Elbit Systems Ltd.

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems' third 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 now received 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, Shemtov. Good day, everyone, and welcome to our third quarter 2021 earnings call. On the call with me today are Buti Mahlis, our President and CEO, Yossi Gaspar, our Chief Financial Officer, and Kobi Kargan, who will take over from Yossi on April 1st next year. Before we begin, I would like to point out that the safe harbor statement in the company's press release issued earlier today also referred to the contents of this conference call. As we do every quarter, we will provide you with both a regular GAAP financial data as well as certain supplementary 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. 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. Please.

Thank you, Rami. Hello, everyone, and thank you for joining us today. I would like to begin by welcoming Kobi Kagan to this call. I have worked closely with Kobi since he joined Elbit in 2008. We are currently conducting a handover process before he takes over the role of LBIT system CFO from April next year. The results of our third quarter reflect the successful execution of our global diversification strategy that is delivering strong revenue growth and an improved operational performance, which is a result of efficiency measures we discussed in the past. We continue to implement mitigation plans to limit the impact of the strengthening of the Israeli shekel. In the short term, these include the adoption of a rolling hedge policy and efficiency measures. Over the longer term, we plan to expand our manufacturing footprint in high-quality, lower-cost countries to better balance our currency exposure and reduce risk. I will now highlight and discuss some of the key figures and trends of our financial results. Third quarter revenues were $1,363,000,000 and increased by over 20% year over year. A major part of the growth was organic in addition to the contribution from Spartan, which we acquired in the second quarter of 2021. In terms of revenue breakdown across our areas of operation, airborne systems accounted for 37% of the total quarterly revenues and and increased year-over-year mainly due to airborne precision-guided munition sales. Land systems accounted for 23% of total revenues, a similar level to the revenues of the third quarter of 2020. C4ISR at 27% of revenues increased year-over-year primarily due to the acquisition of Sparta. Electro-optics accounted for 10% of total sales and increased year-over-year due to the ramp of LBIT night vision programs. Other sales were 3% of revenues and increased year-over-year due to the growth of our U.S. medical device subsidiary. Our diverse geographic revenue base is important to the long-term sustainability of our business. In the third quarter, Asia-Pacific contributed 31% of revenues North America 30%, Israel was 18%, and Europe 17%. The growth in US was mainly due to the Spartan acquisition and sales of non-defense medical devices. Asia Pacific revenues increased mainly due to sales of precision guided munitions and UAS. The growth in European revenues was due primarily to C4ISR sales to the UK. The non-GAAP gross margin for the third quarter was 27.2% compared with 26.7% in the third quarter of 2020. GAAP gross margin in the third quarter of 2021 was 26.6% of revenues compared with 20.9% of revenues in the third quarter of 2020. The GAAP gross profit in the third quarter of 2020 included a $60 million non-cash expense from asset impairments and inventory write-offs due to the impact of COVID-19. The gross margin improvement during the second quarter and third quarters of 2021 is encouraging and reflects the benefits of the cost control measures we adopted. The third quarter non-GAAP operating income was $123 million, or 9% of revenues, compared with 93.1 million or 8.2% of revenues last year. Gap operating income for the third quarter was $110 million versus $24 million last year following the inventory write-offs and impairments. The operating expense breakdown in the third quarter was as follows. Net R&D expenses were 7.4% of revenues versus 8% in the third quarter of last year. Marketing and selling expenses were 6.2% of revenues versus 6.3% last year. G&A expenses were 4.9% of revenues compared with 4.5% last year. Financial expenses were $13.5 million in the third quarter compared with $9.7 million in 2020. We recorded a tax expense of 8.3 million in the third quarter compared with 2.2 million in 2020. Defective tax rate in the third quarter was 8.6% compared with 15.4% in 2020. Our non-GAAP diluted EPS was $2.33 in the third quarter compared with $1.64 last year. The GAAP diluted EPS was $2.08 compared with $0.38 last year. Our backlog orders as of September 30, 2021, was approximately $13.6 billion, $2.7 billion higher than the backlog at the end of September 2020, and at a similar level to the backlog at the end of June 2021. Approximately 40% of the current backlog is scheduled to be performed during 2021 and 2022, and the remainder is scheduled for 2023 and beyond. The percentage of the backlog for the remainder of the year and the following year is lower than the third quarter 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 the future. Cash flow from operating activities for the third quarter was 150,000 outflow compared with 63 million outflow in the same quarter of last year. During the third quarter, we successfully completed the tender of three series of nodes raising approximately $575 million. The notes will be traded on the Tel Aviv Stock Exchange and provide us with good long-term source of funding for ongoing business operations as well as potential acquisitions. The Board of Directors declared a dividend of 46 cents per share for the third quarter of 2021. I will now turn the call over to Mr. Mahlis, Elbit's CEO. Butzi, please.

