Elbit Systems Ltd.

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems' second quarter 2021 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 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 Systems Investor Relations Director. Rami, please go ahead.

Thank you, Michal. Good day, everyone, and welcome to our second quarter 2021 earnings call. On the call with me today are Butzi Machlis, 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. 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 financial information and the reconciliation in today's press release. Yossi will begin by providing a discussion of the financial results, followed by Butsy, 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 result of our second quarter reflects sustained demand for Elbit system solutions and services from our customers around the world, as reflected in the growth in revenues, the backlog, and an encouraging operational improvement. Second quarter results include the results of Spartan and Rocar acquired in the beginning of April. At the beginning of July, we completed public tenders for three series of notes, raising approximately $600 million. S&P Global Ratings, Maalot, an Israeli rating agency, assigned its Israeli AA rating with a stable outlook to the notes, which are traded on the Tel Aviv Stock Exchange. The significant participation by investors in the tenders provides a strong vote of confidence in the company. I will now highlight and discuss some of the key figures and trends in our financial results. Second quarter revenues were $1,302,000,000, increased 21% year over year. A major part of the growth was organic in addition to the contribution from Spartan. In terms of annual revenue breakdown across our areas of operation, airborne systems accounted for 40% of total quarterly revenues and increased year-over-year mainly due to the airborne precision-guided munitions sales. Land systems accounted for 22% of total revenues, a similar level of revenues to the second quarter of 2020. C4ISR at 26% of revenues increased year over year, primarily due to the acquisition of Spartan. Electro-optics accounted for 8% of total revenue and declined year over year, mainly due to the phasing of Elbit night vision recent programs in the U.S. I would like to note that significant volumes of electro-optic equipment are included on solutions that we report as part of our airborne, land, and C4ISR systems areas of operation. Other sales were 4% of revenues and increased significantly year-over-year due to growth at the U.S. medical device subsidiary. Our diverse geographic revenue base is important to the long-term sustainability of our business. In the second quarter, North America was the largest, contributing 34% of our revenues, Israel was 21%, Asia-Pacific 26%, and Europe 16%. The growth in the U.S. was mainly due to the Spartan acquisition and the revenues from non-defense medical device sales. Asia-Pacific revenues increased mainly due to the sales of precision-guided munitions. The non-GAAP growth margin for the second quarter was 26.6%, compared with 26.5% in the second quarter of 2020. Gap growth margin in the second quarter of 2021 was 26% of revenues in line with the second quarter of 2020. The sequential improvement in growth margin compared to the first quarter of 2021 is encouraging and reflects the initial benefits of cost control measures we adopted to help mitigate the financial impact of the stronger shekel and the COVID-19 that we discussed with you previously. The second quarter non-GAAP operating income was $114.9 million or 8.8% of revenues compared with $92.7 million or 8.6% of revenues last year. GAAP operating income for the second quarter was $117 million, similar to the second quarter last year. Gap operating income in the quarter included the profit from the sale of a building in Israel recorded under the other operating income. Gap operating income in the second quarter of 2020 included the profit from the sale and easeback of two of Elbit Systems of America's facilities. The operating expense breakdown in the second quarter was as follows. Net R&D expenses were 7.3% of revenues, similar to the second quarter of 2020. Marketing and selling expenses were 5.8% of revenue versus 6.2% last year. G&A expenses were 5.1% of revenues compared with 4.8% last year due to the acquisition-related expenses in the quarter. Financial expenses were 7.1 million in the second quarter compared with 16.5 million in 2020. The lower level of financial expenses was mainly a result of gains from changes in fair value of financial assets and liabilities. We recorded a tax expense of 20.1 million in the second quarter compared with 23.6 million in 2020. The effective tax rate in the second quarter was 18.5% compared with 20.8% in 2020. Our non-GAAP diluted earnings per share was $2.11 in the second quarter compared with $1.56 in last year. The GAAP diluted EPS was $2.30 compared with $2.02 last year. Our backlog of orders as of June 30, 2021, was approximately 13.6 billion, at 2.8 billion higher than the backlog at the end of June 2020, and 1.8 billion higher than that at the end of March 2021. Approximately 51% of the current backlog is scheduled to be performed during 2021 and 2022. and the rest is scheduled for 2023 and beyond. This ratio is lower than at the second quarter of last year, following a number of multi-year contracts awarded recently. The order backlog is equivalent to more than two and a half years of revenues and provides good visibility for future revenues. Cash flow from operating activities for the second quarter was 170 million inflow, compared with 179 million inflow in the same quarter last year. The net proceeds from the recent bond offering will be included in our third quarter results. Following a review of capital structure and cash requirements, the Board of Directors declared a dividend of 46 cents per share for the second quarter of 2021. I will now turn over the call to Mr. Machles. Please, Buzi.

