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Elbit Systems Ltd (ESLT 0.37%)
Q3Â 2020 Earnings Call
Nov 24, 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 Third Quarter 2020 Results Conference Call. [Operator Instructions] Following management's formal presentation, instructions will be given for the question-and-answer session. [Operator Instructions] 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 Myerson, Elbit Systems Investor Relations Director. Rami, please go ahead.
Rami Myerson -- Director of Investor Relations
Thank you, Elena. Good day, everyone, and welcome to our third 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 Yossi. Yossi, please.
Joseph Gaspar -- Chief Financial Officer
Thank you, Rami. Hello, everyone, and thank you for joining us today. The results of our third quarter reflect the resilience of Elbit Systems, the sustained demand for our products and services, and the operational improvement that is a result of the initiatives we have discussed with you in the past.
As you are all familiar with COVID-19 has resulted in a significant slowdown in commercial air traffic and industry experts forecast that the commercial air traffic recovery to the 2019 level will likely take a number of years, Elbit System's commercial aviation exposure is relatively small as a percentage of revenues, but we are not immune to the slowdown in the market. Our third quarter results include a $60 million non-cash expense for the impairment of commercial aerospace assets and inventory write-offs as a result of the impact of the COVID-19 on demand for products and services that Elbit Systems supplies to the commercial aviation markets. These expenses have been recorded mainly in the cost of revenues line item in the P&L and have been excluded from our non-GAAP results as we believe these expenses are not representative of Elbit's regular ongoing business.
The recent news on COVID-19 vaccine are encouraging, and we continue to monitor the situation closely, while adhering to the instructions of the governments of the various countries in which we operate.
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 can find all the detailed GAAP financial data, as well as the non-GAAP information and the reconciliation in today's press release. The non-GAAP information is particularly relevant this quarter, as the third quarter results in 2019 included a one-off capital gain from a sale and leaseback transaction in Israel, and the third quarter results of this year include the inventory write-offs and impairment as mentioned above.
Overall, we are satisfied with the improved performance in a challenging environment. Our order backlog and revenues increased year-over-year and in comparison to the previous quarter. There were improvements in profitability reflecting the increased focus on operations, as well as the measures we have implemented to mitigate the financial impact of the COVID-19 pandemic.
Our backlog of orders as of September 30, 2020 was $10.9 billion, more than $1 billion higher than the backlog at the end of the third quarter of 2019, and $55 million higher than that at the end of the second quarter of 2020. The order backlog is equivalent to more than two years of revenues and provides good visibility into the future. I should also note that the acquisition of Elbit Night Vision from L3Harris closed on September 15, 2019 and was therefore consolidated into our financial statement commencing that the date of the acquisition.
I will now highlight and discuss some of the key figures and trends of our financial results. Our third quarter 2020 revenues were $1.134 billion. In terms of revenue breakdown across the areas of operation, land systems sales accounted for 29% of total sales and increased year-over-year, mainly due to precision-guided munitions sales to customers in North America and Asia-Pacific. Electro-optics accounted for 10% of total sales and increased year-over-year, mainly due to the acquisition of Elbit Night Vision. C4ISR at 25% of sales declined year-over-year primarily due to lower radio sales to Latin America.
Our diverse geographic revenue base is important to the long-term sustainability of our business. In the quarter, North America was 30% of total revenues, was the largest graphic area followed by Israel at 25%, Asia-Pacific at 22%, Europe at 19% and Latin America at 2%. Growth in Israel was driven by tank fire control systems and the decline in Latin America was due to lower C4ISR sales as mentioned.
For the third quarter, the non-GAAP gross margin was 26.7%, up from the 26.3% in the third quarter last year. The improvement reflects increased focus we have placed on operational improvement that includes multiple initiatives and workflows. GAAP gross margin was 20.9% compared with 26% in the third quarter of last year as a result of the non-cash expenses related to inventory write-offs and asset impairment due to the impact of the COVID-19 as mentioned above.
Third quarter non-GAAP operating income was $93 million, or 8.2% of revenues compared with $81 million, or 7.3% of revenues in the third quarter of last year, due to higher gross margin and lower operating expenses. GAAP operating income in the quarter was $24 million versus $102 million in the third quarter of last year following the inventory write-offs and impairment. Our GAAP operating income in the third quarter of 2019 included a $28 million capital gain related to a sale and leaseback transaction in Israel.
