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Elbit Systems (NASDAQ:ESLT)
Q1 2019 Earnings Call
May 28, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems' first quarter 2019 results conference call. As a reminder, this conference is being recorded. You should have all received by now the company's press release.

If you have not received it, please contact Elbit's Investor Relations team at GK Investor and Public Relations at 1 (646) 688-3559 or view it in the News section of the company's website, www.elbitsystems.com. I would now like to hand over the call to Mr. Ehud Helft of GK Investor Relations. Ehud, please go ahead.

Ehud Helft -- Investor Relations

Thank you, and good day to everybody. On behalf of all the investors, I would like to thank Elbit Systems management for hosting this call today. Joining us today on the call are Mr. Bezhalel Machlis, Elbit's president and CEO; and Mr. Joseph Gaspar, Elbit Systems' chief financial officer.

Joseph will begin by providing a discussion of the financial results of the first quarter of 2019, followed by Bezhalel, who will talk about some of the significant events during the quarter and beyond. We will then turn over the call to the question-and-answer session. 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.

With that, I would now like to hand over the call to Joseph. Joseph, please.

Joseph Gaspar-- Chief Financial Officer

Thank you, Ehud. Hello, everyone, and thank you for joining us today. As we do every quarter, we will provide you with both our regular GAAP financial data as well as certain supplemental non-GAAP information. This quarter, in particular, there were a number of larger differences. Specifically, I would like to mention that our non-GAAP numbers factored out the exchange rate difference which this quarter was significant mainly to the adoption of ASU 2016-02-Leases. You can find all of the detailed GAAP financial data as well as the non-GAAP information and the reconciliation in today's press release.

The first quarter of 2019 is the first full quarter that consolidates the results of our recent acquisition of IMI. Overall, we are pleased with the performance. With year over year revenue growth of 25%, we are now a company with a revenue rate of over $4 billion per year and our backlog is approaching $10 billion giving us good visibility over the long-term.

I will now highlight and discuss some of the key figures and trends in our financial results. Our first quarter of 2019 revenues were $1.022 billion compared with $819 million as reported in the first quarter of 2018, up 25% year over year. The strong growth was primarily driven by the consolidation of IMI and Universal, our recent acquisitions.

In terms of revenue breakdown across the areas of operation in the quarter, Airborne Systems was 36%, C4I Systems was 24%, Land Systems was 30% Electro-optics 7%, and the rest was 3%. Compared with the first quarter of last year, we saw an increase in Land Systems mainly due to our acquisition of IMI. There was a decrease in C4I sales due to lower sales of systems through Europe this quarter as well as the fact that we haven't consolidated Cyberbit commercial revenues.

The increase in airborne was mainly due to the consolidation of revenues of Universal. In terms of geographic breakdown for the quarter, we continue to be fairly well diversified between the various regions in which we operate. With North America at 27%, Israel at 26%, Europe at 19%, Asia Pacific at 21%, Latin America at 4%, and the rest of the world at 3%. Compared to the first quarter of last year, we saw an increase in sales in North America and Israel primarily due to the recent acquisitions of Universal in the US and IMI in Israel. For the first quarter, the non-GAAP gross margin was 27.7% compared to the first quarter of last year of 29.3%. The lower gross margin was primarily reflective of the lower gross margin of IMI.

The first quarter non-GAAP operating income was $84 million or 8.2% of revenues, compared with $69.4 million or 8.5% of revenues last year. I note that despite lower gross margins, we managed to close much of the gap in the operating margin. First quarter GAAP operating income was $76 million versus 63.3 million last year.

In terms of our GAAP operating expenses, for the quarter, total operating expenses were 19.7% of revenues, compared with 21% of revenues in the first quarter of last year. The operating expenses breakdown in the quarter was as follows. Net R&D expenses at 7.6% of revenues versus 8.3% last year; marketing and selling expenses at 7% of revenues versus 8.3% last year, and G&A expenses at 5.2% of revenues versus 4.4% last year, with the relative increase primarily due to our recent acquisitions.

