia Pacific at 22%, Europe at 19%, and Latin America at 2%. Growth in Israel was driven by tank fire control systems, and the decline in Latin America was due to lower C4ISR sales, as mentioned. For the third quarter, the non-GAAP growth margin was 26.7%, up from the 26.3% in the third quarter last year. The improvement reflects increased focus we have placed on operational improvement that includes multiple initiatives and workflows. GAAP gross margin was 20.9% compared with 26% the third quarter of last year as a result of the non-cash expenses related to inventory write-offs and asset impairment due to the impact of the COVID-19 as mentioned above. Third quarter non-GAAP operating income was 93 million or 8.2% of revenues compared with 81 million or 7.3% of revenues in the third quarter of last year due to higher gross margin and lower operating expenses. Gap operating income in the quarter was $24 million versus $102 million in the third quarter of last year following the inventory write-offs and impairments. Our gap operating income in the third quarter of 2019 included a $28 million capital gain related to a sale and leaseback transaction in Israel. The operating expenses breakdown in the quarter was as follows. Net R&D expenses at 8% of revenues versus 7.2% in the third quarter of last year. Marketing and selling expenses declined to 6.3% of revenues versus 6.9% last year due to reduced travel and participation in trade exhibitions. G&A expenses were 4.5% of revenues versus 5.2% last year. Financial expenses for the third quarter of 2020 were $9.7 million compared to $18.5 million last year, mainly due to changes in the shekel dollar exchange rate in the period. The effective tax rate in the third quarter of 2020 was 15% higher than the 9.5% tax rate in the third quarter of 2019, mainly due to the geographic spread of the income, which included the write-off in the quarter. Income from affiliated companies and partnerships was $4.9 million versus a loss of $470,000 in the third quarter of 2019 due to a $2.3 million write-off of an investment in an affiliate company in Israel last year. Our non-GAAP diluted EPS was $1.64 in the third quarter compared with $1.33 in the third quarter last year. Gap EPS was $0.38 versus $1.63 last year. Our backlog orders of September 30, 2020 was $10.86 billion, $1.1 billion higher than the backlog at the end of the third quarter of 2019, and $55 million higher than that at the end of the second quarter of 2020. Approximately 46% of the current backlog is scheduled to be performed during the remainder of 2020 and 2021, and the rest is scheduled for 2022 and beyond. This ratio is broadly similar to that of the third quarter of last year. Operating cash flow for the quarter was a negative of $63 million compared with a negative $49 million in the same quarter last year and reflects a working capital outflow due to the timing of invoicing and collections from our customers, mainly from the Ministry of Defense in Israel. The Board of Directors declared a dividend of 44 cents per share for the third quarter of 2020. I will now turn the call over to Mr. Machles. Please, Buzi.

