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Elbit Systems Ltd (NASDAQ:ESLT)
Q1 2020 Earnings Call
May 26, 2020, 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 2020 Results Conference Call. [Operator Instructions]

I would now like to hand over the call to Mr. Rami Myerson, Elbit Systems' Investor Relations Director. Rami, please go ahead.

Rami Myerson -- Director, Investor Relations

Thank you, Rainn.

Good day, everyone, and welcome to our first quarter 2020 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.

Yossi will begin by providing a discussion of the financial results, followed by Butzi 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.

Joseph Gaspar -- Executive Vice President and Chief Financial Officer

Thank you, Rami.

Hello, everyone, and thank you for joining us before today. Before reviewing our financial results, I would like to address the COVID-19 pandemic and the global economic environment.

We are monitoring the situation closely and are adhering to the instructions of the governments of the various countries in which we operate. During the first quarter of 2020, our businesses were not materially impacted by the pandemic. Subsequently, some of our businesses have begun to experience certain disruptions due to government directed safety measures, travel restrictions and supply chain delays. As of today, the financial impact of this disruption has not been material.

As we reported on April 13, we have implemented a series of actions to protect the safety of our employees, maintain business continuity and our supply chain and leverage our abilities to assist and protect our communities. All of these actions remain ongoing. We have also initiated a series of cost-control measures to mitigate any financial impact on the Company in parallel to the measures we are taking to maintain business continuity and deliveries to our customers.

We believe that as of the end of the first quarter, Elbit Systems has a healthy balance sheet, adequate levels of cash and access to credit facilities that provide liquidity when necessary. We have prioritized cash management and adequate cash reserves to run the business. During the quarter, we drew additional cash from our existing credit facilities to increase our financial flexibility. We utilized some of our financial resources to secure our supply chain and build buffer inventories to mitigate the potential impacts of COVID-19.

The extent of the impact of COVID-19 on the Company's performance will depend on future developments, including the duration and the spread of the pandemic, the measures adopted by governments to limit the spread of the pandemic and resulting actions that may be taken by our customers and our supply chain.

Turning now to our results. As we do every quarter, we will provide you with both our regular GAAP financial data as well as certain supplemental non-GAAP information. We believe that this non-GAAP information provides additional detail to help understand the performance of the ongoing business. You may find all the detailed GAAP financial data as well as the non-GAAP information and the reconciliation in today's press release.

Overall, we are satisfied with our performance in the quarter. We booked a number of significant contracts that indicate continued momentum across our end markets and sustained demand for our products and services. Our backlog of $10.8 billion provides good visibility and reflects the long-term nature of our business. It generally takes time to finalize contracts in our industry, but once we booked them, they often provide many years of revenues. I should also note the acquisition of Elbit Night Vision from L3Harris was closed on September 15 last year and was therefore consolidated into the income statement of Elbit, commencing the date of the acquisition.

I will now highlight and discuss some of the key figures and trends in our financial results.

Our first quarter 2020 revenues of $1.071 billion were up 5% year-over-year. In terms of revenue breakdown across our areas of operation, airborne systems sales, at 36% of sales, increased year-over-year primarily due to growth in military aircraft systems to US customers. Electro-optics accounted for 11% of total sales and also increased year-over-year, mainly due to the acquisition of the Night Vision operation in the US.

Our diverse geographic revenue base is important to the long-term sustainability of our business. In the quarter, North America was the largest, contributing 34% of our revenues; Israel was 23%; Asia Pacific, 20%; and Europe, 17%. The growth in North America in the quarter more than offset lower revenues in Israel, Europe and Asia Pacific. The growth in North America was primarily due to the airborne systems sales, as mentioned, and the acquisition of Elbit Night Vision.

For the first quarter, the non-GAAP gross margin was 27.6%, similar to the first quarter of last year at 27.7%. GAAP gross margin was 27% compared with 27.2% for the first quarter of last year.