The operating expenses breakdown in the quarter was as follows. Net R&D expenses at 8% of revenues versus 7.2% in the third quarter of last year. Marketing and selling expenses declined to 6.3% of revenues versus 6.9% last year, due to reduced travel and participation in trade exhibitions. G&A expenses were 4.5% of revenues versus 5.2% last year. Financial expenses for the third quarter of 2020 were $9.7 million compared to $18.5 million last year, mainly due to changes in the shekel/dollar exchange rate in the period.
The effective tax rate in the third quarter of 2020 was 15%, higher than the 9.5% tax rate in the third quarter of 2019, mainly due to the geographic spread of the income, which included the write-off in the quarter.
Income from affiliated companies and partnership was $4.9 million versus a loss of $470,000 in the third quarter of 2019, due to a $2.3 million write-off of an investment in an affiliated company in Israel last year.
Our non-GAAP diluted EPS was $1.64 in the third quarter compared with $1.33 in the third quarter last year. GAAP EPS was $0.38 versus $1.63 last year. Our backlog of orders as of September 30, 2020 was $10.86 billion, $1.1 billion higher than the backlog at the end of the third quarter of 2019, and $55 million higher than that at the end of the second quarter of 2020. Approximately 46% of the current backlog is scheduled to be performed during the remainder of 2020 and 2021, and the rest is scheduled for 2022 and beyond. This ratio is broadly similar to that of the third quarter of last year.
Operating cash flow for the quarter was a negative of $63 million compared with a negative of $49 million in the same quarter last year and reflects a working capital outflow due to the timing of invoicing and collections from our customers, mainly from the Ministry of Defense in Israel. The Board of Directors declared a dividend of $0.44 per share for the third quarter of 2020.
I will now turn the call over to Mr. Machlis. Please, Butzi.
Bezhalel Machlis -- President and Chief Executive Officer
Thank you, Yossi. Before I'll review the results for the quarter, I would like to provide our perspective on global defense budgets as we have received numerous questions from investors on the topic since the outbreak of COVID-19.
Elbit Systems has not seen a change in demand for its products and services from its customers around the world. The growth in the backlog over recent quarters provides a good indication of the demand, and we have also seen an increase in the expression of interest in RFPs. We also have not seen any indication of plans to cut defense budgets in most of the countries in which we operate.
The geopolitical tension around the world have not declined following the COVID-19 pandemic, and we expect these tensions to continue to drive defense budgets growth over the medium and longer term. We also expect countries to increase defense budgets to stimulate growth and support domestic employment and innovation.
The announcement by the British Government to increase defense spending by GBP16.5 billion over the next four years is very encouraging. The UK is an important market for Elbit. Elbit Systems UK employs more than 500 people across the UK delivering key programs and capabilities to the UK MOD, such as the Watchkeeper UAV program and Affinity that provide services for the UK Military Flying Training System. We believe there are many opportunities for our solutions in this important market, including command and control systems, training solutions, and unmanned aerial and ground systems.
Elbit Systems has built geographical customer base and presence in strategic assets. Elbit Systems diversified customer base and presence is a strategic asset. It has taken decades to build, and we continue to invest to maintain the long-term sustainability of our business through defense budget cycles.
At Elbit Systems, we will review our businesses and portfolio on a regular basis to ensure that the company is aligned correctly to evolving customer priorities and to generate synergies between the broad range of technologies in our portfolio. Following the latest review, we decided to implement a reorganization of some of our business activities.
Our unmanned aircraft systems business will be integrated within the manned aircraft business to leverage the synergies across manned and unmanned military aircraft. We will integrate our electro-optical systems and electronic warfare and signal intelligence businesses to leverage our sensors and capabilities to provide advanced solutions that cause the electromagnetic spectrum. The precision-guided munitions activities that are part of our military airborne systems activities will be integrated into the strong PGM portfolio that we acquired with IMI. The reorganization will begin during the coming months and will be completed during 2021.
Moving to the business and the quarterly results, the third quarter included a number of strategic milestones and important developments across different areas of our operations. In October, Elbit Night Vision in the US received a $23 million contract from the US Army for Enhanced Night Vision Goggle-Binocular System. This was part of an Other Transaction Authority or OTA framework contract of up to $444 million. Elbit Systems is one of two suppliers of NVGB to the US Army. This is an important milestone for the Night Vision business that we acquired in September last year.
We are very pleased with the acquisition that is performing better than expected. I'm even more optimistic about the potential to generate synergies between our legacy thermal imaging night vision portfolio and the image intensifier night vision business over the coming years. This is clearly the future of advanced systems for night operation and Elbit Systems is well positioned to benefit from the demand for integrating night vision systems.
