Elbit Systems Ltd.

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems' fourth quarter 2022 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, Yoni.

Good day, everyone, and welcome to our fourth quarter 2022 earnings call. On the call with me today are Buti Maklis, 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. Corby will begin by providing a 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. Earlier today, we hosted an investor conference at the Tel Aviv Stock Exchange. A recording of the event is available in the investor relations section of our website at www.elbertsystems.com. Investors and analysts who wish to ask questions related to the topics discussed at the investor conference are welcome to present their questions during the Q&A session of the call. With that, I would like to turn the call over to Kobi. Kobi, please.

Thank you, Rami. Hello, everyone, and thank you for joining us today. The 2022 annual results reflect a healthy business environment supported by growing defense budgets around the world and another year of significant contract awards. We ended the year with a record order backlog of $15.1 billion, up 11% relative to the end of 2021. Our financial performance in 2022 also includes the impact of supply chain disruptions and labor cost inflation. This includes a $62 million expense related to employee stock price link compensation plans and an additional $10 million of retention bonuses. Our GAAP and non-GAAP results have always included these expenses but this year they were higher than in recent years following the share price appreciation. Our budgets and long-term planning assume that the global economic trends, supply chain, and wage inflation headwinds will gradually subside from the second half of 2023. We continue to invest in R&D to enhance our portfolio and maintain our competitive edge. We invest in sales and marketing to expand our customer base and also continue to invest in CapEx to improve and expand our manufacturing footprint. I would note that the sale of Ashot Ashkelon to FEMA Opportunity Funds was completed at the end of the second quarter of 2022, and our results in the second half of 2022 do not include a contribution from Ashot Ashkelon. I will now highlight and discuss some of the key figures and trends in our financial results. Fourth quarter revenue were $1,506,000,000 compared to $1,494,000,000 in the fourth quarter of 2021. For 2022 as a whole, our revenues were $5.5 billion versus $5.3 billion last year. In terms of annual revenue breakdown across our areas of operation. C4ISR, its 29% of revenues increased year over year, mainly due to UAS and anti-submarine warfare sales. Airborne systems accounted for 37% and declined year over year. The growth in training and simulation sales helped offset lower airborne precision guided munition sales. Land systems was 22% of total revenues, and the year-over-year decline is mainly due to the sale of Ashot Ashkelon. Electro-optics accounted for 10% and increased year-over-year due to increased sales of night vision systems. Other sales accounted for 3% and declined year-over-year, mainly due to lower sales at our U.S. medical instrumentation subsidiary. Our diverse geographic revenue base is important to the long-term sustainability of our business. In 2022, North America contributed 27 percent, Europe 23 percent, Asia Pacific 26 percent, and Israel contributed 19 percent of revenues. European revenues increased mainly due to growth in UAS, munitions, and training and simulation sales. North America revenues were lower, mainly to the decline in medical devices sales. Asia Pacific revenue declined mainly due to lower precision guided munitions and C4I sales. The non-GAAP gross margin for the fourth quarter was 25.7% compared to the fourth quarter of 2021 at 25.5%. For the full year of 2022, Non-GAAP growth margin was 25.5% compared with 26.2% last year. GAAP growth margin in the fourth quarter was 25.3% of revenues compared to 25.1% in the fourth quarter of 2021. GAAP growth margin in 2022 was 24.9% compared with 25.7% in 2021. Gross margin in 2022 reflects an unfavorable program mix, wage inflation, and supply chain disruptions. GAAP and non-GAAP gross profit in 2022 include expenses related to stock price-linked compensation plans. The fourth quarter non-GAAP operating income was $103 million, or 6.8 percent of revenues. compared with $120 million or 8% of revenues last year. GAAP operating income for the fourth quarter was $120 million versus $107 million in the fourth quarter of 2021. Non-GAAP operating income in 2022 was $357 million or 6.5% of revenues compared was $451 million or 8.5% of revenues last year. Gap operating income was $368 million versus $419 million last year. Operating margins declined year over year due to higher R&D and sales and marketing expenses. The operating expenses breakdown in 2022 was as follows. Net R&D expenses were 7.9 percent of revenues versus 7.5 percent in 2021. Marketing and selling expenses were 5.9 percent of revenues versus 5.5 percent last year. G&A expenses were 5.7 percent of revenues compared to 5.1 percent last year. We have increased investment in R&D and in sales and marketing to realize the potential opportunities provided by defense budget growth and increased demand for our capabilities. Other operating income of $68.9 million in 2022 included capital gains related to the sale of buildings in Israel and the UK, as well as facility relocation grant of $28.6 million received by a subsidiary in Israel in the fourth quarter. Operating profit in 2022 include expenses of approximately $62 million related to stock price link compensation plans and an additional $10 million of retention bonuses. Financial expenses were $27 million in the fourth quarter compared to $20 million in 2021. Financial expenses in 2022 were $51 million compared to $40 million last year and reflect the higher interest rate environment. Other expenses were $24 million in 2022 and resulted mainly from the re-evaluation of holding in affiliated companies and expenses related to non-service costs of pension plans. We recorded a tax benefit of $5 million in the fourth quarter compared to a tax expense of $92 million in 2021. Taxes on income in the fourth quarter of 2021 included a one-time expense of approximately $80 million related to the amendment of legislation regarding exempt earnings from approved enterprises in Israel. The effective tax rate in 2022 was 8.2% compared to 34.3% in 2021 that included that extraordinary expense. Our non-GAAP diluted EPS was $1.68 in the fourth quarter and $6.03 for the full year of 2022. GAAP diluted EPS was $1.91 for the fourth quarter of 22 and $6.18 for the full year. The stock price link compensation expenses in 2022 were $1.26 on an EPS basis and an additional 20 cents of retention bonuses on an EPS basis. Our backlog of orders as of December 31st, 2022 was $15.1 billion, a $1.4 billion higher than the backlog at the end of 2021. Approximately 60% of the current backlog is scheduled to be performed during 23 and during 2024, and the rest is scheduled for 25 and beyond. Operating cash flow for the fourth quarter was a $195 million inflow compared to $260 million inflow in the same quarter last year. For 2022, we reported a $240 million operating cash inflow versus a $417 million cash inflow in 2021. Cash flow from investing activities includes the higher capex related to the new facilities in Israel and in Charleston, South Carolina, as well as the rollout of the ERP system. the Board of Directors declared the dividend of $0.50 per share. I will now turn the call over to Mr. Maklis, Elbit CEO. Bootsy, please go ahead.