The first quarter non-GAAP operating income was $90.4 million or 8.4% of revenues compared with $84 million or 8.2% of revenues last year. GAAP operating income was $80 million versus $76 million last year.

The operating expense breakdown in the quarter was as follows. Net R&D expenses at 7.5% of revenues versus 7.6% last year. Our investment in R&D as a percentage of revenues is significantly above the average of our industry, enabling us to maintain and build our technological leadership and underpins our long-term prospects. Marketing and selling expenses at 6.6% of revenues versus 7% last year, and G&A expenses at 5.4% of revenues versus 5.2% last year.

Financial expenses for the first quarter of 2020 were $12.5 million compared with $13.9 million last year. Other income of $1.2 million was impacted by a $3.2 million gain from reevaluation of Elbit's share of Cyberbit, our commercial cyber subsidiary, in the first quarter.

On May 19, we announced the $70 million investment by Charlesbank Capital Partners in Cyberbit. Elbit received $49 million for a portion of its shares, and $22 million was invested in Cyberbit. Following the investment and sale of its holdings, Elbit Systems is now a minority shareholder in Cyberbit. Cyberbit is held at fair value on our balance sheet. As I just mentioned above, in the first quarter we reevaluated Cyberbit as the negotiations on the investments were going on. As a result of the closing of the Cyberbit transaction last week as well as the completion of a sale and leaseback real estate transaction by Elbit Systems of America last week, we expect to record income before tax of approximately $40 million in our financial results for the second quarter of 2020 which will be released in August this year. This income will be eliminated on our non-GAAP results due to the nonrecurring nature of the income.

During the second quarter of 2019, Elbit Systems raised $185 million through the sale of treasury shares to institutional investors in Israel. This increased our share count by about 3% to 44.2 million shares, having a slight corresponding impact on our earnings per share relative to the first quarter of 2019.

Our non-GAAP diluted earnings per share was $1.63 in the first quarter compared with $1.54 in the first quarter last year. GAAP EPS was $1.44 versus $1.18 last year.

Our backlog of orders as of March 31, 2020 was $10.8 billion, $1.1 billion higher than the backlog at the end of the first quarter of 2019 and $760 million higher than that at the end of 2019. Approximately 59% of the current backlog is scheduled to be performed during the remainder of 2020 and 2021, and the remainder is scheduled for 2022 and beyond. This ratio is broadly similar to that of the first quarter last year.

Operating cash flow for the quarter was $10 million outflow compared with $47 million inflow in the same quarter of last year. Our cash flow in the quarter reflects payment to our supply chain and inventory buffers we built during the quarter to mitigate potential COVID-19 disruptions, as I mentioned previously.

Elbit Systems continues to manage its balance sheet conservatively. Besides our cash, we have access to multiple credit lines that can provide us with additional liquidity. We drew cash from these facilities during the quarter to increase our flexibility and facilitate the smooth running of our business. This has increased the cash levels on our balance sheet to relatively higher levels. In February, Midroog, the Israeli rating agency affiliated with Moody's, reaffirmed our Aa1 local rating on our Series A Notes following a review of our financials.

The Board of Directors declared a dividend of $0.35 per share for the first quarter of 2020. The Board decided that a reduced dividend for this quarter was appropriate in the current environment as part of the broader effort relating to all of our stakeholders with respect to combating the potential impact from the COVID-19 pandemic.

I shall now turn over the call to Mr. Machlis, our CEO.

Bezhalel Machlis -- President and Chief Executive Officer

Thank you, Yossi.

I also would like to start by discussing our priorities and measures we are implementing to address the COVID-19 pandemic. Since the outbreak of the COVID-19 pandemic, our priorities have to protect the safety of our employees, to maintain business continuity and our supply chain and leverage our abilities to assist and protect our communities. I'm particularly proud of the innovative spirit of our employees that have moved rapidly to adapt our technologies to help the medical teams fighting the pandemic.