Thank you, Yossi. I would like to welcome Kobi to the call and wish him luck. I have worked with Kobi for many years. As you may know, Kobi was VP Finance at Elbit System Land and C4I when I was General Manager. Turning to the financial results, the recent months have been busy and productive with a number of strategic contract awards. We continue to see good momentum across almost all our and markets, including Israel, following the approval of the defense budget. At our investor day in April, we discussed the increased importance of maritime domain and the investment Elbit has made to develop solutions for the growing market. In November, our UK subsidiary, Elbit Systems UK, was awarded a $100 million 13-year contract from Babcock to provide the Royal Navy with new electronic warfare capabilities. As part of this contract, Elbit System UK will design and manufacture maritime EW suits comprised of digital full-spectrum radar electronic support measures and EW command and control systems. These latest generation technologies will enhance the situation awareness and anti-ship missile defense of Royal Navy ships, improving their capability to exploit the electronic magnetic environment. Elbit Systems supplies electronic warfare systems for air, land, and naval platforms, and in recent years has signed a number of contracts to supply EW systems for the U.S. Air Force National Guard F-16s and German Air Force helicopters. We are also installing EW systems on the Israeli Navy's New South 6 corvettes. In September, we received a $56 million contract to provide an integrated anti-submarine warfare solution to the Navy of an Asia-Pacific country. LBIC will provide single unmanned surface disaster confirmed to perform anti-submarine warfare missions and our TORD reliable active passive sonar or TRAP systems. This award follows a contract earlier this year to provide single USVs configured for mine countermeasure missions. The integration of Spartan is progressing as planned. I'm very satisfied with the progress we have delivered in the maritime market this year, expanding our market positions and product portfolio. LBIT is well positioned for growth in this market over medium terms. A few weeks ago, we hosted Israeli Defense Minister Benny Gantz at a cornerstone laying ceremony at our new Ramat Beka facility we are building in the south of Israel. Over the coming years, we will transfer IMI's manufacturing activities from central Israel to a new modern facility. The new facility is an important part of the implementation of the multi-year IMI turnaround plan and we expect to complete the move by 2024. These efforts should support our efforts to enhance IMI's profitability. The second part of the IMI turnover is to increase the share of international sales. These were significantly lower than a bit when we acquired IMI. Accordingly, IMI's international orders have grown rapidly since the acquisition. In the first nine months of 2021, 60% of IMI orders were from international customers, compared to approximately 20% prior to the acquisition in 2018. The acquisition of IMI enhanced Elbit's system portfolio for artillery solutions by adding advanced munitions to our legacy portfolio of Hobbiters, Mortar, Target Acquisition, and dedicated command and control solutions. The Israeli MOD selected the Elbit system to develop and manufacture a new generation of Sigma hobbiters to the IDF. Sigma is a 155mm self-propelled hobbit capable of automatic loading and laying of the gun system, rapid in and out action times, and high rate of fire. The ramp in this program is progressing as planned. Last week, we received a $106 million contract to supply Sigma fully automatic self-propelled Hobitzer gun system to a country in Asia Pacific, the first international order for the Sigma. We believe there is a significant potential for additional artillery orders for militaries around the world looking to upgrade their legacy artillery systems. Elbit Systems' Atmos Hobitzer participated in the U.S. Army shoot-off earlier this year, and we and was on display outside AUSA in D.C. in October. We continue to invest in the expansion of our U.S. footprint. In November, Elbit System of America announced plans to establish a new 135,000-square-foot facility in Charleston, South Carolina. The facility will host the ESA's Ground Combat Vehicle Assembly and Integration Center of Excellence. We expect operations in the facility to begin by the third quarter of 2022 to support contracts ESA received from the Israeli Minister of Defense for the supply of self-propelled Hobbitzer gun systems to the IDF. The new facility is part of Elbit Systems' strategy to expand our engineering and manufacturing capability in the U.S. The facility will create around 300 new jobs with support 280 suppliers across South Carolina and can be used for assembly and integration efforts for future DOD programs. In September, ESA received a $54 million contract for ENVG production from the U.S. Army. This order is part of the OTA contract with a maximum value of $442 million we received in 2020. In October, ESA received a $76 million IDAQ contract to supply head-mounted display systems for the U.S. Army Apache helicopter. 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.