Thank you, Kobi. 2022 was another good year for Elbit Systems with sustained growth and a record-order backlog. We continued the strategic transformation of Elbit Systems, moving up the value chain, from a system provider into a company that provides comprehensive and relevant solutions to its growing global customer base. We initiated this transformation during the previous decade, and you have seen the successful implementation as the order book and revenue growth accelerated in recent years. We have also seen a step-up in the number of large three-digit contract awards. As part of the broader transformation of Elbit Systems, we have invested in an operational transformation to improve performance and our ability to deliver the growing backlog. At our 2023 investor conference earlier today, we presented some of these investments. We have increased our investment to upgrade and expand our manufacturing footprint. We have acquired new machines. We are adopting new technologies and implementing processes to increase the throughput and efficiency of our production facilities. For example, we have increased the capacity of our Tel Hai radio production factory in northern Israel by 60%, or 10,000 additional radios a year. We are also building new facilities around the world. Construction of our new ammunition production site in Ramat Beka is progressing on schedule and should be up and running from 2024. This new state-of-the-art facility should benefit from growing demand for ammunition. We have invested in new production facilities across Europe, in the UK, Germany, and Romania. In 2023, we plan to open a new ground combat vehicle assembly and integration center in Charleston, South Carolina. In 2022 and 2021, we increased our capex to fund the building of this of these and other new facilities. We believe this investment will deliver good returns and support growth over the coming years. We plan to complete the implementation of the new ERP system across the company by the second half of 2023. As a reminder, Elbit system is moving from 11 different ERP systems we used in the past to a signal ERP system. we expect the total investment in the new ERP system to close to $200 million. Approximately two-thirds of this investment is the cost of the system that will be amortized over the coming years. Approximately a third of the investment are the expense cost related to the implementation that impacted our profitability in recent years. We expect a successful implementation of the new ERP system to support an improvement in profitability and cash generation. Elbit system has been impacted by the global supply chain disruption in recent years that slowed revenues growth and increased our cost base to mitigate The impact of this disruption and maintained timely deliveries to our customers will increase inventories. Our working assumption is that global supply chain pressure gradually eases over 2023, with the most significant improvement from the second half of 2023. In 2022, we increased our investment in R&D to sustain development of leading solutions that provide our customers with a valuable comprehensive advantage. A significant award we received in 2022 and in recent months has validated the alignment between Elbit System portfolio and our customers' priority areas for defense spending and their mission-critical requirements. The potential for orders from European countries have come up often during investors' calls and meetings over the last year. following the announcement of a different budget increases by most European governments. We described the noticeable increase in customer interest across Europe and told you that we expect this interest to gradually convert into firm orders. In recent months, we announced a series of European customer contracts across a range of capability areas, including artillery and rocket artillery, UAVs, C4I, and armed vehicles. We also reported strong growth in European revenues in 2022. We expect this trend to continue over the coming years as the European government increased defense spending and recapitalized both the military forces and the domestic defense industrial base. Elbit system is well positioned to benefit from these trends following the significant investment made to expand our presence across Europe over the last decade. Our subsidiaries across Europe, from the UK to Romania, employ hundreds of employees, support the local supply chain, and are an integral part of the domestic defense industrial base. We have also partnered with most of the large European defense companies. In 2022, we announced a joint venture with KMW, the German armed vehicle manufacturer, to cooperate on the EuroPulse, the next generation of rocket artillery system for European customs. The $17 million contract we received in January 2023 and the $133 million contract announced in March for European countries highlight both the demand for rocket artillery in Europe and Elbit's leading position in this market. UAV is the second capability area where we are benefiting from increased demand. In December 2022, UTAX, our UK subsidiary, was awarded a $400 million five-year framework contract by the Romanian Ministry of Defense for Watchkeeper X tactical unmanned air systems. In December, we also received a contract from the Australian MOD for Skylark UAVs. Elbit system is Israel's largest defense contractor and an important part of the Israeli economy. Recent political development and the Judicial legislation proposed by the government have not impacted our business until now. However, sustained political instability has implications for the local defense industry, as we have seen in the past, and could also increase economic uncertainty. I am confident that Israeli leadership will act responsibly to stabilize the situation and ensure Israel's long-term security and prosperity. In recent months, we were awarded significant long-term contracts by the Israeli MOD. In January, we received a $180 million contract to provide and operate a new mission training center to train the Israeli Air Force F-15 and F-16 aircraft. In January, we received a $107 million contract to provide and operate Advanced Armor Training Center for the Israel Defense Armed Forces. Elbit Systems has developed a broad portfolio of market-leading training and simulation solutions for militaries around the world. Our training and simulation technologies have been selected by a range of customers including the US, UK, Greece, and Poland. We believe there is significant potential in this market for solutions that provide more realistic training that better prepare soldiers for a wide range of scenarios at a lower cost. 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 the order they are received. Please stand by while we pull for your questions. The first question is from Ellen Page of Jefferies. Please go ahead.