We developed a stellar command and control system for medical stuff based on our market-leading command and control technologies. This system has already been rolled out in 16 Israeli hospitals. We have also developed a sensor system to remotely read physiological parameters to protect health workers. And, following the request for the Israeli government, we are leveraging our manufacturing capabilities to produce ventilators.

KMC, our medical technology subsidiary based in New Hampshire, designs and manufactures diagnostic equipment and medical devices for leading healthcare companies. KMC has seen increased demand growth due to the COVID-19 and is actively supporting a number of our customers by accelerating some product line to support COVID-19 diagnostic testing, lab management applications and ventilators. We are exploring a range of export opportunities for these and other products related to combating COVID-19.

We have implemented a series of protective measures to protect our employees, including adding shifts and working from home where possible. As a critical industry, manufacturing at almost all our facilities around the world continue as planned as we work to deliver on our commitment to our customers. I'm pleased that most of our operations are starting to return to levels similar to those at the beginning of the year. We have allocated additional resources to secure our supply chain and support timely delivery of our products in order to overcome possible disruptions related directly or indirectly to the pandemic.

While the current situation presents unique challenges, it could also provide Elbit Systems with certain opportunities to leverage the global market position we have achieved and the advanced technologies we have developed in recent years. I would highlight our diverse geographical client base that has taken decades to build and in which we've invested significantly to maintain.

Our broad portfolio of capabilities enhances the effectiveness of platforms and solutions in a cost-effective manner, helping our customers to accomplish more missions at a lower cost. As Yossi mentioned, we have initiated a series of efficiency measures relating to our operations and that strengthen our balance sheet to help mitigate potential impact of COVID-19.

Moving to the business and the quarterly results, I would like to discuss the significant and strategically important EW contracts received in recent months from customers in the US, Europe and Asia-Pacific that contributed to the growth in our backlog in the first quarter.

Elbit Systems has been an Israeli Defense Forces Electronic Warfare Center of Excellence for many decades and is developing the next generation of EW systems for the Israeli Air Force, Navy and ground forces. We were one of the world's first companies to develop infrared missile detection systems. The Israeli Air Force decided to equip its aircraft with our systems, and following the success in the Israeli air force, a number of other countries around the world have chosen to equip the aircraft with Elbit Systems' missile warning systems.

In February, we were selected by the German Air Force to supply EW systems for their CH-53 helicopters. This follows the contract from the Portuguese Air Force in October 2019 for EW systems for their new KC-390 transport aircraft. Under this $50 [Phonetic] million contract, Elbit Systems will supply a complete EW suite for the aircraft comprised of radar and laser warning systems, IR missile warning systems, countermeasures, dispensers, DIRCM and an active ECM pod system.

In March, the US DoD announced the award of Elbit Systems of America of a multi-year IDIQ contract with a total value of up to $471 million for our missile warning system for their National Guard and Air Force Reserve F-16s. This is our first EW contract in the US and is an important recognition by the US Air Force of Elbit Systems' market-leading EW capabilities. In April, we received an approximately $103 million three year contract to supply comprehensive EW suites for an airport in an Asian country.

As Yossi mentioned, last week we announced the $70 million investment by Charlesbank Partners in Cyberbit, our cybersecurity subsidiary that provides market-leading commercial training systems for cybersecurity teams. The investment should enable Cyberbit to further invest to grow and realize its significant potential. We used this opportunity to realize the capital gain and cash return to Elbit Systems while maintaining a minority stake that will allow us to enjoy any future upside. We continue to invest in our defense and cybersecurity capabilities that are fully integrated within our core portfolio.

In summary, Elbit Systems has continued to work hard in recent months to maintain delivery to our customers and protect our employees. It is too early to assess the impact of the COVID-19 but I am encouraged that our activities have begun to return to pre-pandemic levels. Our backlog continues to provide us with significant visibility, and we continue to see significant potential around the world for our leading high technology solutions as we work to generate value for all our stakeholders, our employees, our customers, our suppliers, and of course for you, our shareholders.