Other operating income net was $1.2 million, again resulting from an investment and remeasurement of the company in a subsidiary. Financial expenses for the first quarter of 2019 were $13.9 million, compared with financial expenses of $10.2 million in the first quarter of last year. The higher level of financial expenses this quarter was due to implementation of accounting rule ASU 2016-02 relating to operating leases. In the quarter, this generated a non- cash accounting expense of $9.3 million.

In our GAAP results, we had other expenses of $3.4 million, which was mainly due to the adoption of accounting standard ASU 2017-07, relating to non-service cost components of the pension plans. For the first quarter, non-GAAP net income was $65.8 million or a net margin of 6.4% versus $55.1 million or a net margin of 6.7% in the first quarter of last year. Non-GAAP diluted earnings per share were $1.54, compared with $1.29 in the first quarter of last year.

On a GAAP basis, first-quarter net income was $50.5 million versus $49.6 million in the corresponding quarter last year. GAAP diluted net earnings per share were $1.18 compared with $1.16 in the first quarter of last year.

Our backlog of orders as of March 31, 2019, was $9.66 billion, $1.61 billion higher than the backlog at the end of the first quarter of 2018 and $258 million higher than that of the end of 2018. This represents a 20% increase in backlog year-over-year. The increase from a year ago was primarily due to the addition of backlog following our acquisition of IMI in November 2019.

Approximately 61% of the current backlog is scheduled to be performed during 2019 and 2020 and the remainder is scheduled for 2021 and beyond. The ratio is similar to that of the first quarter of last year. Operating cash flow for the quarter was a positive of $46.5 million, compared with a negative cash flow of $147.9 million in the same quarter last year.

The Board of Directors declared a dividend of $0.44 per share for the first quarter of 2019. That ends my summary and I should now turn the call over to Mr. Machlis. Please?

Bezhalel Machlis -- President and Chief Executive Officer

Thank you, Joseph. We are very pleased with our start to 2019 with Elbit being a company of significantly greater skills than it was only a year ago. Our revenues are 25% greater than those of the first quarter last year, and our backlog is 20% ahead of where it was last year, with the growth in both being partly organic and partly due to the acquisition of IMI and Universal. Our long-term growth has always been built on both investing in our existing businesses, growing it on an organic basis, while at the same time, acquiring and adding synergistic businesses to our organization.

While it will take time to bring the margins of IMI up to where Elbit's margin currently stands, we have a working plan in place that we have already started implementing. We see significant synergies with our new land division, and we have already begun a restructuring process. Already this quarter, we have started to enjoy the initial fruits of our effort. Despite the lower gross margin due to IMI contribution, we are pleased that we managed to report similar consolidated operating margins at Elbit as a whole to those of the first quarter last year.

While the integration process will continue to take time and effort, we have decades of experience in successfully assimilating acquisitions and expect to be successful with IMI as well. Beyond IMI, in April, we announced an agreement with Harris to acquire the Night Vision businesses for $350 million. This third acquisition in the past year will be significant to our long-term growth strategy and will enhance the product portfolio and customer offerings strengthening our proportion in the US.

While we have been busy with acquisitions, our core businesses continued to perform well and we continued to win more businesses in all our target regions, as you can see by continued growth in our backlog, adding $258 million to the backlog since last quarter. We see ongoing demand for our solutions, which are a strong indication of the provisional importance of advanced and combat proven capabilities that we have in all domains in the provisional engagement, maritime, land, and air. As of 2019, Elbit now a company of most significant scale, and we are increasing our status as a major player in the global defense market.

And with that, I will be happy to take your questions. Operator?

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, at this time we will begin the question and answer session. If you have a question, please press * 1. If you wish to cancel your request, please press * 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 questions.

The first question is from Pete Skibitski of Alembic Global. Pete, please, go ahead.