Thank you, Yossi. I would like to begin by thanking the investors that participated in the tender for Albert System notes in July for the strong vote of confidence in the company. Training. The record $13.6 billion backlog at the end of the second quarter included the 1.65 billion 20-year contract from the Hellenic Ministry of National Defense to establish and operate the International Flight Training Center of the Hellenic Air Force signed in April. Elbit Systems has developed a broad portfolio of market-leading training and simulation solutions for militaries around the world that are expanding their simulator and training capabilities. These solutions include provide a more realistic training that better prepares the soldiers for a wide range of scenarios at a low cost. Firefighting squadron in Greece. Elbit Systems operates the Israeli firefighting squadron on behalf of the Israeli Fire and Rescue Authority. This week, the Israeli government sent two firefighting aircraft from the squadron as well as an Air Force transport aircraft to Greece to assist the effort of the Greek firefighters who are battling wildfires across the country. The delegation includes Elbit Systems employees that will provide logistical support. I am proud that Elbit Systems is taking part in this critical mission as part of our commitment to protecting the environment in Israel and around the world. Growth engines. At the investor day in April, we highlighted three medium-term growth engines, network precision munition, maritime systems, and high-powered lasers. I am pleased with the progress that these growth engines demonstrated during the second quarter. Precision-guided munition was one of the revenue growth drivers in the quarter, as Yossi mentioned. The recent conflict in the south of Israel highlighted the growing threat rocket and missiles present to civilian population and military installations around the world, increasing urgency to develop more efficient and cost-effective solutions. In June, Elbit Systems, together with the Israeli MOD and Israeli Air Force, successfully carried out a series of tests of interceptions to shoot down drones with an airborne high-powered laser installed on a light aircraft. The successful interceptions were an important milestone in our development of airborne high-powered laser systems that will be capable of defending large areas by intercepting multiple threats at high altitudes. Elbit Systems has made significant investment in recent years to develop and acquire comprehensive solutions for the increasingly contested maritime domain. In April, we completed the acquisition of Spartan in the U.S. and received an $80 million contract in June to supply AI-powered Spectre XR electro-optical systems for maritime forces of an Asia-Pacific country. Elbit Systems Spectro XR is a multi-spectral long-range electro-optical system that provides naval, air, and land forces with ISTAR capabilities in both day and night and under low visibility conditions. Spectro utilizes artificial intelligence to continuously scan for targets, extract operational insights, and reduce human errors. In June, our UK subsidiary, Elbit Systems UK, received a $60 million contract to supply exact night vision goggles to UK Armed Forces. Systems from the exact family have accumulated significant operational experience and have been selected by a number of NATO countries, including Germany and the Netherlands. In June, our U.S. subsidiary, LB System of America, was awarded two orders with cumulative value of $20 million to upgrade U.S. Army pilot night vision systems. In June, LB Systems' German subsidiary, LB Systems Deutschland, was awarded a $20 million contract to supply E-Links, software-defined multi-channel radios, to the Swedish Army. Under the contract, LB Systems will supply additional E-Links radios for vehicles as part of the Sweden Tactical Radio Upgrade Program. Our E-Links radios have been selected by several armed forces across Europe, including Switzerland, Spain, and other NATO countries. In summary, our broad-based backlog continues to provide us with good visibility, and we continue to see significant potential around the world for our leading high-technology solutions. 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, kindly 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 Greg Conrad of Jefferies. Please go ahead.

Good morning. Good morning. Just, you know, Hey, how's it going? Just to start, first on airborne sensors or systems, you mentioned, you know, the strengths and precision munitions. I mean, how lumpy is that? Or, you know, does this business reset at kind of this higher level when we just think about it going forward?