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 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, Greg. Maybe just to start on revenues, kind of a two-part question, one kind of more short-term, one longer-term. I mean, just in the short-term, is this year any different where you typically have a Q4 ramp for sales or were there some items kind of pulled into Q2 and Q3? And then kind of the second part, longer term, I mean, organic growth has been running well ahead of our expectations and also kind of the mid-single-digit target you've laid out in the past. I mean, has the growth profile been reset or are there headwinds heading into next year? We should think about just kind of how we should think about, you know, the overall growth target.

Well, usually, as you have mentioned, the fourth quarter, is usually a strong quarter at Elbit Systems from point of view of revenues, and we expect this to be the case for 2021 as well. We did see the transformation of the strong backlog growth that we had in recent years into revenues. Actually, I would say that repeatedly we were asked by the markets how come that we grow so strongly in the backlog and we do not see a simultaneous growth in revenues. As we explained, it takes some time from the growth of the backlog until it transforms into revenues, and presently we do see that effect happening this year. Looking forward, I think the transformation of the backlog into revenues will continue. The continued growth in backlog will create continuous growth in revenues. However, I am not sure at this point in time that we will be able to deliver strong double-digit growth through all of next year. We do believe that the growth will happen because of the backlog numbers and that next year we'll see growth in the top line as well.

Thank you for that. And maybe just transitioning to margins, you mentioned cost control measures and a number of maybe efficiencies around manufacturing. How are you thinking about the margin targets? You know, I think you've laid out a 10% longer-term margin target in the past. I mean, how do we think about the path to get there between, you know, maybe mix some of the efficiency measures you've kind of put in place and just overall volume leverage?

I think that our long-term plan is definitely underway, and we started to see the positive results of our long-term strategic plan of reduction of overheads, of cost, of improving efficiencies, of combining production lines, and all the other efficiencies, including centralized acquisitions and so on. All of this is happening. In the past, we mentioned also what we call the one ERP system that is implemented across the whole organization. We are well over 50% already implemented, and we expect to complete that somewhere, most of it during next year and maybe some very small parts in the year after that. And we already start to see the benefits of that, although the biggest part will come in 2022 and 2023 when we have most of the company under the same ERP system. This whole effort will continue and, as I said, is part of a long-term plan that is implemented and does help us in improved performance from the point of view of profitability. Together with that, we have some headwinds because of the local currency exchange rate. We are making all the efforts possible in order to mitigate that, and that effort will also continue into the future. We also are looking at various production sites in order to... in order to enable us to manufacture and do some as well as engineering efforts in high-quality, low-cost countries that will enable us to reduce our cost base in the various areas of cost in the company. One of the elements that helps us to reduce the overall percentage of cost of the operating expenses is, of course, the very strong growth in the top line. And when the company growth is growing, then the reduction in percentage of cost in the G&A, the percentage of cost of R&D and other expenses is also helpful in improving the operating profit line.