Thank you, Justin. Before I review the results for the quarter, I would like to provide our perspective on global defense budgets, as we have received numerous questions from investors on this topic since the outbreak of COVID-19. Elbit Systems has not seen a change in demand for its products and services from its customers around the world. The growth in the backlog over recent quarters provides a good indication of the demand and we have also seen an increase in expression of interest in our field. We also have not seen any indication of plans to cut defense budgets in most of the countries in which we operate. The geopolitical tensions around the world have not declined following the COVID-19 pandemic, and we expect these tensions to continue to drive defense budget growth over the medium and longer term. We also expect countries to increase defense budgets to stimulate growth and support domestic employment and innovation. The announcement by the British government to increase defense spending by £16.5 billion over the next four years is very encouraging. The UK is an important market for Elbit. Elite System UK employs more than 500 people, across the UK, delivering key programs and capabilities to the UK MOD, such as the Watchkeeper UAV program and Affinity that provide services for the UK military flying training system. We believe there are many opportunities for our solutions in this important market, including command and control system, training solution, and unmanned air and ground systems. Elbit Systems diverse geographical customer base and presence is a strategic asset. It has taken decades to build and we continue to invest to maintain the long-term sustainability of our business through different budget cycles. At Elbit Systems, we review our businesses and portfolio on a regular basis to ensure that the company is aligned correctly to evolving customer priorities and to generate synergies between the broad range technologies in our portfolio. Following the latest review, we decided to implement a reorganization of some of our business activities. Our unmanned aircraft systems business will be integrated within the manned aircraft business to leverage the synergies across manned and unmanned military aircraft. We will integrate our electro-optical systems and electronic warfare and signal intelligence businesses to leverage our sensors and capabilities to provide advanced solutions across the electromagnetic spectrum. The precision guided munition activities that are part of our military airborne systems activities will be integrated into the strong PGM portfolio that we acquired with IMI. The reorganization will begin during the coming months and will be completed during 2021. Moving to the business, and the quarterly results, the third quarter, included a number of strategic milestones and important developments across different areas of power play. In October, Elbit Night Vision in the U.S. received a $23 million contract from the U.S. Army for enhanced night vision goggles by Nebula Systems. This was part of an other transaction authority or OTA framework contract of up to $444 million. Elbit Systems is one of two suppliers of NVDB to the US Army. This is an important milestone for the night vision business that we acquired in September last year. We are very pleased with the acquisition that is performing better than expected. I'm even more optimistic about the potential to generate synergies between our legacy thermal imaging night vision portfolio and the image intensifier night vision business over the coming years. This is clearly the future of advanced systems for night operation, and Elbit Systems is well positioned to benefit from the demand for integrating night vision systems. In recent months, we will receive a support contract from our night vision head-up display system for pilots from the U.S. Army and were selected by the U.S. Marines to develop an integrated targeting site. These contracts highlight the breadth of our electro-optical portfolio that are also integrated into aerospace and land platforms. Elbit System market leading command and control solution provides militaries with the ability to connect forces in the air, on the ground, and at sea seamlessly and effectively to support multi-domain operations. Our command and control solutions are deployed around the world by customers from Australia to Sweden. The IDF is ruling out the latest version of Elbit System TorchX command and control solution that enables highly effective sharing of information across multi-domains. The feedback from the users across all domains has been very positive. They have been impressed by the ability to share information seamlessly in ways that were not possible in the past. Elbit System of America supplies the U.S. Department of Homeland Security with a command and control solution from for the U.S. border with Mexico, and we are supplier for the U.S. Army's Command and Control Integrated Infrastructure, or CPI-2 program. In November, the U.S. Air Force selected Elbeck System of America to compete for joint all-domain command and control task orders as part of a large IDIQ contract for multiple suppliers. This selection is another vote of confidence in LBIT technology from the U.S. Air Force following the large Missile Warning System Program award earlier in the year. We are integrating artificial intelligence and data analysis into our command and control solutions that I expect will be an important growth driver for LBIT over the coming years. Elbit Systems has a large portfolio of solutions for armed vehicles and tanks, including manned and unmanned turrets, active protection systems, target acquisition, fire control, and communication systems. Our Carmel Technology Demonstrator integrates the latest generation of legacy capabilities and new technologies for combat vehicles. This includes aero vision that provides the crew with 360-degree vision from inside the vehicle and leverages our helmet, mountain displays, and sensor capability to provide a unique and highly innovative solution. We recently teamed up with BAE Systems, one of the largest global manufacturers of armored combat vehicles, to develop an integrated advanced capabilities for combat vehicles. We are already working with BAE on the integration of Iron Fist on BAE's CV90 for the Netherlands. And there is a significant potential for this partnership over the coming years as militaries around the world would like to replace and upgrade their combat bases. In summary, I would like to thank Elbit Systems employees around the world for their continued hard work in challenging times. Our backlog continues to provide us with good visibility and we continue to see significant potential around the world for our leading high-technology solutions as we work to generate value for all of our stakeholders, our employees, our customers, our suppliers, and, of course, for you, our shareholders. 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. If you have a question, please press star 1. If you wish to cancel your request, please press star 2. If you are using speaker equipment, can you lift the handset before pressing the numbers? Your questions will be pulled in the order they are received. Please stand by while we pull for your questions. The first question is from Sheila Kaiglu of Jefferies. Please go ahead.

Hi. Good afternoon. Good morning, guys. Thank you for taking the question. Can we talk about maybe just free cash flow to start? I might have misheard it, Yossi, but during the prepared remarks, you mentioned some reversal in the Israel payments. Can you just talk about what's going on with the working capital balance and how we should think about quarterly free cash flow run rate?