Well, yeah. The basics of this product lines, which are several of those, are coming from the acquired subsidiary IMI that we did in 2018. Now, there is a big variety of products that are in that category. That means airborne launched precision guided munition. When we bought IMI, we had about 20% or less of international business at IMI, which included very low level of revenues from this kind of product lines. With our geographic spread of our marketing and contacts with the various customers, we were able to promote significantly the interest of customers in this kind of precision guided munition. And we do see a significant growth over the years for this kind of family of products. Our estimate is that this growth will continue into the future as well. particularly because we also introduced some significant upgrades in this kind of munition for improvement of launching capabilities on one side and improvement of precision guidance on the other side. By the way, the acquisition that we did, the smaller acquisition that we did this quarter, a company by the name of Rocard, we bought them from BAE, they do have the capability and the technology to improve the precision guidance of this kind of munitions. Therefore, looking forward, we do see we are very optimistic of continuous growth in this area.

That's helpful, and I mean, you brought up IMI, which I think you've done a good job kind of improving the margins. I mean, margins stood up out in the quarter, good sequential progression, and you know, some of the highest over the past several years. I mean, how much does mix play into that? Or, you know, have you been able to drive productivity where we kind of, you know, think about a nice step up for margins as we go forward?

Well, we have a multi-year plan going out for covering over five years. We are somewhere in the middle of performing and achieving the goals of this plan. We have another two years to go. I think we are ahead of what we initially planned. We are improving at a nice rate the margins, and it looks like that there is still room for improvement for the following two to three years. A major milestone that we will be achieving towards the end of 23, beginning of 24, is the movement of the manufacturing slash production facilities to the southern part of Israel into a new modern production facility. And through that, also lowering the cost of labor. And that will give another boost for improvement of profitability of production of these products.

And then just last one for me. I mean, strong free cash flow in the quarter. You had a nice tailwind from working capital. I mean, any changes or thoughts around your assumptions for working capital as you kind of move through the year, given the good conversion in Q2?

Over the years, over the quarters, we did have some delay in payment from one of our major customers, which is the Ministry of Defense here in Israel. During the second quarter, they did pay some of their billings. However, these are fluctuating a little bit. There may be some fluctuations in the next quarter. We are very optimistic that everything will be settled by year end because the delays were caused by the approval of the overall budget of Israel, including the budget of the Ministry of Defense. This will be solved somewhere in November, and therefore everything, it looks like every outstanding billings will be paid by the year end. Thank you. Thanks, Greg.

The next question is from Dina Korshanov of Leader. Please go ahead.

Hi, guys. How are you? Congratulations with your great results. Thank you, Dina. I have a couple of questions. I think the first one and the most interesting is what are the main segments that contributed to the big increase in the revenue this quarter? Can you... sell us? Do you think it's sustainable for some kind of amount or is it something that happened just this quarter?

Good afternoon. The growth in revenues is not related just for one line of business. We see it all over the portfolio and I think that the strategy that we have chosen is starting to bring results. The strategy is a wide portfolio, very advanced wide portfolio on one hand, and being global as much as we can with local subsidiaries around the globe. We see a growing demand on one hand. for this portfolio because of tensions around the globe and because of interest to increase defense budget. On the other hand, we also see a trend to support the local economies and to create more jobs. And the fact that we have so many subsidiaries all around the world is certainly helping us to get contracts. So the answer is we see a growing demand for the whole portfolio all around the globe. And you see in the backlog, and this backlog should be converted into revenues and profit in the near future, as you saw in these results. And I believe that this trend of growth in revenues and in profitability will continue Talking about profitability, we invest a lot of effort in order to increase effectiveness, efficiency, and to create synergies between the different activities we have in the company, and that's why we are successful to gain more profit, and I believe that this trend will continue well.

I understand. Great. And does the high revenue volume contribute to the increase in the profitability in the quarter?

No, it's too different. The high revenue is related to backlog, which is transformed into revenues. And the reason for the growth in profit is big efforts and a very detailed plan we have implemented recently. quite a long time ago and is starting to bring results to increase effectiveness and efficiency in the company.

I understand. Last question. Do you expect some kind of decline in the results in the next quarter if there will be an acceleration in COVID-19 restrictions in the world?

I think that we have proved that we know how how to operate and how to be successful also under restriction because of COVID-19. And we understand that this pandemic will not disappear in the near future and we are ready to continue to operate in the future also under new restrictions. And the fact, again, that we have so many subsidiaries around the globe is certainly helping us And I think that we are ready to work on the new restrictions also if they happen in the future.

I understand. Okay, great. Thank you, guys.

Thanks, Nina. Thank you.

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

Yes, good afternoon, Batsi and Yossi and Rami. Very nice quarter all around, guys.

Thank you.

First question, the large cash advance that you guys received in the quarter, it was pretty sizable. Was that related to the Greek contract being signed or is that related to something else?