Pete Skibitski -- Alembic Global -- Analyst

Good afternoon, Bezhalel and Joseph. Very nice quarter. I want to ask, to start with a couple of balance sheet questions because they're newer items. The premises evacuation money that you have on the balance sheet, I think you have $334 million current assets and another smaller longer-term asset. Are those monies essentially cash you have received from the government, but you can't categorize it as cash because it's sort of earmarked specifically for the IMI relocation? I just wanted to understand that.

Joseph Gaspar-- Chief Financial Officer

Upon the evacuation of the present location, there is a specific milestone in the contract, according to which we are going to get that money from the government. However, we're looking at having an earlier release of that fund. We'll see how it works out. Therefore, we put it in the short-term asset.

Pete Skibitski -- Alembic Global -- Analyst

Okay. When you get it, it'll all essentially flow through capex when you actually get it approved?

Joseph Gaspar-- Chief Financial Officer

The capex was slow, probably significant part of that will flow into capex somewhere in the coming years when we establish the modern production facility in the southern part of Israel.

Pete Skibitski -- Alembic Global -- Analyst

And then, also on the pension, the pension assets, and liabilities that you've absorbed for IMI, I think the net pension deficit is now $464 million. Can you tell us how much cash do you expect you'll have to contribute to the pension plan this year? And maybe on a longer-term basis, is there some minimum amount that we should assume that you'll be contributing each year to the plans?

Joseph Gaspar-- Chief Financial Officer

This is spread over many years in the future, probably somewhat over 15 years on average. However, with the accelerated departure of some of the employees of IMI, we may spend a part of that cash to compensate that and that was the initial agreement with the government and with the unions of what we bought IMI. The rest is spread over many years.

Pete Skibitski -- Alembic Global -- Analyst

Okay. Do you expect to receive any further cash from the government for the pension plan?

Joseph Gaspar-- Chief Financial Officer

No.

Pete Skibitski -- Alembic Global -- Analyst

No, OK. Okay. Okay, switching off balance sheet, couple of program questions that looked really positive. First, on the Israeli deal that I think you signed the initial $125 million contract for the self-propelled howitzer. I just want to ask, is that a brand-new development program you're starting? And I think some of the press reports indicated that your longer-term, it would end up being worth much more than $125 million. Would you agree with that?

Bezhalel Machlis -- President and Chief Executive Officer

Yeah. The $124 million, that's only the first part. It's a much larger program. And we're in the middle of development. Actually, we have a prototype, a firing prototype. And we are adopting it and we're concluding the development and we expect to merge this program with the government in the coming year.

Pete Skibitski -- Alembic Global -- Analyst

That's great. And then the other one that I saw, I don't think is signed yet, but it sounds like you're the leading contender now, is the Indian artillery program, which I think you're submitting the ATHOS system for that program. I saw at least one press report that indicated that could be worth potentially over $1 billion for you, so that sounded really positive. Is that kind of what you're thinking and when you think you might sign it?

Bezhalel Machlis -- President and Chief Executive Officer

It's certainly a significant contribution program and we are expecting this program to be concluded in the near future. We will, of course, let you know whenever this contract is concluded.

Pete Skibitski -- Alembic Global -- Analyst

Okay. That's great. Sounds good. Thanks so much, guys. I'll get back at the end of the queue.

Bezhalel Machlis -- President and Chief Executive Officer

Thank you.

Operator

The next question is from Ella Fried of Bank Leumi. Miss Fried, please, go ahead.

Ella Fried -- Bank Leumi -- Analyst

Hello, I would like to congratulate you on the results and thank you for taking my question. I would like to ask you on the free cash flow improvement in the quarter, despite the substantial expenses that you had in this quarter. And if you could just explain sort of how is it going to proceed? Do we have to expect some more improvement in the working capital and the policy in this field for the next quarters or years?

Joseph Gaspar-- Chief Financial Officer

I think in the past, we explained some strategic movements that we have decided on several years ago regarding the use of our strong balance sheet in order to capture customer positions, in addition, of course with the advanced technology and our capabilities. This was applied to prime customers. We did give them longer terms of payment in the past, starting at probably 2.5, 3 years ago and so on. Recently, after we were successful in achieving these positions with our customers, we have reviewed our strategy and started to reduce the aspect of the long-term payments. I think I addressed that in the year-end discussion.