Good morning, guys. Thanks for the question. Just looking at Europe, it's like growth through 2022. Obviously, there's a lot of higher defense spending. But how much of the 11% backlog growth can be attributed to Europe? And is there any way to think about the mix of long cycle versus short cycle demand from the region?

Hi, this is Yossi. I'm not sure I got the question properly. Could you repeat it, please?

Sure. So just looking at European demand, how much of the 11% backlog growth was from Europe? And can you talk about the mix of long cycle versus short cycle orders in Europe?

Well, I would say a significant part of our backlog growth did come from Europe. However, Asia Pacific and the US were also a very nice growth of the backlog. We do not provide the exact breakdown, but you are right that Europe is a significant contributor to that. From the point of view of the spread of the backlog, we do indicate we do indicate how much of our backlog is going to be transformed in revenues in the 23 and 24 period, and then the rest of it during 25 and on. Usually it stands at about 60% roughly of our backlog, and this percentage did not change a lot over the years. It's quite stable.

Okay, helpful. And just on land systems, it's been pretty lumpy through 2022. What drove the weakness in the quarter and how do we think about that business into 2023? It's Bootsy. Hi.

I just want to remind us that A short number were deducted from the revenues from the second quarter of 2022. We see a growing demand for land solutions in Europe as well as in other places. So I'm quite optimistic that the growth related to land systems will continue in the near future.

Thank you. I'll hop back into the queue.

Thanks, Anna.

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

Hey, good afternoon, everyone. Guys, maybe to start out, you know, 2022 is a pretty good year. growth year, you know, weighted to the first half. Is something similar for 2023 reasonable for investors to expect something, I don't know, in that 4 to 6% type of a range?

Well, Pete, this is Yossi. You know that we do not provide guidance. However, if you look at our backlog numbers that have grown significantly much more than our revenue numbers, then from that it is just natural that during 23 we are going to be able to realize some of that growth in revenues as well.

Right. Okay. Fair enough. Thank you for that. And then maybe, Yossi, on the 62 million employee shareland comp in 2022, do you guys have the numbers for what that was in 2021 so we could just, you know, judge the magnitude of the increase? and maybe factor in our expectation for 23?

Hi, Pete. Good morning. This is Colby. Actually, the $62 million is the difference between the numbers that we saw on 2021 and 2022. So this is actually a one-time expense, which is higher in that all totality from the numbers in 2021. And in addition, we had some, mostly for engineers, some retention linked price programs that cost us additional one time of $10 million. So it's $72 million of additional expenses that we are not expecting to have similar expenses during 2023. Right, okay.

So I imagine there are people out there thinking that 2022 is probably a trough margin year for LBIT. And that given, you know, hopefully the likelihood that employee linked comp will decline in 23. And I don't know if there are other mixed issues or if net pricing has improved, but is it reasonable for us to expect margins to improve in 23 by some amount? I don't know if you want to put any kind of a range around it or not, but... or add color, but I guess I'll stop there.