It's a combination of various contracts. The Greek contract is definitely a significant contributor to that.

Okay, okay. And Yossi, I think you guys have been alluding to the new implementation of your ERP system. Is that complete at this point? Is that an ongoing process, and has that been pretty important to the margin strength?

It's an ongoing effort. The plan and the implementation started about three years ago. It was a very detailed plan, and we are on plan. give or take some changes. Right now, by the end of this year, we will probably be completed around 70% of the implementation. And by the end of 2022, we expect to be close to 90% of implementation, maybe a little bit higher than that. So, as I said, our financial report statements include all the capital investments that we did in that ERP system. They include all the expenses related with the implementation. But unfortunately, so far, we did not see yet the benefits coming through because not the whole organization is on the same system. We start right now to see some of that very small amount of savings. but I think it looks like that somewhere in 2023 we will face some more material improvement in cost, in reduction of inventory because of commonality of items, in shorter turnaround times, and other benefits that will improve the operational performance of the company, hopefully including the cash flow.

That's great. I appreciate the color. A couple more from me. I want to ask about a program, the F-35, because I know you guys have a good amount of content on the F-35. And the reason I ask is because we've heard from other suppliers that there have been some revenue headwinds over the last couple of quarters, maybe two or three quarters, on the F-35 because Lockheed kind of slowed things down a little bit. They needed to kind of wind down some inventory issues. Have you guys kind of been through that where you've had maybe some revenue headwinds on the F-35 for maybe the last couple of quarters, but maybe that should start to grow again maybe later this year into 2022? I don't know if you could provide any color on that.

On the F-35, you are right that we have significant content growth. The helmet system is one of them. The full display of the cockpit is another one and some other parts as well. So far, we're working with Lockheed Martin hand by hand, and our production plans are very closely related with their requirements. They give us some forecasts, and according to that, we work and, of course, according to the purchase orders that we get from them. So far, I wouldn't say that we have experienced material headwinds, but we definitely work hand-in-hand with them to see that we adapt our engineering and production performance according to what they need. As I said, so far, nothing material yet.

Okay, okay, I appreciate that. And then last one, just with the large capital raise, guys, I guess I'm just curious in terms of how you're approaching kind of M&A going forward, how active you are, and also just kind of, you know, do you see gaps in the portfolio that you'd like to fill, kind of how you see, you know, your desire to reshape the company going forward?

M&A is part of our strategy. It has been. It will continue to be. And the rationale behind that is to expand our portfolio on one hand and also to get additional global positions in the global market. And we continue to look for opportunities. We are monitoring the market. We see some opportunities which are relevant to us. And as you said, we have the right capital. We have the capital right now to continue doing it. I think that we also prove to the market that we know how to make acquisitions and how to merge the activities and how to get synergies from acquisitions, and it will continue to be part of our future strategy as well.

That's great. I appreciate the color. I'll get back in the queue. Thanks, guys.

Thank you.

Thanks, Peter.

Ladies and gentlemen, there is a temporary technical issue in the Q&A polling process. It has been fixed and is now working properly. 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 is a follow-up from Pete Skibitsky of Alembic Global. Please go ahead.

Yeah, thanks. But see, there was some press out there, some articles out there in the quarter about your ground, your mobile artillery system. I think it's called Sigma. I think James had an article, and I think it's still in development, but I think maybe it's nearing the end of development, perhaps. Maybe you could give us a sense of, you know, what kind of domestic and international opportunities are out there for that system, because it, you know, I think it's maybe the maybe the most modern mobile system that's out there right now since it's finishing up development.

Thank you. It's in the middle of development. We have a big contract here in Israel for this Sigma 155 self-propelled gun. It's a very sophisticated piece of equipment. It's a big robot, actually, which can reach ranges for more than 40 kilometers with... limited amount of crew members, and it can fire guided ammunition as well, guided artillery shells. We are in the middle of the development. We are progressing well with our local customers in Israel, and we will start performing live shooting next year, and the first system should be completed around the end of next year. We see a lot of demand. I agree with you that it's one of the most, if not the most, advanced solutions in the market right now. We see growing demand for that in several countries. And we are promoting it already in several countries. And I just want to add that This quarter we acquired the from BAE here in Israel, in Jerusalem, and one of the technologies and one of the assets they have is a guided fuse which can be added to a regular artillery projector to make it guided, which will actually enable us to provide a complete solution for a customer, which includes the hobbit cell itself with all the automation embedded in it, a fire control system embedded, some reconnaissance capabilities collected, which can create targets to the hobbit cell, all types of ammunition, which can be fired, including guided ammunition as well, so we can provide a full solution for our customer, and there is a growing demand for that. It was also published recently that the previous version of the gun was presented in the U.S. for some requirements which are available in the U.S. market as well, and it might be also an opportunity for us.