Yes. Hi, Sheila. How are you? Good. Thank you. Good. Yeah, we are facing some, I would say, challenging times with our customer here in Israel, the Ministry of Defense. Right now, there are some discussions about setting the budgets for this year and next year, and this is under discussion in our parliament. And this is actually the main hurdle in front of the IMOD to release their payments. There is no question about are we going to get the payments. There is a question are we going to get them soon or a little bit later. The IMOD delayed payments on programs this quarter. Just to remind ourselves, last quarter, the second quarter of 2020 was a good quarter and they did pay us quite a significant amount. However, their debt increased this quarter, and from our discussions with the IMOD, the expectation is that the debt will be reduced towards the end of the year, although we have no guarantee yet on this. There is no doubt we are going to be paid as soon as the IMOD gets its budget in place. When is that going to happen? Hopefully this year during December. at the latest during the first quarter of next year.

Okay, got it. And then can we just talk about some of the organic growth trends you guys are seeing? Or, you know, land systems was particularly strong. You know, how sustainable is that? And then if you could just give us a little bit more detail on C4ISR. You mentioned lower radio sales to Latin America. What's going on in that business? When do you expect that recovery? And then similarly with electro-optical systems, just why the decline on an organic basis there?

Well, Sheila, as you know, our company, we recommend to look at our performance on a multi-quarter basis. A specific quarter can fluctuate one way or another in revenues and definitely in the various geographies or the business areas that we operate in. Specifically, your questions, we started definitely to see some improvement and synergy built already through the acquisition of IMI. with significant contracts in the international markets and with that did help the growth of the land systems business. Also, we had some increased sales in this quarter of fire control systems for the IMOD. That is the land systems Going forward, we're definitely looking to see increase in revenues in land systems. Of course, on an average of a multi-quarter basis because the nice things that are happening with the integration of IMI in the land systems. Regarding C4, You know radio equipment is felt in batches worldwide and last year we had in the third quarter some significant sales of radio equipment to Latin America. We do see a strong interest in our radio and communication equipment worldwide. And may I just mention a significant event that happened several weeks ago that a major potential contract was in Switzerland, was approved by the Parliament, and we hope that somewhere in the near future we're going to get a contract on that. But Similarly, we have many places that our C4 equipment is sold, installed, and we expect more contracts. Remember our Australian position, which essentially our C4 business brought in close to over a billion dollars of business in command and control and radio-related equipment. Netherlands, and other places in the world. So we do consider that interoperability requires a lot of bandwidth and communication, and therefore that will continue to push the growth in the revenues in this area of our business.

Okay. Thank you so much. I'll jump back in the queue.

Thanks, Sina.

The next question is from Pete Skibitsky of Alambic Global. Please go ahead.

Yes, good afternoon, Bhatti and Yossi and Rami. I just want to review, guys, the commercial aerospace exposure, just we have a sense of when, how things are likely to annualize for you. Can you ballpark for us just either in absolute terms your revenue exposure to commercial aerospace or as a percentage of revenue? And then I think a lot of the suppliers out there on average, you know, are looking at maybe, you know, a 40% type of decline in revenue for the third quarter and expecting, you know, maybe a couple more quarters of tough comps before things annualize, probably no later than the second or third quarter of 21. So, again, can you maybe ballpark your exposure and let us know if that kind of profile is something that you guys are seeing?

Well, the total non-defense business at Elbit Systems is less than 10%. It is composed of two elements. One is the commercial avionics business, and the other one is the medical instrumentation business. Out of that, now our revenues are over $4.5 billion, so less than 10% is the non-defense part, and part of that 10% is the commercial avionics business. So it's several hundreds of millions of dollars at the max. We did see a reduced requirement. for our products and services in this area due to what the whole world has experienced with lower traffic. The expectation is from what we learn that the level of traffic and requirements for products and services of 2019 will come back somewhere in the 2023-2024 timeframe. We looked at the demand for products and we analyzed our assets and therefore we have impaired that accordingly. So this part, we still have revenues. We still are selling. Most of the areas, we are quite unique. For example, in the area of landing systems in diverse weather, we have very special solutions for that. And this is still required. However, people are flying less, so we are selling less. We do see a significant increase in the other part of the commercial business, and that is the medical instrumentation business, which is in the $100 million to $150 million presently and growing strongly. They are making analysis, laboratories for analysis of liquids and blood and stuff like that. And they are very involved in the presently required COVID-19 detection environment, the needs for that. So that is partly compensating for the reduction in the commercial aviation. And the growth that we have seen in the recent quarters, which is not very strong, but is still growth, does reflect also the reduction in the commercial aviation business.