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

Questions and Answers:

Operator

[Operator Instructions] The first question is from Pete Skibitski of Alembic Global. Please go ahead.

Peter John Skibitski -- Alembic Global Advisors -- Analyst

Yeah. Good afternoon, guys. I apologize if there's any background noise. I'm traveling. So maybe we could talk about cash flow first. You guys I think had high expectations to start off the year for cash flow. I think it was a little lighter than expected, but I imagine perhaps COVID was an impact, and it sounds like you helped all your suppliers a bit. So maybe you could talk a little bit more about what impacted cash flow in the first quarter and then how that potentially could unwind the balance of the year, and if we can start there.

Joseph Gaspar -- Executive Vice President and Chief Financial Officer

Okay. Hi Pete. This is Yossi. Regarding cash flow, we did two major things in the first quarter. First of all, we did collect on some of the late cash from all the missile defense revenues in Israel. However, we didn't get all of it. We are in the process now in the second quarter to further collect from them. So that is one thing we did.

The other thing, we did use our cash to increase our inventories to have some buffer inventories to enable us, I would say, independence almost for our deliveries, not being dependent on late deliveries from our supply chain. The increase in the inventory, if you look at our balance sheet, was close to about $80 million, and that has also used up cash.

The third item, if you again look at our inventory -- at our balance sheet, you will see that we have paid out to our suppliers something close to about $100 million -- increased our payments to suppliers in the first quarter to enable them to operate properly, to reduce risk and again to help our supply chain caused by -- at the end of the day, they are partners in our business.

All of that, of course, has created the situation, as we reported, negative -- slightly less than $10 million of operating cash flow. We expect, during the year, to continue to collect cash from our customers, and that will definitely improve our operating cash flow.

Peter John Skibitski -- Alembic Global Advisors -- Analyst

Okay. Thank you for the color, Yossi. Appreciate it. And then maybe give some detail also on the cost savings measures that you've implemented across the Company. It sounds like with COVID coming through, you really focused on taking out costs. So maybe you can touch on that.

Joseph Gaspar -- Executive Vice President and Chief Financial Officer

Okay. I will address, and maybe Butzi will add on this. We have analyzed our cost basis during the first quarter and have taken some measures. Some of our people, of course, were not very effective in the environment that there were no flights, and most of our business is international. So we had to reduce their level of activity during the first quarter. That is one aspect we did.

We have reduced actually -- a temporary reduction in the salaries of management executives in the Company. We have actually reduced significantly our overhead expenses wherever possible and stopped any overhead expenses that could be delayed to a period that will be after the 2019 time frame. We did also review some of our short-term and long-term and critical engineering activities so that the efforts are focused for doing in the midterm and in the short term what is absolutely necessary and delay whatever is not critical in the performance of the programs and development activities. So all of this -- I would also mention that yesterday, when we had our Board meeting, as management, we were nicely surprised by the initiative of our Directors to suggest a temporary cut in their payment which is probably not material for the overall performance of the Company, but it definitely sends a very positive sign to everybody supporting the Company.

Bezhalel Machlis -- President and Chief Executive Officer

I just want to add that we are also working with our suppliers to encourage saving and to reduce the cost as well. And I'm happy to say that they are very supportive and helping us to reduce the supply chain cost as well.

Peter John Skibitski -- Alembic Global Advisors -- Analyst

Okay. Thanks for all the color, guys. I appreciate it. Maybe one last one for me and then I'll get back in the queue. But from a sales perspective, it looks like the organic revenue growth in the first quarter started off kind of low single digits, but you've had this tremendous backlog growth. So I'm wondering, are you expecting organic sales growth to accelerate the balance of the year? Or is that still kind of hard to tell globally, because of the impact of COVID?