In recent months, we will receive a support contract from our night vision head-up display system for pilots from the US Army and was selected by the US Marines to develop an integrated targeting site. This contract highlights the breadth of our electro-optical portfolio that are also integrated into aerospace and land platforms.
Elbit Systems market-leading command and control solution provides militaries with the ability to connect forces in the air, on the ground, and at sea seamlessly and effectively to support multi-domain operations. Our command and control solutions are deployed around the world by customers from Australia to Sweden.
The IDF is rolling out the latest version of Elbit Systems TORCH-X Command and Control solution that enables highly effective sharing of information across multi-domain. The feedback from the users across all domains has been very positive. They have been impressed by the ability to share information seamlessly in ways that were not possible in the past.
Elbit Systems of America supplies the US Department of Home & Security with a command and control solution from -- for the US border with Mexico, and we are a supplier for the US Army's Command and Control Integrated Infrastructure, or CPI2 program. In November, the US Air Force selected Elbit Systems of America to compete for joint all domain command and control task orders as part of a large IDIQ contract for multiple suppliers. This selection is another vote of confidence in Elbit's technologies from the US Air Force following the large missile warning system program award earlier in the year. We are integrating artificial intelligence and data analysis into our command and control solutions that I expect will be an important growth drivers for Elbit over the coming years.
Elbit Systems has a large portfolio of solutions for armed vehicles and tanks, including manned and unmanned turrets, active protection systems, target acquisitions, fire control and communication systems. Our combat technology demonstrator integrated the latest generation of legacy capabilities and new technologies for combat vehicles. This includes IO vision that provides the [Indecipherable] with 360-degree vision from inside the vehicle and leverages over helmet-mounted displays and sensor capability to provide a unique and highly innovative solution.
We recently teamed up with BAE Systems, one of the largest global manufacturers of armored combat vehicles to develop an integrated advanced capabilities for combat vehicles. We are already working with BAE on the integration of Iron Fist on BAE's CV90 for the Netherlands, and there is a significant potential for this partnership over the coming years as militaries around the world would like to replace and upgrade their combat vehicles.
In summary, I would like to thank Elbit Systems employees around the world for their continued hard work in challenging times. Our backlog continues to provide us with good visibility, and we continue to see significant potential around the world for our leading high technology solutions as we will generate value for all of 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. Operator?
Questions and Answers:
Operator
Thank you. Ladies and gentlemen, at this time, we will begin the question-and-answer session. [Operator Instructions] The first question is from Sheila Kahyaoglu of Jefferies. Please go ahead.
Sheila Kahyaoglu -- Jefferies Equity Research -- Analyst
Hi. Good afternoon. Good morning, guys. Thank you for taking the question. Can we talk about maybe just free cash flow to start. I must have missed it Yossi, but during the prepared remarks, you mentioned some reversal in the Israel payments. Can you just talk about what's going on with the working capital balance and how we should think about quarterly free cash flow run rate?
Joseph Gaspar -- Chief Financial Officer
Yes. Hi, Sheila. How are you?
Sheila Kahyaoglu -- Jefferies Equity Research -- Analyst
Good. Thank you.
Joseph Gaspar -- Chief Financial Officer
Good. Yeah. We are facing some, I would say, challenging times with our customers here in Israel, the Ministry of Defense, where right now, there are some discussions about setting the budgets for this year and next year. And this is under discussion in our parliament, and this is actually the main hurdle in front of the IMOD to release their payments.
There is no question about are we going to get the payments. There is a question are we going to get them soon or a little bit later. The IMOD delayed payments on programs this quarter. Just to remind ourselves, last quarter, the second quarter of 2020, was a good quarter and they did pay us quite a significant amount. However, their debt increased this quarter and from our discussions with the IMOD, the expectation is that the debt will be reduced toward the end of the year, although we have no guarantee yet on this. There is no doubt we are going to be paid as soon as the IMOD gets its budgets in place. When is that going to happen? Hopefully, this year during December, at the latest during the first quarter of next year.
Sheila Kahyaoglu -- Jefferies Equity Research -- Analyst
Okay. Got it. And then, can we just talk about some of the organic growth trends you guys are seeing, or land systems was particularly strong, how sustainable is that? And then, if you could just give us a little bit more detail on C4ISR, you mentioned lower radio sales to Latin America. What's going on in that business? When do you expect that recovery? And then, similarly, with electro-optical systems, just why the decline on an organic basis there?