I really appreciate all the color. I was also intrigued about the reorganization So maybe you guys can talk about, was this primarily, was this a cost takeout, cost reduction type of move, or was it more so revenue synergies, maybe with a desire to kind of align business development activities? Can you give us a sense of what the primary driver of the reorganization was?

Yeah. Good afternoon. The primary driver for the reorganization was was to generate more synergies within the company and to bring more revenues to the company. We are having a strategic session each year. We're trying to predict what will be the market needs in the future. And based on that, we adopt our portfolio. And this reorganization that was declared this week was exactly for that, was to leverage synergies and to create an advanced portfolio, which we believe will lead the market in the near future.

That's great. Very helpful. And very last one for me, more financial. Cash from investing activities this quarter. It looks like you guys booked a large fund. around 70 million or so sale of PP&E in this quarter. Can you give us some color on what that was about?

Well, our capital investment includes replacement of equipment, renewal of inventories, and so on. And then also, we are starting to see some investments required to establish the production site for the IMI transition to the south of Israel. In this, we are preparing everything needed so that the transition can be achieved somewhere during 2023. We have started some investment in that area, and that will continue during the next and following years.

Okay. Did you get a payment from the government for that this quarter?

Oh, this quarter, no, we did not get. We had payments in the past. This quarter, we got inflow we had from different transactions, from other kinds of transactions.

Okay, okay.

Great. Thanks so much, guys.

Thank you.

The next question is from Elad Kraus of Excellence. Please go ahead.

Hi, thanks. I'm Elad. I've been regarding the margins of the company. The IMI acquisition lowered your margins. So do you see improvement in the margins of Elbit in the future due to the synergies with the IMI? And if so, when do you see it?

We're definitely working hard to improve the margins, and we started seeing some results of that, and this quarter is definitely one of them. This is a gradual process. It will take some time, but it is on the right direction. We have a multi-year plan. that includes many elements of cost reduction, of yield improvements. We did mention in the past the implementation of a one ERP system across the whole organization. By the way, all the investments that you see and the expenses related with that are included in our ongoing results. We have We have initiated that already here in part of the airborne division and the UAS operations. By the end of this year, we'll have the electro-optics business going with the same ERP, and next year we expect other divisions to implement that, and we expect that to result in very nice improvements in efficiencies, reduction in inventories, and so on and so forth. So bottom line, yeah, we are working on it. We have a multi-year plan. We are improving. Unfortunately, we do not reap all the benefits of it because some of that is... is, I would say, is offset by the strong Israeli currency, the strong shekel, versus the U.S. dollar. However, we are managing to take care of that as well as we can go forward.

All right, thanks.

The next question is from Dina Kirshenov of Leader Capital Markets. Please go ahead. Hi, guys.

How are you? Good. You answered most of my questions, so I have just one. Can you tell us a bit about the financial potential of the partnership you have with VAE?

We have came together with VAE for a new program which is about to happen in the US. There is a tender to replace, we expect a tender to replace the Bradley fleet in the US market. The Bradley is a fighting vehicle which was produced by BAE by thousands. And the team agreement which we have with them is for an advanced solution. Part of it will come from BAE and part of it will come from us. And we will submit a joint proposal for this tender. The potential is quite big to replace a big amount of vehicles in the U.S. market. As I mentioned in my brief, we teamed with them also for an upgrade of the CV90 in the Netherlands, and they won. We will provide several systems, such as the Iron Fist, the active protection system for the CV90s.

Okay, I understand. And when do you expect all these things will happen? When we will see all the progress in this area?

We are waiting for the RFP to come. I don't remember the date by heart, but it won't take long.

Okay, thank you very much.

You're welcome. Thanks, Lina.

If there are any additional questions, please press star 1. If you wish to cancel your request, please press star 2. Please stand by while we poll for more questions. 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 1-888-782-4291. In Israel, please call 03-925-5918. And internationally, please call 972-3925-5918. A replay of the call will also be available at the company's website, www.elbitsystems.com. Mr. Machlis, would you like to make your concluding statement? No.

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.

Thank you. This concludes the Elbit System LTD third quarter 2020 results conference call. Thank you for your participation. You may go ahead and disconnect.