Joseph Gaspar -- Executive Vice President and Chief Financial Officer

I think it's a little bit too early to tell because of the COVID-19 situation. Presently, as I mentioned earlier, we do not see a material impact. However, we do sense a little bit of a slowdown in some areas. It very much depends on how early we will get out of this situation, and that will strongly impact of course how our revenue growth will show. Presently, I would say we cannot give you a better answer than that.

Peter John Skibitski -- Alembic Global Advisors -- Analyst

Okay. Understood. Thanks so much, guys.

Joseph Gaspar -- Executive Vice President and Chief Financial Officer

Thank you.

Bezhalel Machlis -- President and Chief Executive Officer

Thank you.

Operator

The next question is from Sheila Kahyaoglu of Jefferies. Please go ahead.

Sheila Karin Kahyaoglu -- Jefferies -- Analyst

Hey. Good morning, everyone, and thank you for the time. First, I guess I want to know where Pete is traveling to in the US because I can't get out. I guess following up on Pete's question, can you clarify for me the comments on the supplier payments? I think you mentioned $100 million. I might have missed the inventory amount. Was that all Q1 or is that your expectation for all of 2020? And how do we think about receivables and the timing of the Israeli government payments?

Joseph Gaspar -- Executive Vice President and Chief Financial Officer

About the payables, if you look at our balance sheet, as to the payable number by the end of 2019 compared to the payable at the end of the first quarter, we reduced the payables significantly. That is close to $100 million, $90 million or some number close to that. So that is one. We paid out to our suppliers so that they would be in a significantly stronger position to perform their responsibilities, so that is the payables in our balance sheet.

Regarding the inventories, they grew by about $80 million, and that is in order to enable us, as I mentioned earlier, to be able to supply our products in time to our customers and not being dependent on critical suppliers. So this is the second item.

The third item, the receivables, they did not change a lot, if you look at our bottom line on the balance sheet. And we expect to receive those receivables during the year and collect that. Still, our Ministry of Defense, a little bit behind the time frame for paying their debt, but we have intensive discussions with them, and now that there is a stable government in place, hopefully there will be a reviewed budget very soon. So it looks like that everything will be in line to solve this issue.

Sheila Karin Kahyaoglu -- Jefferies -- Analyst

Okay. That's super-helpful. And then maybe just given the diversification of your backlog geographically, how do we think about what's going on? And I know there were some comments in the prepared remarks. What are you seeing from international governments in terms of defense budgets? Where are you seeing the areas of most strength and perhaps some pockets of weakness?

Bezhalel Machlis -- President and Chief Executive Officer

We don't see a major change right now from the original plan. In the US, we see additional investments in defense spending, and we enjoy from that. We see it also in other areas, and this is mainly to support the local industry.

And we are lucky to have many subsidiaries all along the world, and the subsidiaries are in a good position to get additional orders to create more jobs and to support the local economies. We see stability in Israel, in Asia, in the EU. Right now, it's too early to judge what will happen in the future. Because of that, we are conservative, as Yossi mentioned. We are trying -- we have good, strong balance sheet and we are in a good liquidity situation. And I believe that in the next quarter or maybe the quarter after that, the picture will be a bit clear and then we can understand where the direction is going.

We are in a good position by having a large portfolio and a strong global presence, and so we are able to deliver to support different needs and also to help boosting local economies. And I believe that's a big strength of the Company and it will help us to overcome difficulties in other markets which might have it.

Sheila Karin Kahyaoglu -- Jefferies -- Analyst

Sure. That's super-helpful. And then just on the C4ISR market, what are you seeing there? I think the business declined in Q1. Is that some sort of seasonality in that segment? And how do we expect it to sort of grow for the rest of the year?