Okay, that's great. I appreciate all that color. I guess last one for me. It seems like in terms of the government in Israel, things are kind of progressing now and are pretty stable. Could you just maybe give us an update in terms of, you know, has the government made all of its appointments to the Israeli MOD? Is the budget outlook fairly stable at this point? Just things like that that maybe people like me internationally don't have as much visibility into?

You know, of course. There is an understanding here in Israel, in the government, about the size of the defense budget for the coming years. And actually, the agreement which has been made between the Ministry of Finance and the Ministry of Defense is presenting growth in defense spending here in Israel. This budget, the national budget here, is under an approval process in the country, and it should be concluded by the beginning of November, and then it should be implemented. This is after more than two years without a national budget here. And when this budget will be implemented, there are many additional opportunities for us, which I expect to happen. So that's the status of the budget. The budget is bigger, and there are several opportunities for it to be embedded in this budget. And this budget will enable the Israeli IMOD to implement the... It's a five-year plan to acquire new type of technologies to support the Israeli forces. What's also important to mention is the budget will be for two years, to cover 2021 and 2022.

Okay. So much more visibility at this point, it seems like, than you've had in a while. So that's great. Thanks so much for the call, guys. Have a great day.

Thank you.

Thanks, Pete.

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

Hi, Boutse. I have a couple of questions. First of all, regarding the new businesses, do you see any change in the margins that you're selling compared to the past? Is it higher, lower, more of the same?

Well, I just want to clarify a little bit of how we work so that... you all understand. First of all, of course, the prices are set by the market. And that is where we compete on one hand. There might be some movements because of changes in economies in the various parts of the world and so on. But the prices are set by market competition. The cost element is set, of course, by our estimates of cost of the various programs and on a multi-year basis, and we definitely take into account anything for the future economic environment that could affect the cost of material and labor. The difference is the budget. So this is the process we are going through. If we look at at what we are getting, the new businesses that we acquire, then definitely we can see that there are some movements, but not major movements, in the prices that we are getting, on one hand. On the other hand, there is movement in the cost structure of our company, which on a multi-year basis we have a significant effort to reduce overheads, to increase yields of production, to centralize production and acquisition operations. And as I mentioned earlier, the ERP system that we are implementing, all of that should lead to effectively lower cost structure of the company, which we do see some movement already in that direction that helps us improve profitability. But by the end of the day, the market is the one that is defining the prices in the competition stage.

I also want to add to that that we have much more to offer to the market than we had a few years ago because of the acquisitions we made and because of the synergies between all different parts of the portfolio. We have much more solutions to provide, and the fact that we control most of the technology in-house creates opportunities for us also for cost reduction as well. I see.

Another thing, do you see any major changes in the tactics of the company due to the fact that you're moving out from the central region and building a new place for IAI?

Well, the CAPEX, I would split that into two parts. The part which is, I would call them ongoing, which supports the ongoing operation of the overall company, in that we do not see significant changes. There are two elements in the CAPEX which do affect the numbers. that are, I would say, one of a kind. One of it is the investment in the one ERP system, which is a significant investment over years, which does affect our capex to the tune of, I would say, 10 to 20, maybe some more, millions of dollars per year. The other element, which is extraordinary, is the movement of the production facilities of IMI to the southern part of the country, which is also one of a kind. It does affect, and it will affect also 2022 and 2023. I don't see a significant step up in that part for the following two years, but it's one of a kind. So if you look at what's happening in the CAPEX in the last five years, let's say the last three years that we went through and the next two years of coming, they do support, the CAPEX number does support these two major efforts, which are not recurring efforts. The recurring CAPEX essentially is rather stable, maybe with some minor increases in some advanced technologies that require specific engineering capabilities, but nothing outstanding.

All right. Thank you very much. Great quarter. Thanks a lot.

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 03-925-5900. And internationally, please call 972-3925-5900. A replay of the call will also be available at the company's website, www.elvetsystems.com. Mr. Machlis, would you like to make your concluding statement?

I would like to thank all our employees again for the 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 Elvis Systems Limited Second Quarter 2021 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.