I'll leave it at two. Thank you, and good quarter. Thanks. Thanks, Greg.

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

Yeah, nice quarter, guys. And Yossi, congratulations on your pending retirement. Thank you.

I will be around for some time. He's not a towing yet.

Understood. So, yeah, second straight quarter of, you know, it looks by my math sort of mid-teens organic revenue growth. And I think the last quarter you talked about a large precision guided munition sale to an Asia Pacific nation as being a key driver of that second quarter growth. I'm guessing maybe that was a big driver in the third quarter as well. Can you give us a sense for when that large program may start to run off, just so we can maybe get an idea for the timing of maybe transitioning from this kind of mid-teens growth to more of a, like you talked about, your long-term goal of mid-single-digit-plus type growth?

Our revenues are definitely impacted by various programs of this kind. This is not the only program that we are running. This specific program, it goes through the next year as well. However, there are some significant other programs with similar characteristics that we have received in our backlog and will eventually replace the revenues from this program, as we usually do over the years.

Okay, okay. And then can we talk cash flow for a second? There was a large receivables bill this quarter. I think I heard you – I don't know if that's related to the PGM sale, but I also heard you guys say that the Israeli defense budget was approved, which I think you were hoping that that could improve cash flow. So I'm just wondering maybe you could speak to expectations for fourth quarter cash flow and kind of catching up on some of the receivables billed.

Well, the one good thing that has happened in November is that the Israeli government has approved and the parliament has approved the budget for the rest of 2021 and 2022. This, of course, has been reflected in approving all the expense elements, the budgets of the MOD in Israel, and that has translated in payments significant payments that were delayed by the Israeli Ministry of Defense for many quarters actually so that at this point in time I can I'm happy to report that a significant part of the delayed payment have been paid and we expect by the rest of this year to get paid for most of the delayed payments of the Ministry of Defense so from that point of view that's very good news and things are back on track as they should have been for normal force of business. And I would emphasize that this is not reflected yet. The improved collection from the Ministry of Defense in Israel is not reflected in the third quarter numbers. Because the budget was approved in November, we will see that in the fourth quarter. From point of view of the other elements, yes, when you have increased revenues, then of course you have increased receivables, and we expect to collect all of that in time. So looking at next quarter, I would cautiously be optimistic by saying that we probably will improve our working capital and we'll see stronger cash generation.

Okay, that's great news. I appreciate that. Maybe I can take one last one in, maybe for Butsy. Butsy, a lot of news, I think, about opportunities for Israeli firms in general, but certainly for Elbit, for I'll call it non-Israel defense sales. I think you guys attended the Dubai air show recently, and there was an announcement that you're setting up a new unit in UAE. So can you talk about maybe how optimistic you are about these kind of new opportunities and kind of, you know, timing and magnitude? And it just kind of seems like a whole new market has opened up to you fairly quickly.

Thank you. It's true. We participated for the first time in the Dubai Airshow. The EBRAM agreements are opening new opportunities in new markets for a bit, and I can tell you that there is a lot of interest in several countries for our technology. And I'm optimistic that it will generate revenues in the future for us in this new market. We are working with the local industries already, and we know the market quite well. And I'm quite optimistic that we will continue to see revenues in this market in the future as well. And this is not true just for UAE. It is true for additional countries which are open for us right now based on the agreement which was declared a year and a half ago.

That's great. I appreciate all the color, guys.

Thanks, Pete. Thank you.

The next question is from Ella Freed of Bank Lumi. Please go ahead.