Bezhalel Machlis -- President and Chief Executive Officer

No. On the contrary, we see a lot of potential for us in the C4 domain in many places. And just to remind all of us, we have been selected to provide a huge contract for communications in Switzerland, for tactical communications in Switzerland. We didn't receive the contract yet. We hope to get it by the end of the year. We are also in a very good position in the Netherlands to get follow-on orders, and also in Australia and in other markets. So there is a lot of potential for us in the area of C4I. We really believe that we are in a leading position in this domain, and there is a lot of interest and lot of potential.

Sheila Karin Kahyaoglu -- Jefferies -- Analyst

Okay. Thank you very much.

Joseph Gaspar -- Executive Vice President and Chief Financial Officer

Thanks, Sheila.

Operator

There is a follow-up question from Pete Skibitski of Alembic Global. Please go ahead.

Peter John Skibitski -- Alembic Global Advisors -- Analyst

Yeah. Thanks again, guys. I wanted to see if we can get a little more color about your exposure -- maybe just on a 2019 basis, your exposure to commercial aerospace and business aviation. I know, particularly in business aviation, you give electro-optics on some of the Gulfstream jets, I believe. So maybe you could size that business for us overall, commercial and business jets, and I imagine that might continue to have greater headwinds this year because of some of the slowdowns.

Joseph Gaspar -- Executive Vice President and Chief Financial Officer

Hi Pete, this is Yossi. In the commercial aviation field, we have actually two major branches of activities. One is related with the commercial avionics part, which, the acquisition that we did in the US, Universal Avionics, is part of that. And also, what we had before is the operation for night vision and adverse weather landing that we had previously with Gulfstream that you mentioned and some other businesses in Europe in that area. So in that branch, we have probably about a couple of hundreds of millions of dollars of business, and we did see a little bit of effect of the decline that, but I wouldn't call that material, several tens of millions of dollars per year on average, and that is in the recent quarter, I mean, if I average over the whole year. So nothing material, I would say there.

The other branch that we have is the branch related with the composite materials that we manufacture parts for military aircraft and also for commercial aircrafts. Boeing is one of our customers, but there are some others as well. Here we have very long-term contracts, multi-year contracts, firm-funded contracts that -- presently they are not affected, and we deliver on time as requested by our supplier. I would say we are probably a third or fourth tier in that level. So any change in the requirement of number of airplanes and so on, if that will have stayed with us for three or four years, then yeah, we would be affected.

However, the military side of that is very strong, and the commercial part is only about several tens of millions of dollars. So in total, we did not really see a strong negative impact on that.

Peter John Skibitski -- Alembic Global Advisors -- Analyst

Okay. Great. Thanks so much. Just one last one for me, a more minor question, on the Cyberbit transaction. Can you remind us -- I think you already were not booking Cyberbit revenue, right? You're only booking the EBIT. So nothing should meaningfully change post that transaction from a revenue perspective. Do I have that right?

Joseph Gaspar -- Executive Vice President and Chief Financial Officer

You are right. All the commercial part was not consolidated in our statements at all. So the military -- the defense cyber is consolidated in our statements, it's part of our C4 division, and it is actually a very good business and growing.

Bezhalel Machlis -- President and Chief Executive Officer

And this element will continue to be with us.

Peter John Skibitski -- Alembic Global Advisors -- Analyst

Okay. Thanks so much for the clarification. Thanks, guys.

Operator

[Operator Instructions] There are no further questions at this time.

And 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 03-925-5900. And internationally, please call 972-3-925-5900. 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?

Bezhalel Machlis -- President and Chief Executive Officer

I would like to thank all of our employees 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.

Operator

[Operator Closing Remarks]

Duration: 39 minutes

Call participants:

Rami Myerson -- Director, Investor Relations

Joseph Gaspar -- Executive Vice President and Chief Financial Officer

Bezhalel Machlis -- President and Chief Executive Officer

Peter John Skibitski -- Alembic Global Advisors -- Analyst

Sheila Karin Kahyaoglu -- Jefferies -- Analyst

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