Ranges, again, Pete, we do not give you exact numbers, but definitely the numbers that Kobe mentioned earlier will not repeat themselves in 23.

Okay, okay. And then any, you know, see, just on net pricing, just in terms of base labor rates, are there Are you guys able to cover the inflation from base labor rates in your pricing in 2023, or are you expecting improvements or a deterioration of that situation? Can you add some color there?

Well, you know, Pete, that about, I would say, 75% of our labor force is in Israel. The compensation of these people is done in local currency, of course, the shekel. During 2022, we had... currency exchange rate between the shekel and the US dollar of roughly about 3.3 shekels to the dollar, in general, on an average. This number is going to improve in 2023. It is still to be calculated, but we expect an improvement in this cost per labor in dollar currency.

Okay, okay, no, I appreciate it. Okay, yeah, I'll stop there. Thanks so much, guys. Thank you.

Thank you, Pete.

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. The next question is from Atink Ozkan of Wood and Company. Please go ahead.

Thank you. Perfect pronunciation of my name. This is from the company. Sorry if my questions are repetitive. I was not able to join earlier part of the conference, but two questions for you, please. The first one is regarding your recent strategic MOU in Japan. You signed it with two local aerospace companies. And we know that Japan is rearming, and they will be spending roughly, I guess, $300 billion over the next five years. Where do you see the strategic opportunities for your products in Japan? Should we assume that you'll start with the needs of Japanese air defense force, given that they are an operator of F-15 and F-35? That's the first question. And the second one is, could you please provide some... update regarding percentage of completion of your ongoing investment programs, whether it's the, you know, the One ERP, the ongoing production line in South Carolina, and the state-of-the-art plant in southern Israel for IMI. Thank you.

With regard to the... Hello. With regard to the first question, we... We all see that there is a growing investment in Japan in defense. We find that our portfolio is very relevant to the growing needs and to the growing requirements in this market. We see there is a lot of interest for our portfolio, and I'm talking about training solutions. I'm talking about avionics. I'm talking about UAVs and others. For that, we have teamed with several companies companies in the country. As you noticed, we presented in the last exhibition two weeks back, and this is not the first time we are in this market. And we certainly see a growing opportunity in these areas as well as in others in the Japanese market. It's a new market for us. We feel very welcome in this market, and we have a very good relationship with the local industry, and the customer, the customer, the Minister of Defense, is well aware of our technologies and capabilities. With regards to our new facilities, our new facility in the south, in Hamad Beka, will start being operational June 2024. And we expect it to be fully operational in 2025. Our production facility in South Carolina will enter into production this year, 2023. And I think you asked about another one ERP system. We invested a lot in our one ERP solution. The system that we are deploying right now will replace 11 different old ERP systems that were in use in the company. The final implementation stage will take place mid-DCU when we are going to implement the system in the old IMI comp operation. And this will be the final implementation phase. The rest of the company is already on the system and we start seeing many benefits coming from this new ERP solution. Chris, you're clear.

Thank you very much. Thank you, Ante. Good to speak.

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

Yeah, thanks, guys. But you talked about increasing defense budgets around the world and how you're spending increased business development money to take advantage of those markets. And I think you were implying that R&D was kind of a part of that overall. And 2022, I think you spent the most on R&D overall. in probably a decade. And I know FX is an impact, et cetera. But kind of going forward, should we expect that R&D spend will remain elevated so that you can kind of take advantage of these very active markets over the next few years? Or have we reached a plateau there? Just was wondering if you had any color to add.

We have... As you know, our strategy is to be a leader in the defense market. And for that, we have to invest R&D. And we're investing in several areas. Just to give you an example, high-power lasers. We have a unique position in this market. We have a unique technology. And we are providing the laser source to the Israeli market. to the Israeli high-power land solution, and we are the prime contractor for the airborne Israeli high-power laser. This is just one area where we invest. And some other areas are guided munition. After the acquisition of IMI, we took a strategic decision to combine our guidance capabilities with the ammunition portfolio of IMI, and today we have a new, very advanced line of business, which is very successful in Israel as well as abroad. Another area where we're investing quite a lot is autonomy. We see autonomy in AI and big data in this area. We believe we are a world leader, and we would like to continue this investment. This year we have invested about 7.9%. in R&D. And percentage-wise, I don't think we will increase the number in the future. So that's more or less the area where we will continue to invest in the future as well.

Okay, thanks so much. Thanks, Pete.

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 03925-5900. and internationally, please call 972-3925-5900. A replay of this call will also be available at the company's website, www.elbetsystems.com. Mr. Machlis, would you like to make your concluding statement?

I would like to thank all our employees for the continued hard work and contribution to Elbit Systems' success. 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 LTD Fourth Quarter 2022 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.