And through that, we start to see the coming back, I would say, of the cash at a higher rate, and the first quarter last year may be the initial steps of that. But on the longer-term, first of all, I would not take a quarterly number as something representative. However, on average, we are going to see a decrease in the working capital of the company because of this change.

Ella Fried -- Bank Leumi -- Analyst

Thank you. And following this matter, in the previous quarter, you've mentioned some factoring that was in the year-end results. Are you going on the decrease because you only specified it in the year-end annual report?

Joseph Gaspar-- Chief Financial Officer

In the annual report, we definitely give all the details of our financial activities. We continue to look at factoring of debt of our customers. However, going forward for the long-term, this will be less and less of an item. We might look at some other aspects of factoring, for example, factoring debt of prime customers, but when it will happen, we'll, of course, explain that.

Ella Fried -- Bank Leumi -- Analyst

And the last question, if you could give us some color on the progress of the Bradley contract.

Bezhalel Machlis -- President and Chief Executive Officer

It's an important and significant contract for the company, bringing active protection systems and the iron fist system to the US forces. There is a process in the US to activate the order. Whenever it will happen, we will let you know, but it's a significant contract and we hope it will happen soon.

Ella Fried -- Bank Leumi -- Analyst

Are there any formal milestones that you have to pass in order to advance or is it just negotiation? How does it work?

Bezhalel Machlis -- President and Chief Executive Officer

We are in dialog with the US Army. I'd prefer not to enter the details, but I believe that there's a good chance that this program will happen quite soon.

Ella Fried -- Bank Leumi -- Analyst

Okay. Thank you and good luck.

Bezhalel Machlis -- President and Chief Executive Officer

Thank you.

Operator

If there are any additional question, please press * 1. If you wish to cancel your request, please press * 2. Please stand by while we pull for more questions.

The next question is from Pete Skibitski of Alembic Global. Pete, please, go ahead.

Pete Skibitski -- Alembic Global -- Analyst

Thanks. Just a couple of follow-ups, guys. First of all, congratulations on the Night Vision acquisition. I think it's a great deal for you. And I just want to clarify, should we expect you're going to issue debt to finance that deal?

Joseph Gaspar-- Chief Financial Officer

I think presently, we have enough bank lines and credit lines and capital and cash to do that acquisition. After the acquisition, we will look at how much cash are we generating and some other targets that might be on the horizon and according to that, we'll have to make a decision on how we proceed.

Pete Skibitski -- Alembic Global -- Analyst

Understood. Okay. And then the last question, just can you maybe update us on the status of your new ERP system implementation?

Joseph Gaspar-- Chief Financial Officer

We are putting a lot of energy into that project. I think it is more or less on the schedule that we have planned. ERP systems, there might be some glitches here and there from point of view of timescale. However, we're still looking at that happening 2019 and then following on 2020, 2021 in the rest of the group and the other operations and gradually, we'll definitely reap the benefits of one ERP system within the group, which will cause us to improve yields, will reduce inventory and other aspects of commonality and better operations. But still we are, generally speaking, we are on track on this program.

Pete Skibitski -- Alembic Global -- Analyst

Great. Thanks so much, guys.

Operator

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 US, please call 1-888-782-4291. In Israel, please call 03-925-5925. And internationally, please call 972-3925-5925. 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?

Bezhalel Machlis -- President and Chief Executive Officer

I would like to thank all our employees for their continued hard work. 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.

Operator

Thank you. This concludes the Elbit Systems Ltd. first quarter 2019 results conference call. Thank you for your participation. You may go ahead and disconnect.

Duration: 24 minutes

Call participants:

Ehud Helft -- Investor Relations

Joseph Gaspar-- Chief Financial Officer

Bezhalel Machlis -- President and Chief Executive Officer

Pete Skibitski -- Alembic Global -- Analyst

Ella Fried -- Bank Leumi -- Analyst

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