Joseph Gaspar -- Chief Financial Officer
Sheila, as you know, our company we recommend to look at our performance on a multi-quarter basis. A specific quarter can fluctuate one way or another in the revenues and definitely in the various geographies or the business areas that we operate in. Specifically your questions, we started definitely to see some improvement and synergy built already through the acquisition of IMI with significant contracts in the international markets and with that, did help the growth of the land systems business. Also, we had some increased sales in this quarter of fire control systems for the IMOD. That is the land systems. Going forward, we definitely are looking to see increase in revenues in land systems, of course, on an average of multi-quarter basis because the nice things that are happening with the integration of IMI in the land systems.
Regarding C4, radio equipment is sold [Phonetic] in batches worldwide and last year, we had in the third quarter some significant sales of radio equipment to Latin America. We do see a strong interest in our radio and communication equipment worldwide. And may I just mention a significant event that happened several weeks ago that a major potential contract was in Switzerland, was approved by the parliament and we hope that somewhere in the near future we are going to get the contract on that. But similarly, we have many places that our C4 equipment is sold, installed and it is -- we expect more contracts.
Remember our Australian position, which essentially our C4 business brought in close -- over $1 billion of business in command and control and regular related equipment, Netherlands and other places in the world. So we do consider that interoperability requires a lot of bandwidth and communication, and therefore that will continue to push the growth in the revenues in this area of our business.
Sheila Kahyaoglu -- Jefferies Equity Research -- Analyst
Okay. Thank you so much. I'll jump back in the queue.
Rami Myerson -- Director of Investor Relations
Thanks, Sheila.
Operator
The next question is from Pete Skibitski of Alembic Global. Please go ahead.
Pete Skibitski -- Alembic Global Advisors -- Analyst
Yes. Good afternoon, Butzi, and Yossi, and Rami. I just want to review, guys, the commercial aerospace exposure because we have a sense of when -- how things are likely to annualize for you. Can you ballpark for us just either in absolute terms your revenue exposure to commercial aerospace or as a percentage of revenue?
And then I think a lot of the suppliers out there on average are looking at maybe a 40% type of decline in revenue for the third quarter and expecting maybe a couple of more quarters of tough comps before things annualized probably no later than the second or third quarter of 2021. So again, can you maybe ballpark your exposure and let us know if that kind of profile is something that you guys are seeing?
Joseph Gaspar -- Chief Financial Officer
Yeah. Well, the total non-defense business at Elbit Systems is less than 10%. It is composed of two elements. One is the commercial aviation -- avionics business and the other one is the medical instrumentation business. Out of that, now we are -- our revenues are over $4.5 billion. So less than 10% is the non-defense part. And part of that 10% is the commercial avionics business. So it's several hundreds of millions of dollars at the max. We did see a reduced requirement for our products and services in this area, due to what the whole world has experienced with lower traffic.
The expectation is from what we have learned that the level of traffic and requirements for products and services of 2019 will come back somewhere in the 2023/2024 time frame. We looked at the demand for products, and we analyzed our assets and therefore, we have impaired that accordingly. So this part, we still have revenues; we still are selling. Most of the areas, we are quite unique, for example, in the area of lending systems. In diverse weather, we have very special solutions for that and this is still required. However, people are flying less. So we are selling less.
We do see a significant increase in the other part of the commercial business and that is the medical instrumentation business, which is in the $100 million to $150 million presently and growing strongly. They are making analysis -- laboratories for analysis of liquids and blood, and stuff like that, and they are very involved in the presently required COVID-19 detection environment, the needs for that. So that is partly compensating for the reduction in the commercial aviation. And growth that we have seen in the recent quarters, which is not very strong, but it is still growth, thus reflect also the reduction in the commercial aviation business.
Pete Skibitski -- Alembic Global Advisors -- Analyst
Okay. I really appreciate all the color. I was also intrigued about the reorganization. So maybe you guys can talk about, was this primarily -- was this a cost take out, cost reduction type of move, or was it more so revenue synergies, maybe with a desire to kind of align business development activities? Can you give us a sense what the primary driver of the reorganization was?
Bezhalel Machlis -- President and Chief Executive Officer
Yeah. Good afternoon. The primary driver for the reorganization was to generate more synergies within the company and to bring more revenues to the company. We are having a strategic session each year. We are trying to predict what will be the market needs in the future, and based on that, we adapt our portfolio. And this reorganization that was declared this week was exactly for that was to leverage synergies and to create an advanced portfolio, which we believe will lead the market in the near future.
Pete Skibitski -- Alembic Global Advisors -- Analyst
That's great. Very helpful. And very last one from me, more financial. Cash from investing activities this quarter, it looks like you guys booked a large around $70 million or so sale of PP&E in this quarter. Can you give us some color on what that was about?