Hello. First, I would like to congratulate the new CFO, Kobi, on his appointment and wish him lots of success. I have a few questions. The first question relates to the operational profit and the hedge level. you have achieved in this quarter quite a nice rate of operational profit, certainly non-gap. And we also remember that this year you set the hedge level at 3.3 shekels for a dollar. I also remember that you established now a continuous hedge. So what are you expecting the next year? Did you catch a nice level for the forward-going quarters?

We have hedged our shekel expenses for this year, and that includes the fourth quarter. For next year, we have been successful to hedge part of that, mainly in the first half of next year. And we, of course, are keeping track on the changes in the currency and looking for opportunities to continue our policy of continuous hedging as it comes along.

So you have two certain quarters ahead of you that are almost fully hedged at the current level, and then you have to try and keep it on. I said part of next year, yes. Part of next year. I decided it's my decision that it's half of next year. Okay. And the next question is actually about, I don't know to whom it's related, but it's about removing facilities. You mentioned it for many years, and now I think the time is now because the levels are really high. The exchange levels are really unheard of. And when you mentioned Charleston, could it be one of the facilities to actually accept the removed operations, or it's just a different project and the operations will be removed to countries with even cheaper labor costs?

Good afternoon.

Good afternoon.

As you know, we have dozens of companies all around the world, in Brazil, in the U.S., in the U.K., in Germany, in India, and many other places. And we, in all these markets, it's very important to create local jobs and to do development and to do production. So we are taking advantage of the positions we have in these markets, and we are extending our facilities there. It helps us first. to be more local, to be more trusted, and to do more jobs on the ground. And secondly, also to hedge some of our activities, which we do in Israel in other facilities. So it's a long-term process, and it's part of the improvement we are trying to gain in the OP, as Yossi mentioned. It's one element there. It's already effective. as you all saw in the last results. Other parts are increasing productivity, which is the Ramat Beka facility will help us with that, and centralized procurement, and the new ERP, all the other measures which were mentioned by Yossi earlier. So altogether, we have a long-term plan to improve the profitability of the company, and we are implementing it quite effective and we will continue to do it in the future. The Charleston facility is just one piece in this puzzle.

Okay, thank you. And the last question is actually also for you. It's a more marketing question. Do you intend to keep in the long term IMI label or you plan to integrate it within a few years into LBIT systems label because there are different sides to it. Do you have a definite plan now?

It's a good question. I can tell you that IMI has a very good reputation all around the globe, mainly for munition and for land platforms. For the time being, we intend to to keep the name of the product, we would like to gain benefit of the reputation, the good reputation IMI is having in many countries.

Okay. Thank you. Thank you for taking my questions.

Thank you, Ella.

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

Thanks. Hi, Yossi and Kobi. I have a couple of questions. First, regarding the sales, I see that Israel is only 19% of the sales. Do you see that a trend that Israel should go lower or it's one time that Israel will come back to the normal where it used to be a few quarters ago? And the second question is also regarding the margins. Do you see any changes in the environment right now that you can say that the margins should be higher or lower? or the same compared to the last quarters?

As you know, Elad, the Israeli market is a limited market. As the company grows, then a big part of our growth is international. So with all the optimism that the Israeli defense budget continues to grow, and it does, it looks like we are growing faster and our expansion is in the international market. So based on that, looking at the longer term and assuming that the company will continue to grow at a relatively high rate, then percentage-wise, the Israeli market will probably be declining However, the absolute value, I expect it to grow at some rate. So this is regarding your first question. Regarding the profitability stuff, I think we explained that and we are doing everything possible in order to improve it. I think we are on track. The prices in the market are defined by the market price. itself. So the improvement in the profitability, we expect it to come from improvement in operations of the company. So this is actually the plan and we see very successful results outcoming from that plan.

I see. So the impact is still at the same level. I mean, there is no higher competition.

The competition is essentially there. It was there. It continues to be there, and we expect it to be there in the future as well. All right. Thanks.

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 asked 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 9723 925-5900. 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?

Yeah, thank you. 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 Systems third quarter 2021 results conference call. Thank you for your participation. You may go ahead and disconnect.