Joseph Gaspar -- Chief Financial Officer
Our capital investment includes replacement of equipment, renewal of inventories and so on. And then also, we are starting to see some investments required to establish the production site for the IMI transition to the South of Israel. And this will -- we are preparing everything needed so that the transaction -- the transition can be achieved somewhere during 2023. We have started some investment in that area and that will continue during the next and following years.
Pete Skibitski -- Alembic Global Advisors -- Analyst
Okay. Did you get a payment from the government for that this quarter?
Joseph Gaspar -- Chief Financial Officer
This quarter, no. We did not get. We had payments in the past. This quarter, we got an inflow we had from different transactions, from other kinds of transactions.
Pete Skibitski -- Alembic Global Advisors -- Analyst
Okay. Okay. Great. Thanks so much, guys.
Rami Myerson -- Director of Investor Relations
Thanks you.
Bezhalel Machlis -- President and Chief Executive Officer
Thanks, Pete.
Operator
The next question is from Elad Krauss with Excellence. Please go ahead.
Elad Krauss -- Excellence Nessuah Securities -- Analyst
All right. Thanks, everyone. Actually, regarding the margins of the company, the IMI acquisition lowered your margins. So do you see improvement in the margins of Elbit in the future due to the synergies with the IMI, and if so, when do you see it?
Joseph Gaspar -- Chief Financial Officer
We are definitely improving -- working hard to improve the margins, and we started seeing some results of that and this quarter is definitely one of them. This is a gradual process. It will take some time, but it is on the right direction. We have a multi-year plan that includes many elements of cost reduction, of yield improvements. We did mention in the past implementation of one ERP system across the whole organization. By the way, all the investments that you see and expenses related with that are included in our ongoing results. We have initiated that already here in part of the airborne division in the US operations.
By the end of this year, we will have the electro-optics business going with the same ERP, and next year, we expect other divisions to implement that. And we expect that to result in very nice improvements in efficiencies, reduction in inventories, and so on and so forth. So bottom line, yeah, we are working on it. We have a multi-year plan. We are improving. Unfortunately, we do not reap all the benefits of it because some of that, I would say, is offset by the strong Israeli currency, the strong shekel versus the US dollar. However, we are managing to take care of that as well as we go forward.
Elad Krauss -- Excellence Nessuah Securities -- Analyst
All right. Thanks.
Operator
The next question from Dina Korshunov of Leader Capital Markets. Please go ahead.
Dina Korshunov -- Leader Capital Markets -- Analyst
Hi, guys. How are you? And you answered most of my questions, but -- so I have just one. Can you tell us a bit about the financial potential of the partnerships you have with BAE?
Bezhalel Machlis -- President and Chief Executive Officer
We have teamed together with BAE for a new program, which is about to happen in the US. There is a tender to replace -- we expect the tender to place the Bradley fleet in the US market. And the Bradley is a fighting vehicle, which was produced by BAE by thousands. And the teaming agreement, which we have with them, is for an advanced solution. Part of it will come from BAE and part of it will come from us. And we will submit a joint proposal for this tender. Potentially, this is quite big to replace a big amount of vehicle in the US market. As I mentioned in my brief, we team with them also for an upgrade of the CV90 in the Netherlands. And they won the -- and we will provide several systems such as the Iron Fist Active Protection System for the CV90.
Dina Korshunov -- Leader Capital Markets -- Analyst
Okay. I understand. And when do you expect all these things will happen? When we will see all the progress in this area?
Bezhalel Machlis -- President and Chief Executive Officer
We are waiting for the RFP to come. I don't want -- I don't remember the date by heart, but it shouldn't take long.
Dina Korshunov -- Leader Capital Markets -- Analyst
Okay. Thank you very much.
Bezhalel Machlis -- President and Chief Executive Officer
Welcome.
Rami Myerson -- Director of Investor Relations
Thanks, Dina.
Operator
[Operator Instructions] 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 03-925-5918, and internationally, please call 972-3925-5918. 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
Yeah. 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.
Operator
[Operator Closing Remarks]
Duration: 38 minutes
Call participants:
Rami Myerson -- Director of Investor Relations
Joseph Gaspar -- Chief Financial Officer
Bezhalel Machlis -- President and Chief Executive Officer
Sheila Kahyaoglu -- Jefferies Equity Research -- Analyst
Pete Skibitski -- Alembic Global Advisors -- Analyst
Elad Krauss -- Excellence Nessuah Securities -- Analyst
Dina Korshunov -- Leader Capital Markets -- Analyst
